demandside

Plus “The End of the End of the Recession” from Zero Hedge……………………………………………

We did get the web site in some order this past weekend.  The charts on economic performance by president are more complete, and we’ll go into those in a moment.  The forecast charts are now in order on the forecast page.  The whole tangled empire is nearly in order.

After the charts we will come through with the promised perspective from last Saturday’s podcast, which was left on the cutting room floor.

We hope you like the deep sky blue.  It may work.

Forecast

Employment and Unemployment

At one time our baseline scenario for employment and unemployment was significantly below that of other economists as represented by the Philadelphia Fed’s survey of professional economists and the quarterly projections of the Federal Reserve Open Market Committee.  (Although you will notice, the actual data tracked our forecast quite well.)  Beginning in March, 2009, the consensus has tracked us more closely.

Unemployment

The unemployment rate cannot help but reflect the deteriorating economy, and particularly the collapse of consumer spending and state and local government revenues.  Business earnings are positive only if those businesses have been very aggressive in cutting their workforces.  This means further weakness down the road.  Similarly, positive news in the form of an increase in the personal savings rate means less spending and a reduction in employment and consequently a reduction in savings down the road as more and more unemployed individuals must tap their rainy day funds to meet current expenses.

Employment

Demand Side expected George W. Bush to come within one million of being the first president in postwar history to preside over an economy that produced no — zero — net new jobs.  Six months after his watch ended, the feat was accomplished.

Employment growth will lead the economy’s true recovery, regardless of when that recovery occurs.  An aggressive jobs-first program will produce the best outcomes.  Unfortunately, private sector job growth is going to lag for years to come, and the growth which does occur will reflect the weak bargaining position of workers.  That is, both the numbers and incomes connected with private sector new employment will lag for some time.

We’re currently at work, as we threaten from time to time, on a second edition of Demand Side, the book.

Economic Performance by Party of the President is basically chapter 4 of Demand Side, the book.

Increase in Employment by Year again displays the “missing teeth” during Republican years and general stability and strength during years of Democratic presidents.  Notice the relatively weak showing of George W. Bush in employment growth does not translate clearly to the chart below, the unemployment rate.  The reasons for this are ambiguous.

Unemployment Rate.

By President

By Presidential Term

In a moment we’ll get to the longer-term perspective.  But we did want to draw your attention to the excellent piece out of Zero Hedge by Tyler Durden, a 72-page presentation entitled, The End of the End of the Recession.

http://zerohedge.blogspot.com/2009/07/end-of-end-of-recession.html

Now a different form of perspective.  The focus of the intelligent these days is on how to get out of the current economic mess.  Our suggestion is that we begin to look at where we’re going, because we cannot get back to where we came from, even if we wanted to.  So, yes, Let’s fix the hole in the boat caused by running it onto the rocks.  But once we’ve done that, let’s not pretend the job is done, because nothing good is going to come from sitting here on the beach.

That said, and at the risk of displaying a little less than perfect foresight, we’d like to read from Demand Side, the book, First Edition.  This is only two years ago.

The point we make here is that everything was not going swimmingly prior to the crash and that going back there is not only not going back to the normal, it is not going back to the healthy or the possible.  Setting a new course is the only way to keep the old outcomes from coming back.

The economic decline of the United States

The United States is in advanced stages of losing its manufacturing base.  It clings to doomed technologies.  Its infrastructure is aging and decrepit.  Both government and citizens subsist on debt and borrowing.  While the U.S. remains the richest nation, the free market ideology that directs federal policy comes with a curiously contradictory price tag in the form of enormous public borrowing by the Free Marketeers who direct fiscal policy.  This borrowing and the resulting debt is then cited as proof of the regrettable profligacy of government.

We have doubled our mortgage debt within the past six years. ( Dean Baker, Dangerous Trends: The Growth of Debt in the U.S. Economy, September 2004.)  Our aging population enters retirement with its Social Security made fragile by decades of borrowing to float general government operations.  The free market advocates who now call for low taxes and high deficits have hidden from us as much as possible the financial facts.  Borrowing does not reduce taxes, only postpones them to be paid back with interest.

Much of our debt is held by foreign central banks or individuals.  They have financed our homes and durable goods.  They will not be satisfied with payment in currency.  Money is simply the medium of exchange.  They will want goods and services.  What will we give them?  Where is the industrial plant or development plan to repay our debts?

Health care demands a sixth of our output, twice the proportion of other industrial nations.  War demands people, treasure and effort that cannot be used to address our other problems.

Huge borrowing also bids up the value of the dollar.  American-made products priced in expensive dollars must then compete with the manufactures of other countries.   Standard economic theory has no explanation for trade deficits of hundreds of billions per year for decades.  The inflated dollar and the trade deficit are inextricably linked, and result from the use of the dollar as reserve currency.  The implications for instability and potentially excruciating correction are enormous if it should return to its role as simply a medium of exchange.  Will the Federal Reserve, the central bank of the US, allow the dollar to collapse?  Or will it pursue in futility the strength of the currency at the expense of a collapse in the economy?

Meanwhile workers and productive industry absorb the costs.  Median incomes have stagnated since 1980, and wages have actually declined in real terms.  Health care, energy, housing and education have consumed more of the family’s budget.  And this richest nation also boasts the greatest disparity between its rich and poor.  (Joshua Karliner, The Corporate Planet, Sierra Club Press, 1997.)

There is a way for the US to become a productive power again and for its government and citizens to operate in the black.  The country can again trade goods and services in balance, rather than support itself on delusion and borrowing.  That way will certainly not be found by running behind the Corporate Oligarchy and hoping for crumbs.  The technologies and consumption patterns will not be the same in a rational world, but will provide for a fully engaged workforce and rising global economy that can convert the daunting challenges into opportunities. The United States, or its Corporate Oligarchy, may not dominate others economically, politically, or militarily, but we can be more prosperous, more secure, and allow our planet to survive as home for us all.

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Plus Idiot of the Week with Robert Eisenbeis………………………………………………………….

Today a little bit of audio and some perspective

Eliot Spitzer and Dylan Ratigan explain the garbage on the Fed’s balance sheet and why we paid real money for it.  Or maybe they just point out that we paid real money for garbage and take the Fed to task.  Stay tuned.

Before that we have Idiot of the week with Robert Eisenbeis.  We have Martin Wolf speaking directly to the bad economics of the past thirty years, and we have our own rendition of what the outlook was before the crisis.

First this note, following our podcast relay of a House subcommittee’s hearing on High Speed Rail, we hear from The Transport Politic website:

Demand Side is cheering.  The sooner and more aggressive the construction of high speed rail, the cheaper and more productive will be the investment.

Now, On to

Idiot of the Week,

With Robert Eisenbeis, former research director at the Atlanta Fed, talking on the idea of stimulus.

EISENBEIS

Clearly, once again, proximity to money does not mean competence in economics.  We’ve already had the tax cuts fail twice, not to mention the huge debt hole they drilled in the one time surplus.  The consumption function is much more substantial when you add stimulus in the form of a new job than in the form of an additional hundred dollars of discretionary income.  The discrete these days save.  We’ll take up the savings rate in the next podcast.

Elsewhere in this interview with Tom Keene, Eisenbeis quotes the P.T. Barnum of economics, Milton Friedman, as saying, “Monetary policy acts with long and variable lags.”  Which, I think, speaks to the vagaries of monetary policy.  The truth is it is far easier to stall an economy with monetary policy than it is to get one going again.  We think you are witnessing that in the current experiment of history.

But, Robert Eisenbeis, Idiot of the Week.

Many of our idiots are fairly competent if they don’t stray too far from their base of competence.  Here is, for example, Eisenbeis in a clip earlier in that Bloomberg interview.

EISENBEIS.

Let’s use this comment on the Fed’s balance sheet as a segue into Eliot Spitzer and Dylan Ratigan taking on the blather of the Fed with regard to what they’ve taken on.  I hope the schtick translates to audio.  It appeared on Ratigan’s MSNBC “Morning Meeting” this week.

SPITZER

Enough of that.

Now to finish the podcast, Financial Times chief economist Martin Wolf gave the best interview of the past week, again on Bloomberg on the Economy with Tom Keene.  Wouldn’t it be nice to have an audio link capacity?  Be that as it may, here is what he had to say with regard to the economic paradigm of the past thirty years.

WOLF:

Martin Wolf

One thing, this should cause despair among those who toiled in the field of rational expectations.  You grew only thorns.  On the other hand, young economists should feel some encouragement.  You didn’t have to learn the wrong stuff and now with a good, direct view, you can be far more competent — notice I did not say employable, only competent — than peers with much more experience.

That brings up the thought.  Why not a reading list?  Yes.  Robert Lekachman’s The Age of Keynes, maybe forty years old, is very good as a start.  I’ll pick some others for the next edition of the podcast.

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Plus, have we finally found a useful format for the blog?

…………………………..

Call this the slick page edition.

First,

I think we’ve finally settled on a useful format for the blog.  On each of the off days from putting up the transcript of the Demand Side podcast, we’ve been putting up a single useful piece from the demand side perspective.  We don’t have time to read as much as we want to, much less translate it back to our readers.  Besides which, Calculated Risk, the Economist’s View, and others like Brad DeLong do it better than we could.

Our one-piece-per-day service on the blog will hopefully be useful for those who want to get meat without picking through a lot of bones.  Five pieces per week plus what you’re listening to now in more or less transcript form.  DEMANDSIDEBLOG.BLOGSPOT.COM

This week, for example, on the blog we see a couple of pieces connected to print magazines.  One from Newsweek asking why Joseph Stiglitz is not at the key adviser’s table at the White House.  Another from Brad DeLong looks at this week’s Economist newspaper’s examination of economists, an exercise in the pot calling the kettle black.

We relay a piece from Project Syndicate by the great man himself, Joseph Stiglitz, entitled “The UN Takes Charge.”  Previous to that are selections from Dr. James Hansen, Paul Krugman, Jeffrey Sachs and others.  We hope it is useful.

If you want a list of the economists who did badly, go to the link in the transcript which identifies those signing an open letter or petition for Fed independence.  As we’ve reported before, the fear that the Fed will lose its independence ignores the fact that the Fed is captive to the financial industry.  So when we hear “independence,” we mean independent from the representative government that must back up its actions.

http://economix.blogs.nytimes.com/2009/07/15/petition-for-fed-independence/

Historically, since it achieved independence in the middle of the night in 1951, with the so-called Treasury Accord, the Fed has operated for the benefit of what Keynes would call the rentiers, keeping interest rates on the plus side and pulling out all the stops to hammer inflation whenever it could.  In fact, a huge premium on debt service has been paid by the taxpayer over what would have been paid with the prior regime.  This is one reason the current massive deficits will be much more difficult to pay off than the massive deficits of World War II.

Continuing this theme on the next podcast we will have Robert Eisebeis, formerly of the Atlanta Fed and elsewhere in mainstream economics, continuing to pound the table for his orthodoxy after everybody has left the room.  That’s on the next idiot of the week.  A two-fer this week.

because we have our first repeat winner.

A couple of weeks ago I commented that I had not followed the charts very well in my forecast update piece.  Aha!  I didn’t even get them up on the web site .  I win!  The coveted first repeater on idiot of the week.  Those charts are halfway up now.  Thanks to one of our listeners, Greg F, for pointing that out.  And one of our more energetic listeners took me up on the challenge to research productivity and the hypothesis that much of the change comes from the price of oil and some of it comes from tight labor markets.  Thank you, Alex.

In six months we will have the definitive statement, or we will have had a good time trying to get it.

On health care reform:

Faiz Shakir reminds us that this is the explicit strategy of some in the GOP:

A strategy memo authored by GOP consultant Alex Castellanos suggests that “it is crucial for Republicans to slow down what it calls ‘the Obama experiment with our health.’” The memo concludes, “If we slow this sausage-making process down, we can defeat it, and advance real reform that will actually help.”

Peter Orzag on CNBC said it this way.

ORZAG

It should be a line in the sand, from point A:  the public option — to point B — done deal by September.  We cannot afford to carry inefficient corporate health care into the future.  It is a public good and should be treated that way.

Now

Industrial Production Declines, Capacity Utilization at Record Low in June from Calculated Risk The Federal Reserve reported:

Industrial production decreased 0.4 percent in June after having fallen 1.2 percent in May. For the second quarter as a whole, output fell at an annual rate of 11.6 percent, a more moderate contraction than in the first quarter, when output fell 19.1 percent. Manufacturing output moved down 0.6 percent in June, with declines at both durable and nondurable goods producers. … The rate of capacity utilization for total industry declined in June to 68.0 percent, a level 12.9 percentage points below its average for 1972-2008. Prior to the current recession, the low over the history of this series, which begins in 1967, was 70.9 percent in December 1982.

From the Census Bureau:

From Reuters

We have the whole Reuters piece in the blog’s transcript.

This is confirmation of our characterization of the Fed’s actions as providing more chips to the players, nothing for the real economy.

Beyond this, VAR should have been buried along with the financial collapse, because it failed so well.  No wonder Nassim Taleb is crazy.

[Reuter’s story continues after the podcast transcript for those wishing to read it]

Why doesn’t the real economy get any of the cheap money.

Here from the New Republic

http://www.tnr.com/politics/story.html?id=257c6e0f-56f5-48bb-b2ee-e89400a7737c

And this brings us back to the Demand Side point.  Businesses will not borrow when there is gross overcapacity, as we led with today.  There are no productive investments to make in any event, with no strong demand in the offing.  Individuals will not borrow when they are saving for retirement or against an uncertain future.  Only government can borrow with the object of increasing value in the society.

They should.  They will have to.

David Cay Johnston has a column at the Nation

look at it.  He is up first with how Dems have created more jobs

not fair to start with 1940, since the war was a different time.

http://www.thenation.com/doc/20090803/johnston

Also up on the blog later this week will be Robert Kuttner’s latest piece, Smoking the Green Shoots, which begins with the question: Where is the economic recovery going to come from?

http://www.huffingtonpost.com/robert-kuttner/smoking-the-green-shoots_b_240395.html

Finally,

http://www.ft.com/cms/s/4e02aeba-6fd8-11de-b835-00144feabdc0,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F4e02aeba-6fd8-11de-b835-00144feabdc0.html%3Fnclick_check%3D1&_i_referer=http%3A%2F%2Fwww.readergoogle.com%2Freader%2Fview%2F%3Ftab%3Doy&nclick_check=1

Reduce debt in the public sector with higher marginal rates on the wealthy, the surcharge idea, by taxes on carbon, and by taxes on financial transactions, to recoup some of the losses from the source of those losses.

Now we leave you a clip from the other great man himself, John Maynard Keynes.

KEYNES

This is Alan

[Continuation of the Reuter’s piece on VAR and Goldman Sachs]

Like other banks, Goldman reports VAR on a net basis after taking account of a “diversification effect”. The diversification effect reflects the fact that risks in different parts of Goldman’s book are not perfectly correlated.

The bank would not expect to lose the maximum amount on all its positions at the same time. So net VAR for the book as a whole is less than the sum of the VARs for the individual components (which Goldman reports as currencies, interest rates, equities, and commodities). Goldman’s net VAR in the second quarter averaged $245 million, up from $184 million in the second quarter of 2008 and $133 million in the second quarter of 2007.

How Much Risk?

Banks understandably prefer to focus on the smaller net figure, but when looking at the amount of market risk on a bank’s book, gross VAR is arguably more useful. The whole point of a crisis is that when it hits, contagion ensures that previously uncorrelated asset classes move in the same direction, and the diversification effect disappears. So it is dangerous to rely too much on the diversification effect to reduce overall risk.

Interestingly, Goldman has been forced to reduce its reported diversification effect from $119 million to $99 million over the last twelve months as correlations have increased, reducing the benefit it receives from diversifying its portfolio, even though the overall trading book appears to have grown.

But whether we use net or gross VAR, Goldman’s risk taking has risen by 50-80 percent over the last two years. Even during the last 12 months, as the financial system has suffered its worst crisis since the 1930s, net VAR is up by 33 percent while the gross figure has risen 14 percent.

Adding Risk in Rates

The additional risk has been added very selectively. All the additional VAR is reported in the firm’s interest rate sector, where the average daily VAR has risen $61 million (42 percent) from $144 million to $205 million. For other components (currencies, equities and commodities) average daily VAR is mostly flat or lower over the last year.

The question is why Goldman has continued to grow its risk-taking even as others have found it prudent to reduce market risk, and why all the extra risk has been added in the fixed income area, when the firm has held the line on risk-taking in other asset classes?

Answers must remain speculative because the firm reports only the minimum detail on average daily VAR by categories required by the Securities and Exchange Commission in its earnings statements and quarterly 10-Q filings.

In the past, though, most changes in Goldman’s VAR have appeared at least partly endogenous. In other words, when the underlying volatility in an asset class has increased, Goldman has preferred to “accommodate” it by allowing traders to continue running positions of roughly the same size, even if total risk is higher, rather than forcing them to cut back positions to keep the VAR level the same.

There is some evidence that the increase in rates VAR was at least partly endogenous in this case. Volatility was especially high in the rate sector during the first two quarters of 2009, as the market struggled to balance hopes of recovery and additional stimulus against fears for continuing recession or an early tightening of monetary policy.

Volatility was far higher than in other asset classes. Goldman may have followed past practice and decided to “accommodate” it rather than push back — especially if the firm concluded its activity in the rates segment was profitable, and that forcing position cuts would weaken its ability to provide liquidity to its customers.

Risk - but Over What Horizon?

That still leaves the question why Goldman felt comfortable allowing VAR to rise so much. One explanation is that the firm is comfortable it can rely on the Greenspan/Bernanke put, now enhanced by its access to the Fed’s discount window as a member of the Federal Reserve System, to limit downside risks in the event of a crisis.

In effect, the put allows the firm to ignore the worst “tail risks”. The firm can ramp up risk-taking confident in the knowledge it will be shielded from the very worst outcomes by the government.

The other explanation has to do the limitations of VAR, and particularly what time horizon to use when measuring volatility.

Like its peers, Goldman publishes VAR on a one-day basis, reflecting price changes from one evening’s close to the next.

But there is nothing special about a one-day horizon (and in some ways it is a very unrealistic measure of risk since a large financial institution would find it impossible to exit all its positions over such a short period).

In practice, banks calculate a whole series of VARs for different time horizons, though only the one-day figures are currently disclosed. VARs for longer horizons (one week, 10 days, one month etc) may paint a very different picture of risk in a trading book. When markets exhibit strong trending behaviour, with many small daily changes cumulating in a consistent direction, VAR will be higher when evaluated over longer horizons. But when markets are choppy and directionless, with large one-day changes frequently reversed the following session, VAR will be higher over a shorter horizon.

The first quarter saw precisely these choppy trading conditions in the interest rate sector. The volatility in asset price changes was much smaller when measured over a five-day period than over the course of single trading session.

Benefit of Unlimited Liquidity

In the circumstances, Goldman’s risk-managers may have decided that the one-day VAR overstated the true risk of loss in the firm’s book and decided to focus on VAR levels evaluated over longer periods, which showed less build-up of risk.

That approach would be sensible for assets the firm intended to hold for more than a single day. The only reason to evaluate VAR over very short periods (daily, hourly) is if liquidity becomes an issue and the firm was not sure it could absorb large one-day profit and loss (P&L) swings and meet margin calls.

But once the firm was sure of unlimited liquidity from the central bank, it could afford to “look through” the one-day P&L swings, holding loss-making positions and waiting for the market to reverse them in coming days.

In one sense, Goldman’s access to unlimited Fed liquidity increased its capacity to absorb short term volatility and conferred a competitive advantage over other institutions, such as hedge funds, that do not have the same access to central bank funding. Armed with a Fed credit line, Goldman understood the risks in its book were smaller than the crude one-day VAR indicated, and could increase apparent risk-taking on this measure without any increase in the real danger to the firm.

The moral is that the basic one-day VAR figures being disclosed by Goldman Sachs and other financial firms in their SEC filings provide a very limited — and potentially misleading — indication of the true amount of risk they are running.

In a world of limited liquidity, VAR measures may substantially understate the true risk. But once central banks step in as market-makers of last resort and guarantee firms against failure arising from liquidity rather than solvency, the one-day VAR measure probably overstates the degree of risk and banks are comfortable ramping it up.

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Republican presidents have borrowed more as a percent of GDP than the economy has grown

Net Real GDP

If you want to see the hole into which the prosperity of the American people has been shoveled, take a look at the chart up on the blog and web site on Net Real GDP

This is a Demand Side exclusive statistic as far as I know.  It is simply Real GDP minus federal borrowing from all sources, including the Socoial Security Trust Fund and other social insurance trust funds.

Real GDP is monetized activity adjusted for inflation, nothing more.  It goes up when we go out for a meal rather than cook at home.  The wife going into the workforce makes a lot of monetized activity like this.  GDP measures bads and goods above the line.  Alcohol counts as much as nutrition.  Prisons as much as schools.  Mayhem as much as — or more — than harmony.

Net Real GDP subtracts from this monetized activity the federal deficits.  After all, deficits are run in theory to increase activity in bad times and jump start growth.  Otherwise they are simply the American blue plate special of borrowing to consume.  There is some discussion about the appropriate size of deficits as a percentage of GDP.  But the idea that government borrowing is in itself economic growth does not stand up to even a cursory examination.  It is like counting the water used to prime the pump as a product of the well.

But the federal government borrows not only from China and Uncle Fred and XYZ Fund, but also from the social insurance trust funds — Social Security and Medicare being the biggest.  This is the source of confusion both about the real size of the deficit and about the integrity of Social Security retirement and disability.

Social Security is on very firm financial footing for decades outward, IF the government bonds that fill it up are any good.  It is a model program, and the rest of us should be so lucky as to have our portfolio in government bonds.  But when they come due, they will need to be paid.  That will mean higher taxes.

This borrowing from the trust funds has masked the size of the deficit, because of the fiction of the so-called unified budget.  Rather than explicitly say the operating slash capital side is raiding the retirement and disability funds, the budget process reduces the official deficit by the amount of these borrowings without a word.

Aside:  This is not the great “unfunded liabilities” debate, wherein some would have us set aside capital that could earn the needed payouts.  The pay-as-you-go scheme was appropriate for the 1930s when it was instituted as part of the New Deal, and it has worked well so far, and why not?

In the early 1980s, Alan Greenspan led a commission to fix social security, because even then they could see that the baby boomers would retire someday.  They fixed it by raising payroll taxes, taxes which would never have passed to fund anything other than social security.  These regressive payroll taxes were almost immediately passed out of the trust funds into the operating budget.  The entire Greenspan exercise turned out to be a Trojan Horse for more regressive taxation.

Perhaps it would be different if the retirement and disability trust funds were the ONLY place from which the federal government borrowed.  But they are not.  The big spenders have also been the big borrowers from the public at large.

And it’s not as if these are productive assets we’re borrowing to build.  Education, infrastructure, R&D.  No.  The vast majority of debt built up since Ronald Reagan made deficits acceptable in polite company have gone for war, war machines, and tax cuts.

All of which is a long way of saying there is no silver lining to the deficits.  They are borrowing from the future, and because half of that borrowiing is hidden inside the unified budget, they are much less benign than many have said.  They do matter, Mr. Cheney.  This is simple borrowing, not earning.

For this combination of reasons, to get an accurate view of the earnings of the economy, we subtract federal borrowing from all sources from gross Real GDP and obtain Net Real GDP, a measure which describes the health and vitality of the economy clean of the artificial animation of borrowing.

Gross Real GDP favors a Democrat in the White House by an average of 1.3 percentage points per year.  Net Real GDP favors Democrats by 2.7 percent.  Gross Real GDP has been 2.7 percent per year under Republicans, 4.0 under Democrats.  When federal borrowing is subtracted, Republicans net only 0.8 percent average annual growth.  Democrats 3.5 percentage points.

More startling, the net real GDP number since Gerald Ford is negative for all presidents of the Republican persuasion.  More than one hundred percent of growth has been borrowed.

Specifically, Eisenhower led Republicans with 3.5 percent net real GDP growth.  Nixon came second with 1.5 percent.  Ford -0.1, Reagan -0.1, Bush I -2.0, Bush II -0.2.  To be fair, you’d have to shift some of the red from Bush II back into the Reagan policies that he inherited.

Among Democrats, Truman 4.5, Kennedy 5.2, Johnson 4.6, Carter 2.2, Clinton 2.1.

Two things about this.  The period of Keynesian influence, before 1970, is at a level above that since.  And the Democrats Carter and Clinton may have suffered from following Republicans.  Clinton, in particular, as is evident from the chart by year, climbed out of a deep hole.  That era of “fiscal responsibility” ended abruptly with the arrival of Bush II.  The Net Real GDP of Clinton’s second term was 4.1, back in the pre-1970 range.

It is the Demand Side suggestion that Democrats do not have the inside dope on the economy.

As one of our listeners Jack Stewart put up on his USvotersite, link on the blog, Jack Stewart’s USvotersite

https://sites.google.com/site/usvotersite/Home/

Much like Alice’s Cheshire cat in the Disney cartoon Alice in Wonderland - political parties have disappeared, leaving behind nothing but the many similar smiles of very independent, entrepreneur politicians.

Instead, they have the constituency which, when served, leads the economy higher.  The Republicans on the other hand, are the party of tax give-aways, which policy has shown little positive benefit for the economy as a whole.

There it is.  Charts on demandsideblog.blogspot.com.

Net Real GDP

Casting back to previous podcasts’ discussion of Bernanke and the banks, David Goldman of the Inner Workings blog, defines zombie more precisely for us.  Goldman writes:

And I forgot James K. Galbraith’s response when I criticized his giving Bernanke a “C” in the handling of the economy.  I said, C?  When the pilot crashes the plane, he shouldn’t get a passing grade just because nobody died.  Galbraith e-mailed me in what is still one of the nicest things this podcast has produced.  He said, “I was grading on the curve.”

From Brad DeLong on the stimulus package:

http://delong.typepad.com/sdj/2009/07/effects-of-the-stimulus-package-in-which-the-usually-sharp-eyed-felix-salmon-is-wrong.html

The Demand Side observation is that a broader stimulus is needed, a recovery program, involving ongoing spending, and this will do much better because private contractors will begin to invest more deeply themselves, the jobs will come with more security and hence higher consumption functions, and the transition away from the consumer society will be accelerated.

from Krugman

Jan Hatzius of Goldman Sachs has a new note (no link) responding to claims that government support for the economy is postponing the necessary adjustment. He doesn’t think much of that argument; neither do I. But one passage in particular caught my eye:

The private sector financial balance—defined as the difference between private saving and private investment, or equivalently between private income and private spending—has risen from -3.6% of GDP in the 2006Q3 to +5.6% in 2009Q1. This 8.2% of GDP adjustment is already by far the biggest in postwar history and is in fact bigger than the increase seen in the early 1930s.

That’s an interesting way to think about what has happened — and it also suggests a startling conclusion: namely, government deficits, mainly the result of automatic stabilizers rather than discretionary policy, are the only thing that has saved us from a second Great Depression.

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The naive are punished

Our forecast and understanding of what lies ahead is based on the idea that policy-makers will alter a course that does not go in the appropriate direction.  This is apparently a naive opinion.  Neither policy-makers, pundits, nor the public has adapted in the sense we assumed.  Instead, the adaptation has been an acceptance of the status quo, a shifting of the load of blame to others, and an entrenchment along ideological lines.  Trying everything until it works, the pragmatism of FDR, is what we counted on with Obama.  By this process of elimination, we expected demand side remedies to get a fair shake.  Once their effectiveness became apparent, we expected them to be reinforected.  This process is not yet in evidence.

Particularly instructive has been the response to the stimulus package, the Recovery Act.  The airwaves have been saturated with critiques and analysis of what effect the stimulus is having.  Where are the jobs?  Where is the much-ballyhooed recovery?  Krugman said, What didn’t the vice president know and when didn’t he know it?

But some of us did predict the double digit unemployment rate.  It was, after all, baked in, we said.  Absent a massive stimulus, it was going to be a lot worse.

Here, again, from Krugman, shortly after his “What didn’t the vice president know, and when did he not know it?” comment.

No, he didn’t have it wrong.  The package got three Republican votes in the Senate, one of whom, Arlen Specter subsequently skipped to the D side, and two of whom remain to constitute the entirety of the Moderate Wing of the Republican Party.

The Demand Side framework has been this:  The economy was weak in 2001 when the Fed began its one percent interest rate policy and the Bush Administration instituted the tax cuts for the rich.  For the next five years it floated on the paper of residential housing financing.  When that huge debt bubble collapsed, the weak economy beneath was exposed.  It had no way of supporting the collapse and the entire financial system broke through.  Now we’re scrambling around in the rubble trying to find our way out.

We have the weak economy of 2001, along with credit markets that do not even function, let alone pump out debt for consumers.  State and local government revenues have shrunk, taking down more demand.  From the demand side, the only game in town is federal spending.  But the Recovery Act is barely replacing the loss of state and local spending, much less filling the hole left by the housing bubble and systemic collapse of the financial system.

The process is made all the more difficult for the blow to consumer confidence, which shrinks the multiplier by shrinking the consumption function.

It is all about demand.  Household demand has plummeted along with household wealth.  State and local demand has dropped because their revenues have dropped.  Business investment demand is nonexistent because there is overcapacity in every area and no prospects for profit on any front.

Yes, the infrastructure is crumbling.  We could spend two hundred billion a year for the next twenty years and barely get back to adequate.  Yes, global warming requires a complete reformation of transportation and energy and support for developing countries to do the same.  These are needs and challenges, but they are not being translated into effective economic demand.  Only the government can do that.

Our prescription has been to rebuild the American economy by rebuilding America.

The counter is what?  First, do as little as possible.  The second ….  I’m not clear on what the second is.  Just don’t do whatever Obama is doing.

A great deal of the problem with government spending is the idea that it will pump up inflation.  First we have to ignore the historical fact that there has been no demand-pull inflation for more than forty years, so a modest increase in government spending in the worst economic downturn since the great depression is not going to cause a fever of buying that would bid up the prices of … what? … food, clothing, gasoline, houses, what is going to be bid up?

Oh, and just because I have to do it every time inflation is mentioned, look at oil prices.  Look at inflation.  Notice that oil prices have not responded to demand-supply.  Notice that oil prices have led every inflation since 1970.  This is called cost-push inflation in our terminology.  It would be different if asset prices were included.  Then you would have housing or stocks pushing inflation.  But it would always be a financial bubble, not demand, pushing up prices.  End of Demand Side aside.

What about just trusting monetary policy.  Let’s not mention that the nay-sayers conflate the Fed’s policy with stimulus building infrastructure, bailing out states and extending unemployment.  Let’s just take the zero interest rate part first.

Yes, monetary policy acts with a lag.  Maybe up to 18 months.  Eighteen months after the Fed began aggressive action on interest rates, the U.S. had the worst quarter for GDP and employment in a quarter century.  Low interest rates gave the players more chips to play with, but it gave nothing to the real economy.  Zilch. Zero. Nada.

Particularly now, when there is no other consumer bubble to blow up.  The ex-Enron traders at Goldman Sachs may invent higher oil prices and milk the casino markets for more big profits, but a widespread consumer boom from lower interest rates.  It is not going to happen. When will they give it up?  Monetary policy simply does not work.  It needs to accommodate growth, but it is never going to cause recovery.

Zero rates is distinct from the Fed’s policy of bailing out the banks.  This is similar to scrounging around in the rubble for broken beams to spend billions of dollars taping back together again and rebuilding the house.  No.  Throw them out.  The government didn’t break them, they broke themselves.  Use the pieces that are not broken, the smaller banks, and get a new system.  Maybe it has to be a smaller financial house, but why the hell was it so big in the first place?  Certainly not because it was sheltering the great majority of us.  Financial houses made nice digs for the financial players.  The rest of us?  Not so much.

We could, of course, try more tax cuts.  After all, the great Bush tax cuts of the early part of the decade did so well.  Oh.  And the first stimulus?  2007 tax cuts from Bush?  Immediate, but ineffective.  They immediately had no effect.  Economy-wide, that is.  It was nice to have the check and it helped cushion the blow, but jump-starting the economy?  No.  Nearly everybody agrees with that now, so long as we’re talking about the past.  Several more voices join in when the discussion of tax cuts in time shifts to the future.  Always there is the Heritage Foundation.

But …

Here’s more Krugman

The suggestion that the Recovery is too slow portends bad things when the recovery does not produce robust growth.  After all, barely ten percent of it has gone out the door.  The vast majority will be spent in 2010 and beyond.  And it is not compared with the lagged effects of monetary policy.

More bad news:

The IMF says the world is pulling out of recession.

The famous bastion of Neoliberalism is marking up its growth forecasts for next year and hinting that it might reduce its estimates for bank losses.

The IMF’s chief economist, Olivier Blanchard, proclaimed, “The recovery is coming,” But it is likely to be a weak recovery.

Maybe another jobless recovery like the first Bush recession.  A jobless recovery is not a recovery.  It is simply an obsession with GDP which is monetized activity which in this case was a housing bubble.

Here in the latest Harper’s

Unless Obama changes course, he’ll look more like Hoover than FDR

an account from New Deal 2.0 by Lynn Parramore reads

We’re putting up our counter to Obama as Hoover this next week.  Or beginning it.  That is the historical fact and statistics that show that a Democrat in the White House has meant good things for GDP, employment and investment.  First, this week, it will be GDP.

By Bureau of Economic Analysis statistics, since 1948 growth in real GDP has averaged 4.0 percent per year under Democrats.  Under Republicans 2.7 percent.  No Democrat has seen this number under 3.7 percent.  That being Clinton.  No Republican has seen growth over 3.4 percent, that being Ronald Reagan.  In fact, only Reagan is above 3 percent at all, and the two Bushes are closer to 2 percent.

We’ll get into that, and into even more evidence showing Democrats mean good things for economy, even after Roosevelt.

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