Category Archives: Unemployment

The Political Economy of Citadelia

By Dan Kervick

Imagine a world and a society in which 500 people own everything – absolutely everything.  These blessed few live in the Citadel, a mighty bastion of comfort with fortified and impregnable walls.  The walls surround the Citadelians’ collections of lavish homes, spacious and opulent gardens, gorgeous pleasure arenas, and well-outfitted factories and workhouses.

Yes, factories and workhouses.  These mighty 500 pay 100,000 other people to do various kinds of work for them.  The work consists in transforming some of the resources and goods belonging to the 500 owners into a variety of consumable products, and also in using some of those products along with other raw materials to perform sundry services for the 500, services that include the production of splendid works of art and intellect.

The labors of the 100,000 workers yield more delights than can possibly be enjoyed by the 500 owners as the latter live out their luxurious but all-too-finite lives.  The result is that the 500 owners in the Citadel are absolutely sated.  They have no need to hire any other people to do any additional work.  They already possess riches beyond the limits of enjoyment and desire.

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Senator McCain’s Economist Warns: If you Criticize Banksters They will Prolong Recessions

By William K. Black

Steven J. Davis, Senator McCain’s chief economics advisor during his presidential campaign, has written a political hit piece on the man that defeated his candidate.  His co-authors were Scott R. Baker and Nicholas Bloom.  For the sake of brevity I will refer to the authors as “the authors” or “Davis.”  They published the piece in Bloomberg.  The article purports to be a straight scientific piece, but it is a partisan screed relying on faux statistics created by Davis to support his views.  Davis’ statistical methodology is not simply unscientific, it is embarrassingly bad.

Davis’ argument, long discredited by actual surveys of employers, is that unemployment is so high because employers refuse to hire because of Democratic policies.  As Paul Krugman has long noted, employers, when surveyed, have consistently and emphatically refuted this claim.  Given that the employers answering the surveys are disproportionately Republicans and opponents of regulation who have strong incentives to blame the regulations for their failure to hire, their failure to do so makes the survey results particularly compelling.  Davis’ statistical index provides no evidence of why employers are not hiring.  Indeed, it is inherently incapable of providing such evidence. 

Davis is a partisan Republican.  He is a theoclassical economist and a proud representative of the one percent.  He has worked for the Hoover Institution, AEI, and Michael Milken’s foundation (the infamous fraud whose crimes destroyed Drexel Burnham Lambert).  He is a professor at U. Chicago’s business school. 


Davis missed the developing crisis entirely, publishing an article about “the Great Moderation” in 2008 as the financial crisis was ripping across the world.  His ideological blinders are so complete that he cannot even consider the obvious – the crisis was brought on by the criminogenic environment produced by the three “de’s” – deregulation, desupervision, and de facto decriminalization plus perverse executive and professional compensation.  The economists George Akerlof and Paul Romer wrote an article about accounting control fraud entitled “Looting: the Economic Underworld of Bankruptcy for Profit.”  They concluded the article with this passage about the criminogenic environment produced by S&L deregulation in the 1980s.

“Neither the public nor economists foresaw that the [S&L] regulations of the 1980s were bound to produce looting.  Nor, unaware of the concept, could they have known how serious it would be.  Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better.  If we learn from experience, history need not repeat itself (1993: 60).”

The reason we have tragic levels of unemployment is the financial crisis, which was fully preventable had the anti-regulators put in place by Presidents Clinton and Bush simply understood the concepts of looting and criminogenic environments that we had made clear a quarter-century ago.  As I will show, Davis takes the remarkable position that we must not learn from our deregulatory mistakes and close the resulting regulatory black holes.    
 
Absent the restoration of effective financial regulation and prosecutions, and the removal of the perverse compensation systems (which also requires regulation), we will continue to suffer recurrent, intensifying financial crises and the severe unemployment they produce.  Effective financial regulation greatly reduces uncertainty by increasing transparency and by preventing Gresham’s dynamics.  George Akerlof explained to the profession 41 years ago in his famous article on markets for “lemons.”

“[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”  

Consider the grave “uncertainty” that would exist in a nation without effective police forces.  Somalia is a good example.  The police do not, and cannot, deal with sophisticated financial crimes.  The FBI’s white-collar crime specialists do not patrol a beat and look for crimes.  They sometimes act on anonymous tips or leads from other investigations, but overwhelmingly they depend on criminal referrals from the regulators.  Our principal function as regulators is to serve as the regulatory cops on the beat to prevent the Gresham’s dynamic by aggressively finding the frauds, putting them out of business, and providing the criminal referrals that make it possible to prosecute the elite frauds.  Absent effective regulators, honest firms often face extinction and their employees will lose their jobs.  

In Davis’ world, however, regulation is unnecessary and harmful.  The former U. Chicago professors, Frank Easterbrook and Daniel Fischel, wrote what remains the U. Chicago bible on accounting control fraud.  A generation of American lawyers has been taught this profession of faith from Easterbrook and Fischel’s 1991 treatise: “A rule against fraud is not an essential or even necessarily an important ingredient of securities markets….”  The Economic Structure of Corporate Law (1991).  Markets are self-correcting, bubbles are impossible, and economic crises are impossible.  This was the theoclassical profession of faith in a miraculous trinity.  Each of these dogmas has been repeatedly falsified by real life, but facts cannot trump blind faith.  Senator McCain’s was a member of the “Keating Five.”  Charles Keating, the most infamous S&L fraud, used the Senators to try to intimidate us into not taking any regulatory action against Lincoln Savings’ massive regulatory violation – a violation that led to billions of dollars in losses.  Neither McCain nor Davis learned any useful lesson from this scandal. 

Davis has mounted politically consistent attacks on the Democrats based on the high unemployment caused by the epidemic of accounting control fraud that hyper-inflated the bubble and drove the U.S. financial crisis.  On January 3, 2010 he published an op-ed with Gary Becker and Kevin Murphy in the Wall Street Journal blaming the Democrats for the high unemployment caused by the Great Recession.  This was their tag line:  “A recession is a terrible time to make major changes in the economic rules of the game.”

Consider the logic of that assertion.  The “economic rules of the game” have just led to an epidemic of accounting control fraud, a hyper-inflated bubble, a Great Recession, and severe unemployment and the theoclassical answer to the catastrophe that their faith-based policies have caused is – engrave those rules in bronze.  They literally call on us to repeat the mistakes of the past.  Theoclassical economists take their cue from the White Queen, who bragged to Alice that with practice she had learned to believe “as many as six impossible things before breakfast.” 

The authors acknowledged that the Great Recession had caused severe unemployment, but added the claim that it was the election of Democrats that prevented a prompt recovery.

“Liberal Democrats won a major victory in the 2008 elections, winning the presidency and large majorities in both the House and Senate. They interpreted this as evidence that a large majority of Americans want major reforms in the economy, health-care and many other areas.”

Obama’s economic team (Summers, Geithner, and Bernanke) was strongly neoclassical and economically conservative.  The authors then singled out any effort to deal with climate change as particularly undesirable.  Apparently it is now a violation of theoclassical principles to require manufacturers to internalize the cost of negative externalities.  That is contrary to economics and would lead to a poisoned world in which firms that spent money to restrict harmful emissions would be driven out of business by their competitors who avoided such expenses and obtained a decisive cost advantage.  This is another example of a Gresham’s dynamic in which bad ethics drives good ethics from the marketplace.  The authors ended by opposing allowing the Bush tax cuts for the wealthy to expire.  They presented no evidence in support of their partisan attack on Democrats and their ideological attack on “liberals.”

On July 15, 2011, Davis wrote an article entitled “Why Employers Are Slow to Fill Jobs.”  

Davis mentioned “policy uncertainty” as one of the contributors to the employers’ failure to hire workers in this article, but what he stressed was that the Great Recession so depressed private sector demand for goods and services that most employers felt little desire to hire additional workers because they could not sell additional output.  He noted that employers had reduced the intensity of their recruiting because they were in a buyer’s market in which they were deluged with applicants and could afford to hire only the most ideal candidates.  Even when Davis discussed uncertainty his primary emphasis was on economic uncertainty – the Great Recession.  He ended by blaming unemployment on the unemployed.  The long-term unemployed were spending fewer hours looking for jobs.  Davis called for ending unemployment benefits for the long-term unemployed.  The prospect of starving in a fortnight would concentrate their minds wonderfully.  (Yes, Davis’ last argument contradicts his earlier arguments, but this is faith-based callousness posing as science.)  His “summing up” paragraph has one clause referencing “uncertainty” as a purported tertiary contributor to the slow reduction in unemployment.  Again, Davis offered no support for this assertion.

Davis’ latest (October 5, 2011) partisan attack is entitled “Policy Uncertainty Is Choking Recovery.”  In five months, Davis’ tertiary, minor asserted contributor to the slow recovery has suddenly morphed into a monster that is the cause of the problem.  You might think that the survey results showing that businesses have repeatedly falsified this claim would pose a problem for this meme, but the authors hit on the obvious answer to inconvenient truths – they ignored them.  Lest you think that this was due to tight space limits placed on a Bloomberg op ed, check their academic paper, which, also ignores the actual surveys.  “Measuring Economic Policy Uncertainty” (October 10, 2011).   This begins to explain why their work is embarrassingly bad.

The partisan slanting of the article is also embarrassing, as is the failure to identify Davis’ role as McCain’s principal economics advisor.  Here is the authors’ thesis:

“But the persistence of policy uncertainty wasn’t inevitable. Rather, it reflects deliberate policy decisions, harmful rhetorical attacks on business and “millionaires,” failure to tackle entitlement reforms and fiscal imbalances, and political brinkmanship.”

Their thesis boils down to the claim that capitalists are wusses.  The reality is that politicians of both parties fall all over themselves saying nice things about business and that the criticisms are addressed to corporate criminals and the wealthy who pay what the vast bulk of Americans view as grossly inadequate taxes.  Moreover, according to the neoclassical economics canon these authors purport to believe raising taxes on the wealthy would be a valuable change that would reduce “fiscal imbalances.”  The authors, instead, assert that any increase in taxes on the wealthy destroys jobs.  By their logic, we should eliminate taxes on the wealthy.  By entitlement “reforms” they mean reducing Social Security benefits – that will do wonders for private sector demand and robust jobs growth. 

Indeed, the authors’ thesis is eerily reminiscent of Jon Stewart’s famous riff when Dick Cheney shot his elderly hunting companion in the face.  Stewart noted that Cheney was so powerful that the victim apologized to Cheney for being shot – by Cheney.  The authors want us to apologize to the elite financial frauds that became wealthy through the accounting control fraud epidemic that drove the crisis, the Great Recession, the great bulk of the federal budget deficit, the state and local government financial crisis, and severe unemployment.  It wasn’t enough that we bailed them out and gimmicked the accounting rules at their demand to ensure that “their” banks could continue to pay them massive bonuses even though they were in economic reality insolvent.  How dare we make “harmful rhetorical attacks” on the frauds!  We should all apologize immediately to the productive class.

Speaking of “rhetorical attacks,” consider this partisan assault by the authors:

“The Patient Protection and Affordable Care Act that President Barack Obama signed into law in March 2010 is another example. Rather than simple reforms aimed at efficiency improvements and cost savings, the law seeks to remake the U.S. health-care delivery system, dramatically expanding the role of government and imposing new burdens on businesses and individuals. Even in narrowly economic terms, the measure adds to the uncertainty facing households and businesses.

Moreover, its political durability is in doubt. The Democratic leadership in Congress opted to pursue the most radical plan that could muster the necessary 60 votes in the Senate and a thin majority in the House. As a result, the legislation failed to attract a single Republican vote in either chamber. That political strategy ensured the act would become the focus of future electoral battles and rollback efforts. “

The authors then go on to complain that the lawsuits challenging the constitutionality of the Act (which they do not note were brought by Republicans) add to uncertainty.  Whatever, the Act is, it is assuredly not “radical.”  It is modeled on a scheme created by a then conservative Republican Governor, Mitt Romney.    


In reality, the Obama administration made obsessive efforts to craft a bill with bipartisan support – substantially weakening an already weak bill and taking out, at the demand of Republican and “blue dog” Democrats, the central “cost savings” provision in the bill – the public option.  The “simple reform” that would vastly increase efficiency and cost savings – and boost the international competitiveness of U.S. firms – is single payer health care funded by the public rather than (largely) through tax-subsidized but still expensive private health insurance provided by employers.  The Republicans and “blue dog” Democrats promised to kill any such bill.  The authors’ dread “liberal Democrats” favored a bill that would produce superior health care at a far lower price in line with other developed nations.  The private health insurers promised to bury such a bill, so the Obama administration went for the ultra conservative alternative developed by Romney.  The authors’ partisan slant causes them to deliberately and comprehensively misstate the facts.

The authors then move to describing their uncertainty “index.”

“We constructed our index by combining three types of information: the frequency of newspaper articles that refer to economic uncertainty and the role of policy, the number of federal tax code provisions set to expire in coming years, and the extent of disagreement among forecasters about future inflation and government spending.” 

To which the obvious first question is:  why?  I begin my analysis with their tax provisions component.  They know that a historically unusual number of tax provisions are set to expire in coming years, so they know that when they use that component they will produce at index showing a surge in uncertainty. 

“Scheduled expirations of federal tax code provisions were rare before 2000 but have grown rapidly. More than 130 provisions are slated to expire in 2011 and 2012, in many cases setting the stage for new political battles.”

Davis wants to report high uncertainty to fit his priors that he has been asserting without any proof.  This is a hopelessly unsound means to produce an index.  Any of us could pick a variable that would “prove” our priors.  The psychological temptation to prove we are right (especially for theoclassical economists who have gotten everything important horribly wrong) is overwhelming.  The bad news is that the tax expirations are the least embarrassing aspect of their index.


An even more ludicrous component is: “the frequency of newspaper articles that refer to economic uncertainty and the role of policy.”  First, the authors know, because Davis has been a part of promoting this meme, that Republicans have organized a coordinated campaign to claim that “regulation” and “taxes” are causing the weak recovery from the recession.  To now use the publicity that one political party, and at least one of the framers of the index, is generating for partisan purposes as purported objective evidence of the harms of ending the regulatory black holes is so unprincipled as to be beneath contempt.  Indeed, the absurdity of this component is demonstrated by the fact that their effort to publicize their index in the form of a partisan op ed and a partisan academic paper has already had the effect of driving their index higher and “proving” their point.  Moreover, this is not a new Republican strategy.  They followed the same strategy of attacking regulation and regulators for years, but the coordinated attacks on regulation emanating from the right’s “think tanks” (funded by firms that wish to prevent effective regulation) have increased greatly since the passage of Sarbanes-Oxley.  Self-generated attacks on regulation become “policy uncertainty,” which becomes a purported empirical basis for preventing effective regulation.  The index provides an elegant solution to the Koch brothers’ policy goals.     


The authors’ third component is almost humorously bad:  “the extent of disagreement among forecasters about future inflation and government spending.”  We have a vastly more reliable means to judge the risks of future inflation in the U.S.  It is called the U.S. bond market.  It prices the risk of inflation continuously.  It already incorporates “government spending” because such spending can affect inflation.  The U.S. bond markets have consistently been telling us since the crisis became public knowledge that there is no material risk of inflation.  Why do the authors believe that “forecasters” are more reliable than bond markets?  Why do they believe that businesses are failing to hire because they are concerned that the inflation hawks have remained delusional in their claims that hyper-inflation is just around the corner?  What does any of this have to do with regulation?  If CEOs were worried about hyper-inflation because they remained in thrall to some inflation hawk analyst who had been proven grotesquely wrong in every forecast over the last five years, wouldn’t those CEOs be happy that the Bush tax cuts were set to expire?  Why do CEO’s base their decision to hire on the variance among analysts as to the size of the federal budget instead of the size of the federal budget deficit?  The authors do not address these issues in their formal paper or op ed.  


The authors then assigned arbitrary weights to their three components.  The news stories measure is weighted one-half, while the tax repeals and both forms of variance in forecasts (inflation and government spending) each receive an individual weight of one-sixth. 

The authors claim in their op ed (but not in their paper, which claims only “some suggestive evidence on causation”) that their index somehow establishes causality and confers the ability to quantify the jobs that would be created if the Republicans would stop their media campaign of blaming “radical” regulation for the slow recovery.  (Of course, the authors don’t phrase it that way, but given the extreme weight they gave to this single component of their index and the fact that the senior author of the paper is a Republican activist pushing this meme in the media, that is how circular and perverse “causality” is in their index.)

“So how much near-term improvement could we gain from a stable, certainty-enhancing policy regime? We estimate that restoring 2006 levels of policy uncertainty would yield an additional 2.5 million jobs over 18 months. Not a full solution to the jobs shortfall, but a big step in the right direction.”

They make no such claim in their paper.  “Yield” is a statement of causality.  Their study inherently cannot establish causality.  Further, as they admit, even they see at best only “some suggestive evidence on causation” – and they are being remarkably over-generous to themselves even in going that far for their study does not present any such “suggestive evidence.” 


They also do not explain how we could undo “uncertainty” – as “measured” under their index.  As long as the right generates attacks on regulation and claims that it causes uncertainty and those complaints are repeated by their array of web sites the index will “measure” high uncertainty.  We went through a remarkable period of radical deregulation, desupervision, and de facto decriminalization that created the criminogenic environments that produced three major crises in 25 years and one party is still demanding that we make the three “de’s” far worse.  Are we supposed to repeal Dodd-Frank?  Would the repeal increase or decrease “policy uncertainty”?  How are we supposed to prevent analysts from being hyper-inflation hawks?  Would making the tax laws longer remove uncertainty?  Congress could still change them at will.  The repeal as of a date certain was meant to reduce uncertainty. 


Every aspect of this index is farcical and a naked partisan weapon of attack on the regulations and prosecutions essential to preventing our recurrent, intensifying financial crises.  Theoclassical economists were the architects of these crises.  They were the great destroyers of jobs and wealth.  The claim that we can never undo their criminogenic designs and that any attempt to even criticize the elite frauds will lead to job losses is pure extortion.  Their index does not allow any statements about causality, and they know that the claims of causality and quantification that they made in their op ed are indefensible.  The direct surveys of employers do allow us to evaluate causality because they are statements (largely) against the political interests of the business people being surveyed.  Those surveys refute the argument. 


Restoring effective regulatory cops on the beat will increase transparency and reduce the Gresham’s dynamic that is the bane of honest firms.  Both effects reduce uncertainty and increase employment.  For example, there were far more aggressive regulatory and prosecutorial responses to the S&L debacle than the current crisis.  We convicted over 1,000 elites in cases designated by the Justice Department as “major” and we brought thousands of civil and enforcement actions against S&L executives.  We largely ended nonprime lending, particularly liar’s loans by S&Ls in 1990-1991.  We placed many hundreds of S&Ls and banks in receivership.  We consistently wiped out the shareholders and subordinated debt holders in those resolutions.  We greatly boosted capital requirements, got rid of junk accounting, and put formal requirements for prompt corrective action in place.  We rapidly sold the bad assets in our liquidating receiverships.  None of these things has been done in Bush and Obama administrations’ tepid response to the current crisis.  The recovery from the recession in the early 1990s was relatively rapid.  Our aggressive regulatory actions added greatly to certainty because our actions were consistent, added to transparency, and helped honest firms.  That result would be consistent with the authors’ purported theory (gratuitous uncertainty poses an undesirable risk that slows recovery), but not with their ideological blinders that cause them to see regulation as inherently adding to uncertainty.


Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.


Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.


Follow him on Twitter: @WilliamKBlack

After Great Recession: A Bleaker Employment Recovery than after the Great Depression

By Eric Tymoigne

The last employment numbers provide yet another disappointing bit of news for millions of households all around the country. No net employment gain. However, I am afraid that this is only the very tip of the iceberg because a long-term view shows a much bleaker picture.

Figure 1 shows how long it took for the employment level to return to its peak level after a recession, and how much job loss occurred relative to that peak. The employment numbers exclude people that were employed in the WPA, NYA and CCC, and focuses on individuals employed in nonfarm activities.

During the Great Depression, the employment level declined for 4 years and almost 10 million jobs were lost compared to the peak employment level that prevailed in August 1929. It took 136 months (over 11 years) to return to this level of employment, but, without the avoidable 1937 recession, the full recovery would have occurred after 102 months (8.5 years) if one takes the trend of recovery that prevailed from 1933.

The Great Recession led to a loss of almost 9 million jobs compared to the peak employment level of January 2008. The loss of jobs occurred at a faster rate than the Great Depression but employment recovered sooner and started to rise after 2 years. However, once the employment recovery started, it occurred at a slower rate than during the Great Depression. If the recovery continues at the same pace, AND assuming that no recession occurs during the recovery phase, it will take about 9 years to return to the employment level of January 2008. Thus, given everything else, it will take longer for employment to fully recover than during the years prior to the 1937 recessions.

The picture is even bleaker today if one included New Deal employment programs. Figure 2 shows that those programs allowed employment to recover fully after 80 month (less than 7 years) and only three years after the New Deal Programs were implemented. The timid Bush and Obama stimulus have barely made a dent in the employment problem over the past two years.

This, once again, suggest a powerful employment policy to help the economy. Instead of concentrating its efforts on tax rebates and bailing out banks, and waiting for them to lend to businesses, the federal government should directly hire people and involve them in activity that benefited the entire country. We do not need a temporary stimulus; we need a permanent institutionalized and decentralized government program that hires anybody willing to work and unable to find a job in the private sector. By sustaining income and the productivity of workers, a government employment program would tremendously helps to sustain the employability of workers and would improve the confidence of private business, which would in turn improve private employment.

Figure 1. Difference between peak employment level and current employment level. Nonfarm payroll employment, seasonally adjusted, millions of people.

 

Sources: BLS (Current Employment Survey), Federal Reserve Bulletin (June and September 1941).
Note: People employed in the WPA, NYA and CCC are not included.

Figure 2. Same as Figure 1 with New Deal Federal Employment Programs.

Sources: Federal Reserve Bulletin, Social Security Bulletin.

Commerce Sells, but Who’s Buying?

 
You have to wonder if the president ever hears from his commerce secretary these days.  Friday’s GDP revisions by the Bureau of Economic Analysis should send a pretty strong signal that the economy is far from recovering, making clear that job killing spending cuts should be last thing on his mind:
           
While the headline number was well below expectations of 1.8%, what must be noted are the major revisions. Q1 2011 is now reported as +0.4%. That’s a major downward revision which demonstrates that QE2 was in fact doing nothing for growth and that the US is already at stall speed even without the negative impact of the European sovereign debt crisis and the debt ceiling fiasco. The double dip scare is real.”  Ed Harrison, Credit Writedowns
           

Unfortunately, the president doesn’t demonstrate any evidence that he’s heard this news.  For all we know, he might have tasked Secretary Locke to go out and “truck, barter and trade” with the American people in an effort to win the future.  So maybe instead of leveling with the president, Locke is out setting up lemon-aid stands across the country.  Who knows?

Judging by the evidence available to me, I have to assume that Obama is either willfully ignorant of the dire situation or patently insane enough to believe that we are in the midst of a recovery. Or perhaps he is fully aware that we are on the verge of a fresh contraction, but thinks the best way to increase business activity is to drive up unemployment.
No, I’m sure Gary Locke is hard at work doing the sort of thing you would expect a cabinet level official to do, not off trying to inspire confidence in the business community through conspicuous acts of commerce.  The president has heard the news alright.  The problem lies in his commitment to, above all else, selling us a phony crisis:
Now, every family knows that a little credit card debt is manageable. But if we stay on the current path, our growing debt could cost us jobs and do serious damage to the economy. More of our tax dollars will go toward paying off the interest on our loans. Businesses will be less likely to open up shop and hire workers in a country that can’t balance its books. Interest rates could climb for everyone who borrows money – the homeowner with a mortgage, the student with a college loan, the corner store that wants to expand. And we won’t have enough money to make job-creating investments in things like education and infrastructure, or pay for vital programs like Medicare and Medicaid.”  President Obama, July 25, 2011
Here he appeals to our fear of the unknown, leading us to conclude that if we don’t reduce the deficit now we will pay dearly tomorrow.  This passage is especially troubling given its blatant disregard for the truth.  The federal government is not a household -  he has yet again committed the classic fallacy of composition.  The public debt is not analogous to Joe the Plumber’s Visa card.  Not even close.  In fact, they are pretty much opposite each other:  public debt is private savings, while credit cards are tools for private sector deficit spending.  From there, he tries to convince us that as deficits increase more of the spending pie will go towards debt service.  Sure, if the economy does not grow with the deficit that might be the case. 
 
So what?  Well, the connection he is hoping we’ll make is that this will eventually leading to exploding deficits and increasing interest rates.  He seems to forget that we have a sovereign currency, and we spend by crediting bank accounts regardless of the sentiment of the bond market.  We decide how much to pay in interest, not bond vigilantes.  And he finishes the argument by asserting that we will not “have enough” money to pay for Medicare and Medicaid, which is patently false.  To pay for those programs you simply credit the bank accounts of recipients.  The money does not exist before that transaction, so it is nonsense to suggest you can ever lack the funds to make the payments.  Of course, you can fail to make the keystrokes necessary to initiate the transaction, but that is not insolvency only political failure.
Up until now, I’ve been inclined to give Obama the benefit of the doubt.  I figured that while he does not seem to understand how the modern economy functions, at least he is in earnest over his deficit fears.  After all, he has surrounded himself with advisers that lack the insight to make effective policy recommendations so why should he know any better?  But, as Dean Baker points out he is apparently unaware of the actual size of the deficit, a matter which he has chosen to make the central pillar of his four years in the Oval Office.  In a gaffe, the president claimed that he inherited a deficit that was approaching $1 trillion for his inaugural year, while the CBO’s projections placed it at the much lower figure of $198 billion. 
That’s a little too wide of the goalposts for my comfort, and it leads me to speculate whether or not he really believes his own rhetoric.  After all, if you desperately want to convince Americans that hacking away at the social safety net is a good idea, you would think you’d have your facts straight.  If he really believes the deficit is too large, then you wouldn’t you think he would know just how large it is?

Unless, of course, you let slip those kind of statements on purpose.  Inheriting a trillion dollar budget deficit from your predecessor sounds a lot more urgent than a couple billion.  And if you want to convince your constituency to roll over and accept cuts in the very programs that have been core to the Democratic party for the better part of a century, you had better be sure to make them believe those cuts to be absolutely necessary.

While Labor Unions celebrate Anti-Austerity Day in Europe, European Neoliberals raise the ante: Governments must Lower Wages or Suffer Financial Blackmail

By Michael Hudson

Most of the press has described Europe’s labor demonstrations and strikes on Wednesday in terms of the familiar exercise by transport employees irritating travelers with work slowdowns, and large throngs letting off steam by setting fires. But the story goes much deeper than merely a reaction against unemployment and economic recession. At issue are proposals to drastically change the laws and structure of how European society will function for the next generation. If the anti-labor forces succeed, they will break up Europe, destroy the internal market, and render that continent a backwater. This is how serious the financial coup d’etat has become. And it is going to get much worse – quickly. As John Monks, head of the European Trade Union Confederation, put it: “This is the start of the fight, not the end.”
Spain has received most of the attention, thanks to its ten-million strong turnout – reportedly half the entire labor force. Holding its first general strike since 2002, Spanish labor protested against its socialist government using the bank crisis (stemming from bad real estate loans and negative mortgage equity, not high labor costs) as an opportunity to change the laws to enable companies and government bodies to fire workers at will, and to scale back their pensions and public social spending in order to pay the banks more. Portugal is doing the same, and it looks like Ireland will follow suit – all this in the countries whose banks have been the most irresponsible lenders. The bankers are demanding that they rebuild their loan reserves at labor’s expense, just as in President Obama’s program here in the United States but without the sanctimonious pretenses.
The problem is Europe-wide and indeed centered in the European Union capital in Brussels, where fifty to a hundred thousand workers gathered to protest the proposed transformation of social rules. Yet on the same day, the European Commission (EC) outlined a full-fledged war against labor. It is the most anti-labor campaign since the 1930s – even more extreme than the Third World austerity plans imposed by the IMF and World Bank in times past.

The EC is using the mortgage banking crisis – and the needless prohibition against central banks monetizing public budget deficits – as an opportunity to fine governments and even drive them bankrupt if they do not agree roll back salaries. Governments are told to borrow at interest from the banks, rather than raising revenue by taxing them as they did for half a century following the end of World War II. Governments unable to raise the money to pay the interest must close down their social programs. And if this shrinks the economy – and hence, government tax revenues – even more, the government must reduce social spending yet further.
From Brussels to Latvia, neoliberal planners have expressed the hope that lower public-sector salaries will spread to the private sector. The aim is to roll back wage levels by 30 percent or more, to depression levels, on the pretense that this will “leave more surplus” available to pay in debt service. It will do no such thing, of course. It is a purely vicious attempt to reverse Europe’s Progressive Era social democratic reforms achieved over the past century. Europe is to be turned into a banana republic by taxing labor – not finance, insurance or real estate (FIRE). Governments are to impose heavier employment and sales taxes while cutting back pensions and other public spending.
“Join the fight against labor, or we will destroy you,” the EC is telling governments. This requires dictatorship, and the European Central Bank (ECB) has taken over this power from elected government. Its “independence” from political control is celebrated as the “hallmark of democracy” by today’s new financial oligarchy. This deceptive newspeak evokes Plato’s view that oligarchy is simply the political stage following democracy. The new power elite’s next step in this eternal political triangle is to make itself hereditary – by abolishing estate taxes, for starters – so as to turn itself into an aristocracy.
It is a very old game indeed. So it is time to put aside the economics of Adam Smith, John Stuart Mill and the Progressive Era, to forget Marx and even Keynes. Europe is ushering in an era of totalitarian neoliberal rule. This is what Wednesday’s strikes and demonstrations were about. Europe’s class war is back in business – with a vengeance!
This is economic suicide, but the EU is demanding that Euro-zone governments keep their budget deficits below 3% of GDP, and their total debt below 60%. On Wednesday the EU passed a law to fine governments up to 0.2% of GDP for not “fixing” their budget deficits by imposing such fiscal austerity. Nations that borrow to engage in countercyclical “Keynesian-style” spending that raises their public debt beyond 60% of GDP will have to reduce the excess by 5% each year, or suffer harsh punishment.[1] The European Commission (EC) will fine euro-area states that do not obey its neoliberal recommendations – ostensibly to “correct” budget imbalances.
The reality is that every neoliberal “cure” only makes matters worse. But rather than seeing rising wage levels and living standards as being a precondition for higher labor productivity, the EU commission will “monitor” labor costs on the assumption that rising wages impair competitiveness rather than raise it. If euro members cannot depreciate their currencies, then they must fight labor – but not tax real estate, finance or other rentier sectors, not regulate monopolies, and not provide public services that can be privatized at much higher costs. Privatization is not deemed to impair competitiveness – only rising wages, regardless of productivity considerations.
The financial privatization and credit-creation monopoly that governments have relinquished to banks is now to really pay off – at the price of breaking up Europe. Unlike central banks elsewhere in the world, the charter of the European Central Bank (ECB, independent from democratic politics, not from control by its commercial bank members) forbids it to monetize government debt. Governments must borrow from banks, which are create interest-bearing debt on their own keyboards rather than having their national bank do it without cost.
The unelected members of the European Central Bank have taken over planning power from elected governments. Beholden to its financial constituency, the ECB has convinced the EU commission to back the new oligarchic power grab. This destructive policy has been tested above all in the Baltics, using them as guinea pigs to see how far labor can be depressed before it fights back. Latvia gave free reign to neoliberal policies by imposing flat taxes of 51% and higher on labor, while real estate is virtually untaxed. Public-sector wages have been reduced by 30%, prompting labor of working age (20 to 35 year-olds) to emigrate in droves. This of course is contributing to the plunge in real estate prices and tax revenue. Lifespans for men are shortening, disease rates are rising, and the internal market is shrinking, and so is Europe’s population – as it did in the 1930s, when the “population problem” was a plunge in fertility and birth rates (above all in France). That is what happens in a depression.
Iceland’s looting by its bankers came first, but the big news was Greece. When that nation entered its current fiscal crisis as a result of not collecting taxes on the wealthy, European Union officials recommended that it emulate Latvia, which remains the poster child for neoliberal devastation. The basic theory is that inasmuch as members of the euro cannot devalue their currency, they must resort to “internal devaluation”: slashing wages, pensions and social spending. So as Europe enters recession it is following precisely the opposite of Keynesian policy. It is reducing wages, ostensibly to “free” more income available to pay the enormous debts that Europeans have taken on to buy their homes and pay for schooling (hitherto provided freely in many countries such as Latvia’s Stockholm School of Economics), transportation and other public services. Manly such services have been privatized and subsequently raised their rates drastically. The privatizers justify this by pointing to the enormously bloated financial fees they had to pay their bankers and underwriters in order to get the credit to buy the infrastructure that was being sold off by governments.
So Europe is committing economic, demographic and fiscal suicide. Trying to “solve” the problem neoliberal style only makes things worse. Latvia’s public-sector workers, for example, have seen their wages cut by 30 percent over the past year, and its central bankers have told me that they are seeking further cuts, in the hope that this will lower wages in the private sector as well, just as neoliberals in other European countries hope, as noted above.
About 10,000 Latvians attended protest meetings in the small town of Daugavilpils alone as part of the “Journey into the Crisis.” In Latvia’s capital city, Riga, yesterday’s Action Day saw the usual stoppage of transportation and an accompanying honk concert for 10 minutes at 1 PM to let the public know that something was happening. Six independent trade unions and the Harmony Center organized a protest meeting in Riga’s Esplanade Park that drew 700 to 800 demonstrators, relatively large for so small a city. Another union protest saw about half that number gather at the Cabinet of Ministers where Latvia’s austerity program has been planned and carried out.
What is happening most importantly is the national parliamentary elections this Saturday (October 2). The leading coalition, Harmony Center, is pledged to enact an alternative tax and economic policy to the neoliberal policies that have reduced labor’s wages and workplace standards so sharply over the past decade. A few days earlier a bus tour drove journalists to the most visible victims – schools and hospitals that had been closed down, government buildings whose employees had seen their salaries slashed and the workforce downsized.
These demonstrations seem to have gained voter sympathy for the more militant unions, headed by the hundred individual unions belonging to the Independent Trade Union Association. The other union group – the Free Trade Unions (LBAS) lost face by acquiescing in June 2009 to the government’s proposed 10% pension cuts (and indeed, 70% for working pensioners). Latvia’s constitutional court was sufficiently independent to overrule these drastic cuts last December. And if the government does indeed change this Saturday, the conflict between the Neoliberal Revolution and the past few centuries of classical progressive reform will be made clear.
In sum, the Neoliberal Revolution seeks to achieve in Europe what the United States has achieved since real wages stopped rising in 1979: doubling the share of wealth enjoyed by the richest 1%. This involves reducing the middle class to poverty, breaking union power, and destroying the internal market as a precondition.
All this is being blamed on “Mr. Market” – presumably inexorable forces beyond politics, purely “objective,” a political power grab. But is not really “the market” that is promoting this destructive economic austerity. Latvia’s Harmony Center program shows that there is a much easier way to cut the cost of labor in half than by reducing its wages: Simply shift the tax burden off labor onto real estate and monopolies (especially privatized infrastructure). This will leave less of the economic surplus to be capitalized into bank loans, lowering the price of housing accordingly (the major factor in labor’s cost of living), as well as the price of public services. (Owners of monopoly utility services would be prevented from factoring interest charges into their cost of doing business. The idea is to encourage them to take returns on equity. Whether or not they borrow is a business decision of theirs, not one that governments should subsidize.) The tax deductibility of interest will be repealed – there is nothing intrinsically “market dictated” by this fiscal subsidy for debt leveraging. This program may be reviewed at rtfl.lv, the Renew Task Force Latvia website.
No doubt many post-Soviet economies will find themselves obliged to withdraw from the euro area rather than see a flight of labor and capital. They remain the most extreme example of the Neoliberal Experiment to see how far a population can have its living standards slashed before it rebels.
But so far the neoliberals are fully in control of the bureaucracy, and they are reviving Margaret Thatcher’s slogan, TINA: There Is No Alternative. But there is an alternative, of course. In the small Baltic economies, pro-labor parties are pressing for the government to shift the tax burden off employees and consumers back onto property and financial wealth. Bad debts beyond the reasonable ability to pay must be scaled back. It may be necessary to let the banks go under (they are mainly Swedish), even if this means withdrawing from the Euro. The choice is between who will be destroyed: the banks, or labor?
European politicians now view this as being truly a fight to the death. This is the ideology that has replaced social democracy.

[1] Matthew Dalton, “EU Proposes Fines for Budget Breaches,” Wall Street Journal, September 29, 2010.

More Reasons to Doubt Rogoff and Reinhart

By Yeva Nersisyan
With unemployment expected to remain high in the U.S. and Europe and the possibility of a double-dip recession growing stronger, some sensible voices are calling for another round of fiscal stimulus. And then there are others who not only argue that we don’t need more stimulus, but make a case for starting to cut spending today, notwithstanding a very fragile “recovery.” Ken Rogoff (see here), who has become the de-facto authority on the issue of sovereign deficits and debt (together with his co-author, Carmen Reinhart), in a recent FT article is trying to make the case for the redundancy of further economic stimulus. Subpar economic performance and unemployment are the usual companions of post-financial crisis recovery, he argues, hence there is no need for a “panicked fiscal response” (even Secretary Geithner has cited their research to demonstrate that the current slow pace of recovery is normal). Rogoff goes on to argue that the long-term effects of government debt accumulation on growth shouldn’t be ignored. The theoretical and empirical bases for his arguments are found in his recent book with Reinhart, This Time is Different, as well as an NBER paper, “Growth in Time of Debt”. This paper, similar to the book, has been very popular, especially among those needing empirical justification for their anti-fiscal policy stance. While the RR book focuses on the short-run, immediate impacts of sovereign debt (i.e. financial and economic crises), the focus of the paper is the impact of sovereign debt on long-term growth. In this blog I want to give a quick, critical evaluation of the paper (a longer version can be found here).

When orthodox economists start their empirical research regarding the long-term impact of deficits and sovereign debt, they do not ask whether deficits contribute to or inhibit long-term economic growth. They do not ask, because they already “know” the answer, as the ECB put it: “Although fiscal consolidation may imply costs in terms of lower economic growth in the short run, the longer-run beneficial effects of fiscal consolidation are undisputed.” (ECB, Monthly Bulletin, June, 2010). What they want to find is some threshold for deficit-to-GDP and debt-to-GDP ratios beyond which debt becomes detrimental to growth. With this goal in mind, Rogoff and Reinhart embark on a “scientific” journey through time and space.
Their method is actually quite simple: they construct some arbitrary ranges for debt-to-GDP ratios (0-30, 30-60, 60-90, >90) and take the average of growth rates for each range. They then take the average of these averages for a large number of countries and conclude that when the government debt-to-GDP ratio crosses the threshold of 90% (again, an arbitrary number), median growth rates fall by one percentage point and the average falls even more. This limit is the same for developed and developing countries, however, when it comes to external debt (which is defined in their book as both public and private debt issued in a foreign jurisdiction, and usually, but not always, denominated in foreign currency), the threshold is much lower, just 60% of GDP. Once a country crosses this lower external debt threshold, annual growth declines by about 2 percentage points and at very high levels, the growth rate is cut almost in half.
Interestingly, however, average growth rates don’t monotonically decline, i.e. the average rate of growth is higher when debt-to-GDP ratio is in the 60-90% range than the lower range of 30-60%. In addition, growth rates don’t slow down for all the countries in their sample. For some countries the average growth rate is higher when debt is over 90% of GDP than for lower levels of debt. Reinhart and Rogoff don’t point out this “anomaly,” nor do they offer any explanations. More importantly, since they take the average of averages of a number of countries, it is possible that countries like the U.S. may drive the results for the whole group. They single out the case of the U.S. in their paper to demonstrate their results. However, a closer look shows that they only have 5 data points for the U.S. when the debt-to-GDP ratio was over 90%. This is only 2.3% of the total of 216 observations. Moreover, 3 out of these 5 observations are for the years 1945, 1946 and 1947, the period after WWII when government debt was high due to war spending. In this period, growth slowed down significantly as the government was withdrawing war spending from the economy. In 1946 alone, GDP contracted at a pace of -10.9%. Rogoff and Reinhart fail to even mention this in their paper. Similar situations might be true for many other countries, where high levels of debt-to-GDP follow extreme economic or political events.
But what is even more important is that what they find in the data is merely a correlation. The causation then is imposed by Reinhart and Rogoff with explanations based on Barro’s Ricardian equivalence theory. “The simplest connection between public debt and growth is suggested by Robert Barro (1979). Assuming taxes ultimately need to be raised to achieve debt sustainability, the distortionary impact imply is likely to lower potential output” [sic].
There is no doubt about the correlation between high debt-to-GDP ratios and low economic growth found in the data. However, there is a more sensible explanation for this correlation. As explained in many past posts on this blog, the government budget balance automatically goes into deficit in a recession leading to an accumulation of public debt. Besides, GDP, the denominator of the ratio shrinks making the ratio even larger. It is sufficient to look at what happened during this most recent crisis to see this. The average rate of growth has been -0.23% for the recession years 2007-2009. At the same time, government debt held by the public has increased from 36% of GDP in 2006 to about 52% in 2009. So if you look at the data, the rate of growth was 2.7% in 2006 corresponding to a debt-to-GDP ratio of 36%. In 2009 growth was -2.6% with a corresponding debt-to-GDP ratio of 52%. Hence there is a correlation between slow growth and high levels of debt which is not surprising. But unless you want to argue that the current recession was caused by high levels of government debt, then it is obvious that causation runs from slow growth to high debt and not the other way around as Reinhart and Rogoff claim.
They also find that growth deteriorates significantly at external debt levels of over 60% and that most default on external debt in emerging economies since 1970s has been at 60% or lower debt-to-GDP ratios (which is the Maastricht criteria). While this might be a surprising finding for them, it should be clear why countries are not tolerant to external debt which is almost always denominated in foreign currency. When a government borrows in foreign currency, even low levels of indebtedness can be unsustainable since the government is not able to issue that foreign currency to meet its debt obligations. As countries need to earn foreign exchange from exports, a sudden reversal in export conditions can render the country unable to meet its foreign debt obligations leading to a crisis and slower growth. Sovereign governments, on the other hand, do not face any financial constraints and cannot run out of their own currency as they are the monopoly issuers of that currency. They don’t need to increase taxes in the future (a la Barro) to pay off the debt as they make interest payments on their “debt” as well as payments of principal by crediting bank accounts, meaning that operationally they are not constrained on how much they can spend. See here for more on this.
While many experts believe that there is an acute possibility of a double-dip recession in the U.S. (see here) and other developed nations, Ken Rogoff is not one of them. And even if we do face the threat, he argues, monetary policy will suffice (if anything, this crisis has demonstrated the ineffectiveness of monetary policy (interest rate management to be more precise) not to be confused with the massive lender-of-last resort operations that the Fed undertook to stabilize the financial system).
Even if there was no threat of a double-dip recession, one could rightly argue that the current high levels of unemployment and underemployment require more government spending. Rogoff’s argument, however, is that sustained high unemployment is the normal consequence of a financial crisis and hence he seems to conclude that fiscal measures to solve the unemployment problem are unnecessary. This is very bad policy advice – we know we have a problem (unemployment), we know how to solve it (public works), but we shouldn’t do so for fear of growth slowing or markets disciplining the government at some indefinite time in the future, a fear based on the wobbly research of Reinhart and Rogoff.
To summarize, the Rogoff and Reinhart research is not a scientific quest but merely a journey with a set destination. It is not based on any sensible theory, and the statistical analysis is of questionable quality as well. Government deficits and debt largely mirror what goes on in the private sector. There are no magic numbers for deficit and debt ratios applicable to all countries and all times. Devising such ratios is a useless exercise.
Even in better times, the U.S. economy is operating with considerably high levels of unemployment and underemployment (see here), underscoring the necessity of government intervention in the economy. In a recession as the private sector cuts back its spending and tries to de-leverage, the role of government, as the only entity in the economy that can run persistent deficits without facing solvency issues, becomes especially important. Regardless of whether there is a threat of a double dip recession, the government should act to solve the unemployment problem through direct job creation TODAY. High levels of unemployment are not compatible with a democratic society.

The CBO’s Misplaced Fear of a Looming Fiscal Crisis

By Eric Tymoigne

The Congressional Budget Office (CBO) has just released an 8-page brief titled “Federal Debt and the Risk of a Fiscal Crisis.” In it you will find all the traditional arguments regarding government deficits and debt: “unsustainability,” “crowding out”, bond rates rising to “unaffordable” levels because of fears that the Treasury would default or “monetize the debt,” the need to raise taxes to pay for interest servicing and government spending, the need “to restore investor’s confidence” by cutting government spending and raising taxes. This gives us an opportunity to go over those issues one more time.

  1. “growing budget deficits will cause debt to rise to unsupportable levels”

A government with a sovereign currency (i.e. one that creates its own currency by fiat, only issues securities denominated in its own currency and does not promise to convert its currency into a foreign currency under any condition) does not face any liquidity or solvency constraints. All spending and debt servicing is done by crediting the accounts of the bond holders (be they foreign or domestic) and a monetarily-sovereign government can do that at will by simply pushing a computer button to mark up the size of the bond holder’s account (see Bernanke attesting to this here).

In the US, financial market participants (forget about the hopelessly misguided international “credit ratings”) recognize this implicitly by not rating Treasuries and related government-entities bonds like Fannie and Freddie. They know that the US government will always pay because it faces no operational constraint when it comes to making payments denominated in a sovereign currency. It can, quite literally, afford to buy anything for sale in its own unit of account.


This, of course, as many of us have already stated, does not mean that the government should spend without restraint. It only means that it is incorrect to state that government will “run of out money” or “burden our grandchildren” with debt (which, after all, allows us to earn interest on a very safe security), arguments that are commonly used by those who wish to reduce government services. These arguments are not wholly without merit. That is, there may well be things that the government is currently doing that the private economy could or should be doing. But that is not the case being made by the CBO, the pundits or the politicians. They are focused on questions of “affordability” and “sustainability,” which have no place in the debate over the proper size and role for government (a debate we would prefer to have). So let us get to that debate by recognizing that there is no operational constraint – ever – for a monetarily sovereign government. Any financial commitments, be they for Social Security, Medicare, the war effort, etc., that come due today and into the infinite future can be made on time and in full. Of course, this means that there is no need for a lock box, a trust fund or any of other accounting gimmick, to help the government make payments in the future. We can simply recognize that every government payment is made through the general budget. Once this is understood, issues like Social Security, Medicare and other important problems can be analyzed properly: it is not a financial problem; it is a productivity/growth problem. Such an understanding would lead to very different policies than the one currently proposed by the CBO (see Randy’s post here).

  1. “A growing portion of people’s savings would go to purchase government debt rather than toward investments in productive capital goods such as factories and computers.”

First, this sentence seems to imply that government activities are unproductive (given that, following their logic, Treasury issuances “finance” government spending), which is simply wrong, just look around you in the street and your eyes will cross dozens of essential government services.

Second, the internal logic gets confusing for two reasons. One, if people are so afraid of a growing fiscal crisis, why would they buy more treasuries with their precious savings? Why not use their savings to buy bonds to fund “productive capital goods”? Using the CBO’s own logic, higher rates on government bonds would not help given that a “fiscal crisis” is expected and given that participants are supposed to allocate funds efficiently toward the most productive economic activity (and so not the government according to them). Second, we are told that “it is also possible that investors would lose confidence abruptly and interest rates on government debt would rise sharply.” I will get back to what the government can do in that case, but you cannot get it both ways; either financial market participants buy more government securities or they don’t.

Third, this argument drives home the crowding-out effect. I am not going to go back to the old debates between Keynes and others on this, but the bottom line is that promoting thriftiness (increasing the propensity to save out of monetary income) depresses economic activity (because monetary profits and incomes go down) and so decreases willingness to invest (i.e. to increase production capacities). In addition, by spending, the government releases funds in the private sector that can be used to fund private economic activity; there is a crowding-in, not a crowding-out. This is not theory, this is what happens in practice, higher government spending injects reserves and cash in the system, which immediately places downward pressure on short-term rates unless the Fed compensates for it by selling securities and draining reserves (which is what the Fed does on a daily basis).

  1. “if the payment of interest on the extra debt was financed by imposing higher marginal tax rates, those rates would discourage work and saving and further reduce output.”

No, as noted many times here, all spending and servicing is done by crediting creditor’s account not by taxing (or issuing bonds). Taxes are not a funding source for monetarily-sovereign governments, they serve to reduce the purchasing power of the private sector so that more real resources can be allocated to the government without leading to inflation (again all this does not mean that the government should raise taxes and takeover the entire economy; it is just a plain statement of the effects of taxation). All interest payments on domestically-denominated government securities (we are talking about a monetarily-sovereign government) can be paid, and have been met, at all times, whatever the amount, whatever their size in the government budget.

  1. “a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates.”

If the US Treasury cannot issue bonds at the rate it likes there is a very simple solution: do not issue them. This does not alter in any way its spending capacity given that the US federal government is a monetarily-sovereign government so bond issuances are not a source of funds for the government. Think of the Federal Reserve: does it need to borrow its own Federal Reserve notes to be able to spend? No, all spending is done by issuing more notes (or, more accurately, crediting more accounts) and if the Fed ever decided borrow its own notes by issuing Fed bonds to holders of Federal Reserve notes (a pretty weird idea), a failure of the auction would not alter its spending power. The Treasury uses the Fed as an accountant (or fiscal agent) for its own economic operations; the “independence” of the Fed in making monetary policy does not alter this fact.

  1. “It is possible that interest rates would rise gradually as investors’ confidence declined, giving legislators advance warning of the worsening situation and sufficient time to make policy choices that could avert a crisis.”

It is always possible that anything can happen, but what is the record? The record is that there is no relationship between the fiscal position of the US government and T-bond rates. Massive deficits in WWII went pari passu with record low interest rates on the whole Treasury yield curve. With the help of the central bank, the government made a point of keeping long-term rates on treasuries at about 2% for the entire war and beyond, despite massive deficits. There is a repetition of this story playing out right now, and Japan has been doing the same for more than a decade. Despite its mounting government debt, the yield on 10-year government bonds is not more than 2% as of July 2010. In the end, market rates tend to follow whatever the central bank does in terms of short-term rates, not what the fiscal position of the government is.

As we already stated on this blog before, a simple observation of how government finance operates shows that government spending injects reserves into the banking system (pressing down short-term interest rate), while the payment of taxes reduces/destroys reserves (pushing short-term rates up). The Fed has institutions that allow it to coordinate on a daily basis with the Treasury (they call each other every day) to make sure that all these government operations do not push the interest rate outside the Fed’s target range.

  1. “If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation.”

That’s a repeat of the first question but with a bit of elaboration. The US government cannot default on its securities for financial reasons, it is perfectly solvent and liquid. (Sovereign governments can, as we have conceded on this blog, refuse to pay – e.g. Japan after the war – but that is because it was unwilling to repay, not because it was unable to pay.) Thus, despite Reinhart and Rogoff’s warnings, the credit history of the US government (and any monetarily-sovereign government) remains perfect. No government with a non-convertible, sovereign currency has ever bounced a check trying to make payment in its own unit of account.

The US government always pays by crediting the account of someone (i.e. “monetary creation”). If the creditor is a bank, this leads to higher reserves, if it is a non-bank institution it leads also to an increase in the money supply. It has been like this from day one of Treasury activities. It is not a choice the government can make (between increasing the money supply, taxing or issuing bonds); any spending must lead to a monetary creation; there is no alternative. Again taxes and bonds are not funding sources for the US federal government; however they have important functions. Taxes help to keep inflation in check (in addition to maintaining demand for the government’s monetary instruments). Bond sales allow the government to deficit spend without creating excessive volatility in the federal funds market. If financial market participants want more bonds, the Treasury issues more to keep bond rates high enough for its tastes; if financial market participants do not want more treasury bonds, the government does not issue to avoid raising rates. The US Treasury (and any monetarily sovereign government as long as they understand it) has total control over the rate it pays on its debts; whether the government understands this or not is another question. A monetarily sovereign government does not have to pay “market rates” in order to convince markets to hold its bonds. Indeed, it does not even have to issue securities if it does not want to. In the US, it is usually the financial institutions that beg the Treasury to issue more securities.

The recent episode of the “Supplementary Financing Program” is a very good illustration of that point. Financial market participants were crying for more Treasuries and the Fed could not keep pace. As a consequence the Treasury agreed to issue more Treasuries than expected to meet the demand and help the Fed drain reserves and thereby hit their interest rate target. According to the Federal Reserve Bank of New York (DOMESTIC OPEN MARKET OPERATIONS DURING 2008, page 28): “To help manage the balance sheet impact of the Federal Reserve’s liquidity initiatives, the Treasury announced the establishment of a temporary Supplementary Financing Program (SFP) on September 17. The program consists of a series of Treasury bills issued by Treasury, the proceeds of which are deposited in an account at the Federal Reserve, draining reserve balances from the banking sector.”

Now look how this was deformed by the Treasury (quite a few journalists and bloggers followed): “The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury’s current borrowing program, which will provide cash for use in the Federal Reserve initiatives.” No, Mr. Treasury, this was not done for funding purpose; it was done to drain reserves from the banking system. The Fed does not need any cash from the Treasury. The Fed is the monopoly supplier of cash.

A final point regarding inflation. Inflation is a potential issue, as we have always maintained. But, there is no automatic causation from the money supply to inflation (a point Paul Krugman appears to have forgotten). Inflationary pressures depend on the state of the economy (supply and demand-side factors). Most importantly, perhaps, it depends on people’s desire to hoard vs. spend cash. Even the massive deficits during WWII, when resources were fully employed, did not lead to a spiraling out of control of inflation. Finally, it is quite possible that causation actually runs the other way around – i.e. from inflation to the money supply – given the endogeneity of the money supply, but that’s a story for another day…


“My alternative proposal on trade with China”

By Warren Mosler*

We can have BOTH low priced imports AND good jobs for all Americans

Attorney General Richard Blumenthal has urged US Treasury Secretary Geithner to take legal action to force China to let its currency appreciate. As stated by Blumenthal: “By stifling its currency, China is stifling our economy and stealing our jobs. Connecticut manufacturers have bled business and jobs over recent years because of China’s unconscionable currency manipulation and unfair market practices.”

The Attorney General is proposing to create jobs by lowering the value of the dollar vs. the yuan (China’s currency) to make China’s products a lot more expensive for US consumers, who are already struggling to survive. Those higher prices then cause us to instead buy products made elsewhere, which will presumably means more American products get produced and sold. The trade off is most likely to be a few more jobs in return for higher prices (also called inflation), and a lower standard of living from the higher prices.

Fortunately there is an alternative that allows the US consumer to enjoy the enormous benefits of low cost imports and also makes good jobs available for all Americans willing and able to work. That alternative is to keep Federal taxes low enough so Americans have enough take home pay to buy all the goods and services we can produce at full employment levels AND everything the world wants to sell to us. This in fact is exactly what happened in 2000 when unemployment was under 4%, while net imports were $380 billion. We had what most considered a ‘red hot’ labor market with jobs for all, as well as the benefit of consuming $380 billion more in imports than we exported, along with very low inflation and a high standard of living due in part to the low cost imports.

The reason we had such a good economy in 2000 was because private sector debt grew at a record 7% of GDP, supplying the spending power we needed to keep us fully employed and also able to buy all of those imports. But as soon as private sector debt expansion reached its limits and that source of spending power faded, the right Federal policy response would have been to cut Federal taxes to sustain American spending power. That wasn’t done until 2003- two long years after the recession had taken hold. The economy again improved, and unemployment came down even as imports increased. However, when private sector debt again collapsed in 2008, the Federal government again failed to cut taxes or increase spending to sustain the US consumer’s spending power. The stimulus package that was passed almost a year later in 2009 was far too small and spread out over too many years. Consequently, unemployment continued to rise, reaching an unthinkable high of 16.9% (people looking for full time work who can’t find it) in March 2010.

The problem is we are conducting Federal policy on the mistaken belief that the Federal government must get the dollars it spends through taxes, and what it doesn’t get from taxes it must borrow in the market place, and leave the debts for our children to pay back. It is this errant belief that has resulted in a policy of enormous, self imposed fiscal drag that has devastated our economy.

My three proposals for removing this drag on our economy are:

1. A full payroll tax (FICA) holiday for employees and employers. This increases the take home pay for people earning $50,000 a year by over $300 per month. It also cuts costs for businesses, which means lower prices as well as new investment.

2. A $500 per capita distribution to State governments with no strings attached. This means $1.75 billion of Federal revenue sharing to the State of Connecticut to help sustain essential public services and reduce debt.

3. An $8/hr national service job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment as the pickup in sales from my first two proposals quickly translates into millions of new private sector jobs.

Because the right level of taxation to sustain full employment and price stability will vary over time, it’s the Federal government’s job to use taxation like a thermostat- lowering taxes when the economy is too cold, and considering tax increases only should the economy ‘over heat’ and get ‘too good’ (which is something I’ve never seen in my 40 years).

For policy makers to pursue this policy, they first need to understand what all insiders in the Fed (Federal Reserve Bank) have known for a very long time- the Federal government (not State and local government, corporations, and all of us) never actually has nor doesn’t have any US dollars. It taxes by simply changing numbers down in our bank accounts and doesn’t actually get anything, and it spends simply by changing numbers up in our bank accounts and doesn’t actually use anything up. As Federal Reserve Chairman Bernanke explained in to Scott Pelley on ’60 minutes’ in May 2009:

(PELLEY) Is that tax money that the Fed is spending?
(BERNANKE) It’s not tax money. The banks have– accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

Therefore, payroll tax cuts do NOT mean the Federal government will go broke and run out of money if it doesn’t cut Social Security and Medicare payments. As the Fed Chairman correctly explained, operationally, spending is not revenue constrained.

We know why the Federal government taxes- to regulate the economy- but what about Federal borrowing? As you might suspect, our well advertised dependence on foreigners to buy US Treasury securities to fund the Federal government is just another myth holding us back from realizing our economic potential.

Operationally, foreign governments have ‘checking accounts’ at the Fed called ‘reserve accounts,’ and US Treasury securities are nothing more than savings accounts at the same Fed. So when a nation like China sells things to us, we pay them with dollars that go into their checking account at the Fed. And when they buy US Treasury securities the Fed simply transfers their dollars from their Fed checking account to their Fed savings account. And paying back US Treasury securities is nothing more than transferring the balance in China’s savings account at the Fed to their checking account at the Fed. This is not a ‘burden’ for us nor will it be for our children and grand children. Nor is the US Treasury spending operationally constrained by whether China has their dollars in their checking account or their savings accounts. Any and all constraints on US government spending are necessarily self imposed. There can be no external constraints.

In conclusion, it is a failure to understand basic monetary operations and Fed reserve accounting that caused the Democratic Congress and Administration to cut Medicare in the latest health care law, and that same failure of understanding is now driving well intentioned Americans like Atty General Blumenthal to push China to revalue its currency. This weak dollar policy is a misguided effort to create jobs by causing import prices to go up for struggling US consumers to the point where we buy fewer Chinese products. The far better option is to cut taxes as I’ve proposed, to ensure we have enough take home pay to be able to buy all that we can produce domestically at full employment, plus whatever imports we want to buy from foreigners at the lowest possible prices, and return America to the economic prosperity we once enjoyed.

*This article first appeared on moslereconomics.com

Can we spend our way out of the recession? Is the fiscal deficit unsustainable? And is it time to cut government spending?

By Eric Tymoigne

If the reader is familiar with history, she or he will note a close similarity between the current policy debates and those of the 1930s; the latest similarity is the proposed spending freeze by the Obama Administration. In the early 1930s, President Roosevelt first criticized President Hoover for engaging in deficit spending and driving the country down the road to ruin, and then proceeded to implement policies that further increased the fiscal deficit of the federal government to about 5% of GDP (a historical record at that time). These policies greatly helped the economy to get out of the Great Depression, but were the subject of ferocious attacks on the ground that the “massive” deficits would lead to the insolvency of the country, uncontrollable inflation, wasteful spending, the taking over of the economy by the government, and, ultimately, the rise of Communism. A cartoon in the Chicago Tribune says it all. Those criticisms were so ferocious and effective at frightening the population that Roosevelt decided to return to a balance budget during the election year of 1936, just like President Obama wants to do.

Did any of those problems actually materialize? As the saying goes “the proof is in the pudding.” There was no government takeover, no rise of Communism, and no insolvency. In fact, Roosevelt proceeded to increase government deficit over 20% of GDP during WWII without any of those problems arising. The non-sense about insolvency and government takeover of the economy have been explained elsewhere on this blog (here and here) and on Bill Mitchell’s blog and no additional time needs to be devoted to that subject. Instead, let us see what the actual consequences of rising federal government deficit (current government outlays minus current government receipts) and rising public debt (the sum of all past and current federal government deficits and surpluses) were.

Staying in the pre-WWII period, unemployment went down steeply to about 10% of the economy, once one removes people employed by government programs from the unemployment data. Even if one just follows the official BLS data (the gray line in Figure 1), unemployment rate was down to 15%. Far from great but much better than 25%. Unemployment would have declined much further if Roosevelt had let the government spending grow. However, political pressures pushed him to limit government spending and government deficit and to actually reduce them massively. This generated a recession in 1937, followed by rising unemployment.

Figure 1. Annual Unemployment Rate in the U.S.: 1890-2009.

The main argument used for counting people employed by the CCC, WPA and other government programs as unemployed, is that those jobs were makeshift jobs not driven by the needs of the private sector. They were wasteful employment not justified by the profit motive. However, while they probably were not profitable, they were extremely beneficial for the welfare of the US population and provided the foundation for the long period of stability after WWII. Here are some of the achievements through June 1940, 3 years before most employment programs ended (NRPB is the National Resources Planning Board’s Security Work and Relief Policy):

Work Projects Adminitration (WPA)
“Through December 31, 1940, some of the tangible accomplishments of WPA projects were as follows: over 560,000 miles of highways, roads and streets constructed or improved; almost 5,000 schools built and 30,000 improved; 143 new hospitals provided and almost 1,700 improved; over 2,000 stadiums, grandstands, and bleachers built; 1,490 parks, 2,700 playgrounds, and more than 700 swimming pools constructed; 19,700 miles of new storm and sanitary sewers laid; over 2,000,000 sanitary privies built. Conservation work included the planting of more than 100,000,000 trees, and the construction or improvement of over 6,000 miles of fire and forest trails. The work in airport and airway facilities included some 500 landing fields and over 1,800 runways. During January 1941, 1,000,000 adults and 37,000 children were enrolled in classes and nursery schools; over 280,000 persons received music instruction and over 67,000 art instruction; and attendance at concerts reached almost 3,000,000 people. Participant hours in various recreational activities totaled almost 14,000,000. Since the beginning of the WPA, welfare activities have included a total of 312,045,000 garments completed by sewing projects and of 85,270,000 other articles, while more than 57,000,000 quarts of food have been canned and almost 600,000,000 school lunches were served.” (NRPB 1942: 342, n.4)
National Youth Administration (NYA)
“Through June 30, 1940, the accomplishments of youth workers on the out-of-school program had included the following: New construction or additions to more than 6,000 public buildings, such as schools, libraries, gymnasiums, and hospitals, and addition to or repair or improvement of about 18,300 others; construction of almost 4,000 recreational structures, such as stadiums, bandstands, and park shelters, and repair or improvement of nearly 6,000 others; construction of 350 swimming or wading pools and 3,500 tennis courts. About 1,500 miles of roads had been constructed and 7,000 repaired or improved; nearly 2,000 bridges had been built. Seven landing fields had been constructed at airports. 188 miles of sewer and water lines had been laid, and 6,200 sanitary privies built. Over 6.5 million articles of clothing had been produced or renovated, nearly 2 million articles of furniture constructed or repaired, and 350,000 tools or other mechanical equipment constructed or repaired. 77.5 million school lunches had been served by NYA youth; nearly 4 million pounds of foodstuffs had been produced and nearly 7 million pounds canned or preserved. Conservation activities had included the construction or repair of 127 miles of levees and retaining walls and 15,700 check and storage dams.” (NRPB 1942: 342, n.5)

Civilian Conservation Corps (CCC)
“Through June 30, 1940, the accomplishments on these [CCC] projects included: The construction of 37,203 vehicle bridges, 21,684,898 rods of fence, and 79,538 mileage of telephone lines; the development of almost 21,000 springs waterhole, and small reservoirs; the building of more than 5 million permanent and temporary check dams in connection with treating gullies for erosion control; as well as the planting, seeding, or sodding of 114 million square yards of terraces for protection against erosion; the planting or seeding of almost 2,000,000 acres of forest land with an average of 1,000 trees to the acre; 5,741,000 man-days spent in fighting forest fires and 5,392,000 man-days in fire presuppression and prevention work; forest-stand improvement on 3,694,930 acres; development of about 55,000 acres of public camp and picnic grounds; stocking lakes, ponds, and streams with 9.3 million fish.” (NRPB 1942: 343, n.8)

The overall cost of running those programs was extremely small, less than 1% of GDP. Despite their limited scope, they helped millions of people to make a living, helped to avoid waste of resources (if they had been left idle), and promoted the growth of U.S. infrastructures. In addition, the large deficit spending flooded the private sector with cash; thereby, restoring profitability and willingness to employ. War deficit spending reinforced this trend by flushing banks and private businesses with money and by creating a long period of financial stability. All this without any sign of insolvency of the federal government.

A final complaint is usually that government deficit always creates huge inflation and even hyperinflation. There is here a ton of data going against this argument. One just needs to look at Japan over the past 20 years: massive debt, very low interest rate, deflation or stable prices. But we do not have to go that far. Here is the United States, the “massive” deficits of the 1930s and 1940s did not generate high inflation.

Figure 2. Annual CPI Growth in the US.

In the 1930s, inflation stayed moderate at about 3%, after WWII inflation did spike to 15% for one year but that was it. And this spike is explained by the disturbances in the production system induced by WWII. After the production capacities were reoriented toward meeting the demands of a peaceful economy, inflation declined tremendously even though public debt was still very high relative to GDP. Today for the first time since 1955, the US economy experienced deflation despite rapidly rising deficits. Thus, there is no automatic relationship between government spending and inflation. It all depends on the state of the economy. If the economy is at full employment, any type of spending (private domestic consumption, private domestic investment, exports, and government spending) leads to inflation. If production capacities are underemployed, as they are today, companies can meet all the additional private or public demand without increasing their prices.

So can we spend our way out of a recession? Yes we can; provided that spending is high enough. Will a sovereign government go bankrupt by doing so? No, it will not. Does government spending lead to inflation? No, it does not. Does bigger government spending mean that the government will take over the economy? No, it does not. Does it mean that all types of spending are equally beneficial? Definitely not. Government spending can be wasteful if there is no improvement in the welfare of society through infrastructure spending, better social programs, and other government spending, preferably employment-enhancing, that improve the standard of living of the population. That is the major critique that one can make about the Obama administration under the guidance of Geithner and Summers. Far too much money was spent on wasteful financial rescues and far too few dollars were used for the benefits of the overall population. The clear example of this is that, while unemployment as leveled off it has not declined significantly. Even more telling is what has happened to the employment-population ratio. The latter has been dropping so much that all the gains of the past 25 years have been eliminated.

Figure 3. Employment-Population Ratio

We need a second “stimulus.” Even better, we need a permanent employment policy that provides a buffer against unemployment through employment-government programs. Those who promote small government do so on the basis of a value system, not on the basis of sound economic arguments or historical data. Unfortunately, this value system is highly dangerous for the well-being of the U.S. population. The alternative is not government takeover but rather using the government in a productive fashion to improve economic well being. Make your voice heard, not just by hanging passively signs in the streets and going to vote, but through massive organized protests and, if necessary, strikes. This is how a healthy democracy works. This is what happens all the time in other democratic countries and this is what this country did in the 1930s with the Bonus Marchers, industrial strikes, and the peasant movements. Want a few ideas to fight for? What about increasing healthcare benefits, eliminating the payroll tax, engaging in massive green infrastructure programs, providing free education in the fields in need (definitely not finance)? Those were the sort of commitments made during the 1930s and they have been hugely popular among the U.S. population, have contributed to the rise of US economic power, and have not affected at all the solvency of the United States. Again the proof is in the pudding: just look at the popularity of Medicare, Social Security, the air transportation system, the highway system and many other achievements of the New Deal and post-WWII policies.

A Plea to the President: Tear Up That Speech

By Stephanie Kelton

My colleague and fellow blogger, Randy Wray, has just argued that President Obama should scrap the speech he’s planning to deliver tonight and surprise the American people with something entirely different. I couldn’t agree more. And while I agree that job creation must be JOB ONE in the months (and years) ahead, I would encourage the President to make massive tax relief the cornerstone of tonight’s speech.
Specifically, the President should call on Congress to support a full and immediate payroll tax holiday. Right now, the government takes away about 15% of our incomes in the form of payroll taxes. With a full payroll tax holiday, a married couple earning $60,000 a year would see their take-home pay increase by about $750 each month. In the aggregate, this will help millions of Americans pay their mortgages, student loans, credit card bills, and so on, while at the same time reducing business expenses (remember that employers contribute to the payroll tax too). All told, a full payroll tax holiday would allow Americans to keep about $1 trillion this year.
So stand before us, Mr. President, and tell us that you want to stop taking this income away from us until we, as a nation, have clawed back every job that has been lost since the start of the recession. Tell us that you intend to take bold steps to protect jobs, keep families intact and provide relief for millions of American businesses. Tell us that you have done all you intend to do to help the banks and the automakers and that you will not accept a jobless recovery — that an increase in economic activity is meaningless without rising employment in good jobs.
And, most importantly, tell us that you refuse to adopt a timeline for cutting the deficit. Tell us that you will not take one dime of payroll taxes away from us until your Administration can declare “Mission Accomplished” on the job front.
Finally, tell the American people that anyone who opposes a payroll tax holiday wants to keep taking hundreds, perhaps thousands, of dollars from them every month. Then watch what happens in 2012.