What Was the Carter Economic Policy That Reagan Reversed?

Paul Krugman has to remind Greg Mankiw why we use business cycle peaks when trying to remove the effect of the business cycle:

So what you want is to somehow abstract from the business cycle. And the easiest way to do that is to compare business cycle peaks, times when the economy is at more or less full employment. True, employment is fuller at some peaks than at others, but those differences are small, whereas the depth of the slump at recession troughs is much more variable.

But there was something else Greg said that caught my eye:

Weren't the policies of those years precisely what Reagan was trying to reverse?

Perhaps but the most significant long-run macroeconomic change was the transition from the fiscal sanity exhibited throughout most of the 1950’s, 1960’s, and 1970’s to the fiscal irresponsibility of the 1980’s. During the earlier period, net national savings averaged approximately 10% of net national product whereas the national savings rate was about half of that during the 1980’s. I seem to recall in the first edition of Greg Mankiw’s macroeconomics text a very good discussion of how this reduction in the national savings rate increased real interest rates and crowded out investment. Which is one reason why average annual output growth fell from around 3.5% during the earlier period to around 3% during the period of fiscal irresponsibility. Which is of course the whole point when we discuss this Laugher curve insanity that somehow fiscal irresponsibility increases economic growth even though good economic logic says just the opposite.

The Lehman Family

A prominent argument among those who want to avoid a Greek restructuring/workout/default at all costs is that it would trigger a new financial panic, otherwise known as Son-of-Lehman. If contagion spreads to Ireland or Portugal, Greece becomes Number One Son-of-Lehman, while the next in line becomes the Number Two Son-of-Lehman, and so on. If all hell breaks loose, and Spain or even Italy is forced to walk the plank, we could be looking at the Mother of all Lehmans.

And why is this?

It isn’t just the direct exposures of thinly capitalized banks that has Trichet et al. so spooked, it’s all the credit default swaps written against them. We don’t know how concentrated the counterparty positions are, nor how vulnerable the issuers would be in the event of a default. Even worse, we don’t know the volume, structure or anything else about the likely mountain of derivatives piled on top of all those CDS’s. This stuff is unrecorded and, at a system level, entirely unsupervised.

So the question is, have we run through a full Minsky cycle in only three years, or are we seeing another phase in the disorderly unwinding of the great financial pyramid of the 00's?

Payroll Taxes as Stimulus: Speaker Boehner Versus Professor Feldstein

Republicans oppose extending the payroll tax break. John Boehner calls this tax break a “gimmick”. Republican economist Martin Feldstein disagrees.

What really happened in the 1980s and where are we now?

From a personal perspective, the 1980s was an alarming decade. It was that time when our family sought to buy a small rural block of land in the North West of Tasmania, Australia. It was our first major purchase. Within the space of two years however we felt the awful financial consequences of the doubling of land prices combined with extraordinarily high real interest rates on our mortgage. There were few jobs at the time - and low-paid at that - to cushion this dramatic decline in our standard of living and the debt burden that went with it. [1]

So what happened?
Why have we gradually moved into a world where it's taken for granted that both parents go out to work, that a normal household lives under the burden of (often) unprecedented levels of debt and where Fukushima logic in the industrial sphere has left many people with a dreaded fear of humanity's extinction event in the short run? The following economic and social narrative may partly explain what I see as our frightening historical evolution into multiple and ubiquitous tipping points.

World oil production per capita peaked in 1979 [2]. It could be argued that this change occurred - not necessarily as a function of resource depletion - but in direct relation to structural shifts in the national and the global economy that evolved in the previous decades. Consumerism, for instance, "proliferated in the US in the 1920s and 1930s, spread to other industrialised nations after the Second World War, particularly in the 1950s." [3] In addition, the US dollar, as the global reserve currency, became unhinged from gold as the Bretton Woods international trading system gradually collapsed. This currency then morphed into a 'petro-dollar' that sustained US global economic hegemony. Nations that purchased oil were forced to find a way to purchase US dollars.

The nine-fold increase in global oil prices in the 1970s heralded new economic norms around the world. For example, the same material quantity in transactions simply involved greater cash flow. GDP rose whilst economies stagnated. No interest rate policy - including the abandonment of usury limits on interest rates by President Carter - was found to contain inflation from the higher energy prices [4]. Economic bubbles formed.[5]

Profit was shifted to different sectors of the national and global economies. Finance became a big 'winner' as family farms declined dramatically [6].

High energy prices, in turn, translated into reduced consumption. In the corporate sector increased productivity derived from the steady abandonment of environmental controls (including the almost totally unsupervised employment of nuclear energy). Global labour and interest-rate arbitrage by multinationals also produced more profit per unit of labour (productivity again). Workers around the world often simply worked longer hours, if they could find jobs at all. A world 'jobs crisis' steadily gained momentum from the 1970s onwards to present day. [7]

Income inequality began to explode under Reagan and by the end of the 1980s the lax environmental regulation began to translate into poorer health outcomes for citizens [8]. So did the steady global depletion of water and cropland.[9] Ronald Reagan gutted the federal anti-trust authorities in America. "Mergers in finance, communications, entertainment, oil, retailing, and on led to the consolidation of economic power in America." [10] The continuing cultural notion that consumption was an indicator of social achievement also participated concentrating economic and political might into fewer hands.

US Government and its leading allies engaged in rigging the value of major global currencies in an unpredictable fashion in order to counter one financial or corporate profit crisis after another [11] Businesses responded by trying to hedge their bets in this uncertain international trading environment. Asset-backed securities (ABS) became popular in the world of structured finance (derivatives).

In the US major cities and public corporations were being kept from bankruptcy by the tax dollars of ordinary citizens. Meanwhilst most leading international banks were insolvent by every standard except by nomenclature [12]. This was largely due to their improvident long-term loans to Third World countries. These loans were often forced on many US banks by the pressure from government to solve the oil-price-currency overhang in the first instance [13]. "Petro-dollar recycling programs allowed lesser developed nations to purchase oil even as its price skyrocketed, and was actively promoted by the United States." [14] Unsustainable third world debt led to US banks lending further funds to these troubled nations to avoid catastrophic debt default.

By the 1990s the primary contradictions of the global economy were evident: " (i) a contradiction between economic mode of organization and national states, (ii) progressive expansion of fictitious capital, (iii) greater class, ethnic, international and subnational tensions were generated. [15] Neoliberalism had failed to deliver the goods. It was clear that the US, as the world leader in economic growth was doing so by reducing everyone else's.

Capitalism is now in crisis. It's no surprise, after all. Vulnerable nations around the world have been prompted to build up their reserves. Massive trade imbalances ensued as a result. This excessive liquidity from 'emerging' nations and debt-dependent consumption in industrial countries (lower wages/workers using rising asset values on their homes as income) has come to the inevitable bust.

Despite all the rhetoric of 'free markets' that sustained the global neoliberalst agenda, the big corporations of the world's 'military-industrial complex' were bailed out (yet again) by taxpayers. Alarmingly, however, the accumulated debts gathered in the previous 45 years of ponzi capitalism have proved to be beyond the ability of sovereign states to sustain. (But at last, it is no longer possible for the mainstream media to continue to compute the virtues of purely competitive markets to monopoly and oligopoly!)

This month the world's biggest central bank, the US Federal Reserve, is levered 50 to 1. Another bout of quantitative easing seems inevitable as the era of unprecedented monetary expansion goes on and on. The traditional assumption to date has been that "economic growth will return and facilitate the repayment of sovereign loans and mop up the excessive liquidity." [16] This time, however, the reduced energy flows around the world are real! We are in an oil plateau that began in 2004 [17]. In the latter half of this year world oil production has been predicted to go into decline.[18] We have not been blessed with a form of governance that would prepare the world for such a crisis. But that's not the only one.

"Now we have entered an age of growing crisis, of shock piled upon shock: vertiginous food price spikes and oil price hikes, devastating weather events, financial meltdowns and global contagion." Says an Oxfam report published this year [19]. A similar sentiment is repeated in many thousands of forums across the internet.

“The system has reached the stage that a bankrupt sovereign state is issuing debt to buy bonds in a vehicle that is tasked with buying debt from a bankrupt Sovereign state that is no longer able to go to market. Folks this is reaching the level of a Monty Python skit.” [20]

“Are the derivatives regulated? No. Are you still getting growth in derivatives? Yes.”[21]

The situation is evolving very fast. As 30% of people in the US rely on loans taken out against their retirment pensions [22] a list of US President Obama's leading economists are stepping down. [23] As the global food system fails [24] it appears that the student loan crisis could be a bigger financial failure than the housing crisis [25].

Here in Australia the economy is reported to have suffered its worst fall since 1991 as record floods, other natural catastrophe's and obvious government mismanagement of finances and resources devastate the economic base of the nation. [26]

Whilst crowds of people riot in the streets of Greece and many other nations the home in the valley gives me a degree of refuge from the hidden fist of the market.... for the time being. There is also some kind of personal reassurance in having found a rough narrative to help me clarify some of the reasons as to how we may have got to this 'place' we're in now, together. But I don't have the answers. Today's predicament poses demands for great and immediate change. Most immediately I see the demand for a quick evolution of a sustainable indigenous economy.

But what we do on our own probably won't get us very far.

Through others, we become ourselves.[27]

REFERENCES:
[1] In the late 1970s and the early 1980s US households experienced a major debt peak relative to personal income and this phenomenon repeated in other nations.
http://www.doctorhousingbubble.com/wp-content/uploads/2009/06/debt-and-income.png
The rise in debt in the US corresponded with the rise in the price of oil and money.See: https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicF1KsjxYLQyBofMeJcuhrIvlCODyJ_Wqp0plO1htyB2K6hBVLQlBqAQWaXACx2zojveNE5wPAVevdsHSu90JtDxFHIBNjxHyOhyphenhyphenMN4QS9ORQra6-7lq_I7zJ8AUFPBTtjDeb-LQbMaqY/s1600/FRED-FEDFUNDS.png
and
Why Growth is Dead
Thursday, May 12, 2011, 1:47 pm, by cmartenson
http://www.chrismartenson.com/blog/why-growth-dead/57764?

[2] The Peak of World Oil Production and the Road to the Olduvai Gorge
Richard C. Duncan, Ph.D.
Pardee Keynote Symposia, Geological Society of America. Summit 2000.Reno, Nevada
November 13, 2000. …World Energy Production per Capita: 1920-1999
http://www.hubbertpeak.com/duncan/olduvai2000.htm

[3] Stewart Lansley, After the Gold Rush: The Trouble with Affluence: 'Consumer Capitalism' and the Way Forward (London: Century Business Books, 1994), p. 85.

[4] Inflation in the US (according to CPI measures) declined between 1981 and 1983 then began a long-term rise.
The True Meaning Of Inflation
John Tamny, 01.25.10. Forbes magazine.
http://www.forbes.com/2010/01/24/inflation-prices-gold-standard-opinions-columnists-john-tamny.html

[5] Drawing on the observations from Henry CK Liu's article:'The real problems with $50 oil' May 26, 2005
http://www.atimes.com/atimes/Global_Economy/GE26Dj02.html

[6] The Economy in the 1980s
http://countrystudies.us/united-states/history-137.htm
Source: US Department of STate

[7] Duration of unemployment in the US, Bureau of Labor Statistics as found at:
IMF fears 'social explosion' from world jobs crisis
By Ambrose Evans-Pritchard
Published: 11:00PM BST 13 Sep 2010
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/8000561/IMF-fears-social-explosion-from-world-jobs-crisis.html
"America and Europe face the worst jobs crisis since the 1930s and risk "an explosion of social unrest" unless they tread carefully, the International Monetary Fund has warned."

[8] A Perfect Storm of GMOs, Chemicals and Cancer.The Peoples Voice.
By Rady Ananda
http://saladin-avoiceinthewilderness.blogspot.com/2011/03/perfect-storm-of-gmos-chemicals-and.html
+
Cancer From the Kitchen?
By NICHOLAS D. KRISTOF Op-Ed Columnist
Published: December 5, 2009
http://www.nytimes.com/2009/12/06/opinion/06kristof.html?_r=4

[9] In 1999 it was reported that "For the first time since China's great famine claimed 30 million lives in 1959-61, rising death rates are slowing world population growth." The World Watch Institute wrote that the AIDS epidemic and water and cropland shortages problems largely ignored by the international community for years are the major cause. See:
Lester R. Brown, coauthor with Gary Gardner and Brian Halweil of Beyond Malthus: Nineteen Dimensions of the Population Challenge. [1999]
via the World Watch Institute
Can be downloaded at: http://www.worldwatch.org/system/files/EWB110_0.pdf


[10] On Reagan's Birthday We Still Celebrate His Policies That Broke the Middle Class. Jeff Madrick, Senior Fellow, Roosevelt Institute. Posted: February 11, 2011 11:03 AM
http://www.huffingtonpost.com/jeff-madrick/on-reagans-birthday-we-st_b_821893.html

[11] Fed, ECB Risk 1987 Rerun With Policy Drift: Michael R. Sesit
Commentary by Michael R. Sesit, June 13 2008
http://www.bloomberg.com/apps/news?pid=20601039&sid=a8xmvHTtLx18&refer=home

[12] Tappan On Survival. by Mel Tappan.Copyright 1981
http://www.giltweasel.com/stuff/Tappan%20on%20Survival.pdf

[13] See William Greider's 'Secrets of the Temple - How the Federal Reserve Runs the Country'

[14] Cardoso, Eliana and Helwege, Ann. Latin America’s Economy. p.116 and Pastor, Robert A. ed. Latin American Debt
Crisis: Adjusting to the Past or Planning for the Future. p.54 and U.S. Senate Joint Economic Committee Website. As quoted in:
The Latin American Debt Crisis of the 1980s and its Historical Precursors
Alexander Theberge. April 8, 1999

[15] Reader Juan – ‘Hoisted From Comments: Has Neo-Liberalism Failed to Deliver the Goods?’
Naked Capitalism. Saturday, July 5, 2008
http://www.nakedcapitalism.com/2008/07/hoisted-from-comments-has-neo.html

[16] Tipping Point- Near-Term Systemic Implications of a Peak in Global Oil Production. An Outline Review. By David Korowicz
Feasta & The Risk/Resilience Network. 15th March 2010. Reviewed April 1.
http://www.feasta.org/documents/risk_resilience/Tipping_Point.pdf

[17] 'Peak Oil’ : Jimmy Carter’s Secretary of Energy sounds the alarm
Interview with Robert L. Hirsch (1/2)
http://petrole.blog.lemonde.fr/2010/09/16/interview-with-robert-l-hirsch-12


[18] OPEC says oil supply gap looms later this year. 10th June 2011
http://www.reuters.com/article/2011/06/10/us-opec-idUSTRE75924U20110610

[19] Oxfam said in a report entitled "Growing a Better Future: Food Justice in a Resource-Constrained World”
Hunger crisis worsens, food system broken - Oxfam
Reuters, Tuesday May 31 2011
http://www.guardian.co.uk/business/feedarticle/9672289

Report at: http://www.oxfam.org.uk/resources/papers/downloads/growing-a-better-future-010611-en.pdf

[20] Jack Barnes. 2011
http://jackhbarnes.com/2011/01/13/european-rescue-fund-needs-rescuing/

[21] Mobius Says Another Financial Crisis ‘Around The Corner’
By Kana Nishizawa - May 30, 2011 9:10 PM GMT+1000
http://www.bloomberg.com/news/2011-05-30/mobius-says-fresh-financial-crisis-around-corner-amid-volatile-derivatives.html

[22] 30% Of People With A 401(k) Have Taken Out A Loan Against It: New All Time Record
Tyler Durden's picture
Submitted by Tyler Durden on 06/09/2011 18:47 –0400
http://www.zerohedge.com/article/record-number-people-have-taken-out-loan-out-against-their-401k

[23] Top White House economist Goolsbee steps down
6th June 2011
http://www.reuters.com/article/2011/06/07/us-usa-obama-goolsbee-idUSTRE75603120110607

[24] How The Global Food System Is Failing
Free Internet Press.Intellpuke
Wednesday, June 1, 2011
http://weeklyintercept.blogspot.com/2011/06/free-internet-press-intellpuke-domingo.html

[25] The Next Bubble Is About to Burst: College Grads Face Dwindling Jobs and Mounting Loans
By: ActivistPost
http://www.activistpost.com/2011/06/next-bubble-is-about-to-burst-college.html

[26] Economy suffers worst fall since 1991
By online business reporter Michael Janda
1st June 2011
http://www.abc.net.au/news/stories/2011/06/01/3232602.htm

[27] L. S. Vygotsky, The History of the Development of Higher Mental Functions

Tim Pawlenty on Tax Revenues During the 1980’s

Lawrence O’Donnell featured Bruce Bartlett to have an intelligent and honest discussion of tax rates and tax revenues. This feature starts with Tim Pawlenty repeating a very discredited claim – that the 1981 tax cuts led to tremendous economic growth almost doubling Federal tax revenues during the 1980’s. We’ve gone over this so many times but let’s do this again.

Table 2.1 from this source does show that total Federal receipts rose from around $517 billion in 1980 to around $1031 billion in 1990, which is what Pawlenty is talking about. But note that this includes payroll taxes which rose from around $158 billion in 1980 to $380 billion in 1990 – a 141% nominal increase. Other Federal taxes (mainly individual income and corporate profits) taxes rose from $359 billion in 1980 to $652 billion in 1990, which represents a 81% increase. A little reminder for Governor Pawlenty – we increased payroll tax rates during the 1980’s.

Bruce Bartlett reminded us that prices rose during the 1980’s – in fact the GDP deflator was over 51% higher in 1990 than it was in 1980. In 1980 dollars, other Federal revenues were only $431 billion. So in real terms, revenues rose only by 20%. Had we left tax rates alone and had we enjoyed the 3.5% average annual growth rates that we had for the period from 1951 to 1980, real revenue growth should have exceeded 40%. But we not only had lower tax rates but we also enjoyed lower real GDP growth during this period. Any serious student of fiscal policy knows this. The next President should know this. And maybe Tim Pawlenty knows all of this – which would mean that he hopes you don’t so he can continue lying to you!

Are We Heading For Banana Republicanization?

Just back from Ecuador, which just happens to have been the world's largest exporter of bananas since the late 1940s, although oil has been ahead of that popular fruit since the late 60s in export earnings (mangoes, shrimp, flowers, and Panama hats [originally from Ecuador] are other biggies). Since full independence in 1830, the country has had 22 constitutions, the most recent apopted in 2006, and numerous military coups. Between 1997 and 2006, the place had seven presidents and a major financial crash that led to dollarization of the economy (although the coins continue to have Ecuadorian figures on them, except for the popular use of the Sacajewea US dollar coin).

In 2006, charismatic economist, Rafael Correa, was elected president and has been reelected since. He has recently been having referenda on allowing him greater control over the media and judiciary and had Hugo Chavez in the week prior to my being there. He claims to chart a course between Chavez and Brazil's Lula, but has made no moves to de-dollarize and is reportedly close to the Catholic Church.

However, the military remains the most powerful entity in the country, reputedly owning many businesses and prior to 1995 receiving half the oil revenues directly. On this past September 30, police were demonstrating against budget cuts proposed by Correa. He went to speak with them, but ended up confined in a hospital by demonstrating police. The military came in and fought with the police, resulting in nine dead and many more injured. The military is now more openly calling the shots.

Many have commented that the US has two paths it can go: more in a European direction or more in a Latin American direction. With our accelerating inequality, our increasing partisanship leading to a breakdown of the ability of established institutions to make decisions (will the Congress really raise the debt ceiling while cutting $2 trillion in spending without raising taxes or will we just default as many seem to want?), the longer term trends in the US may well be leading us to a point where many may despair of democratic decisionmaking processes and long for a "strong hand" to fix up our messes for us. This was the sort of thing that went on in the 30s, and if things do not pick up reasonably soon, the more unpleasant voices may gain strength.

A Tax Break for the “Job Creators” That Will Not Increase Jobs

David Kocieniewski should get high marks for excellent reporting. He starts by noting a supply-side proposal and its rhetoric:

Some of the nation’s largest corporations have amassed vast profits outside the country and are pressing Congress and the Obama administration for a tax break to bring the money home … Under the proposal, known as a repatriation holiday, the federal income tax owed on such profits returned to the United States would fall to 5.25 percent for one year, from 35 percent. In the short term, the measure could generate tens of billions in tax revenues as companies transfer money that would otherwise remain abroad, and it could help ease the huge budget deficit. Corporations and their lobbyists say the tax break could resuscitate the gasping recovery by inducing multinational corporations to inject $1 trillion or more into the economy, and they promoted the proposal as “the next stimulus” at a conference last Wednesday in Washington. “For every billion dollars that we invest, that creates 15,000 to 20,000 jobs either directly or indirectly,” Jim Rogers, the chief of Duke Energy, said at the conference. Duke has $1.3 billion in profits overseas.

If you are thinking we tried this a few years ago, David reminds us that we did:

But that’s not how it worked last time. Congress and the Bush administration offered companies a similar tax incentive, in 2005, in hopes of spurring domestic hiring and investment, and 800 took advantage. Though the tax break lured them into bringing $312 billion back to the United States, 92 percent of that money was returned to shareholders in the form of dividends and stock

David cites this analysis:

Repatriations did not lead to an increase in domestic investment, employment or R&D -- even for the firms that lobbied for the tax holiday stating these intentions and for firms that appeared to be financially constrained. Instead, a $1 increase in repatriations was associated with an increase of almost $1 in payouts to shareholders. These results suggest that the domestic operations of U.S. multinationals were not financially constrained and that these firms were reasonably well-governed. The results have important implications for understanding the impact of U.S. corporate tax policy on multinational firms.

If all of the repatriated earnings go to dividend payments and none to new investments, then no jobs get created - even if the “job creators” get this tax break!

A Garden Variety Recession?

Mark Thoma features the “debate” between Brad DeLong and Jim Grant. Brad has a nice summary of this debate. Mark Sadowski in a comment over at Mark’s place alerts us to an interview with Mr. Grant by none other than Lawrence Kudlow:

Kudlow: Look, you’ve got some pretty convincing stuff [in Grant’s Observer]. This is the most stimulus we have ever seen. I think what you’re saying is the Fed has poured in 18 percent of GDP. Fiscally, spending and taxing 12 percent of GDP. Those are world records. But this isn’t even the worst downturn.

Grant: By the numbers, this is a garden-variety recession. So far, statistically, on the GDP numbers, it is ordinary. What is extraordinary of course is Wall Street’s self-inflicted wounds in credit. However, what is truly momentous is the government’s response. Nothing like it. So there have been 11 recessions/depressions since 1929. On average, the sum of the fiscal and the monetary response as we index them is like 2.9 percent of GDP.

A garden-variety recession this one is not. By Kudlow thinks Grant is “smart”. Kudlow is overestimating the amount of fiscal stimulus with his 12% claim. I suspect he is counting the decline in tax revenues as a result of the recession as part of the fiscal stimulus. But how does one take stock numbers represented exchanges of assets (monetary policy) and call that additions to expenditure flows (18% of GDP)? Most economists would argue that we have had too little stimulus for such an enormous recession but these two clowns think the stimulus is a “world record” while the recession is very modest.

Fiscal Policy: Lamar Alexander Has It Exactly Backwards

Brian Beutler reports on the “logic” of two Republicans opposing President Obama’s proposal to extend the payroll tax relief. One of the opponents is Senator Lamar Alexander:

We don't need short-term gestures, we need long-term strategies that build into our system simpler taxes, lower taxes, fewer mandates, lower costs, more certainty, any changes in the debt structure of tax reform ought to come out of the Vice President's talks or part of a major tax reform.

The current unemployment problem is one of a lack of aggregate demand, which is precisely a short-term problem. The long-run fiscal policy problem, however, is the deficit. Clearly what we need is short-term fiscal stimulus with long-term fiscal restraint. Of course, Senator Alexander is simply echoing the standard Republican mantra. Which is why the leaders of this party should not be trusted with macroeconomic policy.

Fiscal Deficits and the Bond Market Vigilantes

Tim Duy is channeling Hamlet, torn between his concern over mass unemployment in a stagnant economy and his fear that an attack on the dollar could be just around the corner. I think he is right that we came close to a disorderly decline in the dollar during the period leading up to the financial crisis, but it’s a big mistake to think that slashing fiscal deficits is any sort of insurance against a return of this threat. On the contrary, big government deficits are exactly the result of credit contraction in the private sector.

Duy gives us a FRED visual on capital inflows to the US economy; I’m reproducing it here.


Inflows ballooned from the mid 90s until the onset of the financial crisis. This was not a period of outsized fiscal deficits, however; it was the private economy (housing but not only) that ran up the tab. When the bubble popped, it was left to the Fed/Treasury combo to transfer debt from those who couldn’t finance it (households and financial institutions) to those who could (taxpayers). Unless you have a plan to turn a chronic current account deficit into a surplus within the next year or two, this is exactly what financial recovery in the private sector means: fiscal deficits. It’s the macro identity.

(Remember, this is not a functional relationship. It has nothing to do with what people want, choices they make, or probable consequences of their actions. It is an identity. If the private sector overall is to pay down its net debt, in the absence of a change in the balance of payments it is equivalent to saying that the government is taking it on.)

What the Eurozone crisis teaches us, in case we didn’t know it from centuries of prior experience, is that it is a country’s external position, whether it borrows from or lends to the rest of the world, that determines how much confidence there will be in its financial assets. Greece ran up fiscal deficits and got hammered. Ireland and Spain maintained orthodox fiscal policies but had private sector debt binges and got hammered. What they all have in common is that they ran up unsustainable external deficits year after year.

And the US? As Fred’s chart shows, the financial crisis brought about a sudden but transitory collapse in our external borrowing, and now it’s back on the increase. In fact, it appears that only the anemic condition of our economy compared to some of the emerging high-flyers, has kept our borrowing below crisis levels.

Yes, we need expenditure-switching—more exports, fewer imports—but we’re not getting nearly enough of it. A softening of the dollar would help, but we would need consent from our main trading partners to accept a drastic reduction in their trade surpluses, and, in any case, it will take years to undo the structuring of the US economy around imported resources and consumer goods. (Adaptation to credit-driven consumption has gone on for so long it may have become a cultural issue. Political economic considerations also apply, as I’ve argued earlier.)

What will do absolutely no good at all is fiscal retrenchment. It will cause hardship for millions and provide no protection against the risk of a future collapse of US asset values. On the contrary, if households respond to a shortfall in income by ramping up their borrowing again, dollar-denominated assets will once again enter the danger zone. Slashing fiscal deficits is like fighting a war by firing on our own troops.

John Taylor on Pawlenty’s 5% Growth for a Decade Claim

Tim Pawlenty may be getting a lot of criticism for his claim that we can achieve 5% growth for an entire decade but John Taylor argues that this “is not some pie-in-the-sky number”. It is a real stretch, however, especially once one looks at all the assumptions that Dr. Taylor has to make to get even close to this “aspiration”. Taylor starts with the recognition that the employment to population ratio is dismally low:

Currently the percentage of the working-age population (age 16 and over) that is actually working is very low at 58.4 percent. In the year 2000 it reached 64.7 percent, so that is at least a feasible number. Raising the employment-to-population ratio to 64.7 means an employment increase of 10.8 percent (64.7-58.4/58.4 = .108) or about 1 percent per year over 10 years, even without any growth of the population. Adding in about 1 percent for population growth (from Census projections), gives employment growth of 2 percent per year.

I have a couple of quibbles with this even if I earlier sang a similar tune. First of all – cutting government purchases now will likely mean less aggregate demand. I guess Dr. Taylor has joined Pawltenty is failing to recognize the Keynesian nature of the Great Recession. Secondly, I had been chastised by a few smart conservative economists for believing we could get back to a 64.0% employment to population ratio so this notion that 64.7% is feasible does seem like a stretch.

Taylor also seems to think we can get back to the 2.7% productivity growth witnessed during the “IT revolution” of the late 1990’s. Count me as being less optimistic. But his last paragraph is where this really falls off the cliff:

You can see how the types of pro-growth policies in the Pawlenty plan would work toward the goal by reducing spending growth enough to balance the budget without tax increases and thereby remove threats of a debt crisis; by lowering marginal tax rates to spur hiring and job growth; by scaling back unnecessary new regulations which impede private investment and higher productivity, and by restoring sound monetary policy to remove uncertainty about inflation or another financial crisis.

The Laugher Curve in its fullest glory! Pawlenty wants massive tax reductions which are not going to be offset by spending cuts in the real world. So his plan if enacted is likely to be deficit increasing. And at some point when we do eventually get back to full employment – this fiscal insanity will lead to crowding-out of investment.

Is US Commercial Real Estate Sinking To New Lows Or Zooming Towards Its Old Peak?

Amazingly enough, the two leading indices of commercial real estate (CRE) in the US are completely at odds regarding this. Broadly based Moody's Investors Service that tracks closing prices of a broad base of CRE finds that as of the end of March average CRE prices were 47% below their peak observed in October, 2007 and still sinking, http://www.calculatedriskblog.com/2011/05/moody's-commercial-real-estate-prices.html .

OTOH, Green Street Advisors who track reported prices of a subset of CRE that is owned by 80 leading REITs find that after peaking in mid-2007, CRE declined to a low point at 60% of that level in November, 2009, when it turned around and is now at 90% of the peak level and readily rising, http://www.greenstreetadvisors.com . The data from this source has led some to even declare that the wonderful performance of the supposedly more free market CRE compared to the ongoing slump in residential real estate shows how government interventions in housing markets have been the source of all our problems, http://www.coordinationproglem.org/2011/06/recalculation-in-the-commercial-real-estate-market.html .

So, what is up? As far back as 10/27/10, Alex Finkelstein at World Property Channel discussed what was already a large divergence between these two at http://www.worldpropertychannel.com/us-markets/commercial-real-estate-1/real-estate-news-green-street-advisors-moodys-investors-service-jeung-hyun-adelante-capital-management-mike-kirby-michael-gerdes-john-maynard-keynes-3388.php . In this he interviewed the directors of research at the two outfits and got the following.

From Mike Kirby at Green Street Advisors, the optimistic firm, he got "Yes, it's subjective" in terms of their approach, which focuses on large individual transactions. Kirby went on to quote Keynes: "We would rather be roughly right rather than precisely wrong," as he supported the idea that by then CRE had already been rising for nearly a year.

From Michael Gerdes of Moody's he got "We are trying to capture the entire market, not just a subset of institutional quality assets."

A bottom line would appear to be that there is a massive divergence within commercial real estate. There are certain regions and sectors where "high quality" CRE is booming, and these are the items that stock the portfolios of the recently rising REITs. However, the larger mass of CRE in the majority of the economy is doing just the opposite and tracking the housing market, if with some lags: down and still falling with no clear bottom in sight.

Pawlenty’s Economic Goal is Almost Right

Benjy Sarlin notes that one GOP Presidential hopeful is being criticized by GOP economists:

Tim Pawlenty drew widespread ridicule from experts across the political spectrum on Wednesday for his wildly optimistic economic plan. Pawlenty unveiled his platform at a speech in Chicago, a combination of tax reforms and budget cuts that he said would yield an explosive economic recovery. The centerpiece of his proposal was setting a goal of 5% economic growth per year for a decade. "Growing at 5% a year, rather than the current level of 1.8%, would net us millions of new jobs," he said. "Trillions of dollars in new wealth. Put us on a path to saving our entitlement programs. And balance the federal budget."But a group of former CBO directors, who are chosen by Congress to analyze the budget from a nonpartisan perspective, are lambasting the number, saying it's completely out of line with any mainstream assessment of the American economy."The trend growth rate is not going to be 5% in the United States," Douglas Holtz-Eakin, director of the CBO under President Bush and a top GOP advisor, told TPM. "The market just doesn't support that. It just doesn't."

Five percent growth for an entire decade may be “out of line with any mainstream assessment of the American economy” but with a GDP gap near 10 percent and potential GDP growing at about 3 percent per year, 5 percent growth for the next five years strikes me as a very laudable goal.

My problem with Tim Pawlentry is not his policy but with his proposed policies. The GDP gap is due to a lack of aggregate demand. Budget cuts will only serve to further depress aggregate demand.

Republican Revolution

How is it that a minority party can impose its will on the country, while the Democrats were relatively slow to move, even in the midst of the Great Depression? How is it that the Republicans can take the anger that welled up against capital and turn it against labor?

A View From The Puerta Del Sol

I have just returned from nearly a week in Spain, delivering a plenary address at a conference on nonlinear economic dynamics in Cartagena. I also spent a day in Madrid. Spain has the highest unemployment rate in Europe, as high as 40% for youth, and many think that it is the linchpin to maintaining the eurozone, with Germany and the other big countries able to manage defaults and bailouts for Greece, Ireland, and Portugal, but not for Spain. There have been people camping out in the main squares of cities around Spain, and the conservative opposition party has just swept the local elections big time. There was a small group camping out in Cartagena. People there were speaking out and singing in the evening.

However, the biggest group camping out is in Madrid, in its central square, the plaza of Puerta del Sol. I visited this area and walked through the encampment that fills the plaza, actually a long half-oval rather than a square. There were many tents and also tables with people selling stuff and handing things out under canvasses. There signs and all kinds of things, including posters and sculptures and whatnot all over the place, exhibiting a plethora of views and on many issues, not all about unemployment, with green issues and support for Arab Spring demonstraters among other matters focused on. I would also say that while the ideological strand tended more to the left, with many denunciations of capitalism and imperialism, some of it was a lot less clear, with many denunciations of bankers and also of "Europe," possible from either end of the spectrum (there was a particularly bizarre sculpture of a "vampiro banquero"). There were two pictures of Friedrich Nietszche in different spots, whose views and fans have been rather all over the place, and I saw no hammers with sickles.

Emblamatic of the rather foggy, quasi-anarchistic mood and views there was a large poster on the wall of one of the buildings. It showed a nebbishy looking man, sort of like Woody Allen, no beard or moustache, with rimless round spectacles, in an exaggerated military uniform and his right arm clearly raised, although cut off before the image got too far from his shoulder. However, he was also clearly wearing a shirt with a tie, and on his head was an oversized military hat, but with enormous Mickey Mouse ears on it. I could not fully read the label under this image, but it looked something like "Non No Represendar."