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Gitlitz on the Dollar
Tweet Share on Facebook November 15, 2007 CommentDavid Gitlitz, the chief economist over at Trend Macrolytics, puts in his two cents about my recent post on whether the White House should rescue the dollar:
A couple points regarding your blog post about the possibility of an "old-fashioned currency intervention." First, such interventions are notoriously and almost invariably futile. That's because they are routinely sterilized by the central banks involved. The Treasury can direct the Fed to buy dollars against foreign exchange but it has no authority to change domestic monetary policy. Thus, unless the Fed elects to change policy simultaneously (which would be extremely unlikely), it will as a matter of course offset the liquidity effect of the currency intervention through open market operations. Thus the net effect on liquidity is zero and beyond some very short-lived speculative churning in the [foreign exchange] markets, the net effect on currency values is also, almost invariably, nil.
That also gets to the real problem facing the dollar which you overlooked—the Fed's policy stance currently is much too easy, resulting in an excess supply of dollars relative to demand. In a floating exchange rate world, currency values are a reflection of the two central banks on either side of the exchange rate. The [European Central Bank] is steady and the Fed is easy and likely to get easier, so the dollar is falling against the euro. In Japan, the [Bank of Japan] is exceptionally easy but confused and nobody can tell what they might do next, so dollar/yen has been bouncing around in a fairly wide range. ... The only reason the dollar looks like it's not sliding so hard against the yen is because it is an extremely weak currency in its own right.
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Is the Iraq War Costlier Than Doing Nothing?
Tweet Share on Facebook November 14, 2007 Comment (3)The Democratic study on the "real costs" of the wars in Iraq ($1.3 trillion) and Afghanistan ($300 billion) from 2002 through 2008 will almost assuredly lead to a common perceptual pitfall. An explanation: Let's assume that the numbers on Iraq are more or less accurate. And let's stipulate for a moment that when you take into account "hidden costs" such as interest payments on new debt to pay for the war, the expense of long-term healthcare for our injured warriors, and the impact of higher oil prices, the total cost of Iraq is indeed twice what the White House has requested from Congress.
Should we then assume that by not waging the war, Uncle Sam would be a trillion dollars to the better? That would be a questionable assumption, a product of a sort of "static analysis" that assumes if you change one critical factor, all the rest stay pretty much the same. Professional futurists, like the ones at the Big Oil companies, know better than that. They give clients a range of scenarios based on different values for different variables. And that is also what three economists at the University of Chicago's business school did in 2006. They looked at the costs of not going to war with Iraq back in 2003. Their study instead examined the costs of containing Iraq.
Advocates for forcible regime change in Iraq expressed several concerns about the pre-war containment policy. Some stressed an erosion of political support for the containment policy that threatened to undermine its effectiveness and lead to a much costlier conflict with Iraq in the future. Others stressed the difficulty of compelling Iraqi compliance with a rigorous process of weapons inspections and disarmament, widely seen as a critical element of containment. And others stressed the potential for Iraqi collaboration with international terrorist groups. To evaluate these concerns, we model the possibility that an effective containment policy might require the mounting of costly threats and might lead to a limited war or a full-scale regime-changing war against Iraq at a later date. We also consider the possibility that the survival of a hostile Iraqi regime raises the probability of a major terrorist attack on the United States.
Factoring in all those contingencies, the authors find that a containment policy would cost anywhere from $350 billion to $700 billon. Now when you further factor in that 1) a containment policy might also have led to a higher risk premium in the oil markets if Iraq was seen to be gaining in military power despite our efforts to box it in, and 2) money not borrowed and spent on Iraq might well have been spent on something else given the White House's free-spending ways, it's easy to see that doing a cost-benefit analysis on "war vs. containment" might have left administration officials with no clear-cut economic answer. (The GOP counter to the Dem proposal can be found here.)
Of course, the White House apparently didn't even bother to do such a cost-benefit analysis. And had it done so, the results should hardly have been the determining factor whether to wage war or not. As U.S. Court of Appeals Judge Richard Posner notes in his blog with the University of Chicago's Nobel Prize-winning economist Gary Becker (neither gentleman participated in the Iraq war study),
All this said, I do not think a decision to go to war should be based on cost-benefit analysis. It would terrify the world if powerful nations conducted cost-benefit analyses of whether to go to war. There are 192 nations besides the United States; should we ask the Defense Department to advise us which ones we should invade because the expected benefits would exceed the expected costs? Might a conquest of Canada produce net benefits for the United States?
You know, those Canadian tar sands do look awfully inviting...
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Will a Consumer Slump Clinch 2008 for the Dems?
Tweet Share on Facebook November 13, 2007 Comment (19)Possible bad news for all the politics junkies out there: The 2008 election may be over tomorrow. Well, pretty much at least. See, tomorrow is when the Commerce Department releases its monthly retail sales numbers. Analysts will be closely monitoring the sales data for signs that the so-far indestructible consumer is finally collapsing under the quadruple whammy of falling housing prices, tighter credit, higher gas prices, and a slowing labor market.
A consumer collapse is essential to the bears' case for a sharp economic slowdown or even a recession. And if that happens, not only does it seem likely the Democrats will take the White House, but it might well be a blowout. Yale political science Prof. Ray Fair, a guy who runs a great political forecasting model, told me the following a few weeks back: If you assume the economy stays relatively healthy—a dip in the fourth quarter but gross domestic product growth close to 3 percent next year—his model is predicting a Democratic win in 2008 with 52 percent of the two-party vote. But if there's a recession, then the Democrats' share would rise to 55 percent.
But will there be a consumer-led recession? A few points on that:
1) Consumers are grumpy. Merrill Lynch economist David Rosenberg points out that over the four months to November, the University of Michigan consumer sentiment index has collapsed by 15.4 points to 75.0. "In the 30-year history of the data series, we've only seen two other times (we are not including the Katrina effect here) when consumer confidence has fallen so far so fast at this critical shopping period for retailers, and they were October 2001 and October 1990—both times the economy was officially in recession."
2) But consumer-led recessions are rare. As Ed Yardeni of Oak Associates notes, consumer spending has detracted from economic growth in just 14 quarters since 1953. What does cause recessions? Yardeni explains:
In the past, a big contributor to economy-wide recessions was residential investment, which has already been a big negative for seven quarters straight through Q3. It may have three more quarters left on the downside. Another big negative during recessions was the change in inventories from accumulation to liquidation, but that's diminished since the late 1980s with better just-in-time controls. Capital spending can also be a big downer, but that's usually after it was a big upper, which hasn't been the case this time.
But as economic Bruce Kasman of JPMorgan explains, corporate America—except for financials—is still in pretty good shape:
If the expansion is to be in jeopardy, it will come through a broad-based corporate retrenchment. A significant pullback in hiring and the work week would quickly undermine labor income and household spending. And the effect likely would be magnified by a fall in equity prices. But the favorable position of the corporate sector argues against such a shift. Inventories are lean, foreign demand growth remains solid, and while profits may have peaked, margins are elevated.
3) Consumers are employed, with more money to spend. The bulls' case from First Trust Advisers: "Our analysis shows that mortgage re-sets will depress consumption growth by no more than 0.2 percentage points per year. Meanwhile, wages and salaries have grown 2 percentage points faster than GDP in the past year. In addition, resources that were going into housing have shifted and are now showing up in other areas of the economy.... This is still the Energizer Bunny economy; it keeps going and going and going."
And what if the retail sales report and subsequent data show the consumer is still healthy and spending? Then you have to start believing that not only will the economy only brake a bit in the fourth quarter, but it will then begin to accelerate in 2008. And in that case, the presidential race is anybody's game.
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Time for the White House to Rescue the Dollar?
Tweet Share on Facebook November 12, 2007 Comment"Paulson is way too cautious; he'll never do it," was the response of a recently departed Treasury Department official when I asked about the chances of Treasury Secretary Hank Paulson ordering up an old-fashioned currency intervention—the last one was in 2000—to reverse the tumbling dollar.
And maybe that's for the best, anyway. Right now the weak dollar is helping boost our exports and offset damage from the battered housing market. And for all the concerns about a weak dollar being inflationary, falling bond yields are screaming that the big risk out there is weak growth, not higher inflation. It would also look a bit hypocritical to prop up the dollar right at the same time we are telling the Chinese to quit propping up their currency.
Plus, getting back to Paulson's caution, what if the intervention failed? What if the global currency markets shook off Treasury action the way bond markets ignored the Fed a few years back, pushing rates lower even as short rates went higher? It's better to be perceived as powerless than to go ahead and remove all doubt.
Yet I will be the first to admit to a visceral repulsion at the sight of the declining greenback, and part of me would love to see Paulson try to give a kick to the keisters of all those dollar bears out there. Still, it's at those moments that it's critical to understand what is really going on with the dollar.
1) The falling dollar is not some international verdict on our trade or current account deficits. For starters, the trade deficit looks to be narrowing—in September, it was at a 2½-year low overall—as a percentage of gross domestic product going forward. But I doubt whether that gap has been a factor in the first place. A more likely factor is greater currency diversification by other countries. As Morgan Stanley currency analyst Stephen Jen astutely notes:
Exchange rates are no longer driven by trade or concerns about trade imbalances. We don't remember the last time someone told us that they were selling the USD because of [the current account] deficit. Rather, more than ever, exchange rates are driven by cross-border flows, e.g., diversification flows by central banks in Asia and the Middle East, and structural portfolio adjustments in the private sector, as "home bias" [the propensity of investors to use their savings to finance domestic investment rather than overseas investment] declines worldwide.
2) Another big reason we are seeing greater global currency diversification is that U.S. economic growth looks shaky because of the mortgage meltdown and credit crunch. Dollar bears are economy bears. The fourth quarter should prove critical in this regard. If the bears are correct, this is the time when the consumer should roll over, helping drag down growth and pushing the Fed to cut rates further. But if the Fed is right, the economy will be strong enough to weather these various crises on its own without further cuts, leading to a reacceleration in 2008. That scenario, plus a narrowing trade deficit, might mean we are seeing the lows for the dollar.
3) The rest of the world matters, and the dollar's retreat, as JPMorgan Chase economist Jim Glassman argues, "is a reflection of a healthier, better-balanced global economy, not the result of 'global imbalance' chickens coming home to roost, as the doomsayers often portray." He notes that the dollar's retreat back to the levels seen in the 1970s and between 1985 and 1995 is as much about booming global growth providing more options for global investors: "The rise of the dollar since the mid-1990s was the result of recessions across Asia, a Japanese economy that was struggling with deflation, and subpar growth in Europe" with the U.S. economy accounting for some two thirds of real GDP growth in the industrialized economies.
4) Forget about a "strong dollar policy." America needs a "strong economy policy," Glassman contends. That means keeping inflation low and economic growth high. With the current political debate focusing on immigration, trade retaliation, and income inequality, I am not sure that will give international investors much confidence that America is actively pursuing a "strong economy policy."
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Why Income Inequality May Actually Be a Good Sign
Tweet Share on Facebook November 9, 2007 Comment (3)While there has been much angst about rising income inequality here in America—though the increase is probably far less dramatic than the surface stats would seem to indicate—we forget that the same thing has been happening in industrialized nations around the world, even ones that have very different tax systems from ours. So with that in mind, I found the results of this study on income inequality from Claudia Goldin and Lawrence Katz of Harvard University most interesting (Efcharisto—that's Greek for thank you—to Andrew Samwick at Vox Baby):
The majority of the increase in wage inequality since 1980 can be accounted for by rising educational wage differentials, just as a substantial part of the decrease in wage inequality in the earlier era can be accounted for by decreasing educational wage differentials.... Although skill-biased technological change has generated rapid growth in the relative demand for more-educated workers for at least the past century, increases in the supply of skills, from rising educational attainment of the U.S. workforce, more than kept pace for most of the twentieth century. Since 1980, however, a sharp decline in skill supply growth driven by a slowdown in the rise of educational attainment of successive U.S. born cohorts has been a major factor in the surge in educational wage differentials. Polarization set in during the late 1980s with employment shifts into high- and low-wage jobs at the expense of the middle leading to rapidly rising upper tail wage inequality but modestly falling lower tail wage inequality.
My humble take:
1) It really is all about education, both here and overseas. Advanced economies, whether America's or Denmark's, are knowledge economies. And knowledge economies reward education. Get a degree, expand your skills, and you will do just fine. (And this doesn't just mean math and science. Right-brain skills like creativity and communication pay off, too.) The unemployment rate in this country for workers with college degrees is a skimpy 2.1 percent.
Remember, two of the Golden Ages of income equality were the 1930s and 1970s, the two worst decades in the 20th century for the economy. The more educated our workforce, the more productive it will be. The secret of economic growth is getting as many people as possible to work as intelligently as possible. That's it. So it's hard to see why raising taxes and reducing rewards for the highly educated—to a great extent the same group as the so-called rich—and entrepreneurs will make our economy more productive. (It's certainly a risky strategy.) We want people to see education as the path to success. Because it is.
2) The Goldin-Katz study is about wage inequality. For total income inequality, you also have to factor in income from owning stocks and bonds. As I have pointed out before, the stock market has boomed far in excess of overall economic growth for the past quarter century. So, anyone who derives income from wages alone probably can't keep up with those who have big stock portfolios. Since 1981, U.S. gross domestic product has doubled to $11.4 trillion, while total stock market capitalization has increased 14-fold. The real economy—the one that pays wages—just isn't growing as fast as the financial economy. Indeed, the sixfold increase in CEO pay between 1980 and 2003 can, according to the research of MIT economist Xavier Gabaix, "be fully attributed to the sixfold increase in market capitalization of large U.S. companies during that period."
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Kudlow: Why This Ain’t the 1970s
Tweet Share on Facebook November 9, 2007 Comment (118)In his blog (check it out for the great charts), CNBC's Larry Kudlow forcefully explains why high oil prices don't mean we're headed toward a return to 1970s-style inflation:
Stocks and bonds are both telling us that this is not the 1970s.... In the 1970s, commodities and the 10-year bond rate both went up together. That was inflationary. Heck, bond rates reached around 15 percent at one point. They've been sliding down for several decades. Now commodities are booming, while bond rates are at rock bottom, hovering just above 4 percent.... Oil prices rose in the 70s. Stock prices fell. That was global inflation. That was high tax rates. That was crazy wage and price controls and over-regulation. Now look at the difference with the 2000s.... Stocks and oil are rising together. That is a global economic growth signal. It is not an inflation signal.... It's all about low tax rates worldwide. It's all about strong, global, free market capitalism creating high demand for commodities. Production can't keep up, that's all that's going on. That's why prices are high. This is not the 1970s. Not by a long shot.
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The Super-Risks of Taxing the Superwealthy
Tweet Share on Facebook November 8, 2007 Comment (1)"We have a tax system that assumes we are the only game in town." That statement, from a recent chat I had with former top Bush administration economist Lawrence Lindsey, came to mind as I read the blog of economist Robert Reich, President Clinton's first labor secretary. Reich recently wrote the following:
The consequence of fiscal austerity and unwillingness to raise taxes on the rich is that America doesn't have the means to lift the bottom half.... There are only two economic philosophies in America—trickle down and bottom up. Trickle down means the rich get richer and pay less taxes. Supposedly they use their extra income to invest in America, which makes all of us more productive. But it doesn't work that way. In a global economy, investments don't trickle down; they trickle out to wherever on the planet the rich can get the highest return. If trickle down worked as advertised inequality wouldn't be widening so fast.... [Democrats must] stop obsessing about balancing the budget and start pushing for a serious tax hike on the rich. Yet all Democratic presidential candidates are styling themselves "fiscal conservatives" and none has suggested raising the marginal tax rate on the richest beyond the 38 percent rate it was under Bill Clinton. They may talk bottom-up economics but they're still wedded to trickle down.
Now compare Reich's "sock it to the rich" argument to this recent hunk of analysis by Harvard economics Prof. Kenneth Rogoff:
Many super-earners are also super-creative and bring enormous value. Places like the United Kingdom actively court wealthy foreign nationals through extraordinary preferential treatment of their investment income. The ultra-rich are an ultra-mobile group, too. If you are earning $540,000 an hour, it does not take too long to save up to buy an apartment, even in London.... Anyway, there are limits to how much tax pressure the political system can apply to the ultra-rich.... Rather than punitively taxing wealth, globalization strengthens the case for shifting to a flat tax on income (or better yet consumption) with a moderately high exemption. Aside from the usual efficiency arguments, it is just going to become increasingly difficult and costly to maintain complex and idiosyncratic national tax arrangements.
My take: Rogoff's comments help explain the air of unreality surrounding much of this presidential campaign. To a great extent, both parties seem to be largely unaware that the U.S. economy is part of a great race—though one where there does not necessarily have to be any losers—called globalization. Some nations, however, will do better than others. America should have policies that make our economy as innovative and competitive as possible. The tax code would seem to be one element of that.
Consider this: Over the past dozen years or so, some 14 nations have adopted flat income taxes, including many of the formerly captive nations of the now defunct Soviet Union. Even Russia has one. The flat tax seems to be a dead issue for now here in America. Not only might global competition thrust it back into the policy limelight, but the great international economic race might also undermine attempts to massively boost taxes on wealthier Americans.
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Economy May Nudge Iraq as a Key 2008 Issue
Tweet Share on Facebook November 8, 2007 CommentPolitical analyst Charlie Cook makes a good point:
It could be that American politics has such a narrow focus that a war in Iraq, a presidential election, the prospect of a nuclear-armed Iran, and the normal flow of legislation [don't] leave much room for other topics of conversation. Or it could be that candidates and elected officials fear that if they raise a problem, they will be expected to suggest a solution, which they are not prepared to provide yet.... It's hard to say exactly why this disconnect exists, but there is little doubt that it does. When voters tell pollsters they are worried about the economy, jobs and where the country is headed, they are usually not addressing specific concerns as much as a broader unease about America's place in the worldwide economy. They worry about long-term prospects for quality jobs rather than a fear of what might happen in the next six months.
My take: If gas prices are sitting at $4 a gallon and home prices are still tumbling come next November, you can be sure the economy will be the major issue—unless cruise missiles are peppering Iran. There is also the possibility that we will be in the middle of an economic reacceleration. But as in 1988, voters may not notice.
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As Goes California, So Goes America? Better Hope Not
Tweet Share on Facebook November 7, 2007 CommentJan Hatzius and the econ team at Goldman Sachs think California's economy is tanking—and that may bode poorly for the economy overall. Their case, in short, is as follows:
1) Historically, every increase in the three-month average of the California unemployment rate by more than 0.6 percentage point has been associated with a national recession.
2) The 3-month moving average of the California unemployment rate now stands at 5.5%, 0.7 percentage point above the cyclical low of 4.8% seen in December 2006.
3) Together with the regional recessions already visible in Florida and Nevada, a California recession would mean that the housing bust has pushed an area responsible for 20% of US GDP into an outright downturn. ... We suspect that a California recession would form one additional argument for additional monetary easing. At a minimum, we would assume that that San Francisco Fed President Janet Yellen will be arguing for another rate cut at the December 11 FOMC meeting.
One more interesting point: In response to the slowdown, Gov. Arnold Schwarzenegger has ordered up big budget cuts. Hatzius opines that "statewide budget cuts may be necessary for California's credit rating, but they also have the potential to exacerbate the slowdown in economic activity."
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Jimmy P. on CNBC: Kudlow & Co. Recap
Tweet Share on Facebook November 7, 2007 Comment (31)I was on Kudlow & Co. last night. (Check out Larry Kudlow's great blog. ) Some observations and extras:
1) Larry interviewed the always personable presidential candidate Bill Richardson, who again touted himself as a pro-growth, tax-cutting Democrat ... which these days apparently amounts to suggesting a bunch of tax credits for favored industries that the government bets are the industries of tomorrow. One issue with that idea is that if venture capital firms have a tough time picking winners, how successful do government bureaucrats figure to be? The bigger issue, though, is that economic growth is not a big part of the Democratic agenda these days. It's almost as if the party views growth as a scam of sorts—25 years of almost uninterrupted growth, as Democrats see it, has brought us only stagnant wages and higher income inequality. Now it's time to redistribute the fruits of that growth through higher taxes on the rich and more government spending on healthcare and education. (Others on the left equate growth with environmental degradation rather than seeing it as a driver of human progress.) Yet Richardson does seem to realize that technology and innovation drive economic growth, which makes everything from Social Security to potential climate change a lot easier to deal with. That's something, I guess.
2) And Al Hubbard, director of Bush's National Economic Council, was touting the president's commitment to free trade. (Hubbard also let slip that the White House will apparently be pushing for a corporate tax cut in its next budget.) Larry asked him about Bush's record on spending. Before the show, I queried budget guru Chris Edwards of the Cato Institute about Bush's spending record and how the budget could have been balanced by now if the administration had shown just a bit of spending restraint. Here is his E-mail response:
Total federal spending in FY2008 is expected to be $2.925 trillion and the deficit $155 billion (per the [Congressional Budget Office's] August update). How might we have instead balanced the budget by 2008? Bush's first year was FY2001, when spending was $1.863 trillion, thus his actual spending increases (2001-2008) have averaged 6.7% annually. If instead, he had limited his annual spending increases to 5.8% annually, we would have a balanced budget this year. (Spending in 2008 would be $2.770 trillion=$2.925-$155 billion.) ... Spending under President Bush has increased an average 6.7% annually. But if he had restrained spending just slightly to 5.8%, the federal budget would be fully balanced in 2008 and the deficit wiped out." ... Fun fact: Bush will be the president who blasts through both the $2 trillion spending mark and the $3 trillion mark.
