People often ask me why we can’t let banks and organizations such as CITI and AIG just fail. The answer is simpler than most of us would expect. First it is important to think of the economic system as an organism comprised of a series of interrelated systems similar to the human body. The banking system is the circulatory system of the economy; Money is the blood of the economy. If an artery, such as a major bank, gets clogged some other major organ may fail or be severely impaired. We can equate the failure of major financial institutions to the clogging of arteries that lead to cascading organ failure. Clogging of the renal artery can lead to kidney failure. We can survive with one missing kidney but a loss of both will kill the organism. A bad kidney can lead to a bad liver which can affect other organs. CITI or AIG going under can lead to a cascading collapse of other banks and financial institutions to the extent that the whole organism we call an economy can die. Therefore it is necessary to prevent the total failure of these organizations.
However, this does not mean that we must preserve the plaque that got us into trouble to begin with. Just as arteries can be opened using stints and plaque can be reduced with Statins, financial institutions may need a complete change in the clogging agent known as outdated management. In addition, a pacemaker (regulatory agency) and regular check-ups (audits) may need to be added to keep the system healthy.
Saturday, March 07, 2009
Friday, March 06, 2009
REAGANOMICS AND FISCAL RESPONSIBILITY
Whenever I hear the minions of the Republican Party, and the right wing goofballs such as Rush Limbaugh, screaming about the Democratic Party’s lack of fiscal responsibility I am dumbfounded by their self deception. The fact is that history shows our worst years of fiscal responsibility have occurred under Republican Administrations. Data on the Federal Debt as a percentage of GDP, generated by the OMB, demonstrates this.
From 1960 through 1980 there was a general decline in Federal Debt as a percentage of GDP from 56% to 33.1%. However, with the beginning of Reaganomics in 1981 we can see a sharp increase in this percentage. It continues to grow sharply throughout the Reagan and Bush senior years. As stated earlier in 1980 the debt was 33.1% of GDP. Republican prolificacy led the percentage to top out at 67.3% in 1996. Throughout the balance of the Clinton years the value dropped. In 2002 it was down to 59.2%. With Bush junior’s ascendance to the presidency there was a sharp increase in debt until it is projected to reach 67.5% when the final figure for fiscal 2008 is in.
Somehow the Republicans have managed to deceive the press and the public into believing their myth of Fiscal Responsibility. I guess they have learned well from Joseph Goebbels: If you tell a big enough lie often enough people will begin to believe it. When will the press start doing its job and start challenging the deceptions of the right?
From 1960 through 1980 there was a general decline in Federal Debt as a percentage of GDP from 56% to 33.1%. However, with the beginning of Reaganomics in 1981 we can see a sharp increase in this percentage. It continues to grow sharply throughout the Reagan and Bush senior years. As stated earlier in 1980 the debt was 33.1% of GDP. Republican prolificacy led the percentage to top out at 67.3% in 1996. Throughout the balance of the Clinton years the value dropped. In 2002 it was down to 59.2%. With Bush junior’s ascendance to the presidency there was a sharp increase in debt until it is projected to reach 67.5% when the final figure for fiscal 2008 is in.
Somehow the Republicans have managed to deceive the press and the public into believing their myth of Fiscal Responsibility. I guess they have learned well from Joseph Goebbels: If you tell a big enough lie often enough people will begin to believe it. When will the press start doing its job and start challenging the deceptions of the right?
Thursday, March 05, 2009
HAVE WE LOST CONFIDENCE IN OBAMA?
If you read the current press or watch television news you may have heard that Americans have lost confidence in President Obama's ability to engineer an economic recovery. This is despite the fact that he is very popular. The real problem is that the media in their stupidity has given credence to the latest scam of the obstructionists from the right.
The over-riding issue is that the right wing, who believe that government has no role to play, has spent so much time talking about how Obama's plans couldn't work that the economically ignorant press has begun to believe them. If Obama’s plans fail it is because the right has been obstructing so much of anything he tries to do that the people have lost confidence not in him but in the whole political process. When Rush Limbaugh says he wants Obama to fail and Rick Santorum, a light of the "Right" agrees, we find we are all in trouble. The right has learned that expectations have an awful lot to do with how an economy operates. If they can destroy positive expectations then the failure of the recovery can move the right into power in 2012.
Rush and his ilk are traitors. They are more interested in their regaining power than they are in the health of the country. Their governors’ refusal of stimulus funds borders on criminal behavior and implications that they can refuse to follow laws they believe to be unconstitutional is a step toward cession and a new civil war. They would rather see a failure of the republic than allow their opponents any semblance of success.
The over-riding issue is that the right wing, who believe that government has no role to play, has spent so much time talking about how Obama's plans couldn't work that the economically ignorant press has begun to believe them. If Obama’s plans fail it is because the right has been obstructing so much of anything he tries to do that the people have lost confidence not in him but in the whole political process. When Rush Limbaugh says he wants Obama to fail and Rick Santorum, a light of the "Right" agrees, we find we are all in trouble. The right has learned that expectations have an awful lot to do with how an economy operates. If they can destroy positive expectations then the failure of the recovery can move the right into power in 2012.
Rush and his ilk are traitors. They are more interested in their regaining power than they are in the health of the country. Their governors’ refusal of stimulus funds borders on criminal behavior and implications that they can refuse to follow laws they believe to be unconstitutional is a step toward cession and a new civil war. They would rather see a failure of the republic than allow their opponents any semblance of success.
Saturday, February 07, 2009
DO WE DESERVE THIS?
Someone once said that we get the government we deserve. My problem is that I cannot fathom what grievous harm we’ve done to the world to get the congress we have today. We have both Republicans and Democrats screaming that we have a spending program instead of a recovery program on the table. My guess is that all of them failed their Introductory Economics course or they decided that nothing in the field developed after 1899 has any relevance. Our illustrious elected leaders seem to forget that spending is economic stimulus. When Republicans complain that the New Deal took too long and we needed WWII to get out of the depression, they are ignoring the fact that it was the stimulus spending for WWII that finally ended the depression. Even FDR had a tough time spending enough to end the disaster. Now Republicans and some conservative democrats are complaining that President Obama is spending too much. These naysayers are going to end up extending the problem through under spending.
I can understand why the Republicans might want to do this. They believe that they can win the mid-term congressional elections if they make sure that a recovery doesn’t take place. They are willing to see the country go down the tubes in order to gain an electoral victory in 2011. They bring out the old saw of giving money to business to get the economy moving. They believe in something called “Say’s Law” which states that supply creates its own demand. The problem is that nobody in his/her right mind is going to produce goods in the absence of demand. Without an increase in demand, reducing the cost of labor merely increases business profits without increasing employment.
It is time to get tough and call the obstructionists to the carpet. I would use their old saw and state that they are threatening the security of the United States. I would not hesitate to call them traitors who are more interested in lining the pockets of the internationalist multi-national corporations than they are in the security of America. Progressives have, for too long, been too timid in their pursuit of their goals. They have tried to appeal to the mind. It is now time to use the tactics of the conservatives and start appealing to the gut. In 1932 the USA could have gone the way of Germany and Italy or the way of Russia. We found a third way through FDR and the new deal. If the conservative have their way, I’m afraid that our fate will be to resemble Mussolini’s Italy.
I can understand why the Republicans might want to do this. They believe that they can win the mid-term congressional elections if they make sure that a recovery doesn’t take place. They are willing to see the country go down the tubes in order to gain an electoral victory in 2011. They bring out the old saw of giving money to business to get the economy moving. They believe in something called “Say’s Law” which states that supply creates its own demand. The problem is that nobody in his/her right mind is going to produce goods in the absence of demand. Without an increase in demand, reducing the cost of labor merely increases business profits without increasing employment.
It is time to get tough and call the obstructionists to the carpet. I would use their old saw and state that they are threatening the security of the United States. I would not hesitate to call them traitors who are more interested in lining the pockets of the internationalist multi-national corporations than they are in the security of America. Progressives have, for too long, been too timid in their pursuit of their goals. They have tried to appeal to the mind. It is now time to use the tactics of the conservatives and start appealing to the gut. In 1932 the USA could have gone the way of Germany and Italy or the way of Russia. We found a third way through FDR and the new deal. If the conservative have their way, I’m afraid that our fate will be to resemble Mussolini’s Italy.
Friday, January 23, 2009
THE CONSERVATIVE AGENDA
Now that President Obama has submitted a stimulus package I am struck by the fact that the Republican in have returned to their standard of trying to stimulate business through tax breaks and tax credits. They use the excuse that businesses will hire more people if government would only give businesses tax credits for every additional person they hire. The problem is that this is pure bull ****. The demand for labor is derived from the demand for the goods and services businesses sell. When businesses get stimulus credits they are only applying for money based upon people they would have hired anyway. They believe that they are not doing anything wrong because they feel that the money is going for hiring people and since they’re hiring, why shouldn’t they get the stimulus money. The forms that are completed merely move numbers around to prove that the stimulus got them to do the hiring. It is a shell game on a massive scale.
To understand what I’m talking about you only need to look at the CFO.com article of Sept. 24, 2005 entitled “Tax Breaks Don’t Boost Investment.” This article looked at the effect of tax credits on business investment and found that the companies with tax breaks cut their investments by 22%. The article concluded that investment was based more on the demand for a company’s goods than on the cost of making the investment. In other words, the demand for any production input is based upon the demand for the goods and service the inputs produce not on an artificially reduced price of the input. The only effect of the incentives is to increase after tax profits. Investing in tax credits for hiring will get you the same returns as you would have earned with Bernie Madoff.
To understand what I’m talking about you only need to look at the CFO.com article of Sept. 24, 2005 entitled “Tax Breaks Don’t Boost Investment.” This article looked at the effect of tax credits on business investment and found that the companies with tax breaks cut their investments by 22%. The article concluded that investment was based more on the demand for a company’s goods than on the cost of making the investment. In other words, the demand for any production input is based upon the demand for the goods and service the inputs produce not on an artificially reduced price of the input. The only effect of the incentives is to increase after tax profits. Investing in tax credits for hiring will get you the same returns as you would have earned with Bernie Madoff.
Wednesday, January 07, 2009
On Proportionate Responses
The recent actions by Israel have been condemned by many churches and governments. Their main complaint is that the Israeli actions are out of proportion to the Hamas offenses. They imply that they would not be condemning Israel if the responses had been proportional. We need to look at this issue in light of the facts:
1. Hamas launches rockets into Israel specifically aimed at civilian targets.
2. Hamas places its leadership and military centers specifically in civilian locations
3. Hamas locates rocket launchers in or near schools, hospitals, and civilian neighborhoods
4. Israel tries to target only Hamas leadership, military, and launching sites
Given these established facts, we can only conclude that:
1. Hamas doesn’t make a distinction between civilians and combatants unless it meets its political agenda
2. This agenda places Palestinian civilian at risk intentionally.
3. Hamas wants to increase Palestinian civilian casualties because it makes Israel look bad
Given these fact and conclusions I have to conclude that the criticizing governments and churches want the following actions that would be proportional responses:
1. Israel should start lobbing rockets into civilian neighborhoods regardless of whether Hamas has facilities there
2. Israel should make elimination of any concept of a Palestinian State a part of its political goals in the same manner that Hamas has the elimination of Israel on its agenda
3. Hamas fighters captured in battle should be held without notification of their being held.
4. Bodies of Hamas fighters killed in battle should be held and implications made that they are alive and will be returned if certain concessions are made by Hamas.
Do the churches and governments really want proportional responses? If they do, they will be instrumental in perpetrating a higher level of civilian suffering than has been seen to date.
1. Hamas launches rockets into Israel specifically aimed at civilian targets.
2. Hamas places its leadership and military centers specifically in civilian locations
3. Hamas locates rocket launchers in or near schools, hospitals, and civilian neighborhoods
4. Israel tries to target only Hamas leadership, military, and launching sites
Given these established facts, we can only conclude that:
1. Hamas doesn’t make a distinction between civilians and combatants unless it meets its political agenda
2. This agenda places Palestinian civilian at risk intentionally.
3. Hamas wants to increase Palestinian civilian casualties because it makes Israel look bad
Given these fact and conclusions I have to conclude that the criticizing governments and churches want the following actions that would be proportional responses:
1. Israel should start lobbing rockets into civilian neighborhoods regardless of whether Hamas has facilities there
2. Israel should make elimination of any concept of a Palestinian State a part of its political goals in the same manner that Hamas has the elimination of Israel on its agenda
3. Hamas fighters captured in battle should be held without notification of their being held.
4. Bodies of Hamas fighters killed in battle should be held and implications made that they are alive and will be returned if certain concessions are made by Hamas.
Do the churches and governments really want proportional responses? If they do, they will be instrumental in perpetrating a higher level of civilian suffering than has been seen to date.
Friday, January 02, 2009
STOP BLAMING FDR
Paul Krugman and other economists have been attributing the 1937 recession to actions by FDR. They say he was merely following advice regarding the attempt to cut spending and balance the budget. However, whatever FDR did, there still would have been a recession. This is because the Fed, which is independent of the executive, raised the reserve requirement substantially during the same period. From 1917 until August 1936 the Central Reserve City Banks had a reserve requirement of 13% Starting if August of 1936, through May if 1937 , the Fed raised the rate to 26%. The rate for Reserve City Banks went from 10% to 20% an d for country banks the rate went from 7% to 14%.
The reserve requirement is the percentage of deposits that banks are required to hold at the Fed. This is money that cannot be loaned out. If the reserve requirement is raised banks have to either gather in a large number of new deposits and/or reduce lending. Given that the recovery was still ongoing, substantially increasing deposits was problematical. Instead, given the substantial increase in the Reserve Requirement, banks had to virtually halt all new lending. This alone would have caused what we now call a recession. (Note: I believe that FDR coined the term "recession" as a description of a slowdown in economic activity at this time)
So stop blaming FDR.
The reserve requirement is the percentage of deposits that banks are required to hold at the Fed. This is money that cannot be loaned out. If the reserve requirement is raised banks have to either gather in a large number of new deposits and/or reduce lending. Given that the recovery was still ongoing, substantially increasing deposits was problematical. Instead, given the substantial increase in the Reserve Requirement, banks had to virtually halt all new lending. This alone would have caused what we now call a recession. (Note: I believe that FDR coined the term "recession" as a description of a slowdown in economic activity at this time)
So stop blaming FDR.
Tuesday, December 16, 2008
WHAT WERE THEY THINKING
When I read all of the complaints by people and organizations that have lost everything investing in Bernard Madoff’s Hedge Fund, I think about a recent Country song titled “…What Was I Thinking…” People who invest should know four basic principles:
1. Never place all of you investment in something where you have no idea how it will be used. Madoff never described how his Hedge Fund worked. This should have been a clue that something was fishy in on Wall Street.
2. Never put more than you can afford to lose in any one investment. Usually this means no more that 5% of you total investment. Endowment Funds, Pension Funds, and Financial Institutions should know this. In addition, individuals who are investing their pensions should follow the same philosophy.
3. If something is too good to be true it probably is. Madoff was consistently paying steady returns no matter what happened to the market. Markets are volatile by their nature. As a result, it is almost impossible to have steady returns over time.
4. Higher returns are the result of higher risk. 25 Years ago the President of my firm asked me to invest with a firm that was offering 75 to 125 basis points above market for Repurchase Agreements. I refused, saying that there must be a risk that hadn’t been identified. I only kept my job as Treasurer because the CFO backed me. Several months later local school districts and municipalities lost millions when the seller went under.
These four items may not make you rich however; they can help you from ending up poor. Individuals have to be especially careful in regard to these principles because people have a harder time recovering than organizations.
I firmly believe that the Trustees of the Charities that lost all of their endowments were lax in following their fiduciary responsibilities. While I feel for the beneficiaries of the charities; I don’t have sympathy with the managements or trustees. What were they thinking?
1. Never place all of you investment in something where you have no idea how it will be used. Madoff never described how his Hedge Fund worked. This should have been a clue that something was fishy in on Wall Street.
2. Never put more than you can afford to lose in any one investment. Usually this means no more that 5% of you total investment. Endowment Funds, Pension Funds, and Financial Institutions should know this. In addition, individuals who are investing their pensions should follow the same philosophy.
3. If something is too good to be true it probably is. Madoff was consistently paying steady returns no matter what happened to the market. Markets are volatile by their nature. As a result, it is almost impossible to have steady returns over time.
4. Higher returns are the result of higher risk. 25 Years ago the President of my firm asked me to invest with a firm that was offering 75 to 125 basis points above market for Repurchase Agreements. I refused, saying that there must be a risk that hadn’t been identified. I only kept my job as Treasurer because the CFO backed me. Several months later local school districts and municipalities lost millions when the seller went under.
These four items may not make you rich however; they can help you from ending up poor. Individuals have to be especially careful in regard to these principles because people have a harder time recovering than organizations.
I firmly believe that the Trustees of the Charities that lost all of their endowments were lax in following their fiduciary responsibilities. While I feel for the beneficiaries of the charities; I don’t have sympathy with the managements or trustees. What were they thinking?
Sunday, December 14, 2008
IS DON QUIXOTE BERNANKE FIGHTING WINDMILLS WITH HIS LOYAL SANCHO PAULSON BY HIS SIDE
Once Again I read the newspaper and I am astounded by the cluelessness of our economic leadership. Today there is talk that the Fed will again lower the interest rate at which banks lend to each other (The Federal Funds Rate). You would think that by now Mr. Bernanke would realize that the country is in a liquidity trap where the traditional tools of Monetary Policy are ineffective. This is evidenced by the fact that both Mr. Bernanke and Mr. Paulson have been pouring liquidity intro the systems and the banks have responded by buying other banks, paying dividends, and funding bonus pools instead of making loans with the new found liquidity. Attacking an economic crisis with monetary tools when the country is in a liquidity trap is akin to tilting at windmills in the hope of killing a dragon.
The time has come to start using Keynesian aggregate demand based economics instead of the pump priming of liquidity enhancement. The pump is primed; the liquidity is there. What we need now is someone to start demanding the water. This can only be accomplished by a government spending stimulus package that is large enough to turn the economy around. This means that we need to spend as if we were fighting a war. All of the criticisms of the New Deal boil down to the fact that even FDR was too timid in his spending proposals. Alan Greenspan set the precedent of a Fed chief commenting on Fiscal Policy. It is now Mr. Bernanke’s turn to push Paulson toward a fiscal stimulus. At a minimum this should be a set of loans to GM and Chrysler that would stave off a shrinkage in demand. These two firms will eventually have to file for bankruptcy, but the inevitable can be delayed until the economy is better able to manage it and congress has time to arrange a post filing financing package which will mitigate the worst effects of a filing.
The time has come to start using Keynesian aggregate demand based economics instead of the pump priming of liquidity enhancement. The pump is primed; the liquidity is there. What we need now is someone to start demanding the water. This can only be accomplished by a government spending stimulus package that is large enough to turn the economy around. This means that we need to spend as if we were fighting a war. All of the criticisms of the New Deal boil down to the fact that even FDR was too timid in his spending proposals. Alan Greenspan set the precedent of a Fed chief commenting on Fiscal Policy. It is now Mr. Bernanke’s turn to push Paulson toward a fiscal stimulus. At a minimum this should be a set of loans to GM and Chrysler that would stave off a shrinkage in demand. These two firms will eventually have to file for bankruptcy, but the inevitable can be delayed until the economy is better able to manage it and congress has time to arrange a post filing financing package which will mitigate the worst effects of a filing.
Wednesday, December 10, 2008
What Fools the Conservatives Be
The title of this piece is very misleading because, for one of the rare instances in my life, I find that I am actually in agreement with the conservatives regarding the Detroit Bailout. The conservatives are calling for a “Structured Bankruptcy” in- stead of the bailout that is being proposed by democrats. In a November 26 letter to the editor of the “Allentown Morning Call” I outlined the advantages of a structured bankruptcy without using the term.
So, why am I calling the congressional conservatives fools? The problem lies in the fact that politics was once called the art of the possible. (I wish I could remember where the quote came from) The Republican leadership seems to have forgotten this. They are so intent on getting their own way that they appear to be willing to let the country slide further into the abyss of depression rather than agree to a program, which although flawed, has a possibility of passing. Eventually, GM and Chrysler will have to go for a structured bankruptcy. However, just letting them go into Chapter 11 now, without a government financed structure, would throw innumerable Americans out of work and exacerbate the economic downturn. Getting a bankruptcy plan passed under current conditions is impossible.
There is a time for principle and a time for action. Sometimes they do not coincide. This is one of those times. Conservative obstructionism may insure that Republican congressional representation remains out of power for another 40 years as happened in the mid 20th century.
So, why am I calling the congressional conservatives fools? The problem lies in the fact that politics was once called the art of the possible. (I wish I could remember where the quote came from) The Republican leadership seems to have forgotten this. They are so intent on getting their own way that they appear to be willing to let the country slide further into the abyss of depression rather than agree to a program, which although flawed, has a possibility of passing. Eventually, GM and Chrysler will have to go for a structured bankruptcy. However, just letting them go into Chapter 11 now, without a government financed structure, would throw innumerable Americans out of work and exacerbate the economic downturn. Getting a bankruptcy plan passed under current conditions is impossible.
There is a time for principle and a time for action. Sometimes they do not coincide. This is one of those times. Conservative obstructionism may insure that Republican congressional representation remains out of power for another 40 years as happened in the mid 20th century.
Monday, December 01, 2008
LIVING IN LA-LA LAND
This afternoon I listened to Paulson and Bernanke answer questions regarding the bailout and alternative solutions to our financial problems. Paulson was asked why he is not giving greater support to Sheila Bair’s proposals from the FDIC. Mr. Paulson’s response boiled down to the fact that he was more interested in saving Capital Markets.
What he forgets is that the failure of the Capital Markets comes from the inability to price Securitized Debt Derivatives because of the failure of the underlying debt which was securitized. This inability to price the derivatives means that their book-value is limited. (Simply, you can’t sell the derivatives because nobody knows if the original debt is good.) Limited book-value means that some of the financial institutions’ capital has vanished.
However, if the underlying debt is somehow guaranteed then the securities would become marketable. If the securities are marketable the markets will establish a price and capital would be restored. This is the approach that Ms. Blair has proposed and Mr. Paulson has pooh-poohed because he believes that it might apply to mortgages but, according to him, it doesn’t apply to what we are facing in the near future.
The future problems facing us have to do with more securitized debt. This time it is in car loans and credit card debt that has been bundled and sold as derivatives. Again, if we find a way to insure the debt, we can stabilize the price of the derivatives and avert a meltdown.
This is where Mr. Paulson is living in La-La Land. He is so close to the capital markets community that he forgets that the USA is a consumer driven economy. He wants to insure the capital markets without addressing the needs of the consumer. However, the capital markets don’t trust the consumer and are raising interest rates and reducing credit limits on credit cards in spite of the capital infusions Mr. Paulson has provided them. Convincing the consumers that they will not face foreclosure and that their debt will be put on a feasible workout schedule is the only way to restore consumer confidence and hopefully increase spending by those with the capacity to do so. Ms Blair’s approach seems to accomplish this goal as well as the goal of stabilizing the prices of the derivatives and should be expanded to other types of underlying debt.
What he forgets is that the failure of the Capital Markets comes from the inability to price Securitized Debt Derivatives because of the failure of the underlying debt which was securitized. This inability to price the derivatives means that their book-value is limited. (Simply, you can’t sell the derivatives because nobody knows if the original debt is good.) Limited book-value means that some of the financial institutions’ capital has vanished.
However, if the underlying debt is somehow guaranteed then the securities would become marketable. If the securities are marketable the markets will establish a price and capital would be restored. This is the approach that Ms. Blair has proposed and Mr. Paulson has pooh-poohed because he believes that it might apply to mortgages but, according to him, it doesn’t apply to what we are facing in the near future.
The future problems facing us have to do with more securitized debt. This time it is in car loans and credit card debt that has been bundled and sold as derivatives. Again, if we find a way to insure the debt, we can stabilize the price of the derivatives and avert a meltdown.
This is where Mr. Paulson is living in La-La Land. He is so close to the capital markets community that he forgets that the USA is a consumer driven economy. He wants to insure the capital markets without addressing the needs of the consumer. However, the capital markets don’t trust the consumer and are raising interest rates and reducing credit limits on credit cards in spite of the capital infusions Mr. Paulson has provided them. Convincing the consumers that they will not face foreclosure and that their debt will be put on a feasible workout schedule is the only way to restore consumer confidence and hopefully increase spending by those with the capacity to do so. Ms Blair’s approach seems to accomplish this goal as well as the goal of stabilizing the prices of the derivatives and should be expanded to other types of underlying debt.
Saturday, November 15, 2008
THE CASE AGAINST AN AUTO INDUSTRY BAILOUT
Today (14 Nov 08) President Bush called for $25 Billion in loans to the automobile industry. If Mr. Bush really believed in his “market work best” philosophy he would not be asking for these loans. Instead, he would say that the companies should file for bankruptcy under chapter 11. Chapter 11 allows companies to continue in existence while they reorganize. However, the current leadership of the companies, the basic constituency of Mr. Bush, would not be protected. In addition, the golden parachutes of the corporate elite could be nullified by the bankruptcy courts. The President who personifies the politics of greed could never allow this to happen.
On top of the protection of the current management, we are faced with continuing the support of the very people who made the errors which drove the companies to the brink. For the most part, these are the people who decided that they should rely on vehicles that can only be sold when energy is cheap. They gave up on basic transportation and pushed brobdignagian vehicles where it was possible to joke that the best measure of efficiency was gallons per mile rather than miles per gallon. They took the attitude that they were too big to fail. This may have some truth in the financial sector. However, reorganization is often the best solution in the manufacturing sector. If we want to bail them out and minimize the consequences the government should say that they will supply the financing only after GM files for Chapter 11. This will allow for reorganization without the burden of the current incompetent management and will allow the firm to renegotiate some of its most onerous obligations.
On top of the protection of the current management, we are faced with continuing the support of the very people who made the errors which drove the companies to the brink. For the most part, these are the people who decided that they should rely on vehicles that can only be sold when energy is cheap. They gave up on basic transportation and pushed brobdignagian vehicles where it was possible to joke that the best measure of efficiency was gallons per mile rather than miles per gallon. They took the attitude that they were too big to fail. This may have some truth in the financial sector. However, reorganization is often the best solution in the manufacturing sector. If we want to bail them out and minimize the consequences the government should say that they will supply the financing only after GM files for Chapter 11. This will allow for reorganization without the burden of the current incompetent management and will allow the firm to renegotiate some of its most onerous obligations.
Monday, November 03, 2008
Why Government Spending Over Tax Cuts?
In my last blog I indicated that increasing government spending has a larger impact on the economy that tax cuts. A reader has asked me to explain this as a Part 2 to that blog and I will take this opportunity to do so.
The problem arises from something called the multiplier. Whenever income is spent it becomes income to someone else. People do not spend all of their income. Some is saved, some is used to pay down debt, and some is spent overseas (imports). The multiplier is 1 divided by the proportion of new income not going to spending. To get the total re-spending effect we multiply the initial spending by the multiplier. If on average people do not spend 10% of their new income then the multiplier would be 1/.10 = 10. Therefore, a tax refund of $100 million would result in initial new spending of $90 million and a total re-spending effect of $90 x 10 = $900 million.
On the other hand, if the government builds new roads equal to $100 million the initial new spending is the $100 million. The total re-pending effect would then be $100 million x 10 = $1 trillion. A little algebra indicates that getting a $1 trillion increase in economic activity would require $111 million in tax cuts. In this simple example tax cuts would cost the treasury 11% more than increases in public spending. Lets face it, this means 11% higher cost to us. Either way the government would be required to borrow. The issue is which leads to a lower debt?
The right wing says so what if tax cuts cost more; we know how to spend our money better than the government does. The question is: do we? Will we spend our tax cuts rebuilding our infrastructure? Will we install sewage treatment plants? Will we invest in clean coal research? All of these things need doing but the private sector returns for doing them are limited.
The problem arises from something called the multiplier. Whenever income is spent it becomes income to someone else. People do not spend all of their income. Some is saved, some is used to pay down debt, and some is spent overseas (imports). The multiplier is 1 divided by the proportion of new income not going to spending. To get the total re-spending effect we multiply the initial spending by the multiplier. If on average people do not spend 10% of their new income then the multiplier would be 1/.10 = 10. Therefore, a tax refund of $100 million would result in initial new spending of $90 million and a total re-spending effect of $90 x 10 = $900 million.
On the other hand, if the government builds new roads equal to $100 million the initial new spending is the $100 million. The total re-pending effect would then be $100 million x 10 = $1 trillion. A little algebra indicates that getting a $1 trillion increase in economic activity would require $111 million in tax cuts. In this simple example tax cuts would cost the treasury 11% more than increases in public spending. Lets face it, this means 11% higher cost to us. Either way the government would be required to borrow. The issue is which leads to a lower debt?
The right wing says so what if tax cuts cost more; we know how to spend our money better than the government does. The question is: do we? Will we spend our tax cuts rebuilding our infrastructure? Will we install sewage treatment plants? Will we invest in clean coal research? All of these things need doing but the private sector returns for doing them are limited.
Sunday, November 02, 2008
THE POTENTIAL FAILURE OF MONETARY POLICY
Writing in today’s (10/31/08) New York Times Paul Krugman labeled our current financial crisis a “Liquidity Trap.” This is a situation where attempts to lower the interest rate have no effect on investment spending by businesses. The USA hasn’t seen a Liquidity Trap since the great depression. Now, analysts are predicting that the Fed might lower the Fed Funds Rate, the rate at which banks lend to each other, to zero. The Japanese tried this during their economic malaise of the 90’s and it had almost no impact.
Although the current condition of the US economy is unlike that of the 90’s economy of Japan, we are faced with a similar question. That is: are banks willing to lend? The current answer in the US economy is NO! Banks are in panic mode. As the Fed pumps money into the system, the money supply will continue to shrink because the banks are unwilling to lend. On the other hand, businesses are only willing to borrow to meet working capital (short-term) needs rather than capital expansion. With consumers worried about their futures, they have reduced their discretionary spending. An absence of demand will lead to a reduction of businesses' plans for capital expansion even if they can borrow at minimal cost. This situation points up a flaw in Supply Side Economics. The Supply Side assumes that falling costs of capital will induce investment. It ignores the behavioral element which indicates that executives would be hard pressed to recommend expansion when they have excess capacity. In addition, market analyst would pillory executives trying to expand capacity during an economic down turn.
All of this indicates that McCain’s economic plan that is based upon increased saving leading to reduced costs of capital and Bernanke’s monetary expansion will have little or no effect upon an economic recovery. The great depression, and Keynes, has taught us that demand is still the primary determinant of economic activity. The Supply Side mantra of Say’s Law: “…supply creates its own demand…”works only in an economy that is already recovering. What the economy needs is a stimulus to demand. Given the deteriorating condition of our national infrastructure this would be best accomplished through an increase in government spending rather than tax cuts. In addition, it is well known that accomplishing a given increase in economic activity costs more with tax cuts than it does with an increase in government spending. Explaining the reasons for this would take too much space for a blog. However, Mr. Obama should take note of this problem if should he be elected.
Although the current condition of the US economy is unlike that of the 90’s economy of Japan, we are faced with a similar question. That is: are banks willing to lend? The current answer in the US economy is NO! Banks are in panic mode. As the Fed pumps money into the system, the money supply will continue to shrink because the banks are unwilling to lend. On the other hand, businesses are only willing to borrow to meet working capital (short-term) needs rather than capital expansion. With consumers worried about their futures, they have reduced their discretionary spending. An absence of demand will lead to a reduction of businesses' plans for capital expansion even if they can borrow at minimal cost. This situation points up a flaw in Supply Side Economics. The Supply Side assumes that falling costs of capital will induce investment. It ignores the behavioral element which indicates that executives would be hard pressed to recommend expansion when they have excess capacity. In addition, market analyst would pillory executives trying to expand capacity during an economic down turn.
All of this indicates that McCain’s economic plan that is based upon increased saving leading to reduced costs of capital and Bernanke’s monetary expansion will have little or no effect upon an economic recovery. The great depression, and Keynes, has taught us that demand is still the primary determinant of economic activity. The Supply Side mantra of Say’s Law: “…supply creates its own demand…”works only in an economy that is already recovering. What the economy needs is a stimulus to demand. Given the deteriorating condition of our national infrastructure this would be best accomplished through an increase in government spending rather than tax cuts. In addition, it is well known that accomplishing a given increase in economic activity costs more with tax cuts than it does with an increase in government spending. Explaining the reasons for this would take too much space for a blog. However, Mr. Obama should take note of this problem if should he be elected.
Wednesday, October 29, 2008
Mc Cain Clings to the Solutions That Even Greenspan Says were Wrong
Today, in Florida, John McCain once again proved that he has no understanding of economics. He stated that the nation’s economic problems would pass. This is the same argument that classical economists made back during the depression. They said that markets are self correcting and that unemployment and recession are self correcting. This is the same as the specious argument that market discipline would prevent economic excesses. Keynes, much maligned by the Greenspan school of economists, proved that recession was not self correcting.
McCain has also hung his economic hat on the argument that giving businesses breaks to reduce the cost of investing will stimulate the economy. This is saying that supply creates its own demand. This was known, by economists, as “Say’s Law.” The problem is that the biggest boost to investment is demand for the product. If there is no demand, and/or there is excess capacity businesses are not going to invest in equipment, buildings, or inventory.
Another element of McCain’s economic program calls for the reduction of taxes at upper income levels. This will supposedly accomplish two things. Firstly, the rich will save thereby increasing funds available for investment lending. Secondly, these funds will thereby reduce interest rates. For this to work, there have to be banks that are willing to lend and businesses willing to borrow for investment purposes. In the absence of demand, we have already established that businesses are not willing to borrow for investment. In addition, this approach will work only if banks are willing to lend. Observation of current banking behavior indicates that they are not willing to lend. Even with bailout money from the government banks are too risk averse to lend.
Recently, Alan Greenspan has stated that he was mistaken in the belief that actors on the financial stage would act appropriately. What makes McCain thing that this will change?
McCain has also hung his economic hat on the argument that giving businesses breaks to reduce the cost of investing will stimulate the economy. This is saying that supply creates its own demand. This was known, by economists, as “Say’s Law.” The problem is that the biggest boost to investment is demand for the product. If there is no demand, and/or there is excess capacity businesses are not going to invest in equipment, buildings, or inventory.
Another element of McCain’s economic program calls for the reduction of taxes at upper income levels. This will supposedly accomplish two things. Firstly, the rich will save thereby increasing funds available for investment lending. Secondly, these funds will thereby reduce interest rates. For this to work, there have to be banks that are willing to lend and businesses willing to borrow for investment purposes. In the absence of demand, we have already established that businesses are not willing to borrow for investment. In addition, this approach will work only if banks are willing to lend. Observation of current banking behavior indicates that they are not willing to lend. Even with bailout money from the government banks are too risk averse to lend.
Recently, Alan Greenspan has stated that he was mistaken in the belief that actors on the financial stage would act appropriately. What makes McCain thing that this will change?
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