Monday, February 28, 2011

Today's links

1--Shock Doctrine, U.S.A., Paul Krugman, New York Times

Excerpt: ...Naomi Klein’s best-selling book “The Shock Doctrine” ... argued that ... right-wing ideologues have exploited crises to push through an agenda that has nothing to do with resolving those crises, and everything to do with imposing their vision of a harsher, more unequal, less democratic society.

Which brings us to Wisconsin 2011, where the shock doctrine is on full display.

In recent weeks, Madison has been the scene of large demonstrations against the governor’s budget bill, which would deny collective-bargaining rights to public-sector workers. Gov. Scott Walker claims that he needs to pass his bill to deal with the state’s fiscal problems. But his attack on unions has nothing to do with the budget. In fact, those unions have already indicated their willingness to make substantial financial concessions — an offer the governor has rejected.

What’s happening in Wisconsin is, instead, a power grab — an attempt to exploit the fiscal crisis to destroy the last major counterweight to the political power of corporations and the wealthy. And the power grab goes beyond union-busting. The bill in question is 144 pages long, and there are some extraordinary things hidden deep inside.

For example, the bill includes language that would allow officials appointed by the governor to make sweeping cuts in health coverage for low-income families without having to go through the normal legislative process.

And then there’s this... The state of Wisconsin owns a number of plants supplying heating, cooling, and electricity to state-run facilities (like the University of Wisconsin). The language in the budget bill would, in effect, let the governor privatize any or all of these facilities at whim. Not only that, he could sell them, without taking bids, to anyone he chooses. And note that any such sale would, by definition, be “considered to be in the public interest.”

2--Oil prices and consumer spending, Angry Bear

Key quote: "if oil prices remain high or expand well past $100 we are quite likely to see consumer spending suffer across the board."...

Excerpt: With the recent surge in oil prices I thought it would be useful to look at the potential impact with one set of data I watch. It is energy as a share of personal consumption expenditures or consumer spending. In the 1970s energy consumption rose from about 6% to 9% of spending, or about 50%. In the early 2000s energy rose from about 4% to 7% of consumer spending before it collapsed. As of December energy's share of consumer spending was already back to 6% of spending, about the level it peaked at in the last cycle before the financial panic generated a drop in other consumer spending. If you look at energy consumption this way it appears that oil consumption was already at the point where futher oil price increases would rapidly impact consumer spending on other items.

One area where higher oil prices clearly impacts consumer spending is autos, as consumer spending on new and used autos and energy have a very strong negative correlation. If rising oil prices generate a drop in real income or standard of living one of the easiest way to compensate is to delay buying a new,or used car. What would have been new monthly auto payments can be used to sustain consumption of other items. In this chart you can clearly see that this happened in both the 1970s and the 2000s. You can also see that spending on energy and autos accounted for about 10% of consumer spending in the 1990s and 2000s.

But the chart also shows that auto consumption was only about 3.5% of consumer spending at the end of 2010 as compared to a 5% to 5.5% norm in the 1990s and 2000s economic expansions. So the consumer does not really have the option to cut back on auto consumption like they did in the previous examples of oil price spikes. These charts suggest that if oil prices remain high or expand well past $100 we are quite likely to see consumer spending suffer across the board.

3--Quantitative Easing and America’s Economic Rebound, Martin Feldstein, Project Syndicate

Excerpt: The key driver of the increase in final sales was a strong rise in consumer spending. Real personal consumer spending grew at a robust 4.4% rate, as spending on consumer durables soared by 21%. That meant that the acceleration of growth in consumer spending accounted for nearly 100% of the increase in GDP, with the rise in durable spending accounting for almost half of that increase.

The rise in consumer spending was not, however, due to higher employment or faster income growth. Instead, it reflected a fall in the personal saving rate. Household saving had risen from less than 2% of after-tax incomes in 2007 to 6.3% in the spring of 2010. But then the saving rate fell by a full percentage point, reaching 5.3% in December 2010.

A likely reason for the fall in the saving rate and resulting rise in consumer spending was the sharp increase in the stock market, which rose by 15% between August and the end of the year. That, of course, is what the Fed had been hoping for.

At the annual Fed conference at Jackson Hole, Wyoming in August, Fed Chairman Ben Bernanke explained that he was considering a new round of quantitative easing (dubbed QE2), in which the Fed would buy a substantial volume of long-term Treasury bonds, thereby inducing bondholders to shift their wealth into equities. The resulting rise in equity prices would increase household wealth, providing a boost to consumer spending....

The magnitude of the relationship between the stock-market rise and the jump in consumer spending also fits the data. Since share ownership (including mutual funds) of American households totals approximately $17 trillion, a 15% rise in share prices increased household wealth by about $2.5 trillion. The past relationship between wealth and consumer spending implies that each $100 of additional wealth raises consumer spending by about four dollars, so $2.5 trillion of additional wealth would raise consumer spending by roughly $100 billion.

That figure matches closely the fall in household saving and the resulting increase in consumer spending. Since US households’ after-tax income totals $11.4 trillion, a one-percentage-point fall in the saving rate means a decline of saving and a corresponding rise in consumer spending of $114 billion – very close to the rise in consumer spending implied by the increased wealth that resulted from the gain in share prices.

None of this appears to augur well for 2011. There is no reason to expect the stock market to keep rising at the rapid pace of 2010. Quantitative easing is scheduled to end in June 2011, and the Fed is not expected to continue its massive purchases of Treasury bonds after that.

4--Putting People Back to Work, The New York Times

Excerpt: I mentioned on Wednesday that World War II was the stimulus program that finally ended the Depression. My colleague Alan Schwarz — he of concussion-expose fame — said that the mention reminded him of one of his high school teachers, Werner Feig, who used to tell students that the Depression was ended by the Full Employment Act of Dec. 7, 1941. (Mr. Feig evidently made a big impression: Aaron Sorkin, another former student, wove him into a “West Wing” episode.)

The Depression was obviously far worse than our own Great Recession — and of course the War was vastly worse than either — but there are similar lessons from the 1930s and today. The government can indeed put people back to work after a financial crisis. That’s not happening now because the government is not really trying.

5--Good Inflation, Bad Inflation, Paul Krugman, New York Times

Excerpt: Why does deflation have a depressing effect on the economy? Two reasons. First, it reduces money incomes while debt stays the same, so it worsens balance sheet problems, reducing spending. Second, expectations of future deflation mean that any borrowing now will have to be repaid out of smaller wages (if the borrower is a household) or smaller profits (if the borrower is a firm.) So expected future deflation also reduces spending.

So, does a rise in food and energy prices do anything to alleviate these problems? No. In fact, it makes them worse, by reducing purchasing power. So while the commodity surge may temporarily lead to rising headline prices in Japan, the underlying deflation problem won’t be affected at all.

In a way, this is another illustration of the need to differentiate among inflation measures. It’s not exactly the same as the usual case for focusing on core inflation, but it’s related. And once again, the point is that looking at “the” inflation rate is a bad guide for policy.

6--Smaller Government Can Be a Drag (on Growth), New York Times

Excerpt: Output last quarter grew more slowly than initially reported, according to the Bureau of Economic Analysis: an annual rate of 2.8 percent rather than 3.2 percent. One of the main reasons for the downward revision was that state and local governments cut their spending at a 2.4 percent annual pace.

That was a much sharper decline than the 0.9 percent first estimated. The drop was also faster than what the country had experienced in the previous two quarters, reflecting the fact that state and local budgets are in more trouble than ever.

A decline in state and local spending — and the layoffs that are likely to be involved — can have dangerous reverberations throughout the economy. So would the cut in federal spending that many Congressional Republicans have been threatening. Besides chucking even more workers into the pool of the unemployed, such cutbacks would also take away services supporting the many Americans trying to get back on their feet. This in turn hurts their ability to spend, threatening the bottom lines of the businesses they patronize, potentially leading to even more layoffs in the private sector. And so on.

In other words, government cutbacks during a weak economy affect much more than just government payrolls.

7--Heavy losses at central banks?, naked capitalism

Excerpt: ...The European Central Bank, for example, holds an (ever-swelling) pile of periphery eurozone bonds; the Fed’s balance sheet has more than doubled in size, to $2,500bn, as it has gobbled up mortgage-backed bonds and Treasuries; and the Bank of England also holds a large pile of gilts and mortgage assets....

Now as some readers have noticed, the Fed has also institutionalized an accounting dodge so that it will not have to admit to balance sheet losses. Commentators appear to have missed that this finesse does nothing to solve the underlying reality. The Fed can “print” its way out of balance sheet losses only to the extent that it is not constrained by inflation. If it does run into inflationary constraints, it would need an explicit bailout, irrespective of the accounting treatment. As former central banker Willem Buiter wrote in 2009:

….it is possible that, should the private securities default, the central bank will suffer a capital loss so large that the central bank is incapable of maintaining its solvency on its own without creating central bank money in such quantities that its price stability mandate is at risk. Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources. Even if it gets the resources, there is likely to be a price tag attached – that is, a commitment to pursue the monetary policy desired by the US Treasury, not the monetary policy deemed most appropriate by the Fed.

Notice that the Fed has quietly established an accounting finesse to circumvent this outcome. Normally, the Fed remits funds to the Treasury annually. The notion is that any Fed position losses (due to credit losses or adverse interest rate movements) would be credited against income earned on Fed assets. If that number still was negative, it would have a credit at the Treasury. In the next profitable year, the Fed would simply retain some of the income it would normally forward to the Treasury to recapitalize the loss. This is what we call “extend and pretend” when private sector banks use flattering accounting to mask balance sheet holes and hope they can earn their way out of trouble....

the dirty secret of the ongoing Eurozone mess is that its banking system has not been cleaned up, and many countries (England, Germany, Switzerland, the Netherlands, for starters) have banking sectors so large relative to the size of their economies that their central banks cannot effectively backstop them. That should mean that the first order of business ought to be to constrain credit growth to increase the safety and stability of the system. But that’s a no-no. We’ve had various financial reform efforts that leave the system still significantly unfettered, when the size and danger it poses says it should be shackled. And the other mechanism for reducing risk, which is to increase capital in the banking system, is being approached in such a cautious and half hearted manner so as to assure it will fall well short of what is needed (witness the attenuated timetable for implementing Basel III)....

The industry nearly blew itself up, was rescued, and in short order was paying itself even higher bonuses than before the crisis. That means it has every reason to go back to piling on risk. The Fed’s accounting finesse means it has slipped one of the mechanisms, having to deal with the consequences of a loss, that might constrain its behavior and hence make it think more carefully about its balance sheet operations. Incentives matter as much for central bankers as they do for banks themselves, and the one at work for the Fed are poor indeed.

8--Accounting tweak could save Fed from losses, Reuters

Excerpt: "Could the Fed go broke? The answer to this question was 'Yes,' but is now 'No,'" said Raymond Stone, managing director at Stone & McCarthy in Princeton, New Jersey. "An accounting methodology change at the central bank will allow the Fed to incur losses, even substantial losses, without eroding its capital."

The change essentially allows the Fed to denote losses by the various regional reserve banks that make up the Fed system as a liability to the Treasury rather than a hit to its capital. It would then simply direct future profits from Fed operations toward that liability.

This enhances transparency by providing clearer, more frequent, snapshots of the central bank's finances, analysts say. The bonus: the number can now turn negative without affecting the central bank's underlying financial condition.

"Any future losses the Fed may incur will now show up as a negative liability as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible," said Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a former New York Fed staffer.

"The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns since the announcement (of a second round of asset buys) about the possibility of Fed 'insolvency' in a scenario where interest rates rise significantly," Smedley and his colleague Priya Misra wrote in a research note....

9--Fannie, Freddie, FHA combined REO Inventory at Record Level, Calculated Risk

Excerpt: The combined REO (Real Estate Owned) inventory for Fannie, Freddie and the FHA increased to a record 295,307 units at the end of Q4, although REO inventory decreased slightly for both Fannie Mae and Freddie Mac in Q4 (compared to Q3). The REO inventory increased 71% compared to Q4 2009 (year-over-year comparison).

The REO inventory for the "Fs" has increased sharply over the last year, from 172,368 at the end of 2009 to a record 295,307 at the end of 2010.

From Fannie Mae: Fannie Mae Reports Fourth-Quarter and Full-Year 2010 Results

Given the large number of seriously delinquent loans in our single-family guaranty book of business and the large current and anticipated supply of single-family homes in the market, we expect it will take years before our REO inventory approaches pre-2008 levels.

Also, this is just a portion of the total REO inventory. Private label securities and banks and thrifts also hold a substantial number of REOs.

10--Washington Wrecks the Economy: More Evidence, Dean Baker, TMPCafe

Excerpt: We now have even more evidence that inept policies from Washington are causing enormous suffering across the country. It is not quite the line that the right-wingers are pushing. The new evidence is that the stimulus worked and was in fact more effective than had been predicted.

The new evidence comes in the form of a study by two Dartmouth professors, James Feyrer and Bruce Sacerdote. Past estimates of the impact of the stimulus on jobs and the economy relied on simply plugging the tax breaks and spending into standard macro models and reporting the predicted effect. In this sense, the impact of the stimulus was actually built into the model. However this new study directly measures the impact of stimulus spending on employment across states, comparing the number of jobs created to the amount of spending.

The study consistently finds significant results over a wide range of specifications. This means that states that got more stimulus money had more jobs. The multipliers varied across specifications and types of spending but the range was 0.5 to 2.0. (The multiplier is the ratio of the change in GDP to the amount of stimulus spending. If the multiplier is 1.5 this means that $1 billion in stimulus increases GDP by $1.5 billion.) While the authors view their multiplier estimates as being somewhat below those predicted by the standard macro models, given the nature of their study their estimates are almost certainly higher than would be expected.

The range of multipliers found in this study suggests that the actual multiplier for stimulus spending is quite likely higher than the 1.5 in most macro models.

This is hugely important for macro policy debates because it suggests that more stimulus would provide a further boost to the economy and reduction in unemployment. This means that the only reason that we are sitting here with 25 million people unemployed and underemployed is that the politicians in Washington are too intimidated by the Wall Street deficit hawks.

The deficit hawks have used their enormous political power and control over the media to shut down any further discussion of stimulus. They have managed to completely dominate public debate with their brand of flat-earth economics. They are using the crisis that was created through their greed and incompetence to reduce hugely valued public benefits, like Social Security and Medicare. And, now they are using the crisis that they have created for state and local governments to destroy public sector unions.

This looks really awful because it is. Our nations' leaders are deliberately inflicting enormous pain on tens of millions of people to advance their political agenda. This new study helps to prove this fact.

11--Corporate Profits Soaring Thanks to Record Unemployment, The Economic Populist

Excerpt: In a January 2009 ABC interview with George Stephanopoulos, then President-elect Barack Obama said fixing the economy required shared sacrifice, "Everybody’s going to have to give. Everybody’s going to have to have some skin in the game."

For the past two years, American workers submitted to the President’s appeal—taking steep pay cuts despite hectic productivity growth. By contrast, corporate executives have extracted record profits by sabotaging the recovery on every front—eliminating employees, repressing wages, withholding investment, and shirking federal taxes.

The global recession increased unemployment in every country, but the American experience is unparalleled. According to a July OECD report, the U.S. accounted for half of all job losses among the 31 richest countries from 2007 to mid-2010. (2) The rise of U.S. unemployment greatly exceeded the fall in economic output. Aside from Canada, U.S. GDP actually declined less than any other rich country, from mid-2008 to mid 2010. (3)

Washington’s embrace of labor market flexibility ensured companies encountered little resistance when they launched their brutal recovery plans. Leading into the recession, the US had the weakest worker protections against individual and collective dismissals in the world, according to a 2008 OECD study. (4) Blackrock’s Robert Doll explains, “When the markets faltered in 2008 and revenue growth stalled, U.S. companies moved decisively to cut costs—unlike their European and Japanese counterparts.” (5) The U.S. now has the highest unemployment rate among the ten major developed countries. (6).

The private sector has not only been the chief source of massive dislocation in the labor market, but it is also a beneficiary. Over the past two years, productivity has soared while unit labor costs have plummeted. By imposing layoffs and wage concessions, U.S. companies are supplying their own demand for a tractable labor market. Private sector union membership is the lowest on record. (7) Deutsche Bank Chief Economist Joseph LaVorgna notes that profits-per-employee are the highest on record, adding, “I think what investors are missing - and even the Federal Reserve - is the phenomenal health of the corporate sector.” (8)

Due to falling tax revenues, state and local government layoffs are accelerating. By contrast, U.S. companies increased their headcount in November at the fastest pace in three years, marking the tenth consecutive month of private sector job creation. The headline numbers conceal a dismal reality; after a lost decade of employment growth, the private sector cannot keep pace with new entrants into the workforce....

The Fed’s Flow of Funds reveals corporate profits represented a near record 11.2% of national income in the second quarter. (13)
Non-financial companies have amassed nearly two-trillion in cash, representing 11% of total assets, a sixty year high. Companies have not deployed the cash on hiring as weak demand and excess capacity plague most industries. Companies have found better use for the cash, as Robert Doll explains, “high cash levels are already generating dividend increases, share buybacks, capital investments and M&A activity—all extremely shareholder friendly.” (5)

Companies invested roughly $262 billion in equipment and software investment in the third quarter. (14) That compares with nearly $80 billion in share buybacks. (15) The paradox of substantial liquid assets accompanying a shortfall in investment validates Keynes’ idea that slumps are caused by excess savings. Three decades of lopsided expansions has hampered demand by clotting the circulation of national income in corporate balance sheets. An article in the July issue of The Economist observes: “business investment is as low as it has ever been as a share of GDP.”...

U.S. tax law allows multinationals to indefinitely defer their tax obligations on foreign earned profits until they ‘repatriate’ (send back) the profits to the U.S. U.S. corporations have increased their overseas stash by 70% in four years, now over $1 trillion—largely by dodging U.S taxes through a practice known as “transfer pricing”. (18)Transfer pricing allows companies to allocate costs in countries with high tax rates and book profits in low-tax jurisdictions and tax havens—regardless of the origin of sale. U.S. companies are using transfer pricing to avoid U.S. tax obligations to the tune of $60 billion dollars annually, according to a study by Kimberly A. Clausing, an economics professor at Reed College in Portland, Oregon. (18)

The corporate cash glut has become a point of recurrent contention between the Obama administration and corporate executives. In mid December, a group of 20 corporate executives met with the Obama administration and pleaded for a tax holiday on the $1 trillion stashed overseas, claiming the money will spur jobs and investment. In 2004, corporate executives convinced President Bush and Congress to include a similar amnesty provision in the American Jobs Creation Act; 842 companies participated in the program, repatriating $312 billion back to the U.S. at 5.25% rather than 35%. (19) In 2009, the Congressional Research Service concluded that most of the money went to stock buybacks and dividends—in direct violation of the Act. (20)

The Obama administration and corporate executives saved American capitalism. The U.S. economy may never recover.

12--Janet Yellen on Unconventional Monetary Policy, Grasping reality with both hands

Excerpt: FRB: Speech: February 25, 2011: To assess the macroeconomic effects of the Fed's large-scale asset purchase program, I would like to highlight some findings from a recent study by four Federal Reserve System economists.... The baseline incorporates the first round of asset purchases--which brought the Federal Reserve's securities holdings to a little more than $2 trillion. It embeds an assumption that the FOMC will complete the purchases announced last November so that the balance sheet expands to about $2.6 trillion by the middle of this year.

From that point forward, the authors assume that the overall size of the portfolio will remain unchanged until mid-2012 and then shrink gradually at a rate sufficient to return it to its pre-crisis trend line by mid-2016.... [T]he overall characteristics of this assumed trajectory seem broadly consistent with the sense of the Committee's discussions last spring.... [T]he counterfactual scenario in which the FOMC never conducts any asset purchases.... The pace of recovery under the baseline scenario is expected to be painfully slow. But the counterfactual scenario suggests that conditions would have been even worse in the absence of the Federal Reserve's securities purchases: The unemployment rate would have remained persistently above 10 percent, and core inflation would have fallen below zero this year. Of course, considerable uncertainty surrounds those estimates, but they nonetheless suggest that the benefits of the asset purchase programs probably have been sizeable...

13--Notes on GDP, Econbrowser

Excerpt: The 2nd release for US GDP revealed a downward revision BEA; CR reports the breakdown. What is interesting is that the downward revision is due in part to a greater than previously estimated decline in the state and local government spending contribution. Something useful to keep in mind as state and local governments move to rely solely upon spending cuts instead of revenue increases as means to reduce budget deficits (e.g., as in Wisconsin).

14--G-20 Interim Study Faults Short Supply For Rise in Commodity Prices, Wall Street Journal

Excerpt: A report being conducted for the world’s Group of 20 leading economies points to supply not keeping up with demand as the main factor behind price increases in wheat, sugar, cotton, metals, oil and other commodities.

The Organization for Economic Cooperation and Development’s study–which is being put together ahead of the next G-20 meeting of top finance officials in April in Washington– may lead to increased efforts to boost commodities production around the world. It could also help reduce criticism of the U.S. Federal Reserve’s easy-money policies, which some have blamed for stoking global inflation....

A similar supply and demand argument can be made for oil prices, Padoan said. Oil prices have recently surged above $100 a barrel amid concerns that the recent turmoil in the oil-rich North African and Middle Eastern countries could hit production. The price of Brent oil, considered the best benchmark, is close to $110 a barrel, 15% higher than at the start of the year.

Fed Chairman Ben Bernanke has been making a similar case about commodity prices, following strong criticism that the U.S. central bank’s pumping of dollars has sent floods of cash into China and other developing economies, driving up prices for food and energy. The Fed chief puts the blame on strong growth in developing economies and their inadequate response, including China’s reluctance to let its currency rise.

15--Looking bad in the UK, The Streetlight blog

Excerpt: The fact that a significant reason for the slowdown in economic activity in Britain at the end of last year was the result of a reduction in spending by businesses tells me that companies are deeply worried about the economy in 2011. Based on some conversations that I've had with upper management in a couple of UK companies, as well as plain old common sense, I feel quite certain that this pull-back in spending by businesses is primarily a reaction to the "austerity measures" that the UK's government is implementing. There is a widespread and reasonable concern among businesses that this year's substantial tax increases and cuts in government spending will make a serious dent in the recovery. After all, thanks to the austerity measures, economic forecasts for the UK for 2011 have been revised down in recent months. So naturally, businesses are pulling back on their spending, waiting to see how strong demand for their goods and services really is this year.

And then, as if to kick the British economy while it's down, we learned this week that sentiment on the Monetary Policy Committee ("MPC") of the Bank of England is trending toward higher interest rates, not lower:

More MPC members vote for a rate hike

UK interest rates could rise soon following news that the number of policymakers in favour of a hike increased during the last Bank of England Monetary Policy Committee (MPC) meeting.

Minutes published by the bank show member Spencer Dale joined Andrew Sentance, who has long been voting for a hike, and Martin Weale in pushing for an increase....

I must confess that I am truly mystified by this. Yes, inflation in the UK has risen in recent months. But this is almost completely explained by two very temporary factors: the recent spike in commodity prices (led by the price of oil), and the increase in the VAT in Britain, which feeds through to higher prices for nearly all types of consumer goods. Absent these temporary forces, it seems clear (even to the Bank of England's governor Mervyn King) that underlying inflation in the UK is not a problem.

Alas, I take this as evidence that economists and policy-makers in the UK have forgotten as much about how the macroeconomy works as they have in the US. A Dark Age of Macroeconomics has descended upon both sides of the Atlantic.

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