March 18, 2012

The Economy: The Bright and the Blight

by Hal Gershowitz

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We Americans like to think of the economy as a single organic reality, as a big picture that is immediately discernable on its surface, something that is simply good, or not so good, something that produces a sense of well-being or something that produces a sense of foreboding.  Well, the economy is not really a big picture but rather a dynamic composite of many, ever-changing, smaller pictures.  Sometimes, we focus too much on one or two of the images in this composite to the exclusion of the other vital pieces of the collage.  That, very often, results in a flawed understanding of this phenomenon we call the economy.  Often, there are bright spots and, what we’ll call, blight spots.  It is important that we recognize both. While the organic whole might be greater than the sum of its parts, the economy is also a reciprocally related chain that can be seriously compromised by its weakest links.

The good news is that the economy is once again creating jobs and, so far this year, the economy has created well over 200,000 each month.  The White House will, of course, take credit for every one of those jobs (every White House would), but job creation is a product of recovery, and every economic downturn, sooner or later, evolves into an upturn.  This particular upturn simply evolved later rather than sooner.  As the outlook begins to brighten, however, those workers who abandoned the jobs market will return, and they will, ironically, cause the unemployment curve to, once again, turn north, at least temporarily.  Many in the opposition will blame the expected statistical upturn in unemployment on the Administration, which is as silly as crediting the Administration with the current downturn in unemployment.  The upturn in job creation also seems to be broad based and that, too, is positive news…at least at first blush.

If our enthusiasm seems a bit curbed, well, it is.  One has to be seriously shortsighted not to see the troubling tesserae within our economic mosaic.  Presumably, we are experiencing some job creation because of the historically low and unrealistic interest rates which the Fed (not the White House) now has kept in place for years, and which the Fed promises to keep in place for the foreseeable future.  So the Fed’s conflicting mandates of price and employment stability seem to be working…or are they?  Let’s take a closer look.

As the magnitude of the financial meltdown became terrifyingly clear, hundreds of billions, indeed, in excess of a trillion dollars was pumped into the banking system, and short-term interest rates at which banks could borrow were reduced, essentially, to zero.  The prime rate of interest at which an individual or business could borrow (and, of course, the rate which households could earn on their savings or investments) plunged accordingly. Thus, the money supply rapidly expanded and the economy, in theory, should have briskly expanded thereafter.  It didn’t.  That’s because banks, now awash with cash, didn’t loan that cash to consumers or businesses.  So we experienced a rapid increase in the money supply but no real acceleration in the velocity of the money supply (the rate at which money changes hands).

Banks had, and have, two reasons for hoarding their taxpayer provided largess. First, why take on any risk at all when the Fed is making money available at, essentially, no cost, which can then be recycled (at no risk) into interest bearing government treasuries with the banks pocketing the difference as profit.  Second, the banks know that their balance sheets still carry enormous levels of real estate (residential and commercial) valued far in excess of their realistic current value. The incentive is huge for the banks to hoard all, or the lion’s share, of the free cash as a hedge against a day of reckoning the banks know (or fear) may be coming.  So, in effect, trillions of dollars (increases in the money supply) are locked in irons (curtailing the velocity at which money changes hands) and have had little value in stimulating the economy.

We don’t minimize the value of the Troubled Asset Relief Program (TARP), which was initiated under Bush and accelerated under Obama.  One can only imagine how devastating the financial meltdown would have been had a bank run reached critical mass.  But when, and if, that money begins to flow into the economy its inflationary impact (the resulting increase in the velocity of the money supply) could be disastrous.  We do not share the view that we needn’t worry about inflation because it hasn’t reared its head yet.  As we opined in a previous essay, that’s like a physician advising a patient not to worry about smoking, because, so far, there is no sign of lung cancer.

The Fed and the government are in a quandary.  Interest rates have been kept artificially low, we are told, to stimulate the economy and to keep the country from falling back into recession from which, presumably, it emerged three years ago.  That may be true, but the fact is that any significant increase in the rates the government has to pay to its creditors (domestic and foreign) would be a real body blow to any effort to reduce our soaring deficits. We are caught in a proverbial Catch 22. While interest rates may be unrealistically low, and, therefore, in need of some upward adjustment in the near future; the last thing the country can afford is a dramatic spike in the cost of servicing its ever-mounting debt.

Another of the troubling elements, which comprise our current economic collage, is the ever-expanding government debt as a percent of the entire value of the economy (GDP). Actually, if we add what the government owes to the Social Security Trust Fund and other agencies of government, to what the government owes to the holders of its public debt, our debt far exceeds the value of our entire economy.  Pause and ponder that for a moment.  With forty-three cents (and climbing) of every dollar the government spends being borrowed, our national debt exceeds the value of everything that is sold in America and every service that is provided in America. That’s a mind-boggling burden to bear, and it’s only a matter of time before the private sector’s ability to compete (with the government) for financing its growth and the economy’s ability to expand is sharply curtailed.  In fact, the Congressional Budget Office (CBO) has just warned that such a conundrum may be closer than we think.

Last week, the non-partisan Congressional Budget Office reported that Obama’s budget would produce a deficit of nearly a trillion dollars next year. That’s about 75 billion more than previously forecast by the White House.  The CBO report states that President Obama’s proposed policies will result in $6.4 trillion in deficits over the coming decade.  The CBO report goes on to state that Obama’s budget office consistently overestimates tax revenues over the coming decade by about $120 billion each year.  Ironically, CBO anticipates that lower interest rates (we think that may be wishful thinking) and lower cost-of- living adjustments for those on social security (retirees won’t be happy about that probability) could produce lower deficits over the next ten years than the Administration projected.

For the current budget year, CBO says Obama’s proposals will generate a $1.25 trillion deficit, which would represent the fourth consecutive year of trillion dollar-plus deficits.

Our government is engaged in the greatest peacetime spending spree in history, and it threatens to deliver a knockout punch to an economy struggling to get on its feet.  We can almost hear the speeches the President’s writers are penning for the coming campaign demagoguery.  “If only the rich (the top 5%) would pay their fair share (70% not being enough), we wouldn’t have these huge deficits.”  Hold on to your hats. It’s going to get ugly.

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4 responses to “The Economy: The Bright and the Blight”

  1. Sam says:

    That’s what happens when we elect someone who does not know anything about running a business. But we can change that in this election.

    • Not at all. We have, in numerous prior essays, advocated the elimination of special tax treatment (specifically preferential deductions and tax credits) for special interests (and special tax payers) as proposed by Simpson-Bowles. In fact, last November 13th, our essay, “Reducing The Deficits: Let’s Get Serious About Business Entitlements” was devoted to that very point. You will recall that last week’s essay advocated a modified flat tax rate along with the elimination of the panoply of special tax treatments that favor certain businesses and wealthier individuals.

  2. choptank88 says:

    Is there not an implied contradiction in your concluding sentences above versus the points you make so well in the previous week’s analysis which shows that the top X% get far greater tax advantages than everyone else and as a recent NY Times article shows, the top two tiers of the wealthy get much more benefit from government tax policy that the bottom 2 tiers receive in entitlements. Not quite apples to apples, but still I see contradictions in your two conclusions

  3. mark j levick says:

    You note that one trillion dollars was distributed to and retained by the Banks so as to assure the liquidity required to maintain reserves for bad debts which remain understated. Each year we go into debt by an additional trillion dollars allegedly because the economy is too weak to generate the tax dollars needed to balance a budget, but of course the Congress has not passed a budget during Obama’s term in office. Still if the 5% who pay 70% of all taxes just paid 100% all would be well in our corner of the world. Of course those folks can’t generate a spare trillion dollars to balance non budgeted spending not to mention pay down the 16.4 trillion dollar debt. Thus, we are on track to become Greece, when we can’t print enough money to buy our ballooning debt interest rates and return to historical levels. This is unfair to those folks who have are now entitled to food stamps, perpetual unemployment compensation, withholding tax relief and free birth control. Damn George W. Bush. It’s all his fault for not fighting for us like those nice folks who succeeded him in office.

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