FALLING PRICES ARE NOT DEFLATION BUT THE ANTIDOTE TO DEFLATION
GEORGE REISMANThis is the first in a series of articles that seeks to provide the intelligent layman with sufficient knowledge of sound economic theory to enable him to understand what must be done to overcome the present financial crisis and return to the path of economic progress and prosperity.
A disastrous economic confusion, one that is shared almost universally, both by laymen and by professional economists alike, is the belief that falling prices constitute deflation and thus must be feared and, if possible, prevented.
The front-page, lead article of The New York Times of last November 1 provides a typical example of this confusion. It declares:
As dozens of countries slip deeper into financial distress, a new threat may be gathering force within the American economy—the prospect that goods will pile up waiting for buyers and prices will fall, suffocating fresh investment and worsening joblessness for months or even years.Contrary to The Times and so many others, deflation is not falling prices but a decrease in the quantity of money and/or volume of spending in the economic system. To say the same thing in different words, deflation is a general fall in demand. Falling prices are a consequence of deflation, not the phenomenon itself.
The word for this is deflation, or declining prices, a term that gives economists chills.
Deflation accompanied the Depression of the 1930s. Persistently falling prices also were at the heart of Japan’s so-called lost decade after the catastrophic collapse of its real estate bubble at the end of the 1980s—a period in which some experts now find parallels to the American predicament.
Totally apart from deflation, falling prices are also a consequence of increases in the production and supply of goods, which are an essential feature of economic progress and a rising standard of living. In such circumstances, falling prices are not accompanied by any plunge in business sales revenues or profits, by any increase in the difficulty of repaying debt, or by any surge in bankruptcies. All of these phenomena are the result purely and simply of deflation, not falling prices.
Indeed, under a full-bodied, 100-percent-reserve gold standard, falling prices, caused by increased production, are likely to be accompanied by a modest elevation of the rate of profit and a somewhat greater ease of repaying debt, both owing to the increase in the production and supply of gold and thus in the spending of gold. Under such a gold standard, prices fall to the extent that the increase in the production and supply of ordinary goods and services outstrips the increase in the production and supply of gold and the consequent increase in spending in terms of gold.
While this must certainly come as a surprise to The Times, and to everyone else who does not understand the nature of deflation, falling prices are in fact so far removed from being deflation that they are the antidote to deflation. They are what enables an economic system that has experienced deflation to recover from it and thereafter to enjoy the fruits of economic progress.
This conclusion can be demonstrated Socratically, by means of a simple question that could be used on an economics exam for sixth graders.
Thus, imagine that prior to the present financial downturn, Bill used to go shopping once a week in his local supermarket. When he went there, he could afford to spend $10 for bottled water. At the prevailing price of $1 per bottle, he was able to buy 10 bottles. Now, in the midst of the downturn, when Bill visits the supermarket, he can afford to spend only $5 for bottled water.
Here’s the question: At what price per bottle of water would Bill be able to buy for $5 the 10 bottles of water he used to buy for $10? Answer: 50¢.
As this question and its answer make clear, a fall in prices enables reduced funds available for expenditure to buy as much as previously larger funds could buy.
This point applies even when lower prices do not result in greater purchases of the particular item whose price has fallen. Thus, suppose that the price of a gallon of milk is $8 and now falls to $4. Yet Bill and his family do not need more than one gallon in any given week, and so won’t buy any larger quantity of milk at its now lower price. The fall in its price still helps economic recovery. It does so by freeing up $4 of Bill’s funds to make possible the purchase of other things, that he wants but otherwise couldn’t afford because of the lack of available funds.
Another, similar example is that of a fall in the price of gasoline or heating oil, which helps to increase the ability of people to spend in buying products throughout the economic system.
As indicated, in sharpest contrast to falling prices, deflation is a process of financial contraction. In our present crisis, it is a contraction of credit and of the spending that depends on credit. A fall in prices and, of course, in wage rates too, is the essential means of adapting to this deflation and overcoming it.
Nevertheless, the prevailing bizarre confusion of falling prices with deflation, stands in the way of economic recovery. In regarding falling prices, which are the effect of deflation and at the same time the remedy for deflation, as somehow themselves being deflation, people are led to confuse the solution for the problem with the problem that needs to be solved.
On the basis of this confusion, they advocate government intervention to prevent prices from falling. The prices they want to prevent from falling are, variously, house prices, farm and other commodity prices, and, above all, wage rates. To the extent that such efforts are successful, and prices are prevented from falling, the effect is to prevent economic recovery. It prevents economic recovery by preventing the reduced level of spending that deflation represents, from buying the larger quantity of goods and services that it would be able to buy at lower prices and wage rates.
Just as falling prices are so far from being deflation that they are the remedy for deflation, so too preventing prices from falling is so far from preventing deflation that it actually worsens the deflation. This is because it leads people to postpone buying even in instances in which they have the ability to buy. They put off buying in the expectation of being able to buy on better terms later on, when prices and wage rates have fallen to the extent necessary to permit economic recovery.
By the same token, when prices and wage rates finally do fall sufficiently to permit economic recovery, an increase in spending in the economic system will almost certainly occur. This is because the funds that people had been withholding from spending, awaiting the fall in prices and wages rates, will now, in the face of the necessary fall, be spent. Thus the necessary fall in prices and wage rates achieves economic recovery by means of creating greater buying power for a reduced amount of spending. It also brings about a partial restoration of spending and thereby definitively ends the deflation.
Just how far it is necessary for prices and wage rates to fall in order to achieve economic recovery depends on the change that has taken place in what Mises calls “the money relation.” This is the relationship between the supply of money and the demand for money for holding.
During the boom, inflation and credit expansion increase the supply of money and at the same time reduce the demand for money for holding. Then, in the subsequent bust phase of the business cycle, the demand for money for holding rises and the supply of money can actually fall. Both of these factors make for a decline in total spending in the economic system and thus the need for a correspondingly lower level of wage rates and prices to achieve economic recovery.
How far these processes might go in our present circumstances and what might be done, consistent with the principle of economic freedom, to mitigate them, is too large a subject to explain in this one article.[1] However, I must state here that a decrease in the quantity of money can be altogether prevented and that this would dramatically limit the extent of the decline in overall spending in the economic system.
Whatever the reduced levels of spending that the changed money relation will support, the freedom of wage rates and prices to fall can achieve not only economic recovery but more than economic recovery. It can achieve the employment of everyone able and willing to work, i.e., full employment. And it could do so with no decline in the real wages of the average worker in the economic system, indeed, with a significant rise in his real wages. Unfortunately, this too is a subject too large to discuss further in the present article.[2]
Bailouts
Before closing, I must say a few words about the present efforts of the government to overcome the crisis by means of “bailouts” and their associated financing by budget deficits. Ultimately, these efforts are an attempt to overcome the effects of a rise in the demand for money for holding by means of a sufficiently large increase in the supply of money. In its campaign, the government appears to care for nothing but overcoming the crisis of the moment, without regard to the fuel it is providing for the next crisis.
The government today has unlimited powers of money creation. And so it is highly likely, given its evident willingness to use those powers, and the overwhelming public support that exists for using them, that the increase in the supply of money it brings about will ultimately outweigh the present increase in the public’s demand for money for holding. When and to the extent that that happens, and business sales revenues and profits begin to rise and employment and wage rates begin to rise, the public’s demand for money for holding will once again begin to fall.
At that point the massive increase in the quantity of money the government is currently bringing about will fuel sharply rising prices and give birth to a new crisis. This time, a crisis of inflation. Then, the government will either have to be content with a US economy that resembles the economic system of a Latin American country or it will have to rein in its inflation. If it chooses the latter quickly, we’ll be back to the situation that prevailed in the early 1980s and have to undergo a fresh economic contraction, though probably one of much greater size than then, because of the unfinished business left over from the present crisis.
If the government delays too long in reining in its inflation, then when it finally does decide to do so, it may be confronted not only with prices rising as rapidly as they did in Latin America decades ago, but also with the massive unemployment rates that accompanied the efforts to rein in such major inflation. At that time, prices rising at a rate of 20, 30, or 50 percent or more were accompanied by comparably high unemployment rates. (To understand how such a thing can happen, imagine total spending and prices both rising at the rate of, say, 50 percent per year. Now the government, in an effort rein in inflation, succeeds in reducing the increase in spending to 15 percent. If the rise in wage rates and prices has any kind of significant inertia, such as continuing at 40 percent, the effect will be a drop in production and employment to a level equal to 1.15/1.4, which represents a drop of about 18 percent. In the nearer-term future, unemployment will be promoted by any additional powers the government may give to labor unions, who will use them to raise wage rates even in the midst of mass unemployment, as they did from 1932 on in the Great Depression.)
Of course, given the prevailing readiness massively to expand the powers of government in order to deal with short-term crises, it is also possible that the government will enact wage and price controls in its efforts to fight the consequences of its inflation. If and when the controls are subsequently removed, there will again be a crisis of rising prices that, if not accompanied by still more inflation, will be followed by a major financial contraction. If the price controls are not removed, the economic system will be paralyzed and ultimately destroyed.
The upshot is that there is no good way out of the present crisis other than by meeting it through the free-market’s means of a fall in wage rates and prices, mitigated to the maximum extent possible in ways consistent with the principle of economic freedom. What is required is a way out that once and for all ends the boom-bust cycle of inflation and credit expansion followed by deflation and contraction. The free market, a freer market than we have had up to now, is the only such solution.
Economic freedom and economic recovery both require that prices and wage rates be free to fall and that all legal obstacles in the way of their falling be immediately removed. In order for that to happen, as many people as possible must understand that falling prices are not deflation but the antidote to deflation.
Memo to The Banks
Memo to The Banks: Lend or Else
DAVID SMICK
Back in the early 1990s, when Fed Chairman Alan Greenspan was still considered "the Maestro," I asked him what he thought of the Reagan administration's economic program. I anticipated a discussion of 1980s tax and interest rate policy. That's not what I got.
Greenspan theorized that the paradigm shift that moved the 1980s toward greater optimism came largely from something unanticipated. In 1981, President Ronald Reagan fired striking air traffic controllers. This act could have instantly produced a nationwide transportation walkout with devastating economic consequences. Everyone held their breath. But the strike didn't happen. At the time, American businesses had been written off as competitive dinosaurs. But now they had the political green light to restructure and become lean and mean. Economic optimism became infectious.
Barack Obama desperately needs his own paradigm-shifting spark. Like Reagan, he embodies a sense of optimism. But for the first time since the 1930s, we have entered a period of demand destruction. Increased fiscal stimulus is essential, yet new roads and bridges, more generous unemployment insurance, and tax credits hardly constitute "audacious" policymaking -- the spark necessary to shift public attitudes. American consumers are undergoing long-term retrenchment. They are forgoing spending in an effort to replenish the $10 trillion in collective household wealth they have lost. Consumption patterns may be returning to the lower levels of previous decades. That could mean that even a $1 trillion package may be far too small to do more than keep the contraction from worsening.
But there's a larger point. Economies are driven by more than numbers -- the size of either stimulus spending or interest rate cuts. They are driven by psychology. Right now, psychologically speaking, Americans see the U.S. financial system and the larger global system as a bus racing down an icy mountain road toward a village -- with no one behind the wheel.
Obama needs a big play. The place to begin is by confronting our banking system -- possibly even breaking up the financial behemoths considered "too big to fail." Our banks are sitting on mountains of capital. Taken together, their excess cash reserves normally amount to $3 billion to $7 billion. Astonishingly, those reserves today are estimated to exceed $800 billion, a portion of which is our bailout money. We have moved from reckless financial risk-taking to a situation even more dangerous: no financial risk-taking. Many suspect that this cash buildup indicates that the banks' off-balance-sheet debt exposure is far larger than acknowledged.
The first step is to reverse the Paulson policy of idolizing the banks. These are hardly noble institutions. Today's bankers have shown themselves to be devoid of leadership skills and, in some cases, common sense. Who, moments after receiving a bailout, would send their executives on a spa vacation? Or rush out to double their investment in a Chinese bank?
Let's not forget, too, that the subprime crisis mushroomed not simply because loans were made to people who couldn't afford them. The banks played games. To skirt international capital regulations, they hid their subprime-related mortgage-backed securities in off-balance-sheet vehicles.
It's time to bring out the bully pulpit. Obama needs to do with the bankers what JFK did with the steel executives. The bankers say they won't lend, or are imposing extraordinarily tough terms on borrowers, because 2009 will be a tough year. Urge them, at a minimum, to help reduce mortgage rates and increase refinancing. How? By using their Troubled Asset Relief Program bailout funds to buy Fannie Mae and Freddie Mac debt. There is no excuse for not doing so. The debt is now explicitly federally guaranteed.
The bankers say that government regulators are conflicted. Some demand further capital set-asides and less lending; others just the opposite. Given the collapse of the economy, we cannot afford this argument. It's time for a regulatory decision that encourages lending. Worry about bank capital standards after recovery begins.
The bankers say big questions remain about our financial architecture. Who, globally, should decide how much financial leverage is too much vs. how much is dangerously inadequate? What is the future of securitization and can this process be standardized and made more transparent? Can a more reliable market for derivatives be established? Is there an alternative to today's hapless, conflicted credit rating agencies? Answer these questions.
Obama needs to lay out for the banks the potential political risk of the status quo. Imagine this scenario eight to 10 months from now: Unemployment at 10 percent with mountains of bankruptcies and the banks still not lending. Congressional calls to break up the banks -- and remove current management -- would ring out. That is something many analysts believe the Japanese should have done with their politically connected banks during the 1990s, Japan's lost decade.
The financial crisis has entered a new phase. From August 2007 to August 2008, it was only a crisis. Since September, things have shifted to a full-blown panic. Nobody trusts anybody, or any institution. That is why Obama needs the big play, a policy with a psychological "wow" factor. He needs to shock the flat-lining patient. An expanded version of Washington's usual bag of fiscal tricks may not be enough.
David M. Smick is a global financial strategist and the author, most recently, of "The World Is Curved: Hidden Dangers to the Global Economy."
Trillion-Dollar Spree Is Road to Ruin, Not Rally: Kevin Hassett
Commentary by Kevin Hassett
Jan. 12 (Bloomberg) -- We are in the midst of a crisis caused by so many financial institutions borrowing too much money. Somehow, a critical mass of policy makers now believes that the correct response is for the U.S. government to borrow too much money.
The Congressional Budget Office last week forecasted that the 2009 federal budget deficit will be about $1.2 trillion, roughly triple what it was in 2008. We should hope we are that lucky. The deficit will be that low only if Uncle Sam dies and goes to heaven.
Make no mistake, the CBO forecast is the lowest of lowball estimates. It excludes President-elect Barack Obama’s proposed stimulus package and understates the likely costs of the Iraq war, among other things. A comprehensive estimate that accounts for all “known knowns,” as Donald Rumsfeld might say, would be higher by about half a trillion dollars. If the stimulus bill passes, the deficit next year will be $1.7 trillion.
A trillion is a strange and difficult number to contemplate, but thinking through the economic implications of that massive deficit requires doing so.
The number itself is one million millions. A government that started with a balanced budget could run a $1.7 trillion deficit by mailing 1.7 million households $1 million, or 17 million households $100,000.
Military and More
Or try this. The whole world’s military spending in 2006 totaled a little less than $1.2 trillion. So next year’s U.S. deficit could cover that and still have $500 billion left over for building bridges.
Perhaps the most disturbing comparison is this one: When President George W. Bush was first elected, total federal government spending was about $1.7 trillion. In other words, the difference between federal outlays and federal revenue this year will be bigger than the entire government was as recently as 2000.
How could the deficit increase so much, so fast? Part of the story is the decline in revenue, which the CBO forecasts will be $166 billion less than it was in 2008, a 6.6 percent decline. But relative to 2000, revenue has actually increased from $2 trillion to a scheduled $2.4 trillion in 2009.
The deficit has skyrocketed because spending has grown from $1.8 trillion in 2000 to a projected $3.5 trillion in 2009, fully 95 percent higher. Of course, all that happened mostly on a Republican watch.
Compounding the Problem
One reason the increase is so dramatic is the mystery of compounding. Each year, Congress passed pork-laden expenditure bills, which became part of the long-run baseline the minute they became law. Each time that the federal government wasted a billion dollars, it created budget space to waste $1 billion again and again, ad infinitum.
That’s perhaps the scariest fact about next year’s budget. The skyrocketing spending of 2009 will be the CBO baseline for every year after that. It will be easy to provide health care to everyone; the budget space will be blocked out. Indeed, Congress can spend with impunity in years to come, covered by the protective shroud of the CBO baseline that this year delivers.
We can ride big government spending and trillion-dollar deficits all the way to 2017, when the Social Security trust fund itself starts running deficits.
This year may establish a government-spending black hole with gravity strong enough to suck the U.S. economy over the event horizon. Such a spending path has two possible endgames. Neither is pretty.
Print or Tax
The Federal Reserve could print enough money to accommodate all of that debt, in which case the dollar will collapse and the U.S. will be looking at a South-America-style run on its debt.
Or the U.S. government could get its fiscal act in order with higher taxes. For that to happen, income taxes would approximately have to double.
While advocates of Keynesian-style stimulus are correct that this economy is terrible enough to warrant dramatic action, it is hard to understand how such a fiscal path might help. So what if second-quarter gross domestic product blips up a little bit? What business is going to expand its operations with the mother of all tax hikes peeking over the horizon? If government spending provided such a wonderful boost to the economy, we would be in Nirvana already.
If we want to create optimism about our future, we need to provide a reason. Putting a ring road around every city in the U.S. will not accomplish that. The only sensible path is for the U.S. to put its long-term fiscal house in order. Without that, this year’s stimulus will likely be a historic flop.
The good news is that a bipartisan group of senators, led by Democrat Kent Conrad of North Dakota and Republican Judd Gregg of New Hampshire, is on the right track.
Their idea is for Congress to empower a commission to make the tough choices about future benefits and taxes to restore sanity to the U.S. budget outlook, and then to fast-track the commission’s recommendations to an up-or-down vote. If Congress fails to take Conrad and Gregg seriously, we may all be headed for the bread line.
How This Happened
How This Happened
For years, many of us puzzled about how something so stupid and destructive as the New Deal could have happened. The stock market crashed because it was overinflated. That's nothing new. History is filled with credit bubbles that pop. Resources are reallocated to reflect economic reality and we move on.
The New Deal was different. It actually began under Hoover, who initiated new spending programs, jobs programs, and tried to inflate the money supply and bail out the banks. He was blasted by FDR for his big government policies, and FDR won the election. Once in power, FDR went nuts, instituting a program of central planning that combined features of the Soviet and Fascist models.
It was one idiotic program after another. They tried to raise wages when they should have fallen. They tried to save banks that should have collapsed. They destroyed resources when they were most needed. They encouraged spending when people should have been saving. They smashed the dollar at a time when it needed to be shored up. They cartelized business when competition was most necessary.
What were the results? Economic growth went nowhere between 1933 and 1939, with real gross domestic product per adult still 27 percent below trend at the end. Per capita GDP was lower in 1939 than in 1929. Unemployment was at 17.2 percent in 1939. This was actually higher than it was in 1931. This is despite 100 percent increases in monetary expansion. Taxes had tripled. Employing people became ever more expensive due to unions and national income guarantees.
Every time the economy would bottom out and genuine recovery would begin, policy would knock it back down again. Other seeming upturns were entirely artificial: make-work instead of real work, for example. Regimentation was everywhere so that business couldn't compete, farmers were destroying livestock and crops on command, and dissidents were being ferreted out through police-state tactics.
In other words, the whole project was a massive dud. It turned what might have been a short downturn into a decade-long national calamity, the biggest cost of which was freedom itself. And then as a coverup for the calamity, there was war. At last FDR found some use for those unemployed workers: send them to kill and be killed at taxpayer expense. As for wartime price controls and nationalization, it was the New Deal by other means.
(For a full account, with all the detail, in scintillating prose, see Flynn's Roosevelt Myth.)
Was it some sort of national insanity?
No, it was a power grab, and the current political moment shows precisely how this happens. A small group of elites, cut off from the broader reality, decides to finagle the system to serve itself and its friends in the short term while forgetting the big picture and the long term. Sensible people try to point out obvious facts, but their voices are drowned out.
But none of this happens without some philosophical rationale. Even before J.M. Keynes came along to give bad economic ideas a scientific gloss, the notion that government could gin up the economy with spending and inflation was pervasive. Laissez-faire economic theories had already fallen out of favor with the elites who controlled the universities, print houses, and government agencies.
Many nutty ideas were in the air. It's remarkable to see how many pro-Fascist books, for example, were in print in the 1920s and '30s. It was widely assumed that the future of the good society was bound up with the idea of "economic planning." This was an interesting phrase. It covered all forms of socialism plus the interventionist state. "Planning" was the intellectual fashion, and there were very few dissidents.
Once the crisis hit, the intellectual reality became the political reality. (Higgs describes the process in Crisis and Leviathan.)
Now that we are living amidst this, it is easier to come to terms with how the New Deal came about. It makes those in the know feel completely helpless. We look at what is happening to bank reserves and we know what is coming. When the economy recovers — even if only cosmetically — and lending starts again, the internal dynamic of the fractional-reserve system will come into operation. We could be facing inflation at 10 percent or 20 percent or even much higher, depending on how spending psychology plays itself out.
Then we listen to speeches by the president-elect, who is going on about the great stimulus package he is going to push through Congress. It's like listening to one quack doctor propose bleeding the patient even as the last quack doctor who bled the patient is packing his bags to leave. You want to shout: is there a real doctor in the house? But it seems like no one is listening.
What's striking here is how the historians are the ones with power right now. Bush has gone nuts with inflation and intervention as a way of avoiding Hoover's fate, even though the actual historical record (versus the historians' fantasies) shows that Hoover was the first New Dealer. Meanwhile, the Obama clique hopes to recreate the FDR disaster by following his plan detail by detail, even though the plan was stupid and didn't work.
To watch all this happening is like watching a slow-moving train headed over a cliff. The problem is that the engineers have ear plugs in and blinders on.
Will this go on for ten years like the last time? Will it end in World War III, as if following some historical script? Is it possible that we will go the way of Germany in the 1920s, straight into the abyss of hyperinflation and into the hands of a ghastly dictator? It is unwise to rule it out.
And yet, I'm not that pessimistic. It is extremely crucial to realize that there is a difference this time. In the 1930s, technological limits put severe restrictions on information delivery. Government propaganda easily dominated the culture. All of that has changed. Despite everything, people simply do not trust the government as they once did. Obama will enjoy a short honeymoon, but it will be over by summer.
What is still missing is one critical thing: a culture-wide love of liberty that is capable of intimidating and beating back the rogue regime. The conditions are right for this to actually happen, and to reverse the direction of politics today. But it will require all our efforts. Fortunately, everyone has the opportunity today to make a difference.
I hope my own book will help make a difference.
The last words in Ludwig von Mises's book Socialism bear repeating:
Everyone carries a part of society on his shoulders; no one is relieved of his share of responsibility by others. And no one can find a safe way for himself if society is sweeping towards destruction. Therefore everyone, in his own interest, must thrust himself vigorously into the intellectual battle.
Government Finds Itself in Hole, Keeps Digging
Commentary by Caroline Baum
Jan. 12 (Bloomberg) -- If it seems incongruous for elected officials to talk about budget discipline in the same breath as trillion-dollar deficits, it is.
President-elect Barack Obama is being encouraged by economists of all stripes to err on the side of doing too much to get the economy moving again. The bidding starts at $775 billion; only the naive believe it will stop there.
While Obama was in Washington pushing his agenda last week, the Congressional Budget Office was pouring cold water on the rollout. CBO projects a federal deficit of $1.2 trillion in fiscal 2009, 8.3 percent of gross domestic product, the biggest share of GDP ever with the exception of the periods during the two world wars.
The CBO estimates do not take into account the fiscal stimulus package, a.k.a. the American Recovery and Reinvestment Plan. That package will find a new urgency after Friday’s employment report for December closed the book on 2008 and its 2.6 million job losses, the biggest decline since the end of World War II.
Even scarier for those who measure the size of government by how much it spends is the projected jump in outlays to 25 percent of GDP, according to CBO, the highest since 1945.
If economics is, as it’s sometimes defined, the study of scarcity, then resources available to the private sector just got a whole lot scarcer.
Obama held up government as the only solution to the current problems.
“Only government can provide the short-term boost necessary to lift us from a recession this deep and severe,” he said in a Jan. 8 speech at George Mason University in Fairfax, Virginia. “Only government can break the vicious cycles that are crippling our economy.”
Kindness of Strangers
He neglected to say that only government can borrow trillions of dollars at miniscule interest rates. With yields on Treasury bills close to zero, I’m surprised the government hasn’t come up with a plan to borrow forward. Why not capitalize on the demand for super-safe T-bills and sell three-month bills one year from today?
How long the U.S. can count on the kindness of foreigners is an open question, not to mention a potential Armageddon scenario for the Federal Reserve if the dollar collapses.
Confronted with a fiscal situation that is bad and getting worse, what’s the government to do?
Even some groups dedicated to fiscal discipline concede the government has a responsibility to offset the decline in private demand. That the discretionary spending binge comes at a time when the retiring baby boomers are adding to existing strains on the government’s retirement and health-care systems (Social Security and Medicare) is an unlucky twist of fate -- or perhaps a needed wake-up call.
Like It Is
The challenge is “doing what’s necessary in the short-term without aggravating what’s already a monumental long-term problem,” says Susan Tanaka, director of citizens’ education at the Peter G. Peterson Foundation, a group dedicated to increasing public awareness about America’s fiscal future. The spending and tax cuts “should be temporary, targeted and efficient,” she says. “There is never an excuse for wasting money.”
Some of Obama’s supposed $300 billion in tax cuts -- credits for workers who pay no income tax, for instance -- is government spending by another name. (The first step in greater transparency is telling it like it is.)
Even in the face of $56.4 trillion of unfunded promises for future Social Security and Medicare beneficiaries -- $483,000 per household -- some economists are arguing that bigger (fiscal stimulus) is better. They cite statistics showing that every $1 of public spending translates into $1.50 of GDP.
Performance Czarina
If that’s the case, “why not do it every year?” says Andy Laperriere, managing director at the ISI Group in Washington.
The way he sees it, if consumers use the $150 billion of “tax cuts” to pay down credit-card debt, “we have $150 billion in government debt,” the burden of which ultimately falls on the taxpayer. The transaction boosts “short-term GDP at the expense of long-term GDP,” he says.
“The only way the stimulus package makes sense is to halt a downward spiral, to stop a freefall,” he says.
Obama promises the stimulus package will be kosher (pork- free, in other words). Management consultant McKinsey & Co. will be looking over his shoulder to ferret out any government waste and inefficiencies. (Former McKinsey consultant Nancy Killefer was named to the new post of chief performance officer.) And all those bridges that will be part of infrastructure spending? I have one or two to sell you.
Dire Straits
The dire state of federal finances presents an opportunity to educate the public, make the costs of government programs more transparent and “change the political environment so lawmakers can make the decisions they need to make,” Tanaka says.
“We talk about finding ‘efficiencies’ in health care, but these are euphemisms for not being able to get the volume of services we’re used to,” she says. “Everybody wants coverage. What are they willing to pay for it?”
Medical care may appear to be “free” to employees whose insurance premiums are paid by the company, but “it’s not free,” Tanaka says. “It’s coming out of wages.”
Until voters accept that there’s no free lunch, it’s hopeless to expect politicians to get the message.
Trust Me, I Have $1 Billion Stashed in the Bank
Commentary by William Pesek
Jan. 12 (Bloomberg) -- Wondering where all those Arthur Andersen accountants went? It may have been India.
It’s tempting to make that mental leap amid Satyam Computer Services Ltd.’s book-cooking scandal. Ramalinga Raju is no longer the entrepreneur who built India’s fourth-biggest software maker. He’s now allegedly the nation’s answer to Jeffrey Skilling, the former Enron Corp. chief executive officer serving a 24-year prison term.
Satyam’s crisis may be more jaw-dropping than Enron’s in 2001. It’s not just the magnitude of the scam -- 53,000 employees may lose jobs compared with 5,000 at Enron -- but the simplicity.
Enron’s fraud was conducted through a labyrinth of off- balance-sheet deals and other accounting gimmicks. Accounting firm Arthur Andersen approved the company’s financial creativity and collapsed in 2002. Enron didn’t make it easy for the auditor.
Satyam’s con was impossibly transparent: The Hyderabad-based company said it had $1 billion in the bank that it didn’t.
Raju said he inflated earnings and assets. Assuming he’s telling the truth, you would think auditor PricewaterhouseCoopers LLP or board members could have cleared up a mess years in the making with a phone call, a fax machine or even a postage stamp. Management says it has a mountain of cash in the bank and you just flat-out believe it?
And why did the World Bank appear to know more about Satyam’s business practices than everyone else? Last month, the Washington-based lender declared Satyam ineligible for contracts for eight years, alleging “improper benefits” were given to the bank’s employees.
Delving Deeper
If Raju’s version of the story is the right one, it raises a stark question: Could a moderately sized start-up company claim to have $1 billion or $2 billion in cash and then go public without observers delving deeper?
Then again, Raju’s claims have yet to be proven. Investigations are afoot and no one is talking publicly -- no comments all around from auditors and Raju, who was arrested along with brother Rama on Jan. 9.
“There can be two possibilities,” says Ved Jain, president of the Institute of Chartered Accountants of India. “One, the auditor has been negligent. Second, he was aware and intentionally overlooked it.”
The bigger question, of course, is what else is hiding below the surface in Asia’s third-biggest economy. Is this “Enron moment” merely the tip of the iceberg? Or will it have a chastening effect that leaves India better off five years from now? It’s impossible to know.
Second Blow
The days of giving corporate executives the benefit of the doubt are long gone. The shenanigans at Enron, WorldCom Inc. and Parmalat SpA have even lost their shock-value following the failure of Lehman Brothers Holdings Inc. and financier Bernard Madoff’s alleged $50 billion fraud.
Clearly, this isn’t an India-specific problem. It’s important to remember that India’s economy and 1.2 billion people have vast potential. This is as much a setback for global corporate governance as it is for Indian officials.
Yet this is the second big blow for corporate India in recent months. It’s unclear how the Mumbai terror attacks in November that left 164 people dead will affect business. The Satyam affair has only compounded concerns that foreign investors will view India less favorably.
Arun Kejriwal, founder of Kejriwal Research & Investment Services in Mumbai, spoke for many when he said: “This is a black day for India.”
Crown-Jewel Industry
The reason is this scandal involves India’s premier global industry. That amplifies the economic ripple effect. It’s anyone’s guess whether the government will heed calls for a public bailout.
Credit Suisse Group analysts Nilesh Jasani and Arya Sen advised investors in a report last week to own shares of Indian companies with “good corporate governance” as Satyam’s troubles may prompt disclosure of more one-time losses. That’s all well and good, yet that’s what Satyam investors thought they had done.
The last decade has been disorienting for investors, especially the last 12 months. First it was regulators asleep on the job, then credit-rating companies and then accountants.
Raju, 54, was named Ernst & Young Entrepreneur of the Year in 2007. It seems he was far more entrepreneurial than regulators knew. Raju presumably also fooled Satyam’s board of directors.
Precarious 2009
In a letter to the board last week, Raju could have been speaking for shareholders when he said that hiding the truth “was like riding a tiger, not knowing how to get off without being eaten.”
Things just got harder for India at the worst time imaginable. Prime Minister Manmohan Singh expects the economy to grow about 7 percent in the 12 months ending March 31. Even if that rate is achieved, global trends have turned decidedly against India’s prospects.
Two months ago, officials in New Delhi were still saying India was less vulnerable to the global credit crisis than Asian peers. Two stimulus packages since early December, four interest- rate cuts since October and Satyam’s woes all belie that claim.
The risk is that recent events will reduce the foreign investment needed to maintain rapid growth and spread its benefits. India’s 2009 just got a bit more precarious.
Capitalism Freezes in Worldwide Winter of Discontent
Capitalism Freezes in Worldwide Winter of Discontent (Update1)Jan. 12 (Bloomberg) -- As capitalism staggers through its first globalized economic crisis, the costs won’t be measured only in dollars and cents.
From newly rich Russia to eternally impoverished sub- Saharan Africa, social strains are threatening the established political order, putting some countries’ very survival at risk.
In the past month, Nigerian rebels threatened renewed warfare against foreign oil producers, Russia sent riot police from Moscow to quell an anti-tax protest in Siberia and China’s communist leadership warned of social agitation as the 20th anniversary of the Tiananmen Square massacre looms.
The disillusionment and spillover effects of the global recession “are not only likely to spark existing conflicts in the world and fuel terrorism, but also jeopardize global security in general,” says Louis Michel, 61, the European Union’s development aid commissioner in Brussels.
Somewhere in the wreckage may lurk an unexpected test for U.S. President-elect Barack Obama, 47, one that upstages his international agenda just as Afghanistan’s backwardness and radicalism led to the Sept. 11 attacks that defined the era of George W. Bush only eight months into his term.
Among the possible outcomes: instability in Pakistan, a more aggressive if economically stricken Iran, a collapsing Somalia, civil disorder in copper-dependent Zambia, a strengthened, drug-financed insurgency in Colombia and a more warlike North Korea.
Cascading Into a Crisis
The U.S. housing slump that began in 2007 has cascaded into a worldwide crisis that forced central bankers to cut interest rates to near zero to unlock credit markets, pushed governments to bail out their biggest banks amid a $1 trillion of writedowns, and sent titans like General Motors Corp. and American International Group Inc. begging for bailouts.
The World Bank reckons trade will shrink for the first time in more than 25 years, deepening the economic hole for governments in developing nations, where higher food and fuel prices cost consumers an extra $680 billion last year and pushed as many as 155 million people into poverty.
Nuclear-armed Pakistan, once touted by Bush as the key U.S. ally in the war on terror, sits at the nexus between economic insecurity and extremism.
“Blood and tears” may be Pakistan’s fate, says Thaksin Shinawatra, 59, who as prime minister of Thailand fought rural poverty during a stormy five-year tenure until his ouster by a military coup in 2006. “That’s where I’m worried, and also about political stability, and the terrorist activities are there,” he said in an interview.
IMF Bailout
On Nov. 25, Pakistan clinched a $7.6 billion International Monetary Fund bailout to avert a debt default amid ebbing growth and an inflation rate of 25 percent in November that is ruining the livelihoods of its poor.
A day later, an Islamic terrorist group went on a rampage in Mumbai, India’s financial hub, killing 164 people and adding a bloody new chapter to six decades of animosity on the subcontinent. India accused Pakistan of harboring the militants, much as the Taliban uses ungoverned Pakistani tribal regions as a launch pad for attacks on Afghanistan.
Neighboring Iran is among the energy-exporting states afflicted by the 73 percent drop in oil prices from last July’s peak of $147.27. The government, reliant on oil income for more than half the budget, may pare subsidies for utility bills, adding to the pain of October’s 30 percent inflation rate.
Axis of Evil
Elections in June may determine whether Iran, part of Bush’s “axis of evil,”M1LRLCGFMZAI&peplid=1517432&pepllastname=Sarkozy&peplfirstname=Nicolas&peplcompanyname=French_Republic&peplcompanynumber=504367&peplwhohits=45&pepltitle=President&interviewstatus=0&interviewdate=2009-01-12_08_46_36&interviewreporterpepl=0&intervieweditorpepl=1712842&intervieweditoremail=jhertling"bloomberg.net&interviewsource=News_Reporter_Software&srange=8115&erange=8130>Nicolas Sarkozy said at a conference last week in Paris. With globalization, he said, “we expected competition and abundance, and in the end we got scarcity, debt, speculation and dumping.”
Extremism and Violence
Historians say it’s too early to declare the end of the intertwining of the global economy, under way at least since the collapse of the Soviet bloc in 1989. For one thing, developed nations still have a huge stake in the system: Even with $29 trillion wiped off the value of global equity markets last year, the Dow Jones Industrial Average is back where it was in 2003, hardly a time of privation.
As a result, disturbances in the West -- from Greece’s worst riots since the 1970s, to a 31 percent increase in New Year’s Eve car torchings in France, to a pickup in shoplifting at 84 percent of major U.S. retailers -- won’t shake the foundations of those societies.
Failed and Failing
It’s the failed or failing states that stand to lose the most. “The punch line: Poverty does cause violence,” says Raymond Fisman, a professor at Columbia Business School in New York. Researchers led by Edward Miguel of the University of California have even quantified it: a 5 percent drop in national income in African countries increases the risk of civil conflict in the following year to 30 percent.
The frailest nations are those concentrated south of the Sahara desert, plagued by a legacy of despotism, corruption, disease and economic misfortune -- often all at once. The region accounts for seven of the top 10 countries in a ranking of “failed” states compiled by the Fund for Peace, a Washington- based research group.
With commodity prices sinking, cutting the UBS Bloomberg Constant Maturity Commodity Index by almost half in the past six months, mining companies including Anglo-American Plc, De Beers, Lonmin Plc, and Xstrata Plc are slashing jobs, adding to Africa’s economic woes.
Nigeria, holder of Africa’s biggest fossil-fuel reserves, is staring into a $5 billion budget hole due to the oil-price swoon. It also confronts an emboldened guerrilla movement in the southern Niger Delta, the oil-producing region that has attracted the likes of Royal Dutch Shell Plc and Chevron Corp.
‘Not Optimistic’
“The outlook is not optimistic,” says Pauline Baker, president of the Fund for Peace, which ranks Nigeria 18th on the most-at-risk list. “Unless Nigeria begins to pull itself together, I think with the lowering oil price in particular it is quite vulnerable.”
As incomes shrivel in the poor world, the economically troubled rich world isn’t able to fill the gap. Even when the going was good, the Group of Eight industrial powers were struggling to meet a 2005 commitment to increase annual aid to poor countries by $50 billion by 2010. Now, official donations are set to fall by as much as 30 percent, the European Commission predicts.
The IMF may need another $150 billion to help reverse the damage to emerging markets, Managing Director Dominique Strauss- Kahn says. While “demand may be above what we have,” Strauss- Kahn said in an interview that he is convinced the IMF could scrounge up the extra funds.
Putin’s Role
Perched between advanced economies and the raw-materials exporters in the southern hemisphere is Russia, which used the eight-fold oil-price surge from 2002 to 2008 to reassert its claim to the great-power status that evaporated along with the Soviet empire.
Under President-turned-Prime Minister Vladimir Putin, that newfound clout became manifest in last year’s invasion of neighboring Georgia and this month’s shutdown of gas shipments to Europe. The tactics deflected domestic attention from the onset of the first recession since Russia’s debt default in 1998. The ruble dropped 19 percent against the dollar in 2008, the steepest slide in nine years.
Belligerency fueled by sudden wealth is likely to be inflamed by sudden scarcity, says Harold James, a history professor at Princeton University.
“Economic difficulties are always a spur to foreign political adventurism,” James says. “In Russia, there’s already a big devaluation, there’s unrest in Siberia and other provincial cities. This is really where the destabilization is going to come from.”
China’s Course
As Russia clashes with its neighbors, China may be headed toward domestic repression. While growth of 7.5 percent as predicted by the World Bank will outstrip the industrial economies, the pace will be the slowest since 1990, the year after the army put down the Tiananmen pro-democracy uprising.
China’s recipe for raising the standard of living has relied on creating jobs in coastal boomtowns like Shanghai as a magnet for millions of poor from the vast, rural interior. Now that formula is breaking down. More than 10 million migrant workers lost their jobs in the first 11 months of 2008, an unidentified Labor Ministry official told Caijing Magazine last month.
Using Communist Party code for riots and civil disorder, the state-controlled Outlook Magazine last week warned that a spike in “mass incidents” will test the government’s ability to preserve the social peace.
Dissent Insurance
At stake is the endurance of the Chinese hybrid of an open economy and closed political system. During its two-decade rise that has increased gross domestic product almost 10 times to make China the world’s fourth-largest economy and engine of global growth, a buoyant economy provided insurance against political dissent.
In a worst-case scenario, U.S. intelligence agencies warn, the communist leadership would roll back China’s integration into the world economy.
“Although a protracted slump could pose a serious political threat, the regime would be tempted to deflect public criticism by blaming China’s woes on foreign interference, stoking the more virulent and xenophobic forms of Chinese nationalism,” the U.S. National Intelligence Council concluded in November.
China has known outbursts of chauvinism in the past and remained intact, thanks to a social hierarchy dating back to the age of Confucius. Poorer countries lacking that political anchor face a bleaker outlook.
The crisis “could undermine the development momentum,” Liberian President Ellen Johnson Sirleaf said in an interview. “It would mean joblessness would increase, and that could undermine the stability of nations.”
Posts
No comments:
Post a Comment