Is The End Of The Euro In Sight?
The future of the euro is hanging by a thread at the moment. The massive debt problems of nations such as Greece, Italy and Portugal are dragging down the rest of the Europe, and the political will in northern Europe to continue to bail out these debt-ridden countries is rapidly failing. Could the end of the euro actually be in sight? The euro was really a very interesting experiment. Never before had we seen a situation where monetary union was tried without political and fiscal union along with it on such a large scale. The euro worked fairly well for a while as long as everyone was paying their debts. But now Greece has collapsed financially, and several other countries in the eurozone (including Italy) are on the way. Right now the only thing holding back a complete financial disaster in Europe are the massive bailouts that the wealthier nations such as Germany have been financing. But now a wave of anti-bailout sentiment is sweeping Germany and the future of any European bailouts is in doubt. So what does that mean for the euro? It appears that there are two choices. Either we will see much deeper fiscal and political integration in Europe (which does not seem likely at this point), or we will see the end of the euro.
That status quo cannot last much longer. The citizens of wealthy nations such as Germany are becoming very resentful that gigantic piles of their money are being poured into financial black holes such as Greece. In fact, it is rapidly getting to the point where we could actually see rioting in the streets of German cities over all of this.
All of this instability is creating a tremendous amount of fear in world financial markets. Nobody is sure if Greece is going to default or not.
Without more bailout money, Greece will most certainly default. If anyone does not think that one domino cannot set off a massive chain reaction, just remember what happened back in 2008.
Bear Stearns and Lehman Brothers set off a chain reaction that was felt in every corner of the globe. All of a sudden credit markets froze up because nobody was sure who had significant exposure to bad mortgages.
Today, the entire world financial system runs on debt, so when there is a credit crunch it can have absolutely devastating economic consequences. The financial crisis of 2008 helped plunge the world into the greatest recession that the globe had seen since the 1930s.
In the old days, nations such as Greece that got into too much debt would just fire up the printing presses and cover over their problems with devalued currency.
Well, those nations that are using the euro simply cannot do that. The government of Greece cannot simply zap a whole bunch of euros into existence in order to solve their problems.
Right now, major European banks are holding massive amounts of debt from various European governments on their balance sheets. Most of these European banks are also very highly leveraged. Even a moderate drop in the value of those debt holdings could wipe out a number of these banks.
The head of the IMF, Christine Lagarde, recently told Der Spiegel the following....
"There has been a clear crisis of confidence that has seriously aggravated the situation. Measures need to be taken to ensure that this vicious circle is broken"
Unfortunately, what Lagarde said was right. You see, the financial system in Europe is a "confidence game" and a "crisis of confidence" is all that it would take to bring it down because it does not have a solid foundation.
Just like the U.S. financial system, the financial system in Europe is a mountain of debt, leverage and risk. If the winds start blowing the wrong direction, the entire thing could very easily come tumbling down.
Over the past couple of weeks, the outlook in Europe has become decidedly negative. For example, one senior IMF economist is now actually projecting that Greece will experience a "hard default" at some point in the coming months....
I expect a hard default definitely before March, maybe this year
If Greece defaults, that would mean that the bailouts have failed. That would also mean that several other nations in Europe would be in danger of defaulting soon as well.
The consequences of a wave of defaults in Europe would be absolutely staggering. As mentioned above, major banks in Europe are deeply exposed to sovereign debt.
Regarding this issue, Deutsche Bank Chief Executive Josef Ackermann recently made the following stunning admission....
"It's stating the obvious that many European banks would not survive having to revalue sovereign debt held on the banking book at market levels."
Yes, you read that correctly.
There are quite a few major European banks that are in imminent danger of collapse.
Even though there hasn't been any sovereign defaults yet, we are already starting to see massive financial devastation in Europe. Just check out some of the financial carnage from Monday....
*The stock market in Germany was down more than 5%.
*The stock markets in France and Italy were down more than 4%.
*Royal Bank of Scotland was down more than 12%.
*Deutsche Bank was down more than 6%.
*Societe Generale was down more than 8%.
*Italy's UniCredit was down more than 7%.
*Barclays was down more than 6%
*Credit Suisse was down more than 4%.
*The yield on 2 year Greek bonds was up to 50.38%.
*The yield on 1 year Greek bonds was up to 82.14%. A year ago it was under 10%.
Just like in 2008, banking stocks are leading the decline. We have another major financial crisis on our hands and there is no solution in sight.
As the financial world becomes increasingly unstable, investors are flocking to gold. In case you have not noticed, gold is up over $1900 an ounce again.
So what comes next?
Well, on Wednesday Germany's constitutional court is scheduled to announce its verdict on the legality of the latest bailout package for Greece. The court is expected to rule that the bailout package is legal, but if they don't that would be really bad news for the euro.
However, whatever the court rules, the reality is that the turbulent political atmosphere inside Germany is probably a much bigger issue as far as the future of the euro is concerned.
Right now, Germans are overwhelmingly opposed to more bailouts. German Chancellor Angela Merkel's political party just suffered a resounding defeat in local elections in Germany, and many within her own coalition are withdrawing support for any more bailouts.
This is going to make it very difficult to save the euro. At this point, Germans have very little faith in the currency.
Just check out what Bob Chapman of the International Forecaster recently wrote about the current atmosphere in Germany....
76% of Germans say they have little or no faith in the euro, up from 71% two months ago. This is what we have been stating for ten years. Long-term 69% to 71% have never wanted the euro. The poll is not at all surprising. The Germany people are saying we have put up with the euro and euro zone for long enough – we want out now.
Germans are also very much against even deeper European economic integration. For example, recent polling found that German voters are against the introduction of "Eurobonds" by about a 5 to 1 margin.
But Germans are not the only ones that are tired of the euro. The countries of southern Europe have come to view the euro as a "straightjacket" that keeps them from having the financial flexibility that they need to deal with their debts.
Many people living in southern Europe consider the euro to be a financial instrument that allows nations such as Germany to have way too much power over them. Just check out what Professor Giacomo Vaciago of Milan's Catholic University recently had to say....
"It's clear that the euro has virtually failed over the last ten years, even if you are not supposed to say that. We pretended to be Germans, but it was an illusion"
But if the bailouts fall apart and the euro collapses, we are going to see nations such as Greece fall into total financial collapse.
Just how desperate have things become in Greece? Just consider the following excerpt from a recent article by Puru Saxena....
In Greece, government debt now represents almost 160% of GDP and the average yield on Greek debt is around 15%. Thus, if Greece’s debt is rolled over without restructuring, its interest costs alone will amount to approximately 24% of GDP. In other words, if debt pardoning does not occur, nearly a quarter of Greece’s economic output will be gobbled up by interest repayments!
Without help, there is no way that Greece is going to be able to avoid a default.
Sadly, Greece is far from the only major financial problem in Europe. Portugal, Ireland and Italy also have debt to GDP ratios that are well above 100%.
As mentioned earlier, this is a massive problem for the financial system of Europe, because nearly all of the major European banks are leveraged to the hilt and they are massively exposed to government debt.
If you don't think that this is a problem, just remember what happened back in 2008.
Back then, Lehman Brothers was leveraged 31 to 1. When things turned bad, Lehman was wiped out very rapidly.
Today, major German banks are leveraged 32 to 1, and those banks are currently holding a massive amount of European sovereign debt.
Overall, the entire global banking system has a total of 2 trillion dollars of exposure to Greek, Irish, Portuguese, Spanish and Italian debt.
If European countries start defaulting, the dominoes are going to start falling and things will get really messy really quickly.
There are two things that could keep defaults from happening.
Number one, Germany and the other wealthy nations in the eurozone could just suck it up and decide to pour endless bailouts into nations such as Greece and Italy.
Number two, the nations of the eurozone could opt for much deeper economic and political integration. That would mean a massive loss of sovereignty, but it would save the euro, at least for a little while.
Right now, the political will for either of those two choices is simply not there. That does not mean that the political elite of Europe will not try to ram through some sort of a plan, but the reality is that Germans are already so upset about what has been going on that they are about ready to riot in the streets.
Yes, the end of the euro is a real possibility.
If the euro does collapse, it would likely cause a financial panic that would make 2008 look like a Sunday picnic.
So what do all of you think about the future of the euro? Please feel free to leave a comment with your thoughts below....
Even Goldman Sachs Secretly Believes That An Economic Collapse Is Coming
Goldman Sachs is doing it again. Goldman is telling the public that everything is going to be just fine, but meanwhile they are advising their top clients to bet on a huge financial collapse. On August 16th, a 54 page report authored by Goldman strategist Alan Brazil was distributed to institutional clients. The general public was not intended to see this report. Fortunately, some folks over at the Wall Street Journal got their hands on a copy and they have filled us in on some of the details. It turns out that Goldman Sachs secretly believes that an economic collapse is coming, and they have some very interesting ideas about how to make money in the turbulent financial environment that we will soon be entering. In the report, Brazil says that the U.S. debt problem cannot be solved with more debt, that the European sovereign debt crisis is going to get even worse and that there are large numbers of financial institutions in Europe that are on the verge of collapse. If this is what people at the highest levels of the financial world are talking about, perhaps we should all start paying attention.
There is a tremendous amount of fear in the global financial community right now. As I wrote about the other day, the financial world is about to hit the panic button. Things could start falling apart at any time. Most of these big banks will not admit how bad things are publicly, but privately there is a whole lot of freaking out going on.
According to the Wall Street Journal, Brazil believes that "as much as $1 trillion in capital may be needed to shore up European banks; that small businesses in the U.S., a past driver of job production, are still languishing; and that China's growth may not be sustainable."
Perhaps most startling of all is what the report has to say about the debt problems of the United States and Europe.
For example, this following excerpt from the report sounds like it could have come straight from The Economic Collapse Blog....
“Solving a debt problem with more debt has not solved the underlying problem. In the US, Treasury debt growth financed the US consumer but has not had enough of an impact on job growth. Can the US continue to depreciate the world’s base currency?”
Remember, this statement was not written by some guy on the Internet. A top Goldman Sachs analyst put it into a report for institutional investors.
The report also goes into great detail about the financial crisis in Europe. Brazil writes about how the euro is headed for trouble and about how dozens of financial institutions in Europe could potentially be in danger of collapse.
But in any environment Goldman Sachs thinks that it can make money. The following is how Business Insider summarized the advice that Brazil gave in the report regarding how to make money off of the impending collapse in Europe....
- Buy a six-month put option on the Euro versus the Swiss Franc, thus betting the Euro will drop against the Franc (the Franc being the currency that an official Goldman report recently referred to as the most overvalued in the world)
- Buy a five-year credit default swap on an index of European corporate debt—the iTraxx 9. This is a bet that some of these companies will default, and your insurance policy, the CDS, will pay off
This is so typical of Goldman Sachs. They will say one thing publicly and then turn around and do the total opposite privately.
For example, prior to the financial crisis of 2008, Goldman Sachs was putting together mortgage-backed securities that they knew were garbage and marketing them to investors as AAA-rated investments. On top of that, Goldman then often privately bet against those exact same securities.
The CEO of Goldman Sachs has even acknowledged that the investment bank engaged in "improper" behavior during 2006 and 2007.
For much more on the history of all this, please see this article: "How Goldman Sachs Made Tens Of Billions Of Dollars From The Economic Collapse Of America In Four Easy Steps".
So will Goldman Sachs ever get into serious trouble for any of this?
No, of course not.
Yeah, they will get a slap on the wrist from time to time, but the reality is that the top levels of the federal government are absolutely littered with ex-employees of Goldman Sachs. Goldman is one of the "too big to fail" banks and they are going to continue to do pretty much whatever they feel like doing.
Sadly, the power of the "too big to fail" banks just continues to grow. At this point, the "big six" U.S. banks (Goldman Sachs, Morgan Stanley, JPMorgan Chase, Citigroup, Bank of America, and Wells Fargo) now possess assets equivalent to approximately 60 percent of America's gross national product.
Goldman Sachs was the second biggest donor to Barack Obama's campaign in 2008, so don't expect Obama to do anything about any of this.
We have a financial system that is deeply, deeply corrupt and all of that corruption is a big reason why things are falling apart.
Sadly, the 54 page report mentioned above is right - we really are facing a global debt meltdown and we really are heading for an economic collapse.
You aren't going to hear the truth from the mainstream media or from our politicians because "keeping people calm" is much more of a priority to them than telling the truth is.
The debt crisis in the United States is unsustainable and the debt crisis in Europe is unsustainable. Right now we are in the calm before the storm, and nobody knows exactly when the storm is going to strike.
But let there be no doubt - it is coming.
The amazing prosperity that we have enjoyed for the last several decades has largely been a debt-fueled illusion. It was a great party while it lasted, but now it is coming to an end and the aftermath of the coming crash is going to be absolutely horrific.
Keep watch and get prepared. We don't know exactly when the collapse is going to happen, but it is definitely on the way and now even Goldman Sachs is admitting that.
Labor Day 2011: What Are We Celebrating? The Lack Of Jobs In America?
If you still have a good job, you certainly have something to celebrate on Labor Day 2011. So far you have survived the decline of the U.S. economy. But your day may be coming soon. This weekend, there will be millions of Americans that will not be doing any celebrating. They are not enjoying a break from their jobs because they don't have any jobs. In fact, it seems kind of heartless for the rest of us to be celebrating while so many of our countrymen are destitute. What are we celebrating on Labor Day 2011? The lack of jobs in America? At this point, the U.S. economy closely resembles a gigantic game of musical chairs. Every time the music stops, even more good jobs are pulled out of the game and even more workers are added. Once upon a time, if you really wanted a job in America you could get one. But now the competition for even the most basic jobs is absolutely brutal. If you gathered together all of the unemployed people in the United States, they would constitute the 68th largest country in the world. It would be a nation larger than Greece. All of those unemployed people are not going to be taking trips with their families this holiday weekend. Instead, most of them are going to be trying to figure out what to do with their shattered lives.
With the economy in such a mess, you would think that someone out there would be suggesting that Labor Day 2011 should really be a day of mourning. This economic downturn has shredded the lives of millions of American families.
Is there any other crisis in recent years that has had more of an impact on a national level?
On Friday, the U.S. Bureau of Labor Statistics reported that no new jobs were created during the month of August and that the official unemployment rate remained steady at 9.1 percent.
Wait, aren't we supposed to be in the middle of an economic recovery?
Actually, we need at least 125,000 new jobs or so each month just to keep up with the growth of the U.S. population. So it seems odd that the economy would add zero jobs but the unemployment rate would not increase.
But that is what the government is saying.
In any event, things don't look good. According to the U.S. Bureau of Labor Statistics, the civilian employment-population ratio was at 58.2 percent last month. This is an incredibly low figure.
In a recent article, John Mauldin explained what would have to happen to return the employment-population ratio to where it was in the year 2000....
The US has roughly the same number of jobs today as it had in 2000, but the population is well over 30,000,000 larger. To get to a civilian employment-to-population ratio equal to that in 2000, we would have to gain some 18 MILLION jobs.
Does anyone have an extra 18 million jobs laying around somewhere? The following is a chart showing what has happened to the employment-population ratio over the last several decades....
What makes this chart even more startling is that the number of women in the workforce was constantly rising for most of the time period reflected in this chart. So when you take that into account our current situation is far worse.
For example, back in 1969 95 percent of all men between the ages of 25 and 54 had a job. Pretty much any man in his prime working years that wanted a job could get a job.
In July, only 81.2 percent of men in that age group had a job.
But that is only part of the story. Another significant trend has been how flat wages have been. Average hourly earnings fell 0.1% in August. Meanwhile, the prices in the stores continue to go up.
In this column, I write a lot about how the middle class is being destroyed in this country. When you look at the ratio of employee compensation to GDP, it is now the lowest that is has been in about 50 years. In other words, U.S. workers are taking home a smaller share of the pie than at any other time in modern U.S. history.
But at this point those that still actually do have jobs consider themselves to be the lucky ones.
Tonight, there will be millions of desperate unemployed Americans that will blankly stare at their televisions as they try to figure out how their dreams got flushed down the toilet.
Remember how I mentioned at the beginning of the article that unemployed Americans would constitute a country larger than Greece? Well, 42 percent of all of those unemployed Americans have been out of a job for 27 weeks or longer.
What would you do if you lost your job and you were unemployed for half a year?
Would you be able to survive?
In America today, the longer that you are unemployed, the harder it is for you to get another job. If you have been unemployed for at least one year, there is a 91 percent chance that you will not find a new job within the next month.
Out of sheer desperation, many Americans have taken jobs that they never even dreamed that they would take.
Only 47 percent of the U.S. workforce is "fully employed" at this point. Right now there are hordes of Americans that are waiting tables, flipping burgers or stocking shelves at Wal-Mart because that is all that they can find right now.
Sadly, this is all part of a long-term trend.
Back in 1980, less than 30% of all jobs in the United States were low income jobs. Today, more than 40% of all jobs in the United States are low income jobs.
This middle class is being pummeled out of existence, and most Americans don't even understand what is happening.
It certainly does not help that both the Republicans and the Democrats have stood by as millions upon millions of our jobs have been shipped out of the country.
It also certainly does not help that both the Republicans and the Democrats have stood by as millions upon millions of illegal immigrants have taken jobs away from American citizens.
It also certainly does not help that both the Republicans and the Democrats have stood by as U.S. businesses have been absolutely crushed by mountains of nightmarish regulations and have been taxed into oblivion.
The decade that just ended was the worst decade for job growth in America since the Great Depression. In fact, even though thirty million people were added to the U.S. population during the decade, there was essentially zero job growth.
Sadly, things look like they are going to continue to get even worse. For example, the United States Postal Service is in such trouble that it is asking Congress to allow it to lay off 120,000 workers. Overall, the Postal Service wants to eliminate 220,000 positions by 2015.
So is this big speech that Obama is going to give on Thursday going to solve anything?
Of course not.
The reality is that if Obama or any of his advisors had any grand ideas for fixing our situation they would have implemented them by now.
And what is the big deal in making us wait until Thursday to hear these "new ideas"? Why not just tell us now?
Sadly, the truth is that everything that our politicians do now is about setting themselves up for the 2012 election.
Most likely, Obama is just going to take a bunch of tired ideas that do not work and "spin" them into a grand new plan.
Millions of Americans will actually buy into it.
But it is not as if establishment Republican candidates have anything to offer either.
You know, if Obama wanted to do something substantial, one place to start would be to order the Federal Reserve to stop paying banks not to make loans to individual and small businesses.
But just like all of our other weak-minded recent presidents, Barack Obama is not going to confront the Federal Reserve.
In fact, everything that Obama actually does "for the economy" only seems to make things worse.
As I have outlined before, we know exactly why our economy is losing jobs and we know things that we could start doing right now to reverse the long-term trends that are absolutely killing us.
But Barack Obama is not talking about real solutions and neither are the establishment Republican candidates.
So things are going to continue to get worse. The number of Americans on food stamps has increased 74% since 2007. Every month we have been setting a new record. The middle class is going to continue to disappear as the number of good jobs continues to decrease.
So, no, there are not too many reasons to celebrate on Labor Day 2011. Our economy is dying and millions upon millions of our fellow citizens are deeply suffering.
Urgent action is required in order to prevent our situation from rapidly getting worse, but right now the vast majority of our politicians are asleep at the switch.
So instead of celebrating this Labor Day, why don't you say a prayer for America instead?
We really could use it.
Jobs-Creation Lesson from the Past
by Richard W. Rahn
The Obama administration and others on the left seemed to be stunned when the Bureau of Labor Statistics reported no new net jobs last month. When President Obama makes his "jobs speech," the American people will see whether he and his advisers have learned anything from the three years of Obamanomics failures.
Historically, the American economy has been a phenomenal job-creating machine. In a well-functioning economy, the increase in jobs parallels the increase in population. As can be seen in the accompanying table, during eight Reagan years, jobs grew at a much faster rate than did the population, as many disheartened workers re-entered the labor force after the Carter economic fiasco. Almost 17 million new civilian jobs were created from 1981 through 1989, which was 9 million more than can be explained by population growth. Likewise, during the Clinton years from 1993 through 2001, 7 million more jobs were created than can be explained by population growth alone.
But during the presidencies of George H.W. Bush and George W. Bush, job growth did not keep up with population growth. If it had, there would have been approximately 3.7 million more jobs created between 1989 and 1993 and 5.9 million more jobs between 2001 and 2009. The Obama record is far worse. The total number of jobs actually has decreased by 2.6 million since January 2009; if job growth had merely kept up with population growth during that period, there would be 4.8 million additional jobs. At the end of recession, the number of jobs normally grows far faster than population, but not this time.
Richard W. Rahn is a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.
More by Richard W. Rahn
The unemployment rate is a flawed measure because during weak economic periods, many discouraged people drop out of the labor force; thus, the labor force/population ratio declines and the real unemployment rate is understated.
As President Obama searches for solutions to the jobs problem, he ought to look at the policies that worked successfully during the Reagan and Clinton administrations. The Reagan administration sharply reduced marginal tax rates in both the first and second terms, but there was only a small reduction in the tax burden as a percentage of gross domestic product (GDP) — about 1 percent of GDP from 1981 to 1989. However, the job-creating businesspeople knew with great certainty that the tax cost of hiring new workers and investing in new plants and equipment would be going down, not up. They also knew that the administration was serious about applying cost-benefit tests to proposed regulations. In spite of all the talk about reducing government spending, spending as a percentage of GDP did not fall during the first Reagan administration because the cost of the military buildup offset the reductions in domestic spending. Spending as a percentage of GDP dropped 2 full percentage points during Reagan's second term, which was also the period of the most rapid job growth.
Government spending dropped during both terms of the Clinton administration, from 21.4 percent of GDP in 1993 to 18.2 percent of GDP in 2001. President Clinton did increase taxes during his first term but signed the reduction in the capital gains tax rate in his second term. However, most have forgotten that the economy had stagnated at the end of the second Clinton term and the economy was in recession in the first quarter of 2001, when George W. Bush took office — well before Sept. 11, 2001. In retrospect, Mr. Clinton should have cut taxes more sharply in his second term.
The first President Bush abandoned his "flexible freeze" to control spending shortly after taking office and reneged on his "no new taxes pledge," both of which turned out to be mistakes. The second President Bush did cut tax rates but allowed spending to rise 2 full percentage points of GDP during his two terms.
The lessons should be obvious to Mr. Obama and his advisers. Increases in government spending are associated with lower — not higher — job creation and vice versa. (This has been true for the 100 years for which there are good records.) Job creators do not hire workers when they fear higher taxes in the future. Temporary tax and spending gimmicks such as infrastructure projects also have proved not to create net new jobs.
The president should say in his Thursday speech: "I pledge not to propose any increase in taxes until unemployment is under 5 percent. I promise to come forth with a budget next month that will reduce spending each year, so within four years, it will be no higher than 19 percent of GDP. And I am issuing a freeze on all new regulations, which will remain in effect until each new proposed regulation can be shown to be cost-effective." That would take him about 30 seconds to say. Most listeners would be happy to turn to the football game, the markets would soar on Friday, businesspeople would start hiring, and the president might even be re-elected.
Grading the Likely Components of Obama’s New Stimulus Plan
Grading the Likely Components of Obama’s New Stimulus Plan
President Obama will be unveiling another “jobs plan” tomorrow night, though Democrats are being careful not to call it stimulus after the failure of the $800 billion package from 2008.
But just as a rose by any other name would smell as sweet, bigger government is not good for the economy, regardless of how it is characterized.
Here are the most likely provisions for Obama’s new stimulus, as reported by the Associated Press, along with a grade reflecting whether the proposals will be effective.
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Payroll tax relief – C – This proposal won’t do any harm, but it probably won’t have much positive impact because people generally don’t make permanent decisions on creating jobs and expanding output on the basis of temporary tax cuts.
But, to be fair, if the tax cut keeps getting extended, people may begin to view it as a semi-permanent part of the tax code, which would make it a bit more potent.
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Extended unemployment benefits – F – I agree with Paul Krugman and Larry Summers, both of whom have written that you extend joblessness when you pay people to be unemployed for longer and longer periods of time.
And I recently produced a chart showing how long-term unemployment has jumped sharply since Obama entered the White House, a dismal result that almost surely is related to the numerous expansions of unemployment benefits.
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New-hire tax credit – D – This proposal actually would subsidize employment rather than joblessness, so it’s an improvement over extending unemployment benefits, but it’s unclear how the IRS can effectively enforce such a scheme.
This approach was tried already, as part of HIRE Act of 2010 (which was infamous for the FATCA provision), and it obviously didn’t generate great results. Simply stated, giving special tax breaks to companies with high employee turnover is not an effective approach.
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School construction subsidies – F – The federal government should have no role in education. Period.
That being said, the economic flaw of school construction spending-cum-stimulus is that government spending must be financed with either taxes or borrowing, both of which divert resources from the productive sector of the economy. Simply stated, Keynesian spending does not work.
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Temporary expensing of business investment – B – The current tax code penalizes new business investment by forcing companies to “depreciate” those costs rather than “expense” them, thus forcing companies to artificially overstate profits. Temporary expensing mitigates this foolish bias.
But temporary tax cuts, as noted above, are unlikely to have a permanent impact on growth. Temporary expensing, however, will encourage companies to accelerate planned investment to take advantage of better tax treatment, so it can lead to more short-term economic activity (albeit perhaps by reducing economic activity in future years).
The only good news – at least relatively speaking – is that Obama supposedly will propose to misallocate $300 billion of resources, significantly less than what was squandered as part of the 2009 faux stimulus.
But the bad news is that the AP story also notes that “Obama has said he intends to propose long-term deficit reduction measures to cover the up-front costs of his jobs plan.” Translated into English, that means the gimmicks and new spending in the plan proposed tomorrow night will lead to proposed tax hikes at some point in the future.
More taxes and more spending. Hey, it worked for the Greeks, right?
Manmade Disasters
Manmade Disasters
by Michael D. Tanner
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ShareThisEarthquakes, hurricanes, floods — Paul Krugman should be ecstatic. Not about the suffering and loss of life, obviously, but because the cleanup and rebuilding should provide exactly the sort of Keynesian stimulus that Krugman believes this economy needs. There is now an increased demand for home construction, flood remediation, and auto repair.
Remember, this is the same Paul Krugman who mused, a few weeks ago, that what this country really needs is an invasion by space aliens. Preparations for an intergalactic war would mean that "this slump would be over in 18 months," he suggested.
That is because Krugman and other Keynesians believe that what is troubling this economy is a lack of demand. Anything, therefore, that causes people — or governments — to buy more things is good, be it a disaster, space invasion, or a government jobs program. Keynes himself famously noted that the government could create employment during a recession simply by paying some people to dig holes and other people to fill them in. It's only logical, therefore, that we should welcome at least the economic effects of destruction, so we can create jobs by rebuilding.
W]hen it comes to government jobs or stimulus programs, what matters is whether those programs created any net jobs after all the negative effects of the spending and debt are taken into account.
It follows, then, according to Krugman, that "we should have a lot of job-creating spending on the part of the federal government, largely in the form of much-needed spending to repair and upgrade the nation's infrastructure. Oh, and we need more aid to state and local governments, so that they can stop laying off schoolteachers." Krugman also wants a further extension of unemployment benefits and other increases in social-welfare spending to put money in people's pockets and increase demand. Those individuals who receive government payments are able to purchase goods and services that they would not otherwise be able to. The sellers of those goods and services receive income that they would not otherwise receive, and are therefore, in turn, able to purchase additional goods and services. This cycle multiplies through the economy, generating growth. Krugman, for example, estimates that "a dollar of public spending raises GDP by around $1.50."
And tomorrow night we can expect President Obama to give a full-throated endorsement of Krugmanomics.
The details of the president's job program are being kept under wraps, but the broad details are pretty well known. The president wants more federal infrastructure spending, including an "infrastructure bank." He wants to give states and localities more money to repair and rebuild schools, on the condition that those localities stop laying off employees. He wants to extend unemployment benefits again. And as a sop to those who want tax cuts, he will call for an extension of the payroll-tax cut passed last December, exactly the sort of Keynesian tax cut designed not to spur investment but to put more spending money in people's pockets.
But natural disasters do not create economic growth. Hurricanes, earthquakes, and space invasions destroy wealth. The money that people have to spend rebuilding their houses, drying their basements, or buying new cars is money that they can no longer use to go on vacation, send their kid to college, or spend on something else that they want or need. The money that insurance companies must pay out to compensate victims is money that is not otherwise invested in the economy.
And for the same reasons, more government spending will not create more jobs. Government has no money of its own. Therefore, any money that it uses to finance its programs and operations must, of necessity, be extracted from others, either through taxes or borrowing. That means less money for people to spend the way they wish, and — particularly worrisome at a time of slow economic growth and high unemployment — less money available for the private sector to invest, expand, and hire workers.
Michael Tanner is a senior fellow at the Cato Institute and coauthor of Leviathan on the Right: How Big-Government Conservatism Brought Down the Republican Revolution.
More by Michael D. TannerWorse, this is not just a question of substituting a dollar of government spending for a dollar of private spending, although obviously every dollar that government spends ultimately means one less dollar of private spending. But private spending and investment decisions are allocated on the basis of economic forces. People seek the best return on their investments or the best deal on their purchases. Governments allocate much if not most of their spending on the basis of politics. The result is that government spending introduces a host of inefficiencies into the economy, as people and businesses spend time, money, and effort either trying to gain government favors or minimize their share of government costs.
For the last two years the Obama administration and its critics have been arguing about whether the last six stimulus packages created or saved jobs. Undoubtedly, they have, and some conservatives sound silly arguing otherwise. And hurricanes and earthquakes will create some jobs, too. But that is not the real question. What matters is whether on balance we are better or worse off as a result of such events.
And when it comes to government jobs or stimulus programs, what matters is whether those programs created any net jobs after all the negative effects of the spending and debt are taken into account. The question is not "Did we create jobs?" but rather "Might we have created more jobs if we hadn't diverted all those resources to the government in the first place?"
There's not much we can do to avoid natural disasters. Hurricanes and earthquakes will always be with us. But manmade disasters we can do something about. With that in mind, we should reject another round of more-of-the-same from the Obama administration.
President Obama's Jobs Dilemma
by Jagadeesh Gokhale
Tomorrow's much heralded jobs speech by President Obama before a joint session of Congress will contain many proposals — including new spending on infrastructure and education, tax credits for job-creation, jobs training for workers displaced by the recession, tax breaks for employers to hire workers among particular voter groups, and so on. This late summer re-enactment of annual State of the Union spectacles won't ramble on about a wide range of policy issues. The President will focus on just one topic — federal policies meant to foster job creation. That means the President's list of proposals will be long and, according to media reports, will cost about $300 billion. But for an economy debilitated by policy uncertainty, this is exactly the wrong thing to do.
This summer's bruising debate on increasing the debt limit has left lawmakers with no appetite for more spending, whether financed out of taxes or borrowing and the proposals will be DOA. Among Democratic lawmakers, only those with a suicidal urge would suggest that we enact new spending programs financed out of new taxes. That would simply reinvigorate political support for the Tea Party with already proven credentials on successfully opposing any and all tax increases.
The new jobs stimulus includes an extension of the two percentage point reduction in the payroll tax paid by workers due to expire Dec. 31 and a new decrease in the portion of the payroll tax paid by employers. The President will call on Congress to offset the cost of the short-term jobs measures by raising tax revenues in later years. But that means his jobs stimulus will be deficit financed — a policy that is incongruous with the charge of the super-committee convened by the Deficit Control Act of 2011 to reduce federal deficits and debt. And the President, who was calling for eliminating tax loopholes as recently as four weeks ago, is now proposing a large new loophole himself.
Jagadeesh Gokhale is a senior fellow at the Cato Institute, member of the Social Security Advisory Board, and author of Social Security: A Fresh Look at Policy Options University of Chicago Press (2010).
More by Jagadeesh Gokhale
There was a time when responsible lawmakers enacted new spending programs together with new revenues to pay for it. Social Security was enacted in 1935 together with payroll taxes to pay for its expenditures. So was Medicare in 1965 — where Part A was fully funded out of dedicated revenues and Part B was funded partly out of beneficiary premiums and partly out of federal general revenues. But the Medicare Part D prescription drug program was enacted in 2003 with zero new dedicated funding.
The many stimulus programs enacted after the recession began in late 2007 were entirely deficit financed. The combination of reduced revenues from the recession and failed stimulus programs is why we now face a debilitating explosion of federal debt. The economic uncertainty created by rising debt — about how debt will be reduced and who will bear the financial cost — is the fundamental reason for a moribund economy. Proposing new deficit financed spending programs that are impossible to pay for is precisely the wrong thing to do.
But elections have their own compelling logic.
In many earlier speeches, President Obama has revealed a proclivity to criticize and admonish others — mostly lawmakers in a recalcitrant Congress. But such speeches only alienate rather than attract, divide rather than unite. And we're already battered from those experiences: When we hear President Obama exhort lawmakers in Congress to make sacrifices and put country before politics and serve the people's needs rather than their own narrow political priorities, we should remember that he's doing the latter himself.
Obama Said to Seek $300 Billion Jobs Package
Obama Said to Seek $300 Billion Jobs Package
President Barack Obama speaks to Eliane Hart of Gelberg Signs during tour with Luc Brami, left, company principal, in Washington. Photographer: Pool
Sept. 7 (Bloomberg) -- Lincoln Ellis, managing director at commodity clearinghouse Linn Group and chief investment officer at Strategic Financial Group, and Komal Sri-Kumar, chief global strategist at TCW Inc., talk about the outlook for the U.S. economy, corporate profits and the European debt crisis. They speak with Carol Massar, Matt Miller and Adam Johnson on Bloomberg Television's "Street Smart." (Source: Bloomberg)
Sept. 7 (Bloomberg) -- Gregory Valliere, chief political strategist with the Potomac Research Group, talks about President Barack Obama's prospects in the 2012 election and the president's address to Congress tomorrow on a plan to spark job growth. Valliere speaks with Tom Keene on Bloomberg Television's "Surveillance Midday." (Source: Bloomberg)
Sept. 7 (Bloomberg) -- Stuart Eizenstat, a partner at Covington & Burling, discusses the outlook for Federal Reserve policy and President Barack Obama's speech to Congress tomorrow night on a plan for job growth. Eizenstat, a former deputy Treasury secretary, speaks with Betty Liu on Bloomberg Television's "In the Loop." (Source: Bloomberg)
Sept. 7 (Bloomberg) -- Thomas Nides, the U.S. State Department's deputy secretary for management and resources, talks about President Barack Obama's focus on job creation. Nides, who also discusses the outlook for the U.S. banking industry, spoke yesterday in Sydney with Bloomberg Television's Shraysi Tandon. (Source: Bloomberg)
Sept. 7 (Bloomberg) -- Michael Morris, chief executive officer of American Electric Power Co., and Jim Kessler, co-founder of Third Way, talk about U.S. job creation and government regulations. They speak with Erik Schatzker and Deirdre Bolton on Bloomberg Television's "InsideTrack." (Source: Bloomberg)
Sept. 7 (Bloomberg) -- Representative Chris Van Hollen, a Democrat from Maryland, talks about the objectives of the bipartisan congressional supercommittee tasked with creating a plan to reduce the U.S. deficit. Van Hollen talks with Betty Liu and Peter Cook on Bloomberg Television's "In the Loop." (Source: Bloomberg)
President Barack Obama speaks at the Labor Day celebration in Detroit on September 5, 2011. Photographer: Mandi Wright/Detroit Free Press/MCT/Newscom
U.S. President Barack Obama shakes hands with the audience after speaking during a town hall meeting in Atkinson, Illinois, on Aug. 17, 2011. Photographer: AFP/Getty Images
President Barack Obama plans to propose sparking job growth by injecting more than $300 billion into the economy next year, mostly through tax cuts, infrastructure spending and direct aid to state and local governments.
Obama will call on Congress to offset the cost of the short-term jobs measures by raising tax revenue in later years. This would be part of a long-term deficit reduction package, including spending and entitlement cuts as well as revenue increases, that he will present next week to the congressional panel charged with finding ways to reduce the nation’s debt.
Almost half the stimulus would come from tax cuts, which include an extension of a two-percentage-point reduction in the payroll tax paid by workers due to expire Dec. 31 and a new decrease in the portion of the tax paid by employers.
Obama is set to lay out his plans in an address to Congress tomorrow as unemployment remains at 9.1 percent more than two years after the official end of the worst recession since the Great Depression. Payroll growth stalled last month.
The unemployment rate and the sluggish recovery will be central issues as Obama runs for re-election next year. Former Massachusetts Governor Mitt Romney, a leading Republican seeking the party’s nomination to face Obama in November 2012, yesterday offered his own 59-point economic plan, including tax cuts for those making $200,000 or less a year. He and seven other Republican candidates are scheduled to debate tonight in California.
Plan Previewed
The main components of Obama’s jobs plan, though not its scale, have been largely telegraphed by the administration. For weeks, people familiar with deliberations have said the White House is considering tax incentives, infrastructure and assistance to local governments. Obama has stressed construction and tax cuts in recent public speeches
Obama has pressed Congress throughout the year to renew the payroll tax holiday along with extended unemployment benefits, which also expire Dec. 31. Backing for a reduction in the employer contribution to the payroll tax has been under consideration since at least June.
Obama’s jobs plan follows the contours of his $830 billion 2009 economic stimulus package, which also stressed tax cuts, infrastructure spending and assistance to local governments. Still, tax cuts would account for a larger portion of the proposal he will lay out this week.
’New Proposals’
White House press secretary Jay Carney refused to give details of what the president will offer, saying at a briefing yesterday that it would include “some new proposals that you have not heard us talk about.”
Much of Obama’s plan may have trouble passing the U.S. House, where leaders of the Republican majority have signaled opposition to new spending that would add to the federal budget deficit. House Speaker John Boehner of Ohio and Majority Leader Eric Cantor of Virginia released a letter to Obama yesterday saying their objections to the 2009 stimulus, which they called a “large, deficit-financed, government spending bill,” have been validated by continued high unemployment.
Obama said in a Sept. 5 speech in Detroit that he would challenge Republicans to support tax cuts, which a person familiar with administration discussions said would be targeted toward middle-class Americans to spur consumer spending.
Local Government Aid
“You say you’re the party of tax cuts?” Obama said before the annual Metro Detroit Central Labor Council rally. “Well then, prove you’ll fight just as hard for tax cuts for middle- class families as you do for oil companies and the most affluent Americans.”
The direct aid to local governments would focus on halting layoffs of teachers and first responders. Education will be a theme in Obama’s address, and he will also propose as part of his infrastructure program money for school construction. Some of the infrastructure spending would go toward roads, bridges and other surface transportation projects.
White House officials say they anticipate congressional Republicans may go along with some of the tax cuts Obama is seeking, including the extension of the payroll tax cut. Still, they expect to meet Republican resistance to much of the package.
Job Training
To address the problem of long-term unemployment, Obama will likely propose a national program, modeled after a Georgia initiative that allows workers who receive unemployment insurance to train for jobs at businesses at no cost to the employer. Obama, at a town-hall meeting in Atkinson, Illinois, last month, called the Georgia Works initiative a “a smart program.”
Obama also plans to propose measures to make it easier for homeowners to refinance mortgages.
Obama will unveil a framework for the deficit reductions next week, including changes to Medicare and Medicaid, in addition to other cuts in contributions to military pensions and farm subsidies.
After a partisan fight over the deficit and raising the government’s debt limit took the country to the brink of default, Standard & Poor’s lowered the U.S.’s credit rating to AA+ from AAA on Aug. 5. The rating firm said the government is becoming “less stable, less effective and less predictable.” Even so, the government’s borrowing costs fell to record lows as Treasuries rallied. The yield on the benchmark 10-year Treasury note fell from 2.56 percent on Aug. 5 to 1.97 percent yesterday. The note added seven basis points to 2.05 percent today.
Top Rankings
Moody’s Investors Service and Fitch Ratings affirmed their top rankings on the U.S.
Concern over the economy has increased as growth weakened during the first half of the year to its slowest pace of the recovery and market pessimism has risen over the ramifications of the European debt crisis.
Still, stocks rebounded from a four-day global slump that drove valuations to the lowest level since 2009 following news of Obama’s plans. The MSCI All-Country World Index surged 2.1 percent at 10:21 a.m. in New York and the Standard & Poor’s 500 Index jumped 1.7 percent.
Recent signs of economic weakness have led private economists to raise forecasts for the unemployment rate next year. The median forecast for unemployment during next year’s fourth quarter, when the presidential election will be held, is 8.5 percent, according to 51 economists surveyed by Bloomberg News Aug. 2 through Aug. 10.
Since World War II, no U.S. president has won re-election with a jobless rate above 6 percent, with the exception of Ronald Reagan, who faced 7.2 percent unemployment on Election Day in 1984. The jobless rate under Reagan had come down more than 3 percentage points during the prior two years.
Obama Needs Navy SEALs to Target Budget Next
Obama Needs Navy SEALs to Target Budget Next: Amity Shlaes
Obama pulls another Osama. He signs the orders. The operation succeeds. This time the target is another great enemy: the federal debt.
Or so, at least, runs the national daydream.
That Americans indulge themselves in such quirky fantasies reflects a desperation about reality. The reality is that in domestic affairs, President Barack Obama moves not like a leader who nailed Osama bin Laden, but like a passive-aggressive drill sergeant. He is tactical rather than strategic, partisan rather than statesmanlike. He exploits outreach efforts by Republicans to attack their vulnerabilities.
When he announced his new budget plan in April the president wasted time attacking Republicans for helping “billionaires and millionaires.” The Obama plan promised to address the ratio of the national debt to the economy. But it cynically postponed the start of that project to an election year, 2014. Such details lent credence to House Speaker John Boehner’s allegation that the plan amounts to “a political broadside from our commander-in-chief.”
The problem, however, is greater than a specific executive. George W. Bush too worked tactically, sacrificing a long-term national commitment to reducing entitlements to a short-term plan for election victory that included expanding Medicare to cover prescription drugs.
The fault in the system is structural and dates back to 1974. Before then, a president really could play the hero. He could veto bills and also impound money already budgeted so that it wasn’t spent. President Lyndon Johnson vetoed or impounded billions, including planned spending by fellow Democrats on housing, agriculture and highways.
Nixon’s Vetoes
Richard Nixon vetoed, too, even plans that sounded compelling, like one to help underfunded emergency rooms stay open. Nixon also impounded money, taking glee in withholding funds for laws Congress passed by overriding his veto, such as the Federal Water Pollution Control Act.
Congress so resented Nixon’s aggressive budgeting that they welcomed the opportunity to undermine him, and found a good one in the Watergate scandal.
Exploiting Watergate-related hostility for the chief executive, Congress in 1974 passed legislation that had little to do with campaign finance, break-ins or Nixon’s character: the Congressional Budget and Impoundment Control Act.
The bill confined presidential budget authority to a “yes” or a veto of a budget. It severely curtailed impoundment by the executive, gave more power to Congress, established new committees, moved the fiscal calendar to October from July, and created for legislators their own budget war department, the Congressional Budget Office.
‘Nixon Was Right’
The legislation reached the Oval Office the summer when Nixon was already on his way out. He signed the bill less than a month before his resignation. Through staff, Nixon made his skepticism clear. One official told the press that the law would generate “congressional government -- and chaos.”
As historian John Steele Gordon has written, the outcome suggests that gloomy aide had a point. Budgeting proved so difficult in the 1980s that lawmakers began creating complex automatic devices like the Gramm-Rudman-Hollings law of which Obama’s “debt failsafe” mechanism is a descendant.
“Nixon was right,” a Wall Street Journal editorial said. The very reliance upon such gizmos is a cop out; it’s like ordering a drone to take out bin Laden and pretending a Navy SEAL team isn’t needed.
Line-Item Veto
Lawmakers and the White House did manage to balance the budget in the 1990s. But both branches understood that more was necessary, which is why President Bill Clinton signed legislation that gave the executive new impounding authority, the line-item veto. Unfortunately, the Supreme Court struck down that law in 1998.
President George W. Bush offered up another version of the measure in 2006, but it didn’t make it through the Senate. Meanwhile, the debt and the deficit mounted. In Congress’s view, recessions nowadays may be addressed by only one of two policies: spending or more spending.
In short, the chaos that the Nixon aide prophesied is here, and postpones reform. Each day of postponement in turn makes reform more expensive. Voters become more disillusioned, and find themselves falling into those daydreams about SEALs who slash budgets with their knives. Democrats fear trimming entitlements. Republicans fear higher taxes. What both parties overlook is that the disillusionment itself represents a bigger threat than either entitlement cuts or tax increases.
Restoring Balance
Now is the time for legislation that can both restore the executive’s budget power and withstand Supreme Court scrutiny. Such a law needn’t make the president into a dictator. It need merely restore the balance that existed before 1974.
There is a precedent for such a rebalancing: the 1921 Budget and Accounting Act passed after the spending excess of World War I. Its impounding authority gave Presidents Warren Harding and Calvin Coolidge a tool to keep the budget in surplus.
As for Obama and Republican fears, those fears may be overrated. It’s possible that more authority will make any president, right or left, less political, less nasty, more thoughtful, and more forceful. That can also hold for Obama. Give him the power to manage this crisis, and his response may surprise us. It did in Abbottabad.
U.S. Government Merits a Junk Credit Rating
U.S. Government Merits a Junk Credit Rating: Laurence Kotlikoff
Politicians and investors say Standard & Poor’s made a mistake when it cut the U.S.’s credit rating from AAA to AA+. I agree. I wonder why S&P didn’t take it all the way down to CCC.
The country’s political leaders, from President Barack Obama on down, are alternately decrying S&P’s hubris and blaming their opponents. Big investors who hold lots of Treasuries are also on S&P’s case. Warren Buffett said the downgrade “doesn’t make sense,” that Treasuries are still AAA in Omaha, Nebraska, and that S&P should rate U.S. debt AAAA. If AA+ means very low credit risk and AAA means no credit risk, I guess AAAA would signify negative credit risk.
My question, though, is why U.S. government bonds carry a rating any better than CCC, which is well into junk territory. Such a grading, according to S&P, implies the debtor is “currently vulnerable and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments.”
Sounds right to me. Our economy is in horrible shape. Unemployment is stuck at more than 9 percent, real per-capita output hasn’t budged in six years, the national savings rate is zero, and domestic investment is a miserable 4 percent of national income. With 78 million baby boomers heading into retirement, we have made no provision to pay their full annual Social Security, Medicare and Medicaid benefits, which will average $40,000 in today’s dollars. We are spending more than the next 13 countries combined on defense. The U.S. is running enormous budget deficits, and our tax system is collecting the least revenue per dollar of output since World War II.
Credit Risk
True, bad economic conditions don’t necessarily translate into bad credit. Credit risk formally refers to the likelihood of actual default -- that is, not paying debts precisely when they are owed. Even if our economy continues to falter, the government collects enough taxes to do this job for decades, provided it treats its bondholders as senior creditors and pays them before others, like Social Security beneficiaries and soldiers.
There’s another reason the U.S. can always stave off default. The Federal Reserve can simply print dollars to make bond payments. Unlike Greece -- which relies on the European Central Bank for its supply of euros -- our government controls its printing press. The Fed could even print $10.3 trillion and buy up every single Treasury bill and bond held by the public and foreigners. There would be no debt outstanding on which to default. The Chinese could no longer claim we are “addicted to debt.”
Interest and Principal
Where, the reader might ask, would the Treasury get the money to make interest and principle payments on the debt? Simple: from the Fed. The central bank would lend the Treasury the money needed to pay the interest, which the Fed would then return to the Treasury under the heading “profits of the Federal Reserve.” The principal would be rolled over as the Treasury issued the Fed new bonds to pay off old ones.
The questions multiply. If it’s possible just to print money and never default, why aren’t Treasuries rated AAAA, like Buffett suggests? And why doesn’t the Fed go ahead and crank up the printing presses? Why, for that matter, doesn’t the ECB print euros and buy up all the Greek, Italian, Spanish, Portuguese and Irish debt?
To some extent, both the Fed and the ECB have been doing this. But they have been trying hard to keep it quiet. The Fed called it Quantitative Easing II. The ECB has been buying government bonds in large quantities, and euro-area countries have arranged for the ECB to launder more bond purchases through the new European Financial Stability Facility.
S&P Understands
S&P understands what the central banks are doing. It also knows that printing too much money to buy up debt can trigger high inflation rates, if not hyperinflation, which could force Uncle Sam and Tante Brunhilde (Sam’s European counterpart) to slow their printing presses and, at some point, formally default. The trigger could get pulled at any time. If regular folks get wind of what’s really going on, they will drop the dollar and the euro like hot potatoes, producing the inflation that Sam and Brunhilde deeply fear.
S&P knows something else: Its credit grading isn’t viewed strictly as an indicator of repayment probability. Investors think the rating indicates whether a country’s bonds are a safe investment -- that is, whether they will be paid in real, hard currency, as opposed to colored pieces of paper devalued by inflation. If S&P thinks printing money is the only way a country can service its debt and that bondholders will get paid in watered-down dollars, it will think twice about granting a AAA rating.
The real scandal here is that S&P knows that the Fed and ECB have been printing money like crazy to buy up debts, both private and public. It also knows that given long-term fiscal commitments and likely future economic conditions, these central banks will surely need to print vastly more money, which means bondholders will end up being paid back only partially or in debased currencies. And it should know that this implies one and only one rating: CCC.
Granny’s Fate Rides With Bernanke in Jackson Hole
Granny’s Fate Rides With Bernanke in Jackson Hole: Caroline Baum
Illustration by Nathaniel Russell
Investors around the world are waiting to find out whether Federal Reserve Chairman Ben Bernanke puts any QE3 in his opening remarks today at the Kansas City Fed’s Jackson Hole conference. It was one year ago at the same event that he outlined the Fed’s policy options for an ailing economy, including a second round of quantitative easing that started in early November.
A second audience will be listening to Bernanke -- not as closely, perhaps, nor in real time, but with no less a stake in the outcome: retirees living on fixed incomes who have watched their returns dwindle to almost nothing.
Bernanke has already told this group to forget about earning a higher rate of interest anytime soon. At the conclusion of its Aug. 9 meeting, the Fed announced it would keep the benchmark rate near zero “at least through mid-2013.” What’s a small saver to do?
Monetary policy isn’t offering much solace in the short run. That’s because the Fed adjusts interest rates and, in so doing, changes the incentives to spend and to save.
When inflation-adjusted interest rates are high, the public is induced to forego current consumption in favor of future consumption. In plain talk, we’re being paid to save.
Alternatively, when real rates are low or negative, as they are now, the incentive is to spend today and forget about saving for a rainy day. Interest rates act as a guide to our choices.
Risk Management
That’s one explanation of how monetary policy works. There are others. While currently out of favor, monetarism teaches that if the Fed creates more money than the public wants to hold, people will spend it. It’s akin to dropping money from a helicopter, the metaphor adopted by the late Milton Friedman to teach his University of Chicago students how monetary policy works.
Bernanke explains it in a different way. Once short-term rates hit zero, monetary policy works through the portfolio balance channel, a theory he outlined at Jackson Hole last year. Specifically, when the Fed buys risk-free Treasuries, it depresses the yields and forces investors to buy other assets that carry increased credit and interest-rate risk -- long-term corporate bonds or stocks, for example.
In a Nov. 19 speech, he even argued that there was no Q in quantitative easing. The thrust of QE, he said, comes from changing the quantity of bank reserves, a channel he called weak. Securities purchases, on the other hand, work through portfolio substitution.
“The Fed should talk in terms of reserves, not asset prices,” said Marvin Goodfriend, a professor of economics at Carnegie Mellon University in Pittsburgh and a former research director at the Richmond Fed.
Bad Marketing
The reason? To remind the public of the Fed’s unique authority, independent of the political process, “to stabilize the purchasing power of money,” Goodfriend said.
Maybe it’s just a case of bad marketing, although the Fed has been emphasizing the asset side of its balance sheet since December 2008, when it lowered the funds rate to near zero. For an institution that is so concerned with its communication policy, the Fed could do better. The talk about forcing investors to assume more risk sounds as if the Fed is encouraging Gram and Gramps to redeem those six-month Treasury bills, cash out of the money-market fund and let the CDs mature, and go out and buy stocks and high-yield bonds.
Small savers and retirees have reason to be upset. It’s as if monetary policy has been personalized to punish one group that behaved well (savers) and reward another that over-borrowed and over-spent.
Daily 400-point swings in the Dow Jones Industrial Average aren’t for everyone. Most octogenarians, I’d venture to say, prefer less volatility.
Bubble Blindness
Goodfriend says the Great Inflation of the 1970s soured many savers on owning long-term bonds. They opted for short-term instruments instead, which left them vulnerable to periodic bouts of ultra-low rates (the periods seem to be getting longer).
Besides, the Fed’s extended policy of zero-percent interest rates is apt to spark a bubble in some unexpected asset class. (Farm land and student loans have been mentioned as possible candidates.) When it comes to bubble identification, the Fed is the last one to know and even slower to admit to a role in its creation.
The Fed tries to be neutral in its conduct of monetary policy, buying Treasuries only and no other asset classes. (The various lending facilities created in 2007 and 2008 to deal with the financial crisis are the exception.) In the same spirit, the central bank needs to communicate that it’s running monetary policy for everyone, not just sophisticated investors.
Don’t Forget Gramps
“A policy that is effective in getting the economy to grow more rapidly will improve the lives of most people,” says former St. Louis Fed President Bill Poole.
Stronger growth means more hiring, more income, bigger profits, higher stock prices and higher real interest rates.
Figuring out what’s “effective” isn’t so easy. I doubt that Bernanke will offer any new solutions today. After all, three members of the Fed’s policy committee dissented from the Aug. 9 decision to commit to near-zero rates through mid-2013.
Inflation readings are much higher than they were a year ago: 3.6 percent versus 1.2 percent for the consumer price index; 1.8 percent versus 0.9 percent for the core CPI, which excludes food and energy and is given more weight by policy makers. The bar for additional Fed action has been raised.
Whatever Bernanke says or doesn’t say is sure to have a market impact. Stocks, for example, will probably be disappointed without the prospect of a Fed fix.
As for Gram and Gramps, who won’t be attending this or any Fed symposium, Bernanke will have nothing to offer. At minimum he could acknowledge their predicament and stop encouraging them to buy junk bonds.
Where is the Next Steve Jobs?
Where is the Next Steve Jobs?
Illustration by Drew Heffron
Everybody, it seems, wants to be like Apple Inc. Google Inc. (GOOG) is buying Motorola Mobility Holdings Inc., many observers say, so it can integrate hardware and software to be like Apple (and to enlarge its patent pool).
Last week, Joel Ewanick, the global chief marketing officer at General Motors, declared that “it’s time to clearly differentiate our brand and align closer to a true global brand like Apple.” Translation: We want to be like Apple.
Apple has topped Fortune magazine’s list of “Most Admired Companies” four years running. This month it was briefly the most valuable company in the world. Even holding the No. 2 market capitalization is pretty amazing for a company that almost died in 1997, when it was valued at less than $3 billion.
To many people, Apple’s success seems like magic. Others attribute it to cool products, good marketing, and Steve Jobs’s charisma or presentation skills. Critics credit the Apple co- founder’s ability to project a “reality distortion field.”
In his new book “Good Strategy, Bad Strategy: The Difference and Why It Matters,” Richard P. Rumelt, a strategy professor at UCLA’s Anderson School of Management, offers another explanation: the ruthless execution of good strategy.
Strategy is not what many people think it is. It is not a fill-in-the-blanks mission statement blathering about how XYZ Corp. will ethically serve its stakeholders by implementing best-in-class integrated sustainable practices to grow as a global leader while maximizing shareholder value. Such bafflegab is “Dilbert“-fodder that generates cynicism and contempt. It is, at best, a big waste of time.
Neither is strategy a declaration that the ABC Co. will increase sales by 20 percent a year for the next five years, with a profit margin of at least 20 percent. Strategy is not the resolve to hunker down and try harder -- what Kenichi Ohmae of McKinsey criticized in a 1989 Harvard Business Review article as “do more better.” Effort is not strategy. Neither are financial projections. And neither are wishes.
A strategy “is a way of dealing with a high-stakes challenge,” Rumelt told me in an interview. “It’s a way around the obstacles or problems in a difficult situation.”
Every good strategy, he writes, includes what he calls the kernel: a “diagnosis” of the challenge (“What’s going on here?”), a “guiding policy” for dealing with that challenge (the core idea often called a strategy), and a set of “coherent actions” to carry out that policy (the implementation).
For his friend Stephanie’s corner grocery, Rumelt writes, the diagnosis was competition from a large 24-hour supermarket, the guiding policy was “to serve the busy professional who has little time to cook,” and the coherent actions included stocking more prepared meals and opening an extra checkout stand at 5:00 p.m.
This strategy not only told Stephanie what to do but what she had to stop doing. Selling more prepared meals meant taking space away from the munchies for her many student customers. To focus labor expenses on the peak times for her professional customers, she closed earlier, meaning no sales from late-night study breaks. “Strategy is scarcity’s child and to have a strategy, rather than vague aspirations, is to choose one path and eschew others,” writes Rumelt.
A strategy is not a goal like maximizing shareholder value or keeping America safe from terrorism. It’s not even a plan. It is a design -- a coherent approach to defining and solving a particular problem, in which the different elements have to work together.
In this analysis, Steve Jobs is not only a connoisseur and sponsor of good design. He is himself a successful designer -- not of products but of business strategies.
Apple’s recent success has made people forget not only how close the company came to failing but also what Jobs did to turn it around when he returned as chief executive in 1997. He diagnosed Apple’s problem: It was hemorrhaging cash and its product lineup was too diverse, confusing and expensive.
In response, Rumelt explains, Jobs “redesigned the whole business logic around a simplified product line sold through a limited set of outlets.” He cut product offerings down to two: a desktop and a laptop, and no peripherals. He moved most manufacturing to Taiwan, cut software development, and eliminated all but one national retailer, opening a Web store to sell directly to consumers.
And, yes, Jobs also got Microsoft Corp. (MSFT) to invest $150 million in Apple and to commit to continuing to make Mac versions of key software. But that agreement wouldn’t have helped much without the rest of the strategy. “I don’t know how he learned that ruthlessness,” Rumelt says. But it worked.
What Jobs did not do, the book suggests, is equally telling. He avoided all the management responses that masquerade as strategies. “He did not announce ambitious revenue or profit goals; he did not indulge in messianic visions of the future,” Rumelt writes. “And he did not just cut in a blind ax-wielding frenzy.”
The organization’s new, coherent design bought the company time and gave it a clear identity on which to build. Apple’s gutsy decision to open its own retail stores in 2001 made sense only in the context of its new strategy.
Rumelt, who is a business consultant as well as one of the most-cited scholars in his field, met Jobs in 1998, while working for Telecom Italia SpA. (TIT) Rumelt congratulated Jobs on the turnaround but expressed skepticism about Apple’s chances of overcoming the Windows-Intel lock on personal computers. “What are you going to do in the longer term?” Rumelt asked. “What’s the strategy?”
Jobs, he recalls, “just smiled and said, ‘I am going to wait for the next big thing.’”
Jobs recognized that Apple couldn’t change the realities of the PC business. It needed a change in the environment that would make possible a new strategy, oriented toward growth this time rather than survival. He found that opportunity with the iPod and online music.
“Strategy is not a magic potion for overcoming any obstacle,” says Rumelt. “The part that’s hard to write about, that people reject, that they don’t want to hear me say, is that you may be facing an obstacle you can’t deal with. Choose a different obstacle. Play games you can win.”
Rumelt says he was motivated to write his book in part because he believes “bad strategy” -- or, perhaps more accurately, pseudo-strategy or even anti-strategy -- has become increasingly pervasive, not only in business but in all sorts of non-commercial organizations. Feeling obliged to articulate a “strategy” (or compelled to by orders from the board or Congress), people cook up statements that lack the clear-eyed analysis, real choices and coherent actions that good strategy demands.
For example, in 2008 the Los Angeles Unified School District adopted seven “key strategies,” including to “build school and District leadership teams that share common beliefs, values and high expectations for all adults and students and that support a cycle of continuous improvement to ensure high- quality instruction in their schools.”
That is a hope, a goal, or perhaps a prescription for North Korean-style totalitarian conformity. Whatever it is, the statement is not a strategy. It offers no guide to action. It is all too typical of “strategy” -- in the private sector as well as the government, in huge multinational corporations and small local charities.
Bad strategy, Rumelt writes, goes wrong in four common ways. Many bad strategies are just superficial nonsense expressed in big words, which Rumelt very politely calls “fluff.” Others fail to define the challenge. Some mistake goals or wishes, for strategy. And some set impossible objectives rather than focusing on modest but achievable ones.
Even when it doesn’t lead to bad decision-making, Rumelt argues, formulating bad strategy hurts organizations. “You use up the psychological and intellectual resources that could be used for figuring out what we should actually be doing around here, creating these things,” he told me. “If the very top management of the company puts together a retreat for the top 50 executives and what they come out with is a financial forecast, that’s a misuse of the knowledge and energy in the group.”
So if you really want to be like Apple, drop the fluff- filled vision statements and magical wishes. Pretend your company’s existence is at stake, coldly evaluate the environment, and make choices. Stop thinking of strategy as meaningless verbiage or financial goals and treat it as a serious design challenge.
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