Tuesday, August 31, 2010

Can Anything Save the US Economy: No Monetary Policy Answer, What about further Fiscal Stimulus?

Editor's NOTE:

I provide below a short discussion of the way in which the federal government generally looks at the issue of "regulating" the economy. Briefly, there are 2 basic approaches, one, through changes in "Fiscal Policy" and two through Monetary Policy manipulations. Thereafter I briefly outline the approaches which have already been employed and some thoughts on how to proceed from here.

Fiscal Policy:

Fiscal policy can be thought of as the relationship between federal spending and tax revenue collection which often centers primarily on income taxes, employment taxes or other value added taxes and whether or not there is a rough balance between spending and tax revenue rather than for example a contraction (federal spending less than revenue collected) or an expansion (federal spending in excess of revenue collection). The latter is also known as "deficit spending."

A fiscal policy manipulation would be to change the income tax rates, to increase the size of the federal budget by raising the rate at which existing programs grow or to provide a so-called economic stimulus where the government engineers a one-time/short term increase in federal spending. Along with "Monetary Policy", "Fiscal Policy" is part of what the Federal Government uses to control/enhance economic activity.

Monetary Policy:

“Think money” specifically the interest rates charged for borrowing money and the ease with which the federal government "prints new money" (also referred to as "quantitative easing", Quantitative easing is sometimes colloquially described as "printing money" although in reality the money is simply created by electronically adding a number to an account.

Examples of economies where this policy has been used include Japan during the early 2000s, and the United States and United Kingdom during the global financial crisis of 2008–the present) and puts it into circulation. Both have directly to do with getting actual dollars into the hands of people so they can either spend or save them. In order for the federal government to print more money it must either raise available revenue from taxes or borrow it from foreign nations through the issuing of Treasury bonds which pay interest to the bond holders. Another option is to sell fixed assets such as interstate highways, toll bridges and other valued parts of the national infrastructure to raise money.

Quantitative Easing:

The term quantitative easing (QE) describes a monetary policy used by central banks to increase the supply of money by increasing the excess reserves of the banking system. A Central bank does this by first crediting its own account with money it has created ex nihilo "out of nothing"--i.e. printing money almost at will is possible for the US because the US dollar is the reserve currency. Other nations who must trade in dollars are forced to earn them through trade since they cannot print dollars. This naturally is very dissatisfying to them.

The Central bank then purchases financial assets, including government bonds, mortgage-backed securities and corporate bonds, from other banks and financial institutions in a process referred to as "open market operations." The purchases, by way of account deposits, give banks the excess reserves required for them to create new money, and thus a hopeful stimulation of the economy, by the process of deposit multiplication from increased lending in the fractional reserve banking system. Risks include the policy being more effective than intended, spurring hyperinflation, or the risk of not being effective enough, if banks opt simply to pocket the additional cash in order to increase their capital reserves in a climate of increasing defaults in their present loan portfolio --the current situation in the US.

"Quantitative" refers to the fact that a specific quantity of money is being created; "easing" refers to reducing the pressure on banks.
Source for Quantitative Easing: HERE...

Since the Central banks have already decreased the interest rate for borrowing money to virtually zero, and because the federal reserve has already engaged in unprecedented quantitative easing, it appears that there is little if anything more that can be done from the perspective of "Monetary Policy" despite what Federal Reserve chairman Ben Bernanke might say. This of course can be debated by any interested economists who wish to comment on this post.

Unfortunately, while raising income and other federal taxes might provide badly needed additional revenue, it is dangerous to do so during a recession (appears we have now entered the second phase of a double dip recession) and a high unemployment rate--the situation we now find ourselves in. Moreover, we have already significantly increased the budget deficit as a result of the almost $800 billion prior fiscal stimulus package enacted by President Obama and the US Congress only ~ 1/3 of which was actually stimulus in the traditional sense.

Thus, the debate we need to have is: what can be done now to help save the US economy and the millions of suffering American citizens?

Clearly, any approach which would significantly ruduce our budget deficit year to year and over the long run markedly decrease our national debt (currently almost equal to our GDP) would require a substantial reduction in government spending not simply an increase in total tax revenues. Barring a severe austerity program in which the non-discretionary portions of the budget (primarily social security and medicare/medicaid) are severely cut or curtailed we must look elsewhere.

Since the largest portion of the federal budget which is discretionary is the defense and intelligence budgets much of which is hidden, they must be radically reduced if we are to save the overall US fianancial ship of state. If we do not do so soon, foreign governments will be increasingly unwilling to lend us money (thereby markedly increasing the interest rates we will be forced to pay on our Treasury bonds). Ironically should Treasury bond interest rates begin to rise markedly, many of our foreign creditors concerned about our economic demise may begin to cash in their treasury bonds all at once creating a run on the US treasury with default of the US government as these same nations simultanesouly attempt to dethrone the dollar as the world's reserve currency. A persuasive argument can be made that the only thing stopping them from doing so now is that we are the uncontested global nuclear superpower. However, if we actually default as a nation, we will be unable to maintain our military or nuclear weapons threat.

In previous posts I have proposed the following answer to our current financial dilemma, an end to: 1) the occupations of Iraq and Afghanistan, 2) the American global empire of foreign military bases and a marked reduction in the "Defense" budget (in actual fact a "War" department budget) which in reality exceeds 1 trillion dollars per year. 3) This combined with a second short term stimulus would be capable of saving the US from financial insolvency while we work to regain our off-shored manufacturing base and out-sourced job market.

Unfortunately, the oligarchical Regime currently in power has no intention of ending the Empire, the wars or reclaiming our manufacturing/job base because the status quo is simply too financially lucrative short-term. Neither do the Democrats or the Republicans appear willing to pass another short term stimulus bill. What we have is the Hegelian dialectic in action where in this case the "synthesis" between the opposing economic approaches is to provide a lot of heat and no light that is, do nothing while "Rome burns." I invite commentary.

--Dr. J. P. Hubert


U.S. Government Prepares for 'Crisis'

By Jeff Nielson

Most market reporters, commentators and politicians continue to rely upon nothing but the same short-term "snapshots" which have caused them to be "surprised" by everything. However, it is a safe conclusion that even such rampant incompetence (combined with a strong "herd mentality"), could not and does not mean that the entire U.S. government remains in an oblivious state of ignorance regarding this re-acceleration of the collapse of the U.S. economy.

This begs an obvious question. Given that at least some elements of the U.S. government have known all along that the U.S. economy was not recovering and could not recover, why is it that only now are we hearing of tentative, new plans of more "life support" for the dying U.S. economy?

The answer is also obvious. As I pointed out when I originally denounced the Obama stimulus package, it was never anything more than a bad joke. The combination of the collapse of the U.S. housing sector, massive unemployment, and the largest credit-contraction in the history of the U.S. economy had combined to subtract approximately $2 trillion per year in consumer spending from this consumer economy.

The response of the Obama regime to this scenario was a one-time injection of $780 in stimulus, spread out over more than a year. Obviously, you can't replace $2 trillion with less than $800 billion and call it stimulus.

This sets the stage for another chaotic autumn for the global economy -- and even more chaos for markets. While I have outlined what I consider the most likely scenario, we are so close to the true collapse of the sickest economies that there are many dire scenarios possible.

The one scenario which I totally reject is another commodities meltdown which would come anywhere close to 2008. There are two reasons why this part of the pattern cannot repeat itself. To begin with, there is only a tiny amount of the "leverage" which existed in the rabidly bullish commodity markets of 2008. Secondly, the hyperinflationary consequences of more banker money-printing (and debt) are far more obvious today -- after two years of massive, deficit-spending have been factored into fiscal parameters.

The U.S. economy lurches closer and closer to the "hyperinflationary depression" which John Williams (Shadowstats.com ) first predicted in 2003. The precise effect of this collapse on the global economy cannot be predicted -- only its eventual result. We are heading toward a Great Divide: a division of the global economy into winners and losers.

This is not a new phenomenon. What is new is that most of the losers will come from the "Old Guard" economies (i.e. the U.S. and Western Europe). The citizens of these "loser economies" must act now to shield their diminishing wealth from the death of Western banker-paper which is almost upon us. As always, I remind investors that (for hundreds of years) precious metals have represented the best "insurance" against the depravity of bankers (and their servants in government).


The Backward Slide into Recession

By Mike Whitney

August 30, 2010 "Information Clearing House" -- -Ongoing deleveraging has slowed personal consumption and trimmed 2nd quarter GDP to a revised 1.6%. The economy is sliding backwards into recession. As Obama's fiscal stimulus dries up and the private sector slashes spending, demand will continue to collapse pushing more businesses and households into default. The economy is now caught in a reinforcing downward cycle in which dwindling fiscal and monetary support is shrinking the money supply triggering a slowdown in activity in the broader economy.

Far right policymakers have shrugged off increasingly ominous economic data, choosing to pursue their political aims through obstructionism. Their goal is to block countercyclical measures that will boost activity, lower unemployment and narrow the output gap. By torpedoing the recovery, GOP leaders hope to take advantage of anti-incumbent sentiment and engineer a landslide victory in the midterm elections. But the timing could not be worse. The economy is in greater peril than most realize and badly in need of government intervention. As the current account deficit continues to widen, the global system inches closer to a major currency crisis. Ballooning trade imbalances signal that a disorderly unwinding of the dollar is becoming more probable. If the dollar drops precipitously, US demand for foreign exports will fall and the world will plunge into another deep slump.

The Fed ended its bond purchasing program (quantitative easing) at the end of March, but has promised to reinvest the proceeds from maturing bonds into mortgage-backed securities to keep its balance sheet from shrinking. But the Fed's action does not increase the money supply or reverse disinflation which is progressively edging towards outright deflation. The Central Bank is committed to providing additional resources to support the markets, but the Fed's primary policy tool--short-term interest rates---is already stuck at zero making the task more difficult. Without additional monetary stimulus, asset prices will tumble leading to another round of debt-liquidation and defaults. The housing market is already in full retreat. New and existing home sales have fallen to record levels clearing the way for steep price declines. Housing cannot recover without an uptick in employment which means that businesses need to see strong demand for their products. But product demand will remain weak until wages grow and struggling consumers dig their way out of the red. With personal consumption and business investment faltering, the government must step up its spending to avoid a return to recession.

The banks are not prepared for another wave of defaults, foreclosures and write-downs. Bank lending continues to shrink and the system is still fragile. A sudden turnaround in the equities markets would expose the banks to severe losses and force the Fed to provide emergency liquidity for wobbly financial institutions. The solvency of the banking system is largely public relations hype. The faux stress tests merely obfuscated critical details about the true, mark-to-market value of their assets. The nation's biggest banks are still wards of the state.

Much of the rot at the heart of the financial system remains hidden from view. Accounting sleight-of-hand, gigantic liquidity injections, and regulatory forbearance have all helped to perpetuate the fraud. The Fed continues to divert capital into zombie institutions which provide no tangible public benefit. Low interest rates, government guarantees on bonds, interest payments on reserves, the Fed's discount window, and the myriad lending facilities are some of the perks, subsidies, inducements and corporate welfare given to the banks at taxpayer expense. In return, the banks provide nothing; not even sufficient credit to generate another expansion. In its current configuration, the banking system is a net loss to society and a significant drag on growth.

Last week, 2nd quarter GDP was revised down to 1.6%. First quarter GDP was twice the size at 3.7%, while 4th quarter 2009 was higher still at 5%. The underlying trend is reasserting itself as growth turns to stagnation.

The Fed does not have the tools to fix the ailing economy. Quantitative easing can lower rates and keep asset prices inflated, but it cannot increase demand, reduce the output gap or lower unemployment. Only fiscal stimulus can do that and policymakers have rejected that option. The US is now facing a protracted period of high unemployment and subpar economic performance punctuated by infrequent stock market rallies and predictable bursts of optimism. The recovery is over.


Editor's NOTE:

An essay by a business leader in economic research, author and reader of this blog was submitted on this topic and presents a somewhat more contrarian view. His appeal for improvement in education particularly in the area of technology is important. His new book is: Dysfunctions of the Welfare State (Piscataway NJ; Transaction Publishing, 2010).

--Dr. J. P. Hubert

Can Anything Save the Economy:

By: Joel Clarke Gibbons Phd
September 1, 2010

The well known tools of stimulus are broken. Keynes is dead and the short run has run its course. To understand this it is necessary to make a clear distinction between recession and inefficiency. For “inefficiency” some would be tempted to say “poverty,” and it is very true that what is at stake is disappointment over the productivity of the American economy and the wealth of the nation, but it would not be accurate to speak of poverty. That would at this stage be more like the whining of a spoiled child, because we are rich. The problem is not poverty; the problem is just that the dreaded long run – the long run of which Keynes observed “In the long run, we’re all dead” – has arrived. He’s dead. We aren’t. But we have to do something different now.

Many measures of economic success coincide to imply that America has fallen behind in productivity over the last twenty years or so. Obviously, the trade deficit is one such indicator. We live well by consuming what we did not produce and living on the credit extended by developing nations. We exploit the reserve character of the dollar in world finance. That privileged position was the creation of American industry and of shrewd American financial management, with a big assist to the Second World War. But it is a wasting asset. It will not support a standard of living qualitatively higher than the one that the developing world enjoys today, which is what we have become used to.

It would be a mistake however to think that America is not more productive than she was when we were young. All the technological gifts of the microprocessor and the cheap access to computing have revolutionized modern life. If however we judge our prosperity by comparing us with the developing world, we see ourselves falling behind because in truth the developing world really is catching up. The microprocessor – perfected by Americans – has no nationality, and Russian and Chinese developers are working at the state of the art. In other essentially technologies – robotics, nuclear power, and railroads – we have fallen behind, but we are by no means out of the game and in any case they are not important in the economy as a whole to imply that we are behind. We’re just not confidently ahead any more. There is another aspect of development however in which we have lagged. There is a difference between prosperity of the American people and prosperity of America the nation.

The single biggest contributor to our national success has always been immigration. The periods of greatest prosperity coincide with the periods of most rapid immigration. That is just as true of the last twenty years as it was of the 1880s, although the new immigrants come from very different places than immigrants did then. Immigration is our single biggest national asset. But it also inevitably opens up a potential gap between the success of the “American people,” who at any given time are by definition the ones who were already here, and “America.” The successes of the last twenty years, and the prosperity that has rewarded them, are further evidence of the rewards the America reaps from immigration, and in things areas like the housing boom which has grown suburbia far out into the country, the profit has been shared by all. Nonetheless, the disparity between the success of recent immigrants and the stagnant prospects of the native has introduced a new sort of anxiety. It reinforces the fear that America is becoming two countries: America the Empire, with its own citizenship concentrated in North America but scattered all around the world, and America the Homeland.

The natural fear is that the really big money is with the Empire, and that as a result the demands of the citizens of the empire will take precedence over the desires of the homelanders. It is not a new insight that “Where your treasure is, there also will your heart be.” The very poor growth of personal incomes of the natives, poor performance of long standing, extending back to the days of the War in Viet Nam, through the 1970s, 80s, 90s, and so far this new century. As wages and salaries have failed to grow in real terms, investments have also stumbled after the bubble of the late 1990s. The S&P Index is no higher today than it was twelve years ago –it is actually somewhat lower – and the dividend yield over those years was only about 1½ %. On an inflation-adjusted basis, investors have lost money, and have done about as poorly as they did in the notorious 1970s. Those at the top by shocking contrast have profited tremendously, as evidenced by the incomes of the leaders of business and government. Even college and university faculty – occupations that thirty years ago paid very poorly – are now well paid, though the faculty earning those wages are disproportionately immigrants.

The point, to repeat because it bears repeating, is not resentment of immigrants. We’re all immigrants. The problem is the appearance of a two class society, in which entry to the privileged class is not open to the vast majority of the American people. The chairman of the board whose annual bonus dwarfs the wages of the work force is probably the descendent of impoverished Irish or Italian immigrants. That does nothing to relieve our anxiety that his generous salary and bonus owe far more to his warm relations with the governments of distant American allies than they do with his relations with the people of Michigan, or wherever his offices are located.

So, what can save us?

The foregoing outline attempts to identify in broad outline the sources of our problems, and the lesson it delivers is that there is no kind of Stimulus that is going to help. If it is stimulus of the traditional Keynesian sort, history has shown repeatedly that that is nothing but a sop to quiet the public, to put them back to sleep so to speak so that they will stop importuning the Congress and potentially disrupting the serious business of the Empire. The tools for raising the real productivity of the American people are available and are to a large extent well known. Education, and especially education in technical fields. The computer and the Internet and all kinds of modern technologies including robotics and nuclear power.

These tools will not however execute themselves. Technology isn’t that smart. We need a cultural revolution that empowers the American people to govern their own lives, starting perhaps with governing the schools that are supposed to serve their children. At this time they are ruled by – or rather, misruled by – a self-appointed elite not very different from the corrupt elite who have ruled Great Britain since the days of Milner. It has tried to impose a culture antithetical to the people. A culture of instant gratification. A culture of death. A culture without strong ties between men and women, ties based on the needs of men to earn the trust of women and the need of women to trust. We need, to repeat, a cultural revolution that puts the culture of America back into the hands of the American people who it is intended to serve. I can’t rightly say how stimulating this will seem; Americans are not excelled in their capacity to be absolutely trite and boring. But these are their lives and this is their country. They have a right to it.

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