Friday, November 5, 2010
Thursday, November 4, 2010
Jeremy Grantham - Night of the Living Fed
The Ruinous Cost of Fed Manipulation of Asset Prices
My diatribe against the Fed’s policies of the last 15 years became, by degrees, rather long and complicated.
So to make it easier to follow, a summary precedes the longer argument. (For an earlier attack on the Fed, see “Feet of Clay” in my 3Q 2002 Quarterly Letter.)
Purpose
If I were a benevolent dictator, I would strip the Fed of its obligation to worry about the economy and ask it to limit its meddling to attempting to manage infl ation. Better yet, I would limit its activities to making sure that the economy had a suitable amount of liquidity to function normally. Further, I would force it to swear off manipulating asset prices through artifi cially low rates and asymmetric promises of help in tough times – the Greenspan/Bernanke put. It would be a better, simpler, and less dangerous world, although one much less exciting for us students of bubbles.
NIGHT OF THE LIVING FED
by Jeremy Grantham
GMO 2 Quarterly Letter – Night of the Living Fed – October 2010
By hammering away at its giant past mistakes as well as its dangerous current policy can we hope to generate enough awareness by 2014: Bernanke’s next scheduled reappointment hearing.
To Summarize
1) Long-term data suggests that higher debt levels are not correlated with higher GDP growth rates.
2) Therefore, lowering rates to encourage more debt is useless at the second derivative level.
3) Lower rates, however, certainly do encourage speculation in markets and produce higher-priced and therefore less rewarding investments, which tilt markets toward the speculative end. Sustained higher prices mislead consumers and budgets alike.
4) Our new Presidential Cycle data also shows no measurable economic benefi ts in Year 3, yet point to a striking market and speculative stock effect. This effect goes back to FDR, and is felt all around the world.
5) It seems certain that the Fed is aware that low rates and moral hazard encourage higher asset prices and increased speculation, and that higher asset prices have a benefi cial short-term impact on the economy, mainly through the wealth effect. It is also probable that the Fed knows that the other direct effects of monetary policy on the economy are negligible.
6) It seems certain that the Fed uses this type of stimulus to help the recovery from even mild recessions, which might be healthier in the long-term for the economy to accept.
7) The Fed, both now and under Greenspan, expressed no concern with the later stages of investment bubbles. This sets up a much-increased probability of bubbles forming and breaking, always dangerous events. Even as much of the rest of the world expresses concern with asset bubbles, Bernanke expresses none. (Yellen to the rescue?)
8) The economic stimulus of higher asset prices, mild in the case of stocks and intense in the case of houses, is in any case all given back with interest as bubbles break and even overcorrect, causing intense fi nancial and economic pain.
9) Persistently over-stimulated asset prices seduce states, municipalities, endowments, and pension funds into
assuming unrealistic return assumptions, which can and have caused fi nancial crises as asset prices revert back to replacement cost or below.
10) Artifi cially high asset prices also encourage misallocation of resources, as epitomized in the dotcom and fi ber optic cable booms of 1999, and the overbuilding of houses from 2005 through 2007.
11) Housing is much more dangerous to mess with than stocks, as houses are more broadly owned, more easily borrowed against, and seen as a more stable asset. Consequently, the wealth effect is greater.
12) More importantly, house prices, unlike equities, have a direct effect on the economy by stimulating overbuilding. By 2007, overbuilding employed about 1 million additional, mostly lightly skilled, people, not counting the associated stimulus from housing-related purchases.
13) This increment of employment probably masked a structural increase in unemployment between 2002 and 2007, which was likely caused by global trade developments. With the housing bust, construction fell below normal and revealed this large increment in structural unemployment. Since these particular jobs may not come back, even in 10 years, this problem may call for retraining or special incentives.
14) Housing busts also help to partly freeze the movement of labor; people are reluctant to move if they have negative house equity. The lesson here is: Do not mess with housing!
15) Lower rates always transfer wealth from retirees (debt owners) to corporations (debt for expansion, theoretically) and the fi nancial industry. This time, there are more retirees and the pain is greater, and corporations are notably avoiding capital spending and, therefore, the benefi ts are reduced. It is likely that there is no net benefi t to artificially low rates.
Quarterly Letter – Night of the Living Fed – October 2010 3 GMO
http://www.divshare.com/download/13061719-4ca
My diatribe against the Fed’s policies of the last 15 years became, by degrees, rather long and complicated.
So to make it easier to follow, a summary precedes the longer argument. (For an earlier attack on the Fed, see “Feet of Clay” in my 3Q 2002 Quarterly Letter.)
Purpose
If I were a benevolent dictator, I would strip the Fed of its obligation to worry about the economy and ask it to limit its meddling to attempting to manage infl ation. Better yet, I would limit its activities to making sure that the economy had a suitable amount of liquidity to function normally. Further, I would force it to swear off manipulating asset prices through artifi cially low rates and asymmetric promises of help in tough times – the Greenspan/Bernanke put. It would be a better, simpler, and less dangerous world, although one much less exciting for us students of bubbles.
NIGHT OF THE LIVING FED
by Jeremy Grantham
GMO 2 Quarterly Letter – Night of the Living Fed – October 2010
By hammering away at its giant past mistakes as well as its dangerous current policy can we hope to generate enough awareness by 2014: Bernanke’s next scheduled reappointment hearing.
To Summarize
1) Long-term data suggests that higher debt levels are not correlated with higher GDP growth rates.
2) Therefore, lowering rates to encourage more debt is useless at the second derivative level.
3) Lower rates, however, certainly do encourage speculation in markets and produce higher-priced and therefore less rewarding investments, which tilt markets toward the speculative end. Sustained higher prices mislead consumers and budgets alike.
4) Our new Presidential Cycle data also shows no measurable economic benefi ts in Year 3, yet point to a striking market and speculative stock effect. This effect goes back to FDR, and is felt all around the world.
5) It seems certain that the Fed is aware that low rates and moral hazard encourage higher asset prices and increased speculation, and that higher asset prices have a benefi cial short-term impact on the economy, mainly through the wealth effect. It is also probable that the Fed knows that the other direct effects of monetary policy on the economy are negligible.
6) It seems certain that the Fed uses this type of stimulus to help the recovery from even mild recessions, which might be healthier in the long-term for the economy to accept.
7) The Fed, both now and under Greenspan, expressed no concern with the later stages of investment bubbles. This sets up a much-increased probability of bubbles forming and breaking, always dangerous events. Even as much of the rest of the world expresses concern with asset bubbles, Bernanke expresses none. (Yellen to the rescue?)
8) The economic stimulus of higher asset prices, mild in the case of stocks and intense in the case of houses, is in any case all given back with interest as bubbles break and even overcorrect, causing intense fi nancial and economic pain.
9) Persistently over-stimulated asset prices seduce states, municipalities, endowments, and pension funds into
assuming unrealistic return assumptions, which can and have caused fi nancial crises as asset prices revert back to replacement cost or below.
10) Artifi cially high asset prices also encourage misallocation of resources, as epitomized in the dotcom and fi ber optic cable booms of 1999, and the overbuilding of houses from 2005 through 2007.
11) Housing is much more dangerous to mess with than stocks, as houses are more broadly owned, more easily borrowed against, and seen as a more stable asset. Consequently, the wealth effect is greater.
12) More importantly, house prices, unlike equities, have a direct effect on the economy by stimulating overbuilding. By 2007, overbuilding employed about 1 million additional, mostly lightly skilled, people, not counting the associated stimulus from housing-related purchases.
13) This increment of employment probably masked a structural increase in unemployment between 2002 and 2007, which was likely caused by global trade developments. With the housing bust, construction fell below normal and revealed this large increment in structural unemployment. Since these particular jobs may not come back, even in 10 years, this problem may call for retraining or special incentives.
14) Housing busts also help to partly freeze the movement of labor; people are reluctant to move if they have negative house equity. The lesson here is: Do not mess with housing!
15) Lower rates always transfer wealth from retirees (debt owners) to corporations (debt for expansion, theoretically) and the fi nancial industry. This time, there are more retirees and the pain is greater, and corporations are notably avoiding capital spending and, therefore, the benefi ts are reduced. It is likely that there is no net benefi t to artificially low rates.
Quarterly Letter – Night of the Living Fed – October 2010 3 GMO
http://www.divshare.com/download/13061719-4ca
Wednesday, November 3, 2010
How an Economy Grows - Mises Institute's George F. Smith reviews Peter Schiff's "How an Economy Grows"
How an Economy Grows
by George F. Smith on November 2, 2010
Since World War II, most economists have been apologists for government growth.[1] Now the "experts" who never see a crisis coming tell us that we must once again abandon free-market principles to save the free-market system.
But there's always the possibility that people not seated at the government's table will finally wise up. Who or what could help them understand what's going on? People need someone to draw a clear picture of what makes an economy thrive — briefly, without jargon, and, most importantly for today's readers, in an entertaining fashion.
Going Hungry for a Day to Eat Better Later
A strong candidate for this task is Peter Schiff and his illustrated book, How an Economy Grows and Why It Crashes, which he coauthored with his brother, Andrew Schiff. Other elementary texts will continue to be effective in conveying economic basics, but the Schiffs have a story to tell, an extension of a tale first developed by their father, Irwin Schiff. There's nothing quite like a story to get people turning the pages. And in this case, the story is made more enjoyable by the creative work of illustrator Brendan Leach.The authors waste no time getting to the root of economic growth. In the opening chapter, we find three men on an island — Able, Baker, and Charlie — fishing by hand, catching one fish per day each, enough to sustain them until the following day when they head into the surf again. Able gets an idea for an invention that might enable him to catch more than one fish, but when will he have time to build it? He spends all his waking hours working. Nor has he any assurance his invention will work.
One day Able decides to take a chance. He tells the others he will forego fishing for a day to fashion a device he calls a net. They tell him he's crazy, but he goes hungry and succeeds. Using his net, he's able to catch two fish a day, saving one and eating the other. This allows him to spend half as much time fishing and more time working on other ways to improve his life. (In this story, fish don't spoil.)
Schiff augments this narrative with the first of many sidebars he calls a Reality Check. In this one, he points out that Able, in progressing beyond hand-to-mouth existence, was underconsuming and taking a risk.
At the end of this and every other chapter he has a section called Takeaway. What lesson should the reader take from the opening chapter? "By using our natural faculties we can create tools to improve our lives … and to create an economy." No tools, no economy.
Not surprisingly, the other two men want nets but are unwilling to go hungry while they build them. They ask to borrow Able's net on days when he isn't using it. He turns them down. They ask him to loan them fish while they build their nets. He tells them he has no assurance they will succeed. Finally, they propose to borrow fish and pay him back at interest — for every fish he lends them they will pay him back two. If they succeed, everyone will profit. Able accepts their proposal.
The men build their nets, and their economy grows from three fish a day to six, a 100 percent increase.
In another Reality Check, Schiff points out that "the economy didn't grow because they consumed more. They consumed more because the economy grew."
From Barter to Money
As their savings grow, they have more time to undertake other projects. They pool their savings and build a trap that catches 30 fish a week. They never have to fish again. Able starts a clothing company. Baker builds a canoe and a cart, while Charlie constructs a surfboard.Savings, ingenuity, hard work, risk taking, and prudent lending move the economy upward. The island's prosperity attracts and is able to support immigrants seeking a better life. Some of them borrow fish to clear land for farming. People start offering services, such as cooking and fish-trap maintenance. The economy becomes more diversified.
And as it does, they discover they need a better way to trade their goods or services. A spear maker may want the services of a chef, but the chef may not want any spears. What they need is something that can be traded for anything and that is acceptable to everyone. They need money.
They settle on fish. Not only do fish serve to facilitate trade, they can also be saved for old age and emergencies. Money also allows people to specialize in what they do best. Duffy, for example, can build a canoe with eight fish in savings rather than the ten fish that others require. By charging nine fish per canoe, he makes a profit and his customers save money. Over time, Duffy buys specialty tools with his savings that allow him to build a canoe with only four fish. Duffy doubles his production, and by charging six fish, doubles his profit margin and sells canoes at a more affordable price (six fish instead of nine). A luxury becomes an everyday commodity.
As productivity increased, prices fell, benefiting the producer as well as his customers. Falling prices induce people to save, which swells the amount of capital available for loans. The Keynesian fear of falling prices was yet unknown.
A Middleman between Saver and Borrower
Not everyone on the island is willing to work for a better life. Some of them turn to stealing fish. Seeing an opportunity, an entrepreneur named Max Goodbank decides to open a bank and charge a storage fee for safeguarding people's savings.With profits scarce from such a service, Max decides to loan out the savings. To entice people to deposit their fish he pays them interest. He charges borrowers a higher rate of interest so he can pay his expenses and earn a profit. Max calls his enterprise the Goodbank Savings and Loan.
"We can either return to gold or we can pursue the fiat path and return to barter."
Max knows that a prosperous economy would increase fish deposits. Interest on loans would then drop, but so would interest paid to depositors. As savings diminished, Max would charge borrowers a higher interest rate. He would also pay depositors a higher rate to encourage more savings, and eventually the loan rate would come down.
The safety and convenience of the bank attracts depositors, and Max is able to finance a huge waterworks project to bring water inland. New pipelines mean previously infertile land can be made into productive farmland. The steady flow of water can be used to harness machines, giving birth to new industries.
The Birth of Government
To settle disagreements and protect themselves from violence, the islanders decide to form a limited government. They elect 12 senators and a senator-in-chief with executive authority. The senate would create a court system to settle disputes and a police squad to enforce the decrees of judges. It would also create and regulate a navy of spear-packing war canoes.The islanders agree to pay a yearly fish tax to finance the government. To keep the government confined to its assigned responsibilities, they draft a constitution to spell out what it can and cannot do. The constitution protects people from the government and protects minorities from the tyrannies of majorities.
It is widely understood that government could only function because it taxed producers. Government spending therefore was really taxpayer spending, and only taxpayers could vote. The new country is called Usonia.
As generations pass, the island's economy continues to flourish. Then one day some creative senators decide the original constitution was undemocratic in allowing only taxpayer suffrage. The restriction is removed, and on election day the polls are crowded with people who don't care much for government austerity.
The Birth of the Free Lunch
It isn't long before an ambitious senator named Franky Deep comes along with a radical idea. Franky loves power, and the way to get it in politics is to promise voters free stuff. But how could he carry it off? Government can only give by first taking.After breezing into office as senator-in-chief, he comes up with an idea for giving away more than government has. To pay for his spending plans, Franky decides to issue government paper money — Fish Reserve Notes — that can be redeemed for actual fish stored at the Goodbank. Citizens could now use either the fish or the notes in trade.
The island's chief judge points out that the Constitution didn't authorize Franky to issue paper notes for fish. Franky solves the problem by firing the judge. In his place he puts one of his political buddies, who views the Constitution as "a living document" subject to reinterpretation at the discretion of the chief judge.
Though uncomfortable with paper money at first, the citizens begin to like it because it is more convenient to carry. Those who redeem their notes for fish suspect they are not as big as the original fish deposited, but comparing them is outlawed, so no one knows for sure.
With a more progressive judge in office, Franky's people find more spending projects for the government to undertake. All they need is enough support from potential voters. The new notes were the miracle solution.
"Once the savers on the island realize that there is really no safety in bank deposits, they'll stop saving! … Our whole economy could collapse!"
Max Goodbank VII
Taxpayers are pleased because the spending doesn't require tax hikes, progressives love it because government is showing it "cares," and politicians feel relieved because they don't have to balance their budgets. The only potential problem is economists, who might see the subtle theft taking place, but that is solved by cutting them in on the deal with research grants and jobs.
Eventually, bank president Max Goodbank VII starts making noise about government legerdemain. Franky replaces him with Ally Greenfin, and Goodbank Savings and Loan becomes the Fish Reserve Bank. The modern world is born.
The Fate of Usonia
The Schiffs are only getting started, and to see how the former laissez-faire economy of Usonia ends up you will find no better source than the book itself. Though the story illustrates critical economic fundamentals, the authors carry it off with elegant infusions of humor. Some examples: Franky Deep, Jim W. Bass, and Barry Ocuda as chief executives, the "Carp for Carts" program, Finnie Mae and Fishy Mac, Hank Plankton as the head fish accountant, and my favorite, Brent Barnacle, who becomes Ally Greenfin's replacement and promises to drop notes from palm trees if needed. Peter Schiff even pokes fun at himself, making reference toPiker Skiff, TV's comic relief man, who warns of the pending hut collapse.
The Schiffs add a touch of satire when Barnacle tells a conference that Usonia's policy of sending Fish Reserve Notes to the island of Sinopia in exchange for fish and goods is merely the latest development in economic specialization. With their voracious appetites, Usonians "had a comparative advantage in consuming," while Sinopians were tops in the areas of savings and manufacturing things.
Many otherwise-good stories founder with forgettable endings. But I suspect the final two lines of this story will stay with you forever.
Given the critical role of money in an economy, including the economy of Usonia, I would've preferred to see a more detailed development of how the island economy moved from barter to money. The authors tell us on page 52 that because "everyone on this island ate fish, it was decided that fish would serve as money." Though I'm aware of the authors' free-market convictions, the wording left me wondering if the decision was done by a committee rather than the market.
People who find anything related to economics tedious will find the Schiff book an exciting discovery. It should have special appeal to Austrians at all levels of expertise, while the Keynesian wizards who laughed at Peter Schiff when he predicted the housing collapse will likely disdain it.
It might be the only economics book ever written that could be read aloud to one's family without putting them to sleep. The narrative never once lags or becomes academic. The authors manage to convey the critical concepts without straying from their "Connecticut straight-talk" approach.
The Schiffs' tale of Usonia would make an excellent text for a "pre-economics" course, as a way of burning in the basics and of showing how they apply to the US history of the past 100 years. Precalculus is a requirement for premed, as one of my daughters has discovered. A "pre-econ" class featuring How an Economy Works and Why It Crashes would make it clear how government interventions operate in diametric opposition to the medical principle of primum non nocere ("first, do no harm"), with predictable results.
The Schiffs have hit one out of the park. I'm already introducing parts of their book to my five-year-old grandson — who enjoys fishing.
George F. Smith is the author of The Flight of the Barbarous Relic, a novel about a renegade Fed chairman, and Eyes of Fire: Thomas Paine and the American Revolution, a script about Paine's impact on the early stages of the Revolution. Visit his website. Send him mail. See George F. Smith's article archives.
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Notes
[1] See also, "Economists Opposing Fed Audit Have Undisclosed Fed Ties" by Ryan Grim, and "The Gold Standard in Contemporary Economic Principles Textbooks: A Survey" by James Kimball. See the list of prominent economists who signed the petition opposing the Fed audit.Tuesday, November 2, 2010
Election Day Special - Barach Obama: The Oligarch's President by WilliamBanzai7
Barach Obama: The Oligarch's President
I just read an excellent editorial comment written by Charles Ferguson, the director of "Inside Job", Barack Obama: The Oligarch's President. He does a superb job of encapsulating all that has gone terribly wrong with the Obama Presidency vis-a-vis Wall Street.
I am constantly asked why my attitude about President Obama changed 180 degrees. Instead of answering that question myself, I can now hand out and forward this piece, at least until Election Day.
Here are a few choice quotes:
"When I first decided to make a documentary about the financial crisis, in late 2008, my biggest question was how to handle Barack Obama. Alas, the answer rapidly became all too clear, as my film "Inside Job" shows in painful detail."
"When Barack Obama was elected, he had an unprecedented opportunity to shape American history by bringing the country's new financial oligarchy under control. Elected on a platform of change and renewal by a nation in crisis and with strong majorities in both houses of Congress, his election celebrated throughout the world, Obama could have done great things. Instead, he gave us more of the same. America will be paying for his decision for a very long time."
"And now, nearly two years later, the Obama administration has established a clear record. Beginning almost immediately, the president consistently opposed any effort to control financial industry compensation -- even for firms receiving federal aid, as most were in 2009. Then came a long period of total inaction, followed by the toothless Wall Street reform bill passed this summer and the appointment of a former Fannie Mae lobbyist, Tom Donilon, as the new national security advisor. There was no action on the foreclosure crisis and no serious attempt to investigate the causes of the crisis. The SEC has brought only a handful of civil cases ending in trivial fines, with neither firms nor individuals required to admit any wrongdoing.
Most tellingly, there has not been a single criminal prosecution of any firm or any individual senior financial executive -- literally zero -- and, of course, no appointment of a special prosecutor. While we can debate the extent to which fraud caused the crisis, and precisely how much fraud was committed, the answer is clearly not zero. We already know that Lehman and other firms used fake accounting to hide liabilities and inflate assets; that lenders and securitizers frequently knew that the loans they sold and packaged were fraudulent or defective; and, of course, we also now know that Goldman Sachs and other investment banks sold securities they knew to be defective (they were often sold to pension funds for low-paid government employees, by the way) -- and that they designed many of these securities so that they could profit by betting against them after they were sold. Stunningly, this last practice was not ipso facto illegal; but as a practical matter, it’s pretty hard to do if you’re telling the truth. Yet nobody has been prosecuted, and only a very few individuals have even been sued in civil cases.
It is, in short, overwhelmingly clear that President Obama and his administration decided to side with the oligarchs -- or at least not to challenge them."
I don't think anyone could have said it any better. He makes other perceptive political observations regarding our two party duopoly and how it perpetuates this sorry state of affairs.
Here is a link to the full piece as published on Salon.com: Linked Article
ADDENDUM:
I am reading everyone's comments and feel inspired to make a point that I feel very strongly about.
It is very easy for us all to get lured into a discussion about what could have/should have been done, who should have been convicted, the inequity of rewarding common thieves etc.
Here is what I think is the most important point: These people, I mean the Wall Street financiers and their Washington puppets, have done very serious damage to our country.
We are more vulnerable than we have ever been. We are competing with serious rivals who are playing for keeps. Instead of re-channeling ourselves as a nation and making the necessary changes and recalibrations for the benefit of future generations, we have lined the pockets of mortgage pimps, quantitative card sharpers and two bit structured finance artists.
I consider this to be an unforgivable offense.
We obsess about terrorists, as we should, but shouldn't we also devote equal attention to those who continue to commit acts of financial terrorism against our economic homeland?
This is the point that needs to be driven over the backfield fence.
WB7
Let’s get real, the U.S. is bankrupt
Boston University economist Laurence Kotlikoff says U.S. government debt is not $13.5-trillion (U.S.), which is 60 per cent of current gross domestic product, as global investors and American taxpayers think, but rather 14-fold higher: $200-trillion – 840 per cent of current GDP. “Let’s get real,” Prof. Kotlikoff says. “The U.S. is bankrupt.”
Writing in the September issue of Finance and Development, a journal of the International Monetary Fund, Prof. Kotlikoff says the IMF itself has quietly confirmed that the U.S. is in terrible fiscal trouble – far worse than the Washington-based lender of last resort has previously acknowledged. “The U.S. fiscal gap is huge,” the IMF asserted in a June report. “Closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 per cent of U.S. GDP.
This sum is equal to all current U.S. federal taxes combined. The consequences of the IMF’s fiscal fix, a doubling of federal taxes in perpetuity, would be appalling – and possibly worse than appalling.
Prof. Kotlikoff says: “The IMF is saying that, to close this fiscal gap [by taxation], would require an immediate and permanent doubling of our personal income taxes, our corporate taxes and all other federal taxes.
“America’s fiscal gap is enormous – so massive that closing it appears impossible without immediate and radical reforms to its health care, tax and Social Security systems – as well as military and other discretionary spending cuts.”
He cites earlier calculations by the Congressional Budget Office (CBO) that concluded that the United States would need to increase tax revenue by 12 percentage points of GDP to bring revenue into line with spending commitments. But the CBO calculations assumed that the growth of government programs (including Medicare) would be cut by one-third in the short term and by two-thirds in the long term. This assumption, Prof. Kotlikoff notes, is politically implausible – if not politically impossible.
One way or another, the fiscal gap must be closed. If not, the country’s spending will forever exceed its revenue growth, and no one’s real debt can increase faster than his real income forever.
Prof. Kotlikoff uses “fiscal gap,” not the accumulation of deficits, to define public debt. The fiscal gap is the difference between a government’s projected revenue (expressed in today’s dollar value) and its projected spending (also expressed in today’s dollar value). By this measure, the United States is in worse shape than Greece.
Prof. Kotlikoff is a noted economist. He is a research associate at the U.S. National Bureau of Economic Research. He is a former senior economist with then-president Ronald Reagan’s Council of Economic Advisers. He has served as a consultant with governments around the world. He is the author (or co-author) of 14 books: Jimmy Stewart Is Dead (2010), his most recent book, explains his recommendations for reform.
He says the U.S. cannot end its fiscal crisis by increasing taxes. He opposes further stimulus spending because it will simply increase the debt. But he does suggest reforms that would help – most of which would require a significant withering away of the state. He proposes that the government give every person an annual voucher for health care, provided that the total cost not exceed 10 per cent of GDP. (U.S. health care now consumes 16 per cent of GDP.) He suggests the replacement of all current federal taxes with a single consumption tax of 18 per cent. He calls for government-sponsored personal retirement accounts, with the government making contributions only for the poor, the unemployed and people with disabilities.
Without drastic reform, Prof. Kotlikoff says, the only alternative would be a massive printing of money by the U.S. Treasury – and hyperinflation.
As former president Bill Clinton once prematurely said, the era of big government is over. In the coming years, the U.S. will almost certainly be compelled to deconstruct its welfare state.
Prof. Kotlikoff doesn’t trust government accounting, or government regulation. The official vocabulary (deficit, debt, transfer payment, tax, borrowing), he says, is vulnerable to official manipulation and off-the-books deceit. He calls it “Enron accounting.” He also calls it a lie. Here is an economist who speaks plainly, as the legendary straight-shooting film star Jimmy Stewart did for an earlier generation.
But Prof. Kotlikoff’s economic genre isn’t the Western. It’s the horror story – “and scarier,” one reviewer of his book suggests, than Stephen King.
Writing in the September issue of Finance and Development, a journal of the International Monetary Fund, Prof. Kotlikoff says the IMF itself has quietly confirmed that the U.S. is in terrible fiscal trouble – far worse than the Washington-based lender of last resort has previously acknowledged. “The U.S. fiscal gap is huge,” the IMF asserted in a June report. “Closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 per cent of U.S. GDP.
This sum is equal to all current U.S. federal taxes combined. The consequences of the IMF’s fiscal fix, a doubling of federal taxes in perpetuity, would be appalling – and possibly worse than appalling.
Prof. Kotlikoff says: “The IMF is saying that, to close this fiscal gap [by taxation], would require an immediate and permanent doubling of our personal income taxes, our corporate taxes and all other federal taxes.
“America’s fiscal gap is enormous – so massive that closing it appears impossible without immediate and radical reforms to its health care, tax and Social Security systems – as well as military and other discretionary spending cuts.”
He cites earlier calculations by the Congressional Budget Office (CBO) that concluded that the United States would need to increase tax revenue by 12 percentage points of GDP to bring revenue into line with spending commitments. But the CBO calculations assumed that the growth of government programs (including Medicare) would be cut by one-third in the short term and by two-thirds in the long term. This assumption, Prof. Kotlikoff notes, is politically implausible – if not politically impossible.
One way or another, the fiscal gap must be closed. If not, the country’s spending will forever exceed its revenue growth, and no one’s real debt can increase faster than his real income forever.
Prof. Kotlikoff uses “fiscal gap,” not the accumulation of deficits, to define public debt. The fiscal gap is the difference between a government’s projected revenue (expressed in today’s dollar value) and its projected spending (also expressed in today’s dollar value). By this measure, the United States is in worse shape than Greece.
Prof. Kotlikoff is a noted economist. He is a research associate at the U.S. National Bureau of Economic Research. He is a former senior economist with then-president Ronald Reagan’s Council of Economic Advisers. He has served as a consultant with governments around the world. He is the author (or co-author) of 14 books: Jimmy Stewart Is Dead (2010), his most recent book, explains his recommendations for reform.
He says the U.S. cannot end its fiscal crisis by increasing taxes. He opposes further stimulus spending because it will simply increase the debt. But he does suggest reforms that would help – most of which would require a significant withering away of the state. He proposes that the government give every person an annual voucher for health care, provided that the total cost not exceed 10 per cent of GDP. (U.S. health care now consumes 16 per cent of GDP.) He suggests the replacement of all current federal taxes with a single consumption tax of 18 per cent. He calls for government-sponsored personal retirement accounts, with the government making contributions only for the poor, the unemployed and people with disabilities.
Without drastic reform, Prof. Kotlikoff says, the only alternative would be a massive printing of money by the U.S. Treasury – and hyperinflation.
As former president Bill Clinton once prematurely said, the era of big government is over. In the coming years, the U.S. will almost certainly be compelled to deconstruct its welfare state.
Prof. Kotlikoff doesn’t trust government accounting, or government regulation. The official vocabulary (deficit, debt, transfer payment, tax, borrowing), he says, is vulnerable to official manipulation and off-the-books deceit. He calls it “Enron accounting.” He also calls it a lie. Here is an economist who speaks plainly, as the legendary straight-shooting film star Jimmy Stewart did for an earlier generation.
But Prof. Kotlikoff’s economic genre isn’t the Western. It’s the horror story – “and scarier,” one reviewer of his book suggests, than Stephen King.
Monday, November 1, 2010
The Hussman Report
Lessons From a Lost Decade
John P. Hussman, Ph.D.
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Reprint Policy
Over the past decade, stock market investors have experienced enormous volatility, including two separate market declines in excess of 50%. Despite periodic advances, at the end of it all, as a reward for their patience, investors have achieved an average annual total return of approximately zero... Put simply, greater risk does not imply greater reward if the risks that investors take are overvalued and inefficient ones.
The second lesson is that the effects of wasteful misallocation of capital cannot be fixed by policies that encourage the wasteful misallocation of capital. Fortunately or unfortunately, policies can often help to prop up unsustainable patterns of activity in order to "kick the can down the road." This can postpone major economic adjustments, but often makes the ultimate adjustment even worse.
Over the short run, two policies have been primarily responsible for successfully kicking the can down the road following the recent financial crisis. The first was the suppression of fair and accurate financial disclosure - specifically FASB suspension of mark-to-market rules - which has allowed financial companies to present balance sheets that are detached from any need to reflect the actual liquidating value of their assets. The second was the de facto grant of the government's full faith and credit to Fannie Mae and Freddie Mac securities. Now, since standing behind insolvent debt in order to make it whole is strictly an act of fiscal policy, one would think that under the Constitution, it would have been subject to Congressional debate and democratic process. But the Bernanke Fed evidently views democracy as a clumsy extravagance, and so, the Fed accumulated $1.5 trillion in the debt obligations of these insolvent agencies, which effectively forces the public to make those obligations whole, without any actual need for public input on the matter.
Market Climate
As of last week, the Market Climate for stocks was characterized by strenuous overvaluation, overbought price action, overbullish sentiment, and a shift to neutral though not yet rising yield pressures. The Investors Intelligence data shows a significant shift from the "correction" camp to the bullish camp among investment advisors, with 45.6% bulls and 24.4% bears. The more volatile American Association of Individual Investors poll shows an even wider skew, with 51.6% bulls and just 21.6% bears.http://www.hussman.net/wmc/wmc101101.htm
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