This is the first of a number of comments on the economy.
Green shoots notwithstanding–"rough winds (may yet) shake the darling buds of May" (and kill the shoots)–there is no assurance that the economic decline is ending or that it will end shortly–this summer or the fall. Even a devastating relapse should not be ruled out. May of 2009 may in the years to come be compared to the spring of 1930, the beginning of the Great Depression, although even a worse case scenario should not quite lead to what we had in the thirties.
Will May of 2009 be comparable to the summer of 1982? We were then in a severe recession but it was one that ended in the fall of that year. That recession may end up being the worst recession since WW II, if the recovery comes soon, but this present recession is the most dangerous, in that it harbors the possibility of degenerating into a real depression. This was not really true of the recession of 1981-82. That recession was brought on by tight money to stop inflation and ended by easy money. This recession was not brought on by tight money and easy money has not brought us out of it. But assuming the green shoots people are right and the end of the recession is near, what about the recovery?
Using the lettering system developed in the last decade, I think we can say with assurance, we will not have a V, a bottom followed by a strong recovery, although Roubini says V simply stands for a short recession. A U is weaker, but the letter I just typed looks to me to be overly optimistic–a bottoming out, then a pause, followed by a rise to economic heaven. But a third alternative, an L, seems more appropriate, especially the L on my keyboard, since the economy would first level off and then there is an ever-so-slight rise (take out your magnifying glass). Roubini thinks an L is a depression, but I suspect his keyboard has letters with slightly different shapes.
Both the short-run and longer-run prospects seem to me to be dreadful. Let me deal, here, only with the short run. Those who have taken a traditional course in economics (or taught it) probably remember the equation and letters for the gross domestic product–the overall measure of output: GDP = C (consumption) + I (investment) + G (government) + [X (exports) - M (imports)] (Imports are subtracted, obviously, since goods sold here but made in China, are part of China’s GDP, apart from what is done here, which is counted–unloading the ships, trucking the goods to Walmart and then the work of paid, er, underpaid employees selling the stuff.
Given the devastation of an increasingly catastrophic world-wide recession, increases in exports will be limited, at best, undercutting one recovery constituent. More important are the negatives on what is key–investment. Housing construction has properly been put in this category by economic statisticians, even if one might alternatively consider it part of consumption. Usually, in a recession, the Fed lowers interest rates and this helps bring down mortgage rates and this in turn leads to greater housing purchases. And while most of these purchases are of existing housing, there is also a significant growth in housing construction.
But, given the glut of foreclosed houses in this recession, construction is not only dead now, but it clearly will show little life for a long time to come. Thus a very important part of the recovery syndrome is undermined. (And in passing, while there are areas where buyers are stepping in, most reports expect housing prices to continue falling some and mortgage defaults to continue to rise, even if the worst is over.)
But yet another part of a normal recovery is undermined–increased business investment. While most banks may have passed, more or less, the "stress test," banks in general are still very stressed. Even if the worst is avoided--a resumption of major bank defaults (or major outlays to prevent these defaults)–it is clear that it will take quite a while before banks will be able to make the loans to businesses they typically make during a recovery. In other words, investment will be far weaker than it usually is during a recovery.
Consumption is also likely to be more stunted than usual. First, people are fearful and, understandably, because of this, they are being more cautious. (The front page article in the Times yesterday, May 10, entitled "Shift From Spending to Saving May Be Slump’s Lasting Impact" spells out this argument.) Many, who have kept their jobs, are "saving" more by paying off their debts. And while saving is a wonderful activity, and as individuals we should all do it during most periods of our lives, it is the opposite of what is needed during a recession (or during a recovery). The wonderful Keynesian "paradox of thrift," in which attempts to save lead to less actual saving since postponing consumption leads to goods not being sold, and workers being laid off, is as alive and well as it was when originally put forth by Keynes in the thirties.
Consumption is also being hit by two other sources. People can’t spend by borrowing on the increased value of their houses, since their houses have decreased in value. And banks at this point won’t lend many potential borrowers the money even if the value is there. The other negative is that credit card companies are being forced to be more careful. Moreover, they are increasing their rates, which not only discourages borrowing directly but indirectly allows for less consumption, rather than more, since more must be spent on payments of interest.
We are left, therefore, with one hope, and one hope only, if the recovery is to be stronger than what it appears it will be, whenever it begins to take place–the last letter in the equation above, G (government). The stimulus will help, but unfortunately, big as it is, it is too small. Moreover, too much of it is going to tax cuts, much of which will not be spent, but saved–the paradox of thrift again. The President’s attempt to be bi-partisan, whether induced by belief (and/or temperament) or caused by political considerations, has led to a lower stimulus than what we needed, with too much of it perversely directed into tax cuts, instead of spending projects.
I thought Obama could have achieved immediate results–countering the argument that spending takes too long to go into effect–if the federal government had given the money to the states, and to their universities, and to cities, enabling the states and cities to reduce their cutbacks in education, libraries, infrastructure and everything else that is being cut. And almost all of this kind of spending is considered socially useful, and appropriate, by all who are not clones of Ron Paul.
Given all this, what do I think will happen in the short run? While a recovery of sorts could possibly be around the corner, to use the (unfortunate) phrase Herbert Hoover employed in the early 30's, the greater likelihood is that it will not take place until later in the year. Or worse, it may even be delayed until 2010 when the effects of the stimulus kick in enough to reverse the decline, although other factors such as the rebuilding of inventory may cause GDP to increase slightly at an earlier point. But, like the situation after the recession of 2001, an end to the recession can be determined and announced by the official arbiters of the dating process (of recessions), the National Bureau of Economic Research, but I fear that most persons will be unable to distinguish the recession from the recovery. Nevertheless, the optimistic part of all this is that barring a disastrous set-back in the financial sphere, we are probably near the bottom.
Unemployment is now 8.9 %. But a more appropriate measure of unemployment, one which includes those too discouraged to look for a job and those working part time who would like to work full time, is about 16 %. The official rate is likely, as I predicted a few months ago, to reach double digits this summer. If not, it will surely come close. This level of unemployment, while nowhere near the level reached in 1933, is nonetheless dismaying. But even more daunting is the fact that a weak recovery almost ensures that the level of unemployment will keep on rising, even after a recovery begins. This is usually the case, but this time it will likely rise more than it does on average, and rise longer than it usually does, since the recovery is almost guaranteed to be an anemic one.
Monday, May 11, 2009
Obama Interview
On the cover of The New York Times Magazine of May 3 was a picture of a thoughtful Barack Obama. It appears because this issue featured an interview of the president by David Leonhardt, entitled "After the Great Recession."
Overall, I think that Obama’s understanding of economic issues is better than that of all other presidents since World War II, with the exception of Bill Clinton. (I watched Clinton in the late fall of 1992, about a month after he won the presidency, at an economic conference which included top level economists and you would think that he too had a Ph. D. in economics.)
Obama is obviously highly intelligent and he surely knows his way around the economic mine fields. Even if there is nothing unexpected in what he is arguing for, or against, or explaining his positions, what he says is almost always stated clearly with a sophisticated take and backed by facts. Thus in arguing against restoring the Glass-Steagall Act of 1933, which prohibited commercial banks from also engaging in investment banking, he points out the success Canada has had in the banking area, even though it permits banks to be both investment banks and commercial banks.
He intelligently describes the shortcomings of our educational system, calling for more and better education, but understands that what is learned must be more effective in the economic realm. He specifically wants to see more math, science and engineering graduates. In arguing this, he acknowledges that "we are not going to return to an economy in which manufacturing is as large a percentage as it was back in the 1940s just because of automation and technological advance."
I have three doubts or criticisms about what he argues. First, while it is good for the mind to study and understand mathematics, many such graduates are limited to jobs as actuaries and there are only so many actuaries. There is no easy path for scientists unless there is a vast increase in research funding that I doubt will come about. And finally, it is all well and good to talk of "more folks in engineering," many of the engineering jobs of the future may well be outsourced to India and unless there is an enormous increase in infrastructure funding, civil engineers, who are on-the-spot workers, will not find jobs. Or, more to the point, students will not become civil engineers.
I doubt anyone believes that more education is unwise, but I think Obama does not appear to understand that the payoff to better education, if we are talking about starting from the kindergarten on, will take decades and decades. There is no indication, unless I missed it, that Obama recognizes that this needed improvement–better education at all levels–is not something whose benefits we will be reaping during his presidency or the one which follows or even the one which follows that (assuming all serve eight years), but a process that will take many generations.
Finally, I am amazed at the comment he made, that I quote above, on the size of manufacturing. Not only is it absurd to mention that we are not going to have manufacturing at the level it was in the 1940's, it is highly unlikely that as a percentage of GDP, we will ever get back the percentage that existed as recently as 1990, even if you are wildly optimistic. This one sentence, unlike almost all of what else he says, sounds more like George W. Bush than it does Barack Obama.
He pushes the case for the "smart grid," which a footnote describes as a more efficient system of transmitting energy and believes that one of the constraints is that "we don’t have enough trained electricians to lay down those lines." I would like to understand more about what this will accomplish. Is it simply a lesser dependence on Middle East oil; is it more a desire to preserve the environment; is it also a hope that the greater efficiency of appropriate technology will give us a meaningful, competitive advantage?
My fear is that behind all the high-sounding phrases (illustrated, often, one might add, with concrete and homey examples–there is one on his grandmother’s hip replacement) there is an emptiness. A feeling that beautiful and inspiring words are being spoken, but behind them is a an absence of substance–a shell.
That is, somehow, I feel Obama thinks we have lost our way and a return to our best traditions will restore us. Now there is of course some truth in this. But I think he assumes the present is more or less like the past, although he recognizes that "our long-term competition will be in the global economy–China, India, the E.U., Brazil, Korea" (countries that, to be sure, would not have been mentioned thirty years ago), following this up with a statement that success will come to those countries with a work force "whose education system emphasizes the sciences and mathematics . . . ."
Yes, all true. But another way of seeing the world is that we are in an altogether new situation. China, with a population of over 1 billion and 300 million people, and India, with a population of 1.1 billion, constitute nearly 40 % of the world’s population. These two countries, and others like Vietnam, are still very poor, but they are on the move. This wasn’t true as recently as two decades ago. And these countries have workers that make as little as $2 a day, a minute fraction of what our workers make. This means that all bets are off in virtually all areas of economics, especially manufacturing, and that barring a miraculous new development, we will in general be unable to compete–temporary or even permanent exceptions aside–however much we improve our educational system; however many mathematicians, scientists and engineers we graduate; or however much we develop a smart grid.
In short, I think Obama is thinking of the world he (and I) grew up in, not the new world we have entered where there are vast numbers of workers being organized to compete in the world economy at a wage a fraction of what our workers make.
Obama believes–and does he ever–in hope. But hope is not going to solve the problems we face. I have no idea how he should have brought these questions up, or even if he should have mentioned them at all. But to me, it seems as though he has no idea that this new world situation exists. He is, at bottom, however eloquent, an ordinary traditionalist. And this, I find distressing and disconcerting.
One last thought, since ending without it, may lead some to despair (or more likely, denial). Our living standards (along with those of much of Europe and Japan) are far higher–but really far higher--than the living standards of the average person in China and India. This can’t remain intact. Theirs will rise and ours will fall. But the process will be slow–decades from now our living standards will in all likelihood still be significantly higher than those in China and India, though the gap will likely be far less. There will be always be areas in which we can excel. Our land and climate, for example, is unusually good for the production of certain crops. There will always be new products and with a better education, we can produce our share.
But in the end, what is needed is a way of life in which happiness is not based as much on material wealth. Getting from here to there will, in my view, be the challenge of those who follow us. And coping with the politics of disappointment will be part of that challenge.
Endnote:
At one point, Obama is asked by Leonhardt about vigorous economic debate, mentioning Robert Rubin (the centrist) and Robert Reich (the liberal). Obama replies, "But I don’t have (on my team) Paul Krugman or Joseph Stiglitz" (Laughter). Later on he mentions that he has enormous respect for Stiglitz and reads "his stuff all the time. I actually am looking forward to having these folks in for ongoing discussion."
Krugman’s blog: May 5, 2009, 5:11 pm
Nothing to say (the title of his posting)
Andrew Leonard and Calculated Risk want to know why I didn’t blog about dinner at the White House. Um, because the conversation was off the record.
Clicking on Andrew Leonard, one gets the following"
Monday, May 4, 2009 11:27 PDT
Obama’s dinner with Stiglitz and Krugman
In David Leonhardt’s epic interview with President Obama, published in this past weekend’s New York times Magazine but which actuaoly took place on April 14, the president says he has "enormous respect" for economist Joseph Stiglitz and that "I actually am looking forward to having these folks in for ongoing discussion."
Now we learn from Newsweek, (via Taegan Goddard) that
On the night of April 27, for instance, the president invited to the White House some of his administration’s sharpest critics on the economy, including New York Times columnist Paul Krugman and Columbia University economist Joseph Stiglitz. Over a roast-beef dinner, Obama listened and questioned while Krugman and Stiglitz, both Nobel Prize winners, pushed for more aggressive government intervention in the banking system.
Not even a whisper of this momentous news made it into Paul Krugman’s blog, which seems to me to represent a misuse of the medium. I’m sure the conversation was designated off-the-record, which makes it understandable why we have no blow-by-blow from Krugman, but still: I promist all HTWW readers that if I ever have dinner with the president, I will at least mention it in this blog. What else are blogs for if not to tell people about your cool dinner dates?
Oh, but would I have loved to have been a mouse in that dining room.
KRUGMAN: If you do not nationalize Citigroup and Bank of America, you will have proven to the american people that the White House is owned, lock-stock-and-barrel, by Wall Street!
STIGLITZ: The Geithner plan to fix the banking system is outright robbery of the American people, Mr President!
OBAMA: How do you like your roast beef? Raw and bloody, I presume. Please, have some more.
One thing we so know: Paul Krugman’s oppositional stance was not ameliorated by the meeting, at least as judged by his last two blog posts, here and here. Although one does wonder if Obama’s harsh attack Thursday on the hedge funds who refused to budge on Chrysler was in any way influenced by the two Nobel Prize-winning economists.
In any case, although I feel inclined to agree with Newsweek’s Evan Thomas that "it will take more than a few dinner parties to avoid the fate of presidents who lost touch with reality," I’m still glad to hear that alternate points of view are making it into the White House.
Overall, I think that Obama’s understanding of economic issues is better than that of all other presidents since World War II, with the exception of Bill Clinton. (I watched Clinton in the late fall of 1992, about a month after he won the presidency, at an economic conference which included top level economists and you would think that he too had a Ph. D. in economics.)
Obama is obviously highly intelligent and he surely knows his way around the economic mine fields. Even if there is nothing unexpected in what he is arguing for, or against, or explaining his positions, what he says is almost always stated clearly with a sophisticated take and backed by facts. Thus in arguing against restoring the Glass-Steagall Act of 1933, which prohibited commercial banks from also engaging in investment banking, he points out the success Canada has had in the banking area, even though it permits banks to be both investment banks and commercial banks.
He intelligently describes the shortcomings of our educational system, calling for more and better education, but understands that what is learned must be more effective in the economic realm. He specifically wants to see more math, science and engineering graduates. In arguing this, he acknowledges that "we are not going to return to an economy in which manufacturing is as large a percentage as it was back in the 1940s just because of automation and technological advance."
I have three doubts or criticisms about what he argues. First, while it is good for the mind to study and understand mathematics, many such graduates are limited to jobs as actuaries and there are only so many actuaries. There is no easy path for scientists unless there is a vast increase in research funding that I doubt will come about. And finally, it is all well and good to talk of "more folks in engineering," many of the engineering jobs of the future may well be outsourced to India and unless there is an enormous increase in infrastructure funding, civil engineers, who are on-the-spot workers, will not find jobs. Or, more to the point, students will not become civil engineers.
I doubt anyone believes that more education is unwise, but I think Obama does not appear to understand that the payoff to better education, if we are talking about starting from the kindergarten on, will take decades and decades. There is no indication, unless I missed it, that Obama recognizes that this needed improvement–better education at all levels–is not something whose benefits we will be reaping during his presidency or the one which follows or even the one which follows that (assuming all serve eight years), but a process that will take many generations.
Finally, I am amazed at the comment he made, that I quote above, on the size of manufacturing. Not only is it absurd to mention that we are not going to have manufacturing at the level it was in the 1940's, it is highly unlikely that as a percentage of GDP, we will ever get back the percentage that existed as recently as 1990, even if you are wildly optimistic. This one sentence, unlike almost all of what else he says, sounds more like George W. Bush than it does Barack Obama.
He pushes the case for the "smart grid," which a footnote describes as a more efficient system of transmitting energy and believes that one of the constraints is that "we don’t have enough trained electricians to lay down those lines." I would like to understand more about what this will accomplish. Is it simply a lesser dependence on Middle East oil; is it more a desire to preserve the environment; is it also a hope that the greater efficiency of appropriate technology will give us a meaningful, competitive advantage?
My fear is that behind all the high-sounding phrases (illustrated, often, one might add, with concrete and homey examples–there is one on his grandmother’s hip replacement) there is an emptiness. A feeling that beautiful and inspiring words are being spoken, but behind them is a an absence of substance–a shell.
That is, somehow, I feel Obama thinks we have lost our way and a return to our best traditions will restore us. Now there is of course some truth in this. But I think he assumes the present is more or less like the past, although he recognizes that "our long-term competition will be in the global economy–China, India, the E.U., Brazil, Korea" (countries that, to be sure, would not have been mentioned thirty years ago), following this up with a statement that success will come to those countries with a work force "whose education system emphasizes the sciences and mathematics . . . ."
Yes, all true. But another way of seeing the world is that we are in an altogether new situation. China, with a population of over 1 billion and 300 million people, and India, with a population of 1.1 billion, constitute nearly 40 % of the world’s population. These two countries, and others like Vietnam, are still very poor, but they are on the move. This wasn’t true as recently as two decades ago. And these countries have workers that make as little as $2 a day, a minute fraction of what our workers make. This means that all bets are off in virtually all areas of economics, especially manufacturing, and that barring a miraculous new development, we will in general be unable to compete–temporary or even permanent exceptions aside–however much we improve our educational system; however many mathematicians, scientists and engineers we graduate; or however much we develop a smart grid.
In short, I think Obama is thinking of the world he (and I) grew up in, not the new world we have entered where there are vast numbers of workers being organized to compete in the world economy at a wage a fraction of what our workers make.
Obama believes–and does he ever–in hope. But hope is not going to solve the problems we face. I have no idea how he should have brought these questions up, or even if he should have mentioned them at all. But to me, it seems as though he has no idea that this new world situation exists. He is, at bottom, however eloquent, an ordinary traditionalist. And this, I find distressing and disconcerting.
One last thought, since ending without it, may lead some to despair (or more likely, denial). Our living standards (along with those of much of Europe and Japan) are far higher–but really far higher--than the living standards of the average person in China and India. This can’t remain intact. Theirs will rise and ours will fall. But the process will be slow–decades from now our living standards will in all likelihood still be significantly higher than those in China and India, though the gap will likely be far less. There will be always be areas in which we can excel. Our land and climate, for example, is unusually good for the production of certain crops. There will always be new products and with a better education, we can produce our share.
But in the end, what is needed is a way of life in which happiness is not based as much on material wealth. Getting from here to there will, in my view, be the challenge of those who follow us. And coping with the politics of disappointment will be part of that challenge.
Endnote:
At one point, Obama is asked by Leonhardt about vigorous economic debate, mentioning Robert Rubin (the centrist) and Robert Reich (the liberal). Obama replies, "But I don’t have (on my team) Paul Krugman or Joseph Stiglitz" (Laughter). Later on he mentions that he has enormous respect for Stiglitz and reads "his stuff all the time. I actually am looking forward to having these folks in for ongoing discussion."
Krugman’s blog: May 5, 2009, 5:11 pm
Nothing to say (the title of his posting)
Andrew Leonard and Calculated Risk want to know why I didn’t blog about dinner at the White House. Um, because the conversation was off the record.
Clicking on Andrew Leonard, one gets the following"
Monday, May 4, 2009 11:27 PDT
Obama’s dinner with Stiglitz and Krugman
In David Leonhardt’s epic interview with President Obama, published in this past weekend’s New York times Magazine but which actuaoly took place on April 14, the president says he has "enormous respect" for economist Joseph Stiglitz and that "I actually am looking forward to having these folks in for ongoing discussion."
Now we learn from Newsweek, (via Taegan Goddard) that
On the night of April 27, for instance, the president invited to the White House some of his administration’s sharpest critics on the economy, including New York Times columnist Paul Krugman and Columbia University economist Joseph Stiglitz. Over a roast-beef dinner, Obama listened and questioned while Krugman and Stiglitz, both Nobel Prize winners, pushed for more aggressive government intervention in the banking system.
Not even a whisper of this momentous news made it into Paul Krugman’s blog, which seems to me to represent a misuse of the medium. I’m sure the conversation was designated off-the-record, which makes it understandable why we have no blow-by-blow from Krugman, but still: I promist all HTWW readers that if I ever have dinner with the president, I will at least mention it in this blog. What else are blogs for if not to tell people about your cool dinner dates?
Oh, but would I have loved to have been a mouse in that dining room.
KRUGMAN: If you do not nationalize Citigroup and Bank of America, you will have proven to the american people that the White House is owned, lock-stock-and-barrel, by Wall Street!
STIGLITZ: The Geithner plan to fix the banking system is outright robbery of the American people, Mr President!
OBAMA: How do you like your roast beef? Raw and bloody, I presume. Please, have some more.
One thing we so know: Paul Krugman’s oppositional stance was not ameliorated by the meeting, at least as judged by his last two blog posts, here and here. Although one does wonder if Obama’s harsh attack Thursday on the hedge funds who refused to budge on Chrysler was in any way influenced by the two Nobel Prize-winning economists.
In any case, although I feel inclined to agree with Newsweek’s Evan Thomas that "it will take more than a few dinner parties to avoid the fate of presidents who lost touch with reality," I’m still glad to hear that alternate points of view are making it into the White House.
Krugman vs Meltzer
Recently (Monday, May 4), readers of the op ed section of The New York Times were handed a special treat. At the bottom of the page, there was the column of their regular contributor, the Nobelist, Paul Krugman, expressing his deep concern about falling wages and deflation (or falling prices). At the top of the page, in an unusually long article, Allan Meltzer, a well-known conservative economist (a professor of political economy at Carnegie Mellon University), expressed his deep concern about inflation.
So who has it right? Readers of this blog will not be surprised when they hear that I think Krugman has it right and that Meltzer is all wet. Even Krugman was irked enough by what Meltzer wrote to openly criticize him that very day on his blog, first quoting him: "Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation."
He followed this up with a chart that shows what happened in Japan between 1991-2003. Its money supply went up and its deficits went up, but inflation went down. Japan "experienced deflation," Meltzer notwithstanding. Specifically, during those twelve years of increasing money supply and increasing deficits, prices fell about 2 ½ percent. (Given there is no way of measuring "the prospect of sustained currency devaluation," Krugman omitted this in his chart.)
Elsewhere, on the Nouriel Roubini blog site, Krugman argues that interest rates (and therefore by implication, inflation rates) will only go up if (US) government solvency is in question. Because the rest of the world is in such dire straits, he thinks that the solvency of the dollar is not in question (at least by implication, in the near future).
Krugman’s argument on wage rates is a variation of his argument on deflation (falling prices). He believes that falling wage rates are in essence all but taking place, citing a BLS (Bureau of Labor Statistics) report that the "average cost of employing workers in the private sector rose only two-tenths of a percent" recently and suspects "overall wages (will) start falling later this year."
If this happens, it won‘t lead to employers hiring more workers because they are now cheaper (supply and demand), the pre-Keynesian view as to how we will get out of the Great Depression, but (in a variation of the paradox of thrift–see the initial article in this series), less income will lead to less consumption leading to higher unemployment.
Krugman concludes that we need a real recovery, not just stabilization. This means: "more stimulus, more decisive action on the banks, more job creation."
But Meltzer is so concerned about inflation that he writes, "It doesn’t help that the administration’s stimulus program is an obstacle to sound policy." Yes, in the name of stable prices Meltzer is apparently willing to allow unemployment to reach astronomical levels–thirties level is implied–and this would mean the American people (and its economy) would truly be forced to go through the wringer.
This is unalloyed fanaticism. Some might even come to the conclusion that Meltzer, credentials notwithstanding, is simply a wing nut. (Wikipedia: a derogatory American slang term for a person who holds strongly right-wing political beliefs, shortened from right wing nut.")
Meltzer argues, unconvincingly (to me) that the Fed is no longer independent but is simply the monetary arm of the treasury, "bailing out A.I.G., taking on illiquid securities from Bear Stearns and promising to provide as mush as $ 700 billion of reserves to buy mortgages." Since all this began during the Bush Administration, Meltzer is arguing that the Fed is under the control of two very different Treasury departments. Isn’t it more likely that Bernanke is trying to have the Fed do its utmost to prevent this super-serious downturn from turning into a full blown depression?
Without its independence, the Fed, in Meltzer’s view, will be unwilling to stop the inflationary surge when it comes. I doubt this, but more shortly.
Meltzer praises the efforts of Paul Volcker during his chairmanship of the Federal Reserve. In order to stop double-digit inflation (or even the possibility the inflation rate might increase), Volcker was willing in 1981-82 to drive up interest rates to astronomical heights–the prime rate reached 21.5 percent (mentioned by Meltzer) and mortgage rates were above 17 % (not mentioned). Volcker’s hard line policies are defensible given the situation. But there are at least three things missing or not emphasized in Meltzer’s account of things.
First, he understates the impact of oil prices when he writes that 1979 rates of inflation were "worsened by the oil shock." Both in the early 1970's and in the late 70's oil was the primary cause of inflation, as OPEC on two separate occasions raised the price of oil by cutting back output. Without these increases–and the impact of oil prices then were greater than they are now–it is doubtful inflation would have been a major problem. Perhaps Meltzer minimizes the impact oil prices had on inflation then, because they are not a factor in today’s world and certainly not a cause for concern about inflation, which is what Meltzer is all about. Simply put, the threat of inflation is much lower, because the oil situation is under control, Meltzer not withstanding.
Second, he does what most conservatives do. He ignores the inflationary impact of Reagan’s tax cut of 1981. He argues that a "decisive change of attitudes (on combating) inflation didn’t take place until the spring of 1981, but ignores that Volcker in part was responding to the inflationary potential of the Reagan tax cut, a potential to drive inflation to triple digit levels, if not countered resolutely.
Reagan is portrayed by Meltzer as a hero, when in actuality he was anything but. His tax cut led to Volcker’s hard line which pushed unemployment rates to double digits–the highest since the Great Depression (a level challenged, alas, by the recession we are currently in). Conservatives–even those who put countering inflation as their first priority–have rarely if ever been able to face up to the irresponsibility of Reagan’s tax cut.
Third, he points to Volcker’s success in bringing inflation down to (just) "below 4 percent," a potential level it seems he will not tolerate today and one we are far below as I write.
After all his ranting and raving, what is Meltzer really saying about inflation? He asks, "When will it come?" And then he answers, "Surely not right away." In his next sentence, he writes "sooner or later." Well, is this not a mouse roaring? Some day (when–2013?) inflation will rear its ugly head and the Fed will not do what is required. This is a reason to be scared out of our boots? In short, Meltzer is so obsessed about the possibility of inflation in the distant future, he is willing to have us chance a major depression by doing nothing to counter the downturn. No stimulus. Nada.
Some time back Krugman argued that when the time comes–and inflation rears its ugly head–the Fed will simply raise interest rates enough to stop it. And I suspect Bernanke, if he is still chairman (or whoever replaces him) will simply raise rates.
But there is a problem. When inflation is externally caused–oil, for example–we get something that first arose in the 1970's, stagflation. This is simultaneous unemployment (stagnation), at high levels, and inflation, at high levels. And when this occurs there are no easy answers. Unemployment is probably worse that inflation, in general, since wages usually keep up with the inflation, approximately, but high rates of inflation that are not countered tend to accelerate. One is soon facing devastating levels of inflation that are potentially so disruptive that the economy can no longer function (or function in a meaningful way).
Under ordinary circumstances downturns cause inflation to be reduced as demand for labor and goods diminishes. But as I have already pointed out, a problem may arise, as Krugman has indicated, if government solvency is in question. I am not sure about government solvency when you pay your debts in your own currency, but I do believe that much of the world is deeply troubled by the fact that money is being printed by the US at astronomical levels. There are three intertwined aspects to this–the enormous and unprecedented trade deficit; the gigantic and perhaps unprecedented budgetary deficit that we are going to have (unprecedented at least in peace time); and, lastly, the various Federal Reserve bail-outs and acquisitions, separate from the budgetary stimulus–of A.I.G. and Bear Stearns–and the $700 billion of reserves to buy mortgages it is providing.
At the moment the alternatives to holding the dollar are suspect–especially the Euro. But the time may not be distant when fear will take over and though no holder of immense amounts of dollars, say China, wants to see the dollar crash, the likelihood that this can be permanently avoided do not seem to me to be high. But there is no precedent and therefore the word "likelihood" is not exactly used scientifically. However, if the Dow can decline about 23 % in a day, as it did in 1987, is a dollar collapse unimaginable? Given the fact that the factors that are potentially weakening it are not going away–after all, the trade and budge deficits will continue at high, possibly unprecedented, levels barring a miracle far less likely than the Red Sea parting.
If the dollar depreciates, then we have stagflation. That can lead to a politics that is ugly and conservative (or worse). Last time, before it was obvious we were losing our competitive edge, stagflation led to Ronald Reagan. If somehow the dollar doesn’t depreciate, or the depreciation is mild and steady, then the prospects for the future will depend on how we are able to compete in a world in which our competitors pay their workers peanuts. There are no scenarios for a rosy future.
But, for the time being, there is little reason to worry about inflation. This means that we should ignore the worries of Meltzer and listen to Krugman–"more stimulus, more decisive action on the banks, more job creation." Otherwise, we’ll face "years of deflation and stagnation."
So who has it right? Readers of this blog will not be surprised when they hear that I think Krugman has it right and that Meltzer is all wet. Even Krugman was irked enough by what Meltzer wrote to openly criticize him that very day on his blog, first quoting him: "Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation."
He followed this up with a chart that shows what happened in Japan between 1991-2003. Its money supply went up and its deficits went up, but inflation went down. Japan "experienced deflation," Meltzer notwithstanding. Specifically, during those twelve years of increasing money supply and increasing deficits, prices fell about 2 ½ percent. (Given there is no way of measuring "the prospect of sustained currency devaluation," Krugman omitted this in his chart.)
Elsewhere, on the Nouriel Roubini blog site, Krugman argues that interest rates (and therefore by implication, inflation rates) will only go up if (US) government solvency is in question. Because the rest of the world is in such dire straits, he thinks that the solvency of the dollar is not in question (at least by implication, in the near future).
Krugman’s argument on wage rates is a variation of his argument on deflation (falling prices). He believes that falling wage rates are in essence all but taking place, citing a BLS (Bureau of Labor Statistics) report that the "average cost of employing workers in the private sector rose only two-tenths of a percent" recently and suspects "overall wages (will) start falling later this year."
If this happens, it won‘t lead to employers hiring more workers because they are now cheaper (supply and demand), the pre-Keynesian view as to how we will get out of the Great Depression, but (in a variation of the paradox of thrift–see the initial article in this series), less income will lead to less consumption leading to higher unemployment.
Krugman concludes that we need a real recovery, not just stabilization. This means: "more stimulus, more decisive action on the banks, more job creation."
But Meltzer is so concerned about inflation that he writes, "It doesn’t help that the administration’s stimulus program is an obstacle to sound policy." Yes, in the name of stable prices Meltzer is apparently willing to allow unemployment to reach astronomical levels–thirties level is implied–and this would mean the American people (and its economy) would truly be forced to go through the wringer.
This is unalloyed fanaticism. Some might even come to the conclusion that Meltzer, credentials notwithstanding, is simply a wing nut. (Wikipedia: a derogatory American slang term for a person who holds strongly right-wing political beliefs, shortened from right wing nut.")
Meltzer argues, unconvincingly (to me) that the Fed is no longer independent but is simply the monetary arm of the treasury, "bailing out A.I.G., taking on illiquid securities from Bear Stearns and promising to provide as mush as $ 700 billion of reserves to buy mortgages." Since all this began during the Bush Administration, Meltzer is arguing that the Fed is under the control of two very different Treasury departments. Isn’t it more likely that Bernanke is trying to have the Fed do its utmost to prevent this super-serious downturn from turning into a full blown depression?
Without its independence, the Fed, in Meltzer’s view, will be unwilling to stop the inflationary surge when it comes. I doubt this, but more shortly.
Meltzer praises the efforts of Paul Volcker during his chairmanship of the Federal Reserve. In order to stop double-digit inflation (or even the possibility the inflation rate might increase), Volcker was willing in 1981-82 to drive up interest rates to astronomical heights–the prime rate reached 21.5 percent (mentioned by Meltzer) and mortgage rates were above 17 % (not mentioned). Volcker’s hard line policies are defensible given the situation. But there are at least three things missing or not emphasized in Meltzer’s account of things.
First, he understates the impact of oil prices when he writes that 1979 rates of inflation were "worsened by the oil shock." Both in the early 1970's and in the late 70's oil was the primary cause of inflation, as OPEC on two separate occasions raised the price of oil by cutting back output. Without these increases–and the impact of oil prices then were greater than they are now–it is doubtful inflation would have been a major problem. Perhaps Meltzer minimizes the impact oil prices had on inflation then, because they are not a factor in today’s world and certainly not a cause for concern about inflation, which is what Meltzer is all about. Simply put, the threat of inflation is much lower, because the oil situation is under control, Meltzer not withstanding.
Second, he does what most conservatives do. He ignores the inflationary impact of Reagan’s tax cut of 1981. He argues that a "decisive change of attitudes (on combating) inflation didn’t take place until the spring of 1981, but ignores that Volcker in part was responding to the inflationary potential of the Reagan tax cut, a potential to drive inflation to triple digit levels, if not countered resolutely.
Reagan is portrayed by Meltzer as a hero, when in actuality he was anything but. His tax cut led to Volcker’s hard line which pushed unemployment rates to double digits–the highest since the Great Depression (a level challenged, alas, by the recession we are currently in). Conservatives–even those who put countering inflation as their first priority–have rarely if ever been able to face up to the irresponsibility of Reagan’s tax cut.
Third, he points to Volcker’s success in bringing inflation down to (just) "below 4 percent," a potential level it seems he will not tolerate today and one we are far below as I write.
After all his ranting and raving, what is Meltzer really saying about inflation? He asks, "When will it come?" And then he answers, "Surely not right away." In his next sentence, he writes "sooner or later." Well, is this not a mouse roaring? Some day (when–2013?) inflation will rear its ugly head and the Fed will not do what is required. This is a reason to be scared out of our boots? In short, Meltzer is so obsessed about the possibility of inflation in the distant future, he is willing to have us chance a major depression by doing nothing to counter the downturn. No stimulus. Nada.
Some time back Krugman argued that when the time comes–and inflation rears its ugly head–the Fed will simply raise interest rates enough to stop it. And I suspect Bernanke, if he is still chairman (or whoever replaces him) will simply raise rates.
But there is a problem. When inflation is externally caused–oil, for example–we get something that first arose in the 1970's, stagflation. This is simultaneous unemployment (stagnation), at high levels, and inflation, at high levels. And when this occurs there are no easy answers. Unemployment is probably worse that inflation, in general, since wages usually keep up with the inflation, approximately, but high rates of inflation that are not countered tend to accelerate. One is soon facing devastating levels of inflation that are potentially so disruptive that the economy can no longer function (or function in a meaningful way).
Under ordinary circumstances downturns cause inflation to be reduced as demand for labor and goods diminishes. But as I have already pointed out, a problem may arise, as Krugman has indicated, if government solvency is in question. I am not sure about government solvency when you pay your debts in your own currency, but I do believe that much of the world is deeply troubled by the fact that money is being printed by the US at astronomical levels. There are three intertwined aspects to this–the enormous and unprecedented trade deficit; the gigantic and perhaps unprecedented budgetary deficit that we are going to have (unprecedented at least in peace time); and, lastly, the various Federal Reserve bail-outs and acquisitions, separate from the budgetary stimulus–of A.I.G. and Bear Stearns–and the $700 billion of reserves to buy mortgages it is providing.
At the moment the alternatives to holding the dollar are suspect–especially the Euro. But the time may not be distant when fear will take over and though no holder of immense amounts of dollars, say China, wants to see the dollar crash, the likelihood that this can be permanently avoided do not seem to me to be high. But there is no precedent and therefore the word "likelihood" is not exactly used scientifically. However, if the Dow can decline about 23 % in a day, as it did in 1987, is a dollar collapse unimaginable? Given the fact that the factors that are potentially weakening it are not going away–after all, the trade and budge deficits will continue at high, possibly unprecedented, levels barring a miracle far less likely than the Red Sea parting.
If the dollar depreciates, then we have stagflation. That can lead to a politics that is ugly and conservative (or worse). Last time, before it was obvious we were losing our competitive edge, stagflation led to Ronald Reagan. If somehow the dollar doesn’t depreciate, or the depreciation is mild and steady, then the prospects for the future will depend on how we are able to compete in a world in which our competitors pay their workers peanuts. There are no scenarios for a rosy future.
But, for the time being, there is little reason to worry about inflation. This means that we should ignore the worries of Meltzer and listen to Krugman–"more stimulus, more decisive action on the banks, more job creation." Otherwise, we’ll face "years of deflation and stagnation."
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