It is widely recognized and deplored, see here and here, that economic growth in the U.S. has been very slow, averaging only 2% per year, since the end of the Great Recession in June 2009.
The Federal Reserve has taken unprecedented steps to limit the severity of the recession by holding down both short term and long term interest rates. But these efforts are only partially working and are, unfortunately, having a number of negative effects as well.
It also has been made quite clear that the problem is supply side and not demand side. This is because, on the one hand, wages are beginning to rise more quickly and consumers are spending more money but, on the other hand, business investment is shrinking which is leading to slow productivity growth. The American Enterprise Institute’s James Pethoukoukis has just provided new data on the current weakness of business investment as illustrated in the above chart. Furthermore he quotes the economist, Robert Gordon, who has clearly described the many headwinds holding back the U.S. economy to the effect that:
“The American tax code exerts a downward pressure on capital formation and therefore on economic growth. It is now 30 years since the passage of comprehensive federal tax reform in the U.S. In the intervening years, nearly every developed country has reformed its tax codes to make them more competitive than that of America. Meanwhile the U.S. has allowed its tax code to atrophy.”
Conclusion. Yes, economic growth can be speeded up. But monetary policy won’t do the trick. Congress must intervene with the right changes to fiscal policy, i.e. lowering tax rates for both individuals and corporations, paid for by closing loopholes and shrinking deductions.
There is an informative article in the May 12, 2016 issue of Bloomberg Businessweek, “How to Pull the World Economy out of Its Rut.” Recall that Janet Yellen succeeded Ben Bernanke as Chair of the Federal Reserve in January 2014. The other candidate for the post was Larry Summers. They have rather different views about the role of a central bank:
Janet Yellen insists that economic conditions are returning to normal, even if slowly. She is neutral about the slow growth, secular stagnation hypothesis and using fiscal stimulus to overcome it.
Larry Summers argues that world growth is stuck in a rut because there is a chronic shortage of demand for goods and services. Growing inequality puts a bigger share of the world’s income in the hands of rich people who spend less. The new economy is asset-lite (Uber and Airbnb prosper by exploiting existing assets) and so needs less investment. Software doesn’t require the construction of new factories. He thinks that central bankers should spend more time and effort trying to influence fiscal policy. For example, more government spending on infrastructure, global warming and improving education. Also changing the tax code to put more money in the hands of lower- and middle-income families who would spend it.
I think that they are both partly right and partly wrong.
Janet Yellen is correct in believing that the Fed should stick to monetary policy. But she is too cautious in raising interest rates back to more normal levels. There will be some (stock market) pain in accomplishing this but it needs to be pushed faster regardless.
Larry Summers is correct in calling for action on the fiscal front. But his suggestions for how to do this are mostly off base because they will lead to massive new debt which must be avoided.
So what is the proper course to get out of our economic rut? It is what I’ve been saying over and over again but I’ll repeat it for good measure in my next post! Stay tuned!
The financial crisis of 2008 was the biggest shock to our financial system since the Great Depression of the 1930s. It caused a deep recession from which we are still recovering. To aid the recovery the Federal Reserve launched an unprecedented expansion of the money supply, referred to as quantitative easing, as well as keeping short term interest rates near zero. As explained by James Rickards, a portfolio manager at West Shore Group, in his new book, “The Death of Money, the coming collapse of the international monetary system,” such a severe recession would normally have caused a corrective period of deflation. Quantitative easing has warded off deflation and, so far, without igniting inflation. We are now in a catch-22 situation. Congress could and should adopt several policy changes to speed up the recovery as I described several days ago in “The Federal Reserve Cannot Revive the Economy by Itself.” But, if and when the economy does start growing faster, it will require great skill by the Fed to exit from its current policies without harm. If it contracts the money supply too quickly, it risks a sharp rise in interest rates. If it contracts the money supply too slowly, it risks a sharp rise in inflation. Mr. Rickards doubts that the Fed will be able to accomplish this fine tuning without another major crisis. Here are his Seven Signs of what to look for:
The price of gold ($1300 per ounce today). A rapid rise to $2500 will anticipate inflation. A rapid decrease to $800 signals severe deflation.
Gold’s continued acquisition by Central Banks. Large purchases by China, for example, will announce inflation.
IMF governance reforms, e.g. towards more voting power for China, will be an inflation warning.
The failure of regulatory reform, i.e. reinstatement of Glass-Steagall in addition to the Volcker Rule, will increase the chances of systemic failure.
System crashes, resulting from high-speed, highly automated, high volume trading. An increasing tempo of such events will cause disequilibrium which could close markets.
The end of QE, could give deflation a second wind and lead to a new round of QE.
A Chinese collapse (predicted by Rickards), will lead first to deflation and then inflation.
We all hope that the Federal Reserve can steer clear of a new, and much deeper, financial crisis. But it doesn’t hurt to have guideposts and Mr. Rickards knows what he’s talking about.
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe.”
Ludwig von Mises, Austrian economist, 1881 – 1973
The economist/investor John Mauldin writes a weekly newsletter, “Thoughts from the Front Line” (http://d21uq3hx4esec9.cloudfront.net/uploads/pdf/140426_TFTF2.pdf) which offers good general insight. In the latest issue Mr. Mauldin writes “For all intents and purposes we have adopted a trickle-down monetary policy, one which manifestly does not work and has served only to enrich financial institutions and the already wealthy. Now I admit that I benefit from that, but it’s a false type of enrichment, since it has come at the expense of the general economy, which is where true wealth is created.” Mr. Mauldin also quotes the economist William White, “When you talk about crisis resolution, it’s about attacking the fundamental problems that got you into trouble in the first place. And the fundamental problem we are still facing is excessive debt. Not excessive public debt, mind you, but excessive debt in the private and public sectors. … With ultra-loose monetary policy, governments have no incentive to act. But if we don’t deal with this now, we will be in worse shape than before.”
What then should government do? The best single thing is to develop a concentrated focus on boosting the economy. This would put millions of people back to work and raise salaries for the entire workforce. Tax revenue would rise and both public and private debt would be paid down more quickly.
The way to do this is with fundamental, broad-based tax reform. This means lowering tax rates for both individuals and corporations, paid for by closing loopholes and shrinking deductions. This would have the effect of taking from the rich and giving to the poor, i.e. putting more money in the hands of those who are most likely to spend it, thereby creating more demand leading to faster economic growth.
It’s not that hard to figure out!
An article in yesterday’s New York Times, “Detroit Ruling Lifts a Shield on Pensions”, reports a ruling by bankruptcy judge Steven W. Rhodes that Detroit “could formally enter bankruptcy and that Detroit’s obligations to pay pensions in full is not inviolable.”
The article goes on to say “that most here agree that the city’s situation is dire: annual operating deficits since 2008, a pattern of new borrowing to pay for old borrowing, miserably diminished city services, and the earmarking of about 38 percent of tax revenues for debt service. A city that was once the nation’s fourth largest has dropped to 18th, losing more than half of its population since 1950. The city was once home to 1.8 million people but now has closer to 700,000.”
The parallels and analogies between what has happened in Detroit and what is now happening in the U.S. are striking. The U.S. has had huge annual deficits for five years in a row and the accumulated debt is enormous, the Federal Reserve is holding interest rates down to make borrowing cheaper, and our country’s infrastructure is deteriorating much faster than it is being repaired.
Right now interest on the national debt is small ($223 billion in 2013, or 8% of federal revenues). But interest rates will inevitably return before long to their average historical rate of about 5%. Right now the public debt (on which we pay interest) is just over $12 trillion. This means that in the near future interest on the national debt will be at least $600 billion per year and probably much larger because the debt is still growing so rapidly. This will take a huge bite out of revenue and leave far less of it for other purposes.
This problem will continue to exist even if the budget were to be miraculously balanced from now on but it would at least lessen over time as the economy continues to grow. Without budget restraint the problem will never go away and will be a perpetual drag on our national welfare.
This is, of course, exactly the condition in which Detroit finds itself at the present time. Detroit has the option to declare bankruptcy and make its creditors and pensioners take big losses. Once it does this it can make a fresh start and perhaps recover its former status.
But are we prepared to let the whole country suffer a similar fate? The consequences would be enormous. If the U.S. goes down, the whole western world could come down with it. Democracy and human progress would be severely threatened. This is really too terrible a tragedy to even contemplate. Let’s turn things around before they get any worse!
Several of my recent posts have been pretty gloomy. “Average is Over,” “What, Me Worry?” and “The Age of Oversupply,” for example. Here’s another gloomy one. The British economist, Stephen King, has an Op Ed column in last Monday’s New York Times, “When Wealth Disappears.”, based on his new book, “When the Money Runs Out.”
Our GDP grew at 3.4% per year in the 1980s and 1990s, then dropped to a growth rate of 2.4% from 2000 – 2007. Since the Great Recession ended it has averaged barely 2% per year. The Democrats say we just need more fiscal stimulus and monetary easing to boost the growth rate. The Republicans say deficit reduction including entitlement reform, slashing regulations and tax reform is what is needed to revive the economy.
“Both sides are wrong,” says Mr. King. “The underlying reason for the stagnation is that a half-century of one-off developments in the industrialized world will not be repeated.” These one-off developments are: the unleashing of global trade after World War II, financial innovation such as consumer credit, expansion of social safety nets which reduces the need for household savings, reduced discrimination which has flooded the labor market with women and, finally, the great increase in the number of educated citizens.
What Mr. King recommends is “economic honesty, to recognize that promises made during good times can no longer be easily kept. What this means is a higher retirement age, more immigration to increase the working age population, less borrowing from abroad (by holding down deficit spending), less reliance on monetary policy that creates unsustainable financial bubbles, a new social compact which doesn’t cannibalize the young to feed the boomers, and a further opening of world trade.”
“Policy makers simply pray for a strong recovery. They opt for the illusion because the reality is too bleak to bear. But as the current fiscal crisis demonstrates, facing the pain will not be easy. And the waking up from our collective illusions has just begun.”
It is obviously time to bite the bullet, lower our expectations, and start doing the hard work needed for even incremental economic progress.
David Malpass, president of Encima Global LLC, has an op-ed in yesterday’s Wall Street Journal, “The Economy Is Showing Signs of Life”, pointing out that business loans, auto sales and hourly earnings are up. Mr. Malpass says that “The sequester is a bad way to set spending priorities, but it reduces the risk of future tax increases, contributing to the upturn in consumer and business confidence. … The good news is that an end to the latest version of the Fed’s quantitative easing would create space for more growth in private credit and a shift back toward market, not government allocation of credit. …Because America’s private economy is the world’s biggest net creditor and capital allocator, the United States will be the biggest beneficiary of a return to market based interest rates, with vast potential in efficiency, intellectual property and the capacity to innovate.”
Federal Reserve Chairman, Ben Bernanke, is given much credit for the fact that the Great Recession did not turn into another depression. But now, four years after the end of the recession, we have the twin problems of a slow growth economy, which keeps the unemployment rate much too high, and the potential for huge inflation caused by the vast increase in the money supply. Mr. Malpass makes an excellent argument that the economy has recovered enough so that further quantitative easing will now retard future growth. It clearly also increases the chance of runaway inflation.
Current artificially low interest rates also disguise the future damage now being created by huge federal deficit spending. When interest rates go back up, as they inevitably will, interest payments on our rapidly increasing national debt will also increase dramatically, and force far greater cuts in federal spending than are currently being caused by the sequester.
In other words, to speed up economic growth, curtail the risk of future inflation and to put more pressure on Congress to control federal spending, the Federal Reserve should begin to exit from quantitative easing in the very near future!
In yesterday’s Wall Street Journal, Mortimer Zuckerman, the Chairman of U.S. News and World Report, writes that “A Jobless Recovery is a Phony Recovery”. He points out that counting the people who want full time work and can’t get it, as well as those who have stopped looking, the real unemployment rate is really 14.3% rather than the officially reported 7.6%. Enormous fiscal (deficit spending) and monetary (quantitative easing) stimulus has been able to stimulate an average growth rate of only 2% for the past four years since the recession ended in June 2009. During these last four years the civilian workforce-participation rate has actually declined from 65.7% to 63.5% which has never happened before in an even slowly expanding “recovery” like we have at the present time.
Keynesians and Obama Administration apologists say that we need even more fiscal stimulus (we can worry about deficits and debt later); tax reform won’t help because tax rates are already low; massive new regulations (ObamaCare, Dodd-Frank financial regulations, EPA environmental regulations) are so important that they override negative economic effects; etc. At some point, the sooner the better, we need to recognize that current policies are not working and are, in fact, retarding the recovery from the recession.
Tax reform is the biggest single change which would help. Removing deductions and tax preferences, and replacing them with lower tax rates, would give a big boost to investment and entrepreneurship, and thereby be a huge stimulus to the economy. This includes eliminating the tax exemption for employer provided health insurance. Combining this reform with repeal of ObamaCare’s Employer Mandate would also lead to getting the cost of healthcare under much better control. The overall cost of healthcare, 18% of the American economy and growing, is a huge long term burden and must be turned around.
The massive complexity of Dodd-Frank is a huge burden on the financial industry. Preventing banks from becoming “too big to fail” can be accomplished by having more adequate reserve requirements along with sufficient default and liquidity insurance pools, along with otherwise minimal regulation.
Only more private investment and risk taking can make the economy grow faster and bring down the unemployment rate. The sooner our national policy makers (and the voters who elect them!) figure this out and act accordingly, the sooner that our economy will truly begin to recover from the Great Recession.
I began this blog last November, right after the national elections, to promote my strong view that the United States is on a dangerous fiscal course, with an already enormous, and still rapidly growing, national debt. After four years in a row of deficit spending exceeding $1 trillion per year, the current year’s deficit is projected to be “only” $640 billion. Far too many people, including many of our national leaders, interpret this to mean that the problem is getting solved and so we can relax. But the already accumulated $12 trillion in public debt will cost our economy $600 billion a year, a significant fraction of total revenue, in interest alone when interest rates return to their historical average of 5%.
This is just the tip of the iceberg. Federal spending is out of control all across the board. Entitlement spending on Medicare and Medicaid is growing at twice the rate of inflation and is an especially acute problem. But progress here depends on figuring out how to get healthcare costs in general under control, a huge challenge. The much reviled sequester is working but it’s not nearly enough by itself to get discretionary spending under control.
Four years after the end of the Great Recession the economy is still limping along at 2% GDP growth and 7.6% unemployment. And this is after enormous fiscal stimulus (deficit spending) as well as quantitative easing by the Federal Reserve. Current policies are not working. What we need is broad based tax reform with lower marginal rates (offset by ending tax preferences) to stimulate business investment and the private risk taking which propels the economy and creates jobs. And, of course, faster economic growth will also increase tax revenue and therefore lower the deficit, as well as boosting employment.
This is a brief summary of what I’ve been saying for the past eight months. To me it just seems like simple common sense, but not everyone agrees! At any rate I’ll be out of town for the next two weeks. I hope to be able to make a few new posts while I’m gone. Stay tuned!
In today’s Wall Street Journal the economist Alan Blinder writes, “The Economy Needs More Spending Now”, that the tax hikes and spending cuts agreed to in January and before are reducing GDP growth by 1.5% – 2% annually. Mr. Blinder claims that it would be easy to design a new fiscal stimulus package that adds 2% to GDP per year as long as it lasts. He also claims that a fundamental change like tax reform might only add a much smaller .2% to GDP per year although this much smaller annual effect would repeat indefinitely and therefore eventually amount to a large cumulative effect. This is a sensible argument as far as it goes but is incomplete.
In the last five years there has been almost $6 trillion in (deficit) stimulus spending, coupled with a $3 trillion quantitative easing program by the Federal Reserve. This represents an unprecedented fiscal and monetary stimulus to the economy by the federal government. And the result has been a tepid although steady 2% annual growth in GDP, much slower than usually follows a recession.
After all of this enormous stimulus, which is having only a meager effect, what makes more sense: to try even more stimulus or to try something different? What else is there to try? Immigration reform will boost the economy by drawing our 11,000,000 illegal immigrants into the main stream economy. Note that citizenship (amnesty) is not required to accomplish this, only legal status. Also, requiring many people receiving welfare (food stamps, disability benefits, etc.) to work would boost the economy by increasing the size of the labor force.
Broad based tax reform, greatly curtailing most, if not all, tax preferences, would be so attractive that it should not be put on a back burner, as Mr. Blinder suggests. In fact, completely repealing the ACA’s Employer Mandate, now that it’s been postponed for a year, would give a big boost to many medium sized companies for which required health insurance is a big impediment to growth.
The point is that there are many ways to boost the economy besides even more artificial deficit stimulus, whose effect would be at most temporary anyway, as Mr. Blinder suggests. It really is important to shrink our still very large annual deficits down to zero fairly quickly so that we stop adding to the huge burden which we have already placed on future generations. In other words, we can likely have stronger economic growth and fiscal restraint at the same time, the best of all possible worlds!