Did the Republicans name Obama’s economic team?

“What would you call a group of economists who are skeptical of regulating mortgage markets, who think unemployment insurance and unions increase unemployment, who say that tax hikes retard economic growth, and who believe that the recovery from the Great Depression was a monetary phenomenon rather than the result of New Deal fiscal policy?

No, it is not a right-wing cabal. It's Team Obama.

Here's the evidence:

When Senator Christopher J. Dodd, Democrat of Connecticut, gave his opening statement last week at the hearings lambasting the rise of “risky exotic and subprime mortgages,” he was actually tapping into a very old vein of suspicion against innovations in the mortgage market.....Congress is contemplating a serious tightening of regulations to make the new forms of lending more difficult. New research from some of the leading housing economists in the country, however, examines the long history of mortgage market innovations and suggests that regulators should be mindful of the potential downside in tightening too much.

--Austan Goolsbee

Unemployment insurance also extends the time a person stays off the job. Clark and I estimated that the existence of unemployment insurance almost doubles the number of unemployment spells lasting more than three months. If unemployment insurance were eliminated, the unemployment rate would drop by more than half a percentage point, which means that the number of unemployed people would fall by about 750,000. This is all the more significant in light of the fact that less than half of the unemployed receive insurance benefits, largely because many have not worked enough to qualify.

Another cause of long-term unemployment is unionization. High union wages that exceed the competitive market rate are likely to cause job losses in the unionized sector of the economy. Also, those who lose high-wage union jobs are often reluctant to accept alternative low-wage employment. Between 1970 and 1985, for example, a state with a 20 percent unionization rate, approximately the average for the fifty states and the District of Columbia, experienced an unemployment rate that was 1.2 percentage points higher than that of a hypothetical state that had no unions.

--Larry Summers

Tax changes have very large effects on output. Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent.

--Christina Romer (writing with husband David)

Given the key roles of monetary contraction and the gold standard in causing the Great Depression, it is not surprising that currency devaluations and monetary expansion became the leading sources of recovery throughout the world....the new spending programs initiated by the New Deal had little direct expansionary effect on the economy.

--Christina Romer

All points well taken. Indeed, quotations like these make me pleased with recent economic appointments. I just hope that the above lessons make their way into the President-elect's briefing memos and that he is persuaded by them.

These quotations also make me a bit surprised we have not heard more complaining from the left-wing of the Democratic party. But that may be still to come.”

Greg Mankiw, “The Next Team”, Greg Mankiw’s Blog (30 November 2008).

http://gregmankiw.blogspot.com/

N. Gregory "Greg" Mankiw (1958-) is a professor of economics at Harvard University. From 2003 to 2005, he was the chairman of President Bush's Council of Economic Advisors. Professor Mankiw is among the most influential economists in the world. His text on economics is used in classes at Regent University.

Let me add that others on the Obama Team, such as Timothy Geithner, Jason Furman and Peter Orszag, are not as centrist as the three mentioned above, and they have been placed in the “operational” positions of the Obama Administration rather than the “thinking” positions of Summers and Romer. Austan Goolsbee, Obama’s economic advisor during the campaign, was also on the left side of the intellectual spectrum. Obama’s Team, taken as a whole, is a mixed bag, and frankly more dangerous for the fact that the advice of the centrists is like to be ignored in the actual implementation of policy.

As mentioned before, we are in an unprecedented situation. I don’t think anyone has a good grasp of the problem before us or what to do about it. I am sure the incoming administration will do something -- they have to do something -- but one would hope that they would be willing to be flexible and willing to change policy directions if the measures they take do not work. Right now, the guess is they will try to prop up spending by a massive Keynesian spending program. I for one am doubtful that a fiscal stimulus will work in the present circumstances as the real economy is not yet in such distress that it could benefit from an injection of additional aggregate demand.

To me, the problem is people now have tremendous liquidity preference, that is, they want to hold money rather than bonds or equities. They do not want invest and they do not want to spend. They want to hoard. Pumping more money into the economy or increasing government spending is not going to help. People don’t have confidence in the economy or the policy makers.

What will help is for people to regain confidence that the financial system is sound. The must feel that the investments they make will not melt away because of irrational rules imposed by the government or insane bets made by money managers, that the job they have will not disappear because the exchange rate or taxes drove their firm out of business, that the tax rates they have to pay will not constantly change on a politician’s whim, that the taxes and regulations they must pay and conform to when operating their businesses will not suddenly change and destroy their livelihood, and that the trade and budget deficits be addressed so the exchange rate doesn’t collapse and interest rates don’t skyrocket. In a word, people want the economy and government policy to be stable so they can plan their own futures with confidence.

First and foremost, this means stable economic policies that create a stable macroeconomic environment. No more of this today we’re going to increase your taxes but tomorrow we’re going to lower your taxes. No more of this today we’re going to expand energy production in the U.S. but tomorrow we’re not going to do a thing about energy. No more of this today we’re concerned about the twin deficits but tomorrow we’re going to spend like there’s no tomorrow. No more great swings in interest rates and no more great bailouts.

Let us hope that the new economic team will emphasize simple prudence and stability in economic policy. Then the financial system and the economy will recover by itself.

Did the Stimulus Act of 2008 work?

“The incoming Obama administration and congressional Democrats are now considering a second fiscal stimulus package, estimated at more than $500 billion, to follow the Economic Stimulus Act of 2008. As they do, much can be learned by examining the first.

The major part of the first stimulus package was the $115 billion, temporary rebate payment program targeted to individuals and families that phased out as incomes rose. Most of the rebate checks were mailed or directly deposited during May, June and July.


The argument in favor of these temporary rebate payments was that they would increase consumption, stimulate aggregate demand, and thereby get the economy growing again. What were the results? The chart nearby reveals the answer.

The upper line shows disposable personal income through September. Disposable personal income is what households have left after paying taxes and receiving transfers from the government. The big blip is due to the rebate payments in May through July.

The lower line shows personal consumption expenditures by households. Observe that consumption shows no noticeable increase at the time of the rebate. Hence, by this simple measure, the rebate did little or nothing to stimulate consumption, overall aggregate demand, or the economy.

These results may seem surprising, but they are not. They correspond very closely to what basic economic theory tells us. According to the permanent-income theory of Milton Friedman, or the life-cycle theory of Franco Modigliani, temporary increases in income will not lead to significant increases in consumption. However, if increases are longer-term, as in the case of permanent tax cut, then consumption is increased, and by a significant amount.

After years of study and debate, theories based on the permanent-income model led many economists to conclude that discretionary fiscal policy actions, such as temporary rebates, are not a good policy tool. Rather, fiscal policy should focus on the "automatic stabilizers" (the tendency for tax revenues to decline in a recession and transfer payments such as unemployment compensation to increase in a recession), which are built into the tax-and-transfer system, and on more permanent fiscal changes that will positively affect the long-term growth of the economy.”

John B. Taylor, “Why Permanent Tax Cuts Are the Best Stimulus”, The Wall Street Journal (25 November 2008).

http://online.wsj.com/article/SB122757149157954723.html

John B. Taylor is professor of economics at Stanford University. He was a member of the President's Council of Economic Advisers during the Ford and George H. W. Bush administrations.

Following a Keynesian prescription to stimulate aggregate demand in a downturn, the first and possibly a second fiscal stimulus package now under discussion are intended to temporarily compensate for the drop in consumer spending caused by the credit crisis of 2008. In this view, the cash received by households would be spent on consumer goods at retail merchants, which would in turn revive wholesalers, shippers and eventually suppliers of the goods and services purchased.

However, consumers may not act in the way assumed by Keynesian economics. The permanent-income hypothesis of Milton Friedman and the Life-Cycle theory of Franco Modigliani suggest that consumers consider their entire future, not just their position at the moment. If they think their future income might be lower than they previously thought, they will lower their current spending, even if their income might temporarily rise. The uncertainty of the present situation and the possibility that the current crisis could portend a significant change in the economy’s long-term performance could well change peoples’ assessment of their future income. Moreover, the stock market decline and the general view that capital assets may well have suffered a permanent deflation could cause a lasting negative “wealth effect”, where the fall in their wealth could lead them to “tighten their belt” and spend less than in the past. Indeed, any temporary injection of income may well be saved as people attempt to rebuilt their wealth position and replenish their saving.

After pointing out the limited response to the first stimulus package and the uncertain impact that any new package of temporary measures might have, Professor Taylor goes on to suggest some bipartisan measures that are, in his words, permanent, pervasive, and predicable:

First, make a commitment, passed into law, to keep all income-tax rates were they are now, effectively making current tax rates permanent. This would be a significant stimulus to the economy...

Second, enact a worker's tax credit equal to 6.2% of wages up to $8,000 as Mr. Obama proposed during the campaign -- but make it permanent rather than a one-time check.

Third, recognize explicitly that the "automatic stabilizers" are likely to be as large as 2.5% of GDP this fiscal year, that they will help stabilize the economy, and that they should be viewed as part of the overall fiscal package even if they do not require legislation.

Fourth, construct a government spending plan that meets long-term objectives, puts the economy on a path to budget balance, and is expedited to the degree possible without causing waste and inefficiency.

In his view, these proposals would be more helpful to the economy than the ideas and policies now being discussed and implemented.]

Brad DeLong’s question: Huh? Where did the money go?

“Brad DeLong asks a question which seems obvious enough to me – but seems to elude him.

“Why oh why can't we have a better press corps? Eric Dash and Julie Creswell write that:

• Citigroup had poor risk controls.
• As a result, the bank owned $43 billion of mortgage-related assets that it incorrectly thought were safe.
• They weren't.
• And so as a result the market value of Citi has collapsed by a factor of ten: from $200 billion to $20 billion.

To which the only appropriate response is: "Huh?" How can losses out of $43 billion of optimistically overvalued assets eliminate $224 billion of value? Eric Dash and Julie Creswell don't answer that question. They don't even seem to recognize that it is a question that they should be interested in. That they were given this story to write, and that no editors said "wait a minute! this doesn't add up!" is yet another signal that The New York Times is in its death spiral: not the place to go to learn anything about an issue.”

I think he is a little rough to criticise the NYT for that – or for that matter any other paper – because at the moment the Treasury and the FDIC are also acting (at least until now) as if they do not know the answer.

The answer is that the crisis is not about the amount of losses yet realised or yet to be realised, and it is not about capital adequacy of the banks and it is not about their level of leverage. It is simply about the question “do we trust them to repay their debts”. You might think is about capital or losses or leverage – but even if the bank has adequate capital and losses come are relatively small if we believe collectively that they can’t repay then they can’t repay. Sure more capital would produce more trust – but the level of distrust at the moment is so high that nobody can tell you how much capital is needed. All estimates are a shot in the dark. In reality all that is needed is more trust.

The short answer to the Brad deLong question is that due to the losses and the lack of risk control people stopped believing in Citigroup – and hence Citigroup dies without a bailout. It was however pretty easy to stop believing in Citigroup because nobody (at least nobody normal) can understand their accounts. I can not understand them and I am a pretty sophisticated bank analyst. I know people I think are better than me – and they can’t understand Citigroup either. So Citigroup was always a “trust us” thing and now we do not trust. “

John Hempton, “The Brad DeLong question - and how to design a bailout that works”, Bronte Capital Blog (25 November 2008).

http://brontecapital.blogspot.com/2008/11/brad-delong-question-and-how-to-design_24.html


John Hempton is a (semi) retired fund manager based in Sydney Australia. Brad DeLong, who Hempton quotes, is professor of economics at the University of California, Berkeley.

It’s a good question. It is said that only a relatively small percentage of U.S. homeowners, probably no more than 5 per cent of the total, had a serious problem paying their mortgage. Yet once the housing problem became generally known the price of housing did not just fall, it collapsed, and when it collapsed Wall Street and many financial institutions were brought down in a cascading tumbling of one bank and insurance company after another. How is this possible? Equally, how is it possible that Citigroup, the world’s largest financial services network and owner of a major international bank such as Citibank, can go under when only a small portion of its assets become questionable?

The answer is that Citibank, like all banks, borrows short and invests long. It has a lot of deposits -- short-term liabilities -- and it has a lot of investments -- long-term assets on which it expects to earn future income to cover its costs and generate a profit. Citibank has taken the money of a lot of people and promised them they can have it back any time they want it. The problem is Citibank doesn’t have their money, at least not in a form it can use to pay them back immediately, for it has lent that money out to borrowers or purchased securities with the cash of its depositors. In normal times, its assets far exceed its liabilities, as the prices of its assets remain stable and the number of depositors asking for their money back is small. In crisis times, however, its assets become sharply devalued and it quickly becomes insolvent.

When a crisis develops questions are raised about a bank’s ability to meet its commitments, and its troubles multiply quickly. Its assets are in the future while its liabilities are due today. To meet its obligations it must immediately sell its investments to generate needed cash. But future assets are worth less than current assets, for they are uncertain, and the more the assets a bank like Citibank holds are in the future, the lower and more uncertain their present value. Worse, if questions arise about the quality of the assets they are quickly and substantially discounted, for risky assets are worth much less than safe assets. Even worse yet, if the depositors, other financial institutions and the public in general do not trust the institution, it must dump its assets, probably to no avail, because it will in all likelihood become insolvent.

One of the purposes of the Fed is to act as “lender of last resort” to banks facing a run and needing liquidity. But the magnitude of the current crisis has overwhelmed the Fed. Moreover, the fall in asset prices is so steep, their value so uncertain, and the trust among the institutions and with the public so destroyed, that normal policies and regular mechanisms are completely ineffective in restoring financial stability.

In short, the money depositors originally put into the banks disappeared because the value of the assets the banks purchased disappeared and the value of the assets disappeared because they had to be sold at a deep discount and they had to be sold at a deep discount because people stopped trusting Citibank and the other banks. Deposit insurance and injections of funds from the Treasury and the Fed will make almost all depositors whole by shifting the losses to the general public. But until some semblance of trust within the financial community, and between the financial community and the public, is regained, there will be no end to the ongoing financial crisis.

The Great Depression, the New Deal and our present problems

“Many people are looking back to the Great Depression and the New Deal for answers to our problems. But while we can learn important lessons from this period, they’re not always the ones taught in school. ... I would start with the following lessons:

Monetary Policy is Key: As Milton Friedman and Anna Jacobson Schwartz argued in a classic book,... the single biggest cause of the Great Depression was that the Federal Reserve let the money supply fall by one-third, causing deflation. Furthermore, banks were allowed to fail, causing a credit crisis. Roosevelt’s best policies were those designed to increase the money supply, get the banking system back on its feet and restore trust in financial institutions. ...

Today, expansionary monetary policy isn’t so easy to put into effect, as we are seeing a shrinkage of credit and a contraction of the “shadow banking sector,”... So don’t expect the benefits of monetary expansion to kick in right now, or even six months from now.

Still, the Fed needs to stand ready to prevent a downward spiral and to stimulate the economy once it’s possible.

Get the Small Things Right: ...Roosevelt instituted a disastrous legacy of agricultural subsidies and sought to cartelize industry... Neither policy helped the economy recover.

He also took steps to strengthen unions and to keep real wages high. This helped workers who had jobs, but made it much harder for the unemployed to get back to work. One result was unemployment rates that remained high throughout the New Deal period.

Today, President-elect Barack Obama faces pressures to make unionization easier, but such policies are likely to worsen the recession for many Americans.

Don't Raise Taxes in a Slump: The New Deal’s legacy of public works programs has given many people the impression that it was a time of expansionary fiscal policy, but that isn’t quite right. Government spending went up considerably, but taxes rose, too. ... When all of these tax increases are taken into account, New Deal fiscal policy didn’t do much to promote recovery.

War Isn't the Weapon: World War II did help the American economy, but the gains came in the early stages, when America was still just selling war-related goods to Europe and was not yet a combatant. ...

While overall economic output was rising, and the military draft lowered unemployment, the war years were generally not prosperous ones. As for today, we shouldn’t think that fighting a war is the way to restore economic health.

You Can't Turn Bad Into Good: The good New Deal policies, like constructing a basic social safety net, made sense on their own terms and would have been desirable in the boom years of the 1920s as well. The bad policies made things worse. Today, that means we should restrict extraordinary measures to the financial sector as much as possible and resist the temptation to “do something” for its own sake. ...

Our current downturn will end as well someday, and, as in the ’30s, the recovery will probably come for reasons that have little to do with most policy initiatives.”

Tyler Cowen, “The New Deal Didn’t Always Work, Either”, The New York Times (21 November 2008).

http://www.nytimes.com/2008/11/23/business/23view.html


Tyler Cowen is a professor of economics at George Mason University.

In this Op Ed, Professor Cowen points out that in the view of many economists the Great Depression was caused mainly by a monetary collapse that can be traced to the failure of the Federal Reserve to properly manage the money supply. During the time from August 1929 to the cyclical trough of the depression in March 1933 the money supply fell by a third, and in their view it is this contraction in the stock of money that brought about the collapse of the banking system and accelerated the decline in production and employment. In some sense, the economic and financial catastrophe of the 1930s is seen as a failure of leadership on the part of the Fed, as drift and indecision on the part of members of its governing board paralyzed policy making and needed action to stem the contraction of the economy.

Cowen also points out that the root of today’s crisis is not in a monetary contraction and deflation. In this regard, the Fed has done everything it can (some would say too much) to prop up banks and other financial institutions. In doing so, one of its problems is that a huge shadow banking system has developed where credit derivative instruments not under the control of the Fed are traded. Since monetary policy does not directly affect shadow institutions, the effect of the Fed’s actions are weakened and therefore it will take monetary policy longer to stimulate the economy. Nevertheless, it is fair to say the Fed is doing all it can to implement an expansionary monetary policy and save the banks. If the deteriorating economy is to be turned around, it will have to come from other measures.

This leaves fiscal policy and ad hoc measures. However, some of the proposals under discussion are similar to those made as part of the New Deal, and many of those ideas clearly made a bad situation worse. Any attempt by the government to prop up housing prices, for example, would leave in its wake a tremendous inventory of unsold houses with the potential for another housing crisis down the road. Efforts to make it easier to unionize the work force without the clear agreement of the workforce, as proposed in the “Employee Freedom of Choice Act”, would drive up wages and potentially raise the long-term unemployment rate. As another example, an auto industry bailout that protected the industry from foreign competition and tightened the insane Corporate Average Fuel Economy standards while it failed to address the need to invigorate management with a sense of purpose and the unions with a sense of reality would be disastrous for the entire manufacturing sector. Finally, raising taxes or, just as bad, flirting with protectionism, would set the stage for a prolonged and deep recession.

The U.S. economy is in deep trouble. Two months have passed since Treasury Secretary Paulson announced the financial system was on the verge of collapse. It still has not been stabilized, as reflected in by a very week interbank market and the continuing fall in equity prices, particularly those of banks. It would appear that government regulators are considering a plan to bail out Citigroup and the spreads for the credit default swaps of major banks are rising, indicating that the financial markets believe other banks have the potential to default on their obligations. Add to this the mad scramble by every firm, every state and every city for a bailout and a picture of utter financial chaos emerges.

One can only pray that the President-Elect and his economic team provide the intellectual and policy leadership during a crisis that the Federal Reserve and the Executive Branch failed to show during the Great Depression.

Have the incomes of middle income Americans really stagnated?

“According to the U.S. Census Bureau, median household income adjusted for inflation increased a scant 18 percent over the past 30 years. In contrast, data from the Bureau of Economic Analysis (BEA) indicate that income per person was up 80 percent, almost doubling. A widely reported explanation for these statistics is that the rich reaped most of the benefits of economic growth over this period, while middle-income households gained little. Findings on rising inequality are consistent with this view.

These statistics appear quite compelling, but hiding in the background are some key issues that might alter the story. Average household size declined substantially
during the past 30 years, so household income is being spread across fewer people. The mix of household types—married versus single, young versus old—also changed considerably, so the “median household” in 2006 looks quite different from the “median household” in 1976. Finally, the measure of income used by the Census Bureau to compute household income excludes some rapidly growing sources of income.
…
The claim that the standard of living of middle Americans has stagnated over the past generation is common. An accompanying assertion is that virtually all income growth over the past three decades bypassed middle America and accrued almost entirely to the rich.

The findings reported here … refute those claims. Careful analysis shows that the incomes of most types of middle American households have increased substantially over the past three decades. These results are consistent with recent research showing that the largest income increases occurred at the top end of the income distribution. But the outsized gains of the rich do not mean that middle America stagnated.”

Terry J. Fitzgerald, “Where Has All the Income Gone?”, The Region: A Publication of the Federal Reserve Bank of Minneapolis (September 2008).

http://www.minneapolisfed.org/pubs/region/08-09/income.pdf


Terry J. Fitzgerald is a Senior Economist with the Federal Reserve Bank of Minneapolis.

One frequently hears that the modern American economy distributes income inequitably and that income growth over the past few decades has been confined almost entirely to the rich.

But before accepting these statements one should be aware that the measurement of income distribution and the benefit of economic growth to different groups in the economy is fraught with difficulties and misconceptions, and people sometimes chose data that simply fit their preconceptions.

A host of factors can affect the measurement of the growth and distribution of real income among the population. These include the changing size of households mentioned above, the choice the price index used to deflate income, changes in the types of households (whether a household consists of Married couples or singles, or whether children are present or not), changes in the age structure of households, whether income is measured pre- or post-tax, whether one looks at changes to the incomes of a standard sample of income recipients or allow the introduction of new households, among many other factors. One should also be aware that income distribution patterns also vary of the business cycle, becoming more even during upturns and more uneven during downturns when unemployment rises.

When assessing the rise in income over the longer-term, it is useful to keep in mind that patterns of income change only slowly whereas increases in real incomes can rise markedly. For this reason, when measured comprehensively and adjusted for changes in demographic attributes, the benefits of economic growth tend to be distributed rather evenly across the entire population. At times the rich may benefit more from growth than lower income groups, but the incomes of low and middle income groups have not stagnated in the U.S. and they certainly have not fallen, as many reports in the popular press allege.

Thanks for Greg Mankiw’s blog for the pointer.

Auto worker compensation: Detroit vs. the Japanese transplants

“Why is GM (and Ford and Chrysler) seeking taxpayer subsidies when Toyota, Honda, Nissan, Kia, BMW, Daimler, Hyundai and other foreign nameplate producers, who are facing the same contracting demand and credit crunch quietly weathering the storm, are not? Because the latter have costs structures that haven’t been made obsolete and uneconomic by ludicrous union demands (see chart above, …). And, of course, they make cars that Americans want to buy.”

“A Cancer on the Big Three: The $29/Hr. Pay Gap”, Carpe Diem: Professor Mark J. Perry's Blog for Economics and Finance (14 November 2008).

http://mjperry.blogspot.com/2008/11/cancer-on-big-three-29hr-pay-gap.html


Dr. Perry is Professor of Finance and Business Economics at the University of Michigan-Flint.

The differences in costs between the Big 3 automakers of Detroit and the foreign transplants that also build autos in the United States is reflected in the $25-$30 difference in hourly pay. Given this difference, if the government bails out the Big 3, one might very well ask why an autoworker in the South should pay taxes to support his better paid Northern counterpart, when they work just as hard in the South as they do in the North. Indeed, one might ask why should any American should subsidize well paid autoworkers (or for that matter, extremely overpaid CEOs on Wall Street).

More generally, overpaid autoworkers are only one part of the difficulty before the American auto industry. Just as important, perhaps more important, is weak management and its years of failing to restructure an industry in desperate need of restructuring. In a recent article in the Wall Street Journal, David Yermack, a professor of finance at New York University's Stern School of Business, explained recently in the Wall Street Journal (15 November 2008) part of the problem before the country as it tries to decide what to do about GM and the other auto dinosaurs:

“Over the past decade, the capital destruction by GM has been breathtaking… GM has invested $310 billion in its business between 1998 and 2007. The total depreciation of GM's physical plant during this period was $128 billion, meaning that a net $182 billion of society's capital has been pumped into GM over the past decade -- a waste of about $1.5 billion per month of national savings. The story at Ford has not been as adverse but is still disheartening, as Ford has invested $155 billion and consumed $8 billion net of depreciation since 1998.

As a society, we have very little to show for this $465 billion. At the end of 1998, GM's market capitalization was $46 billion and Ford's was $71 billion. Today both firms have negligible value, with share prices in the low single digits. Both are facing imminent bankruptcy and delisting from the major stock exchanges. Along with management, the companies' unions and even their regulators in Washington may have their own culpability, a topic that merits its own separate discussion. Yet one can only imagine how the $465 billion could have been used better -- for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen.”

As the country considers what to do about GM and the other dinosaurs of the auto industry, it should keep in mind that one of the wonderful things about free market capitalism is that poorly run businesses are driven out of business, and their incompetent managers are, as Ludwig von Mises put it, “relegated to a place [unemployment] in which [their] ineptitude no longer hurts people’s well being”. Only intervention by government can save management so that it continues to inflict its damage on society.

Basically, two arguments are made for the auto bailout, that the auto industry is so important and so tied into the rest of the economy that large-scale damage would occur if Detroit were to go under and that if the financial sector is rescued, why not the auto industry, too. Yes, Detroit is big and its demise would be very, very damaging to the rest of the economy. Many jobs are at stake, not only at the auto companies but also at their dealers and suppliers, and the pensions and health care of many others would be adversely affected by the closing of these firms. But no one is talking about closing down the Big 3 completely. Rather, through bankruptcy they would be more completely reorganized and have a better chance at gaining long-term viability. And, with regard to bailing out the banks, clearly, saving one sector of the economy, in this case, finance, is not a reason to save any other. The web of finance extends far and wide and literally affects everything economic. Its central role makes it different.

The auto industry is declining in the U.S. for many reasons, some of them due to the industry’s inflexibility and some of them due to bad macroeconomic and regulatory policies, such as an exchange rate that has fluctuated in a way that has made long-term planning impossible and CAFE standards that distorted its market. Whatever the reasons for the failures of the industry, bailing out the auto companies will only allow the management in place to continue to mismanage the industry and destroy more capital.

Rather than being “rescued” by the government, the industry should be left to find its own way in an extremely competitive world market. This means allowing it to strive to make a profit without the burden of needless regulations and government intrusions that always accompany any government “help” to a distressed industry.

Why Arnold Kling is paranoid about sovereign debt

“Sovereign debt crises happen suddenly. One day, a country is paying normal interest rates and has full control over its fiscal and monetary policy. Then, investors lose confidence. Within days, the country has collapsed, and within weeks the savings of the majority of its people are wiped out, as the government either defaults or radically devalues its currency.

The election is not the source of my paranoia. I think that Obama is more likely to have advisers who understand the concept of currency crises.

What has me paranoid is the enormous surge of debt issuance that is coming. If enough international investors decide that they need a large risk premium to compensate them for funding this debt, we could find ourselves with a lot of Treasury bills to roll over in an environment where interest rates are 10 percent or more. The government will not be able to afford to pay those rates, and so something drastic will have to be done.

At that point, what are the government's options? Sharp spending cuts? My guess is that will be unthinkable (we might still be in a recession, after all). Print money to pay the debt? My guess is that option will not look attractive politically.

That leaves the option of declaring a national emergency and enacting what is known as a wealth tax or a capital levy. The idea is you undertake a one-time confiscation of assets and promise never to do it again. You hope that this has zero adverse incentive effects but brings in a boatload of money.

Only a relatively small portion of the population will be affected--and even they can be persuaded that the alternative is riot or revolution. So it can be the least bad alternative from the standpoint of political survival.”

Arnold Kling, “Why I am Paranoid”, EconLog Blog (6 November 2008).

http://econlog.econlib.org/


Arnold Kling is a noted economist who has worked for the Federal government and as a professor at several universities. He holds a Ph.D. in economics from the Massachusetts Institute of Technology, and worked as an economist in the Federal Reserve System from 1980 to 1986 and at Freddie Mac from 1986 to 1994. He is a founder and co-editor of EconLog, a popular economics blog that reflects Libertarian thinking.

Here are some figures related to the public debt of the United States. At the end of September the total national debt of the United States exceeded $10 trillion, or approximately $33,000 for every man, woman and child in the country. Of this amount, somewhat more than half, $5.8 trillion, is debt owed to the public (states, corporations, individuals, and foreign governments), the rest being held by government agencies (e.g., the Social Security Trust Fund and other government-controlled accounts). The figure for the national debt does not include unfunded Social Security, Medicare and Medicaid obligations, which are estimated to be some $60 trillion. Note that these estimates also do not include any debt incurred during the month of October and to date in November, months in which the U.S. government assumed the obligations of Freddie and Fanny (~$5 trillion) and has been spending hundreds of billions like a drunken sailor, and if the rhetoric coming out of Washington is any indication of the future, the sailor thinks the party has just begun.

The external debt of the U.S. is that portion of the national debt owed to foreigners. Approximately 25 to 30 per cent of the total debt, around $3 trillion (not counting the Freddie and Fanny obligations owed to foreigners), is in the hands of foreign nationals or foreign governments. It is difficult to ascertain how much of the debt is held directly by sovereign wealth funds, that is, held in state-owned investment funds under the control of other countries’ governments or their central banks. It is likely that it is a high percentage, approaching 50 per cent.

The risks to the United States of its external debt is three-fold. First, even if nothing extraordinary happens in the next few years the borrowing demands of the Federal government are expected to be huge. Much of the financing must come from foreign investors, who have expressed an increasingly unwillingness to lend. To entice them to do so, a higher interest rate will no doubt have to be paid on any new debt and any rollover debt, raising debt service costs greatly, even if it doesn’t create a crisis. Second, much of the debt is held by countries that -- how may I put it politely? -- do not hold the United States of America in highest regard and indeed may not have this country’s interests and welfare as a high priority on their national agenda. Indeed, much of the debt is held by countries that wish us the worst and we are now vulnerable to decisions they make and therefore we must be sensitive to their reaction our decisions on a host of foreign policy questions. And Third, financial crises can occur suddenly and without warning and for completely unexpected reasons. As we have seen in recent months, a crisis in one market may set off contagion to other financial markets, and credit everywhere dries up. Foreign exchange markets and prices of foreign assets are far more volatile than domestic markets, and simply stated while a crisis cannot be predicted we can say if it occurs it will be extremely bad.

Dr. Kling is noting a possibility that has been mentioned many times in Tdjs. The United States has placed itself in a very difficult position and made itself very vulnerable to events and decisions by its adversaries over which it has no influence. We can only pray that the foreign governments now controlling our fate realize that it is not only this country that will suffer if the dollar collapses and the U.S. is forced to take extreme measures to pay its debts.

The American people should ask how they allowed themselves to be put into this position, and, more importantly, how much sacrifice they are willing to make to eliminate the danger that now surrounds us.

Vernon Smith on Barack Obama’s Economic Program

“I think the answer to Alan Reynolds's excellent question and article ("How's Obama Going to Raise $4.3 Trillion?," op-ed, Oct. 24) is that Barack Obama is not going to raise $4.3 trillion, and he is not going to perform on his rhetoric. He excels as a rhetorician -- common to both the great and the least of past presidents -- but performance cannot run on that fuel. Inevitably, I think his luster will fade even with his most ardent supporters as that reality sets in. We also have seen luster fade time after time with Republican presidents. The rhetoric of a smaller and less invasive government always leads to king-size performance disappointments. This weakness is as central to the reality of our political economy as are its strengths. With all its foibles, its strengths become transparent when you compare it, not with our various idealizations, but with the litter of human experiments in political economy that have delivered far more suffering and murder than human betterment to the citizens of those economies.

Of course it is entirely likely that Mr. Obama will succeed in going for higher business, capital gains and income taxes, but it is an economic illusion to think for a minute that this will benefit the poor. All our wars on poverty have been lost by failing to help the poor help themselves. Higher business taxes, which ultimately can only be paid by individuals anyway, will simply export more economic activity to the world economy. Higher capital gains and income taxes will primarily reduce savings and investment at the expense of greater future productivity, which is at the heart of cross-generational reductions in poverty. A dozen countries, including the third largest economy, already have zero taxes on capital gains, and eight of them score high on the Economic Freedom Index and high in gross domestic product per capita.

I favor making all individual savings and direct investments deductible from income for tax purposes. In that world there would be no need to make any distinction between ordinary income and capital gains. By adding a negative feature to such a net consumption tax, the poor would not only receive redistribution benefit, but have an incentive to save and accumulate capital. Some poor will see this as an opportunity to help themselves.

Vernon L. Smith”

Vernon L. Smith, “Only Economic Growth Can Provide Positive Change”, Letter to the Editor of The Wall Street Journal (31 October 2008).

http://online.wsj.com/article_email/SB122541237504586451-lMyQjAxMDI4MjA1MjQwMTIyWj.html


Vernon Lomax Smith (1927-) is professor of economics at Chapman University School of Law and School of Business in Orange, California, a research scholar at George Mason University Interdisciplinary Center for Economic Science, and a Fellow of the Mercatus Center, all in Arlington, Virginia. Smith shared the 2002 Nobel Memorial Prize in Economic Sciences with Daniel Kahneman. He is the founder and president of the International Foundation for Research in Experimental Economics and an Adjunct Scholar of the Cato Institute in Washington D.C.

Smith is right to note how we often compare the actual performance of an economy with some idealized system or notion of perfection that ought to be reflected in its performance. All economies are in reality mixed economies in practice and suffer from all the imperfections associated with the real world. They must grapple with real world problems and they must deal with the fact that people have very different objectives and very different judgments about the values society should promote. What is perfection to one person brings horror in the eyes of another. For this reason, any criticism people make must be discounted by the difficulties of leadership and the difficulties of the situation on the ground. And, needless to say, assertions that they or their party could do better are worthless unless they have a track record of good performance.

Critics of the contemporary economy of the United States and its performance under George Bush have been very critical of the man and the economy during his years as President. In macroeconomic terms, however, the performance of the economy under George Bush has not been bad at all: Following a slowdown that began before he became President and a setback caused by the tragedy of 9/11 the pace of growth recorded since 2002 compares favorably with other Presidents, and, similarly, rates of inflation and unemployment since the recovery are lower than other recent Presidents except for Clinton. The prevailing academic wisdom that living standards of the poor under Bush have declined is nonsense, as the average poverty rate for the Bush years is lower than that under Clinton and all other Presidents. History will argue that the financial crisis has been building for many years, as Robert Shiller points out in a recent New York Times article (http://www.nytimes.com/2008/11/02/business/02view.html), but Bush’s responsibility for the disaster is shared with the Congress, the Fed and the regulatory agencies. In terms of economics, Bush has done as well as other Presidents, and it reflects badly on his critics that they have distorted his record to the point of dishonesty.

And it is easy to assert with cool and self-righteous confidence, as Barack Obama does, that the man who has been grappling with the problems and produced decent results is somehow stupid and unequal to the task. Should he win the Presidency, Obama will find it much more difficult to deliver as it was to promise. He should pray that he does as well as Bush and that he will not have to suffer the mockery and disparagements and isolation that Bush has had to endure.

Barack Obama is an untried man advocating untested policies in an unprecedented situation. He proclaims “This is our time!” and “I will change the world!”. Dealing with real world problems, however, requires much more than words and by raising expectations beyond what any human being can deliver Obama has opened himself up to the very criticisms he has heaped on Bush.

Whether Barack Obama or John McCain becomes President he will need our prayers and support. For the problems before the country are immense and the man elected President is only a human being with greatly limited powers.