In the politico-economic context, there is similar law at work: For every action, there is an equal and opposite reaction.
The trick – and the true art of economics or politics – is the ability to predict what reaction (or collateral damage) your action will cause. So, for example, if the government decides to borrow money to pay for its programs, it causes predictable effects on the general economy. First, the credit supply (and money supply) is reduced, as the available credit is taken up by the government, and less is therefore available to businesses and consumers. Second, because supply is affected, price is affected as well, so interest rates begin to rise. Third, to pay down that debt and the interest, the government (which produces nothing and has no ability to generate income) increases taxes to generate revenues. This in turn has the effect of further reducing the money available for investment by businesses and consumers.
All of this, of course, is quite simplistic, and many econometricians would express disdain and call it so, preferring to create complex formulae to describe and then predict these causes and effects. But it is important to remember that as Einstein once said, “the whole of science is nothing more than a refinement of everyday thinking.”
A politician, then, might retain an economist to assist in predicting the effects of a particular piece of legislation. If I raise the standards for fuel economy and emissions, what may I predict will be the result on the car industry? The economist would advise that this will require research and development, retooling, and a large expenditure of capital, and this will in turn increase the price of automobiles. He will also point out that this capital will likely be borrowed, which will have effects on money and credit supply, and the interest on that capital will also ultimately increase the cost of the car. The consumer, if he has no alternatives, will either choose not to buy, or will, if he buys, have less money available for other purchases, or for investment. If the particular automaker is already at or near the edge of being able to compete, because he has managed badly or has irresponsibly agreed to non-competitive wage and benefits levels for his workforce, then the economist would predict that this automaker will probably not recover his investment, will suffer from a non-attractive price and a corresponding lack of sales, and these factors will in turn create difficulty in repaying the capital borrowed. If, at some point, the automaker defaults or is slow in paying, there are other negative effects, all combining to make it all the more difficult for the automaker to compete efficiently. It the politician decides to insist that wages and benefits be protected at these non-competitive levels, he must know, and take into account, that this action will predictably and adversely affect the automaker’s ability to compete. If the politician also passes a law requiring the automaker not to sell at a loss, then the automaker will lose even more sales, and will lose cash flow which might have allowed the debt to be serviced in the short term, until efficiencies could be implemented to achieve a better cost structure. If he passes a law making it easy for unions to organize and grow, he has to understand that historically, increases in union membership (facilitated by their government-sponsored monopoly power) have caused a corresponding decrease in the number of jobs in the economy, by a startling 2:1 ratio. If he taxes the small business to the point of cutting its available capital, that money won’t be invested, those jobs won’t be created, that new equipment won’t be purchased, hence it won’t be produced, with corresponding effects on production inventories and, ultimately, jobs. The law always works – the art is accurately predicting what the effects will be, and balancing effects, aiming for those that are more tolerable.
Some collateral effects are more predictable than others. Whether one is a “supply-side” economist or not, it is generally predictable that tax increases have the potential to have negative effects on revenues, because the taxed parties take steps to avoid the taxes. Further, during economic contraction, there is both less profit to tax, and fewer people who are earning taxable incomes. So it was at least possible (some would say predictable) that federal tax revenue plunged, as it measurably did, in April 09 versus a year ago – by $138 billion, or 34%, according to a study by the American Institute for Economic Research. This is the biggest drop since 1981. When the economy is in recession, tax revenues go down. Six million people have lost jobs in the year ending in April, so income tax revenues are predictably down even more than the overall revenues above – by 44%. Hotair.com lists the annual US deficits dating from 2000 (which, along with 2001, reported surpluses), and only one since then (2008) is greater than 400 billion. Yet, the Obama government by its own estimates offers deficits of $1.75 trillion in 09, over $800 billion in ’10 and ’11, and additional $500 billion-plus deficits in each of the remaining years to 2019. And these estimates are based on questionable assumptions about growth, expecting a -1.2%, when the first quarter shows an annualized growth for ’09 of -6%! It is highly unlikely, with these revenues and the unemployment numbers, that we can expect a turnaround in 2009 that will produce the assumed growth levels. Using proper growth projections, the deficits in each year are 10% higher or more, and all those from 2014 and beyond are greater than 800 billion per year. Further, the $138 billion revenue shortfall has to be added directly to the bottom line deficit, meaning even with an economic turnaround of fantastic proportions, the deficit in ’09 will be at least $1.85 trillion.
These deficits have already hurt our ability to sell bonds, and if the recent credit downgrades of Japan and the UK are any indicator, we are facing downgrades within 5-8 years, meaning the cost of the debt will go up dramatically. Again, this is collateral damage, resulting from government monetary and fiscal policy and irresponsible legislative ambitions. Worse, it was all probable, if not predictable, yet the three key advisors for this administration – Summers, Bernanke and Geithner – all appear to believe they are smarter than the markets and can manipulate policy as necessary to correct or offset these known effects. So far it hasn’t worked. Despite spending $700 billion in TARP funds, the Treasury was showing no progress in loosening up credit markets. Most forms of credit were still unavailable, and the economy was reacting negatively world wide. So in March, rather than reassess the advisability of attempting a command economy following Keynesian principles, the Fed took another step to jump-start credit, by dropping short term rates to zero, committing to buy $300 billion in long term treasuries and $100 billion in GSE securities, and promising to buy another $750 billion of mortgage-backed securities of at least dubious value. Acting this aggressively and swiftly was an unprecedented play which meant that results were less predictable, but as our “Newton’s Third Law” makes clear, there were effects. He hoped credit would loosen as he made purchases monetizing treasuries that now total over $130 billion, for the first time in half a century. Instead, T-bond prices have continued to plunge, while interest rates are sharply higher. Treasury yields (10-year) are now climbing above 3.7%, the highest since November. That rate hurts other areas, because it helps determine mortgage lending rates. Desperate to reflate the housing market, the Fed, plunging ever farther into efforts to shore up mortgages, is now facing the wrath of bond investors. Despite half-a-trillion in mortgage security purchases, mortgages bonds have followed the same path as treasuries, with prices up and mortgage rates down.
In fact, debt buyers and bond investors are expressing concerns – the Chinese Premier in March said he was concerned about the safety of assets in US instruments. No wonder. Over $1.5 trillion of China’s $1.95 trillion in foreign currency reserves is held in US debt instruments. According to the Council on Foreign Relations, China holds $768 billion in US treasuries, $489 billion in GSE-agency bonds, $121 billion in US corporate bonds, and $41 billion in deposits. The head of China’s central bank has publicly advocated replacing the US dollar as the world’s reserve currency with the IMF’s Special Drawing Rights, beginning to shy further away from US debt. Yet, if China doesn’t buy our debt, then we must monetize it, meaning we buy it from ourselves by printing money, which results in inflation, in turn lowering the value of Chinese holdings. And if it buys the debt, it faces increasing risk, as noted above, of losses from a downgrade or default. With no apparent consideration of the collateral effects on the value of the dollar, Obama committed, apparently on the advice of Geithner, to a $100+ billion line of credit expansion at IMF (which supports, and in fact accelerates, moving to the SDR as a world currency reserve, rather than the dollar). Yet, in order to finance the deficit expected this year by the Obama administration, Treasury will have to issue at least $1.84 trillion in new debt, which doesn’t count the additional amount required if the economy rebounds slower than hoped, or worsens. And that doesn’t consider the costs of defaults in the trillions on credit that the government guarantees, or the new money to GM, or the money being requested by state and local governments. Printing money and inflating our currency won’t fix the problem either, because we still have over $14.5 trillion in outstanding Treasury, GSE and mortgage securities issued world-wide. Trying to deal with this new debt merely aggravates the problems with our existing debt. If five or ten percent of those trillions in instruments are put up for discounted sale by nervous investors, the sales that triggers would overwhelm the Fed’s proposed and continuing purchases. The US just doesn’t have enough money to “save” us. Yet, are such sales of treasuries possible? The reason these investors are nervous is fear of inflation and downgrading of credit – and our main debt-holders are already making public statements about this concern. So what do you think?
History instructs, without question, that following this economic path ultimately leads to stagnant markets, costly credit, and more failure. The USSR, with arguably the richest aggregation of natural resources in the world, did not fail because it lacked resources. It failed because it pursued a command economy, which blunted innovation, increased costs, and made markets wholly unresponsive to demand. Europe has stagnated in the last two decades not because its citizens are lazy or stupid, but because its social democratic policies squelched ambition, entrepreneurship, and productivity, while government competition for credit increased its cost, and government tax levels made the commodities necessary for growth far more expensive. These mistakes are invariably made by earnest folk who believe they have figured out the system, and are smarter than their forebears. We can only hope that Obama and his economic triumvirate are smarter than the markets, and can overcome all these pesky economic laws.
P.S. One (uncharacteristically) humble caveat: Despite my disdain for the excessively complex analyses of too many econometricians that lead them to miss the forest for the trees, the economy really IS complex, especially when it comes to timing. So while I have a high degree of confidence in the “laws” of econo-physics, I have much less confidence about the timetable when the predictable consequences of economic actions will come about. So if it takes the Obama Administration 12 years to wreck the dollar and the economy, I will admit error on the timetable but I’ll still say “I told you so.”
0 comments:
Post a Comment