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Economic Growth Slows in 1st Quarter

The Bureau of Economic Analysis released their report of economic growth and it was disappointing.  Even though there was 1.8% growth in real gross domestic product, we typically want to see a figure above 3%.  While I agree that we can attribute some of the slower growth to rising gas and food prices, one must also recognize the impact of large government spending cuts, along with worse than expected weather conditions across many regions of the U.S.

It is true that there has been an increase in inflation over the last quarter, but it was not significant.  The Federal Reserve Bank of Cleveland reports trends of various inflation measures.  Their first measure of the Consumer Price Index (CPI) looks at prices of all items, including food and energy.  When calculating quarterly inflation rates, including food and energy, from the 4th quarter of 2010 and 1st quarter of 2011, we see that it increased slightly from 1.27% to 2.13%.  If you exclude food and energy prices, then the effect is even more moderate with quarterly Median CPI increasing from 0.6% to 1%.  As a guide, most economists actually want some form of inflation with the consensus being around 1-2% as healthy because it allows businesses to increase revenues and create jobs.

Having said that, I do expect inflation to play a more significant role in dampening economic growth in the second quarter.  Usually, gas and food prices are volatile in that there is much upward and downward movement each month.  However, both have been trending upward consistently.  If the trend continues over a long period of time, then we should expect people to be more cautious about their spending habits.  Additionally, it is also expected that businesses will eventually have to pass along their increased supplier costs from higher commodity and energy prices to the consumer in the form of higher prices.  Right now, a sluggish labor market and tenuous recovery are making businesses reluctant to raise prices across the board.

One might have heard pundits say that raising taxes during slow economy is an ill-fated policy, but they neglect to add that cutting government spending also damages the economy, too.  There are actually four components to economic growth:  consumer spending, business investment spending, government spending, and net export spending.  Of those four categories, only government spending actually witnessed a decline from last quarter.  In fact if you took out government spending, the economy would have grown by 2.89%, which would have approximated historical norms.  (Note:  Refer to Table 2. Contributions to Percent Change in Real Gross Domestic Product.)

The federal and state governments funds programs that sustain jobs in all regions of the U.S.  Referring to the federal level, national defense, services, and infrastructure spending impact multiple private businesses that have contracts in place.  In particular, there was a decline in defense spending, along with funding from the stimulus package ending which contributed a drop of $30 billion.  Portions of that spending would have gone toward economic growth.  On the state government side, we are seeing both a reduction in services and personnel as budget constraints are causing expenditures to decline at a rapid rate.

Another factor that should be pointed out is the abnormally bad weather experienced in many segments of the U.S. market.  In particular, the Midwest, Northeast, and Southeast suffered through winter storms that kept consumers at home.  That could be one factor causing the growth rate of personal consumption expenditures to decline, rather than rising prices.  Surely, a sluggish labor market and continued weakness in residential real estate are both relevant factors.

In conclusion, the threat of a double-dip recession remains small despite the lethargic economic performance.  However, this should be a cautionary tale about the impact of drastic cuts to the federal government spending before an economic recovery is able to gain steam.  Given the mandate to balancing budgets, most states do not have the same level of flexibility, so their options are more limited.  When achieving deficit reduction which will provide future benefits in the form of lower interest rates and greater credit access, a more balanced approach where deficit reductions are spread out over a longer period of time might be in order.

Inflation remains a concern and might even have a more negative impact on next quarter's economic growth.  The combination of poor global weather and the Federal Reserve's stance on monetary expansion are driving inflation risks up.  Currently, the Federal Reserve is reluctant to unwind their quantitative easing program which is aimed at keeping money flowing through the system or raise the federal funds rate.  Either policy would slow inflation, but it would come at the cost of higher unemployment.  Since labor markets are still operating at below capacity, one can see their reluctance in pursuing that route.  However, inflation risks are still moderate now, so it is not expected to unduly affect economic growth in the near future.

Learn Why Labor Market Is Gaining Steam

The U.S. job report was very favorable in March and exceeded expectations.  While the unemployment rate only dipped a tenth of a percent to 8.8%, it was encouraging to see 216,000 new jobs.  That occurred despite further contraction of government jobs with the private sector adding 230,000 positions.  Ideally, we need to see a consistent trend of job growth closer to 300,000 jobs added per month to revert back to pre-recession levels, but it should be noted that this figure is the highest since May 2010.  We can attribute most of these gains to increased economic activity from exports, business investment, and consumer spending.

A boost in exports is always favorable to job creation.  Exports are goods and services produced in the U.S., but sold abroad.  There is usually a direct correlation between exports and job creation and has been a point of emphasis for the Obama administration and the U.S. Federal Reserve.  Over the first two months of 2011, the U.S. totaled $286.1 billion in exports of goods and services, which is an increase of 14.8%.  During this time period, we have seen the trade deficit increase by 7.4%, but that's actually natural given a rich country like the U.S.  One of the reasons why China continually runs trade surpluses is that its home economy is so poor.  Therefore, our focus should be placed more on the level of exports and its upward trend is promising.

Business investment trends are an important indicator on the future health of labor markets.  Before jobs can be added, firms must be confident that the economy is improving.  Even though many Americans remain frustrated with the sluggish job market, business optimism has been on the rise.  According to the Conference Board, CEO confidence index is up 12 points to 62 from 50.   This is a quarterly survey given to key business leaders to assess their optimism of the U.S. economy.  It should be noted that any reading above 50 should be construed as more positive than negative.

To a lesser degree, consumer spending remains relatively good.  Before firms decide to expand payrolls, they need revenues to increase and this is enhanced when consumers open up their pocketbooks.  According the economic snapshot complied by the Atlanta Federal Reserve, we see that real personal consumption expenditures (real PCE) rose by 0.3% in February compared to last January.  While it should be noted that the rate of increase in real PCE between February 2010 and February 2011 (+2.5%) has fallen slightly when compared to January 2010 and January 2011 (+2.7%).  There is concerned whether this will continue because the Consumer Confidence Survey plummeted 8.6 points to 63.4 in March, according to the latest report from the Conference Board.  Concerns about gas and food prices are obviously impacting this figure and might negatively impact future spending.

Overall, we should be encouraged by the new labor report, but we must also recognize that turbulent tailwinds might be on the way.  Consistent progress in economic activity is finally bearing some fruit with job creation.  As we have mentioned before, there is always a lag between an economic recovery and an improved job market.  Having said that, global events can reverse any gains, so we must carefully monitor events in the Middle East, Japan, and areas across the world.  Political turmoil, weather, and public policy initiatives can all play a role in expanding or constricting the U.S. labor market.

Japan's Economic Fallout Part II - Economic Cost

In my first segment, an assessment of Japan's earthquake dealt with environmental cost.  As the crisis continues, we learn more specifics, such as radiation possibly affecting water supply.  As time passes, we will continue to assess the damage on the overall environment.  Now let us shift our thoughts to the possible economic damage to Japan and the global economy.

Certainly, this tragedy will negatively impact Japan's economic growth as reconstruction efforts stretch their declining credit status.  The possible damage to food and water will impact their domestic industries and their level of exports.  In addition, their fiscal problems are much greater than the U.S. and cleanup efforts will exacerbate their debt issues that supersede the U.S.  Their public debt is extremely high at $10.84 trillion in 2011, which remarkably represents 202.5% of GDP.  For comparison purposes, the U.S. is at 64.9% of GDP. Additionally, Japan's credit rating was already downgraded to AA- by Standard & Poor's and remains far below the U.S. credit rating of AAA, which is the highest possible rating.  This is important because it will be more costly for Japan to service their debt and resulting higher interest costs will hamper future investment and job creation.

The Bank of Japan, Japan's version of the U.S. Federal Reserve, embarked on an aggressive monetary policy campaign that have implications to the U.S. economy.  Soon after the earthquake, many Japanese insurance companies, sold significant portions of their U.S. dollar holdings for yen because they anticipated making large payouts to destroyed residences and businesses, who were covered through insurance.  This event caused the yen to dramatically appreciate and the U.S. dollar to depreciate.

That actually was a worst case scenario for Japan because they are an export-oriented economy with the U.S. being able to take advantage of a cheaper dollar to increase their exports at Japan's expense.  In order to prevent this from happening, the Bank of Japan was able to stabilize the currency markets by buying over 15 trillion yen ($184 billion in U.S. dollars).  They were also able to persuade six of the G7 nations, which is comprised of the U.S., France, Germany, Italy, Great Britain, Canada and Japan,  to assist by selling their yen holdings.  The combination of these efforts stopped the yen from rising and will make Japanese exports more competitive.

Even though the Bank of Japan's monetary actions quelled market pressure, there are still implications on trade and its impact on U.S. companies.  With severe damage to the nuclear reactor complex in northeast Japan, they have imposed rolling blackouts throughout the country to conserve energy.  This method is slowing industrial production and is causing difficulty to U.S. and global manufacturing that need those suppliers to meet their manufacturing, electronic, and chemical needs.  Depending on its severity and length, the cost of finished goods will continue to rise and that can lead to greater inflation and smaller profit margins. As of right now, it appears that overall production declines will not be severe, though.

There is also concern about radiation and its impact on food supply, but the impact is deemed marginal.  The U.S. Food and Drug Administration announced last week that it is temporarily halting food imports from Japan.  While this action should place upward pressure on food prices, it is not expected to have much of an effect since they only represent 4% of total U.S. imports.

So far, it appears that the crisis has been quarantined to primarily affect Japan.  The cost of reconstruction will be another obstacle for Japan and their attempts to reverse their economic malaise.  While some will point to increased economic activity that goes with reconstruction, we must not fall prey to the broken window fallacy.  It is true that jobs will be created in rebuilding or replacing nuclear reactors, along with fixing damaged facilities and roads.  However, this is simply diverting funding that could have been used in elevating current production, rather than replacing lost production.

On the other hand, relatively successful efforts in containing nuclear waste means that any damage will be moderate and should not be a lag on U.S. or global economic growth.  It is true that we might see a temporary rise in auto, electronics, and other durable goods, but it appears that it will not contribute a significant drag on U.S. economic activity.  Quick and decisive action led by U.S. intervention in containing the nuclear reactor crisis has helped to moderate the rise in economic cost for the U.S. and the world.  Unfortunately, the same cannot be said for Japan.

Japan Economic Fallout Part I - Environmental Costs

The global economic impact of Japan's earthquake cannot be underestimated with disaster efforts estimated to exceed Hurricane Katrina, which was estimated at $125 billion. The official loss of lives is currently at 8,199 as of March 20th, but there are still 12,272 more unaccounted for.  As we reflect on the economic implications of this catastrophic event, there are so many complex forces in play that it is too numerous to condense into one blog entry.  Therefore, this first part of the analysis will focus on the environmental damage to not only Japan, but also to the U.S. and Europe.

The environmental cost arising from Japan's nuclear power plant might have implications on its future viability as an alternative energy source globally.  Right now, it looks like the there has been limited success in cooling down the nuclear reactors., however there remains concern with Unit 3, which is one of six that were at risk of emitting radiation.  Transitioning back to the U.S., we can see the current sites of nuclear power in the U.S. shows where trouble areas extend across multiple regions.  While the double whammy of an earthquake and the resulting tsunami is creating current nuclear crisis, U.S. experts actually places the highest risk with the Indian Point Energy Center in Buchanan, NY, which is not along the coast like Japan.  There are concerns that many of the nuclear power plants throughout the East, South, and Midwest were constructed with design standards that might have been compromised due to the perceived low risk of an earthquake.  While there are safeguards that the U.S. can implement, they will be expensive and intensive.

As for Europe, the impact has already been felt in Germany where Chancellor Angela Merkel has switched her stance on nuclear power.  She has called for a moratorium of three months on whether to extend the life of its 17 power plants beyond 2022.  Even before disaster, many Germans were wary of nuclear power.  Expect other countries to reevaluate nuclear power and this can negatively impact global economic growth if another reliable source of alternative energy is not found.

When thinking about alternative energy sources, one must recognize its importance in economic activity.  If consumers see gasoline prices rise, along with electricity and other utility bills, then that will impact their overall purchasing power.  This could impact other industries if consumers decide to slash expenditures in entertainment, electronic goods, and other large ticket items.  Rising energy costs also affect businesses, especially those that are reliant on energy to produce their products.  Given the downward pressures of wages from a stagnant labor market, firms may have to bear those costs themselves and that scenario will dampen profit margins.  If these trends are significant and sustaining, then economic growth will be compromised in the future.

Despite these concerns, Dr. Glenn E. Sjoden, cautions Americans to not be overly concerned and believes that nuclear power is essential in meeting our future energy needs.  For the foreseeable future, Dr. Sjoden does not believe that any other alternative will come close to supplying global energy needs.  He also believes that current nuclear power development is superior in the U.S. and that the likelihood of a similar catastrophe is low.  In supporting this contention, he cites the heavy use in France where they have not experienced any problems for over 40 years.

In summary, policy makers in the U.S., Europe, and the rest of the world will have to carefully balance the environmental costs with the potential decline in living standards.  If world leaders decide that nuclear power is too risky and its use declines significantly, then we can expect productivity and living standards to fall.  Productivity is the ability to make goods and services in the most efficient way. Raising productivity is the key to improving economic growth and living standards.  When looking at energy, its use can impact productivity significantly.  If they decide to rely on traditional sources, such as crude oil, then consumers and businesses can count on energy prices to continue to rise.  While the U.S. continues to demand crude oil in disproportionate levels relative to the rest of the world, there is also rising demand in developing countries in China, India, Russia, and Brazil.  Their incomes and prosperity are quickly rising and energy prices will not dissipate in the near future if nuclear power is abandoned.

All Eyes on Saudi

As we see gas prices rise across the U.S., we can blame most of it to turmoil in the Middle East.  Uprisings in Tunisia, Egypt and now Libya threaten monarchial rule.  Markets have responded with crude oil prices rising beyond $100 per barrel.  One can speculate that some of the rise can be attributed to speculation as political risk significantly increases.  Political risk refers to the potential of disruption of governmental rule and usually occurs when rebellion or war takes place.  As clairvoyantly reported in the February 28th, 2011 edition of Bloomberg Businessweek, the future trend in oil prices lie with Saudi Arabia.

The oil reserves in Saudi Arabia vastly supersedes those in Libya and Tunisia.  Of course, unrest there impacted markets.  However, severe reverberations will be felt if opposition leaders are successful in disrupting oil supply in Saudi Arabia.  That is one of the main reasons why stock markets tumbled heavily on Thursday, March 9th.  Of course, market analysts are prone to overreaction and the current uprising is not that significant yet.  As pointed out by Bloomberg Businessweek, King Abdullah of Saudi Arabia has many resources at his disposal to quell any social unrest.

King Abdullah's main strategy is to lavish his people with the extensive wealth earned through crude oil revenue.  He recently announced $36 billion in jobless benefits, education, housing subsidies, and debt write-offs.  This is quite extensive when recognizing that Saudi Arabia currently produces between $592.6 billion and $622.5 billion a year in economic activity (gross domestic product).  It is still questionable whether these efforts will be enough to minimize significant income inequality that threatens to tear the social fabric of the country.  Saudi authorities are also implicitly pointing blame at current U.S. foreign policy of encouraging peaceful assembly as an universal right.  They believe the current stance of the U.S. is emboldening protest movements that now threatens their political stability.

It is difficult to measure the extent of income inequality in Saudi Arabia, but it is assumed to be high.  According to the Heritage Foundation's Index of Economic Freedom, their living standards are relatively high at $23,221 being their GDP per capita figure.  Certainly, this ranks below the U.S. and other advanced nations in Europe, but is above Mexico and other middle income countries.  Though, that can be deceiving and most analysts believe that income inequality is quite severe as pointed out by this study by economists from the University of California at Santa Cruz.  Despite the efforts from Obama and U.S. State Department officials, there have been slow efforts in addressing this gap and that is cause for the current turmoil.

As we look to the future, the tenuous U.S. recovery will be heavily contingent on how Saudi Arabia weathers the storm.  If King Abdullah is able to maintain order and hopefully direct economic reforms that can improve the plight of his people, then the spike in oil and energy prices will eventually moderate.  Otherwise, we can expect a sustained period of high energy prices that will punish consumers and businesses alike.  That is an alternative that could dampen economic prospects in the U.S. and globally.

Job Picture Brightens in February

The latest job report for February is promising as the unemployment rate fell to 8.9% from 9.0% in January and job creation of 192,000 is the highest level recorded since last May.   Even though the unemployment rate was three-tenths of a percentage lower than expected, it should be noted that economists were fairly accurate when they expected an increase of 190,000 jobs this month.  In particular, the private sector added 222,000 jobs, but the public sector continues to decline (30,000) as state and local governments tighten their belts.  Overall, this is a good start and a precursor to improved labor picture as the weather improves.

Private sector employment is a key indicator to a healthy labor market.  Most jobs are created by industries and organizations made up of private individuals, rather than government.  One attractive aspect is that over 68% of industries reported job gains, which is the highest since 1998.  This is a sign that business optimism is on the rise and they are expecting the U.S. economy to recover.

One potential negative is that Americans are more leery of the recovery than businesses.  It should be noted that economists was prescient in their job growth forecasts, but were wrong in predicting that the unemployment rate would rise slightly to 9.2%.  Even though it appears that a declining unemployment rate in this case is good, that should be tempered by the fact that many people are still discouraged.  As reported by the Economic Policy Institute, labor force participation rate remains low at 64.2%.  During a healthy labor market, we want to see that figure to be in the high sixties.  Another indicator that people are still on the sidelines is that the employment to population ratio has declined from 58.5% to 58.4%. Of course, the momentum can quickly change as the weather improves and business optimism continues.

As we look in the future, there are trends that will need to be monitored.  Should we be encouraged by higher business activity and greater optimism?  Or should we be concerned by the recent surge in gas and energy prices?  If the labor market continues to improve, then one can point to a stabilizing Middle East picture.  However if rebellion and disruptions become more significant in that region, that can reverse labor market optimism quickly.

Middle East Can Wreck Havoc on Global Economy

Much has been deservedly written on the oppression and economic deprivation of the lives of Middle Eastern people.  When one thinks about the depths and scope of global poverty, we can look back and see that it was inevitable that a broad and bloody rebellion would take place.  However, it is still shocking to see the speed of how oligarchies are crumbling all around the Middle East.  The impact is being felt in energy as crude oil prices skyrocket with Nomura Holdings projecting a possible price of $220 per barrel.  That is a mind-boggling figure that will have severe implications for the U.S. and global economy.

Crude oil is a key ingredient in providing various sources of energy.  In addition to it being refined to make gasoline, it is also used for heating oil and diesel fuel.  Right now, it is being traded between $96 and $108 per barrel which is already a high amount.  That is one of the primary reasons why we are seeing a significant rise in gasoline and diesel fuel prices.  Expect to see an even greater surge as the Middle East crisis expands.

The U.S. recovery will be tested during this crisis.  As gas prices rise, consumers will find an increasing portion of their spending going toward transportation at the expense of other items.  One can expect that the refinery and energy companies to increase their profitability, but it will be at the expense of other industries.  In particular, firms most negatively impacted with be those that rely on large transporation costs in delivering products or utilize significant energy costs in producing their products.  If this continues, then the brighter prospects for the U.S. will have to be dimmed.

The global economy will also be impacted by this.  China, India, and Brazil have experienced explosive growth recently, but have been hampered by inflation risks.  Rising crude oil prices will only exacerbate this issue as firms try to shift costs on to consumers.  If not managed properly, then we could see their economies collapse and go into a deep recession.  As for Europe, they are better positioned to handle this crisis because they have made significant investments in finding alternative energy sources.  However, their significant debt burden can ill-afford events that will burden both consumers and businesses.

Typically, revolutions take years and even decades before stable governments emerge.  Meanwhile, the worst part is the general uncertainty and increased political instability risks.  As the fighting intensifies, the main concern is the potential damage done to oil fields.  Once a victor is established then there is the question of the type of government formed.  If it discourages private and foreign investment, then that will negatively impact the global economy.  Given these unknowns, it typically leads to more pessimism within the business community and that is certainly an obstacle to creating jobs.

Buffett Applies Price Elasticity of Demand

In Friday, February 18th, 2011 edition of Bloomberg, Warren Buffett gives insight on his stock picking analysis.  Given the recent exam that is coming up, it is hoped that my Micro students can see applications from the price elasticity of demand here.  Specifically, Buffett stated that he focuses on pricing power, rather than management quality, in picking stocks.  In other words, he is picking firms that are able to raise prices without losing much business.  This concept ties very closely to elasticity of demand and specifically firms that have inelastic demand characteristics.

In Mankiw's Elasticity chapter, he discusses four factors that help us determine the type of elasticity of demand.  They include:

1. Availability of close substitutes
2. Definition of market
3. Necessities versus luxuries
4. Time horizon

If you noticed, I placed "availability of close substitutes" in a bold text because that is specifically what Buffett is looking at.  Inelastic demand occurs when the availability of close substitutes are few and elastic demand occurs when the availability of close substitutes are many.  This is important to understand because goods and services that have inelastic demand characteristics will see revenues rise when prices increase.  On the other hand, goods and services with elastic demand characteristics will see revenues fall when prices increase.

In the examples cited by Buffett, we can see why his favored industries appear to have inelastic demand characteristics.  His portfolio includes railroads and electricity producers.  It should be noted that each of those industries have little competition due to their natural monopoly attributes.  Natural monopoly occurs when a single firm can supply a good or service to an entire market at a smaller cost than two or more firms.  That is fairly consistent with both railroads and public utilities that both incur extensive upfront investment costs that makes it prohibitive for competitors to enter.  Buffett also mentioned Coca Cola and Kraft Foods.  By mentioning their strong brand loyalty, he is implying that their customers are less likely to switch from their products even when they increase their prices.  If this is true, then that is another example of inelastic demand.

In cases where competition is less, management quality is not as important.  When you are the "only game in town", then your weaknesses in delivering or marketing a product will not be punished by market forces.  That will only occur when there are a number of competitors that can exploit those weaknesses.

Budget Battle: Obama vs Republicans

On Monday, February 14th, President Obama released the 2012 budget that totaled over $3.7 trillion in government spending, but also includes spending reductions of $1.1 trillion over the next ten years.  That is in contrast with the Republican Study Committee that lists cuts of $2.5 trillion over the next ten years.    A review of both proposals show a distinct difference in priorities.  While both emphasized cuts to discretionary spending, the Republican plan will take a much deeper cut on domestic spending.  Our budgetary issues are significant and either plan will be distasteful to a number of Americans.

You might be asking why do we have to balance the budget.  Actually, the U.S. does not have to balance the budget.  One must recognize that most Americans have not balanced their "budgets" and continue to carry credit card and loan balances to maintain their standard of living.  However, it is important that the U.S. establish a more responsible path to dealing with rising deficits.  Just as an individual's credit rating can decline when their spending patterns become irresponsible, the U.S. can lose their top credit rating unless they can rein in future deficits.  If the U.S. continues along this profligate path, then our future economic prosperity will take a hit as borrowing costs rise, which will impact consumers and businesses alike.

Alternatively, you might be asking why not balance the budget NOW.  It is the same reason why Americans do not pay off all of their credit card debt in one month.    Imagine paying off $14,750 in one year, which is the average balance for households with credit card debt.  (Note:  By the way, over 51% of U.S. households carryover a balance each month.)  Think about how that would impact how they live.  Correspondingly, drastically cutting government spending to balance the deficit in a year would have a profound effect on economic activity, social stability, and national security.

While Obama's plan centers on strategic spending initiatives aimed at boosting future economic growth, the focus of Republicans is on lowering government spending and hoping that will spur private investment.  Obama hopes to add funding of $148 billion toward research and development with most of that centering on alternative energy.  In Principles of Microeconomics and Mankiw's Externalities, there is a concept called technology spillovers where the impact of one firm's research and production efforts can positively impact another firm's activities.  He hopes that subsidies and tax credits to specific industries will result in advancement in finding alternative sources of energy.  While there is debate among economists over this effect, we can infer that President Obama believes this effect to be relatively significant and eventually lessen our dependence on crude oil and lower energy costs in the future.

On the other hand, Republicans side with economists that think the technology spillover effect is relatively small and they want to unleash the power of capitalism and the private sector.  In order to do this, a closer inspection sees the potential for much collaterial damage to ordinary and middle-class Americans.  While it seems that simply reverting spending levels from fiscal year 2011 to fiscal year 2008 is reasonable, one must recognize that after adjusting to inflation and population increases that the level of services received by Americans will be lower than what they received three years ago.  In particular, giving up federal control of Fannie Mae and Freddie Mac is particularly dangerous because it is key source of financing for many middle-class Americans.  Given the toxic state of their balance sheet, it is very questionable whether they would be able to attract enough private capital to remain afloat and that could leave great uncertainty in the housing market.

On the positive side, these spending cuts can fuel future economic growth and greater productivity.  Lower deficits will be looked upon favorably abroad and lead to lower interest rates.  There also can be room to lower taxes for both consumers and businesses.  That can boost investment spending and hopefully result in more job creation.  On the downside, they are not well positioned to handle the potential aftereffects of Middle East instability due to large reductions in alternative energy sources.  Also, there is scant mention to declining infrastructure needs that the private sector historically underserves.

There are concerns about spending reductions and how it can affect social stability.  While one of President Obama's goals is to minimize income inequality, tough choices on specific programs could alleviate those concerns.  First, there will be a number of government programs that will either be eliminated or reduced.  One proposal will involve a reduction of $2.5 billion in subsidies to the poor to handle rising energy costs, so that will affect their spending for food, transportation, and other activities.  Another involves eliminating Pell Grant funding in the summer.  Pell Grants are given to low-income students, so its elimination will slow matriculation rates in college for this group.  Scaling back community development grants will burden distressed areas that are already having trouble generating jobs and encouraging economic development. 

The defunding of these programs will hurt, but would be much larger if not obtaining additional revenue streams from high income households.  In particular, Obama would like to limit mortgage interest and charitable deductions on households earning $250,000 or more.  This would essentially be a tax increase, but is consistent with his pledge to not raise taxes on the middle class.  Though Jerry Howard of the National Association of Home Builders asserts that this is a tax increase on the middle class, one should note that the median household income was $50,221 as of 2009, which is significantly lower than $250,000.  On the other hand, this does have the potential to impact home purchases in affluent areas and could spell trouble for non-profit organizations that are more dependent on private fundraising now that government support is trending downward.

Of course, these concerns will be magnified under the Republican plan.  All of the above would occur, but at much higher rates.  Another potential concern is shifting the costs of Medicare and Medicaid from the federal government to the states in meeting the health care needs of the indigent.  States would be forced to find alternative funding sources or decide to not cover health care services for many of their citizens.  This has the potential to disrupt the social fabric of the U.S. with many not realizing the actual impact until it is too late.

Lastly, national security could be an issue, in particular if Obama's initiatives are passed.  Specifically, his budget will call for a 5% reduction and he hopes that this will occur as troops leave Iraq as projected and the Pentagon is able to generate $78 billion in saving.  Many communities depend on economic activity from the military, so this will politically difficult to acheive.  When looking at the Republican plan, there was no mention of cuts in defense spending, so their emphasis remains on maintaining strong national security.  Given the hot spots across the globe, its emphasis can be easily justified.

In summary, it is highly doubtful that either proposal will be fully adopted because the political cost will be too much to bear for much of Congress.  However, it is imperative that our political leaders be upfront with Americans on the importance of addressing our deficit problems and how it will negatively impact our future growth, if it goes unaddressed.  There are no easy solutions where we can rely on waste and inefficiency to solve our fiscal problems.  In particular, changing demographics will be a huge obstacle as Social Security benefits and rising health costs will quickly absorb a large portion of upcoming budgets.  Tough choices that involve some combination of reductions in government spending or raising taxes will inevitably cause short-term harm to the economy, but making the right strategic choices now can better position Americans to enjoy prosperity in the future.

When Republicans Embrace Government Over Markets

In a review of any beginning economics course, one learns about the power of markets.  We are often told that the best economic system is one where markets are run with as little interference as possible from the government.  In a quick examination of the two major political parties, it is often assumed that Republicans always support market-friendly solutions.  They typically frown on government interference and its distortion on market outcomes, but there is one exception to this rule.  As the libertarian, conservative-leaning think tank, Cato Institute, points out, why are Republicans hypocritical in the area of farm subsidies?

A simple answer is a dose of political reality that a large majority of Americans implicitly do not favor a pure market economy, especially when market forces can cause job losses.  In the case of agriculture, developing countries are showing improvement as they accept more market-based fundamentals.  Most of this growth can be attributed to better farming methods and technology, which has resulted in a significant amount of exports throughout the world.  While this is good and minimizing global poverty, there is concern that their advances are coming at the expense of farmers in the U.S. and advanced countries.  In order to counteract this, they are ironically condoning governmental intervention to protect jobs, even if the result is inefficiency and a waste of resources.

Farm subsidies are inefficient because they reward less productive behavior.  It is essentially a price control, more specifically a binding price floor, where farmers receive direct income from the government that range between $15-35 billion a year.  By receiving these subsidies, there are concerns that this can lead to a surplus of food production and possibly lead to warehousing cost to the federal government.  If ended, then industry would shift to more productive uses.  The savings of $15-35 billion could be applied toward paying down the deficit and this can lead to lower interest rates where businesses and consumers can adjust their spending priorities accordingly.

The current farm subsidy system is also not equitable.  It is often assumed that farm subsidies are needed to help the ordinary farmer, but a quick overview shows that their share of the windfall is very small.  Based on the Environmental Working Group study, we see that mostly large corporations rather than the individual farmer are receiving most of the aid.  Even if not eliminated, there are opportunities to restructure the program to cutting funds without impacting low- and middle-income farmers at all.
Another issue is that it can lead to unintended consequences.  For instance, our search for alternative energy sources led to legislation of significant subsidies toward ethanol.  It was once thought that ethanol would be a cheaper form of energy and yield greater benefits to the environment.  However, recent studies show that the opposite is the case.  Greater use of ethanol as an energy source has driven up the cost of food prices and potentially damage the environment more than gasoline.  If that is the case, then our current efforts in subsidizing the ethanol industry to the tune of $7.7 billion last year may need to be reevaluated if we are truly concerned with improving the environment.

Most supporters of farm subsidies point to concerns with national security if the program was ended.  They believe that the U.S. could be vulnerable to global shocks to food supply arising from political instability or regimes supported by terrorists.  However, it is reasonable to suggest that this risk is minimized by the diverse sources of agriculture throughout the world.  Plus, a portion of those savings can be applied to national defense to better address trouble spots throughout the world.  Also, one can say that these artificial price supports from both the U.S. and Europe contribute to global instability and terroristic activities as farmers throughout the world find it more difficult to compete.  If South America, Africa, and Asia reverse their economic gains due to unfair trade practices, shouldn't we be concerned about the implications on national security?

Others point to protection for farmers when market conditions are unfavorable.  They need government assistance to remain viable when poor weather results in low yields.  That is certainly a possibility, but this type of protection distorts incentives for farmers.  Through proper planning and storage, your effective farmers can handle the volatility in farming.  For those that cannot, then maybe they should devote their energies to another occupation.  A capitalist economy regularly punishes inefficient producers, so why should proponents of this system not apply this principle in agriculture.

A transition away from an agriculture to service-based economy could actually generate more economic benefits in the long run.  Certainly, there will be a painful transition with a certain segment of farmers losing their livelihood as market forces favor low-cost producing farms from developing countries over food production in advanced economies, like the U.S.  Economists call this creative destruction where jobs destroyed are replaced with jobs that pay better.  When one thinks about it, we have seen this process take place many times in the U.S.  Does anybody remember the milkman, blacksmith, or elevator operator?  While it was definitely painful for the families that had to adjust to a new livelihood, the U.S. economy and American worker have successfully made the adjustment in the past. 

Even though farm subsidies enjoy broad support across the U.S., that does not make it good economic policy.  Given the broad support that this policy enjoys across both political parties, it is not practical to eliminate it altogether.  However, it can be adjusted by limiting benefits enjoyed by large corporations and high income farmers.  The savings gained from this action can be applied to the deficit, which will lower borrowing costs for firms and consumers.  It can also make it easier to fund needed investment in infrastructure and alternative energy that can lead to higher future economic growth.  Lastly, the national security issue is a dubious claim, particularly when one sees the damage that U.S. and European price supports can do to economic advancement in developing countries.  Surely, our new Republican leaders within the new Congress, who are quick to denigrate government and embrace the market system, will eventually see the light, right?

Will U.S. Soon Lose Its Top Credit Rating?

Unless the U.S. economic recovery meets expectations, there is concern that the U.S. will lose their top credit rating.  Contrary to popular belief, the U.S. is currently not broke despite recent annual deficits topping over a trillion dollars.  This is because our economic activity exceeded $13 trillion in Real GDP last year.  However, it is essential that the U.S. acts relatively quickly in addressing future deficits that are projected to balloon due to rising entitlements from Social Security and higher health care costs.  If Congress fails to act soon, then it is quite possible that we will lose our Aaa rating soon.

Currently, the U.S. is taking a different tact from Europe in dealing with debt reduction.  While Europe's crisis involving Southern Europe has forced them to curtail government spending and raise taxes, it appears that the U.S. is primarily focused on cutting government spending to achieve the goal.  When looking at the extension of the Bush tax cuts for both the middle and upper income classes, this actually increased projected budget deficits because previous budget estimates assumed that the tax cuts would expire at the end of 2010.  Actually, a reduction in government spending and increasing taxes will negatively impact economic activity in the short run, but both actions might be necessary to ensure that interest rates do not rise in the future for businesses and households.

A downgrade of our credit rating will have ripple effects on our economy in the future.  Its first effect will be increasing the cost of deficit spending for the U.S. Treasury.  As has been the case historically within the U.S. with limited exceptions, we have spent more than we have collected in tax revenues.  Therefore, the U.S. has to issue U.S. Treasury debt.  With a Aaa rating, interest costs are minimized.  If Moody's or S&P credit agencies downgrade the U.S. credit rating, then it will be more expensive to issue debt.  When that occurs, then we could see a rise in interest rates that will dampen both consumer and investment spending. 

One only has to look at Japan to see the effects of damaged credit status.  In the 1980s, they were seen as a major threat to U.S. economic supremacy.  However, weaknesses within their credit underwriting caused their banking and financial industries to collapse.  That led to a severe recession and deflation that exists to this day.  Starting in 2002, their credit rating from Standard & Poor's fell to from AAA to AA.  Now they just recently experienced a reduction to AA-.  While they remain the third largest economy to China and the U.S., their high debt levels and corresponding borrowing costs are hampering their current economic growth efforts.

Referring back to the U.S., their immediate fate will probably depend on the status of our current recovery.  As of right now, U.S. Federal Reserve Chairman Ben Bernanke still believes that the prospects for 2011 will be better than 2010.  If that occurs, we should expect growth rates to be around 3%.  On the other hand, slower than expected economic growth will cause tax revenues to fall with jobs not materializing.  That will exacerbate our budget deficits and lead to an undesirable result.

Unemployment Rate Drops, So Why Is That Not Good?

A look at January's job report would appear to suggest improvement since the unemployment rate fell from 9.5% to 9%.  However, that's not the key number to look at.  In this case, we want to focus on the number of jobs created.  When looking at it from that perspective, we can see why this report is less than rosy.  That is because only 36,000 jobs were created this month, which is the poorest performance since last September.  In order for us to return to employment levels from the pre-recession days we will need at least 9 times that amount for a sustained period of time.  This is an example where the unemployment rate is actually not a good indicator of the health of the labor market. 

Even though one should classify this report as disappointing, it is premature to classify this as a negative trend.  Bad weather hampers shopping activity, so businesses are less likely to increase their job rolls.  Also, poor weather makes job seekers less likely to actively pursue a job.  This means that there was a rise in discouraged workers, who would like a job but are not actively seeking work.  Since they are not counted in the official unemployment rate, the figure is misleading.  In February, one would expect weather to not play as much of a role, so that could lead to a different result.  As we look to February and beyond, we will have to see if a promising holiday shopping season eventually results in a more sustained recovery or whether poor weather and global events will stall our tepid economic recovery.

Poor weather conditions can also have a carryover effect, particularly as it relates to agriculture and food prices.  Abnormally cold weather will probably negatively impact crop yields and this can lead to higher prices.  Crops will be more scarce because of the poor weather and could lead to a shortage in the spring.  As we learned in economics, a shortage can only be corrected by raising the price.  Therefore, higher food prices typically mean that consumers will cut back their spending on other activities.  Thus, if significant, this can curtail overall economic growth in the future.

As we look to next month, we should also be mindful of global events.  The Middle East situation is still murky and political instability is on the rise there.  This will certainly cause investors and analysts angst because they realize that an unstable Middle East region usually results in higher gas and energy prices.  If they remain high, that has the potential to dampen consumer spending and worsen profitability of firms.

Admittedly, those two conditions appear grim, but there are still signs that the U.S. economy is getting better.  Consumer spending rose during the last quarter as we saw a relatively healthy economic growth rate of 3.2% during the fourth quarter of 2010.  Manufacturing activity in 2011 is off to a good start, too.  If both indicators remain strong, then they can offset the negative influences of poor weather and uncertainty in the Middle East.

Finding The Right Balance in Corporate Tax Reform

Given the difficult terrain for jobs, businesses have been able to leverage our vulnerability for their benefit.  Through use of tax credits and other loopholes, they have been able to limit their tax liabilities and enjoy advantages in infrastructure, resources, and services that enable their company to grow.  The U.S. is commonly referred to as not being business-friendly with many citing a very high corporate tax rate that ranks among the highest in the world.  However, that distinction might be misleading, as reported by David Leonhardt's "The Paradox of Corporate Taxes" in the New York Times Economix blog.  In order to ensure that revenue sources are enhanced to improve the fiscal conditions for all forms of government, it is essential that our corporate tax code be revised. 

Many economists believe that tax reform is necessary.  Certainly, we do not advocate tax levels being so high that they are overly burdensome and lead to job destruction, rather than job creation.  However, it is fair to suggest that business might not be paying their fair share in infrastructure needs.  New highways, more accessible roads, sewer, and electrical connections are all essential drivers to economic growth.  Their construction will lead to more business activity and facilitate higher market shares and profitability.  By reforming the tax code and limiting the amount of loopholes, we can generated needed revenues, while also lowering tax rates.

Even though this appears to be a sensible solution, there is significant backlash against this type of reform.  Of course, the business community favors a lower tax rate, but they are not willing to sacrifice closing any loopholes.  Given the tenuous recovery, they have been able to effectively frame the debate in terms of facing an onerous tax code that prevents them from expanding operations, rather than looking at the strain this method puts on our federal, state, and local economies.  If infrastructure needs are to be met, then they are increasingly being financed through debt financing at the federal level and higher property and sales taxes at the state and local level.

While there is significant debate within economists regarding whether our tax code should be geared more toward equality or efficiency, most will agree that loopholes and excessive tax credits are bad policy.  By limiting the use of loopholes, one can expand the base of businesses to pay for taxes.  If one favors a corporate tax code that will enhance economic growth and job creation, they will want the tax rate to be low.  Sufficient revenues can be collected through low tax rates, but that can only happen through closing loopholes.  Then there is another segment that argues that businesses are receiving a benefit through enhancements to roads, facilities, and other resources, so they should pay for these services.  This can be done by a combination of closing loopholes and maintaining similar tax rates.  If this occurs, then more equality will be achieved and the end result could be lower debt spending and more tax relief for consumers and property owners.

Changing Our Paradigm on Jobs

A look at the latest figures from unemployment show are mixed.  While it is good that the unemployment rate fell from 9.8% to 9.4% in December 2010, job growth remains underwhelming at 103,000.  According to an estimate from the Economic Policy Institute, we would need to see an average growth of nearly 300,000 jobs for a period of five years to return to pre-recession employment levels.  Since it is likely we will not see much of a change in the labor market, how do we fight frustration and find inspiration in landing gainful employment?

Even with unemployment rates near the double-digits over the last year, the overall picture is worse when one takes into account the underemployment rate.  The underemployment rate remains very high at 16.7% as of December.  This measure attempts to count the jobless, who have dropped out of the labor force.  Economists refer to them as the discouraged workers and are not included in the official unemployment rate figures.  It also accounts for individuals employed, but are working at wages that are vastly different from their skillset.  An example would be a law school graduate flipping burgers at a local fast food restaurant.

Given the dire labor market, it is easy to see that the psychological toll of unemployment can be significant.  In particular when you are the main bread winner, it can be very discouraging to find out that you can no longer support your family.  In some instances, this leads one into a tailspin where multiple rejections results in them dropping out of the labor force altogether.  It is vitally important that people fight this urge to give up because sustained periods of idleness will result in skill erosion and further limit your marketability.

Now is the time to take inventory of your career and establish a plan of action.  First, have a positive attitude and rid yourself of people with negative thoughts.  It is essential that you maintain a healthy outlook and a strong faith that your efforts will not be in vain.  When you surround yourself with pessimistic people, you are potentially inflicting damage to yourself and that could lead you to not reach your destiny. 

Next, do a careful assessment of your strengths and weaknesses.  Think back to previous jobs and determine if they were ideally suited for your personality, mindset, and skill levels.  In order to learn about yourself, seek out career services that offer testing to determine what career is best suited for you.  In particular, personality tests offer good insight on yourself and where to target your occupational pursuits.  While it is possible that those tests come with a fee, they can be a good investment if their results can quicken your job search and lead to more successful job leads.

With your additional free time, make sure to obtain balance.  Do not spend all of your time seeking a job.  Consider it a blessing to have more time to spend with family and friends.  That can involve connecting more with your children or spouse.  You also want to exercise more.  You will be amazed how increased physical activity will improve your outlook and energy level.  Lastly, always seek to improve through reading more.  Establishing regular quiet time to enjoy various pieces of literature can be relaxing, along with minimizing the erosion of skills from long periods of unemployment.

Even though it is easy to focus on a poor economy, look at it from a new perspective.  Realize that you control your destiny and no one can deny your blessings and favor.  Stay positive, identify strengths, and seek balance.  When that occurs, do not be surprised when your outlook changes for the better.

Will Fed's QE2 Be Impotent?

It is too early to make a definitive call, but so far the Federal Reserve's (Fed) efforts to stimulate economic activity through quantitative easing has not been effective as noted by this December 10th, 2010 Wall Street Journal piece written by Jon Hilsenrath and Mark Whitehouse.  Quantitative easing is a process where the Fed issues short-term U.S. Treasuries to the marketplace and uses its sale proceeds to purchase longer-term U.S. Treasury bonds in an attempt to drive down interest rates on borrowing and investment.  Even though the Fed's action by itself was supposed to lower interest rates, separate market forces are counteracting their efforts, so far. 

Surprisingly, long-term interest rates have risen sharply.  This is not good because this increases the borrowing costs for investors and homeowners.  Therefore, it is less likely for us to receive a boost in investment spending or reverse the slide in housing prices.  When investment spending is on the upswing, that means that businesses are more likely to create jobs.  As for housing, a rise in prices will increase overall wealth and that is usually followed by more consumption spending, which is the main driver for economic growth. 

One reason that long-term interest rates might be rising is due to anticipated acts from Congress.  First, the markets are anticipating that legislation extending the Bush tax cuts will take place before the end of the year.  In addition, this legislative piece is also expected to stimulate the economy with its mixture of tax breaks and a reduction in payroll taxes.  Both components are expected to boost economic activity, so investors believe inflation expectations might rise.  The reason for this is because firms will be anxious to raise prices once the economy picks.  Lastly, continuing the Bush tax cuts, along with other stimulants, will increase the budget deficit.  In fact, the cost of this proposed package will probably exceed the $787 billion tab of the American Recovery and Reinvestment Act of 2009.

The expected decline in the dollar has not yet materialized and that is vital to increasing U.S. exports.  U.S. exports are goods produced domestically, but sold abroad.  When exports rise, this means more jobs here.  As our students learn in Principles of Macroeconomics and Mankiw's Open-Economy Macroeconomics:  Basic Concepts, increasing money supply will decrease the U.S. nominal exchange rate.  However, we can see that after declining for most of 2010, we are starting to see the U.S. dollar appreciate over the last month, as shown by the chart on the upper left-hand corner from the New York Federal Reserve Bank.. 

Also when the Federal Reserve implemented QE2, it was expected that money supply would increase substantially, but we have not seen that yet.  While October's M1 and M2 has grown over the last 12 months according to the charts from the New York Federal Reserve Bank, both growth rates were moderate at around 4-6%.  That is low when one sees that money growth rates were almost as high as 40% in 2008.  Certainly, the instability of Europe as fiscal weakness in Greece, Portugal and Ireland are causing investors to be more comfortable with the U.S. dollar.

Another effect of European turbulence is investors turning to the U.S. stock market.  We have seen improvement in U.S. stocks, so that is leading investors to sell U.S. bonds and reinvest them into the stock market where they can earn a higher rate of return.  That could be another reason why long-term bond yields are rising.

Overall, it is too early to make final assessments on QE2, but it does appear that its impact will not be substantive.  Even though we have not seen the negative effects of inflation, it remains risky to rely on monetary policy tools for an extended period of time.  We should also point out that long-term interest rates were already relatively low and economic activity was subdued.  Therefore, fiscal policy should have a much stronger impact and that's why passage of the this bill is important.  When an economy is struggling, it is neither prudent to raise taxes or cut government spending if you want the economy to grow soon.  However, the time frame for being able to pursue aggressive actions on the economy is quickly diminishing.  Otherwise, we will soon be forced to confront a burgeoning budget deficit that will require economically debilitating tax increases and government spending cuts.  When this time arrives, it will be better if the economy is on more stable footing than it is now.

Regional Economic Update for Southeast Portion of U.S.

The Federal Reserve Bank of Atlanta released a December 1st, 2010 report on the latest economic activity from the Sixth District of the Federal Reserve System.  A map of the Federal Reserve System shows the area that encompasses the Sixth District, which includes all of Georgia, Florida and Alabama, along with the eastern portion of Tennessee, and the southern halves of Mississippi and Louisiana.  Their economic findings are grouped into five areas:  manufacturing, employment, economic growth, inflation, and real estate, but my focus will be on three of the five areas.

U.S. manufacturing activity remains moderate.  We still saw growth, but it has slowed down since October with the Institute of Supply Management's Manufacturing Purchasing Managers Index (PMI) declining from 56.9 to 56.6.  As long as the index is above 50, this means that it is expanding.  However, it is not significant enough to indicate that the recovery is heating up.

Referring back to regional data on employment, we see some improvement in October.  The Sixth District added 29,000 jobs during this month with most of the gains occurring under in the leisure and hospitality sector.  Given our aging demographic relative to other regions of the U.S., that would be consistent of previous patterns.  In past months, we have seen significant decreases in government, but that trend moderated this month. 

Additional trends in employment can be found under the Economic Policy Institute's Economy Track, which looks at employment levels since the recession started in 2007.  A look at our region shows that we still have not recovered from all of the jobs lost since then.  Even though we can see that all regions experienced job loss, a look at the Sixth District demonstrates that we have been hit harder than other areas.  In particular, Florida and Georgia suffered greatly with job losses of 9.3% and 8%, respectively.  On the positive side, we can see that Louisiana has done better than most with only -1.3% loss in jobs.

A look at unemployment rates shows that half of the states within this region were better than the U.S. unemployment rate of 9.6% in October.  Louisiana, Tennessee, and Alabama all experienced lower unemployment rates with Louisiana the lowest at 8.1%.  In particular, Florida's unemployment rate stands out with a discouraging 11.9% with Georgia following them at 9.9%.  Most of this can be attributed to the housing markets that have disportionately affected Florida and Georgia.  Overall, the Sixth District had 10.3% unemployment.  The fact that all of Florida and Georgia is included in the Sixth District, while half of Lousiana and Tennessee are not is one of the reasons why unemployment rates are skewed upward here.

Real estate is one area that is holding performance back.  While there has been a slight improvement over the last month for the major cities of Atlanta, Miami and Tampa, almost all of their monthly and annual trends lag behind the rest of the country.  With foreclosures continuing to be a problem, it is possible that we have not reached the bottom.  Until we start to see home prices start to appreciate, it will be difficult to mount a strong recovery because higher housing prices instill more confidence for individuals and stimulate consumer spending.  

Is Rising Inequality The Root Of Our Problems?

According to University of Chicago economist Raghuram Rajan and his Money Magazine interview with David Futrelle on November 24th, 2010, he believes income inequality is the main problem with the U.S. today.  This is a trend that started in the 1980s as tax code changes and technology dramatically transformed the economic landscape.  Also, the rapid decline in delivering goods across the globe led to the rise in globalization and the diminishing influence of unions.  As for fighting income inequality, the question focuses on whether to create a larger safety net or emphasize strategies on improving the productivity gap.

Before addressing this issue, you might be asking why minimizing income inequality is even important.  My response is that it can be necessary to encourage more social mobility and prevent bad economic policy.  In these times, images of wealth and prosperity often dominate our airwaves and lead to envy and conflict.  As we have seen with this past recession, many middle class Americans have seen their wages shrink, while also noticing the multi-million dollar bonuses given to executives of failing firms.  While this particular scenario is not ideal, it does provide a distorted picture of today’s economy where global forces play a significant role.

It is common to question the merits of globalization, while not realizing its impact in growing prosperity in the U.S. and beyond.  Rising living standards and wages from the 1990s happened because former President Bill Clinton openly embraced free trade, which led to lower costs and greater productivity.  Instead, we see headlines of jobs leaving and going overseas, but do not recognize the new jobs that are created due to lower prices paid by consumers.  When we only recognize the negatives, it can lead our policymakers to bad economic decisions, such as reverting to past protectionist policies that led us to the Great Depression of the 1930s.  In order to prevent this from happening, we need to ensure that our workforce is adequately trained to adjust to the strains of globalization.

Rajan believes that the promotion of home ownership by both political parties caused our current economic troubles.  Democrats wanted to address the wealth gap and thought that the key was affordable housing.  They expanded the role of Fannie Mae and Freddie Mac, who bought up various mortgages from servicers and packaged them into investment products called mortgage backed securities.  These investment products were initially attractive to investors, who saw above average returns and low risk, given the implicit guarantee from the U.S. government.  However, a souring economy caused delinquencies and foreclosures to rise and many of these mortgage backed securities lost their values, in particular subprime mortgages.  Subprime refers to borrowers that do not have good credit and must pay higher interest rates and are considered greater credit risks.  Since Fannie Mae and Freddie Mac had no control over underwriting any of these mortgages, they were ill-equipped to handle the rapid decline in credit quality.

It should be noted that the George W. Bush administration also did not take steps to limit the influence of Fannie Mae and Freddie Mac because they wanted to refute charges that they were the party for the affluent and were very interested in boosting home ownership rates to generate wealth and more social mobility.  Their thinking was that communities would improve if home ownership took precedence over renting.  With owning more private property, it was thought that people would take greater care of it and this would limit decay, which brings more violence and crime.  If this initiative was successful and the poor and lower middle class found more access to wealth, then they would be more amenable to changing their allegiance to the Republican Party.  Given that Fannie Mae and Freddie Mac allowed individuals to buy homes with a lower down payment than one would receive from a traditional bank, there were limited efforts from the Bush administration to deemphasize their influence.

Since home ownership failed in closing the wealth gap, then the question focuses on whether we should revert back to the income redistribution strategies that occurred before the 1980s.  This can take the form of either tax code changes and/or the rise in-kind transfers that can diminish income inequality.  Starting in the 1980s, we started seeing a shift in the tax code that showed the marginal income tax rates dropped from 70% for the highest income bracket to 35% today, as referenced by the Tax Foundation's history of U.S. federal individual income tax rates.  While this change certainly contributed to high economic growth, it also created a tax system that was less progressive.  In the mid-1990s, the Clinton administration and a Republican-controlled Congress pushed through the Welfare Reform Act of 1996, which yielded benefits during an economic prosperity in the late 1990s.  However, we have since seen increases in poverty as two recessions during the last decade have taken a toll on the less fortunate.  Therefore, should we make the tax system more progressive with the wealthy taking on a greater burden of tax liability or should we expand the safety net for vulnerable segments of society?

One way to accomplish this is by focusing on income redistribution strategies to help vulnerable Americans subsist when their jobs go away.  However, expanding welfare programs and raising taxes on even the wealthy is carrying less currency with many Americans.  They are increasingly concerned about expanding government's role further.  As inferred by Rajan, raising the marginal tax rates on the wealthy can be disruptive to our current fragile recovery.  We have seen the difficulty in letting the Bush tax cuts expire for even the wealthy with Senate Republicans blocking two measures aimed at letting them expire at either the $250,000 or $1,000,000 income levels. 

Both methods are examples of income redistribution that can lead to less income inequality, but it can come at the expense of lower living standards overall.  High deficits matter because it can ultimately lead to higher borrowing costs for both businesses and consumers.  If businesses invest less and consumers buy less, then that is a double whammy on the economy.   The end result can be an upward trend to the unemployment rate that is much too high as it is.

Then, the question becomes what can we do if above strategies do not work.  To answer that question, we need to answer whether the U.S. workforce that is suffering from structural and not cyclical unemployment.  In other words, are jobs not available because the economy is in a downward business cycle or is it because employers are having difficulty matching the required skills with their new jobs? 

Since I believe the latter is the problem particularly in the South, then attaining more education and skills will be necessary. In this case, our priority should be on lowering the high expense of attaining a college education.  Therefore, Obama's efforts in boosting funding for Pell Grants and financial aid are essential, along with expanding partnerships between community colleges and the private sector.  If these efforts can be successful, then opportunity to wealth can be more equitable to all Americans.

Also, a 2007 speech from Ben Bernanke hints at other efforts at addressing inequalities that go beyond traditional K-12 and college education.  Certainly, we understand the importance of K-12 and college education, but Bernanke points out that any type of training, whether it is from on-the-job training, community colleges, vocational colleges, and financial literacy training are also important in closing the income gap.  Until the gap in human capital is minimized, then income inequality will be difficult to overcome.

In summary, we must address income inequality in order to improve social mobility and develop a more stable society.  It is a challenge that involves complications brought on by the vestiges of discrimination; disparate funding between school districts; and self-defeating cultural behavior traits.  It is very difficult to implement public policy that can distinguish individuals, who truly need and appreciate a helping hand, with those that use public resources to maintain an irresponsible and unproductive lifestyle. 

Our fiscal situation and declining overall wealth will also limit the level of income redistribution that can be done, so more strategic programming will be needed to increase productivity across all social classes.  While also acknowledging that families who made sacrifices and accomplished great success should be rewarded and not penalized, they must be made aware that it is in their self-interest to have an America that is more equitable.  When that occurs and people feel that they are being given a fair chance at success, we will have an America that is less fractured and more self-sustaining in the long run.

Job Recovery Continues To Hit Bumps

The November job report was disappointing as job growth rose slower than expected and the unemployment rate increased by two-tenths of percentage point, as reported by the December 3rd, 2010 CNNMoney article written by Annalyn Censky.  While 39,000 jobs were created, it was much lower than last October's of 172,000.  Also, it should be noted that this is the 19th straight month of the unemployment rate being above 9%. which will break the Post-World War II record previously set in the 1980s.  Uncertainty in the business climate and deteriorating state and local fiscal conditions are all contributing to the sluggish job report.

A closer review of the press release from the Bureau of Labor Statistics shows declines in retail and manufacturing, while health care and temporary jobs were on the rise.  Even though most analysts projected that holiday sales would be better than last year, Black Friday sales show only a modest increase of 0.3%.  That might explain the loss of 38,000 in retail trade.  As for manufacturing, we did see an increase in activity for the 16th straight month, but it should be noted that the increase was less than October.  The Institute for Supply Management (ISM) showed that its activity index was at 56.6, which is slighly lower than October's 56.9.  In addition, firms have been able to boost productivity without increasing labor as described in this November 24th, 2010 Bloomberg Businessweek article written by Craig Torres and Anthony Feld.  Both of these factors can explain manufacturing jobs declining by 13,000.

When looking at overall jobs, one can surmise that businesses are awaiting a change in Congress next year.  One question is whether the Bush tax cuts will be extended to all Americans and not just the middle class.  In addition, they will be lobbying for changes in the tax code that will encourage more saving and investment.  When dealing with health care and other regulatory activity, they might also try to influence legislation to minimize their costs there.

As we look to the future, it will be important to anticipate trends that influence economic activity.  While Black Friday sales were somewhat disappointing, it will be interesting to see if sales activity will increase in December.  If sales are better than expected, then that can lead to more business optimism and more job creation.  In this globalized economy, we also need to monitor events abroad.  There is the European crisis where efforts are underway to minimize its contagion and there's North Korea's nuclear ambitions that threaten to disrupt economic activity in China and South Korea.  Even though the job market remains muddled and unclear, a turnaround in 2011 can occur, but the above trends will need to be more favorable.

Georgia's Recovery Stalled by Troubled Banks

Georgia's recovery is contingent on a healthier banking system.  In the November 29th, 2010 article from TheStreet, we can see that Georgia banks are still vulnerable.  They have the 41 banks that are considered undercapitalized which is more than double than Florida, which has the second most troubled banks.  One can mainly attributed the troubles to the Atlanta housing market and deregulatory environment as described by NY Times columnist, Paul Krugman, and his "Georgia On His Mind" article on April 11th, 2010.

When looking at the last recession, it should be noted that it mainly affected major metro areas.  Typically, it involved areas where housing prices skyrocketed and ultimately creating an asset bubble that burst.  However, Atlanta did not experience this type of price acceleration due to urban sprawl.  Instead, a large number of new banks popped up, and in their haste to boost market share, they engaged in unsafe banking practices.  As surmised by Krugman, lax consumer protection laws which allowed Georgia borrowers to obtain additional funds by increasing the size of their mortgages.  When the economy took a plunge, many of these mortgages started to go under water.  As shown by Forbes Best Places for Business and Careers, you can see that Atlanta ranks 136th out of 200 metro areas in the number of subprime mortgages which represented 13.6% of all originations between 2006 and 2008.  Subprime mortgages are an indication of overall credit quality and negatively impact bank performance.

With the latest figures in home prices, we can see that Atlanta has not yet recovered from their pre-recession levels. A look at S&P/Case-Shiller U.S. National Home Price Index for the 3rd quarter of 2010, we can see that Atlanta's home prices have declined by 3.1% over the last year.  In addition, the November 30th, 2010 edition of the Atlanta Business Chronicle reports from Brookings Global MetroMonitor how much Atlanta has fallen over the last few years.  Compared to 2007 where Atlanta's economic performance ranked 57th overall, they now stand at a lowly 136th as rising unemployment and income declines hamper current activity.  All of these indicators need to improve in order to improve the health of Georgia's banking system.

In order for the banking system to improve, bank management will need to be more prudent and take on less risk.  They will need to find ways to raise capital and instill more investor confidence.  As of right now, their focus should be installing more effective risk management and loan underwriting systems in order to minimize credit problems in the future.  Lastly, it might be helpful for the state legislature to take a more proactive approach in implementing stronger consumer protection statutes in order to prevent a similar meltdown from occurring in the future.