As reported in the November 30th, 2010 CNNMoney article written by Les Christie, home prices fell by 2% during the third quarter of 2010. S&P Case-Shiller U.S. National Home Price Index uses a composite of single-family homes from nine U.S. Census divisions, which are calculated quarterly. Housing is a strong indicator to future economic performance because it drives more economic activity. When a family buys a home, it typically leads to more buying. This includes furniture, appliances, kitchen items, along with other household goods. That impacts a number of industries and leads to higher economic growth. However, this downward trend suggests that our immediate future remains cloudy as a sluggish labor market and an uncertain foreclosure market are drags on housing.
The unemployment rate remains high, so naturally individuals are cautious in buying big ticket items. The U.S. unemployment rate remains very high at 9.6% as of October. Then one look at the Economic Policy Institute report on the current labor market and the outlook is particularly dire. As they suggest, it might take 20 years for us to see unemployment rates near our normal rate of 5%, unless job growth increases substantially. When the labor market is sluggish, people are less secure and therefore less willing to make a significant financial commitment on a new house.
Foreclosure markets will need to operate more smoothly before we can see improvement. There appears to have been questionable practices from banks that may not have followed proper procedures. Another viewpoint offered here in this November 29th, 2010 Housing Wire article from Paul Jackson blames the mortgage servicing industry and governmental efforts in creating more affordable housing. Regardless, litigation risk is on the rise and this will have a negative effect on the housing market.
Tuesday, November 30, 2010
Monday, November 29, 2010
Wal-Mart Goes African: Will Trend Toward Emerging Markets Continue?
As demonstrated in this November 29th, 2010 Bloomberg article written by Margaret Brennan and Cotten Timberlake, Wal-Mart has decided to expand its presence to South Africa. This will be their first expansion in Africa, while they already have a presence in South America, Central America, and Asia. Rather than purchase a full stake in Massmart, they opted to buy majority share at 51%. As shown by South Africa's Economic Freedom index score from the Heritage Foundation, one can see that they rank below the world average at 45 which suggests that governmental regulation looks unkindly to total foreign control of a firm. Despite this barrier, this is an indication that Wal-Mart is becoming bullish toward emerging markets.
One reason for this is that emerging markets have actually outperformed advanced economies recently. A review of Real GDP growth from World Bank's Global Economic Outlook shows that developing countries will almost double the growth rate for high income countries. As stated in the article, Wal-Mart is also interested in expanding China and Brazil where both areas are expanding at explosive rates that are near double digits. Even when looking at forecasted rates in South Africa, you can see that their growth over the next two years rate comparatively to the U.S. at 3.1% and 3.4% in 2010 and 2011, respectively.
One reason for this is that emerging markets have actually outperformed advanced economies recently. A review of Real GDP growth from World Bank's Global Economic Outlook shows that developing countries will almost double the growth rate for high income countries. As stated in the article, Wal-Mart is also interested in expanding China and Brazil where both areas are expanding at explosive rates that are near double digits. Even when looking at forecasted rates in South Africa, you can see that their growth over the next two years rate comparatively to the U.S. at 3.1% and 3.4% in 2010 and 2011, respectively.
Will Airlines Receive A Boost?
In Principles of Macroeconomics and Mankiw's Production and Growth, we analyze the relationship between productivity and living standards. In determining why certain countries are wealthier than others, one common feature is the growth rate of productivity. There are four general factors that we look at in examining productivity and they include:
A reduced cost structure will provide Luthansa with a pricing advantage that can expand their market power. By getting better fuel mileage along with cheaper fuel, they have more flexibility to lower prices without sacrificing their profit margins. By offering better prices, they can also increase the number of customers and widen their market share. Of course, they will eventually be susceptible to competitors utilizing the same resource, but all travel customers would benefit by traveling at lower fares.
A potential downside could occur if this process is adopted at a significant level. If other airlines decide to use vegetable oil to fuel their planes, then this will cause an increase in demand for vegetable oil. That would mean the food industry could be affected as the price of vegetable oil rises. Therefore, restaurants and other businesses that use vegetable oil could see their cost structures increase in the future.
- Physical capital per capita
- Human capital per capita
- Natural resources per capita
- Technological knowledge
A reduced cost structure will provide Luthansa with a pricing advantage that can expand their market power. By getting better fuel mileage along with cheaper fuel, they have more flexibility to lower prices without sacrificing their profit margins. By offering better prices, they can also increase the number of customers and widen their market share. Of course, they will eventually be susceptible to competitors utilizing the same resource, but all travel customers would benefit by traveling at lower fares.
A potential downside could occur if this process is adopted at a significant level. If other airlines decide to use vegetable oil to fuel their planes, then this will cause an increase in demand for vegetable oil. That would mean the food industry could be affected as the price of vegetable oil rises. Therefore, restaurants and other businesses that use vegetable oil could see their cost structures increase in the future.
Sunday, November 28, 2010
Expensive Bailout for Irish
Based on the articles from the November 28th, 2010 editions of Reuters and the Financial Times, Ireland is set to receive a 85 billion euro ($110 billion) rescue package from the European Union. As for the specific terms, around 10 billion euros of the funds will be used to recapitalize their financial system and bring them up to core Tier 1 capital requirements. Tier 1 capital is what the industry uses to measure liquidity and their ability to absorb bad loans. An additional 25 billion euros will be available to cover any future deterioration. As for the remaining amount, they will be used by the Irish government in meeting their budgetary requirements. Overall, this is a costly bailout for the Irish and will require significant sacrifice from its citizens.
We must consider that the Irish government has already made a commitment to resolving their economic crisis where their solutions are geared toward more efficiency and less equity. They have committed a combination of spending cuts (67%) and tax increases (33%) totaling 15 billion euros over a four year period. Due to concerns about losing direct foreign investment, they decided to maintain their corporate tax rate from 12.5%, which is substantially lower than the U.S. corporate tax rate of 35%. However to accomplish this, they had to resort to cuts in welfare and lowering the pay of public sector workers. In addition, the minimum wage will be slashed by 12% and tax code changes that are more onerous to the working poor. By lowering the bar where income tax rate kicks in, more lower income individuals will see their tax liability rise. These proposals are considered more efficient because it will minimize the loss of foreign capital that can boost economic growth, but will lower equity because the burden will of the shortfall will be felt more by the poor than the wealthy.
Then there are concerns about the high interest rate for obtaining the rescue funds. As reported in the November 28th, 2010 Irish Times, the average interest rate will be 5.8% which exceeds the average interest rate for 5.2%. This is a bitter pill for Ireland to swallow because they have exhibited a stronger political will than Greece, their southern brethren. Under these terms, they will no longer get access to short-term funds from the European Central Bank, which are much cheaper.
In order to save Ireland's financial industry, further commitments from the Irish and the International Monetary Fund will also be needed with concerns that this contagion can spread. The Irish government has agreed to commit 17.5 billion euros, while the International Monetary Fund, where the U.S. is the largest stakeholder, will extend 22.5 billion euros.
There is concern of moral hazard where poor business practices are rewarded, but for now the global community does not want to risk the ramifications of any European country going bankrupt. Greece started the trend with their 110 billion euro bailout in May 2010. At the time, there was concerned that it would not stop there and it looks like it could go beyond Ireland. Both Portugal and Spain are encountering similar problems, so it will be interesting to see if Europe can contain this burgeoning crisis. Some argue that countries should be allowed to fail, but that ignores the significant financial interests present in the U.S., the rest of Europe, and throughout the world. If any of the European countries did go bankrupt, then banks with European interests across the world would take massive losses. This is problematic because global financing would be disrupted and that could lead to a severe credit crunch. Its impact could be felt globally with the end result being further economic decline and higher unemployment.
We must consider that the Irish government has already made a commitment to resolving their economic crisis where their solutions are geared toward more efficiency and less equity. They have committed a combination of spending cuts (67%) and tax increases (33%) totaling 15 billion euros over a four year period. Due to concerns about losing direct foreign investment, they decided to maintain their corporate tax rate from 12.5%, which is substantially lower than the U.S. corporate tax rate of 35%. However to accomplish this, they had to resort to cuts in welfare and lowering the pay of public sector workers. In addition, the minimum wage will be slashed by 12% and tax code changes that are more onerous to the working poor. By lowering the bar where income tax rate kicks in, more lower income individuals will see their tax liability rise. These proposals are considered more efficient because it will minimize the loss of foreign capital that can boost economic growth, but will lower equity because the burden will of the shortfall will be felt more by the poor than the wealthy.
Then there are concerns about the high interest rate for obtaining the rescue funds. As reported in the November 28th, 2010 Irish Times, the average interest rate will be 5.8% which exceeds the average interest rate for 5.2%. This is a bitter pill for Ireland to swallow because they have exhibited a stronger political will than Greece, their southern brethren. Under these terms, they will no longer get access to short-term funds from the European Central Bank, which are much cheaper.
In order to save Ireland's financial industry, further commitments from the Irish and the International Monetary Fund will also be needed with concerns that this contagion can spread. The Irish government has agreed to commit 17.5 billion euros, while the International Monetary Fund, where the U.S. is the largest stakeholder, will extend 22.5 billion euros.
There is concern of moral hazard where poor business practices are rewarded, but for now the global community does not want to risk the ramifications of any European country going bankrupt. Greece started the trend with their 110 billion euro bailout in May 2010. At the time, there was concerned that it would not stop there and it looks like it could go beyond Ireland. Both Portugal and Spain are encountering similar problems, so it will be interesting to see if Europe can contain this burgeoning crisis. Some argue that countries should be allowed to fail, but that ignores the significant financial interests present in the U.S., the rest of Europe, and throughout the world. If any of the European countries did go bankrupt, then banks with European interests across the world would take massive losses. This is problematic because global financing would be disrupted and that could lead to a severe credit crunch. Its impact could be felt globally with the end result being further economic decline and higher unemployment.
Wednesday, November 24, 2010
Corporate Profits Soar Higher
It might be odd with the U.S. recovery not recognized by many, but U.S. businesses continue to surge forward as described in November 23rd, 2010 NY Times article written by Catherine Rampell. At the end of the third quarter of 2010, U.S. corporate profits rose to $1.659 trillion which is the highest recorded figure in over 60 years. Even though it is not adjusted by inflation, that is certainly a healthy figure. One might ask how that can occur given economic conditions in the U.S. The explanation lies in higher productivity rates and globalization.
First, corporate performance is directly related to productivity. If firms can produce a good at a faster rate of time, then that can lower their overall costs and lead them to gaining more market share because they can be more competitive on price. Even with a downsized workforce, investments in technology have paid off for firms. That means that can maintain production levels with less workers. That is one of the reasons why the U.S. is transitioning from manufacturing to service-oriented jobs, so U.S. workers must improve their human capital and technology skills to become more marketable and attain higher paying service jobs.
One other aspect that led to the quick recovery of U.S. firms during the last recession is the U.S. economic system. When looking at the U.S. economic profile from the Heritage Foundation's Index of Economic Freedom, you will see that they score very high in labor freedom at 94.6 out of 100. This means that there are very few costs in firing an employee. Therefore when the economy deteriorated, businesses were able to layoff workers quickly to improve their bottom line. This is in contrast to European countries, who impose high costs on firms who want to fire workers. For instance, Germany's labor freedom index score rates at a low 39.9. While this is obviously good for European workers, European firms were slower in recovering as reflected in this March 18th, 2010 Economist article comparing U.S. and Europe productivity rates. When looking at 2009, you can see that U.S. firms still had positive productivity rates at 2.5% rise in GDP per hour, while Europe had a -1.1% decrease in GDP per hour. It should be noted that European countries have since rebounded, though.
Another factor is that the U.S. has capitalized on globalization. Even though the U.S. economy tanked, many U.S. multinational corporations were able to offset their domestic losses by taking advantage of higher growth in developing countries, such as China, Brazil, and India. In addition to being able to market their products and services in these new markets, they were also able to outsource production overseas. This improved their cost structure and enabled them to boost their profits.
While many Americans are discouraged by oursourcing and the loss of jobs, there are hidden benefits that many do not see. In the Fruits of Free Trade produced in the 2002 Annual Report of the Federal Reserve Bank of Dallas, we can see how we capitalize from freer markets. It is outdated because it shows the U.S. as the world's greatest exporter, but we have since been taken over by Germany and China. However, the U.S. consumer is better off due to the cheaper imports entering the marketplace. While it is true that free trade destroys jobs, there is an economic concept called creative destruction where inefficient firms are replaced by more efficient producers. In fact before the recession, more jobs were being created than destroyed. The problem is that these new jobs require different skillsets, so the distribution of these jobs are not always equitable.
First, corporate performance is directly related to productivity. If firms can produce a good at a faster rate of time, then that can lower their overall costs and lead them to gaining more market share because they can be more competitive on price. Even with a downsized workforce, investments in technology have paid off for firms. That means that can maintain production levels with less workers. That is one of the reasons why the U.S. is transitioning from manufacturing to service-oriented jobs, so U.S. workers must improve their human capital and technology skills to become more marketable and attain higher paying service jobs.
One other aspect that led to the quick recovery of U.S. firms during the last recession is the U.S. economic system. When looking at the U.S. economic profile from the Heritage Foundation's Index of Economic Freedom, you will see that they score very high in labor freedom at 94.6 out of 100. This means that there are very few costs in firing an employee. Therefore when the economy deteriorated, businesses were able to layoff workers quickly to improve their bottom line. This is in contrast to European countries, who impose high costs on firms who want to fire workers. For instance, Germany's labor freedom index score rates at a low 39.9. While this is obviously good for European workers, European firms were slower in recovering as reflected in this March 18th, 2010 Economist article comparing U.S. and Europe productivity rates. When looking at 2009, you can see that U.S. firms still had positive productivity rates at 2.5% rise in GDP per hour, while Europe had a -1.1% decrease in GDP per hour. It should be noted that European countries have since rebounded, though.
Another factor is that the U.S. has capitalized on globalization. Even though the U.S. economy tanked, many U.S. multinational corporations were able to offset their domestic losses by taking advantage of higher growth in developing countries, such as China, Brazil, and India. In addition to being able to market their products and services in these new markets, they were also able to outsource production overseas. This improved their cost structure and enabled them to boost their profits.
While many Americans are discouraged by oursourcing and the loss of jobs, there are hidden benefits that many do not see. In the Fruits of Free Trade produced in the 2002 Annual Report of the Federal Reserve Bank of Dallas, we can see how we capitalize from freer markets. It is outdated because it shows the U.S. as the world's greatest exporter, but we have since been taken over by Germany and China. However, the U.S. consumer is better off due to the cheaper imports entering the marketplace. While it is true that free trade destroys jobs, there is an economic concept called creative destruction where inefficient firms are replaced by more efficient producers. In fact before the recession, more jobs were being created than destroyed. The problem is that these new jobs require different skillsets, so the distribution of these jobs are not always equitable.
Tuesday, November 23, 2010
Evaluating Krugman's Axis of Depression
In Paul Krugman's Axis of Depression article in the November 19th, 2010 edition of the NY Times, he creates an allegory on George Bush's famous reference of the Axis of Evil, which represented Iran, North Korea, and Iraq in the early part of 2000. While Bush was concerned about terroristic activities from Iran, North Korea and a Saddam-led Iraq, Krugman is worried that China, Germany, and the Republican Party are favoring policies that will send us to economic calamity. Recently, we learned that the U.S. Federal Reserve Open Market Committee (Fed) led by Bernanke decided to implement a second round of quantitative easing aimed at stimulating economic activity by driving down interest rates. In this editorial, Krugman not only agrees with the Fed's moves, but is adamant that government should play a much larger role in sustaining and growing this recovery.
This debate is actually an age-old argument on the proper role of a central bank in running an economy. In the Principles of Macroeconomics and Mankiw's Five Debates over Macroeconomic Policy, there are two schools of thought. On one hand, you have monetarists, such as John Taylor, who believes the primary goal of the Fed is to maintain price stability. Then you have other economists such as Krugman, who favor the Fed playing a more active role in steering the economy where they increase money supply to increase employment. While this act might improve the labor market, it should be noted that it can lead to higher inflation.
When the Fed plays an activist role in managing the economy, they must recognize that the two goals of low inflation and unemployment often conflict with each other. In Principles of Economics and Mankiw's Ten Principles of Economics, there is Principle #10 stating that society faces a short-run trade-off between inflation and employment. This means that the Fed can increase money supply, which floods additional reserves to financial institutions, and eventually leads to more lending and investment activities. Jobs typically follow higher investment spending, so unemployment should fall. However the downside to this strategy is that more money in consumer pockets can lead to excessive spending. While that sounds good, the problem occurs when businesses are not able to meet the rise in consumer demand for goods and must respond by raising prices to ensure their goods remain stocked. This can result in higher inflation and that spooks investors and consumers alike.
Krugman's central argument is that the current economic environment calls for a more aggressive response to improving the labor market and not be as concerned about inflation because it is already so low. Economists often remark how monetary policy is an art where we carefully have to guide through the ebbs and flows caused by market forces. The general rule is that you increase money supply when inflationary risks are lower than unemployment risk. Conversely, you decrease money supply when inflationary risks are higher than unemployment risk. As I remark in my November 18th, 2010 blog entry, current inflation rates are near historical lows and there's even concern that deflation could be an issue. Therefore, this is strong evidence to support Krugman's reasoning for quantitative easing and boosting money supply.
On the other hand, it should be acknowledged that inflation often takes on disguised forms and can strike with immediacy and great force. While Krugman states that inflation remains low, he neglects to mention that the market also prices bonds based on inflation expectations. Based on past history, bond investors are wary about extended efforts in keeping interest rates low and money supply high. As pointed out in this November 15th, 2010 WSJ Real Time Economics blog, we can look back to the 1960s where the Fed was too aggressive in keeping interest rates low by buying short-term bonds over an extended period. You can see the what happened to inflation based on their actions as shown in this graph of core inflation rates from 1965 to 1984 from the Federal Reserve Bank of Cleveland. The measure of core inflation was initially low in 1965, but quickly exploded in the mid-1966 and continued its rise for over a decade. (Note: There was a brief respite in the early 1970s, but that was due to flawed price controls implemented by President Richard Nixon, which only led to hyperinflation a couple of years later.) Only the vigilant actions of former Fed Chairman Paul Volcker was able to stave off inflation around 1983. Therefore, the Fed must tread carefully with monetary policy because an incorrect move can damage an economy for a long period of time.
Another ancillary benefit to the quantitative easing is its potential impact on U.S. exports and jobs that can be created from it. One of the effects of increasing money supply is that it will devalue the U.S. currency. This is beneficial because a cheaper dollar can make our U.S. goods less expensive to foreign goods, which is one of the reasons why Krugman casts a dismissive eye to complaints from China and Germany. In fact, both of these countries passed the U.S. in overall exports. In particular, China was able to do this by tying its currency rate to the U.S. dollar at artificially low exchange rates, while Germany capitalized on a unified currency (Euro) that enabled them to attract investment away from its European breathren. Both would see their position weaken with a cheaper U.S. dollar, so Krugman discounts their criticism as being self-serving.
Krugman's angst with Republicans is their preoccupation with limiting government's role during an economic downturn. Their concerted efforts in watering down last year's stimulus legislation, along with reluctance in passing an infrastructure bill, can also stall economic activity. As we have seen with the impotence of monetary policy so far, one could assert that the U.S. is in a liquidity trap where the private sector is either unwilling or unable to create jobs. In those instances, government can intervene by boosting spending on highways, investment in alternative energy, and serve as a stopgap for state finances that continue to deteriorate. While not being specific, the Republican Party believes that government excess can be cut. While their proposals could lead to lower deficits, one cannot forget that lower government spending will lead to economic declines in the short run. Local businesses would be affected if welfare spending and extended unemployment benefits are cut. Areas that depend on military bases could be greatly affected if those bases close due to cuts in national defense.
In fact, one look at history can see the danger in addressing the budget deficit immediately. When looking at historical data on U.S. budget deficits from the U.S. Census, one can see the potential harm. Specifically, you can look at 1937 and 1938 where the budget deficit was significantly curtailed from $4.3 billion in 1936 to $2.2 billion in 1937 and a paltry $89 million in 1938. During this time period, Democrat President Franklin D. Roosevelt was concerned about budget deficits and immediately reacted by drastically cutting government expenditures from $8.2 billion in 1936 to $6.8 billion in 1938 and the results were staggering as shown in this table of Real GDP growth rates from the Bureau of Economic Analysis. Economic growth rates went from an explosive 13% in 1936 to a demoralizing -3.4% in 1938. This is indicative of why Krugman is concerned about the Republican priority of slashing government spending.
In summary, the U.S. recovery is still fragile and I believe the actions from both the Fed and Congress will influence the direction of future economic growth. It is my belief that Bernanke anticipates gridlock from a divided Congress, so that is why the Fed decided to organize a second round of quantitative easing because they want to avoid a deflationary environment that could occur if our recovery stalls. Despite this risk of deflation, I do not think quantitative easing is the right method now. As inferred by even Krugman, the effect of quantitive easing will probably be minimal anyway. However, the risks of retalitory currency manipulation, along with heightening inflation risks in the future, outweigh the benefits of this monetary policy response.
A more appropriate course of action would be Congress quickly passing legislation aimed at additional public investment and reforming the tax code. Industrial policy aimed at investments of transportation systems and alternative energy projects are essential to maintaining our competitive edge globally. While I understand that these investments are costly and could crowd out private investment in the future, I think this could be balanced by imposing deficit-cutting methods that will start to take effect three or four years down the road. As for the tax code, I do believe that it needs to be modified to boost revenues and better align incentives. This can be done by slowly limiting deductions for both individuals and businesses over time. By broadening the tax base, we can increase revenues through these efforts and then make it politically more viable by cutting marginal income tax rates for everyone, along with lowering the corporate, capital gains, and dividend tax rates.
Lastly, we also need to address the strain of entitlement spending and national defense. As the baby boomers retire, Social Security, Medicare, and Medicaid spending will skyrocket, so politicians will soon not be able to ignore it. Then combine that with a volatile world where nuclear proliferation and terrorism threaten our security, there will be increased pressure to raise defense spending. All of these forces are leading the U.S. to an unsustainable fiscal state soon. Therefore, politicians will need to be frank with the public and outline priorities that will require sacrifice by all of us.
This debate is actually an age-old argument on the proper role of a central bank in running an economy. In the Principles of Macroeconomics and Mankiw's Five Debates over Macroeconomic Policy, there are two schools of thought. On one hand, you have monetarists, such as John Taylor, who believes the primary goal of the Fed is to maintain price stability. Then you have other economists such as Krugman, who favor the Fed playing a more active role in steering the economy where they increase money supply to increase employment. While this act might improve the labor market, it should be noted that it can lead to higher inflation.
When the Fed plays an activist role in managing the economy, they must recognize that the two goals of low inflation and unemployment often conflict with each other. In Principles of Economics and Mankiw's Ten Principles of Economics, there is Principle #10 stating that society faces a short-run trade-off between inflation and employment. This means that the Fed can increase money supply, which floods additional reserves to financial institutions, and eventually leads to more lending and investment activities. Jobs typically follow higher investment spending, so unemployment should fall. However the downside to this strategy is that more money in consumer pockets can lead to excessive spending. While that sounds good, the problem occurs when businesses are not able to meet the rise in consumer demand for goods and must respond by raising prices to ensure their goods remain stocked. This can result in higher inflation and that spooks investors and consumers alike.
Krugman's central argument is that the current economic environment calls for a more aggressive response to improving the labor market and not be as concerned about inflation because it is already so low. Economists often remark how monetary policy is an art where we carefully have to guide through the ebbs and flows caused by market forces. The general rule is that you increase money supply when inflationary risks are lower than unemployment risk. Conversely, you decrease money supply when inflationary risks are higher than unemployment risk. As I remark in my November 18th, 2010 blog entry, current inflation rates are near historical lows and there's even concern that deflation could be an issue. Therefore, this is strong evidence to support Krugman's reasoning for quantitative easing and boosting money supply.
On the other hand, it should be acknowledged that inflation often takes on disguised forms and can strike with immediacy and great force. While Krugman states that inflation remains low, he neglects to mention that the market also prices bonds based on inflation expectations. Based on past history, bond investors are wary about extended efforts in keeping interest rates low and money supply high. As pointed out in this November 15th, 2010 WSJ Real Time Economics blog, we can look back to the 1960s where the Fed was too aggressive in keeping interest rates low by buying short-term bonds over an extended period. You can see the what happened to inflation based on their actions as shown in this graph of core inflation rates from 1965 to 1984 from the Federal Reserve Bank of Cleveland. The measure of core inflation was initially low in 1965, but quickly exploded in the mid-1966 and continued its rise for over a decade. (Note: There was a brief respite in the early 1970s, but that was due to flawed price controls implemented by President Richard Nixon, which only led to hyperinflation a couple of years later.) Only the vigilant actions of former Fed Chairman Paul Volcker was able to stave off inflation around 1983. Therefore, the Fed must tread carefully with monetary policy because an incorrect move can damage an economy for a long period of time.
Another ancillary benefit to the quantitative easing is its potential impact on U.S. exports and jobs that can be created from it. One of the effects of increasing money supply is that it will devalue the U.S. currency. This is beneficial because a cheaper dollar can make our U.S. goods less expensive to foreign goods, which is one of the reasons why Krugman casts a dismissive eye to complaints from China and Germany. In fact, both of these countries passed the U.S. in overall exports. In particular, China was able to do this by tying its currency rate to the U.S. dollar at artificially low exchange rates, while Germany capitalized on a unified currency (Euro) that enabled them to attract investment away from its European breathren. Both would see their position weaken with a cheaper U.S. dollar, so Krugman discounts their criticism as being self-serving.
Krugman's angst with Republicans is their preoccupation with limiting government's role during an economic downturn. Their concerted efforts in watering down last year's stimulus legislation, along with reluctance in passing an infrastructure bill, can also stall economic activity. As we have seen with the impotence of monetary policy so far, one could assert that the U.S. is in a liquidity trap where the private sector is either unwilling or unable to create jobs. In those instances, government can intervene by boosting spending on highways, investment in alternative energy, and serve as a stopgap for state finances that continue to deteriorate. While not being specific, the Republican Party believes that government excess can be cut. While their proposals could lead to lower deficits, one cannot forget that lower government spending will lead to economic declines in the short run. Local businesses would be affected if welfare spending and extended unemployment benefits are cut. Areas that depend on military bases could be greatly affected if those bases close due to cuts in national defense.
In fact, one look at history can see the danger in addressing the budget deficit immediately. When looking at historical data on U.S. budget deficits from the U.S. Census, one can see the potential harm. Specifically, you can look at 1937 and 1938 where the budget deficit was significantly curtailed from $4.3 billion in 1936 to $2.2 billion in 1937 and a paltry $89 million in 1938. During this time period, Democrat President Franklin D. Roosevelt was concerned about budget deficits and immediately reacted by drastically cutting government expenditures from $8.2 billion in 1936 to $6.8 billion in 1938 and the results were staggering as shown in this table of Real GDP growth rates from the Bureau of Economic Analysis. Economic growth rates went from an explosive 13% in 1936 to a demoralizing -3.4% in 1938. This is indicative of why Krugman is concerned about the Republican priority of slashing government spending.
In summary, the U.S. recovery is still fragile and I believe the actions from both the Fed and Congress will influence the direction of future economic growth. It is my belief that Bernanke anticipates gridlock from a divided Congress, so that is why the Fed decided to organize a second round of quantitative easing because they want to avoid a deflationary environment that could occur if our recovery stalls. Despite this risk of deflation, I do not think quantitative easing is the right method now. As inferred by even Krugman, the effect of quantitive easing will probably be minimal anyway. However, the risks of retalitory currency manipulation, along with heightening inflation risks in the future, outweigh the benefits of this monetary policy response.
A more appropriate course of action would be Congress quickly passing legislation aimed at additional public investment and reforming the tax code. Industrial policy aimed at investments of transportation systems and alternative energy projects are essential to maintaining our competitive edge globally. While I understand that these investments are costly and could crowd out private investment in the future, I think this could be balanced by imposing deficit-cutting methods that will start to take effect three or four years down the road. As for the tax code, I do believe that it needs to be modified to boost revenues and better align incentives. This can be done by slowly limiting deductions for both individuals and businesses over time. By broadening the tax base, we can increase revenues through these efforts and then make it politically more viable by cutting marginal income tax rates for everyone, along with lowering the corporate, capital gains, and dividend tax rates.
Lastly, we also need to address the strain of entitlement spending and national defense. As the baby boomers retire, Social Security, Medicare, and Medicaid spending will skyrocket, so politicians will soon not be able to ignore it. Then combine that with a volatile world where nuclear proliferation and terrorism threaten our security, there will be increased pressure to raise defense spending. All of these forces are leading the U.S. to an unsustainable fiscal state soon. Therefore, politicians will need to be frank with the public and outline priorities that will require sacrifice by all of us.
Thursday, November 18, 2010
Not Much Change in Georgia Job Market
As reported in the November 18th, 2010 Atlanta Business Chronicle, the unemployment rate was unchanged at 9.9% in October. It should be pointed out that September's unemployment rate was revised downward by 0.1%. On a positive note, there was job growth of 22,300 over the last month. Even though most of the growth was in retail and considered temporary, that is usually going to be the case during the holiday season.
More robust job growth will be needed to achieve more significant cuts in unemployment. Even though we should continue to see more temporary unemployment in the next couple of months, a better than expected holiday season of retail sales can alter the future outlook for businesses. Therefore, it will be interesting to see how those numbers eventually play out. Though, our expectations should be tempered because most analysts are only expected a modest improvement from last year.
Challenging state fiscal conditions are another barrier to boosting economic activity and generating jobs. Sluggish tax revenues will make it harder to faciliate investment spending and attract businesses to our state. In order to counter this trend, Atlanta Business Chronicle article written by Dave Williams highlights the difficulty that Georgia's Department of Transportation is having in funding highway projects. In fact, they have made a decision to tap into reserves in order to spend $350 million right away. Unless they are able to generate additonal funding, that will be another obstacle to overcome in getting Georgia's economy on track.
More robust job growth will be needed to achieve more significant cuts in unemployment. Even though we should continue to see more temporary unemployment in the next couple of months, a better than expected holiday season of retail sales can alter the future outlook for businesses. Therefore, it will be interesting to see how those numbers eventually play out. Though, our expectations should be tempered because most analysts are only expected a modest improvement from last year.
Challenging state fiscal conditions are another barrier to boosting economic activity and generating jobs. Sluggish tax revenues will make it harder to faciliate investment spending and attract businesses to our state. In order to counter this trend, Atlanta Business Chronicle article written by Dave Williams highlights the difficulty that Georgia's Department of Transportation is having in funding highway projects. In fact, they have made a decision to tap into reserves in order to spend $350 million right away. Unless they are able to generate additonal funding, that will be another obstacle to overcome in getting Georgia's economy on track.
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