What's the Fed to do?

Even though Wall Street has suddenly decided that American companies are worth 15% more than they were worth at about 2:00p.m. est on Friday. I still don't think that anyone has any clue what's going on with the American and global economy. Last week was mostly bad news all around. This is a short week here in the States and I expect it to be quiet.

But of interest is a continuation of what I touched on Friday... what is the Fed to do?

Right before Halloween, the Fed set the target rate for federal funds at 1%. But the reality is much lower than that: the effective rate according to the Economist is 0.25% (it is now about 0.50%):

The irony is that, were the gap to disappear, there would be a de facto tightening of monetary policy. On the other hand, if the effective rate remains near zero, the Fed will have to turn to more unconventional means of stimulating growth. Michael Feroli of JPMorgan Chase proposes outright purchases of mortgage-backed securities—another faint echo of Japan.

So what are unconventional means?

I'm not sure, but one suggestion: Don't do what Japan has done since the 1990s.

And suddendly things look bad again...

The stock market is down, unemployment is up, consumer spending is down, banks aren't loaning money to anyone... that's right the economy still looks bad. And while we might have dodge a total collapse of the credit markets, the key word is "might". A week ago I think most people would have assumed that we/the world had done so. Now? Not so much.

And on top of all this the truly scary word of deflation has begun to be uttered after the announcement this week that consumer prices had fallen 1% in October.

Deflation is, simply, a continuous fall in the general price level of goods and services. This sounds like a great thing—prices go down meaning you and I can buy more stuff. But that's in the very short term. If firms are making less from their goods or services, that means they have to cut back on costs—that can mean anything from cutting jobs, wages, or closing factories. And therefore you and I will be making less, and thus not spending more.

The other worrisome aspect of deflation is that firms and consumers may decide to wait to build/expand their business or wait to purchase goods. If prices are falling, I may wait to buy a new TV or car knowing that in 9 months it will cost less. A firm may wait to build a new factory because the price of the material goods and labor will be less in six months than it is today. What this means is that people aren't spending money and therefore demand continues to fall.

From a policy perspective there is only so much a government can do. Interest rates can only be cut so low—zero percent obviously. The Fed has set interest rates at about 1%. So it can't cut rates too much more (and more on that later).

Krugman and some others have begun to call for a huge stimulus. This makes sense since it would inject billions into the U.S. economy (if Americans are good at anything, it's spending money). While this might be problematic—people might just save that money, pay off debt, or invest it in some market—it also may fix the problem at hand if people spend the money.

But again, policy makers can only do so much in a deflation cycle or period. However, we are seeing policy makers acting quickly and doing something, and as I've aruged, something is better than nothing. Why? Becuase the last time we did nothing, the Depression went from bad to Great. Japan did nothing and it's stuck in 1991. Sweden did something at it is still one of the strongest economies in the world. So although you and your neighbor and some talking heads on TV might not like, sitting on our hands has proven to be the wrong decision.

Three Reasons Why We Should (and Should Not) Bailout GM (and maybe Ford)

Although it doesn't look likely at the moment, The Big Three from Detroit have gone to Congress asking for money to bail them out.

I'm working under the assumption that Chrylster is unsavagable. Also, as a disclaimer, your author owns seven shares of GM stock. That's right, $20 bucks! Drinks on me!

Why the U.S. Government Should Bailout GM (and maybe Ford)
1.) According to David Cole of the Center for Automotive Research if:

Detroit’s production falls by 50%. He estimates that in the first year that
would cost 2.5m jobs: 240,000 from the carmakers themselves; 795,000 from
suppliers and 1.4m from other firms indirectly affected. The cost in transfer
payments and lost taxes would exceed $100 billion over three years. Some of Mr
Cole’s assumptions are likely to be too pessimistic, but his blood-curdling
forecast and others like it have helped to convince legislators that the $50
billion of help that the carmakers are asking for would be cheap at the price.

If the Center for Automotive Research's cost/benefit analysis is even sort of on target, giving the money to GM and Ford is a no brainier.

2.) The long term prospects of each company are actually pretty good. Both have a strong presence in Europe (especially Ford) and other emerging markets (especially GM). They have both started producing competitive compact and fuel efficient cars (everyone seems to rave about the Focus) moving away from the SUVs that American drivers demanded for such a long time. And in 2007 GM and Ford struck a deal with the UAW union which allowed them to cut costs by about $1,000 a car.

Should they have been making more fuel efficient cars? Probably, but that's easy to say today. The SUV market in the 90s and early 2000s was not a result of Ford and GM forcing American buyers to buy big gas guzzling cars. SUVs were attractive to American consumers because gas was so cheap... thanks in part to the U.S. government levying such small taxes on gasoline.


3.) Lehman Brothers - When the Treasury let Lehman Brothers die everyone seemed to support the decision. But it quickly became evident that letting Lehman 'die' might have been a huge mistake. The financial world simply was not ready for a bank as big as Lehman Brothers to go "buh-bye". Is the American economy ready to lose a few million jobs? And what about the pressure the bankruptcy of GM and Ford would have on the Pension Benefit Guaranty Corp--the Federal agency that insures benefits to retirees in the auto industry and other industries?


Why the U.S. Government Should NOT Bailout GM (and maybe Ford)
1.) When Becker speaks, I listen:

Nevertheless, I believe bankruptcy is better than a bailout for American consumers and taxpayers. The main problem with American auto companies is that during the good times of the 1970s, 1980s and 1990s, they made overly generous settlements with the United Auto workers (UAW) on wages, pensions, and health benefits...

It is not that cars cannot be produced profitably with American workers: the American plants of Toyota and other Japanese companies, and of German auto manufacturers, have been profitable for many years. The foreign companies have achieved this mainly by setting up their factories in Southern and border states where they could avoid the UAW, and thereby introduce efficient methods of production. Their workers have been paid well but not excessively, and these companies have kept their pension and health obligations under control while still maintaining good morale among their employees.

Bankruptcy would help GM and Ford become more competitive by abrogating significant parts of their labor contracts with the UAW.

2.) A.I.G. - What a mess this has become. This is in part the fault of the Treasury which basically has given A.I.G. billions upon billions of dollars without out any oversight. Conservatives cannot complain about welfare anymore after the A.I.G. fiasco. These guys are paying themselves bonuses for running the company into the ground... why? Because they don't want to lose the talent that nearly caused the company to disappear. Congress and taxpayers are right to be cautious about handing any private company billions of bucks after watching A.I.G. reward themselves for being total fucking morons (pardon my French).

3.) While I don't agree with much of Mitt Romney's reasoning he does make an important point in his Op-Ed today:
Without that bailout, Detroit will need to drastically restructure itself. With it, the automakers will stay the course — the suicidal course of declining market shares, insurmountable labor and retiree burdens, technology atrophy, product inferiority and never-ending job losses. Detroit needs a turnaround, not a check.
A bailout does not guarantee further restructuring within Ford and GM. Both companies need further diversification in their products--the pickup truck and SUV business was lucrative until gasoline became expensive. And since both companies relied far too much on those big gas guzzlers and didn't really have smaller, fuel efficient cars to offer consumers, they're in the position that they're in today. Giving them a few billion won't guarantee a change in philosophy in Detroit, something we should all be worried about.

Not surprisingly Joesph Stiglitz has Some Good Ideas on How To Fix Everything

Nobel Prize laureates Joesph Stiglitz has been busy over the last two months writing about the economy. But of interest for us here, is his 'State of the Economy' piece in Vanity Fair "Reversal of Fortune." Let's break it down... Dr. Jack style.

The real meat of the essay is towards the end, but he does pick apart the policy decisions that got us into this mess. And he places much of this blame on George W. Bush. This is a tad harsh—there were fundamental policy problems prior to Bush taking office. But Stiglitz is correct to place more blame on Bush's handling of the economy (if you can call it that) than other non-critics:

...the tax cuts in 2001 and 2003 set the stage for the current crisis. They did virtually nothing to stimulate the economy, and they left the burden of keeping the economy on life support to monetary policy alone. America’s problem today is not that households consume too little; on the contrary, with a savings rate barely above zero, it is clear we consume too much. But the administration hopes to encourage our spendthrift ways.

He is on the mark with this assessment. What is happening today is a result of the spend today worry about tomorrow... tomorrow ways of the last five plus years. The Bush administration encouraged everyone to spend, spend, spend. Aside from cutting the capital gains taxes, Americans weren't encouraged to save money.

I haven't railed against it too much here, but I am against our current policies towards corn ethanol. Giving any sort of tax credits or subsideis to corn ethanol production is silly as Stigliz sums up:

Our ethanol policy is also bad for the taxpayer, bad for the environment, bad for the world and our relations with other countries, and bad in terms of inflation. It is good only for the ethanol producers and American corn farmers. It should be scrapped. We currently subsidize corn-based ethanol by almost $1 a gallon, while imposing a 54-cent-a-gallon tariff on Brazilian sugar-based ethanol. It would be hard to invent a worse policy.

And on to fixing the current housing mess:

Remember, too, that we already give big homeowner subsidies, through the tax system, to affluent families. With tax deductions, the government is paying in some states almost half of all mortgage interest and real-estate taxes. But many lower-income people, whose deductions are meaningless because their tax bill is too small, get no help. It makes much more sense to convert these tax deductions into cashable tax credits, so that the fraction of housing costs borne by the government for the poor and the rich is the same.

A ways back I was critical of the Feds handling (or lack there of) concerning inflation. Stiglitz points out that I was off base:

The standard analysis coming from financial markets these days is that inflation is the greatest threat, and therefore we need to raise interest rates and cut deficits, which will restore confidence and thereby restore the economy. This is the same bad economics that didn’t work in East Asia in 1997 and didn’t work in Russia and Brazil in 1998. Indeed, it is the same recipe prescribed by Herbert Hoover in 1929.

It is a recipe, moreover, that would be particularly hard on working people and the poor. Higher interest rates dampen inflation by cutting back so sharply on aggregate demand that the unemployment rate grows and wages fall. Eventually, prices fall, too. As noted, the cause of our inflation today is largely imported—it comes from global food and energy prices, which are hard to control. To curb inflation therefore means that the price of everything else needs to fall drastically to compensate, which means that unemployment would also have to rise drastically.

This makes total sense. Worrying about inflation during a recession or depression is silly, and when the cause of inflation is not a result of domestic economic forces, attempting to control it is only more difficult for central bankers.

Finally, like any good economist, Stigliz believes that American economic policy should follow:

Spending money on needed investments—infrastructure, education, technology—will yield double dividends. It will increase incomes today while laying the foundations for future employment and economic growth. Investments in energy efficiency will pay triple dividends—yielding environmental benefits in addition to the short- and long-run economic benefits.

If growth is the goal of capitalism, then techonology is probably the biggest force in economic expanision. And techonology and innovation comes about though strong education. We could have a debate about how big of a role the government should play in the building and maintaining infrastrucutre; but I think the government should play a bit, if not the biggest role, in infrastrcutre projects.

Anyway, I highly suggest checking out the entire essay, there are some really good ideas, sorry common sense, in there.

Spreading the Wealth Around

I got this chain e-mail from a friend of mine a few days ago and heard some GOP Talking Head mention it on the radio a day or two later.

Yesterday on my way to lunch I passed a homeless guy with a sign that read 'Vote Obama, I need the money.' I laughed.

Once in the restaurant my server had on a 'Obama 08' necktie, again I laughed as he had given away his political preference -- just imagine the coincidence.

When the bill came I decided not to tip the server and explained to him that I was exploring the Obama redistribution of wealth concept. He stood there in disbelief while I showed him a ten-dollar bill and told him that I was going to 'redistribute' his tip to someone who I deemed more in need--the homeless guy outside. The server angrily stormed from my sight.

I went outside, gave the homeless guy $10 and told him to thank the server inside as I've decided he could use the money more. The homeless guy seemed genuinely grateful. (surprised me).

At the end of my rather unscientific redistribution experiment I realized the homeless guy was grateful for the money he did not earn, but the waiter was pretty angry that I gave away the money he did earn even though the actual recipient needed the money more.

I guess redistribution of wealth is an easier thing to swallow in concept than in practical application.

A few things about this e-mail:
1) The homeless guy is working and he earned that money... he's hustling. He got 10 bucks out of his efforts/work. While some people might not find pan-handling working, it technically is: one is using their time sitting or standing in high foot traffic areas hoping to get contributions (a wage) from passer bys. And that's what work is—a worker is paid for his/her time for someone else.

2) Obama does not want to take all of Paul's money to give to someone else. And that's what happening in this story, all the money is being taken away from the waiter and given to the pan-handler. No where in Obama's policy proposals does he even imply that he'll do this. While his now somewhat infamous quote to Joe the Plummer about how he wants to "spread the wealth around" is the reasoning behind this story above, Obama is not talking about taking all the money people make and dividing it equally.

Rather Obama is more speaking about closing the gap between the wealthiest and poorest in this country. This indicator, called the Gini Coefficient, has increased over the last 20 to 25 years at a pace that probably worries most policy makers and economists. According to the UN, the U.S. Gini Coefficient is 40.8, which is about the same as Georgia, Sri Lanka, Ghana, Turkmenistan, and Mali. And another recent study showed that American cities are as unequal as those in Latin America or Africa.

Slowing down or even closing the gap between the have and have nots in this country isn't the worst idea in the world; espiecially if it's done so in an intellegent, pragmatic way.

Is the Culture War Over? Did it ever begin?

One of the reasons that Sarah Palin was chosen to be John McCain's running mate was because of her cultural values. A social conservative, Palin helped McCain bring the GOP base together. For a week, it looked like Palin was the perfect pick.

But then Lehman Brothers went under and the credit crunch got rolling... and the voting public became very worried about the economy. The economy was always the biggest issue during the 2008 election, and pretty much every issue (the War on Iraq, energy policy, education) was all put on the back burner. And cultural issues, which weren't a big issue during the summer, became a complete non-factor.

Why? Because people don't care as much about gay marriage, abortion, and school prayer when they're not sure where their next pay check is coming from.

What about Proposition 8 in California? True, cultural issues still exist, but when it comes to voting for a President or Senator or Representative or any elected office, the candidates cultural views do not matter as much as the media and social conservatives (and some social liberals) would like us to believe. If voters did care as much about cultural issues as some would like us to believe, Obama would not have won Califorinia.

And here in lies the problem with the Republican party today—they have lost their way obsessing over cultural issues. True, it delivered back-to-back Presidential victories for Geroge W. Bush (barely), but the fact that the Republicans barely won should have been a sign that as a policy issue, it is a fickle issue. An issue that matters only when things are going very well economically, and even then that's debateable. The cultural divide that we hear so much about actually isn't that deep.

Poll after poll, focus group after focus group show that the vast majority of Americans -- the Silent Majority, perhaps? -- are pragmatic, independent and un-partisan in their basic views. They are eclectic: "liberal" on some matters, "conservative" on others. They are not slaves to that hobgoblin of small minds, consistency. On fundamental matters such as belief in equality for women and minorities, or how large a role religion and family play in individuals' lives, the consensus among voters is broad. Unlike other times in U.S. history, there simply are no issues such as slavery, Prohibition or Vietnam that inspire violent protest or social disruption.

However, no matter what, God has made his decision and therefore social conservatives just have to have faith that it was the right one.

A Most Peculiar Editorial

Lame title, I know... but let's just get down and dirty to one of the more peculiar editorials out there today:

His triumph was decisive and sweeping, because he saw what is wrong with this country: the utter failure of government to protect its citizens. He offered a government that does not try to solve every problem but will do those things beyond the power of individual citizens: to regulate the economy fairly, keep the air clean and the food safe, ensure that the sick have access to health care, and educate children to compete in a globalized world.

This is true, but it reeks of anger and raises a fair question: Did W fail to protect America and American citizens? I think it's a bit harsh. Where many of his policies either misguided or short sided? Yes. Is he—most likely—going to go down as one of the worst Presidents in history? Yes. But Bush did not expose this nation to harm. No a better way to say what he failed to do was that... well he failed to do anything.

Mr. Obama inherits a terrible legacy. The nation is embroiled in two wars — one of necessity in Afghanistan and one of folly in Iraq. Mr. Obama’s challenge will be to manage an orderly withdrawal from Iraq without igniting new conflicts so the Pentagon can focus its resources on the real front in the war on terror, Afghanistan.

Obama was not elected to fix or end Iraq. For Obama's political sake, I hope he realizes this.

The campaign began with the war as its central focus. By Election Day, Americans were deeply anguished about their futures and the government’s failure to prevent an economic collapse fed by greed and an orgy of deregulation. Mr. Obama will have to move quickly to impose control, coherence, transparency and fairness on the Bush administration’s jumbled bailout plan.

A harsh critique of W... but the Times is on the right path here. Obama was elected to fix the economy. But unlike Paul Krugman, the NYT editorial board doesn't totally get it.

Climate change is a global threat, and after years of denial and inaction, this country must take the lead on addressing it. The nation must develop new, cleaner energy technologies, to reduce greenhouse gases and its dependence on foreign oil.

Mr. Obama also will have to rally sensible people to come up with immigration reform consistent with the values of a nation built by immigrants and refugees.

There are many other urgent problems that must be addressed. Tens of millions of Americans lack health insurance...

This editorial is exactly what Obama should not listen to and HAS to avoid when he takes office. Obama needs to realize that he was elected to fix the economy—not Iraq, not immigration, not education, not energy—and to a certain extent health care. So why is the New York Times calling for Obama to leave Iraq, bring about immigration policy changes, fix the environment, and change energy policy?

Because the New York Times doesn't get it. They're too busy believing that Obama has this huge mandate to change everything W has done and fix everything he didn't bother to deal with. This would be a mistake. Those are issues you deal with as time moves on. And these were the issues that prevented John Kerry and Al Gore from being elected.

The New York Times is calling for Obama to be ambitious and to tackle a buch of issues quickly. This would be a mistake. There is a lot to be done, but slow and steady wins the race. If Obama can come in and do something about the economy, then he'll have the political capital to fix everything the New York Times wants. But to waste his political capital on something like, oh, climate change or immigration reform, would be a gigantic mistake since there is a good chance nothing would get done. And as we saw with W; once you burn your political capital, it ain't ever coming back.