Update: Jobs, Debt, Bank Reform
This has been a dull week for economic reporting with only dribs and drabs of news being released, and the Senate ploughing on through what seems like an endless pile of amendments to the basic Dodd bank reform bill. Nonetheless there are some small items to discus:
Jobs:
The weekly report on first time claims for unemployment assistance edged down once again, repeating the pattern of recent weeks. The decline was minimal at 4,000, and so does not signal a breakthrough in the jobs market. The weekly total of 444,000 is still way too high for us to relax and imagine that unemployment will come down quickly. Instead it marks another small step forward in what has become a war of attrition. We have to look over longer time spans to comprehend the improvement: this time last year the weekly claims were in the 600,000+ range, which means that we have improved about 30% over the last twelve months. That’s good progress, but insufficient, and the weekly gains have all but vanished: we have gained only 2.2% in the first third of 2010, which implies that the market has flattened out at an unacceptably high level. My own estimate is that we need the first time claims number to be somewhere in the mid 300,000 range before we will see dramatic changes in the unemployment rate. Until then we have to make do with these tiny weekly advances.
The more worrisome figure is the huge build up in long term unemployment. 4.63 million workers are now collecting long term unemployment benefits and more drop out weekly as they exhaust even the full 99 months now available. As I have mentioned before the existence of this huge number of long term unemployed has sparked a spirited debate in economics. The question being whether these workers represent ‘structural’ or ‘cyclical’ unemployment. This is an important distinction. If they are cyclically unemployed the implication is that they are still well skilled and that when jobs re-appear they will quickly find work. If, on the other hand, they are structurally unemployed, they are unlikely to find work quickly at all. This is either because their skills have atrophied due to prolonged unemployment, or that their skills do not match the requirements of the new jobs being generated. Clearly the policies put in place to fend off cyclical unemployment are very different from those needed to cure structural unemployment. In the case of cyclical job losses the focus should be on bolstering demand sufficiently to restore business activity to its pre-recessionary levels. Structural job losses are intractable to simple demand management: they need a longer term perspective and respond only to things such as retraining and relocation.
The resolution to this debate will have very large consequences for government policy during the upcoming year. Right now I think the answer seems to be that we have shed a great number of jobs that will never return. Which implies the need for aggressive retraining and career development support rather than simple demand management.
Debt:
The background chatter about our national debt continues. David Leonhardt in the New York Times did us all a disfavor this week by writing a long article comparing the US and Greek debt situations. Everywhere, it seems, commentators are asking whether we will go down the same road as the Greeks, and the big question has become: will the US default?
The short answer is no.
This, of course, seems like an evasion, especially when the Congressional Budget Office issued its assessment of the monthly budget deficit. On the surface the CBO report makes for ugly reading: the first seven months of the US fiscal year show an accumulated deficit of $800 billion, with April being much worse than the equivalent month last year. It was April’s poor figures that sparked quite a flurry of doomsaying: April 2010 saw a monthly deficit of $85 billion compared with April 2009’s $21 billion. The significance of April, of course, is that it tax month, and usually shows a net inflow of revenue for the government from all those tax receipts. In neither of the last two years did April show such an inflow, which means that the government has now suffered its longest ever run of deficit moths – the record run now stands at 19 consecutive loss making months. That’s awful. But entirely explicable. The big drop in this April’s revenue, when compared with last year’s, results simply from the massive drop in personal incomes being taxed. The biggest inflow each April comes from taxes on income that is not subject to withholding. Those taxes tend to be bunched up and paid at tax time. The problem this year is that the tax non-withholding incomes earned in 2009 dropped substantially over those of 2008. So, naturally, the amount of tax revenue dropped also. To get a better look at the trend in government revenues we need to look at the taxes being collected on incomes subject to withholding. Those are the incomes that are more immediately affected by the economy and the recovery. At that level of detail we find a significant improvement in tax revenues inflows. This supports the notion that the deficit will start to drop quickly as the economy generates more incomes on which taxes can be collected.
The outlook for the deficit is, in other words, improving, despite the flood of red ink.
But.
We still have an enormous budget problem that will not go away even when the economy is back to strong growth.
Not only are we burdened by the cost of the Bush tax cuts that contributed over half of the current deficit – the stimulus and the bailouts combined represent less than a third of the problem – but the long term trajectory of our costs is wrong: we are heading into an era of high costs. This is especially the case in health care, which is why I have been beating the drum of health care reform as a budget saving device. Even with the modest reform passed this spring we still have a long term gap in the budget that needs to be filled.
But the gap is nowhere near that of Greece. So the two situations cannot be compared. The American budget problem is far less difficult to deal with than the Greek problem. To deal with its crisis Greece will have to endure depression like reductions in aggregate demand, and an austerity program that will have to last for years. In contrast, the US has to lower its spending – increase its federal revenues – by about 6% of GDP. That’s still a big hole to fill, but it is not a crisis.
The number that people like Leonhardt obsess over is the accumulated national debt when compared with annual GDP. Right now the Greek debt stands at about 115% of GDP, and Leonhardt projects the US to hit somewhere around 140% when we reach the peak a couple of decades out.
This is nonsense.
First is is speculative. Second it assumes that tax and spending stays at their current levels. And, third, it fails to take into account the impact of rising inflation.
Speculation is inherent in any forecast, but it is entirely unreasonable to assume that tax policies remain unchanged. There will be tax hikes. There will also be spending cuts. I agree that politicians are notoriously incapable of imposing painful decisions on the voting public, but the current crisis and the global mess highlight the need for restrictive action. I think fiscal restraint will become the watchword, but only as the crisis, and the need for laxity, abates.
The two areas that are crying out for attention are defense and entitlements. The former is bloated by bureaucracy and outmoded thinking – the US military is awash with waste and duplication. I have advocated eliminating the Air Force entirely and handing its role back to the Army and Navy. The cost reduction by that move alone would be enormous. And we would lose no effectiveness. The litany of wasteful weapons programs and duplicative base locations is another perennial nut to crack. As for entitlements: we have to come to terms with the idea that those programs were put in place in an era when life spans were very different. they were never funded for the modern world. The idea that someone can retire at 65 and then live for another couple of decades is preposterous. The burden on the future taxpaying population is simply intolerable. It is this that has made the ‘unfunded’ liability explode. The mismatch between life expectancy and the amounts being set aside to cover the costs of those extended lifetimes is the source of the crippling outlook. So the answer is simple: current workers need to save more since they will have the benefit of longer lives; and we need to raise the age at which benefits can be collected. The notion of early retirement needs to be abolished. In any case, the concept of retirement is a modern post-industrial invention. We need to modify it to take into account medical advances.
Bank Reform:
Speaking of needed modification: the Senate’s slow crawl towards bank reform continues.
This last week we have been treated to a couple of stunning examples of bi-partisan cooperation. Senator Sanders from Vermont managed to get his amendment to create audits of the Federal Reserve Board passed by a 96 – 0 margin. While Senator Boxer’s amendment concerning the rules for winding up large banks and restricting the use of taxpayer money for bail-outs passed by a 96 – 1 margin. That audit of the Fed is highly restricted and does not apply to monetary policy decisions. The libertarians amongst you will be disappointed by that, but I think the maintenance of an independent monetary policy making body is worth a certain amount of obfuscation. I am glad, therefore, that Senator Sanders watered his amendment down even though he incurred, along the way, the wrath of Ron Paul and the more extreme anti-Fed evangelists.
Such is the hubris, willfulness, and incompetence of the banking industry that it has engendered this astonishing moment of cooperation in Congress. No one, it seems, wants to defend the banks too much.
Good.
But, there have been losses as well.
The Brown-Kaufman amendment to reduce the big banks in order to force an end to ‘too-big-to-fail’ was defeated by a healthy margin. Yet I think this aspect of the debate has opened up paths towards other ways of reining the banks in. So the efforts of Senators Brown and Kaufman will not go to waste.
Other issues being voted on concern the elimination of naked credit default swaps, and the introduction of a modicum of transparency into the derivatives market.
A naked CDS is one where a bank buys insurance against the failure of an asset that it doesn’t even own. This is an absurd practice and is akin to pure gambling. It allows Goldman, for instance, to purchase insurance against the failure of an asset owned by AIG. Not only is this a massive disconnect in the financial marketplace, but it encourages anti-social behavior. It decouples risk taking from risk management with the result that risk takers have no interest in limiting the damage on bad credit decisions. On the contrary they have vested interest in encouraging failure. This disincentive to manage risk has become pervasive and, I believe, contributes heavily to the destabilization of the credit market. When we remove the incentive to manage risk, because it is covered by a naked short position, we simultaneously remove the need for sound upfront credit policies and practices. The erosion in basic banking that the development of these pseudo-risk management products has wrought is astonishing and dangerous. So getting rid of the more egregious examples moves us in the right direction.
The Senate is continuing its deliberations. The current trend in the voting on the various amendments seems to be towards a more stringent final legislation than either Dodd or the Administration anticipated. I think this trend is welcome. My initial reaction to the Dodd proposal was that it was weak and meek. Hopefully Dodd’s lack of spine will be offset by the anger that seems to have taken hold of the Senate.
We can only hope.
Meanwhile, politics intrudes at every turn. The Senate is delaying a vote on the inclusion of the derivatives ruling from the Agriculture Committee until after the Arkansas Democratic primary. The reason? Blanche Lincoln is in danger and needs to present a populist success to her electorate. She runs the Agriculture Committee and is responsible for the more draconian rules agreed there. The Senate as a whole is likely to agree to a watered down version of those rules, so it is politic to allow the tough rules to appear dominant until Lincoln has weathered the vote.
And so it goes on.
