Sunday, February 28, 2010

On the Possibility of Both Monetary and Fiscal Impotence

dre cummings recently used the term "incredulous" to describe his reaction to optimistic accounts of the economy. As usual dre is right. Above is a chart of bank reserves held at the Fed. The bottom line is the banks are still hoarding massive capital--even more than during the fall of 2008. They obviously do not trust their own balance sheets, the economy or both. This represents a massive pool of idle capital. The flip side is that banks are not lending. Thus, the WSJ headline from Wednesday: Lending Falls at Epic Pace. Under these circumstances monetary policy is ineffective because it depends upon banks lending their liquid assets.

We are also out of fiscal policy ammunition. Credit markets are wary of sovereign debt, and as Martin Wolf (Chief Economics Commentator at the Financial Times) points out it seems that a sovereign debt crisis is inevitable. Frankly, we wasted our fiscal stimulus on ineffective tax cuts instead of massive investment, as I argued in late 2008. Political support for a timely stimulus is wanting to say the least.

So with no monetary policy solution and no fiscal policy solution any kind of crisis will not be met with appropriate government action. We seem destined to face the next major downdraft without hope of government rescue.

Will there be such a downdraft? Well, spring is just around the corner, and in Chicago during the spring even the thought that the Cubs could win the World Series seems plausible.

But, the economy is facing severe headwinds. One excellent summary of the problems (with some level of excessive pessimism) can be reviewed here. Everyone should look at the gory facts--all 15 of them. They fully support dre's point. Any one of these problems could cause a repeat of the nightmare of late 2008; in fact, our government has done virtually nothing to assure that such a repeat does not occur. As Noble prize winning economist Joseph Stiglitz puts it:

"On regulatory issues, almost nothing has been done. The structure of the banking sector is worse. The too-big-to-fail banks are bigger. Of the smaller banks, 181 went bankrupt since 2008. In the bailout, the banks didn't do what they were supposed to do, which was to restart lending."

Stiglitz also maintains that US standards of living now have nowhere to go but down. We have been living from bubble to bubble, consuming more than we produce for too long. Now we are indebted and need to tighten our belts not just to live within our means but to pay off excessive debt. Indeed, as the chart to the left shows, our debt situation has worsened through the present crisis, as our wealth has shrunk, our incomes are declining, and our debt is therefore more unsustainable now than it was at the beginning of this nightmare.

To sum up: we still have way too much debt in our economy; the banks still seem insolvent, terrified of their balance sheets and unable to lend; our regulatory system is a proven catastrophe; and we must under go a painful deleveraging that is just getting started because we missed our opportunity for massive government led investment. And, we have reached the point of both monetary and fiscal (or at least political) impotence--something that has never before happened in the history of modern capitalism.

The question I have is this: if we do experience another downturn and government is unable to respond in force, what does that reality look like?


  1. I followed your link to the EPI website. The EPI is a left-wing, union backed think tank specifically set-up to promote a political agenda. Not surprisingly, their "research" finds fault with tax cuts and advocates more government spending.

    This article, published in the New York Times and written by Harvard economist Gregory Mankiw presents the other side of the argument.

    Quoting from your EPI source:

    Even worse were the Bush tax cuts of 2003 ...

    Following the 2003 tax cuts the unemployment rate fell from 6.3% to 4.7% and real private sector investment surged 28%. Not only did tax revenue not fall off, as predicted by left-wing economists, but revenue from capital gains doubled. Further, following the tax cuts of 2001 and 2003 the rich wound up shouldering more of the overall tax burden, not less.

    In addition, the 2008 package called for $100 billion in personal tax ‘rebates’. Only about one-third of the rebate checks, which ranged from several hundred to two thousand dollars per family, were spent.

    This is the same old tired leftist trope; transfer payments = tax cuts. It's important to use clear language. "Tax cuts" refers to a reduction in payment for those who actually pay taxes. "Tax rebates" refers to transfer payments to those who either do not pay taxes or pay very little in taxes. We used to call this welfare. The later, transfer payments, is what President Obama and the Democrats included in the 2008 "stimulus" and no conservative believed that they would be successful at stimulating the economy since they did not a) reduce the tax burden of taxpayers and b) provide incentive for investment.

    The economy is languishing is for several reasons. 1) Businesses know that their tax burden is going to increase significantly in the not too distant future, due to both the expiration of the Bush tax cuts and the dramatic increase in government spending. 2) The uncertainty of health care reform and it's associated costs has made businesses reluctant to add to payrolls. 3) The policies of the Obama administration threaten to increase the costs of energy and other inputs - particularly if those inputs are secured from foreign sources. 4) Businesses see the current government entitlement regime as unsustainable and economically destructive and fear that, absent reform, it will dramatically increase the cost of employment and diminish economic growth. In short, the administration has added increased uncertainty to a predictably difficult future.

    Young people entering the workforce today will spend most of their productive working lives paying for the reckless spending of this congress and administration and for entitlement programs that they cannot hope to benefit. Is that the Change they had Hoped for?

  2. To blame the "reckless spending" on Obama is just wacked. George W. Bush spent money like a drunken sailor. Two very expensive wars were mismanaged at a cost of trillions. The Big Pharma giveaway cost trillions more. Then allowing the financial meltdown to occur in a regulatory vacuum killed our economy. Finally, the Bush-Paulson bailouts were the ultimate in big spending programs that trashed our economy for the long term. The greatest socialist in our history was George W. Bush. He gave the keys to the US Treasury to his pals.

    The tax cuts caused enormous deficits even before the financial crisis and also washed away the bi-partisan surpluses of the 1990s.

    Your partisan rhetoric is always the same nonsense: everything is the fault of Democrats and the GOP has a monopoly on virtue.

    The truth is this fiscal night mare was 98% engineered by George Bush and the GOP.

  3. Your partisan rhetoric is always the same nonsense ...

    Unlike your partisan rhetoric which seems to be backed up solely with studies from left-wing think tanks.

    Here's a little civics lesson, only Congress can spend money. Every spending bill must originate in the House of Representatives. In 2006-7, when Nancy Pelosi and the Democrats took over Congress the budget deficit was approximately $150 billion dollars. Since that time, it has been the Democrats that have been spending like "drunken sailors". ALL of the spending that you would like to lay at the feet of George Bush was first appropriated by the Democrats and Barrack Obama supported ALL of it, either as a senator or as president. In fact, Bush used about half of the TARP funds supporting banks that have largely paid that money back, with interest. The other half was used by Obama to bailout the UAW who, along with other unions, spent $450 million getting Democrats elected.

    What's truly "wacked" is your willful blindness to the damage that government involvement in the economy has caused, and the impact that has had on the futures of thousands of innocent people. Instead, you rant against Wall Street, the bankers and the corporations claiming that all of this could have been avoided if only the "truly enlightened" were given greater authority to regulate the same industries that they, through their previous misguided regulation, had just laid waste too. Talk about claiming a monopoly on virtue.

    As for the "Big Pharma giveaway", it pales in comparison to the trillions upon trillions that trial lawyers have stolen through legislative sweetheart clauses and fraudulent lawsuits. Lawsuits which have driven up the cost of everything from medical care to transportation. And, unlike trial lawyers who seek only to enrich themselves, "Big Pharma" produces products that reduce suffering and save lives. What have trial lawyers given us in return for their giveaway?

    Save the lectures for someone who doesn't know any better.

  4. Have you ever tried a case? Ever represent a defendant or a plaintiff?

    Ever hear of Rule 11?

    Name one "legislative sweetheart clause."

  5. Name one "legislative sweetheart clause."

    Alright, how's this for starters?:

    Buried in Speaker Nancy Pelosi's 1,990-page bill is a provision that provides "incentive payments" to each state that develops an "alternative medical liability law" that encourages "fair resolution" of disputes and "maintains access to affordable liability insurance." Sounds encouraging. Read on, however, and you come to this nugget: The state only qualifies if its new law "does not limit attorneys' fees or impose caps on damages."


    Huge contingency fees and damage awards are the mother's milk of frivolous lawsuits. That's why 30 states have adopted caps on awards as the core of their reform, with huge success. Texas imposed malpractice caps in 2003, and the state has been rewarded with fewer lawsuits, a 50% drop in malpractice premiums, and a flood of new doctors. The House bill is intended to discourage other states from doing the same.

    The Pelosi bill also provides these incentives only if states adopt watered-down alternatives to existing malpractice caps. Those alternatives include certificate-of-merit rules, which in theory require lawyers to get medical proof before suing but in practice mean that lawyers recruit and finance "expert" witnesses.

    States could also provide "early offer" rules, which are supposed to encourage fair settlement of legitimate claims. But as organizations like the Manhattan Institute have noted, those offers only work if combined with restrictions on lawyer fees and damage awards that reduce the incentive to go for the jackpot judgment.

    Wall Street Journal

  6. Not enough?? There's lots more.

    Concerned by the increasing regularity with which some state attorneys general are hiring personal injury lawyers to pursue lawsuits on behalf of their states, the American Tort Reform Association has published a 50-state study of the statutes governing such hiring and the disclosures thereof.

    Entitled Setting the Course, Establishing Best Practices for Attorney General Use of Outside Counsel (4.6MB PDF), the ATRA study grades state laws on the good government principles of public disclosure, competitive bidding, oversight and fiscal responsibility. It focuses on the inadequacies of requirements placed on state attorneys general as they sometimes engage in inappropriate relationships with outside counsel.

    "Some activist state attorneys general are offering no-bid contingency fee contracts, potentially worth many millions of dollars or more, to personal injury lawyers who have made substantial campaign contributions to those same AGs," explains ATRA president Tiger Joyce. "This abusive pursuit of personal interests directly conflicts with the public interest, and state laws should work to eliminate such abuse."

    The National Association of Attorneys General has appointed a Best Practices Task Force that has considered ATRA's recommendations for greater transparency. The task force is expected to report to the full NAAG during its annual meeting in Washington in early March.

    LINK to Study ATRA

    Tort lawyers are about to get another big payoff from Congress and the Obama administration for the hundreds of millions of dollars they contributed to candidates in the last election cycle (over 75% of which went to Democrats). If it reconciles the differing versions of the so-called Fraud Enforcement and Recovery Act of 2009 that the House and Senate passed (which could happen yet today), Congress will finalize amendments to the federal False Claims Act that will hurt our economy but make the trial lawyers very happy indeed.

    Heritage Foundation

    The Trial Lawyers' Earmark: Using Medicare to Finance the Lifestyles of the Rich and Infamous

  7. Is it possible banks arent lending because they dont know how? Wouldnt the last 5-8 years show that the under qualified loan officers they hire, (no college education required) squandered money and allocated funds to families who were not capable of affording the interest payments. A friend of mine 23 and an AA from Keiser made $135,000 his first year in the business. I knew something was wrong then. Commercial real estate is tanking, opening up a business is a great risk especially when some of those expenses are going to be on credit cards who are now charging 25%. If I were a bank I'd sit on my money too. It would be bad business not to. Banks have gotten free money and their throwing it into treasury's. Borrow at zero and getting three percent not a bad deal. In the mean time the american family borrowing at 25%. Some stimulus?
    Aaron Passy STU

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