Obama must start punching harder
By Gideon Rachman
Just five years ago, Barack Obama was still a local politician in Illinois, preparing for a run for the US Senate. His office wall in Chicago at the time was decorated with the famous picture of Muhammad Ali standing over Sonny Liston, after knocking him out in a heavyweight title fight. Ali famously boasted that he could “float like a butterfly and sting like a bee.” But now that Mr Obama is president, he seems to float like a butterfly – and sting like one as well.
The notion that Mr Obama is a weak leader is now spreading in ways that are dangerous to his presidency. The fact that he won the Nobel Peace Prize last Friday will not change this impression. Peace is all very well. But Mr Obama now needs to pick a fight in public – and win it with a clean knock-out.
Read the FT’s international affairs columnist’s authoritative and lively commentary throughout the week
In truth, the Norwegians did the US president no favours by giving him the peace prize after less than a year in office. The award will only embellish a portrait of the president that has been painted in ever more vivid colours by his political enemies. The right argues that Mr Obama is a man who has been wildly applauded and promoted for not doing terribly much. Now the Nobel committee seems to be making their point for them.
The rightwing assault on the president is based around a number of slogans that are hammered home with damaging frequency: Obama the false Messiah; Obama, the president who apologises for America; Obama, the man who is more loved abroad than at home; Obama, the man who never gets anything done; Obama the hesitant; Obama the weak.
Of course, this is the kind of stuff that was always going to be hurled at a liberal, Democratic president by the Republicans. The danger for Mr Obama is that you are beginning to hear echoes of these charges from people who should be the president’s natural supporters.
One leading European politician warns that Mr Obama is looking weak on the Middle East: “If he says to the Israelis ‘no more settlements’, there have got to be no more settlements.” And yet it is the White House, not the Israeli government, that has backed down.
Even before the Nobel announcement, liberal American columnists were sounding increasingly sceptical about the man they once supported with such enthusiasm. Richard Cohen wrote in the Washington Post that the president “inspires a lot of affection but not a lot of awe. It is the latter, though, that matters most in international affairs where the greatest and most gut-wrenching tests await Obama”. Now Saturday Night Live – the slayer of Sarah Palin – has turned its fire on President Obama, portraying him a do-nothing president.
How has this impression built up? The promise of bold changes of policy on the Middle East and Iran – without much to show for it – has not helped. The public agonising over policy towards Afghanistan has been damaging. The slow pace of progress on healthcare has hurt.
Even the president’s strengths can begin to look like weaknesses. His eloquence from a public platform has begun to contrast nastily with his failure to get things done behind the scenes. I winced when I heard him proclaim from the dais at the United Nations that “speeches alone will not solve our problems”. This, from a man who was due to give three high-profile speeches in 24 hours in New York. I winced again, when Muammer Gaddafi of Libya told the UN that he would be happy “if Obama can stay forever as the president”.
Obviously, the gloom can be overdone. Mr Obama has been dealt a very difficult hand. He arrived in office when the entire global financial system was still shaking. The American economy remains in deep trouble. The president inherited two wars that were going badly and a deep well of international resentment towards the US. The Nobel committee’s decision was silly, but it reflected something real – the global sense of relief that the US now has a thoughtful, articulate president, who has some empathy for the world outside America. Mr Obama’s conservative critics might deride him as “Hamlet” because of his indecision over Afghanistan. But President Hamlet is still preferable to President George W. Bush. At least Mr Obama makes decisions with his head, rather than his gut.
It is worth remembering that the presidency of Bill Clinton also got off to a very rocky start. Mr Clinton failed over healthcare, blundered around over gays in the military (an issue that President Obama is now revisiting) and suffered military debacles in Somalia and Haiti. And yet he went on to be a successful president. Mr Obama has not yet suffered setbacks comparable to the early Clinton years – and he still has plenty of time to turn things around.
But momentum matters. The president badly needs a quick victory or a lucky break. He also needs to show that, at least sometimes, he can inspire fear as well as affection. Mr Obama can charm the birds off the trees. He can inspire crowds in Berlin and committees in Oslo. But – sad to say – he also needs to show that he can pack a punch.
So How Is the Stimulus Working Out?
Give us money, and we’ll give you jobs. That was the promise President Barack Obama made when he asked Congress for a $789 billion stimulus bill back in January. The cash, the administration said, would create millions of jobs over the next two years.
Here was the argument as presented in the January report by the Council of Economic Advisors' Christina Romer and chief economist to the vice president Jared Bernstein, called “The Job Impact of the American Recovery and Reinvestment Act”:
The U.S. economy has already lost nearly 2.6 million jobs since the business cycle peak in December 2007. In the absence of stimulus, the economy could lose another 3 to 4 million more. Thus, we are working to counter a potential total job loss of at least 5 million … even with the large [stimulus] prototypical package, the unemployment rate in 2010Q4 is predicted to be approximately 7.0%, which is well below the approximately 8.8% that would result in the absence of a plan.
Based in part on this argument, President Obama got his money. So what happened since then?
Using data from the president’s website Recovery.gov and data from the Bureau of Labor Statistics, this chart shows the monthly increase in the unemployment rate in tandem with the administration’s stimulus spending.
Since April 2009, the administration spent roughly $90 billion, or 18 percent of the total stimulus spending, on top of $62 billion in tax relief. During that time, the unemployment rate grew from 8.9 percent to 9.8 percent. And according to the Bureau of Labor Statistics, job losses accelerated in September. As we see here, the current unemployment rate is already far above the 8.8 percent the administration said the rate would top out at next year without a stimulus.
How can we explain this? For starters it seems the administration misjudged the severity of potential job losses.
When the government grows by $1, the private sector shrinks by 20 cents, according to one estimate.
With respect to the stimulus, there are two theories on why unemployment keeps rising despite stimulus dollars. Some economists, including Paul Krugman, have argued that the problem with President Obama’s plan is that it doesn't spend enough. Hence, they think that a second stimulus is needed. Yet it is hard to argue that we already need another stimulus when less than a quarter of the money has been spent.
Other economists are arguing that the money is not being spent fast enough. Indeed, at this rate, the economy is likely to have recovered before most of the stimulus money has been spent.
One potential problem with the slow rate of spending is highlighted by some new Keynesians who typically teach that government spending can only grow the economy in the short run. After that, government spending actually hurts the private sector. Under the current plan, only 25 percent of the total spending will take place in 2009 (within four years all the money will be spent). That is too slow, they claim, since by the time the economy starts recovering, most of the stimulus money will remain unspent and, by then, government spending will actually hurt the economy.
It is hard to argue that we already need another stimulus when less than a quarter of the money has been spent.
So, what do the data say? There are few studies on the issue, but two have found that government spending shrinks the private sector, at least a little. Looking at war spending, Harvard University’s economist Robert Barro estimates that the multiplier of government spending is 0.8: when the government grows by $1, the private sector shrinks by 20 cents. Also, using a variable that takes into account the fact that military spending is anticipated several quarters before it actually occurs, the University of San Diego’s Valerie Ramey has shown how U.S. military spending influences GDP and estimates that the multiplier of government spending is between 0.6 (when World War II data is excluded) and 1 (when it is included). Thus both papers support the “crowding out” hypothesis.
More interestingly, in a recent Wall Street Journal piece, Barro and Charles Redlick add that while government spending during a period of average unemployment crowds out private investment, an increase in unemployment makes government intervention slightly more efficient. They write, “Our research also shows that greater weakness in the economy raises the estimated multiplier: It increases by around 0.1 for each two percentage points by which the unemployment rate exceeds its long-run median of 5.6%. Thus the estimated multiplier reaches 1.0 when the unemployment rate gets to about 12%.” In other words, it takes a lot of job losses for government spending to stop shrinking the private sector.
Putting aside the question of whether the stimulus is too small or being spent too slowly, what too many stimulus advocates overlook is that to spend money, the government needs to either borrow, tax, or print it (or combine these). Money taxed or borrowed from the private sector is money that firms cannot spend on goods or employees. The government’s slice of the pie gets bigger by making the rest of the pie smaller. This may explain in part why the stimulus has not translated into declining unemployment.
Veronique de Rugy is senior research fellow at the Mercatus Center.
It was because of a woman named Bertha Kinsky. She was a pacifist and a free-thinker (which means anti-religious). He fell in love with her, and they married, but she left him. He was wealthy, but not intellectually respected. He inherited his father's industrial business, which was, horror of horrors, an arms manufacturer. He was not a college graduate, but he learned chemistry anyway and developed dynamite, and became one of the wealthiest men in the world. He went on to write poems and anti-Christian plays, but they never respected him. She never really respected him. Alfred Nobel had money, but not status.
Then came an erroneous news report that he had died. Nobel had an experience that few ever get: he read his own obituary. It was harsh, referring to him as a merchant of death. Didn't they know what dynamite was mainly used for? Roads, bridges, tunnels. Dynamite brought people together when giant mountains of stone kept them apart. But that never was enough for the intellectuals, the journal people, Bertha's kind of people. Alfred Nobel, who had used his mind to create something of much greater value than all of the free-thinking playwrights and revolutionary poets, was unhappy. He wanted them to love him; he wanted her to love him. He wanted a glowing obituary.
His beloved Bertha, with whom he still corresponded long after their divorce, had an idea: Alfred could use his money to create a prize. People who work for peace, like Bertha's friends, would get money and acclaim for their efforts.
So he gave much of his fortune to the creation of a prize that would give money to exactly the type of people who had held him at arms length. He tried to buy their love. He tried to buy her love. He gave the authority to confer the prize to the government of Norway (which at the time was under the same crown as Sweden).
He got his glowing obituary. He didn't get the girl. The world got dynamite and was crisscrossed with train tracks and roads and bridges. Mountains became temporary impediments, rather than permanent dividers. The backs of millions of laborers were saved by this useful chemical compound. And yes, sometimes dynamite was used as a weapon.
But the prize has been used as a weapon, too. A Nobel to Carter, a Nobel to Gore, a Nobel to Obama. It appears that the parliament of Norway does not like George W. Bush very much. Carter was given a prize for negotiating a nuclear non-proliferation agreement with North Korea that was violated almost immediately. Gore's came just before his global warming hypothesis began to unravel among serious scientists and practically anyone else with a thermometer. Obama got one, well, just for being Obama. Or, more to the point, for not being Bush.
And let's not forget Arafat. Alfred Nobel tried to buy atonement from the intellectual world for the 'sin' of creating an explosive. But in 1994, in its finite wisdom, the Nobel committee bestowed his prize on the greatest recruiter of suicide bombers in historyWhy Milton Friedman Is Still Right
The easy-money advocates had a tough summer. In August alone, the price level increased almost half a percent, raising the average annual rate of inflation for the past three months to almost 5 percent. Wholesale prices, especially of raw materials, have also been moving upwards, as has the “prices paid” index of the Institute for Supply Management's survey of the manufacturing sector (the service sector has had more mixed recent results). Across the board, the stats show a broad consensus that we have switched from a deflationary trend to an inflationary one.
When the facts are against you, you can either change your mind, or switch the argument from facts to theory. The easy-money guys have chosen the latter course.
Recently, a client sent me an article written by economics blogger John Mauldin (see his chart below). Mauldin has written some of the best work arguing that America is far more likely to see deflation than inflation. His argument revolves around the concept of monetary “velocity,” that is, the rate of money turnover. If each dollar is spent and re-spent many times over, that is a high velocity. If the money is spent only a very few times, then the velocity is low.
Others are advancing the velocity view. For example, the New York Times’s Paul Krugman has dusted off the Keynesian liquidity trap theory in order to convince America that deflation is the more worrisome threat. In Krugman’s case, it seems as though politics are in charge, and the economics seem to be there for no more reason than to provide an elaborate justification for more stimulus spending. I have been taught that the best way to uncover truth is to debate against the opposing views in their clearest and best forms: and the clearest and best form of the case for deflation is not Krugman’s political polemics but Mauldin’s economic theory. Mauldin is a truth-seeker, not a propagandist.
Originally, the strong focus on the velocity of money goes back to John Maynard Keynes, who used it as part of his general effort to overthrow the Victorian classical consensus that a stable supply of money is the source of stable prices. Keynes argued that inflation was as much a matter of the velocity of money as of its supply. Hence, the government had an obligation to manipulate the economy in such a way as to stimulate velocity in order to overcome deflationary recessions. In essence, Keynes said do not worry about debasing the currency, because that is not a likely source of inflation.
It did not take long before the classical camp corrected the record. Financial journalist Henry Hazlitt accurately identified the theoretical problems with this view:
I have said nothing above about the much-discussed “velocity-of-circulation” of money, and its supposed effect on prices. This is because I believe the term “velocity-of-circulation” involves numerous irrelevancies and confusions. Strictly speaking, money does not “circulate”; it is exchanged against goods. A house that frequently changes hands does not “circulate.” A man can only spend his monetary income once. Other things remaining equal, “velocity-of-circulation” of money can increase only if the number of times that goods also change hands (say stocks or bonds or speculative commodities) increases correspondingly …
An increase in the “velocity-of-circulation” of money, therefore, does not necessarily mean (other things remaining unchanged) a corresponding or proportionate increase in “the price-level.” An increased “velocity-of-circulation” of money is not a cause [emphasis Hazlitt’s] of an increase in commodity prices; it is itself a result of changing valuations on the part of buyers and sellers. It is usually a sign merely of an increase in speculative activity. An increased “velocity-of-circulation” of money may even accompany, especially in a crisis at the peak of a boom, a fall in prices of stocks or bonds or commodities.
---The Failure of the ‘New Economics,’ by Henry Hazlitt, 1959
Later, Milton Friedman’s monumental Monetary History of the United States empirically crushed the Keynesian model with page after page of data. Friedman concluded that “inflation is always and everywhere a monetary phenomenon.” And that has been that ever since.
But the trauma of recent history has convinced some, and pro-stimulus special pleading has convinced others, to abandon the classical model once again and declare that the monetary and fiscal spigots should remain open for a long time; commodity, dollar, and bond investors have been using their mouse clicks to vote early and often for the opposite. Others are arguing that we need not worry about inflation because inflation cannot occur without an increase in monetary velocity. Therefore the various market indicators should be ignored and the Fed should keep the money flowing.
Mauldin, in particular, argues that Friedman’s views are obsolete because Friedman did his inflationary work in the time before changes in monetary velocity were measured. So, Friedman (and by implication all of the classical free-market crowd) were stuck focusing on money supply when it was velocity that was caused inflation. But the problem is that the velocity argument was wrong from the beginning. It put money in the center of the analysis, rather than the production and exchange of goods and services. Money is the means, not the ends of economics. Transactions are what count. For a time they were conducted by barter, then later facilitated by money, but money is ancillary. In classical logic terms, it is accidental to the transaction, not essential to it. The transaction causes money exchange, not the other way around.
If we are buying and selling at the same rate as we were before, then the only way to change prices is to change the supply of money.
This points in a powerful way to an extremely important flaw that Keynes introduced into modern economic reasoning. Keynes repeatedly argued that certain variables were “functions” of other variables. Since function theory was all the rage in mathematical reasoning at the time, this gave Keynesianism a veneer of scientific sophistication. It did add precision to economic calculation and that was an advance. But it also took something away. It took away the notion of causality. Classical economics was built on the foundation of classical philosophy and formal logic. Logic taught that there are three acts of the mind which were needed to derive a valid inference. First there was apprehension, that is the mind had to understand the terms involved. Second, there was judgment, the action in which the mind assents to the truth of a statement. Finally, there is reasoning, by which the mind uses premises to draw a valid conclusion. Apprehension answers the question “what.” Judgment answers the question “whether” and reasoning answers the question “why.”
When Keynes began to declare that, say, output, was a function of, say, velocity. He was actually destroying insight, because functions are silent on the question of cause and effect. Equations do not flow in one direction or another, they make no distinction between Y=MV on the one hand and MV=Y on the other, so they take causality out of the thought process. Once that was done, economics became at once more confused and at the same time more confident in its newfound scientific rigor.
One of the ways to guard yourself against this confusion is to translate ideas back from mathematical expression into plain English prose with concrete subjects, verbs, and predicates. Once that is done the fallacies are far more easily detected and dealt with. Once you have grasped the true cause-and-effect relationships between various ideas, you can go back to the formula and know where and how to use it.
For example, Mauldin (brace yourself for a bit of algebra, or skip this paragraph) argues that
Y=MV
Y=PQ
so
MV=PQ
if M and Q are held constant, then
V varies with P
In quasi-English:
Output (basically GDP) is a multiple of the amount of money (M) and the velocity of money (V). Then he argues that Y=PQ, that is output is a multiple of the price of goods (P) and the quantity of goods sold (Q). If Y equals MV and Y also equals PQ, then it follows mathematically that MV=PQ. So if M stays the same and Q stays the same, and V goes up then P must go up too. Hence, velocity causes inflation!
Except that in the real world velocity doesn’t cause inflation. The attached chart which Mauldin himself produced shows that sometimes velocity and inflation coincide and sometimes they do not.
The problems become apparent once the algebra is translated into plain English. Yes, output is composed of the number of new goods and services purchased times the average price. Yes output also equals the number of dollars circulating times the number of times each dollar circulates. Both things have to be true, but it is the causes that matter. Dollars circulate because people are buying and selling things. The more cars and houses and cab rides and computer programs we produce and sell, the more turnover of money there is, but the money does not cause the transactions. It is the other way around: the transactions cause the money flows. Once you understand this, the whole velocity argument falls into ruins. Because if you translate the math into plain English, you are really saying that if we increase the number of times people pay for things, but do not increase the number of times people sell things, then the price will go up. But this is insanity. In the real world, velocity of money and quantity of sales go up and down together: you cannot possibly increase V without increasing Q. Money changes hands precisely so that goods can change hands.
Once we get that notion, we can never be fooled by Keynes again. Taking into account the way the real world of cause and effect operates, we see that you should hold velocity and quantity the same. This means that as money goes up, so does price. In English, if we are buying and selling at the same rate as we were before, then the only way to change prices is to change the supply of money.
In other words, “inflation is always and everywhere a monetary phenomenon.”
Jerry Bowyer is an economist, columnist, and CNBC contributor, and blogs at www.bowyerbriefing.com.
Have We Misdiagnosed the Crisis?
Most people have a general idea of the events that led to the current recession. Lax lending standards contributed to a housing bubble that peaked in mid-2006. As housing prices began declining, more and more mortgages were defaulted on, and bank balance sheets deteriorated rapidly. In September 2008, Lehman Brothers failed, and the financial crisis seemed to become much worse. A mild recession turned into one of the most severe since the 1930s. But what if the conventional wisdom is wrong? Is it possible that we have fundamentally misdiagnosed the crisis? You might be surprised to learn that some basic insights from modern macroeconomics suggest a very different interpretation of recent events.
I will start with my own somewhat unconventional take on recent events, and then discuss why other economists have reached different conclusions. Keep in mind that this is not merely an exercise in Monday morning quarterbacking; unless we correctly diagnose the problem, we will not be able to come up with effective remedies.
It will be helpful to begin with the concept of nominal GDP, the current dollar value of economic output. Over the past few decades NGDP has grown at just over 5 percent per year. Because real GDP growth averages about 3 percent per year, inflation has recently averaged just over 2 percent. Modern macro theory suggests that monetary policy determines the growth path of nominal GDP. In the long run, monetary policy affects only nominal variables such as inflation and NGDP growth, but in the short run a sudden change in nominal GDP growth can have important real effects, as we are seeing today.
Yes, many foolish subprime loans were made in recent years, but the fall in nominal GDP has turned a $1 trillion fiasco into a $3 to $4 trillion tragedy. It didn’t have to be this bad.
After the magnitude of subprime losses became apparent in the late summer of 2007, NGDP growth slowed, averaging 3 percent during the following nine months. Not surprisingly, real growth slowed as well. When you consider that we also faced a very severe “supply shock” from high oil prices, it is surprising the recession wasn’t more severe during early 2008. The real economy grew slightly during the first half of 2008, despite both the banking crisis and the record oil prices. Then after July 2008 (and before Lehman failed in mid-September) the economy slowed sharply. The recession had been initially concentrated in the subprime real estate markets, but now spread to many inland housing markets.
More ominously, after July 2008 there were many other indicators that money was far too tight. About this time the dollar began rising sharply against the euro; and commodity prices began a sharp decline. Real interest rates rose from less than 1 percent in July to more than 4 percent by November. In the first ten days of October the stock market crashed 23 percent, signaling much more bearish expectations for the economy. The recession spread beyond housing, depressing manufacturing and other sectors. Both real and nominal GDP fell at annual rates of 5 percent to 6 percent in the fourth quarter of 2008 and the first quarter of 2009. By the second quarter of 2009, nominal GDP was 2.4 percent below its level a year earlier, and an astounding 7.5 percent below the long-term trend. Nominal GDP growth is very important during a debt crisis, as loan defaults soar when nominal incomes decline. During 2009 we may well experience the largest decline in nominal income since 1938. Yes, many foolish subprime loans were made in recent years, but the fall in nominal GDP has turned a $1 trillion fiasco into a $3 to $4 trillion tragedy. It didn’t have to be this bad.
Over the past several months, I have been arguing that the general public and even most economists missed a fundamental change in the nature of the crisis during the late summer of 2008. Whereas the initial downturn was mostly caused by “real shocks,” such as banking turmoil and high energy prices, the far more severe second stage of the recession was triggered by a sharp decline in NGDP, which represents a failure of monetary policy. A common cold had turned into pneumonia, but was still being treated like a viral infection. The most controversial part of my thesis, and the hardest to understand, is my argument that monetary policy was actually far too contractionary during late 2008, relative to the needs of the economy. At the time, most economists simply assumed that policy was expansionary because the Fed had cut rates to relatively low levels, and the “monetary base” (which is the money produced by the Fed) rose very dramatically in the fourth quarter of 2008. Neither nominal interest rates nor the money supply, however, is a reliable indicator of the stance of monetary policy.
You might be surprised to learn that economic historians no longer believe that financial instability was the cause of the Great Depression.
To better understand this issue, let’s go back and look at what happened in the Great Depression. After the stock market crashed in late 1929, the Fed gradually cut interest rates, from about 6.5 percent to 1.5 percent. In addition, they sharply raised the monetary base over the following three and one half years. Does this sound familiar? At the time, most people thought that monetary policy was highly expansionary, and that the Depression was caused by financial instability (the stock market crash, banking panics, etc.). Today, as in the 1930s, almost everyone considers the financial crisis to be the proximate cause of the severe contraction that occurred late last year (although experts differ as to the deeper root causes); indeed it is difficult to find anyone promoting alternative explanations. Therefore, you might be surprised to learn that economic historians no longer believe that financial instability was the cause of the Great Depression. Instead, the most accepted explanation, popularized by Milton Friedman and Anna Schwartz, is that the Depression represented a failure of monetary policy.
Friedman and Schwartz argued that both nominal interest rates and the monetary base were unreliable indicators of monetary policy during the Depression. Interest rates fell because of deflation and a weak economy, not because money was easy. In fact, tight money can actually cause interest rates to fall, and did so in December 2007, when a contractionary policy surprise from the Fed (a smaller than expected rate cut) reduced Treasury bond yields on maturities from three months to 30 years. Most people are only familiar with the so-called liquidity effect, the tendency for nominal interest rates to fall when money is added to the economy. But monetary policy also affects real growth and inflation, and in doing so can cause interest rates to move in a “perverse” direction. That happened in the early 1930s, and again in 2007 to 2008.
But what about the money supply? Didn’t that fall in the Great Depression? Actually the quantity of money directly produced by the Fed rose sharply, as the Fed partially accommodated the extra demand for liquidity by the public and banks. Today, we again see a big increase in the monetary base (comprised of bank reserves and cash.) Friedman and Schwartz focused on the so-called monetary aggregates, such as M1 and M2, which are mostly comprised of bank deposits. It is true that M1 and M2 have recently risen, whereas these aggregates fell sharply in the early 1930s. But that doesn’t mean money is easy today, rather the earlier pattern reflected the lack of deposit insurance. Today, FDIC-insured bank deposits are a very safe and liquid refuge in a time of financial instability. Furthermore, in the 1980s most economists concluded that monetary aggregates such as M1 and M2 were not reliable monetary policy indicators.
If neither the money supply nor nominal interest rates are reliable policy indicators, which indicators are reliable?
Of course, not everyone accepts Friedman and Schwartz’s interpretation of the Great Depression. But Federal Reserve Chairman Ben Bernanke does, at least he accepts their argument that the Fed was to blame for the Great Contraction of 1929 to 1933. So I don’t think we can simply say that Fed policy was “obviously” expansionary in late 2008, simply because nominal interest rates were cut and the monetary base increased sharply. That may be the case, but we need to probe more deeply before reaching any conclusions. But if neither the money supply nor nominal interest rates are reliable policy indicators, which indicators are reliable?
For almost a quarter-century, I have been advocating a “forward-looking monetary policy,” where policy makers would target the forecast. Thus, if the Fed’s policy goal were 2 percent inflation, they would adjust monetary policy until the expected rate of inflation was about 2 percent. If inflation was expected to be more than 2 percent, the current policy stance would be too expansionary, and vice versa. More recently, prominent economists such as Lars Svensson of Princeton have also advocated targeting the forecast. Bernanke has not explicitly endorsed this policy, but in a number of statements he has hinted that he looks at things this way. For instance, he recently stated that “the longer run projections of inflation may be interpreted, in turn, as the rate of inflation that FOMC [Federal Open Market Committee] participants see as most consistent with the dual mandate given to it by Congress.” Note that Bernanke only commits to targeting longer run inflation forecasts—multi-year forward inflation rates, not the 12-month forward rate that I would like to see targeted.
At first the idea of using forecasts of inflation or NGDP growth as monetary policy indicators seems very odd; we are used to concrete policy tools like the Fed funds rate or the monetary base, not vague concepts such as expectations. But on closer analysis there is nothing that could be more sensible. After all, why should the Fed set policy at a level where they do not expect to hit their target? Why should they adopt a policy stance that is expected to fail? If they want 2 percent inflation, and their forecast unit expects 0 percent inflation, doesn’t that indicate that policy is too contractionary? And yet this is essentially what happened last fall. You might wonder how I can be so certain about this, after all, the Fed does not even set an explicit inflation target, so how can I possibly know that they expected to miss their target?
To my great surprise I found very few economists who shared my view that monetary policy was disastrously off course, far too contractionary for the needs of the economy.
Although the Fed has never set an explicit policy target, they have frequently hinted that they prefer roughly 2 percent inflation. One reason that the Fed has not set an explicit target is that important congressmen such as Barney Frank oppose the idea, and like to remind the Fed of its “dual mandate” to focus on both inflation and unemployment. For this reason, I suggest that they adopt a NGDP target, which takes both inflation and real growth into account. And indeed the Fed does focus on both variables in the short run. Thus, if inflation is right on target but output is falling, the Fed will usually ease policy; and if inflation is 2 percent and the economy is booming, the Fed will often raise the Fed funds target.
During early October 2008, virtually every economic forecast and every market indicator showed both inflation and real output falling far below the Fed’s implicit target. I spoke to a number of prominent economists at this time and there seemed to be little question that the Fed was very worried about the future trajectory of prices and output. This was the first time in 25 years that Fed policy clearly seemed far off course, not just in terms of my own policy preferences, but in terms of any plausible targets the Fed might have. So what went wrong? To my great surprise, I found very few economists who shared my view that monetary policy was disastrously off course and far too contractionary for the needs of the economy. Instead, all the discussion focused on the Bernanke and then–Treasury Secretary Hank Paulson’s bank bailout proposal, as if that could fix a problem of falling NGDP. To me this got things exactly backward; a monetary policy expected to produce sharply falling NGDP would seriously worsen bank balance sheets, making the crisis much worse. It was as if they were trying to bail water out of a boat without first plugging the hole in the hull.
Over the last year, the highly pessimistic forecasts of economists and financial markets during early October 2008 have come to pass. Both prices and output have fallen sharply, dramatically worsening the banking crisis. In his recent “60 Minutes” interview, Bernanke admitted that the early bailout cost estimates had been far too low, as the weakening economy made the banking situation much worse than expected. No one asked him why the Fed set policy last October at a level expected to produce falling prices and output, or why the Fed adopted a policy stance expected to fail. Indeed most of the criticism that did occur last fall focused on the Fed’s ballooning balance sheet, reflecting worries that it might lead to high inflation in the future. What explains this lack of criticism for the Fed’s failure to enact effective stimulus? The most common explanation I get from other economists (for their lack of attention to monetary policy) is that we were in a liquidity trap, and monetary policy had done all it could. I find this response bewildering, for many different reasons.
What explains this lack of criticism for the Fed’s failure to enact effective stimulus? The most common explanation I get from other economists is that we were in a liquidity trap, and monetary policy had done all it could. I find this response bewildering, for many different reasons.
During the stock market crash of early October 2008, the Fed funds rate was set at 2 percent, which is not the 0 percent which occurs in a liquidity trap. It is very possible that an additional 2-percent cut would not have been sufficient to prevent the recession from dramatically worsening, but that hardly explains why it was not attempted at that time. Then, on October 6, the Fed made one of the most significant errors in their 95-year history by beginning a policy of paying interest on bank reserves. This is a policy that the Fed had been planning for some time, and which other central banks have adopted, but the timing could not have been worse. It essentially created a liquidity trap-type environment, at an interest rate still well above zero. Previous liquidity traps, such as in the United States during the 1930s and Japan much more recently, occurred when nominal interest rates fell to zero on short term government debt, and then bank reserves and government debt became almost perfect substitutes. In that environment an increase in the monetary base may simply be hoarded by banks, and thus fail to boost nominal spending.
The policy of paying interest on reserves prevented interest rates from falling to zero, despite huge increases in the monetary base. Many economists were lulled into thinking policy was expansionary when they saw the base nearly double in late 2008. During normal times such a policy would have led to hyperinflation. But monetary theory is based on the assumption that money earns no interest, and thus normally is not a good substitute for interest-bearing securities. After October, however, reserves were like super T-bills, with a higher yield, more liquidity, and zero default risk. These reserves were more like securities than “money” in the normal sense of the term. The entire point of an expansionary monetary policy is to put more money into circulation than the public wants to hold. The attempt to get rid of excess cash balances boosts spending on goods, services, and assets. Now the Fed was deliberately preventing that sort of expansionary effect, by paying banks to hold on to the extra reserves. The justified the policy by arguing that it prevented market interest rates from falling below their target, what economists Robert Hall and Susan Woodward correctly called a “confession” of contractionary effect.
It is very possible that even zero interest rates would not have prevented a severe downturn in late 2008, but the Fed could have gone much further. Once they decided to pay interest on reserves, there was no reason why they could not make that rate negative, at least on excess reserves. A high enough interest penalty would have forced banks to sharply reduce their demand for excess reserve balances, which would have dramatically boosted aggregate demand. In the very unlikely event that all these excess reserves were then hoarded by the public, the Fed could have begun quantitative easing in October 2008. I very much doubt this last step would have been necessary, as demand for base money by the public (in the absence of 1930s-style bank runs), does not change very rapidly. The roughly $700 billion in excess reserves during late 2008 was more than enough to hit any reasonable Fed NGDP target. If an excess reserve interest penalty had forced this money out into circulation, it would have nearly doubled the amount of cash held by the public.
During fall 2008 I was stunned by the lack of criticism of Fed monetary policy by most macroeconomists. I could find almost no one who blamed the Fed for the sharp contraction, despite the fact that much of modern macro theory assumes that central banks, not commercial banks, determine the path of NGDP. But I also found a very interesting pattern; although almost no one agreed with my criticism of the Fed, they disagreed for three very different reasons. One group of economists argued that because we were in a liquidity trap, monetary policy had lost traction, and we now needed to focus on fiscal stimulus. Paul Krugman is probably the most influential proponent of this viewpoint. But I also doubted that this could fully explain the profession’s passivity—after all, the most popular money and banking textbook (by Frederic Mishkin) says that “Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.” I have always believed this to be true; but I began to wonder whether I was the only one.
It turned out that lots of economists are dubious of the liquidity-trap argument against monetary policy effectiveness. And there is good reason for that skepticism. During 1932, Fed attempts to revive the economy were hamstrung by gold outflows, but when Franklin Delano Roosevelt took us off the gold standard in 1933 he was immediately able to sharply raise prices and output. And the Japanese case doesn’t fit either: the Bank of Japan seems to have a target of roughly 1 percent deflation, as each time they approach price stability they have tightened monetary policy. So we do not have any examples of monetary policy being unable to boost nominal aggregates under a fiat money regime. Instead, many conservative economists seem to have refrained from criticizing the Fed for entirely different reasons.
During fall 2008 I was stunned by the lack of criticism of Fed monetary policy by most macroeconomists. I could find almost no one who blamed the Fed for the sharp contraction.
Some conservatives argued that there was not much sign of deflation, other than a brief drop in the Consumer Price Index when oil prices crashed, and thus there was no need for a more expansionary Fed policy. Notice that this view conflicts with not just those on the Left, but even many moderate and right-wing economists, who agreed with Krugman that faster growth in aggregate demand was desirable, but doubted the effectiveness of fiscal stimulus. This second group, which includes figures like Robert Lucas, argued that monetary policy was still effective, and indeed was the best way to boost aggregate demand. So why hasn’t this group been more critical of Fed policy? Lucas argued that the Fed had already adopted a highly expansionary policy, specifically citing the large increase in the monetary base.
I have similar views to many monetarists about the monetary transmission mechanism, and the power of monetary policy in a liquidity trap. So how did I end up with such a different view of the Fed’s role in the crisis? I think there are two reasons. Most economists overlooked the problem of interest payments on excess reserves, and most economists have never fully accepted the radical view that policy must be forward-looking, that the Fed must always target the forecast. Instead, many economists seem to still hold to the old “long and variable lags” view of policy, the idea that the Fed should do some adjustments, and then “wait and see” for the lags to play out. But there is no lag between monetary policy actions and expectations.
On September 16, 2008, the Fed made one of its most costly errors ever. Immediately after the failure of Lehman Brothers, the FOMC decided to leave the target rate unchanged at 2.0 percent. The FOMC statement indicated that they saw the risks of inflation and recession as being roughly balanced. And yet on that day the economy had already been in recession for nine months, and the spread between the yield on five-year Treasury bonds and five-year indexed bonds (a commonly used proxy for expected inflation) stood at only 1.23 percent. They chose to ignore inflation expectations, and instead focus on the relatively high inflation rate during the previous year. By last fall and winter, the indexed bond market showed near-zero inflation expectations over the next five years. Admittedly, the indexed bonds spreads can be misleading, but the consensus forecast of private economists was also well below the Fed’s target; even the Fed’s internal forecast was well below 2 percent. Today the indexed bond market is signaling an expected inflation rate of roughly 0.5 percent over two years and 1.4 percent over the next five years. While we do not have a direct market indicator of NGDP or real GDP growth expectations, both economists’ forecasts and the implicit forecasts embedded in stock and commodity prices pointed to very slow growth in the period after August 2008. In plain English, this means that both economists and investors expected both monetary and fiscal stimulus to fail. Monetary policy should have been much more expansionary last October, and it should be more expansionary even today.
There have been a few other voices who have spoken out forcefully against the stance of Fed policy. James Hamilton is very knowledgeable about the Fed’s balance sheet, and was one of the first to notice the perverse effects of interest payments on bank reserves. Robert Hetzel has an excellent paper showing that policy was too contractionary during August and September 2008. Earl Thompson has shared my interest in forward-looking monetary policies, and has strongly criticized the Fed for ignoring deflation signals.
In 1989 I published a paper arguing the Fed should create and stabilize a NGDP futures market. For instance, if the goal is 5 percent NGDP growth the Fed would agree to buy or sell unlimited quantities of NGDP futures contracts at that price, and let each transaction trigger a corresponding open market operation. If they had done so in the middle of 2008, then 12-month forward NGDP growth expectations would have stayed at plus 5 percent during the fall and winter. Instead they plummeted to levels far below zero, dramatically worsening the financial crisis and creating the worst recession since the 1930s. This policy blunder also resulted in a massive fiscal stimulus and bank bailouts, which will balloon the deficit for years to come. None of this had to happen, even with the subprime crisis. Those loan losses were sunk costs, and would not have prevented an aggressively expansionary policy from boosting nominal GDP. This crisis should be a wake-up call to the Fed and to macroeconomists in general. We need a much more aggressively forward-looking monetary policy.
Scott Sumner is professor of economics at Bentley University and editor of The Money Illusion, a blog that focuses on monetary policy.
Rhett Butler Comes to Washington
In the inaugural issue of National Affairs, University of Chicago Professor Luigi Zingales has a shrewd piece on Capitalism After the Crisis arguing that “the nature of the [economic] crisis, and of the government's response, now threaten to undermine the public's sense of the fairness, justice, and legitimacy of democratic capitalism.”
One of his main points concerns the distinction between being pro-market and being pro-business. Much as the Left tries to conflate these, they are different indeed.
Business, especially big business, is happy with crony capitalism, franchised monopoly, or any other device that will avoid the Darwinism of the free market. Of the billions of dollars now spent lobbying, almost none supports the free market as a concept or an institution. “While everyone benefits from a free and competitive market,” Zingales writes, “no one in particular makes huge profits from keeping the system competitive and the playing field level. True capitalism lacks a strong lobby.”
‘True capitalism lacks a strong lobby.’
Zingales has interesting things to say about the history and implications of the “serious tensions [that] emerge between a pro-market agenda and a pro-business one,” in the United States and elsewhere, and his conclusions are not cheery. He thinks the administration is “launch[ing] us on a vicious spiral of more public resentment and more corporatist crony capitalism so common abroad—trampling in the process the economic exceptionalism that has been so crucial for American prosperity.”
Actually, Zingales may be a bit of an optimist, because the situation is even worse than he depicts. Crony capitalism is irritating, but, within limits, much of it is hardly important. Which company gets a franchise or a contract does not matter much, as long as the project itself is productive and the work is competently done. A tipping point comes when the lobbying for special advantage turns into lobbying for programs that destroy the economic health of the nation, and this is where those billions in lobbying money are, increasingly, going.
For example, the indispensable Overlawyered.com reports on the continuing disaster for small business of the Consumer Product Safety Improvement Act. “Like the other giant in the business, Hasbro, Mattel actively lobbied for CPSIA’s passage, and even as the law has brought undreamt-of woe to thousands of smaller producers of kids’ products, the two big companies seem to be doing rather well under it.”
The lobbying over climate change and green energy grows more intense as the underlying “science” weakens, because the companies committed to making money out of climate change subsidies are frantic to double down before the wheels come off the bus. Health companies are lobbying for vague reforms that address none of the real problems of healthcare—such as the employer base, mandates, state restrictions, tort reform, and lack of portability. Finance companies are accused of looting the Treasury, and of promoting dysfunctional trading systems so that they can skim.
One of Zingales’s main points concerns the distinction between being pro-market and being pro-business. Much as the Left tries to conflate these, they are different indeed.
Since business is business, companies can adopt the philosophy of Rhett Butler in “Gone with the Wind,” that as much money can be made from a civilization’s destruction as from its rise. Furthermore, while it might be thought to raise some problems of personal ethics, management can take the next step and say they owe it to the shareholders to help that destruction along if that is where the opportunities are.
However, it is unlikely that the increasingly mutinous middle class will understand such fine points of corporate and Washington ethics, or forgive a business culture that promotes destruction and stagnation. The danger is that the public does not understand that crony destructionism is about as far from market capitalism as one can get, so heaven knows where we will wind up.
Perhaps business can learn from Rhett, who was less scoundrely than he claimed, because he at least did not actively try to destroy his civilization. We know he joined the Army, after an honorable career as an entrepreneurial blockade runner. We don’t know exactly how he got rich after the war, but if he was a scoundrel, he was a productive one.
So while one cannot escape one’s time, and if destruction is at hand it is reasonable to go into the salvage business, it would be wiser for businesses to band together to defend free market culture and make their money from our civilization’s rise instead.
James V. DeLong is vice president and senior analyst of the Convergence Law Institute, LLC, and special counsel in the Washington, D.C. office of Kamlet Reichert, LLP.
Commentary by Caroline Baum
Oct. 13 (Bloomberg) -- Bubble sightings are proliferating by the day, and with interest rates near zero, it’s not hard to understand why. Easy money leads to excess credit creation, which eventually produces inflation in goods and services prices or some type of asset bubble.
Whether these sightings are real or imagined, on the mark or off-base, is another matter.
Current nominees for bubble status include commodities, stocks and bonds: commodities, because a weak dollar stimulates demand for hard assets; stocks, because they’ve come so far so fast and earnings may not justify the prices; and Treasury bonds, because, I imagine, their absolute yields are low.
Those low yields (high prices) represent the antithesis of a bubble. Treasuries manifest none of the bubble zeitgeist. They’re going up in price because of the fear that everything else may go down. And prices are staying up without the support of New-Era prophesies.
Let’s take a look at bonds in the context of typical asset bubbles and see how they stack up.
1. Optimism
Bubbles may be fueled by credit, but they are kept afloat by an overriding sense of optimism about an asset class, the economy or the future in general.
How do bonds measure up on the sentiment scale? Poorly.
No one is buying 10-year Treasuries at a yield of 3.3 percent because the future looks bright. In fact, investors are buying bonds because they aren’t sure stocks and commodities, with their implied rosy outlook, have a lock on the future; because de-leveraging is deflationary in the short run while the Fed’s bloated balance sheet carries future inflation risks; because credit risk is still a concern; because the banks aren’t done with the cycle of writedowns and credit losses now that commercial real estate is facing the same problems as its residential counterpart; and because return of investment is more important than return on investment.
Investors -- dollar-recycling foreign central banks notwithstanding -- are buying bonds because they’re pessimistic, not optimistic.
2. Belief that prices can’t go down
The recently expired housing bubble is a perfect example of the triumph of faith over reason. Soaring home prices in 2005 represented a little “froth,” not a bubble, according to Alan Greenspan, Federal Reserve chairman at the time.
And who could argue with him? House prices had never fallen on a national average basis since the Great Depression. With history on their side, speculators joined homeowners in the free-for-all (free except for the U.S. taxpayer). Home prices increased by leaps and bounds. Bubble accusations were met with reasons why this time is different.
Buying for Losses
Bonds aren’t part of the ever-rising-prices school. If Treasuries are a bubble, they must be the one where buyers don’t expect huge gains. In fact, it’s just the opposite. Bond buyers know the next big trade is down (yields up). They just aren’t sure about the timing.
Ten-year Treasuries have traded in a post-crisis range of 4 percent to 2 percent and back to 4 percent. Since May, the yield has been slipping, which isn’t a healthy sign. With inflation expectations edging higher -- from close to zero at the start of this year to 1.85 percent now -- the decline in nominal yields is a result of the drop in the real interest rate, or the real cost of borrowing.
Sure, 10-year yields could go back to 2 percent if the stars line up correctly (if stocks test the March lows). Rather than justify the prices, everyone buying the rally will be looking to get out at the first sign of fatigue.
3. New Era
For investors in Internet and technology stocks in the late 1990s, it wasn’t just a New Era they were touting. It was a New Era for a New Economy. Technological innovation related to the Internet was creating boundless opportunities for productivity growth.
Earnings? Not an issue for the New Economy. Concept was everything, with page hits the new metric and return-on-vision the key ratio.
Rising interest rates? Not a problem. Tech start-ups had unlimited access to venture capital. Interest rates didn’t matter. Borrowing was for sissies.
You can’t fool all of the people all of the time, but if enough of them are delusional for a spell, bubbles can continue to inflate.
Yields on Treasury bills may have gone negative in December, but there’s no New Era talk about note and bond yields falling to zero.
The bull market that started in 1981 with bond yields over 15 percent has nowhere to go. One hears a lot more concern about inflation than deflation, which makes sense when the central bank has an over-active printing press.
For Treasuries, then, the upside is limited while the downside potentially huge. If that’s a bubble, just imagine what a bear market looks like.
By Kate Andersen Brower
Oct. 13 (Bloomberg) -- President Barack Obama said a decision on his strategy for Afghanistan will be made “in the coming weeks” as he assesses what the U.S. needs to do with both military and civilian resources.
The president said he wants to achieve stability in the region, including in Pakistan, by training Afghan forces and boosting agriculture and education in both countries.
“We are going through a very deliberate process,” Obama said at the White House, referring to the series of meetings he is holding with national security and military advisers. The next one is set for tomorrow morning.
Obama made the comments after a lunch meeting with Prime Minister Jose Luis Rodriguez Zapatero of Spain. Spain has about 800 soldiers in Afghanistan as part of the North Atlantic Treaty Organization’s International Security Assistance Force, and sent 450 additional troops to provide security for the presidential election in August.
The “principal goal remains to root out al-Qaeda and their extremist allies,” Obama said.
Zapatero said that while Spanish troops have sacrificed in Afghanistan, they will continue training local forces.
Zapatero, a Socialist, has been trying to rebuild ties with the U.S., which deteriorated after he pulled Spanish troops from Iraq in 2004.
Afghanistan Options
Obama is examining options for the Afghan war after the top commander on the ground, General Stanley McChrystal, warned that the U.S. risks failure without doing more to protect the local population from the Taliban. In an Aug. 30 assessment, McChrystal said more international troops would be needed to provide security and train Afghan forces.
Obama is coming under pressure from Republicans and some Democrats to put more resources into the eight-year-old conflict in Afghanistan. Senator John McCain of Arizona, the top Republican on the Armed Services Committee, has said McChrystal is seeking to add 30,000 to 40,000 troops to the 68,000 the U.S. will have there by the end of the year.
“The great danger now is not an American pullout,” McCain, who was his party’s 2008 presidential nominee, said Oct. 11 on CNN’s “State of the Union” program. “The great danger is a half-measure” that tries to “please all ends of the political spectrum.”
Guantanamo Bay
Along with Afghanistan, Obama and Zapatero also discussed the status of the prisoners detained in the war against terrorism and being held U.S. detention facility at Guantanamo Bay, Cuba, as well as Iran and the Middle East and the economy.
Zapatero said they are “still assessing” the number of Guantanamo prisoners that Spain will accept, “but our resolve to support President Obama in this is absolutely clear.”
Obama’s promise to close Guantanamo by early next year has gotten hung up by objections from lawmakers and voters to transferring some prisoners to the U.S. for trial or detention. The administration is under pressure from lawmakers in Congress to send the detainees, who number about 200, to other countries instead of bringing them into the U.S.
The two leaders said Iran must be pushed “to take a path that allows for peaceful nuclear energy” and reject building a nuclear weapon, said Obama.
“I respect President Obama’s peace efforts,” said Zapatero who said he supports the call for a global reduction in nuclear weapons.
Obama said he and Zapatero agreed that “the time is right” for a resumption of negotiations between Israel and the Palestinians that will lead to creation of an independent Palestinian state.
Zapatero said that as the global recession ebbs, he wants to encourage more U.S. companies to invest in Spain.
By Susanne Walker
Oct. 13 (Bloomberg) -- Treasuries rose for the first time in three days on speculation the dollar’s decline will spur demand from foreign investors as the Federal Reserve keeps interest rates at a record low through late 2010.
Today’s rally follows the biggest weekly decline in Treasuries in two months and comes as the dollar slid to the weakest level against the euro since before the bankruptcy of Lehman Brothers Holdings Inc. Fed Vice Chairman Donald Kohn said very low interest rates will be warranted for “quite some time.”
“A decline in the dollar makes Treasuries cheaper,” said Michael Pond, an interest-rate strategist in New York at Barclays Plc, one of 18 primary dealers that trade with the Fed. “That could encourage some buying. If that trend is expected to continue, then foreign investors should expect a decline in the value of their foreign holdings.”
The yield on the 30-year bond fell six basis points to 4.17 percent at 4:15 p.m. in New York, according to BGCantor Market Data. The 4.50 security due August 2039 increased 1 1/32, or $10.31 per $1,000 face amount, to 105 21/32. The yield rose 23 basis points last week, the most since it gained 31 basis points over the five days ended Aug. 7.
The Dollar Index, which IntercontinentalExchange Inc. uses to track the greenback against the currencies of six major U.S. trading partners, dropped as much as 0.5 percent to 75.738, the lowest level since Aug. 11, 2008.
‘And We Must Act’
“It’s a double-edged sword because the weaker dollar is good for exports and the economy, but as a reserve currency you don’t want people losing faith in the value,” said Thomas Tucci, head of U.S. government bond trading at RBC Capital Markets New York, another primary dealer. “We’ve seen the reinvestment of dollars in the front end of the curve over the course of the last three months. It has helped to keep the curve steeper.”
Inflation and economic growth will probably stay below the central bank’s objectives for “quite some time,” Kohn said in a speech to economists in St. Louis.
Policy makers “need to be ready to adjust our plans if events don’t turn out as predicted,” Kohn said. “We have the tools to exit our unusual policies when the time comes. And we must act well before demand pressures or inflation expectations threaten price stability.”
‘Turning Around’
Treasuries fell last week after Fed Chairman Ben S. Bernanke said policy makers will tighten monetary policy once the economic outlook improves. The Fed will hold off raising interest rates until its August 2010 meeting, according to a October survey of 47 economists by Bloomberg News.
“You want to see the economy start to recover in all its dimensions, output and trade” before raising rates, Fed Bank of St. Louis President James Bullard said yesterday in a Bloomberg Radio interview in St. Louis. “We do have some of those turning around now.”
The jobless rate rose to a 26-year high last month of 9.8 percent, the Labor Department said on Oct. 2.
Retail sales in the U.S. probably fell in September as auto showrooms sat empty after the “cash for clunkers” program expired, economists said ahead of the Commerce Department report tomorrow.
Retail Sales
Purchases dropped 2.1 percent after rising 2.7 percent in August, according to the median forecast of 72 economists surveyed by Bloomberg News. Other reports this week may show inflation and factory production cooled last month, according to Bloomberg surveys.
“There is no one data series that will be the ultimate catalyst for the Fed to raise rates or for the removal of monetary policy,” said Barclays’ Pond. “It’s expectations on sustainable growth and how quickly the output gap will close.”
The financial crisis started with the collapse of the U.S. property market in 2007 and has triggered $1.62 trillion of writedowns and credit losses at banks and other institutions, according to data compiled by Bloomberg.
Now investors are preparing for another potential crisis: a surge in the cost of living spurred by the $11.6 trillion the Fed and the government has lent, spent or guaranteed to shore up the economy and the financial system.
Long View
BlackRock Inc., Pacific Investment Management Co. and Vanguard Group Inc., which together manage $3.45 trillion, say investors are pouring money into inflation-linked debt even as consumer prices post the longest series of contractions since Dwight D. Eisenhower was president in 1955.
“Investors are really taking the long view and trying to hedge inflation risk,” said Mihir Worah, who oversees the $15.4 billion Real Return Fund for Newport Beach, California-based Pimco, the world’s biggest bond manager. “That’s the biggest reason why we’re seeing the flows.”
Treasury Inflation Protected Securities, or TIPS, have gained 7.9 percent this year, according to Merrill Lynch & Co. indexes, while Treasuries overall lost 2.8 percent. That’s the biggest outperformance since the U.S. first issued TIPS in 1997.
Bernanke said at a Fed Board of Governors conference Oct. 8 in Washington that while “accommodative policies” will be in place for an extended period, the central bank will be prepared to tighten monetary policy “to prevent the emergence of an inflation problem down the road.”
TIPS remain cheap by historical measures. The difference in yield between 10-year TIPS and 10-year notes is 1.85 percentage points, compared with an average of 2.18 over the past five years.
Trading of Treasuries was closed yesterday in the U.S., Japan and London, because of a public holiday in North America. U.S. 10-year note futures expiring in December rose 0.2 percent yesterday, and were little changed at 118 19/32 today.
By Laura Litvan and Nicole Gaouette
Oct. 13 (Bloomberg) -- The Senate Finance Committee approved an $829 billion plan to overhaul U.S. health care, clearing the way for a full Senate debate over the broadest expansion of the government’s role in the medical system since the creation of Medicare in 1965.
Just one Republican on the panel, Senator Olympia Snowe of Maine, voted for the measure in an otherwise party-line 14-9 tally. That marked the first time a Republican in either the Democratic-controlled Senate or House has supported the revamp legislation, President Barack Obama’s top domestic priority.
“Ours is a balanced plan that can pass the Senate,” said panel Chairman Max Baucus, a Montana Democrat.
Baucus had spent months courting Snowe and other Republicans, making his committee the last of five congressional panels to complete its version of the legislation. Senate and House Democratic leaders must now merge the bills and schedule floor debates. After each chamber votes, they’ll have to reconcile their measures.
Senate Majority Leader Harry Reid will meld the finance panel bill with one approved by the Senate health committee in July, forcing him to resolve differences over a host of issues that divide both political parties and risk rupturing Democratic unity. Reid spokesman Jim Manley said the health- care bill should be on the floor the week of Oct. 26.
“There are many miles to go in this legislative journey,” Snowe said. “My vote today is my vote today. It doesn’t forecast what my vote will be tomorrow.”
Stocks Fall
The Standard & Poor’s index of 13 health insurance stocks lost 2.4 percent. UnitedHealth Group Inc., the largest insurer by sales, led the decline, with the shares of the Minnetonka, Minnesota, company dropping 94 cents, or 3.7 percent, to $24.29 at 4:01 p.m. in New York Stock Exchange composite trading. Health Net Inc. followed, with the Woodland Hills, California, company falling 61 cents, or 3.6 percent, to $16.27.
“We cannot support this legislation in its current structure,” Robert Zirkelbach, a spokesman for America’s Health Insurance Plans, an industry trade group, said in an e- mail.
Senator Jon Kyl, an Arizona Republican, criticized Baucus for saying he was proud of the bill. “That sets the bar pretty low,” Kyl said in an interview after the vote. “All you have to do is raise taxes, but that hits the American people pretty hard.”
Premiums Seen Rising
Kyl said critics were unfair to dismiss a study released two days ago by the insurance industry group charging that the finance panel plan would more than double premium costs. Kyl said the Congressional Budget Office and health policy firms “all agree that premiums will go up.”
The White House criticized the report, and doctors, medical-device makers and one of two hospital groups reiterated their support for the overhaul.
Unlike other versions, the finance bill includes a new tax on the most-expensive insurance plans, doesn’t require employers to provide coverage to workers, and omits a provision creating a new government insurance program, the so-called public option, which most Republicans oppose.
Nonprofit co-operatives would instead provide competition to an insurance industry that stands to gain millions of new customers because the bill requires Americans to obtain insurance. The measure also imposes new restrictions on insurers’ ability to deny people coverage.
‘Extraordinarily Complicated’
The legislation seeks to curb health costs and provide coverage to almost all Americans who lack insurance. Democrats want to expand the Medicaid program for the poor and provide subsidies for millions of Americans to obtain policies.
The Congressional Budget Office gave the bill a boost last week when it estimated the measure would cut the federal budget deficit by $81 billion over 10 years. Obama has vowed not to sign any bill that adds “one dime” to the deficit. The agency also said the proposal would provide insurance for 94 percent of all legal residents of the U.S., up from 83 percent now.
Obama today praised Baucus’s panel for “plowing forward on what we all acknowledge is an extraordinarily complicated issue.”
‘Slippery Slope’
Senator Charles Grassley, the ranking Republican on the panel, echoed the view of many members of his party by saying the legislation will strengthen the federal government’s management of the health-care system.
“This bill is already moving on a slippery slope toward more government control of health care,” Grassley said. He said it’s likely to continue a “march leftward” as the legislation is merged in Congress.
The finance committee has sole jurisdiction in the Senate over how to pay for the overhaul, making its tax and spending- cut provisions almost certain to remain in the final bill the chamber considers.
They include a new 40 percent excise tax, beginning in 2013, on insurers of employer-sponsored health plans with benefits exceeding $8,000 for individual coverage and $21,000 for families. Thresholds are increased by $1,850 and $5,000 for retirees 55 and older and for employees in the coal mining and other union-heavy industries.
Biggest Tax Increase
That provision would raise $201 billion over 10 years, the CBO said, making it the biggest tax increase in the measure.
Another tax provision would increase the threshold for itemized deductions for unreimbursed medical expenses from 7.5 percent of adjusted gross income to 10 percent. The measure also imposes $13 billion in new annual fees on drugmakers, medical device manufacturers and health insurers.
The legislation is also offset by $404 billion in cost savings over a decade in both the Medicare and Medicaid programs. That includes $117 billion in cuts to Medicare Advantage, a program in which private insurers offer 10 million senior-citizen enrollees benefits such as dental or vision coverage not offered by the government program.
To expand health-insurance coverage, the legislation requires all U.S. citizens or legal residents to have coverage, or pay a penalty of $750 per year, with the fines phased in between 2014 and 2017. Those forced to pay more than 8 percent of their income to buy insurance are exempt.
Expansion of Government
Employers with 50 or more workers would pay a fee, though in contrast to other pending bills, penalties for companies that don’t offer health benefits would only apply to those workers who qualify for a lower-income tax credit to get their own policy. The penalty could reach as high as $400 per worker receiving a tax credit.
The measure seeks a sweeping expansion of government aid to reduce insurance costs for every American with an income below 400 percent of the federal poverty level. That level is $18,310 for a family of three in 2009.
Beginning in 2014, non-elderly people with an income below 133 percent of the poverty level would be covered by Medicaid. The measure also establishes an online insurance exchange where others without insurance can purchase a policy.
Legislation approved by three House committees and the Senate health panel would create a public option within the exchange which, like Medicare, would compete with insurers to provide coverage. The finance committee bill’s nonprofit co-ops are a bid to appeal to Republicans and centrist Democrats. The co-ops would get $6 billion in seed money.
Taking All Customers
The finance committee would bar insurers from excluding new enrollees based on pre-existing medical conditions. It would also allow variation in premium rates based on age limited to a 4 to 1 ratio, meaning older people could be charged no more than four times what younger policyholders are.
By contrast, the Senate health measure has a much-stricter 2 to 1 ratio for insurers, making that another issue of interest to industry that Democratic leaders must decide before the measure goes to the Senate.
Democrats on the committee made clear they will seek changes during Senate debate that include amendments to create a public option, scale back the penalties for those who fail to get coverage, and further expand subsidies.
Now Playing at Reason.tv: Cuban Punk Rocker Gorki Aguila on Music, Life, and Getting Led Zeppelin Records in Cuba
Gorki Águila is blunt in his assessment of Fidel Castro's half century of revolution: "Communism is a failure. A total failure. Please, leftists of the world-improve your capitalism! Don't choose communism!" Águila, a Havana resident, wears homemade anti-government t-shirts, frequently denounces the Castro brothers as geriatric tyrants, and heads up perhaps Cuba's only explicitly political punk band, Porno Para Ricardo. And because of his stubborn belief in free speech, he is routinely arrested on charges of "social dangerousness." Tired of his anti-regime music, Cuban authorities made the rare decision to grant Águila a visa to travel abroad, perhaps hoping that he wouldn't return.
In September, Reason.tv's Michael C. Moynihan caught up with Águila on the Washington, D.C. leg of his American promotional tour to talk about his music, the origins of Porno Para Ricardo, and how long it takes to get Led Zeppelin records in a totalitarian society.
Radicals for Capitalism
Reason celebrates freedom and the ideas of Ayn Rand
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- Reason on Rand’s resurgence as capitalism is under siege
Max's Adventures in Wonderland
Why health care "reform" won't pay for itself
Mercifully, House and Senate Democrats recently blocked amendments that would have required health care bills to be posted online for 72 hours before a committee vote, sparing us the needless irritation of grappling with fancy facts about the most consequential piece of legislation in recent memory.
No need to get into the weeds for you and me. No way. Just think of legislation as abstract art. The Congressional Budget Office does.
The CBO's new estimate, which magically meets every one of President Barack Obama's preconditions, is based on "conceptual" language provided by Baucus rather than on any of those maddeningly specific Arabic numerals.
That's because the estimate isn't rooted in an actual bill per se, nor does it incorporate hundreds of amendments that will be part of any final product—well, not exactly ... What we do have is a CBO that has been browbeaten long enough by the White House to finally summon the conviction to get a figure that so many wanted to hear.
It's also, believe it or not, free.
According to the CBO, the Senate plan—which actually would cost more than earlier estimates, rising from nearly $800 billion to $829 billion (or $904 billion, according to a number of economists)—has triggered many excited journalists and politicians to claim that the bill miraculously would "pay for itself."
The CBO says that not only would it pay for itself—and this part is really wonderful—but also the government's spending an additional $829 billion over the next 10 years would reduce the federal deficit by $81 billion.
How exactly does health care "reform" pay for itself in Wonderland? In this case, it pays for itself by charging taxpayers new "fees," delivering new mandates and penalties, adding pass-through costs, and cutting hundreds of billions of dollars from Medicare.
As you know, if there's anything old folks—already prone to irascibility from time to time—absolutely adore it's the prospect of cutting their Medicare benefits. Yet even those savings seem to defy reality.
One of the many assumptions in the Baucus plan is that there would be continual cuts in physician reimbursements, cuts that Congress never has allowed and precious few onlookers believe would be politically palatable. So without a major attitude adjustment in Washington, this savings is just fantasy, as well.
Not to worry, though, there are sure things. One of the most popular and cost-effective programs, Medicare Advantage, would take a hit of $117 billion through 2019.
That might seem somewhat mysterious to you. Then again, Medicare Advantage involves private insurance firms (a curse on their house!), which should be squashed like a cockroach.
CBO Director Douglas Elmendorf previously warned that Medicare Advantage payment cuts would have the potential to hurt seniors' private health plans, which, of course, is the point of "reform."
The most exhilarating aspect of this plan, however, isn't that it would do nothing to contain costs for average consumers; it's that average consumers would help pay for it long before they failed to receive any tangible benefits.
According to Democrats, health care reform must be passed this very moment even though it wouldn't kick in until 2013. Don't worry; it would start taxing Americans in 2010, three years before you got nothing.
All of this probably adds up to the most expensive dependency program yet devised.
Coming at a time when the nation has hit 9.8 percent unemployment, with no help from Washington in sight, the latest Pew Research Center survey on the health care issue claims that "more people now generally oppose the health care reform proposals in Congress (47 percent) than favor them (34 percent)."
That 47 percent just doesn't believe. They don't believe higher taxes would bring down costs. They don't believe that more spending could shrink the deficit. They can't believe that fees wouldn't be taxes. Or that an entitlement program, for the first time in history, would pay for itself.
What they do believe in is reality.
David Harsanyi is a columnist at The Denver Post and the author of Nanny State. Visit his Web site at www.DavidHarsanyi.com.
Liz Cheney Takes on ‘Radical’ White House
By Don
Liz Cheney the eldest daughter of former veep Dick Cheney is forming a group to rally opposition to Barack Obama and his radical agenda.
From the Politico
Former Vice President Dick Cheney’s eldest daughter Liz will launch a new group aimed at rallying opposition to the “radical” foreign policy of the Obama administration which it says has succeeded only in undermining the nation’s security.
The new group, Keep America Safe, will make the case against President Barack Obama’s moves to wrench America away from Bush era foreign policy on issues from detaining alleged terrorists at Guantanamo Bay to building a missile shield in Eastern Europe.
“The policies being proposed by the Obama administration are so radical across the board,” Cheney said. “Whether you’re a Republican or a Democrat, you want the nation to be strong and so many steps this president is taking are making the nation weaker.”
The new group will add institutional heft to a scathing critique of Obama articulated first and loudest by Liz Cheney’s father, and fills a void left by a Republican Party made skittish by the Iraq War, and apparently more eager to engage the president on domestic issues like health care. Its formation marks the end of an unusual partisan truce on America’s central national security challenge, Afghanistan, and after a presidential campaign in which Obama and Republican John McCain agreed on many security issues from Central Asia to Guantanamo Bay.
Keep America Safe will focus on issues like troop levels, missile defense, detainees, and interrogation, according to Liz Cheney, who is heading the group along with Weekly Standard editor William Kristol and Debra Burlingame, the hawkish sister of an American Airlines pilot killed in the September 11 attacks.
The group, incorporated as a 501 (c ) 4 non-profit, launches its fundraising drive online Tuesday with a web video accusing Obama of failing to back up his “tough talk” and with a website aimed to provide an organizing tool for hawks.
“The Left has dozens of organizations and tens of millions of dollars dedicated to undercutting the war on terror,” said Kristol, a seasoned partisan warrior. “The good guys need some help too.”
Charlemagne
The presidency stakes
Tony Blair is the front-runner, but he faces plenty of competition
A PARISH council would not choose a chairman before his role and powers had been agreed. A corner shop would not select two bosses without deciding which carried more clout. Not so the European Union, which is preparing to choose two new bosses without any final agreement on the sort of person who should run the club.
At a summit at the end of this month (or, just possibly, in December if the Czech president still has not signed the Lisbon treaty) 27 national leaders will gather in Brussels and—after hours of coffee-fuelled, fluorescent-lit horse-trading—emerge with the name of the first permanent president of the European Council, a new post whose holder will chair summits and represent EU governments around the world. They should also choose a new foreign-policy high representative. Both choices are in theory made by majority vote. The pecking-order between the two posts will become clear only when they are filled. Lisbon sketches out the job of council president: the only guaranteed role is the rather dull one of chairing summits. The high rep’s job is described in detail and enjoys things that convey power in the EU: a big budget, lots of staff and a guaranteed seat in important meetings. Yet if the president is a big-hitter whose name opens doors in Beijing and Washington, he will surely overshadow his rival.
That would not please everyone. Small countries dislike the European Council, an inter-governmental body in which the biggest countries rule and smaller fry struggle to be heard. Fredrik Reinfeldt, the Swedish prime minister, whose small country holds the rotating EU presidency, does not even like to use the term “president” to describe the new job, preferring to talk of a “chairman”. The Benelux countries sent other governments a joint paper on October 6th saying that the new job must go to someone who “listens to the member states” and is “sensitive” to the union’s “institutional balance”: ie, is nice to tiddlers and respects the European Commission, the bit of the EU machine in which all members are equal, at least in theory.
To a striking degree, the race for EU president is a contest between Tony Blair and everyone else. There are many reasons to expect the British former prime minister to fail. His name has been in the headlines for weeks, and front-runners rarely secure euro-jobs in the end. Federalists mutter that this job should not go to anybody from Britain, which shuns the single currency, refuses to join the borderless Schengen area and always fights to keep its special rebate from the EU budget. Among politicians from Mr Blair’s (nominal) political family, the European Socialists, views of him range from “mild dislike to hatred”, notes one senior official. In the eyes of the left, Mr Blair won three elections only by abandoning socialism.
Across much of Europe, moreover, he is remembered for splitting the EU with his uncritical support for the Iraq war and for George Bush. It is not clear that national leaders would welcome his Hollywood star power: at future summits, for instance, journalists might all go to Mr Blair’s press conference. His own country is divided by the idea of a President Blair. The opposition Conservatives are already cross that the Lisbon treaty will enter into force without the British public being able to vote on it in a referendum. Now, they fume, Britons must stomach the prospect of Mr Blair “suddenly pupating into an intergalactic spokesman for Europe”, in the phrase of London’s Tory mayor, Boris Johnson.
In Mr Blair’s favour, he is the only global star on the list. Annoying the British Tories might appeal to many, and his deracination arguably makes him a truly European figure. He has public support from Britain and Ireland. Italy has sent mixed signals. Spain’s José Luis Rodríguez Zapatero hated the Iraq war but gratefully remembers Mr Blair’s help fighting Basque terrorism. Nicolas Sarkozy of France used to back Mr Blair vocally but has since played games, dropping in the name of Felipe González, a former Spanish prime minister (who has little other support). If Mr Blair is vetoed, some wonder if France’s prime minister, François Fillon, could emerge as a compromise.
The also-runners
Germany’s Angela Merkel has said she could live with Mr Blair, diplomats say, but with no great enthusiasm. She takes a rather minimalist vision of the post, sparking talk of German support for Jan Peter Balkenende, the Dutch prime minister, a sober conservative who barely excites his own countrymen, let alone Europe. Other names include Paavo Lipponen, a former prime minister of Finland, though his work as a consultant for Nord Stream, a gas pipeline planned by Russia’s Gazprom, raises eyebrows in east and central Europe. A Finnish former president, Martti Ahtisaari, won a Nobel peace prize for mediating nasty disputes, which might help at EU summits, but he is 72. The Belgian prime minister, Herman van Rompuy, is clever but lacks charisma and has been in office less than a year. Federalists dream of Jean-Claude Juncker, a chain-smoking Euro-fanatic who leads both tiny Luxembourg and the Eurogroup of finance ministers from the euro area. But the British loathe Mr Juncker (it is mutual) and Mr Sarkozy thinks he bungled the start of the financial crisis.
The final decision will be linked with haggling over the high rep. Foreign-policy buffs long for that job to be filled on merit. Instead, the holder may be chosen for reasons of political, geographical or gender balance, with the French stopping anyone too keen on EU membership for Turkey, and a German black spot for anyone who alarms the Russians. This may seem a funny way of giving the EU a powerful, more coherent voice in the world, a stated aim of the Lisbon treaty. Perhaps, deep down, European leaders may prefer not to be overshadowed by an EU star. Their choice of president will reveal all.
Cuba's economy
The demise of the free lunch
Near-bankruptcy is causing Cuba to jettison the Utopian paternalism of Che and Fidel. The future involves hard work for higher, but still-paltry, wages
THIS month staff at four government ministries in Havana had to make new arrangements for lunch. The ministries’ free canteens were shut down and workers given a wage increase of 15 pesos ($0.60) a day in compensation. Since that raises their salaries by more than half in return for losing an often poor-quality lunch, on this occasion Granma, the daily newspaper of the ruling Communist Party, may have got it right when it headlined the news, “Giving, more than taking away”.
Small though the change is, it is of huge symbolic import. It is the first step in a wider, albeit stealthy, abandonment of Fidel Castro’s half-century effort to forge a “new man” in Cuba by limiting individual reward in favour of all-embracing social provision, with the state imposing its choice of consumption as well as of production. Granma said that after the plan was “perfected” some 3.5m Cubans could expect their 24,700 workplace canteens to close too, and would get a similar wage increase.
The government is also organising thousands of public meetings across the island to discuss a wider ten-point plan that proposes an end to the monthly ration of free staples and a host of perks, such as free wedding cakes. Instead, the focus is on creating incentives to work harder by raising wages, and thus productivity.
All this reflects the ideas of Raúl Castro, who after almost half a century as defence minister replaced his elder brother as Cuba’s president last year and who has been much franker in discussing the country’s economic failures. While acknowledging the damage inflicted by hurricanes last year and by the American economic embargo against the island, he has stressed the economy’s inefficiencies. “Nobody, no individual or country, can indefinitely spend more than she or he earns,” he told the National Assembly in August.
Cuba is close to bankruptcy. Foreign businesses have been waiting for months for permission to transfer abroad hundreds of millions of dollars in profits from joint ventures that are sitting in local banks. The government has slashed imports by more than 30% this year, and budgets for state companies and ministries have also been cut. Cuba does not produce enough and its population is ageing. Theft and absenteeism are rife in workplaces across the island.
Raúl has placed trusted military men in charge of economic policy. Their aim is to save foreign exchange and raise output. They reckon that Cubans do not value the true cost of free services. Workplace canteens used some $350m in imported food last year, according to Granma.
On the streets, reaction was mixed. A finance-ministry worker who had brought from home a lunch box of chicken breast and mashed malanga (a starchy root) supported the change. Another grumbled that 15 pesos would buy only a bun and a slice of ham and was no substitute for a hot meal. Menierva, a woman who sells pizzas at her front door next to the ministry on Havana’s Calle Obispo, said that her sales were rising. Cubans grumble, too, that the monthly ration of staples only lasts 10-15 days, and many items are often unavailable. But when it goes, they may miss it.
Raúl is cautiously decentralising the economy, giving state companies more autonomy and leasing idle state land to private farmers. Officials at the Ministry of Economy and Planning are mulling over whether to introduce greater flexibility to other activities, by using co-operatives, say. Some local economists want to encourage family-owned restaurants and takeaway businesses, such as Menierva’s, to fill the lunch gap.
Although Fidel Castro has withdrawn from day-to-day decision-making since an abdominal operation in 2006, big changes still require his consent. He continues to abhor markets. After the collapse of the Soviet Union and its generous subsidies to Cuba, Fidel allowed limited foreign investment and self-employment. When the economy briefly recovered, he cracked down: only 200,000 Cubans now have licences allowing them to run micro-businesses, such as restaurants or hairdressers, down from a peak of 350,000.
The government said state-run restaurants will now provide more lunches. That is a recipe for appalling food and service. Some farmers complain of the state’s continuing monopoly over inputs and sales. Bumper crops of tomatoes and rice were partly wasted because of transport and processing problems.
What nobody is saying publicly is that Raúl is tossing into the dustbin of Cuban history the idea espoused by Ernesto “Che” Guevara, at the start of the revolution that Cuba’s communist economy should be based on “moral incentives”, rather than material ones, and that this process would create a “new man”. Through various zigzags Fidel never wholly relinquished that idea. When opponents criticise Cubans’ derisory wages (averaging $20 per month), officials always point to the additional “social wage” of free housing, health, education, transport and food rations.
Some of this will now go. Raúl, a practical man, has no time for Utopianism. He gives every sign of knowing that if Cuban communism is to survive its founders it will have to supply people with a few more material goods. But he may find it hard to raise wages by much without more radical reform.
Cuban society no longer resembles that of the Soviet days. In real terms wages are still less than 50% of their level of 1989. Meanwhile, remittances from abroad, self-employment, tourism, foreign investment and the informal economy have lifted the incomes of a large group of Cubans. Some local sociologists say that around half the population is doing fine by developing-country standards, whereas the other half is living on the edge of poverty. “Maintaining subsidies and gratuities for all once ensured greater equality, but today they only exacerbate inequality,” a recent report for the Communist Party concluded. That seems to presage a move towards targeted social policy—radical indeed for Cuba.
Down Mexico
Brazil envy is rife in Latin America’s other big economy
WHEN Brazil was not only included but named first among the BRICs, the widely used acronym for the leading emerging economies, Mexican business leaders protested that their country should also have been there. Well, maybe. But adding an "M" to the initial letters of Brazil, Russia, India and China would have made the name much less catchy (MBRICs? BRIMCs?). And the man who coined the acronym in 2001, Jim O’Neill of Goldman Sachs, has said that Mexico (along with South Korea) was in fact considered, but did not quite fit.
Mexico’s Brazil-envy is more intense than ever, as this columnist discovered last week in Mexico City. One local business leader said he was optimistic about the economic outlook, but that was because “I choose to be, because I don’t want the alternative—and, besides, next year can’t be any worse than this, can it?” Others mostly seemed worried, predicting several difficult years ahead—except for one bullish entrepreneur who has just started a consulting firm called, appropriately enough, Plan B.
A lament for MexicoThe Mexican economy was hit hard by the slump that followed the collapse of Lehman Brothers last year. Brazil’s economy suffered much less—and is already roaring back, in sharp contrast to Mexico’s. This is symbolised by the strength of Brazil’s stockmarket. Last week Santander, a Spanish bank, raised $7 billion by selling shares in its Brazilian subsidiary, the biggest share offering the country has seen. In June the initial public offering (IPO) of Visanet, a Brazilian credit-card firm, raised almost $5 billion, and there are several other big local offerings in the pipeline. By contrast, the most recent IPO in Mexico was in June 2008.
Part of the problem is that Mexico, especially since the creation of the North American Free-Trade Area, has increasingly specialised in making things cheaply for export to America, a strategy that looks less than brilliant now that the American consumer is on strike. Meanwhile, commodity-rich Brazil is benefiting from exporting to China, which has made up for weaker exports to America with a domestic spending binge which, among other things, requires lots of imported materials to build new infrastructure.
But that is by no means the only difference between the two economies. Mexico has lately been plagued by some serious management gaffes. Cemex, a cement firm that was not so long ago an exemplar of the trend for world-beating multinationals to emerge from developing economies, is suffering serious indigestion after borrowing heavily to make foreign acquisitions at the peak of the market.
Comercial Mexicana, the country’s third-largest retailer, lost a fortune after a currency hedge moved against it when the dollar soared during the financial crisis. This presented an opportunity to Wal-Mart, an American retailer which is the market leader in Mexico. It has taken advantage of its rival’s weakness by expanding rapidly, opening a couple of hundred new stores in the country this year. The only other business with such ambition in Mexico at the moment is the empire of Carlos Slim, a telecoms magnate, which has also been busy expanding during the crisis. More success for the powerful Mr Slim—now perhaps the richest man on earth—is regarded even by Mexicans as something of a mixed blessing.
Mexican business people are also depressed by growing fears for their own security. Violence is increasing in the country as the government takes on the illegal drug cartels, prompting them to retaliate brutally. Mexico is now close to the top of the list of countries where kidnapping is likely. Crime in Brazil’s cities is bad, but not quite so bad.
In the eyes of business leaders the government’s lack of success against organised crime is on a par with its failure to reform the economy. Although some business people are content that the Mexican economy is dominated by a small, powerful clique, many feel that the lack of competition is a serious problem. Many also lament the failure to reform the sluggish state oil and gas monopoly, Pemex, which continues to decline as Brazil’s reserves, and its state oil firm, Petrobras, soar. Just as worrying is the slow progress in revamping the tax system. Mexico has one of the world’s lowest ratios of tax collection to GDP, which deprives the government of the funds it needs to do its job properly.
Brazilian entrepreneurs found that President Luiz Inácio Lula da Silva and his Workers’ Party were much less hostile towards business in office than in opposition. Lula’s most likely successor in next year’s election is an experienced figure from the business-friendly Social Democrats, who in their last stint in the presidency passed vital reforms that laid the foundations for Brazil’s recent strong growth.
In Mexico, judging by the mood at last week’s Economist conference in Mexico City, President Felipe Calderón may frustrate the business community, yet business leaders have little enthusiasm for the favourite to succeed him, the soap-star-dating governor of Mexico State, Enrique Peña Nieto. Still, at least they take some comfort from the fact that the hard left’s candidate, Andrés Manuel López Obrador, who so nearly defeated Mr Calderón for the presidency three years ago, is lagging in the polls.
Mexican business leaders fear that their president, following his party’s heavy defeat in recent parliamentary elections, may see out his remaining three years as a lame duck. The one hope is that, seeing how bad things look, Mr Calderón may be provoked into embarking upon the fundamental reforms that the economy so badly needs. In that light, what could be more encouraging than the government’s decision on October 12th to take on one of Mexico’s most powerful unions by closing down the country’s largest electricity provider? If this battle is won, perhaps Mexican business people can start believing that their country has what it takes to become more competitive and powerful than its big rival down south. If not, plenty more gloom and doom are likely to follow.
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