Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
I am sitting in one of my “offices” – the little nook I have found at Melbourne airport that lets me work while waiting for planes – watching the video fo the US President’s recent Press Conference (June 29, 2011). I have “offices” like this at various airports. In the speech he berates the Republicans for refusing to show leadership in the current budget debate. My assessment is that after reading the full speech (the video goes for 67 minutes and 5 minutes is too long) – is that the US President outlined in the most categorical terms why he shouldn’t be in charge of the largest economy in the World. In the short time I have to write my blog today I will tell you why that is the case. But overall – as I noted the other day – it is looking more every day like a case of RIP USA.
Before we start though, the following quote is worth reflecting on. In the 2010 State of the Union Address (January 27, 2010), the US President said:
Rather than fight the same tired battles that have dominated Washington for decades, its time to try something new. Let’s invest in our people without leaving them a mountain of debt. Let’s meet our responsibility to the citizens who sent us here. Let’s try common sense.
This quote is also emblazoned on the home page of the Office of Management and Budget where I was visiting to get some historical data. The quote immediately captured my attention.
I wanted to see the whole context so I searched for where the US President actually made that statement and tracked it down to the above Address. But searches always come up with interesting results even if they are completely depressing. Among the resources that the search engine found were discussion forums which provided considerable insights – like:
“His is clearly magical Marxist thinking”
“Let’s try chutzpah and brazen lies, and call it common sense, and try to ram through as much socialism as possible before we get our asses handed to us in November”
“He is Mussolini in diapers. The same dictatorial aspirations, but too PC’d even to admit he wants a totalitarian, fascist state with himself at the head”.
I know that Marxism and National Socialism share some commonality – influence of Hegel – but this is getting ridiculous.
At least one “expert” tried to conduct some economic analysis – “Whose money is he going to be investing, and in what people? And how can a government – a non-productive entity – ‘invest’ without debt?”
As I said, insights … insights into how bad the problem in the US is and why they are lumbered with the politicians they have. As the joke goes (in Australia at least) – these people vote!
But on the substantive matter – since when has a government that provides risk free assets with a return above zero to supplement private sector wealth been a bad thing (from the wealth accumulation perspective)?
Anyway, back to yesterday’s speech.
Before he took questions from the Press Gallery, the US President said “a few words about the economy”. He noted that:
Many people are still looking for work or looking for a job that pays more.
Many equals millions.
He then went into the usual pap about how he is trying to get the “government regulation” monkey off the back of private US businesses so they can employ more workers. No matter how easy it becomes to employ people firms will only increase output and employment if there is a rise in sales.
The following macroeconomic verity is indisputable: Spending equals income which leads to sales which underpin employment growth. It doesn’t matter how “cheap” employees become to a firm if there are no customers coming through the door then firms will not hire the “cheaper” labour to build inventory.
Further, when the neo-liberals like Obama talk about freeing up firms by further deregulation etc the flip side of that is typically degraded conditions of work, reduced job security or other reductions in the capacity of the workers to gain a reasonable share of real GDP.
The US President then blamed the US Congress for tying up essential job creating legislation that his Administration has proposed. My assessment is that the measures he noted (you can find them in the full transcript) will not be employment-rich.
Then he moved onto the main theme with this introduction:
Of course, one of the most important and urgent things we can do for the economy is something that both parties are working on right now — and that’s reducing our nation’s deficit. Over the last few weeks, the Vice President has been leading negotiations with Democrats and Republicans on this issue, and they’ve made some real progress in narrowing down the differences. As of last week, both parties had identified more than $1 trillion worth of spending cuts already.
But everyone also knows that we’ll need to do more to close the deficit. We can’t get to the $4 trillion in savings that we need by just cutting the 12 percent of the budget that pays for things like medical research and education funding and food inspectors and the weather service. And we can’t just do it by making seniors pay more for Medicare. So we’re going to need to look at the whole budget, as I said several months ago. And we’ve got to eliminate waste wherever we find it and make some tough decisions about worthy priorities.
At which point, one’s jaw drops, eyes glaze over and you wonder what planet the speaker is on. In saying that I am probably being unkind to the other planets. All the sci-fi movies I have seen (Outer Limits was a favourite TV series in my youth) the residents of the alien spaces would never have been so stupid to say that it is an urgent need for the US to cut its deficit right now.
That sort of stupidity is probably monopolised by Earthlings – totally stupified by the neo-liberal ideology that holds them (us) in their grip. We are too stupid to realise that the messages that are continually pumped into our homes and offices by the mainstream media is largely devoid of meaning or substance. Just now some character on the radio (ABC) is saying that the US is on the right track because both sides of politics recognise that the most important policy issue is the dangerous deficit and unsustainable public debt.
The radio was turned off at that stage.
The US President then quibbled about where the budget cuts might be made and indicated that the top-end-of-town should share in the burdens of the public net spending cuts. He also said that a “balance approach” to fiscal consolidation would require some spending cuts and some tax increases (especially targetted at the high income earners).
From the perspective of Modern Monetary Theory (MMT) the emphasis is on aggregate levels of demand although the composition of demand (who is doing the spending) is not unimportant.
In that context, it might be desirable from an equity perspective (or some other perspective) to reduce the capacity of the high income earners to spend. But it is madness to cut spending overall which is what the US President is claiming is an important and urgent policy goal when there is so much idle productive capacity.
I know most progressives want to reduce the capacity of the rich to spend. I have no problem with that view as long as they also advocate how the spending gap (whatever it is) that such a policy environment would create would be filled.
The Press Conference then moved into the press questions for the US President.
Among the questions he was asked (many were about Libya etc) was one that challenged the notion that “the August 2nd deadline is the final deadline by which a deal must be raised?” (which refers to the current debate about raising the public debt limit in the US).
The US President replied:
By August 2nd, we run out of tools to make sure that all our bills are paid. So that is a hard deadline. And I want everybody to understand that this is a jobs issue. This is not an abstraction. If the United States government, for the first time, cannot pay its bills, if it defaults, then the consequences for the U.S. economy will be significant and unpredictable. And that is not a good thing.
We don’t know how capital markets will react. But if capital markets suddenly decide, you know what, the U.S. government doesn’t pay its bills, so we’re going to start pulling our money out, and the U.S. Treasury has to start to raise interest rates in order to attract more money to pay off our bills, that means higher interest rates for businesses; that means higher interest rates for consumers. So all the headwinds that we’re already experiencing in terms of the recovery will get worse.
Which is not a truthful statement. They do not “run out of tools to make sure that all our bills are paid”. They could introduce legislation to force the central bank to provide sufficient spending capacity to meet all its obligations.
There would be no need to increase interest rates to attract demand for bonds.
He claimed that this view was not his “opinion” but rather “a consensus opinion”. It is not a consensus opinion. Even the bond markets know that if things became bleak the US government has all the capacity to isolate them (not issue debt) and go on spending regardless. They also know that the central bank can target whatever interest rate they like (at any maturity on the yield curve) by standing by to buy the debt that the private traders boycott.
The bond markets also know that the offer of risk-free public debt is a substantial corporate welfare initiative and while they might make threats they will never stop buying US government debt. The only reason they are holding the Greek government to ransom is because they know there is true default risk in that case. All EMU goverments face default risk because they surrendered their currency sovereignty.
It got worse. The US President challenged the view that the government might side-step the debt ceiling constraint by just paying “interest on the debt” and said:
This is the equivalent of me saying, you know what, I will choose to pay my mortgage, but I’m not going to pay my car note. Or I’m going to pay my car note but I’m not going to pay my student loan. Now, a lot of people in really tough situations are having to make those tough decisions. But for the U.S. government to start picking and choosing like that is not going to inspire a lot of confidence.
The US household is not a currency issuer and faces a continual and binding financial constraint.
The US government is a sovereign government and is never revenue constrained because it is the monopoly issuer of the currency.
There is no applicable analogy between a household and a sovereign government. The false analogy is a vehicle used by conservatives to entice unknowing voters into relating the experiences and options of the government to their own budget constraints. This flawed intuition then makes it easier for the neo-liberals to maintain their false policy agenda. But there is no valid analogy and we should continually expose the falsehoods that are embedded within it.
After suggesting that his young children do their homework on time (even early) as so demonstrate if something has to be done you should “just do it” he claimed that leadership required that the US Congress should just show leadership in bringing down the budget deficit.
He then further demonstrated how poor his understanding of the economics is:
I do think that the steps that I talked about to deal with job growth and economic growth right now are vitally important to deficit reduction. Just as deficit reduction is important to grow the economy and to create jobs — well, creating jobs and growing the economy also helps reduce the deficit. If we just increased the growth rate by one percentage point, that would drastically bring down the long-term projections of the deficit, because people are paying more into the coffers and fewer people are drawing unemployment insurance. It makes a huge difference.
So which is it? Deficit reduction creates growth and jobs or vice versa?
There is no credible evidence to support the proposition that a nation that starts hacking into public spending in situations as exist now in the global economy and particularly in the US will grow and create jobs.
There is an overwhelming body of evidence to support the opposite – cutting budget deficits when there is slack private spending growth and external deficits will erode growth and destroy net jobs.
There is also overwhelming evidence that growth reduces the budget deficit for the reasons the President acknowledges.
As an aside, I often get asked whether I would support spending cuts if they truly targetted public spending waste. The answer is always the same. Waste is typically a bad thing but in this context is usually a loaded term. Spending on corporate initiatives is usually considered productive but when spending is focused on the poor it is considered to be wasteful and eroding incentives.
But moreover, “wasteful” spending is still contributing to aggregate demand and therefore creating jobs and reducing unemployment. It would obviously be better if public spending was not deploying real resources wastefully. So I don’t support spending cuts that create unemployment but definitely support spending that promotes welfare gains and uses real resources in a non-wasteful manner.
Former IMF senior economist, Simon Johnson considered the fiscal contraction expansion argument in this article (June 23, 2011) – Fiscal Contraction Hurts Economic Expansion. While I do not agree with the underlying logic of his analysis (which would be a separate blog to explain) I do agree that Johnson understand the problems facing the US more coherently than the US leadership.
He says that:
There are four conditions under which fiscal contractions can be expansionary. But none of these conditions are likely to apply in the United States today.
These conditions are:
1. Low “perceived sovereign default risk”. He might has said zero default risk. He thinks that has something to do with the fact that the US dollar is widely used “as a reserve asset” which misses the point that any nation that issues its own currency and trades it freely in foreign exchange markets has no sovereign default risk in relation to any liabilities issued in its own currency.
2. It is “highly unlikely that short-term spending cuts would directly boost confidence among households or firms in the current US situation”. I provide some evidence below to support that statement. Johnson notes the high unemploymenr rate and the high real GDP gap.
3. Monetary policy cannot become “more expansionary” that it already is in the US. Again, this is true but largely irrelevant and reflects the bias that Johnson and most “mainstream” economists have towards the use of monetary policy as the principle counter-stabilisation tool. As I have explained many times, monetary policy is a poor macroeconomic tool if you desire to stimulate (or contract) aggregate demand.
4. The US has limited capacity to depreciate its currency and enjoy the increased international competitiveness. We might consider a strong currency to be a good thing because it means consumers can buy foreign goods more easily. But irrespective of that debate, I agree with Johnson that the US is not likely to experience a large boost in aggregate demand from net exports any year soon. It runs consistent external deficits (which benefit their citizens in material terms) and they are not about the change.
Johnson argues that the “best way to bring debt-GDP” down (he uses the emotional and meaningless term “under control”) is to is “to limit future spending increases and boost revenue while the economy continues to recover”.
My statement would be that the debt-GDP ratio will fall once growth is strong enough. The policy emphasis has to be on growth not the debt. The rise in debt is just a reflection of the parlous growth rate in the US. Further, it might be at some point public spending will have to fall and taxation rise. But that has nothing to do with the debt levels. Rather it would reflect the need for the US government to ensure that aggregate demand is growing in line with real productive capacity while maintaining the desired public-private balance (whatever the political process determines that to be).
In that sense, I agree with Johnson when he says that:
The major reason debt surged relative to GDP in the past three years is the deep recession – the result of a financial crisis brought on by the irresponsible build up of debt.
He might have been more specific and used the term PRIVATE debt. And then he might have indicated that with the need for the US private domestic sector to reduce its debt exposure and his own recognition that the US is not going to turn around its external deficit any time soon, the only way growth can occur is if the public deficits persist and probably grow even larger.
Empirical reality check
When I read statements by politicians espousing cuts in net public spending I think the technicians in the auditorium or wherever should immediately beam up the following two graphs on the screen behind the speaker.
The first is the US Congressional Budget Office measure of the real GDP gap in America from 1990 to 2011. The measure is likely to understate the size of the gap given the methodology used.
There is a massive shortfall in capacity utilisation given that the real GDP gap measures the percentage difference between actual real output and potential output. The improvement in the early part of this year has been very modest indeed.
There is no secret here. Firms will not increase production and push the real GDP closer to potential unless there is increased spending.
Will there be a fiscal contraction expansion in the US? Answer: highly unlikely. Which means that the spending necessary to reduce this real GDP gap will be further undermined by the government in the US.
The human element of the real GDP gap is captured by the BLS U6 measure of broad labour underutilisation. This measure recognises that the official unemployment rate (percent of unemployed workers in labour force) is a very narrow indicator of labour wastage. It ignores underemployment (part-time workers unable to find enough hours of work); hidden unemployment (workers excluded from the labour force because they give up actively looking for work); and other marginal worker categories.
The BLS defines the U6 measure as comprising:
Total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force
A number of related pathologies are associated with this level of labour wastage including increased family breakdown, increased demands on the judicial systems (rising crime rates etc), increased demand on health systems (mental and physical); and other problems beyond the obvious income losses which lead to poverty after personal saving is exhausted.
It is very sad when such potential (the US workforce) is left to hang out to dry by the political leaders in a nation. But it is clear – there is no viable and effective political leadership in the US at present capable of putting the people first (especially the most disadvantaged workers).
Time to finish.
That is enough for today!