Debtmageddon:
the Non-Problem Problem
by
Sinclair Noe
DOW
+ 207 = 12,795
SPX + 27 = 1386
NAS + 62 = 2916
10 YR YLD +.04 = 1.61%
OIL + 1.22 = 86.67
GOLD + 18.20 = 1732.90
SILV + .80 = 33.21
SPX + 27 = 1386
NAS + 62 = 2916
10 YR YLD +.04 = 1.61%
OIL + 1.22 = 86.67
GOLD + 18.20 = 1732.90
SILV + .80 = 33.21
Pete
Domenici and Alice Rivlin are co-chairs of the Bipartisan Policy
Center for Debt Reduction Task Force, offering the following
recommendations in an article in the New
York Times over the weekend:
Economic
growth must precede full-scale debt restraint.
Congress
should take action now to pass legislation phasing in tax reform that
yields new revenues and restructuring entitlements to curb the
continued growth of federal spending, particularly for health care.
We
cannot resort to such ham-handed mechanisms as the approaching
sequester cuts, large across-the-board tax increases and other
elements of the “fiscal cliff.”
In
late 2010, the task force recommended a holiday from the full 12.4
percent Social Security payroll tax, not the partial 2 percent cut
that Congress ultimately passed. The idea is that whether it comes in
the form of a payroll tax holiday, an income tax rebate or another
similar mechanism, the most pressing priority is to get the economy
out of “stall speed.”
The
task force also suggested a possible “framework” for the
lame-duck Congress to pass a modest down payment on deficit reduction
in December, while pursuing a comprehensive agreement, a “grand
bargain” of sorts, in 2013.
If
I may break it down in a nutshell; growth before austerity.
Federal
Reserve Board Chairman Ben Bernanke will travel to New York City
tomorrow to deliver a speech in which he will explain that the
central bank is not having any second thoughts about its ultra-easy
monetary policy stance. Bernanke
will likely use his speech to emphasize once again that monetary
policy will remain highly accommodative and will stay that way even
after the recovery strengthens. Fed watchers generally think the Fed
will boost its easing power in December by converting its expiring
Operation Twist program into an outright Treasury purchase plan
program. At the moment, the Fed is buying $45 billion of Treasurys
per month under this plan, but the purchases are offset by sales of
short-term securities. Don't expect any groundbreaking news from the
Fed head, but expect a tone generally supportive of further easy
monetary policy. The next Fed FOMC meeting is December 12-13.
Bernanke
and the FOMC will likely adopt a wait and see attitude. They will
wait to see if the dysfunctional Congress will really run like
lemmings over the fiscal cliff. They might, but we have to let it
play out. Policymakers
are faced with a new round of momentous choices – how to balance
the imperative for job creation with the pressure to address budget
shortfalls.
There will be temptations to hold firm and there will be temptations
to cut a deal. The whole framework around cutting a deal is based on
the idea that we must reduce the deficit and there must be fiscal
responsibility. You could replace fiscal responsibility with
austerity for the purposes of discussion.
The
federal budget deficit isn’t the nation’s major economic problem
and deficit reduction shouldn’t be our major goal. Our problem is
lack of good jobs and sufficient growth.
Deficit
reduction leads us in the opposite direction — away from jobs and
growth.
Too much deficit reduction, too quickly would suck too much demand
out of the economy; however, more
jobs and growth will help reduce the deficit. With more jobs and
faster growth, the deficit will shrink as a proportion of the overall
economy. Europe offers the same lesson in reverse: Their deficits are
ballooning because their austerity policies have caused their
economies to sink. Yes, they are cutting spending but their economies
are shrinking faster than the spending cuts; and the debt-to-GDP
ratio grows. In fact, if there was ever a time for America to borrow
more in order to put our people back to work repairing our crumbling
infrastructure, it’s now.
And
yet, there is still a loud chorus for debt reduction, and the media
has bought into the idea, or at least they've hooked onto the fear
factor involved with the phrases “fiscal cliff” and
“debtmageddon”. They repeat the talking points of a small
cottage industry that has sprung up around debt reduction. They say
that it is a given that tax rate will go up; they say it is a given
that spending will be cut; it's a given that deficits are bad. There
has been very little discussion and debate about the dangers of
deficit reduction. And so, the closest we've come to a serious debate
is to discuss the timing: It
all boils down to timing and sequencing: First, get the economy back
on track. Then tackle the budget deficit.
Sounds
good, but why does the deficit have to be tackled? Deficit
hawks routinely warn unless the deficit is trimmed we’ll fall prey
to inflation and rising interest rates. But there’s no sign of
inflation anywhere. The world is awash in underutilized capacity As
for interest rates, the yield on the ten-year Treasury note is about
1.6%, near record lows.
We
certainly don’t want to go where Europe has been going lately.
They’re a great example of how NOT to manage your way out of a debt
crisis. It would take superb timing to avoid the fate of the Eurozone
nations by planning for deficit reduction later, or at all? The
assumption here is that there must and will be a time when we can
reduce the deficit without harming the economy. What if there’s no
such time? What if any substantial deficit reduction to under 4% of
GDP, a figure envisioned in most of the deficit reduction plans being
offered, means making the private sector poorer in the aggregate?
Wouldn't that get priced in?
That's not
just a theoretical question. Right now, the US imports more than it
exports in an amount greater than 4% of GDP. If we continue to do so,
and the Government deficit is forced down to a number below 4% of
GDP, then a
private sector surplus in the aggregate will
be literally impossible to attain, and, if we continue with such a
policy, year after year, the private sector will lose more and more
of its net financial assets as the Government eats the private
economy in a fit of fiscal irresponsibility, that since it’s now
way past 1984, the austerity advocates label fiscal responsibility.
Public
investments that spur future job-growth and productivity shouldn’t
even be included in measures of government spending to begin with.
They’re justifiable as long as the return on those investments –
a more educated and productive workforce, and a more efficient
infrastructure, both generating more and better goods and services
with fewer scarce resources – is higher than the cost of those
investments.
In
fact, we’d be nuts not to make these investments under these
circumstances. No sane family equates spending on vacations with
investing in their kids’ education. Individuals can differentiate
between spending and investing. Yet the politicians can't seem to do
that with our federal budget.
I
suspect the real concern over a “deficit problem” is due to fear
of the markets and,maybe, just maybe there is no problem with running
continuous deficits provided the Fed, along with the Treasury,
control interest rate targets, and that the bond markets are
powerless to impose their will on Mr. Bernanke and the Treasury
Secretary if they want to keep rates near zero, or at any other level
of interest they would like the US to pay. Well, guess what, the
bond markets and the ratings agencies are basically powerless to
drive up interest rates against the combined determination of the Fed
and the Treasury to keep them low.
Of
course, too much deficit spending can cause inflation, but the remedy
for that is to raise specific taxes and lower specific spending in
such a way that price stability and full employment result from
fiscal policy.
The
best fiscal policy is one that spends what the US needs to spend to
solve its serious problems.
Gross
domestic product probably increased at about a 2.9 percent annual
rate in July-September, according to economists from Goldman Sachs
and Barclays. That would be the fastest quarterly growth this year,
beating the Commerce Department’s initial estimate of 2 percent.
Help is coming from a housing recovery, strengthening job market and
healthier household finances that are driving gains in consumer
confidence and spending. While the damage from Sandy and an
anticipated tightening of fiscal policy mean growth will decelerate
this quarter and next, the economy may emerge on stronger footing in
the second half of 2013.
Sales
of previously owned homes climbed in October. Purchases increased
2.1 percent to a 4.79 million annual rate. According to the report
from the National Association of Realtors property values rose over
the past 12 months by the most in seven years as inventories dropped
to the lowest level in almost a decade.
Thirteen
cents of every retail dollar is spent at gas stations, but that level
has stagnated in recent years amid weaker demand. Americans spent
some $47.85 billion at gas stations in October; that represents 13%
of the $367.56 billion spent at all retail locations in the month.
That share has increased a bit in recent months, but overall it’s
little changed over the past two years. In the third quarter it was
12.5%, the same level as the first quarter of 2011.
The
American Petroleum Institute reports US oil demand fell 2.3% in
October from a year earlier, to 18.4 million barrels a day. Demand
in the first 10 months of the year was 2.1% below the same period in
2011. A modest economic recovery and continued high unemployment, as
well as higher fuel-economy standards, have reduced demand.
Another
factor in reduced demand for gasoline, in relation to retail sales,
is that e-commerce continues to grow. More than five cents of every
dollar spent at retailers in the July-to-September period was spent
online. That share has basically quintupled in the past decade, and
while growth slowed slightly during the recession, it has continued
to steadily march upward. The more goods people can get online, the
less time they need to spend in the car traveling to brick-and-mortar
retailers.
The
shadow banking industry has grown to about $67 trillion, $6 trillion
bigger than previously thought. The Financial Stability Board, or FSB
says the
size of the shadow banking system, which includes the activities of
money market funds, monoline insurers and off- balance sheet
investment vehicles, “can create systemic risks” and “amplify
market reactions when market liquidity is scarce.”
The
FSB, a global financial policy group comprised of regulators and
central bankers, found that shadow banking grew by $41 trillion
between 2002 and 2011. The share of activity based in the US has
declined from 44 percent in 2005 to 35 percent in 2011, moving to the
UK and the rest of Europe.
While
regulatory watchdogs believe they have reined in excessive
risk-taking by banks in the wake of the collapse of Lehman Brothers
in 2008, they are concerned that lenders might use shadow banking to
evade the clampdown. Already, the European Union is planning to
target money market funds in a first wave of rules for shadow banks
next year.
The
FSB also targeted repurchase agreements and securities lending for
tougher rules, recommending that regulators implement minimum
standards for calculating losses on the different types of collateral
used in the transactions.
Repurchase
agreements are contracts where one investor agrees to sell a security
and then buy it back at a future date and a fixed price. Securities
lending agreements involve institutional investors such as pension
funds lending financial instruments against cash collateral. The
group is also concerned that regulators are unable to monitor the
scale of the trades.
The
FSB says large firms should disclose more information about the deals
to investors and may be required to publish regular statements
detailing how much collateral they have and what it is used for. The
need here is simple: a lack of transparency and disclosure results in
counterparty risk, which in turn can lead to credit freeze, runs, and
a general repeat of 2008. In other words, the FSB report tells us
that the problems of 2008 haven;t been fixed, they've only grown in
size.
New
research from the Federal
Reserve Bank of New York finds
cheaper monthly mortgage payments significantly reduce mortgage
default risk even when the principal value of the home stays the
same.
The report was based in part on findings on
the performance of Alt A adjustable-rate mortgages, between 2008 and
2011.
The
report says: “Interest
rate changes dramatically affect repayment behavior. Our estimates
imply that cutting a borrower’s payment in half reduces his hazard
of becoming delinquent by about two-thirds. Government or lender
programs that allow underwater borrowers to refinance at a lower
rate, or loan modifications that lower the interest rate, have the
potential to significantly reduce delinquencies, and the view that
principal reduction is the only way to meaningfully reduce defaults
is incorrect.”
Here's
the scary part; they're just figuring this out. Years ago, most people learned that when the loan sharks put the rates too high, it resulted in default; when rates were lower and closer to reasonable, people tended to pay their debts.
