The Confidence Fairies Love Austerity

Popular Economics Weekly

January’s economic numbers are in, so we can say government stimulus spending has worked; there is just not enough of it. Whereas the views of those Paul Krugman characterizes as “confidence fairies” doesn’t work. Austerity and budget cutting during recessions doesn’t boost growth for the simplest of reasons—consumers and private sector businesses can’t spend the money they don’t have.

The confidence fairies so loved by small government types somehow believe when budget deficits are reduced that businesses and consumers will invest and spend more. But how, when workers are laid off and salaries cut to achieve that result? This results in lower incomes, so lower spending, hence lower demand for the very goods and services that would spur growth.

The U.S. now seems to be entering a virtuous growth cycle just because we didn’t follow the advice of the confidence fairies. Increased stimulus spending has increased hiring, causing in turn increased demand, which then spurs more hiring, and so on. Whereas the Eurozone economies are falling into another recession.

 

Paul Krugman has been telling Europeans what would happen if EU leaders continued to listen to their confidence fairies: “Specifically, in early 2010 austerity economics — the insistence that governments should slash spending even in the face of high unemployment — became all the rage in European capitals. The doctrine asserted that the direct negative effects of 00spending cuts on employment would be offset by changes in “confidence,” that savage spending cuts would lead to a surge in consumer and business spending, while nations failing to make such cuts would see capital flight and soaring interest rates. If this sounds to you like something Herbert Hoover might have said, you’re right: It does and he did.”

So it is our experience with the Great Depression and President Roosevelt’s New Deal that has kept us from following the path of austerity economics, even in the face of continued cries for less government involvement in our recovery. That doesn’t work, as ‘Hoovernomics’ proved. In fact, it was GW Bush’s attempts to follow Hoover’s path that led us into the Great Recession. Bush decided on all those tax breaks, instead of using Clinton’s 4 years of budget surpluses to fix social security and Medicare, resulting in the largest budget deficits since Ronald Reagan, told in telling detail by Bush Treasury Secretary Paul ONeill and Ron Susskind in The Price of Loyalty.

Meanwhile, the U.S. economy continues to grow. Retail sales are one of the best indicators of consumers’ financial health. Excluding autos, retail sales surged 0.7 percent in January after decreasing 0.5 percent in December (due to lower auto sales, said the report). But that may be an anomaly due to a small sampling of auto dealers, because other data show auto sales have been increasing. The Fed’s January Industrial Production report said the output of motor vehicles and parts surged 6.8 percent following an upwardly revised increase of 3.8 percent in December.

Graph: Econoday

Overall industrial production was unchanged in January after a 1.0 percent jump the month before, but the manufacturing component jumped 0.7 percent, following a 1.5 percent comeback in December.  In January, utilities dropped 2.5 percent while mining output declined 1.8 percent, was the reason for overall production being flat. The manufacturing sector was strong in several Fed regions. Both the Empire State (New York Fed), and Philly Fed manufacturing surveys jumped.

Graph: Econoday

These factors also led the index of leading economic indicators to a solid 0.4 percent gain in January following upwardly revised gains of 0.5 and 0.3 percent in the prior two months. Other areas showing strength in January include credit activity and building permits, gains that underscore the improving outlook for the housing and construction sectors.

Graph: Econoday

What makes me think this is really a virtuous growth cycle, rather than another early-in-the-year spurt that might die later is that the nation's inventories are lean and well managed—meaning there are no headwinds from excess inventories. Business inventories rose a moderate 0.4 percent in December, below the 0.7 percent rise for sales and pulling down the stock-to-sales ratio by 1 tenth to 1.26. That means demand is keeping up with production, since the stock-to-sale ratio hasn’t increased.

Graph: Econoday

“Now the results are in”, says Krugman, “and they’re exactly what three generations’ worth of economic analysis and all the lessons of history should have told you would happen. The confidence fairy has failed to show up: none of the countries slashing spending have seen the predicted private-sector surge. Instead, the depressing effects of fiscal austerity have been reinforced by falling private spending.”

“Look, I understand why influential people are reluctant to admit that policy ideas they thought reflected deep wisdom actually amounted to utter, destructive folly. But it’s time to put delusional beliefs about the virtues of austerity in a depressed economy behind us.”

Harlan Green © 2012

Why are Some States Poorer Than Others?

Financial FAQs

We have austerity in our own country as a result of the Great Recession, but it doesn’t fall equally on all states. In fact, states suffering the most are mainly those in the South, Midwest and manufacturing rust belts.

We also know most of them are red states, and so the most conservative. Yet those states—the poorest, who have lost the most wealth—also receive the most government benefits.

How can that be so when they have spawned the most conservative politicians who decry government benefits of any kind? Dean P. Lacy, a professor of political science at Dartmouth College, is one of several researchers who have identified this anachronism. Support for Republican candidates, who generally promise to cut government spending, has increased since 1980 in states where the federal government spends more than it collects. The greater the dependence, the greater the support for Republican candidates, says his research.

Conversely, states that pay more in taxes than they receive in benefits tend to support Democratic candidates. And Professor Lacy found that the pattern could not be explained by demographics or social issues.

But it can be explained by other factors. One of my earlier columns, entitled “The Have and Have-Not States”, identified several of the factors that differentiate the poorest from the wealthiest states in the U.S., as measured by those states with the highest percentage of passport holders. It comes from a study reported on Grey’s Blog, which shows New Jersey with the highest percentage of passports-68.36 percent-to Mississippi with 19.86 percent of its population having passports.

Grey’s Blog

That factor is openness to outside experience, which is a psychological trait that comes from either having overseas’ relations, or a better education, or a geographical proximity to other cultures. Those states with the highest percentage of passport holders had also the most diverse population, were most educated, most politically liberal, and the wealthiest. Of course, wealth seems to go in hand with education, which shouldn’t be surprising.

Graph: Grey’s Blog

But those same states also had the best public services, most creative workforce and best health care outcomes, as well. Conversely, those states with the fewest passport holders were the least educated, least wealthy, even though they garnered the most governmental services.

Paul Krugman has listed 3 reasons in his own blog why the poorest states tend to elect conservative politicians, who certainly have not enhanced the economic opportunities of their own constituents.

“And what these severe conservatives hate, above all, is reliance on government programs,” says Krugman. “Rick Santorum declares that President Obama is getting America hooked on “the narcotic of dependency.” Mr. Romney warns that government programs “foster passivity and sloth.” Representative Paul Ryan, the chairman of the House Budget Committee, requires that staffers read Ayn Rand’s “Atlas Shrugged,” in which heroic capitalists struggle against the “moochers” trying to steal their totally deserved wealth, a struggle the heroes win by withdrawing their productive effort and giving interminable speeches.”

But he doesn’t mentioning scape-goating, a common tactic used by the most conservative politicians to explain why their own constituents tend to be worse off than those in the blue, more liberal states.

Though Christ’s teaching, “Let he among you who is without sin cast the first stone” should be foremost in the minds of conservative church-goers, particularly, conservative pundits have blamed government and high taxes for their ills, when in fact it has been their own Social Darwinist views that has held back development in the red states.

In fact history has shown that it is during periods of regulatory breakdown, when so-called ‘free market’ ideologies prevailed as during the Hoover and GW Bush eras—i.e. when government oversight was at its weakest—that the greatest economic downturns happened. So it should be no surprise that “Political scientists who use Congressional votes to measure such things find that the current G.O.P. majority is the most conservative since 1879,” says Krugman, “which is as far back as their estimates go.”

That was the era of social Darwinism—when the struggle for survival of the fittest prevailed and made sense to Americans, as we were still struggling to settle and civilize our wildernesses.

But the American landscape is far different today. Modern technology has conquered the means of production, so that we suffer from too much being produced rather than too little. What we cannot or will not domestically produce is easily imported. That is the reason for the succession of burst asset bubbles—from the dot-com market crash, to too- big-to-fail financial institutions, to housing—that Americans have suffered through.

So there is no reason for a regression to 19^th century thought and philosophy that the Republican Presidential candidates seem to be yearning for. There is also no reason for the wide divergence of wealth between states. Research has shown the most prosperous states are the most pro-government, most forward-looking, most open to other cultures and new ideas. What economy (or state) can grow otherwise?

Harlan Green © 2012

Builder Confidence Soars in 2012

The Mortgage Corner

WASHINGTON (MarketWatch) — Home builder confidence in the market for new single-family homes climbed in February for the fifth straight month to reach the highest level in more than four years, said a Marketwatch headline. And there are good reasons for builders’ growing confidence as housing starts, affordability, and even employment continue to increase.

The National Association of Home Builders/Wells Fargo housing market index rose to 29 in February from 25 in January, meaning the gauge has more than doubled since September. Economists polled by MarketWatch had expected a reading of 26.

 

Graph: Calculated Risk

“This is the longest period of sustained improvement we have seen in the HMI since 2007, which is encouraging,” said NAHB Chief Economist David Crowe. “However, it is important to remember that the HMI is still very low, and several factors continue to constrain the market. Foreclosures are still competing with new home sales, and many builders are seeing appraisals come in at less than the cost of construction. Additionally, prospective home buyers are finding it difficult to qualify for a mortgage.”

The main reason for increasing optimism is total housing starts were at 699 thousand (SAAR) in January, up 1.5 percent from the revised December rate of 689 thousand (SAAR). Note that December was revised up from 657 thousand. Single-family starts declined 1.0 percent to 508 thousand in January, however December was revised up by 43 thousand from 470 thousand. There were the first two months above 500 thousand since the expiration of the tax credit.

Graph: Calculated Risk

And the delinquency rate for mortgage loans on one-to-four-unit residential properties also decreased to a seasonally adjusted rate of 7.58 percent of all loans outstanding as of the end of the fourth quarter of 2011, a decrease of 41 basis points from the third quarter of 2011, and a decrease of 67 basis points from one year ago, according to the Mortgage Bankers Association’s (MBA) National Delinquency Survey. The non-seasonally adjusted delinquency rate decreased five basis points to 8.15 percent this quarter from 8.20 percent last quarter.

The delinquency rate includes loans that are at least one payment past due but does not include loans in the process of foreclosure. The percentage of loans in the foreclosure process at the end of the fourth quarter was 4.38 percent, down five basis points from the third quarter and 26 basis points lower than one year ago.

And, housing affordability is at its highest level in 20 years. Nationwide housing affordability, as measured by the National Association of Home Builders/Wells Fargo Housing Opportunity Index (HOI), rose to a record level during the fourth quarter of 2011, while prospective home buyers continued to feel the constraints of tighter credit standards and a soft economy.

The just released HOI data indicated that 75.9 percent of all new and existing homes sold in the fourth quarter were affordable to families earning the national median income of $64,200, the highest percentage recorded in the 20-year history of the index.

"While today's report indicates that homeownership is within reach of more households than it has been for more than two decades, overly restrictive lending conditions confronting home buyers and builders remain significant obstacles to many potential homes sales, even with interest rates at historically low levels," said Barry Rutenberg, chairman of the National Association of Home Builders (NAHB).

Despite restrictive credit conditions, low jobs creation is still the main roadblock to a housing recovery. But 2012 may show continued signs of improvement on that front also, as initial unemployment claims continue downward.

Graph: Calculated Risk

In the week ending February 11, the advance figure for seasonally adjusted initial claims was 348,000, a decrease of 13,000 from the previous week's revised figure of 361,000. The 4-week moving average was 365,250, a decrease of 1,750 from the previous week's revised average of 367,000. In fact, the 4-week moving average is at the lowest level since early 2008.

In fact, small businesses provide 70 percent of new hires, so that is where we should look for jobs’ improvement. A good measure of small business is the National Federation of Business Optimism Index, which hasn’t yet risen above recession levels. But the jobs market is tightening, in line with U.S. overall improved employment.

 

Harlan Green © 2012

“Reports of workforce reductions are at their lowest level since October 2007,” said the latest NFIB report. “Forty-one percent of owners hired or tried to hire in the past three months, but 31 percent reported few or no qualified applicants for the position(s). The increase in the percent of owners with hard to fill job openings indicates that job markets are tightening somewhere, and correctly anticipated a decline in the unemployment rate.”

So we will see if builders’ optimism is warranted. It has been a long time coming.  But a new generation of home owners and renters are becoming adults—the echo boomers born between 1986 to 2000. I believe the builders’ optimism is warranted, because echo boomers, or Gen Y’ers, are the children of baby boomers and number more than 80 million, more than baby boomers—in fact, the largest generation in our history.

Harlan Green © 2012

Where is the Inflation?

Financial FAQs

If we would listen to the Europeans advocating austerity measures to punish Greece and Italy in particular for their profligacy, then inflation is right around the corner, according to the Germans, at least. Germany’s Finance Minister Wolfgang Schaubele is the most hawkish in advocating that the Greeks won’t get the next installment of their rescue package unless they shave off 130M euros in spending cuts to bring down their some 400M euros in debt.

Herr Schaubele is the principal advocate of what Paul Krugman calls the “confidence fairy”. The confidence fairy is the myth that too much debt causes the loss of confidence in a sovereign currency, driving up interest rates and inflation, even during recessions. It is the rationalization extreme fiscal conservatives use to justify their ideology that all debt is bad (though it is their wealthy supporters who do the most lending), and so debtors must be punished for their borrowing.

That is behind Herr Schaubele’s attempts to drive Greece out of the euro by insisting on such draconian austerity measures that Greece cannot possibly fulfill. Herr Schaubele’s efforts have succeeded instead in pulling several EU countries back into recession, as prices and output are falling, which is what one would expect, because such austerity measures cause a huge drop in incomes, and so any stimulus to grow economies. Great Britain, Ireland, Italy the Netherlands, and Spain are just a few countries suffering from its effects.

“We doubt that the euro zone will be able to avoid further contraction in the first quarter and very possibly the second as well in the face of tighter credit conditions, a further tightening in fiscal policy in many countries, the ongoing pressures facing consumers (high and rising unemployment, and still squeezed purchasing power) and limited global growth,” said Howard Archer, chief European economist at IHS Global Insight, said in a Marketwatch interview.

Economists have been discussing the dangers of inflation since the beginning of economics, but don’t really spell out that there are at least 2 kinds of inflation. There is consumer inflation measured by such as the Consumer Price Index, and there are many commodity price indexes that measure asset inflation.

Graph: Econoday

Consumer price inflation was nonexistent in December at the headline and core levels. The consumer price index in December was unchanged for the second month in a row with lower energy costs playing a key role. Excluding food and energy, the core CPI decelerated to a modest 0.1 percent increase after gaining 0.2 percent in November, and is up just 2.2 percent year-over-year. 

Graph: The World Bank

For the U.S., commodity prices are best measured by the U.S. Producer Price Index for producer goods, which at the producer level in December was tugged down by gasoline and food costs but the core was warmer than expected.  Producer prices edged down 0.1 percent after rebounding 0.3 percent the prior month.

The two are not necessarily related, because producers cannot always pass on their costs to consumers, though economists still take sides. The so-called monetarists, or neo-classicists tend to be fiscal, small government conservatives that believe all economic activity depends on the size of the money supply. And government should not be in the business of boosting the money supply with stimulus, which only causes more inflation.

Whereas Keynesians, or neo-Keynesians, believe that there is really no danger of inflation as long as unemployment is high, which happens during recessions. That’s because consumers who power some 67 percent of aggregate demand cannot create inflationary pressures as long as personal incomes, wages and salaries and the like are stagnant.

In fact, Keynesians maintain from their Great Depression experience that the overall money supply doesn’t increase during recessions, but is hoarded, causing deflationary pressures. And deflation is the hardest to root out, as Japan found out since their bubbles burst in 1990. In fact, corporations are the largest hoarders of cash (some $2 trillion to date), so don’t expect much hiring from them.

Yet, it is really small businesses that provide 70 percent of new hires, so that is where we should look for jobs’ improvement. A good measure of small business is the National Federation of Business Optimism Index, which hasn’t yet risen above recession levels. But the jobs market is tightening, in line with U.S. overall improved employment.

“Reports of workforce reductions are at their lowest level since October 2007,” said the latest NFIB report. “Forty-one percent of owners hired or tried to hire in the past three months, but 31 percent reported few or no qualified applicants for the position(s). The increase in the percent of owners with hard to fill job openings indicates that job markets are tightening somewhere, and correctly anticipated a decline in the unemployment rate.”

So beware of the confidence fairies, says Nobelist Paul Krugman. If you believe in them, you will surely lose confidence in the very institutions that create economic growth.

Harlan Green © 2012

Where is the Housing Bottom?

The Mortgage Corner

The housing bottom is really a function of incomes, jobs, and inventory of houses for sale. All three indicators are favorable for housing sales to pick up this year. But prices have to bottom first. The main price indicators are the monthly S&P Case-Shiller and FHFA price indexes that supervise Fannie and Freddie telling their direction. Another indicator that tells us when housing markets are improving is weekly mortgage application totals put out by the Mortgage Bankers Association.

Graph: Calculated Risk

Mortgage applications increased 23.1 percent from one week earlier (last week’s results included an adjustment for New Years Day), according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending January 13, 2012.

“Interest rates dropped last week due to continuing anxieties regarding the fragile economic situation in Europe,” said Michael Fratantoni, MBA’s Vice President of Research and Economics.  “With mortgage rates reaching new lows, refinance volume jumped and MBA’s refinance index reached its highest level in the last six months.  Purchase activity also increased as buyers returned to the market after the holiday season.”

Graph: Calculated Risk

The Refinance Index increased 26.4 percent from the previous week to its highest level since August 8, 2011. The seasonally adjusted Purchase Index increased 10.3 percent from one week earlier to its highest level since December 12, 2011.

And builder confidence in the market for newly built, single-family homes continued to climb for a fourth consecutive month in January, rising four points to 25 on the latest NAHB/Wells Fargo Housing Market Index (HMI). This is the highest level the index has attained since June of 2007.

"Builder confidence has now risen four months in a row, with the latest uptick being universally represented across every index component and region," noted Bob Nielsen, chairman of the National Association of Home Builders (NAHB). "This good news comes on the heels of several months of gains in single-family housing starts and sales, and is yet another indication of the gradual but steady improvement that is beginning to take hold in an increasing number of housing markets nationwide -- and that has been shown by our Improving Markets Index. Policymakers must now take every precaution to avoid derailing this nascent recovery."

Privately-owned housing starts in December were at a seasonally adjusted annual rate of 657,000. This is 4.1 percent below the revised November estimate of 685,000, but is 24.9 percent (±18.3%) above the December 2010 rate of 526,000.

Graph: Calculated Risk

But Single-family starts increased 4.4 percent to 470,000 in December - the highest level in 2011, and the highest since the expiration of the tax credit. This should give a boost to 2012 growth.

Another upside surprise was signs of increased employment. Momentum is building in the labor market. Payroll jobs in January advanced 243,000 after jumping 203,000 in December (originally 200,000) and rising 157,000 in November (prior estimate up 100,000). The net revisions for November and December were up 60,000.

Graph: Econoday

As for some time, says Econoday, private payrolls outstripped the total, increasing 257,000 in January, following a gain of 220,000 in December. So we are seeing a reason for the jump in builder confidence.

Existing-home sales might also pick up, because of the fire-sale prices. Total housing inventory at the end of November fell 5.8 percent to 2.58 million existing homes available for sale, which represents a 7.0-month supply at the current sales pace, down from a 7.7-month supply in October.

Graph: Calculated Risk

We know that it’s the combination of a better jobs market and even increased household formation that increases the demand for housing. Demand is increasing in spite of some 4 million homes somewhere in the foreclosure process. Maybe a key is that the younger, echo boomer generation is creating more households. Household formation has fallen drastically since 2007, so maybe this is the year when it will return to historical levels.

Harlan Green © 2012

Why the Surprising Jobs Report?

Financial FAQs

Why so much surprise in January’s employment report that added 243,000 payroll jobs and dropped the unemployment rate to 8.3 percent? The U.S. has now added an average of 183,000 jobs a month in the past five months, while both the manufacturing and service sectors have been expanding for 30 months, since August 2009. You would think that would be grounds for some optimism this year, but it hasn’t cheered up many, including the Federal Reserve.

Economists and pundits, in particular, seem to have been blinded by everything from the euro’s demise, to slower growth in emerging countries, to an overheating of the Chinese economy had been used to tone down predictions for 2012 growth. Even the Fed’s forecasts have been downgraded, though Fed Chairman Bernanke did say the jobs market “had improved modestly” in his latest congressional testimony.

Graph: CBPP

Some of the surprise was due to a pickup in both residential and non-residential construction, as real estate seems to slowly recovering, in part because of extremely affordable housing prices. Construction employment has added 52,000 jobs over just the past 2 months.

A total of 257,000 jobs were added in the private sector minus 14,000 public sector job losses. And Marketwatch reported that employment rose by an incredible 631,000 in January in the Household survey (that includes the self-employed) after adjusting for the effects of updating the population count. That’s the biggest increase since late 2007. Over the past six months, employment as measured by the household survey has increased by 1.98 million, the biggest increase in more than six years.

But there’s more to the story. The steady stream of irrationally pessimistic stories has until now reinforced the belief that our institutions had failed—from government to financial markets, and the private sector business in general that laid off more than 8 million workers from 2008-10.

The bad news had been drowning out the good news, in other words, had reinforced the stories we all hear in the media and elsewhere that tended to emphasize the negative in any report, in spite of the now 2 years of steady job and overall expansion of economic growth since the June 2009 end of the Great Recession .

Graph: Calculated Risk

This is what Robert Shiller and George Akerlof discussed in Animal Spirits, How Human Psychology Drives the Economy and Why it Matters for Global Capitalism, which further develops famous economist John Maynard Keynes’ thesis that animal spirits, or emotions, drive most financial decisions. It was as much the negative news that permeated the air waves as anything that drove down consumer confidence to it record lows, in other words, and caused consumers and businesses to stop spending.

And we can measure the degree of confidence at any time in the economy, mainly via the two major confidence surveys of the Conference Board and University of Michigan. Confidence plunged to record lows in June, 2009 at the actual end of the recession, but are now returning to more normal levels.

Graph: Inside Debt

This was reinforced by faulty government statistics that said, for instance, there were no payroll jobs created last August—zip, zero—when in fact later revisions added 103,000 jobs in August, and additional jobs in later months.

Small business hiring has been part of the reason for increased employment, in part because of the Obama Administration’s freeing of $32 billion in SBA financing last year. And small business accounts for 70 percent of new jobs. Bank lending has increased 5 percent in the last half of 2011, according to NPR radio’s All Things Considered news program. In fact, stimulus spending over the past year may have contributed at least 1 percent to current growth, says the Center for Budget Priorities and Policies.

Also pushing growth has been large jumps in both manufacturing and service sector activity, via the ISM Purchasing Management surveys. A gigantic surge in employment and almost an equally dramatic surge in new orders headline a very strong ISM non-manufacturing report where the headline composite index jumped to 56.8, well beyond Econoday's consensus for 53.3 and a strong 3.6 points above December's upwardly revised 53.0.

Graph: Econoday

New orders jumped nearly 5 points to a 59.4 level that indicates strong monthly growth and points to acceleration in general activity in the months ahead. But the employment index is the eye catcher, up 8 points to 57.4 for by far the strongest reading of the recovery. This index has been lagging improvement in employment data from the government -- but not any more.

Graph: Econoday

Moderate and steady growth is the indication from the ISM manufacturing report where readings pretty much match those of December, said Econoday. The January composite index rose to 54.1, safely over 50 to indicate monthly expansion and 1 point over December to indicate a slightly faster rate of expansion (prior revised). A key highlight of the report is the new orders index which rose nearly 3 points to 57.6 to indicate a little bit more than just a moderate rate of monthly expansion. In another positive, backlog orders increased 4.5 points to show a build at 52.5.

Even builder confidence in the market for newly built, single-family homes continued to climb for a fourth consecutive month in January, rising four points to 25 on the latest NAHB/Wells Fargo Housing Market Index (HMI). This is the highest level the index has attained since June of 2007, and is why construction spending jumped 1.5 percent in December and has increased some 7 percent in one year.

 

"Builder confidence has now risen four months in a row, with the latest uptick being universally represented across every index component and region," noted Bob Nielsen, chairman of the National Association of Home Builders (NAHB). "This good news comes on the heels of several months of gains in single-family housing starts and sales, and is yet another indication of the gradual but steady improvement that is beginning to take hold in an increasing number of housing markets nationwide -- and that has been shown by our Improving Markets Index. Policymakers must now take every precaution to avoid derailing this nascent recovery."

So we don’t have to be pessimistic anymore. Rising confidence levels lifts all boats, as the saying goes.

Harlan Green © 2012

Corporate Austerity Not the Answer in 2012

Popular Economics Weekly

Why so much gloom and tentativeness about U.S. economic growth when all the indicators are looking up for 2012? For instance, the Conference Board’s Index of Leading Economic Indicators again showed positive growth ahead. It rose 0.4 percent with 7 of its 10 indicators positive.

And the Q4 ‘advance’ estimate of GDP growth was 2.8 percent, almost double Q3. Equipment and software, which includes autos and exports, was the largest component. It would be even higher if corporation would use more of their cash hoard for job creation, rather than speculative investments and excessive executive compensation.

Graph: Econoday

Could it be because of the euro’s problems? “This somewhat positive outlook for a strengthening domestic economy would seem to be at odds with a global economy that is losing some steam,” said Ken Goldstein, a Conference Board economist. “Looking ahead, the big question remains whether cooling conditions elsewhere will limit domestic growth or, conversely, growth in the U.S. will lend some economic support to the rest of the globe.”

But JP Morgan’s President Jamie Dimon said even the damage from a default of Greek debt would be “negligible”, in a CNBC interview at the Davos, Switzerland economic summit. So what’s the problem? The austerity (meaning deficit) hawks have their hands around the throats of European commerce. Why? In the mistaken belief that more stimulus spending will increase debt without actually causing more growth.

But Professor Robert Shiller, co-author of Animal Spirits with Nobelist George Akerlof, calls it debt delusion. When the private sector, including households, becomes over indebted, they begin to save more and spend less. But if governments do it at the same time, it causes a downward spiral towards deflation and recession or depression. This comes from the belief of fiscal conservatives that public borrowing takes money away from private users.

That, however, isn’t the case, because the private sector has plenty of funds, but is hoarding them (some $2 trillion in cash to date), rather than creating more jobs. So if governments are also hoarding their monies—in the form of trade or currency surpluses, as is happening in most of Europe today, then the bottom falls out of the economy. I.e., if no one is buying and everyone is saving, then no business gets done. This should be self-evident, because such a truth has been known since the Great Depression and New Deal that established our modern safety net, and ultimately put so many people back to work.

What underlies that truth is that Great Depressions and Great Recessions only happen when there is a wrenching transformation of whole economies. It was transformation of a mostly rural economy to manufacturing in the 1920s that brought on the Great Depression, and now it is wholesale migration of manufacturing jobs overseas and transformation to the Information Age, when little needs to be manufactured in the U.S.

Rutgers Econ Professor James Livingston has explained this transformation best in recent papers and articles. The great wealth shift away from wage earners-consumers to corporate profits began during the Great Depression, according to Livingston: “The underlying cause of that economic disaster (the Great Depression of 1929-33, 1937-38) was a fundamental shift of income shares away from wages/consumption to corporate profits that produced a tidal wave of surplus capital that could not be profitably invested in goods production—and, in fact, was not invested in good production…and that, on the other hand, produced the tidal wave of surplus capital which produced the stock market bubble of the late-1920s.”

And in a recent New York Times Op-ed, It’s Consumer Spending, Stupid, Livingston expands on the reasons for our current prolonged malaise:

“As an economic historian who has been studying American capitalism for 35 years, I’m going to let you in on the best-kept secret of the last century: private investment — that is, using business profits to increase productivity and output — doesn’t actually drive economic growth. Consumer debt and government spending do. Private investment isn’t even necessary to promote growth.”

This, to put it mildly, explodes that rationale used by Wall Street and corporations to justify not passing on more of their profits to consumers—80 percent of which are wage and salary earners. The reasoning being that it is their profits that drive growth.

Professor Livingston says, “Economists will tell you that private business investment causes growth because it pays for the new plant or equipment that creates jobs, improves labor productivity and increases workers’ incomes. As a result, you’ll hear politicians insisting that more incentives for private investors — lower taxes on corporate profits — will lead to faster and better-balanced growth.”

Not so, says Livingston, “But history shows that this is wrong. Between 1900 and 2000, real gross domestic product per capita (the output of goods and services per person) grew more than 600 percent. Meanwhile, net business investment declined 70 percent as a share of G.D.P. What’s more, in 1900 almost all investment came from the private sector — from companies, not from government — whereas in 2000, most investment was either from government spending (out of tax revenues) or “residential investment,” which means consumer spending on housing, rather than business expenditure on plants, equipment and labor.

“In other words, over the course of the last century, net business investment atrophied while G.D.P. per capita increased spectacularly. And the source of that growth? Increased consumer spending, coupled with and amplified by government outlays.”

Much has been written already about the record profits of both financial and non-financial corporations that have drained consumption, and that is the main reason why average real household incomes have actually declined over the past 30 years. In fact, corporate profits today are highest in history as a percentage of GDP.

Graph: Trading Economics

And this could be actually endangering economic growth by causing rampant market speculation, rather than productive investments, say many pundits, including Professor Livingston: “So corporate profits do not drive economic growth — they’re just restless sums of surplus capital, ready to flood speculative markets at home and abroad. In the 1920s, they inflated the stock market bubble, and then caused the Great Crash. Since the Reagan revolution, these superfluous profits have fed corporate mergers and takeovers, driven the dot-com craze, financed the “shadow banking” system of hedge funds and securitized investment vehicles, fueled monetary meltdowns in every hemisphere and inflated the housing bubble.”

How to cure the record income inequality that has resulted from so much power going to Wall Street and the corporations? Let us return to the income tax brackets that brought on so much prosperity to the middle class during the 1960s and 1970s. What were they?

The maximum bracket has fluctuated from 91 percent for those earning more than $400,000 in 1960, to the current low of 35 percent for those earning more than $379,150 today. And this has coincided with the astronomical increase in both household and government debt.

So it should be a no-brainer, if we want to see American growth restored to historical levels. Higher taxes have meant more growth, because public revenues are invested in growth-inducing infrastructure, better public safety, and upward mobility inducing education, for starters. Whereas lower taxes mean higher debts, with less growth and more speculative risk-taking to show for it. Why history is so easily forgotten may be a question only psychologists can answer.

Harlan Green © 2012