WEEK OF September 10, 2007--BERNANKE'S 9/11 SPEECH ATTACKS TRADE DEFICIT, BUT NOT FED BUDGET DEFICIT

It is perhaps fitting that Fed Chairman Ben Bernanke on the anniversary of 9/11 should be making a speech in Berlin that attempts to clarify why we have run up such a trade deficit—of approximately $1 trillion last year alone.

Chairman Bernanke made the speech on the 9/11 anniversary for several reasons. It is consumer spending and borrowing since 9/11—fueled by record low interest rates—that enabled the huge trade deficit, and the trade deficit in turn has enabled the huge federal budget deficit—up to $8 trillion at this writing.

Those twin deficits are a major headache for Bernanke. They happen at the same time that “the U.S. has already reached the leading edge of major demographic changes that will result in an older population and more slowly growing workforce,” said Bernanke in his speech.

This explains why the Fed has been reluctant to drop consumers’ interest rates as it finally did for its banks last month. It wants to discourage consumer spending and encourage more savings, which would reduce the twin deficits.

There is also a second reason behind the Fed’s reluctance. Too much money in consumers’ pockets tends to cause higher inflation. Bernanke and many other Fed Governors, apparently, believe that part of their mission is to discourage consumers from any inflationary tendencies. I.e., if consumers believe the Fed is hawkish and vigilant concerning any inflation, then consumers might shop more carefully. It is only if consumers believe the Fed is serious about controlling prices, in other words, that consumers will control their spending.

In fact, a famous speech Bernanke made when the Fed’s Vice Chairman in 2001 outlined this philosophy. He claimed it was the Fed’s anti-inflation vigilance in the 1980s that caused a period he called the “Great Moderation”, when inflation was subdued. Inflation began to moderate in the 1980s after such draconian Fed measures as raising their fed funds rate to 19 percent in 1981. This caused 2 recessions within 3 years, needless to say.

However, Bernanke is only giving us part of the story. Consumers are over indebted not only due to the Fed’s very accommodative credit easing, but the federal tax cuts of 2001 and 2003 put a huge amount of money back into consumers’ pockets. This encouraged the borrowing binge, and caused the dollar’s value to fall to a 15 year low. It has also caused the price of imported oil—which is paid in dollars, let us not forget—to rise to $80 per crude barrel of devalued dollars at this writing.

The influx of foreign savings also had a hand in the double-digit housing price rises of the past several years. For it is foreign savings that have been the main cause of lower long-term interest rates (i.e., bonds), at the same time the Fed was raising short-term interest rates. This became a disconnect that could not last. It is the rise of short-term, adjustable rates that has fueled the huge number of defaults, hence the current credit-crunch.

The latest news continues to be mixed. Retail sales are still growing at a 3.9 percent annual clip, but only because of deep discounts on last year’s models in August. Industrial production fell, while the U. of Michigan’s preliminary Sept. survey of sentiment edged up slightly, and inflation expectations declined. That is a good sign. There certainly is not yet a credit squeeze on credit cards or car loans. But there’s the rub, to borrow from Shakespeare. If and when the Fed does begin to drop consumers’ short-term rates, this will encourage more borrowing and spending, not more savings.

Consumers tend to save more when interest rates are higher, in other words—such as in the 1980s. But that hurts economic growth. A much better way to cure the twin deficits is to raise taxes on the wealthiest, those making more than $200,000 per year, as was done during the 1990s. Cutting taxes neither cuts deficits nor helps retirees’ benefits, period.

Copyright © 2007

WEEK OF SEPTEMBER 3, 2007--FEDERAL RESERVE TOO HESITANT?

The markets jitters come from more mixed news. July’s unemployment rate remained at 4.6 percent, but payrolls shrank by 4,000 for the first time in 4 years—as opposed to the 100,000 plus monthly jobs average of late. The NAR’s pending existing-home sales index fell, as did construction spending. But both manufacturing and service sector activity continue to expand. And retail sales are robust, especially at the high end.

All of this makes it virtually certain that the Federal Reserve will begin to reduce short-term interest rates sometime this month—maybe this week. Their mandate is not only to fight inflation, but nurture “sustained economic growth”. And any jobs uncertainty is a sure sign that employers are holding off on hiring until the real estate market settles down.

Lawrence Yun, NAR senior economist, said abnormal factors are clouding the existing-home sales picture. “It’s difficult to fully account for mortgage disruptions in the index, and our members are telling us some sales contracts aren’t closing because mortgage commitments have been falling through at the last moment,” he said.

These temporary problems are primarily with jumbo loans, and there are continuing issues for subprime borrowers. But new lenders are stepping into the breach to replace those who have stopped lending—contrary to the early 1980s, when the disparity between short and long term interest rates caused even the largest banks to stop mortgage lending. This is not the case today, as banks are flush with profits from the 5-year expansion.

The economy as a whole seems to be doing quite well of late, including consumers. One such indicator is consumer spending, which had declined but now is rising again along with personal incomes, as I have said. The government’s latest figures show that personal incomes jumped 0.5 percent in July, while real consumption expenditures have averaged 3 percent annually, indicating that third quarter economic growth could also be above 3 percent. Q2 GDP was revised to a 4 percent growth rate.

UNEMPLOYMENT—July’s unemployment rate was unchanged at 4.6 percent because the same number left the workforce as lost their jobs—more than 300,000 in each case, according to the telephone survey of households. There was a 68,000 plunge in construction and manufacturing employment, while education and health services’ employment rose 63,000, according to the payrolls survey. This balancing act is keeping the economy chugging along.

What about real estate sales? Interest rates are already plunging, with conforming 30-year fixed rates now at 5.875 percent for slightly more than a 1 point origination fee. And if the Fed drops its short-term fed funds rate, the Prime Rate and other ARM indexes would follow its lead.

“Some consumer concerns remain, but since mid-August the market has been stabilizing somewhat,” said the NAR’s Yun. “If lenders focus on the essentials of creditworthiness and adjusted valuations based on comparable sales, and ignore speculation on what might happen in the future, broader stabilization will come sooner rather than later,” Yun said.

By not acting sooner, the Fed seems to be trying to downsize the largest issuers of jumbo subprime and Option ARMs, who can no longer sell these loans on the secondary market. Neither consumers, nor these lenders will see any relief until the ARM indexes, including the Prime Rate at 8.25 percent, begin to decline.

Copyright © 2007

WEEK OF AUGUST 13, 2007—CREDIT CRUNCH WORSENS

POPULAR ECONOMICS WEEKLY

In order to understand the abrupt changes in mortgage interest rates, it helps to understand what is going on in the secondary mortgage markets. The so-called secondary market is where most mortgages are sold by banks, mortgage banks, thrifts, and anyone else who funds loans, so they can lend another day. And events this week caused the Federal Reserve to radically shift its bias—and monetary policy—from an inflation danger to the growing danger of slower growth and higher unemployment.

The credit crisis was triggered by borrowers defaulting on their loan payments. This in turn meant that the investors who bought those pools of mortgages—usually in the form of bonds—lost income. Their investments were then worth less, which caused many to want to take their money out of the investment funds.

And when many clamor to withdraw funds, it is much like a run on the bank. Since such funds generally have a limited amount of cash on hand to pay those wanting refunds, they borrowed from their banks. And since banks also have a limited amount of cash on hand, they turned to the Federal Reserve to borrow more money.

Because of the turmoil, secondary market investors (usually mutual, hedge, or pension funds) have been reluctant to buy more mortgages. Why? Until it is known exactly how many mortgages will default, investors cannot measure the risk and so price of their investment. But that won’t happen until we work through more of the $1 trillion in adjustable rate mortgages (ARMs) on the books as their payments continue to adjust upward.

In light of these facts, it is hard to understand why the Fed has taken so long to lower interest rates—as it did Friday with a one-half percent cut in its overnight discount window rate. The damage to economic growth and consumers’ pocketbooks by the credit shortage is far more than that inflicted by a small jump in the inflation rate. It is borrowers not being able to meet their mortgage payments—which are as high as 8.5 percent for even prime borrowers with ARMs—that is causing the squeeze in the first place. And lowering short-term interest rates will help to lower the mortgage payments on those ARMs.

The inflation news has been benign of late, as gas prices have fallen. Both wholesale and retail prices rose slightly, while industrial and service sector production fell. Also, the NAHB/Wells Fargo housing market index fell two points in August to 22, which means about one fifth of builders nationwide think the market is "good." A year ago, the index was at 33. Two years ago it was at 67.

The Commerce Dept. also reported that housing starts (construction) and permits continued to decline. Residential Construction is down 37 percent from their peak of last year, while commercial construction continues to hum along.

PPI and CPI—Wholesale (PPI) prices rose 0.6 percent, but the core rate rose just 0.1 percent without food and energy. Finished wholesale goods are up 4 percent in a year, mainly due to 2.5 percent rise in energy prices. Meanwhile July retail (CPI) prices rose just 0.1 percent, core rate rose 0.2 percent. This is because energy prices fell 1 percent (read gas prices) at the retail level!

HOUSING STARTS--U.S. home builders cut back again in July, starting construction on the fewest number of new homes in more than 10 years, the Commerce Department reported Thursday. Housing starts fell 6.1 percent to a seasonally adjusted annual rate of 1.381 million, the lowest since January 1997. Meanwhile, authorized building permits dropped 2.8 percent in July to a seasonally adjusted annual rate of 1.373 million, the lowest since October 1996.

The Fed only cut the more expensive loan rate to banks, but has not yet acted on the fed funds rate that controls the Prime Rate and ARM indexes of mortgage holders. But Friday’s cut is a sign that central banks may begin to lower interest rates in earnest. In fact, this writer believes a fed funds rate cut sometime before the next September 18 FOMC meeting is now a foregone conclusion, as I have said.

Copyright © 2007

WEEK OF AUGUST 6, 2007—GOOD EMPLOYMENT PICTURE KEEPS FED ON SIDELINES

Last week’s unemployment report confirmed that “moderate” economic growth will continue for the rest of this year. It also confirmed the Federal Reserve’s decision not to change interest rates at its August FOMC meeting. But fast changing conditions in the credit markets could cause the Fed to lower their rates come September. “Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing,” said the FOMC press release. “Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.”

The Fed’s inaction disappointed some analysts who had been calling for the Fed to acknowledge the plight of homeowners caught in the credit crunch. Some lenders are now only offering conforming mortgages that fit Freddie Mac and Fannie Mae guidelines. But good jumbo fixed and adjustable interest rates and programs are still available at lending institutions that did not leverage themselves too highly.

The July unemployment rate rose slightly to 4.6 percent, but that is still considered full employment. This may be one reason the Fed is reluctant to lower interest rates at this time. Fed officials are still seeing strong growth, in other words. Payrolls added just 92,000 jobs, below the 136,000 monthly average for 2007, but wages are rising and the consumer is still borrowing as if there is no tomorrow.

In fact, two crucial sectors in real estate—construction and financial services—have not had a net loss of jobs in 2007 to date, while two other sectors—insurance and securities—have continued to add jobs. This is not surprising in view of the fact that commercial real estate is booming, as new construction is finally catching up to the demand from the continued business expansion.

CONSUMER CREDIT—Consumers borrowed another $13 billion, up 6.5 percent in June. Credit card debt has averaged a whopping 10 percent jump in May and June, biggest increase since 2006, which means the housing slump hasn’t done much to diminish consumers’ so-called wealth-effect!

ECONOMIC GROWTH—The initial estimate of real (inflation adjusted) second quarter Gross Domestic Product (GDP) growth jumped 3.4 percent, showing the economy had recovered from near zero growth in Q1. And inflation was tame, with the PCE core inflation that measures all consumer prices up just 1.9 percent. The growth spurt was mainly due to surging exports, which is helping to keep the U.S. economy at full employment.

We still have a ‘goldlilocks’ that is not too hot or too cold, in other words, and as we have said in the past. This GDP estimate also included revisions over the past 3 years, which showed that consumers had actually saved more and spent less than previously thought. In fact, the revisions show that our personal savings rate has been positive over the past 2 years. This is another reason to be optimistic about future economic growth (with little inflation).

The Federal Reserve has already begun to inject additional monies into the banking system as of this writing to ease the credit crunch--$38 billion as of this writing—while European banks have injected almost $200 billion. This is an early sign that several central banks may begin to lower their interest rates. In fact, the odds continue to grow that the Fed will begin easing even before the September 18 FOMC meeting. This writer believes it now is a foregone conclusion.

Copyright © 2007

Where Is the Corporate Conscience?

August 12, 2007

BARRON’S MAGAZINE

Other Voices Submission

I applaud Leo Hindery’s August 13 Other Voices commentary in Barron's Magazine, “A Plea For Corporate Conscience” for putting corporate responsibility back into play. It shocked me to learn that corporate CEOs—of the Business Roundtable, at least—felt that maximizing shareholder wealth (and so their own) has become the only job of business!

The fact that wages and household incomes have not kept up with productivity gains since the 1970s is just one result of such a shortsighted policy that has resulted in a “growing divergence between its (U.S.) national interests and the interests of those U.S. multinational corporations that seem bent on moving everything but consumption offshore,” says Hindery.

We see the result of the broken contract with the middle class. We know that the massive resulting Federal budget deficits have pushed us back to inequality levels last seen in the 1920s—at the expense of a decent health care system (for our veterans as well), and declining educational system (our elementary and high school children rank lower in math and reading skills than those in Japan and other developed countries).

U.S. citizens now have much longer working hours than in other developed countries, fewer benefits including paid vacations and sick leave, a greater incidence of major diseases, shorter life spans, and higher infant mortality than in some developing countries (including Cuba).

The increase in major diseases was documented in a major British-American study published in the May 3, 2006 AMA’s Journal of the American Medical Association. Using well-respected national survey data on the health and lifestyles of more than 6,400 Americans and 9,300 English people aged 40 to 70, the researchers found that U.S. citizens aged 55 to 64 are twice as likely as their peers in England to be diabetic (12.5 percent of Americans surveyed vs. 6.1 percent of British); 10 percentage points more likely to have high blood pressure (42.4 percent vs. 33.8 percent); 6 percentage points more likely to suffer from heart disease (15.1 percent vs. 9.6 percent); and at nearly double the risk for cancer (9.5 percent vs. 5.5 percent). Americans also had higher rates for heart attack, stroke and lung disease when compared to the British.

Leo Hindary’s initial recommendation to link corporate tax rates to the productivity of a corporation’s U.S. employees will do nothing to encourage workers to produce more, however, unless employees receive their ‘fair’ share of its benefits. And who is to say such savings will be passed on to employees?

A much better idea is to improve the health and security of all U.S. workers by guaranteeing basic health care for all, as in all other industrialized countries. We should also strengthen our retirement system, so that workers do not have to worry about their old age. Treasury Secretary Paul O’Neill was fired for suggesting that $1 trillion of the Clinton budget surplus be set aside to rescue social security and Medicare, instead of using it to finance the drastic tax cuts that have caused much of the current budget deficit (i.e., $8 trillion in public debt, 45 percent of which is owed to foreign investors).

Sincerely,

Harlan Green,

Editor, PopularEconomics.com

What Tax Cuts Helped Economy?

July 14, 2007

Editor

BARRON’S MAGAZINE

Other Voices Submission

J.T. Young’s “Other Voices’ (July 16) essay, “Tax Cuts Helped Economy Stay Afloat,” is but a repetition of what has become the Bush Administration’s mantra: “…cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible.” (as originally coined by economist Milton Friedman). Simply put, Young’s assertion that the 2001 (and 2003?) tax cuts “produced the best recession/recovery cycle of the past 60 years” was given the lie by the 2006 elections, in which much of the Democrats success was attributed to voters’ dissatisfaction with the economy.

There is almost no dispute among economists that the 2001 recession was one of the shallowest in history. But that was mainly due to the fact that the Fed dropped interest rates too low for too long—a policy that resulted in the printing of limitless amounts of money that powered the greatest housing boom on record (and bursting of the subsequent housing bubble), as well as a credit bubble based on fraudulent subprime loans that is bursting as we speak.

But the strength of the recovery is another matter. Most Americans did not benefit, just the top 10 percent of income earners—i.e., those who now control almost 80 percent of the wealth of this country. These numbers are corroborated by everyone from the Federal Reserve Bank to the Congressional Budget Office, to the international Organization for Economic Co-operation and Development (OECD).

Nobelist Joseph Stiglitz and fellow economist Peter Orszag said it best in a Business Week essay of that time: “The administration’s (tax cut) package largely ignores the central feature of a recession: lack of demand. The primary problem is that the nation’s firms face a reduction in demand for their products—not that they lack available workers, equipment, or anything else needed to produce goods and services. Indiscriminately injecting cash into such firms through tax breaks, without linking the tax breaks to new activity, would do little if anything to address the underlying difficulty.”

What did Drs. Stiglitz and Orszag recommend? They recommended a temporary extension of unemployment insurance and cut in income taxes for salaried workers, which directly benefits those who spend the largest portion of their income. This is classical Keynesian economics, of course.

Supply-side economists (conservatives one and all), on the other hand, swear by Say’s Law that says demand is never the problem, only an adequate supply of goods and services. Let wages fall where they may (though wage levels are the major determinate of aggregate demand). Allow workers to work for next to nothing, in other words, and eventually any economy will recover!

That certainly happened during this administration. By not giving tax cuts to those who could most use it—rather than investment tax breaks on capital gains and dividends--real average household incomes for working age households under 65 fell 5.4 percent 2000-2005, after inflation. Incomes have only begun to recover over the past three quarters, too late to prevent the lowest personal savings rate since the Great Depression. Consumers’ personal savings rate has been negative for more than 2 years.

The conservatives’ tax cuts were in fact a calculated shift of wealth from the lower and middle classes to the already wealthy and their supporters. The massive resulting Federal budget deficits have pushed us back to inequality levels last seen in the 1920s—at the expense of a decent health care system (and our veterans), and declining educational system (our elementary and high school children rank lower in math and reading skills than those in Japan and other developed countries).

These results are confirmed by scientific studies. U.S. citizens now have much longer working hours than in other developed countries, fewer benefits including paid vacations and sick leave, a greater incidence of major diseases, shorter life spans, and higher infant mortality than in some developing countries (including Cuba).

What should be some remedies that a majority of Americans already advocate, but that recent administrations and a congress beholden to lobbyists have not had the courage to adopt? Spend more tax dollars on domestic programs than the military, for starters. Our defense expenditures now make up half the federal budget. And military expenditures only benefit the military-industrial complex (and its supporters) when we are already the sole military super-power.

Then use some of those savings (military spending is notoriously wasteful) to take health care out of the hands of the HMOs, drug, and insurance companies, and replace it with a national health care system for all U.S. citizens, like every other industrialized country in the world!

The current policy of lavishing our tax monies on the military ignores the economic advantages our neglect of domestic spending has given Japan, Asia and our European allies who use their tax monies more wisely. They choose to invest their citizens’ money in improving their human capital, which after all, is the real basis of any nation’s wealth.

Otherwise, continuing such blatantly unworkable tax policies means not only will we fall back further in the competitive global race for economic supremacy, but winning hearts and minds in the global war on terror as well.

“Cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible,” is really a formula for disinvestment in people. It puts the United States of America on a dangerous course of decline in both status and the power to influence worldwide events.

Harlan Green, Editor

PopularEconomics.com

What Do We Mean by Fair Taxes?

July 16, 2007

letters@nytimes.com

Harvard Professor N. Gregory Mankiw believes the rich pay their “fair share” of taxes in his July 15 op ed piece, “Fair Taxes? Depends What You Mean by Fair’.” But using President Bush’s pronouncement that, “On principle, no one in America should have to pay more than a third of their income to the federal government,” is not a very believable standard. This is a president, after all, who has run up the largest federal budget deficit in history and a federal debt load that exceeds $8 trillion, much of it owed to foreign investors.

We can think of a better definition of ‘fair share’. For example, the fact that the poorest fifth of our population (20 percent equals 60 million people!) have an average annual income of $15,400, is below what the U.S. Census Bureau has deemed the poverty line. Why should they be taxed at all? And we are supposed to be the richest country in the world?

Why not make the measure of what is ‘fair’ how our taxes are spent? For taxation policy is really a mechanism for the redistribution of wealth. Maybe there would be little debate on taxation policy, or the need to raise or lower taxes, if we had a balanced federal budget, for example. Half of our ‘unbalanced budget’ is now spent on the military. And so it is the military-industrial complex and its supporters—the likes of VP Cheney’s Halliburton, the Carlyle Group, and oil companies—who benefit most from our tax monies. Much less is now spent on the much more important human capital that determines our standing and competitiveness in the world—like education and health care.

We are falling behind the rest of the developed world in many categories of human capital: a decent health care system (including for our veterans) would not allow more than 40 million uninsured. An adequate educational system would not allow our elementary and high school children to rank lower in math and reading skills than those in Japan and other developed countries.

These results are confirmed by scientific studies. U.S. citizens now have much longer working hours than in other developed countries, fewer benefits including paid vacations and sick leave, a greater incidence of major diseases, shorter life spans, and higher infant mortality than in some developing countries (including Cuba).

So why not concentrate on a ‘fair’ distribution of our wealth? Other developed countries spend their tax monies more wisely—i.e., on their citizens rather than war-making ability. And that increases their ability to compete globally. Libertarian philosophers and economists such as Milton Friedman like to cite the ‘freedom to choose’. But we know from evolutionary psychologists and behavioral economists, among others, that the wealthy are freer to make intelligent choices than the 60 million of our poorest members.

Harlan Green, Editor

PopularEconomics.com