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November 25, 2011

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Latest Posts from Economist's View


Paul Krugman: We Are the 99.9%

Posted: 25 Nov 2011 12:42 AM PST

The wealthy can pay more in taxes without endangering the economy's ability to create jobs:

We Are the 99.9%, by Paul Krugman, Commentary, NY Times: "We are the 99 percent" is a great slogan. It correctly defines the issue as being the middle class versus the elite (as opposed to the middle class versus the poor). And it also gets past the common but wrong establishment notion that rising inequality is mainly about the well educated doing better than the less educated; the big winners in this new Gilded Age have been a handful of very wealthy people, not college graduates in general.
If anything, however, the 99 percent slogan aims too low. A large fraction of the top 1 percent's gains have actually gone to an even smaller group, the top 0.1 percent — the richest one-thousandth of the population.
And while Democrats, by and large, want that super-elite to make at least some contribution to long-term deficit reduction, Republicans want to cut the super-elite's taxes even as they slash Social Security, Medicare and Medicaid in the name of fiscal discipline. ...
But ... why do Republicans advocate further tax cuts for the very rich even as they warn about deficits and demand drastic cuts in social insurance programs?
Well, aside from shouts of "class warfare!" whenever such questions are raised, the usual answer is that the super-elite are "job creators"... So what you need to know is that this is bad economics. ...
For who are the 0.1 percent? Very few of them are Steve Jobs-type innovators; most of them are corporate bigwigs and financial wheeler-dealers. One recent analysis found that 43 percent of the super-elite are executives at nonfinancial companies, 18 percent are in finance and another 12 percent are lawyers or in real estate. And these are not, to put it mildly, professions in which there is a clear relationship between someone's income and his economic contribution.
Executive pay ... is famously set by boards of directors appointed by the very people whose pay they determine; poorly performing C.E.O.'s still get lavish paychecks, and even failed and fired executives often receive millions as they go out the door.
Meanwhile, the economic crisis showed that much of the apparent value created by modern finance was a mirage..., seemingly high returns before the crisis simply reflected increased risk-taking — risk that was mostly borne not by the wheeler-dealers themselves but either by na├»ve investors or by taxpayers, who ended up holding the bag when it all went wrong. ...
So should the 99.9 percent hate the 0.1 percent? No, not at all. But they should ignore all the propaganda about "job creators" and demand that the super-elite pay substantially more in taxes.

Fed Watch: Europe Can't Move Fast Enough to Halt Crisis

Posted: 25 Nov 2011 12:33 AM PST

Tim Duy:

Europe Can't Move Fast Enough to Halt Crisis, by Tim Duy: Today the leaders of Germany, France, and Italy came together, offering a commitment to work toward new fiscal rules in Europe while keeping a leash on the European Central Bank. From the Wall Street Journal:

The leaders of the euro zone's three largest economies pledged Thursday to propose modifications to European Union treaties to further integrate economic policy and crack down on profligate spenders, but they played down suggestions that the European Central Bank have a greater crisis-busting role.

It should be painfully evident at this point that any process toward greater fiscal integration will be a years-long process. Financial markets, however, move at something much closer to the speed of light - as fast as traders can hit the "sell" button. As such, the European political process is grossly incapable of addressing the fiscal crisis. Apparently, however, market participants continue to hold out hope:

Investors were quick to register their disappointment that the leaders hadn't produced some sort of breakthrough to address the bloc's protracted sovereign-debt crisis. European stocks lost ground while the euro fell to its lowest level in seven weeks.

Seriously, who believes a breakthrough is coming? I imagine some thought the disastrous German bund auction would force Chancellor Angela Merkel's hands, but it appears to have only deepened her resolve. Obviously, one interpretation of the auction is that the crisis is spreading to Germany, making its debt more risky. But risky how? The specter of Eurobonds, in my opinion, argues for shying away from Eurobonds as investors need to price German debt at that of the eventual Eurobond, which will almost certainly be greater than current German prices. This would help explain Merkel's objection to Eurobonds:

Germany vehemently opposes creating such commonly backed bonds before a natural alignment of euro-zone economies is achieved through sound economic policies, the introduction of so-called debt brakes to restrict deficits, and creating the ability to severely punish profligate euro-zone members.

Ms. Merkel, addressing the issue during the news conference, said the recent widening of the gap between euro-zone interest rates reflects the strengths of countries such as Germany and the structural weaknesses of those such as Greece and Portugal. The introduction of euro-zone bonds would create artificial convergence of interest rates and not address the root cause of the crisis, she said.

"It would be a completely wrong signal to allow these different interest rates to become ineffective because they are an indication of where more work is needed," said Ms. Merkel. "If we all work responsibly, convergence will take place all on its own. But to impose convergence on everyone would weaken us all."

The message is that you can't identify the bad actors without differential yields, which is possibly reasonable with respect to solvency issues but less so when considering liquidity crisis. Germany is looking for hard and fast rules that would force the periphery debt down to German yields rather than the latter up to the former. Does this suggest that Germany would insist on some sort of convergence criteria as a precondition for the issuance of Eurodebt as well? Something to think about. Calculated Risk directs us to an even more disconcerting Merkel quote via the Telegraph:

Ms Merkel instead used a three-way summit with France and Italy in Strasbourg to insist that new treaty powers to intervene and punish sinner states remained the key focus of Europe's rescue efforts. She said: "The countries who don't keep to the stability pact have to be punished – those who contravene it need to be penalised. We need to make sure this doesn't happen again."

Similarly, Germany needed to be punished via the Versailles Treaty - and look how well that worked. It is tough to advise anything other than to sell Europe as long as Germany insists on this morality play.

If you have any delusions about the difficulties of pushing through new fiscal rules, turn to the story evolving in Ireland. Credit Writedowns points us to Ambrose Evans-Pritchard at the Telegraph:

The Irish government has suddenly complicated the picture by requesting debt relief from as a reward for upholding the integrity of the EU financial system after the Lehman crisis, though there is no explicit linkage between the two issues...

..."We are looking at ways to reduce the debt. We would like to see our European colleagues address this in a positive manner. Wherever there is a reckless borrower, there is also a reckless lender," he said, alluding to German, French, British and Dutch banks.

"We have indicated to Europe's authorities that it will be difficult to get the Irish public to pass a referendum on treaty change," he said.

The EU's new fiscal rules would be legally binding and "justiciable" before the European Court, he said. This raises the likelihood that Ireland's top court would insist on a referendum.

Translation: If you want to move forward on fiscal unity, we need a quid-pro-quo in the form of debt relief. Ultimately, Portugal will want the same. And Greece will eventually ask for more as well. True, the imminent standoff on the next tranche of aid has been alleviated as the ND opposition party offered its written commitment to the October summit deal. Of course, the commitment is predictably soft, with the money quote:

On the evidence of the budget execution so far, we believe that certain policies have to be modified, so as to guarantee the Program's success. This is more so, since according to the latest European Economic forecasts, Greece in 2012 will be the only European country with 5 consecutive years in recession!

The agreement is crushing the Greek economy, so modifications will be needed. But does anyone believe that only minor modifications will suffice? Anyone? Bueller? Still, given the clock was ticking down on the next aid tranche, policymakers probably believe it best for all parties to back down a little and kick the can down the road for another three months, when we can expect another "voluntary" haircut after the deteriorating economic conditions further erodes the Greek fiscal situation.

While European leaders continue to pretend there exists a timely political solution to the crisis - that the crisis will end the instant sinner states offer up enough political commitment to the ever changing goal of austerity - Germany continues to insist the ECB be kept on a short leash, pushing Italian debt pack above 7%. Via the Telegraph:

"The three of us want to indicate our support to the ECB and its leaders," Mr Sarkozy said. "The three of us have indicated that we will respect the independence of this essential institution and we agreed that we should refrain making any demand, positive or negative, on it. That is a position that we have elaborated together."

The statement appeared to contradict comments from senior French politicians earlier today that the country was seeking a greater degree of involvement from the area's central bank in tackling the debt crisis.

Like it or not, the ECB is the one institution that can act quickly. To be sure, arguably it is now too late to act "quickly." Now quick action is needed to just limit the damage as financial conditions accross Europe freeze solid as a block of ice.

This is not shaping up to be a festive holiday season in Europe.

Links for 2011-11-25

Posted: 25 Nov 2011 12:06 AM PST

Andolfatto: Not Enough US Debt?

Posted: 24 Nov 2011 11:07 AM PST

David Andolfatto says the world has a "huge worldwide appetite for U.S. Treasury debt (as reflected by absurdly low yields)," and "this is the time to start accommodating this demand. Failure to do so at this time will only drive real rates lower (possibly via deflation)." In comments, he adds "Surely, there are infrastructure projects that can yield in excess of zero percent? If not, then we're all in big trouble." Having made the same point myself on many, many occasions, I obviously agree:

Not enough U.S. debt?, by David Andolfatto: ...The ratio of U.S. federal debt to GDP is currently close to 100%.... Of course, what has a lot of people worried is not the level, but the trajectory, of this ratio. Clearly, the debt-to-GDP ratio cannot rise forever.
No, but on the other hand, there is some evidence to suggest that it can feasibly go much higher. (Whether it should be permitted to do so is a different question, of course.)
Before I go on, I want to clear up a misguided analogy that I frequently hear repeated. The misguided analogy is the idea of the government behaving like a household running up a massive amount of credit card debt.
If this is the way you like to think about things, let me ask you this: Which of your credit cards charge you 0% interest? I ask because that is the interest rate creditors around the world are willing to lend to the U.S. federal government. And what sort of credit card company starts to reduce the interest it charges on your debt as you become progressively more indebted (see the figure...)?
In fact, the terms are even much better than 0%. The real cost of borrowing is measured by the real (inflation adjusted) interest rate. ... As the following figure shows, the U.S. government can now borrow funds for 10 years at close to zero real interest. It can borrow funds for 5 years at a negative real interest.

Now, a negative real rate of interest is a pretty cool deal. Imagine importing 100 bottles of beer from China today, and having to return only 99 bottles next year. ... Before we get too carried away, however, I explain here why these very low real rates constitute bad news.
Why are real rates so low?
My own view is that this phenomenon, at its root, has little to do with Federal Reserve or Treasury policy. I believe that the decline in real rates on U.S. treasuries reflects a steady change in how agents and agencies around the world want to structure their wealth portfolios. There has been a massive substitution away from many asset classes into U.S. treasuries; and it is this fundamental market force that is driving real interest rates lower.
The phenomenon began in the early 1990s, with the collapse of the Japanese stock market. Then Mexico in 1994, the Asian crisis 1997-98, Russia in 1998, and Brazil in 1999; see Bernanke (2005). Investors became rationally pessimistic about the returns to investing in these countries, as well as similar countries that had not yet experienced crisis. The natural effect of this would be capital outflows from these countries into relative safe havens, like the United States.
The basic thesis here is very much related to what Ricardo Caballero calls a "global asset shortage." See his discussion here and here; and my own discussion here and here.
The global investment collapse associated with the recent recession has pushed already low real rates lower still. There has been a flight to U.S. treasuries not only by foreigners, but this time by Americans too. Evidently, the perceived return to domestic capital spending remains low. (Some basic theory available here.)
Policy 
Given this pessimistic outlook, it seems unclear what monetary policy can do (the Fed is largely limited to swapping low interest currency for low interest treasuries).
I do, however, believe that there may be a role for the U.S. treasury (in principle, at least). In particular, given the huge worldwide appetite for U.S. treasury debt (as reflected by absurdly low yields), this is the time to start accommodating this demand. Failure to do so at this time will only drive real rates lower (possibly via deflation). For a world economy that is reasonably expected to grow, negative real interest rates imply a dynamic inefficiency. In short, this is the time to start raising real rates, not lowering them (real rates theoretically rise when new debt crowds out private capital, but note that new debt can also be used to finance corporate tax cuts to stimulate investment, if so desired).
Of course, what theory also tells us is that the government should also be prepared to reverse this recommended debt expansion (assuming that tax rates remain unchanged) once the domestic and world economy return to normal. One may legitimately question whether the government can be expected to make these cuts at the appropriate time. If the government lacks credibility along this dimension (or if future governments cannot be expected to abide by policies put in place by previous governments), then political forces may emerge to block an otherwise socially desirable debt expansion. Perhaps this is one way to interpret recent events.

Happy Thanksgiving

Posted: 24 Nov 2011 08:46 AM PST

Thanksgiving

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