Beat the Press is Dean Baker's commentary on economic reporting. Dean Baker is co-director of the Center for Economic and Policy Research (CEPR).
Yes, it’s Sunday and Thomas Friedman has another of his whacky big picture columns:
“Now let me say that in English: the European Union is cracking up. The Arab world is cracking up. China’s growth model is under pressure and America’s credit-driven capitalist model has suffered a warning heart attack and needs a total rethink. Recasting any one of these alone would be huge. Doing all four at once — when the world has never been more interconnected — is mind-boggling. We are again ‘present at the creation’ — but of what?”
pretty profound stuff.
Okay, let’s get to specifics. We leave out the Arab world, skip China for a moment, and jump to the European Union. Friedman tells us:
“Farther north, it was a nice idea, this European Union and euro-zone: Let’s have a monetary union and a common currency but let everyone run their own fiscal policy, as long as they swear to work and save like Germans. Alas, it was too good to be true. Large government welfare programs in some European countries, without the revenue to finance them from local production, eventually led to a piling up of sovereign debt — mostly owed to European banks — and then a lender revolt. The producer-savers in northern Europe are now drawing up a new deal with the overspenders — the PIIGS: Portugal, Italy, Ireland, Greece and Spain.”
There is lots of good stuff here. First, the European Union and the euro-zone are not the same thing. There are countries with names like the United Kingdom, Denmark, and Sweden that have been longstanding members of the European Union that are not members of the euro-zone. While there have been some suggestions that heavily indebted countries consider leaving the euro, one would be hard-pressed to find anyone suggesting they leave the European Union.
This is not the only complete invention in Friedman’s story. The story of the heavily indebted countries as serious overspenders spits in the face of reality. Spain and Ireland were actually running budget surpluses in the years preceding the recession. Italy and Portugal had relatively modest deficits. Only Greece had a clearly unsustainable budget path.
The story of the debt crisis of these countries is primarily the story of the inept monetary and financial policy run by the European Central Bank (ECB) in the years leading up to the crisis. They opted to ignore the imbalances created by housing bubbles across much of the euro zone and the rest of the world. Rather than taking steps to rein in these bubbles, they patted themselves on the back for hitting their 2.0 percent inflation targets. Remarkably, none of these central bankers lost their jobs and the 2.0 percent cult still reins at the ECB.
If there is a crisis in the euro zone it is that a dogmatic cult has seized control of the euro zone monetary and financial policy to the enormous detriment of its economy and its people. And, there is no obvious mechanism through which they can be dislodged. Friedman might have devoted his column to this problem, but it requires far more knowledge of the economy than he seems to possess.
Now let’s get to the China and U.S. problem that Freidman discusses. Friedman tells us that:
“China’s growth model is under pressure and America’s credit-driven capitalist model has suffered a warning heart attack and needs a total rethink.” To a large extent these are actually the same issue.
The United States has been running large trade deficits ever since the Rubin-Greenspan-Summers clique used their control of the IMF to impose draconian bailout terms on the East Asian countries following the East Asian financial crisis. The result of this action was that countries throughout the developing world began accumulating dollars like crazy in order to protect themselves against ever being in the same circumstances.
Their effort to acquire dollars led to the over-valued dollar (Robert Rubin’s “strong dollar”), which in turn gave us our large trade deficits. Large trade deficits logically imply either large budget deficits or large private sector savings. This fact is well-known to people who know national income accounting, which unfortunately is a tiny minority of those who write about economic issues for major media outlets.
China is one of the countries that has been accumulating massive reserves. If it desires to slow its growth rate (no one other Friedman would call going from 10 percent growth to 7 or 8 percent a crisis), the most obvious mechanism is to raise the value of its currency against the dollar. This will reduce its exports to the U.S. and increase its imports from the United States. That will help boost growth in the United States and reduce its indebtedness. In short, Friedman’s two problems here are in fact one problem with a simple solution.
Finally, Friedman shows a stunning ignorance of arithmetic when he tells readers:
“China also has to get rich before it gets old. It has to move from two parents saving for one kid, to one kid paying for the retirement of two parents. To do that, it has to move from an assembly-copying-manufacturing economy to a knowledge-services-innovation economy. This requires more freedom and rule of law, and you can already see mounting demands for it. Something has to give there.”
Using somewhat more realistic numbers (China is not seeing its population cut in half), let’s say that it is moving from having 5 workers per retiree to 2 workers per retiree over 30 years, a far faster decline than it is actually seeing. China’s output per worker has been increasing a rate of more than 8 percent a year. This means that over a 30 year period, output per worker will increase more than 10 fold.
Suppose our 5 workers are taxed at a 12 percent rate at the start of the period to give retirees an income equal to 70 percent of the typical worker’s after tax income. If we want to maintain this 70 percent ratio, when 2 workers support each retiree, it would take a tax rate of just under 24 percent to maintain this ratio.
Okay, so output per worker has increased by 1000 percent. We have to increase the tax rate from 12 percent to 24 percent. This means that with the higher worker to retiree ratio, the average worker will have a bit less than 9 times the after-tax income (76% of 1000 percent, as opposed to 88 percent of 100 percent) of her predecessor thirty years earlier who only had to support one-fifth of a retiree. If there is a problem here, it is very hard to see it.
So there we have it, Thomas Friedman once again letting his poor grasp of economics and arithmetic invent grand problems where there are none. What would be do without him?Add a comment
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The media love to jump on politicians when they say something stupid or inaccurate about their personal lives.They will fill pages and pages of print, and take up hours on radio and TV, talking about the comment. They will bring on experts (i.e. political reporters and gossip columnists) to tell the public what the gaffe means and why it makes that person inappropriate for elected office.
However they somehow don't get the same urge when a political figure makes an incredibly foolish remark about a policy matter. This is striking because most people are perfectly competent to assess the appropriateness of a statement about a personal matter based on their own lives' experience. In other words, they really don't need the "experts" to tell them how important or unimportant a particular remark is. On the other hand, most people do not have expertise in the various areas of public policy, so they could benefit from having an expert tell them when a political figure makes an especially off the wall comment.
In that spirit, the Washington Post absolutely should have included a heavy dose of expert ridicule when it reported that President Obama said:
“I have to admit, I didn’t know how steep the climb was going to be. Because we didn’t realize — we just found out a week ago that the economy that last few months in 2008 was even worse than we had realized.”
It is true that the Commerce Department just revised down the GDP data to show that the decline at the start of the recession was even steeper than had previously been reported. However, by far the most meaningful measure of the steepness of the climb needed for recovery is the employment to population ratio (EPOP):the percentage of the working age population with jobs. This is reported monthly and is not subject to substantial revision.
President Obama's team always knew exactly how far the EPOP had fallen since the start of the downturn and therefore knows how many people must be put to work to get the economy back to full employment. The lower than previously reported GDP is an interesting piece of information, but tells us almost nothing new about how much ground must be made up.
The Post should have included the comments of economists ridiculing the idea that President Obama has just now discovered how bad the downturn was. It might even be worth a separate article or two. If the statement is actually true (i.e. President Obama just realized how bad the downturn was) then it is deserving of far more attention than his comment about working class whites being bitter and clinging to gun and religion before the Pennsylvania primary.Add a comment
It is the media's responsibility to inform the public about the key issues affecting their lives. One of the key issues is the economy. At the moment more than 25 million people are either unemployed, involuntary working part-time, or have given up looking for work altogether. The reason is that the folks running the economy somehow could not see the $8 trillion housing bubble that eventually collapsed and took the economy down with it.
One way to get people back to work is government stimulus. This could be spending on various items, it could be tax cuts, or it can (and usually is) some mix. However, stimulus does cause deficits. This brings us to an NPR story that told us the real debt was not the widely advertised $14.3 trillion debt subject to the debt ceiling, but rather $211 trillion.
The implication is that we shouldn't be worried about putting people back to work, we should be worried about cutting the deficit. And by the way, that may also mean taking an ax to Social Security and Medicare.
I blogged on this story when it ran a couple of weeks ago and called it cesspool journalism. The reason is that it's only purpose could be to frighten people about the deficit. It could not possibly be to inform since it is almost inconceivable that anyone hearing or reading this story would have any clue of how this $211 trillion debt figure was derived.
The methodology used for the calculation is obscure and used by almost no one except Lawrence Kotlikoff, the economist who developed it, and a few of his former students. For example, the debt figure is based on the assumption that no one not currently in the work force ever pays taxes. It also conceals a projected explosion in private sector health care costs whereby it will cost an average of $40,000 a year in 2030 (in 2011 dollars) to provide care to an 85-year old. By 2080 this number will exceed $100,000 a year (also in 2011 dollars). These are among the reasons that almost no one other than Mr. Kotlikoff uses this methodology.
NPR ombudsman took up my blognote and turned to Weekend All Things Considered Supervising Senior Editor Rick Holter for a response. In essence, Mr. Holter's response was that NPR had aired the views of people less hawkish on the deficit, like Paul Krugman and Peter Diamond (I have also been NPR talking about the deficit), so it was reasonable to include an extreme deficit hawk like Kotlikoff.
The question of devoting a segment to Kotlikoff is not simply one of balance, although I would argue that NPR has been seriously unbalanced in its coverage of the deficit in general and especially in the last few months. The issue with Kotlokoff is that the piece could not have provided information to NPR's audience. There was almost no way that anyone who is not a policy analyst working on budget issues would have the ability to assess Kotlikoff's $211 trillion number. This was about scaring people, not informing them.
There's nothing wrong with having Kotlikoff present his views on NPR. But the station has the responsibility to ensure that it is done in a context where it is providing information, not just spreading scare stories. This piece only did the latter.Add a comment
The NYT made a remarkable assertion in its discussion of Federal Reserve Board Chair Ben Bernanke's speech at Jackson Hole today. It told readers:
"The most dramatic option available to the central bank would be an announcement that it intends to increase the total size of the portfolio. This is what markets refer to as “QE3,” meaning that it would represent a third round of the strategy known as quantitative easing."
Let's try about 2000 "NO"s for that one. The Fed could target a long-term interest rate. For example, it could announce that it was going to push the interest rate on 5-year Treasury bonds to 1.0 percent. It could target a higher inflation rate, for example 3-4 percent as has been advocated by people like Ben Bernanke before he was Fed chair. And it could buy assets other than government bonds, like the bonds of private corporations.
All of these steps would have a much more dramatic impact than "an announcement that it intends to increase the total size of the portfolio." It is incredible that the NYT reporters/editors on the Fed beat are apparently unfamilair with such proposals since they have been mentioned frequently by economists involved in monetary policy debates for years.
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Morgan Stanley director Laura Tyson included this line in a piece that argued for the need for government stimulus. It is common for people to make this assertion, but it is not clear what they mean by "recovers."
The economy was driven by a housing bubble in the last upturn. It lead to both a building boom and a consumption boom. Is the implication that we need another housing bubble to drive the economy?
There is a simple issue of accounting identities. Currently the country has a large trade deficit. To make up the shortfall in demand created by this deficit, we either need negative private savings or negative public savings (e.g. budget deficits) or some combination. It seems that Tyson is arguing for negative private savings as a long-run solution, as opposed to pushing the dollar down to eliminate the trade deficit.Add a comment
The Washington Post featured an extraordinary exercise in mind reading on page 3 today. The article, which carries the subhead, "candidates gravitate to potential job creators rather than unemployed," told readers:
"the contenders in the GOP field appear to be spending most of their time with those they think could be the solution to the country’s economic hardship (business owners) rather than those who are most directly experiencing the hardship (people out of work)."
Of course the Post has no idea what the Republican presidential candidates think. A serious newspaper would restrict itself to telling readers what the candidates do and say.Add a comment
In an article discussing three trade agreements being debated by Congress, the NYT told readers:
"under the agreements, American service providers would be able to compete in the three countries, ostensibly adding new jobs to the American economy. Because of this, they are widely supported by the U.S. Chamber of Commerce and other business trade groups."
This is wrong, wrong, and wrong. Corporations do not exist to create jobs, nor do they claim this as a goal. Invariably, corporate CEOs will say that their responsibility is to produce returns for shareholders, as they announce large layoffs. If the Chamber of Commerce is supporting these deals it is because it believes that they will increase profits, end of story.
The piece also bizarrely tells readers that the deals are projected to expand exports by $12 billion without mentioning how much it is expected to increase imports. This is like reporting a baseball score by telling us how many runs the Yankees got and not mentioning how many runs their opponents got.
It is net exports, the difference between exports and imports, that creates jobs. If the GM relocates an assembly plant from Texas to Mexico, the export of car parts from the United States is not adding jobs. Any reporter should know this and never print an export projection without including the corresponding import projection.
The piece also wrongly refers to the deals as "free-trade agreements." This is just a term that proponents use to make them sound more appealing. In fact, the deals will increase many forms of protectionism, most notably by imposing stronger patent and copyright protections on the three countries in these deals. A neutral report would just use refer to the deals as "trade agreements."Add a comment
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Morning Edition had a piece on the Federal Reserve Board's annual meeting at Jackson Hole. The segment included a comment from an analyst (link not available yet) saying that we are seeing the risk of political interference undermining good Fed policy.
This would have been a great comedic comment, if it were not said in complete earnestness. This is sort of like worrying that the performance of the Federal Emergency Management Agency would deteriorate after the departure of Michale Brown, except the damage caused by Brown's incompetence was trivial compared to the enormous suffering that has resulted from the Fed's incompetence.
The Fed (i.e. Alan Greenspan and his then sidekick Ben Bernanke) sat back and let the housing bubble grow to ever more dangerous levels. It possessed all the tools necessary to rein it in but chose to do nothing. This is like a school bus driver drunkenly swerving into oncoming traffic and killing all aboard. Incredibly, in Federal Reserve Board land, the driver comes to work the next day and no one says anything.
Yeah, we should worry that it gets worse than this!Add a comment
The NYT has been reporting on the occasional shortages of important generic drugs that arise. It discusses possible answers today, but doesn't discuss the extent to which drug patents are a part of the problem. Because patents allow pharmaceutical companies to sell drugs at prices that are far above their competitive market price, there is relatively little interest among manufacturers in producing drugs that have come off patents. In many cases, the barriers created by the patent holders (e.g. the potential of legal harassment) means that they maintain an effective monopoly long after their patents have expired.
As a practical matter, it would be almost costless for the government to establish a stockpile of key off patent drugs. (They could contract it with a private firm.) If they bought up a million doses of each of 200 drugs, this would cost around $800 million. The drugs could be sold at prices that cover the cost of the purchase, storage, and wastage. It is difficult to see a good argument for not taking a costless measure that could ensure people's health while saving money.Add a comment
"by one estimate, $85 billion a year."
It sure would be nice to see the name of the person who could be hanged with this estimate. According to the piece, Fannie and Freddie back $2.4 trillion in mortgages that have interest rates over 4.5 percent. If all of these mortgages were refinanced and the average saving was 1.5 percent, this would save homeowners $36 billion. This is just over 40 percent of our $85 billion estimate.
In fact, most of these mortgages could already be refinanced today, if the homeowners wanted to do so. Removing the obstacles for underwater homeowners or homeowners with bad credit would be unlikely to allow even one quarter of these mortgages be refinanced, providing a net savings of less than $9 billion.
If we look at the economic impact, we have to also remember that the interest payments were income for some people. The investors on average are certainly much richer than homeowners, but they would still spend some portion of their interest earnings. If we assume a 40 basis points gap in marginal propensities to consume (e.g. homeowners consume 90 percent of their additional income, investors consumer 50 percent) then the net boost to consumption from this measure would be less than $4 billion a year or 0.03 percent of GDP.
The article discusses concerns that house prices are continuing to fall. Actually we should expect house prices to continue to fall, they are still close to 10 percent above their long-term trend. If there is a reason that we should expect house prices to stay above this trend, the NYT has never bothered to run a piece on it.
Finally, the piece includes comments from Frank E. Nothaft, the chief economist at Freddie Mac. Mr Nothaft made himself famous for repeatedly asserting during the bubble years that nationwide house prices never fall. If he has ever been right about anything connected with the housing market there is no record of it.Add a comment
The Washington Post and Robert Samuelson did their part in publicly passing along the marching orders from the rich and powerful to Ben Bernanke and the Federal Reserve Board. The word from these folks is "No Inflation!" If that means millions more people will suffer unemployment for a few more years, that's a price that the Post and Samuelson are willing to pay.
Of course the rich and powerful have numerous channels for making their concerns known to the Fed, they don't need the Post and Samuelson to put them into print. So, this really is a public service.
What's neat about this picture is that there is little dispute about the basic facts surrounding inflation. Inflation is a problem that stems from an overheated economy. Apart from war or political collapse there are no instances of inflation just shooting up from low levels into Weimar type hyper-inflation. This means that if we are going to have a problem with inflation, it will arise gradually and we will first have to get back to something near full employment. It will not just creep on us overnight when we are sleeping. (There can be supply induced inflation. Suppose Saudi Arabia's oil fields are blown up and the price of oil goes to $400 a barrel. This would cause inflation, but the Fed's actions are not going to affect this outcome.)
The other basic fact is that moderate rates of inflation do very little harm. The economy operates every bit as well with 4-5 percent inflation as it does with 1-2 percent inflation. This is a heavily researched topic and the overwhelming majority of this research has found little or no negative effect from moderate rates of inflation (e.g. here and here).
Yet, both the Post edit board and Samuelson argue strongly that Bernanke should not risk higher inflation to try to reduce the unemployment rate. The edit told readers:
"the core rate of inflation (price increases excluding food and energy costs) has crept up to within striking distance of the Fed’s 2 percent target. Printing more money might push it above that, unleashing dangerous inflationary expectations."
Ooooooh, dangerous inflationary expectations. That's really scary. Since the core inflation rate has been above 2.0 percent for most of the last 50 years, it's hard to see what anyone would be worried about.
But then the Post gets to the substance of the matter:
"The Fed recently promised to continue making funds available to the financial system at nearly zero percent interest. While perhaps necessary in the short run, this policy amounts to a penalty on prudent savers and a reward to over-leveraged debtors."
Yep, we should really be worried about rewarding those over-leveraged debtors -- lazy bums, many of them are not even working. And the "prudent savers?" Yes, that woud include all those wealthy people with large amounts of money to invest. But hey, no class issues here.
Robert Samuelson also notes how more expansionary policy has the effect of transfering wealth from creditors to debtors in the context of discussing a proposal by Harvard economist to deliberately target 6 percent inflation for a couple of years:
"To be sure, higher inflation represents a wealth transfer to debtors (who repay in cheaper dollars) from creditors (who receive cheaper dollars). That’s unfair, Rogoff says, but it may be less unfair and disruptive than outright defaults by overborrowed debtors."
Samuelson concludes that the risks of inflation are just too great and then wrong tells readers:
"Remember: The economy’s basic problem is poor confidence spawned by pervasive uncertainties."
As noted in today's lesson on accounting identities, the share of GDP devoted to investment in equipment and software is almost back to its pre-crisis level. And, the saving rate is still below its post-war average, meaning that consumption is high, not low. The economy's basic problem is that the dollar is too high, which is causing a large trade deficit.
When we think about the trade-offs between inflation and unemployment it is important to remember that the tens of millions of people who are unemployed or underemployed today did not do anything wrong. It was people like Alan Greenspan and Ben Bernanke who messed up. And of course other actors in national policy debates, who were too obsessed with budget deficits to notice an $8 trillion housing bubble did not help either.Add a comment
National income accounting is really basic stuff. It is taught in every intro economics class. It would be a really great thing if only the people who wrote about and implemented economic policy understand it.
Starting at the beginning, we know that we can add up GDP on the output side by summing its components, consumption, investment, government, and net exports. This must be equal to the incomes generated in production. This gives us a basic identity that:
1) C+I+G+(X-M) = Y
where Y stands for income. This identity must always hold, it is true by definition.
We can then divide Y into disposable income, which is total income, minus taxes. This gives us:
2) Y = YD + T
We can then divide disposable income into savings and consumption, since by definition any income that is not consumed is saved. This gives us:
3) YD = C+S
since we now know that Y = C+S+T, we can rewrite equation 1 as,
4) C+I+G+ (X-M) = C+S+T
we then eliminate consumption from both sides and we get:
5) I+G+(X-M) = S+T, rearranging terms gives:
6) (X-M) = (S-I)+(T-G)
This one actually has a clear meaning. X-M is exports minus imports, or the trade surplus, S-I is private saving minus private investment, and T-G is taxes minus government spending, or the budget surplus. This identity means that the trade surplus is equal to the sum of the surplus of private savings over investment and the government budget surplus. Remember, this is an accounting identity, it must be true.
Now, let's bring this back to the concerns that the Post and Samuelson raise today. Both are very concerned about inflation (I'll beat up on them for this is another post), but they also hold out the hope that the economy will get back to full employment once consumers and firms are more confident about the economy.
But consider the accounting identity. The country has a large trade deficit, which means that X-M is a large negative number. It's currently around 4 percent of GDP (just under $600 billion), but would certainly be much larger if the economy were near full employment. Imports rise with income, so that with a higher level of GDP the trade deficit would expand.
If X-M is negative, then either or both (S-I) or (T-G) MUST be negative. This means either or both that we have negative private savings or we have a budget deficit.
We can have the former with a very low private saving rate, as we did during the stock and housing bubble. In both periods there was aa consumption boom driven by transitory wealth created by the bubbles. It is difficult to understand why anyone would want a low private saving rate.
It means that people reach retirement with very little to support them other than their Social Security or Medicare, which both the Post and Samuelson want to cut. So no one can consistently want both low private saving and cuts to Social Security and Medicare, unless they want the elderly to be very poor. (It is in principle possible to raise investment, but in practice very difficult. The equipment and software investment share of GDP is already almost back to its pre-crash levels, so the prospects of further increases are very limited.)
The other possibility is that we can have a large budget deficit, making T-G a big negative number. But, we know the Post and Samuelson hate budget deficits, they complain about them all the time.
For those who believe in accounting identities and evolution there is only one other place to go, we must get our trade deficit down. We need X-M to be a much smaller negative number. The best mechanism for getting the trade deficit down is reducing the value of the dollar.
A lower dollar would make imports more expensive for people in the United States, leading them to buy fewer imports. It would also make our exports cheaper for people living in other countries, leading them to buy more of our exports. Fewer imports and more exports translates into a smaller trade deficit.
So we should want a lower dollar, right? Not so fast, Samuelson explicitly warns that a falling dollar could be a bad consequence of higher inflation. The Post editorial never mentions a lower dollar as a possible benefit of more expansionary monetary policy.
What can we conclude from this? We can conclude that Samuelson and the Post do not know national income accounting.
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I was going to swear off Casey Mulligan for the rest of the summer, but it can be hard to stick to a diet. He has a delicious new post and I just have to take a couple of swipes.
First, he criticizes me and Paul Krugman because we have praised studies of the impact of the stimulus that do not take account of displacement effects. Mulligan's example is the move of Yankee Stadium. He notes that the move created jobs in the new location but correctly points out that these was pretty much entirely offset by the jobs lost in the previous location.
This is a fair enough critique in the context of Yankee Stadium. In fact many claims of job creation by businesses (e.g. Boeing creating jobs in its proposed plant in South Carolina) are in fact stories of displacement. In the Boeing case, the jobs would be coming from unionized facilities in Washington State.
But how do we envision the job displacement in the stimulus story? If Illinois has more jobs in road construction due to the stimulus or more teachers in its classrooms, do we think this means fewer construction workers or teachers have jobs in Indiana or Wisconsin? It's a bit hard to see how that works. In the Yankee Stadium and Boeing example, we are taking something away and moving it to a new location. What exactly is being taken away in the stimulus story?
The other point Mulligan raises that deserves comment is his argument that more workers are employed in the summer because of the increased supply of young people looking for jobs. Mulligan sees this as evidence that the underlying problem is supply and not demand, since the additional supply of young workers seeking jobs led to more employment.
Of course there is a flip side to this picture that Mulligan has ignored. There is also increased demand in the summer. This is when families take vacations and go to beaches and resorts. That is both because the weather is better (not many lifeguards are employed on Coney Island in January) and because the kids are out of school. In other words, spending on tourism and recreation is highly seasonal.
We could use Mulligan's seasonal argument as a test of whether unemployment was driven by supply or demand factors if we could just isolate the supply side of the picture. But there is no easy way to do that and Mulligan certainly has not found one.Add a comment
The NYT reported on S&P's downgrade of Japanese government debt to the 4th highest level. It explained the downgrade by noting Japan's continued weak growth, political problems and concerns about deflation. These are factors that might concern the Japanese public when they vote for their leaders, but it is difficult to see what they have to do with bondholders holding Japanese government debt.
Bondholders are presumably worried about whether they will get paid back. None of the issues raised in this discussion have any direct bearing on whether Japan's government can repay its debt. In fact, since the debt is denominated in yen, it would be difficult to understand how Japan would be unable to repay its debt, unless it forgets how to print yen.
In fact, the concern about deflation undermines one of the arguments that is occasionally made in the context of the U.S. downgrade, that S&P is concerned about inflation eroding the value of the debt. While this story never made sense in any case, if Japan sees deflation then bondholders will actually be repaid in yen that are worth more than the yen they lent. (The credit rating agencies are not in the business of making inflation forecasts. Furthermore, if an increased risk of inflation was the basis for its downgrade then S&P should have downgraded all dollar denominated debt regardless of the issuer.)
It is important for the media to analyze the basis for these downgrades since there are serious questions about the competence of S&P and the other credit rating companies. They rated hundreds of billions of dollars of subprime mortgage backed securities as Aaa. They also gave top investment grade ratings to Lehman, Bear Stearns and AIG until their bankruptcies (or bailout in the case of AIG).
Given their abysmal track record, it is entirely plausible that there is no basis for their downgrades of sovereign debt. There certainly cannot be a prima facie assumption that they have any idea what they are doing.Add a comment
The NYT told readers that the Fed will be reluctant to engage in more quantitative easing or take other steps to boost the economy because it is worried about inflation. It then told readers that inflation has been 3.6 percent over the last year, implying that this is a serious problem.
Actually, as a matter of policy the Fed has long focused on the core inflation rate, which excludes food and energy prices. Over the last 12 months, the core inflation rate has been just 1.8 percent, which is below its 2.0 percent target. Furthermore, in prior years the Fed had not even viewed the 2.0 percent core rate as a strict bound. The year over year inflation rate was consistently above 2.0 percent in two decades prior to the recent recession, with the exception of a period in 2003-2004 when the weak economy pushed inflation below this rate. In other words, if Bernanke and the Fed now view 2.0 percent core inflation as an upper bound, then this is a much stricter anti-inflation policy than they have applied in the past.
Furthermore, higher inflation is actually one of the goals of a quantitative easing policy. Higher inflation reduces the real interest rate. Firms are more likely to invest if they expect that they can sell the goods that they produce at a higher price in future years. This is why Bernanke actuallyadvocated that the Bank of Japan deliberately target a higher inflation rate in a paper that he wrote while he was still a professor at Princeton.
This is also the reason that deflation can be a problem as the article notes. However, there is no magic to zero. The problem of deflation is that the the inflation rate is lower than is desired. If the desired inflation rate is 4.0 percent, then the drop of the inflation rate from 0.5 to -0.5 percent is no worse than the drop from 1.5 percent to 0.5 percent. Deflation per se is only a problem when the rate of price decline is so rapid that it undermines the ability to plan. This was the case at the start of the Great Depression when prices were declining at a near double-digit annual rate.Add a comment
That is how CBS News would report it. In its discussion of the rise in the deficit in the years that President Obama has been in office it tells its audience:
"Mr. Obama blames policies inherited from his predecessor's administration for the soaring debt. He singles out:
- "two wars we didn't pay for"
- "a prescription drug program for seniors...we didn't pay for."
- "tax cuts in 2001 and 2003 that were not paid for."
He goes on to blame the recession, and its resulting decrease in tax revenue on businesses, for making fewer sales, and more employees being laid off. He says the recession also resulted in more government spending due to increased unemployment insurance payments, subsidies to farms and funding of infrastructure programs that were part of his stimulus program."
It is likely that President Obama blames the recession for the rise in the deficit because it happens to be true. For example, the deficit was 0.4 percent of GDP in 1974. In 1976 it was 4.0 percent of GDP ($600 billion in today's economy). In 1981 the deficit was 2.6 percent of GDP. In 1983, in the middle of the recession, it hit 6.0 percent of GDP. In 1989 the deficit was 2.8 percent of GDP. The recession raised the deficit to 4.7 percent of GDP in 1992. And in 2000 the surplus was 2.4 percent of GDP. The impact of the recession, coupled with the war and the Bush tax cuts, turned this into a deficit of 3.5 percent of GDP in 2003.
In other words, this is not a debatable point. Recessions lead to deficits, and severe recessions, like the one that accompanied President Obama's move to the White House lead to large deficits. Reporters should know this and if they do, they should identify this as a fact to their audience, not an assertion by a politician to be viewed with skepticism.Add a comment
That's what the Dow Jones effectively told readers today. The article reported that in response to a question at a conference:
"Greenspan also said he believes that the sharp rise in gold prices is due to market concerns about inflation taking off in the long run. He noted how there has never been such a major expansion of credit in U.S. economic history."
Let's look this one up. There is an organization called the "Federal Reserve Board" that puts out really good data on credit. If we look at its most recent Flow of Funds accounts, we see that credit for the economy as a whole expanded at a 3.0 percent annual rate in 2009, a 4.2 percent annual rate in 2010, and a 2.3 percent annual rate in the first quarter of 2011, the most recent quarter for which data is available.
Has there ever been "such a major expansion of credit in U.S. economic history?"
Well, actually credit expanded more rapidly than the 4.2 percent rate in 2010 in every single year that Greenspan chaired the Fed. In fact, it expanded more rapidly in every year in this series (going back to 1976) and probably every year since the Great Depression. In other words, for Alan Greenspan night is day, up is down, he is looking at an extraordinarily slow pace of credit expansion and telling reporters that is the fastest on record.
Of course, Greenspan is probably not familiar with the Flow of Funds data. If he had been, he probably would have noted the historic drop in the ratio of homeowners' equity to market value that occurred even as house prices were soaring to record levels. (Rising house prices translate one to one into equity. Other things equal, rising house prices should have meant a rising ratio of equity to value.) This was a very clear warning sign about the housing bubble to those familiar with the Fed's data.
A serious news service should not be passing along such ill-informed nonsense to its readers uncorrected, except if its purpose is to point out that the person who chaired the Fed for almost two decades doesn't have a clue about the economy.Add a comment
A Reuters article on plans by the European Union to impose a tax on foreign exchange transactions (actually the proposed tax would apply to a wide array of financial transactions, not just foreign exchange) reads like an editorial against such a tax. It tells readers that the tax could cause traders to leave the London market, that it would reduce liquidity and thereby increase volatility and also disrupt efforts to develop algorithms for intraday trading. It describes these as unintended consequences of the tax.
If it had talked to a proponent of the tax, she would have noted the size of the taxes being discussed would just raise transactions costs back to where they were in the 80s or 90s. The cost of trading has plummeted in the last 3 decades due to computers. This tax will simply reverse some of this decline. There was already an extremely well-developed market in foreign exchange in the 80s.
The effect of a tax on volatility is unclear. While it reduces the incentive for arbitrage, it will also make speculation less profitable. This could make large speculative swings of the sort that we have seen in financial markets in recent weeks less likely.
Finally, it is not clear why it views the fact that the tax will make it more difficult to construct trading algorithms as an unintended consequence. These algorithms may provide large profits to the people who develop them, but the benefits to the economy and society are likely to be near zero. If a transactions tax discourages skilled mathematicians and computer programmers from developing complex formulas for financial arbitrage and instead has them work in a productive area of the economy, then the tax will have been a great success.
[Addendum: Reuters does go a small bit of the way back toward saving its soul by running this column from my friend Mark Thoma.]Add a comment