I came across some rather insightful analysis and commentary by Rob Parenteau on the PrudentBear website. It details the housing bubble and the self-reinforcing logic that locks both sides (lenders and borrowers) into behavior that cannot continue indefinitely. There is good commentary on what the Fed is attempting in order to "manage" the housing bubble, as well as a very profound footnote (#12 at the bottom) on the Keynesian response to a "liquidity trap", which Paul Krugman has written on extensively.
This commentary often references the Federal Reserve Z-1 "Flow of Funds" tables which is required reading for anyone studying the performance of the U.S. economy. The quarterly release shows the distribution of lending and borrowing activity in the U.S. economy, as well as America's "balance sheet": the distribution of our assets and liabilities. A plethora of Fed related articles: good analysis of the flow of funds, quarterly global capital flows and Dean Baker's quick and dirty Beige Book analysis can be found at the Financial Markets Center.
'LUCKY DUCKIE' INVITES EDITORS INTO HIS POND I am one of those lucky duckies, referred to in your June 3 editorial "Even Luckier Duckies" who pay little or nothing in federal income tax (at least by the standards of Wall Street Journal editors; $800 is more than a chunk of change to me). I am not, however, a stingy ducky, and I am willing to share my good fortune with others. In this spirit, I propose a trade. I will spend a year as a Wall Street Journal editor, while one lucky editor will spend a year in my underpaid shoes. I will receive an editor's salary, and suffer the outrage of paying federal income tax on that salary. The fortunate editor, on the other hand, will enjoy a relatively small federal income tax burden, as well as these other perks of near poverty: the gustatory delights of a diet rich in black beans, pinto beans, navy beans, chickpeas and, for a little variety, lentils; the thrill of scrambling to pay the rent or make the mortgage; the salutary effects of having no paid sick days; the slow satisfaction of saving up for months for a trip to the dentist; and the civic pride of knowing that, even as a lucky ducky, you still pay a third or more of your gross income in income taxes, payroll taxes, sales taxes and property taxes. I could go on and on, but I am sure your editors are already keen to jump at this opportunity to join the ranks of the undertaxed. I look forward to hearing from you. Pier Petersen Chicago
How about it, WSJ Editorialists? Put your money where your mouth is?
P.S. Note that there's a big difference between the WSJ, which is a great source of news and analysis, and the WSJ Editorial Page, which is just plain wacky.
"University of Michigan's closely watched gauge of consumer confidence slipped to 87.2 in June from May's 92.1," Reuters reports. Gains in the stock market (it's about where it was a year ago, after being way down), and dividend tax cuts, cuts in the top marginal rates, and expansion of the 10% bracket, are apparently not enough to offset the fears caused by steadily increasing unemployment and ballooning deficits.
A very informative article in the (registration required) New York Times about the increasing restriction on the use of pharmaceuticals from HMOs. In many plans, co-payments on all drugs have more than doubled, and many classes of non-generic drugs are banned altogether or require a cumbersome approval process. For example, when Claritin was approved for over-the-counter sale, most HMO's started to require a doctor's letter to authorize all remaining prescription allergy medications.
While the ongoing new jobless claims have not received much attention from the executive branch, this dour economic news surely will.
Seriously, if regressive tax cuts come at the expense of growth (either directly or because they foreclose some alternative and more stimulative policy) then they don't even help they rich. Or, more precisely, they improve the relative (to everyone else) wealth of the rich, but come at the expense of absolute wealth.
Another way of seeing this is to ask your rich friend which they would prefer: (1) Paying a marginal tax rate of 39.6% and having the economic growth of the Clinton Years, or (2) Paying a marginal tax rate of 35% and having the economic growth of the Bush Years (I or II)?
According to TheStreet.com, the Semiconductor Industry Association halved its chip sales growth forecast for the year from around 20% growth to 10% growth. And that's from a really low base, after semi sales have been savaged over the past three years. What a rebound!
According to the Fed, the economy is still sluggish:
"Although reports from the twelve Federal Reserve Districts indicated some signs of increased economic activity in April and May, conditions remained sluggish in most Districts," the Fed said in its "beige book" report, an anecdotal summary of economic conditions around the country.
"The unwinding of war-related concerns appears to have provided some lift to business and consumer confidence, but most reports suggested that the effect has not been dramatic."
I've blogged before about the credit crunch among small businesses inefficiently deflecting capital towards the housing market and Federal bonds. I'm honestly very confused about what's going on, as the equity markets are pricing in a recovery while the bond markets are pricing in the opposite.
The credit crunch continues:
last week's commercial and industrial loan number was $932 billion, or $178 billion lower than it was in the fourth quarter of 2000. That means banks have collected $1.4 billion more business loans than they have made every week for the past 130 weeks.
Lower interest rates would set off yet another round of refinancing, but not business lending, which is where the capital crunch is occurring. Banks are simply concentrating on lending to homeowners. And why not? It's profitable and risk-free. There are no looming problems there, right? Right?
Never mind that during this man's tenure we've had a stock-market crash, an S&L crisis/bailout, a recession that allegedly cost Bush I re-election, a Mexican debt crisis/bailout, an East Asian currency crisis/bailout, a stock market bubble/bailout, and now a $500 billion a year trade deficit and a housing bubble. Economic disaster just seems to follow this guy around. Yet he's widely thought to be a shoe-in for his fifth appointment as Fed Chairman. It only proves "Greenspan is able to handle a crisis", in the same way "only Nixon was able to go to China". Despite a career of creating crises, the general cluelessness of the media about how the economy works makes this guy a genius. We need a solution now, whatever the longer run ramifications. And somehow, Greenspan by lowering interest rates and printing money is going to solve this problem.
It's pretty clear that the average American, who knows very little about how the economy works, realizes we're in a severe situation. Economists have to be scratching their heads, though, because from a historical perspective the data is not terribly bad. GDP growth of 2.0% over the past year is only a bit lower than average (3.2%) rate of growth since the bottom of the 1982 recession. It's far from negative at any rate. The unemployment rate of 6.1% is in the range of what economists would have considered "full employment" as recently as 1996. The past year's 2.2% inflation rate is near the low points of the past two decades.
Yet Alan and Co. are reacting as if the world is collapsing around them. There have been 13 rate cuts in a little over two years, bringing the Fed Funds rate, Treasury bond rates and mortgage rates to levels not seen since the 1950s. Clearly there has been some structural change in the economy that is requiring a panic-response from the Federal Reserve despite the sanguine (one of Alan's favorite words) economic data.
About the only statistic that jumps out are asset prices and debt. Household real estate is now valued at 140% of GDP, versus about 110% in 1996. Similar things could have been said about the stock market, which climbed from around 50% of GDP in 1982 to over 160% of GDP by the 2000 peak. Total consumer debt is now over 100% of disposable income, a record. Corporate debt is bit over 100% of GDP, another record.
It's pretty clear when Alan mentions "deflation" that deflation of financial assets is his only concern, not deflation in prices. He has presided over the greatest accumulation of debt in American history. That credit was used to finance the biggest asset bubbles in American history, which made people feel richer, but did little to sustain growth. Now as the bubbles pop, they destroy wealth, ruining the retirement plans of millions of Americans, the balance sheets of thousands of corporations, and exploding the future commitments of government, greatly reducing the possibility that these commitments will be honored.
Alan now can cut interest rates but he can't raise them again, ever. How much refinancing would get done if mortgage rates rose back to 7%? Who could afford the monthly mortgage payments on houses at current prices at that rate? Would corporations be able to afford rolling over their existing debt at those rates? Would federal and state governments want to borrow or cut spending at those rates? How much more of their budgets would get devoted to interest payments? What would happen to mortgage lenders that have locked everyone in paying 5% if they have to borrow at 6%? How about auto companies that have locked in millions of cars at 0%? If they've insured themselves with derivatives, what about their derivative counterparties? The system we've been locked into is unsustainable. It requires greater and greater borrowing at lower and lower interest rates to maintain consumption and asset prices. At the same time, those consumption rates and asset prices result in greater and greater trade deficits with the world, and greater borrowing requirements to service those deficits. The dollar is now under continuous pressure, stoking inflation in consumer goods at the same time our assets are in danger of deflating.
Does anyone seem to care that the Federal Reserve has been at the forefront of all of this, or that the Chairman will throw all his personal beliefs to the wind in order to prevent the ire of the Administration in power? It seems like most Americans care deeply about their wealth, their jobs and their income security, but if the Fed can no longer protect those, it is up to the Federal Government. And if the Legislative and Executive branches don't care about protecting those, then what? Certainly these are the questions the media should be asking, not printing hopeful missives that somehow everything will be better soon and feeding the Greenspan cult of personality.