The Bush Administration figured out how to implement a successful tax cut. In 2001, they offered a "rebate" by giving $300 to every American and $600 to couples. This didn't work for two reasons. First, the money had already been collected, so it ended up as a transfer payment that offset in the GDP accounts. Second, when the rebate was credited to the 2001 tax returns, Americans found the tax cut was no more than an advance, and there was no follow through in spending.
In 2003, the Administration simply advanced payroll tax reductions that they'd passed in 2002. Miracle of miracles, GDP growth hit 8.2% in the third quarter. Since the tax cut was an immediate payroll tax reduction, it immediately ended up in personal income without being offset as a reduction in government spending. The deficit increased by $250 billion, but being met by borrowing instead of income flows meant that all the tax cut went right into the "flow variable" GDP accounts, while the revenue loss went right into the "stock variable" federal debt. The same would be true if we took out a home equity loan of $30,000 to finance a new Ford Expedition (we did that too in the third quarter).
Foreigners protected the dollar. While the dollar weakened in 2003, it could have been much worse without the help of East Asian central banks. The greenback lost 20% versus the Canadian Dollar and the Euro, 15% versus the Swiss Franc, 12.5% versus the Japanese Yen and 10% versus the British Pound. However, the dollar lost 0% versus the Chinese Yuan, which is still fixed at 8.3 to the dollar. To keep their currencies from falling further, the Japanese Central Bank increased its holdings of foreign reserves from $450 billion to nearly $600 billion. China's foreign reserves rose from around $250 billion to $400 billion. Taiwan's foreign reserves rose from $160 billion to $200 billion. South Korea's foreign reserves rose from $115 billion to $145 billion. The inflow of capital in to dollar assets protected U.S. interest rates from rising, kept the dollar from falling further and offset our $500 billion annual trade deficit. It also exported a good deal of our reflationary efforts: industrial production in these countries is rising at double-digit annual rates, while U.S. industrial production remains flat over-the-year.
Consumers and businesses refinance.
Corporate debt issuance should hit a record $500 billion for all of 2003. As most of this is not to develop new domestic production (who needs it?), the bulk is being used to lower interest payments by retiring higher yielding securities. Ford is a case in point. Last year, the company was downgraded by the major bond ratings agencies and the difference between its borrowing rate and U.S. treasuries rose above 5%. This year saw the search for yield reach out to companies like Ford. Its bonds currently yield only 2.5% above equivalent treasury securities, so it has been a big issuer in corporate debt markets, both to retire 2002 bonds and to finance it's rebates, 6-year loans and seemingly endless zero-percent financing program. Consumers, too, used the lowest mortgage rates in forty years to refinance like gangbusters. The MBAA mortgage index hit an all time record of nearly 10,000 in June 2002. The result was that consumers could afford bigger houses, home prices rose in some areas by over 20% and home production, starts, and sales hit volume and growth records in 2003. Businesses could also increase profits without cutting employment and costs as much. Payroll employment has increased by nearly 300,000 in the past three months.
Fannie and Freddie buy out everybody. From Doug Noland: Despite its interminable accounting woes, Freddie Mac posted strong growth during October. Freddie’s Book of Business jumped $38.0 billion for the month, a 33.8% annualized growth rate, to $1.387 Trillion. Over three months, the company’s Book of Business surged $96.0 billion, or 29.8% annualized. Freddie’s Retained Portfolio expanded at a 27% annualized rate during the month to $655.5 billion. Over the past three months, the company’s Retained Portfolio jumped $60.3 billion, or 40.5% annualized. Freddie and Fannie’s combined Retained Portfolios increased an unprecedented $169.3 billion over four months (the onset of near Credit market dislocation in July through October), or 36.3% annualized. It is not often in financial history that a $1.5 Trillion portfolio expands at such a pace. Over the past 12 months, Freddie and Fannie’s Retained Portfolios have increased $280 billion, or almost 22%. For comparison, total Federal Reserve Assets are up about $25 billion so far this year to $758 billion.
While money supply growth has fallen into negative territory, the credit bubble has run unabated. Higher mortgage interest rates have reduced mortgage refinancing to only a quarter of June levels, but Fannie and Freddie's largesse have kept credit available for mortgage lenders to keep making deals. Adjustable-rate loans have increased to over a quarter of all loan volume. Forty-year mortgages are now available to lower monthly payments. Seniors are being pressed to take out reverse mortgages to pad incomes being constricted by low CD, bond and savings rates. Down payment programs like Nehemiah continue to expand even though foreclosures on the loans they finance continue to increase. Minsky's "financial spandex" continues to adapt to conditions that would have popped the same credit bubble in 1929 and possibly even as recently as 1990.