Bernie Sanders for the Economy, Part 2

Bernie Sanders for the Economy, Part 2

With regard to Democratic establishment economists who continue to say that Sanders' plans are unrealistic, I have three arguments in favor of Sanders:

1. The Democratic economists have a poor track record in making economic predictions.
2. Most of Sanders proposals have been succcessfully implemented in developed nations around the world. 
3. Young people have good reason to support Sanders' economic proposals.

Democratic economists have a poor track record in making economic predictions.

• Democrats in 1980 criticized Reaganomics as unrealistic because of "supply side economics" and consequent budget deficits.  Budget deficits have not been a problem since.  The real problem with Reaganomics was increasing income inequality, something the Democratic economic establishment missed at the time and continues to underplay.  
• Paul Krugman became the foremost spokesman for Democratic economists, yet has been wildly off the mark with regard to the issue of government deficits.  See Paul Krugman in 2003 predicts the exact opposite of what has taken place seen then.  Krugman has since changed his position 180 degrees with regard to the dangers of too much government spending, but remains attached to the discredited theories which got him to the wrong position in the first place.
• Austan Goolsbe in 2007 praised subprime housing loans, just as the subprime housing loan crisis was evolving into the deepest recession since the 1930s.
• Mainstream economic forecasting around the world has been consistently overoptimistic about economic growth.  Inflation has consistently come in below expectations.  Yet Democratic economists continue to give the underlying economic models credibility.  
• Models favored by the Romers
• Federal Reserve GDP predictions
• Japanese central bank predictions
• European central bank predictions
• OECD predictions
• World Bank predictions
• Council of Economic Adviser predictions
• When forecasts have proven wrong, Democratic economists have responded by lowering estimates of what is potentially achievable.  As the Romers say,
  Even very generous estimates of the amount of slack still present in the American economy would not be enough to accommodate demand-driven growth of anything near what Friedman is estimating. As a result, inflation would soar and monetary policy would swing strongly to counteract them.
  Friedman predicts growth similar to that achieved during the Reagan Administration, and the Romers say this is impossible.

Most of Sanders proposals have been succcessfully implemented in developed nations around the world.

Health Care Financing:  It's widely known that every developed country has government mandated universal health care, with comparable or better results than the U.S., and at a fraction of the cost and administrative complexity.

Minimum Wage:  Sanders minimum wage proposal ($15/hour) is less than the actual minimum in other developed countries such as Australia.  

Higher Education:  College is much more heavily subsidized in other developed countries, and much more affordable.   For example, college is free in Germany.

Young people have good reason to support Sanders' economic proposals.

Middle class is much less affordable than it used to be.  Pensions are no longer guaranteed, health care involves much higher out-of-pocket payments, education is more expensive.  Overall, the trend is to get people in debt when they are young, and to let them spend their lives in that state.  We can do better than this, and have in the not too distant past, and most other countries do better today.

Bernie Sanders for the Economy

Status Quo Panic

As a supporter of Bernie Sanders, I was upset to hear, a few days ago, of a flurry of panicky articles by elite Democratic economists criticizing Bernie Sanders' ecconomic plans:

• An Open Letter from Past CEA Chairs to Senator Sanders and Professor Gerald Friedman
• Worried Wonks, by Paul Krugman
• Bernie Sanders' Campaign Has Crossed Into Neverland, by Kevin Drum

I have very much wanted to look into this and respond, and today I have a bit of time to do this.

I am overjoyed to see that one of my favorite economists, Jamie Galbraith, has already responded with an open response to the CEA Chairs.  And Galbraith's response is typically brilliant, with wit and wisdom.

Furthermore, I found that Kevin Drum has already recanted:

A severely critical letter from former CEA chairs ... roasted Friedman's study without doing any actual analysis of his forecasts... And it turns out that...Friedman isn't projecting anything wildly out of the ordinary after all... I set out to take another whack at these projections, and I didn't really get what I expected. [On Second Thought, Maybe Bernie Sanders' Growth Claims Aren't As Crazy As I Thought]

Kudos to Drum for following up and correcting the record.   Don't expect any such admission of premature judgment by Krugman, who is notorious for never acknowledging when he is wrong.

As for the substance of the Sanders economic debate, I'll just quote Galbraith:

So, let's first ask whether an economic growth rate, as projected, of 5.3 percent per year is, as you claim, “grandiose.” There are not many ambitious experiments in economic policy with which to compare it, so let's go back to the Reagan years. What was the actual average real growth rate in 1983, 1984, and 1985, following the enactment of the Reagan tax cuts in 1981? Just under 5.4 percent. That's a point of history, like it or not...
When you dare to do big things, big results should be expected. The Sanders program is big, and when you run it through a standard model, you get a big result...

Paul (Krugman) relies on you (the former CEA chairs) to impugn an economist with far less reach, whose work is far more careful, in point of fact, than your casual dismissal of it. He and you also imply that Professor Friedman did his work for an unprofessional motive. But let me point out, in case you missed it, that Professor Friedman is a political supporter of Secretary Clinton. His motives are, on the face of it, not political. 

Unfortunately, this episode fits a pattern of panicky status quo reaction to the Sanders phenomenon.  In addition, there have been Clinton attacks on Sanders for having temerity to criticize Obama at times over the past 8 years, and on caucus eve, Clinton’s allies warn Nevada Latinos to beware of Bernie Sanders.  

Larger Significance

I strongly believe, with regard to the economy,  that the Democratic status quo is better than the Republican alternative.  But the Democratic status quo is badly flawed, and it doesn't help the team to pretend otherwise.  Sanders' proposals are realistic in my opinion, and this becomes clearer the more one examines attacks such as the one described here.  

Loser Loop

One Plausible Scenario in which Trump Wins

I expect Trump to win the Republican nomination (he's got a HUGE lead), but until this morning had not seriously considered the possibility that he might win the presidency.  After all, polling shows him to be pretty much unelectable:

We’ve got an unpopular set of presidential candidates this year– Bernie Sanders is the only candidate in either party with a net-positive favorability rating — but Trump is the most unpopular of all. His favorability rating is 33 percent, as compared with an unfavorable rating of 58 percent, for a net rating of -25 percentage points. By comparison Hillary Clinton, whose favorability ratings are notoriously poor, has a 42 percent favorable rating against a 50 percent unfavorable rating, for a net of -8 points. [fivethirtyeight.com]

While the book I am currently reading may be affecting my judgment, it occurs to me that Trump's favorability, as an extreme outsider, could rise dramatically if the U.S. economy slump dramatically.  Suppose, for example, that Hillary wins the Dem nomination and then the economy crashes in the summer or fall, as it did before the 2008 election.  In that case Trump the extreme outsider looks much better against Hillary the veteran insider.

Where the book I'm reading (Railroading Economics) comes into play is in its description of the Great Depression.  I see a lot of similarities between the economy in the 1920's and that of the current U.S. / global economy. Here are a few:

1. Increasing wealth inequality leading to more investment and less consumption (as a proportion of total income)
2. Overinvestment leading to decreased returns on productive investment and increasing amounts of questionable financial investment.
1. stock markets in bubble territory -- now at 89th percentile, comparable to 1929, 2000, and 2007, and propped up by loans financing stock buybacks.
2. junk bonds of questionable value
3. An establishment that considers a depression pretty much impossible, and tries to maintain prosperity with the power of positive thinking as opposed to realistic action.

As was the case in 2008 when the U.S. / world plunged into the Great Recession, the overwhelming majority of economists, business, and political leaders view a recession in 2016 as a remote possibility.  I have been putting my money against every mainstream economist and beating them all in recent years.  Please see:

• Something's Rotten
• Conventional Wisdom

The latest I've seen is that less than 5% of economists see a greater than 50% chance of recession over the next year.  [Financial Times survey of 51 economists]

In the late 1920s and early 1930s, there was a similar sanguinity regarding the possibility of the economy falling into depression.  The 1920s was an era of welfare capitalism, and the conventional wisdom was that a depression would not happen because corporate America wouldn't let it.  This is what I learned from reading Railroading Economics (linked above),

Hoover  believed that the provision of adequate information would suffice for enlightened business leaders to ward off business cycles. (page 165)

The Hoover administration became apostles of the...doctrine that high wages are a guarantee and an essential of prosperity.  At the beginning of the depression, Hoover pledged industry not to cut wages, and for a long time large-scale industry adhered to this pledge.

In today's economy, employers have been reluctant to lay off employees, despite the sluggish economy, shrinking profits, and soaring inventory levels (although this is not due to presidential jawboning).

During the Depression...the major welfare capitalists quickly realized that the collapse was overwhelming their ability to maintain their commitment to their expressed ideals...The welfare capitalists saw the momentum of the Depression build up.  In the face of these pressures, their attempts at carrying out the supposed mandate of welfare capitalism vanished.  By the fall of 1931 major corporate employers could no longer refrain from aggressively cutting wages.  When push came to shove, unrelenting market forces compelled major firms to renounce all pretenses to the ideals of welfare capitalism. [page 160]

Ultimately welfare capitalism was doomed to failure from the very beginning.  Business was incapable of overcoming the tendency of markets to careen out of control.  Once the Great Depression struck, people realized that the rhetoric of welfare capitalism was hollow.  Most people understood that they could not count on business to protect them from harsh market forces--a lesson that has continued to fade over the subsequent decades.  [page 168] 

Every morning when I watch Bloomberg TV, I am bombarded by optimistic businesspersons and commentators.   Mainstream Republicans and Democrats alike are certain that the economy is doing just fine.  As noted elsewhere in this blog, I believe the facts point otherwise.  And apparently, I am not alone.  Just as in the early 1930s, fascist and socialist politicians are popular as people crave an alternative to the status quo.

Railroading Economics explains that the welfare capitalism of the 1920s was an outgrowth of the successful combination of government and business in World War I, and that fascism had a somewhat similar perspective:

Welfare capitalism had the capacity to transform itself into fascism without too much difficulty.  It already contained a heavy measure of nationalism and racism.  It was more than willing to cede more power to the state, provided that the state would act in the interest of the welfare capitalists.  [page 164]

The similarities to the Republican party of recent years and the Trump phenomenon are clear.  If the economy does slip dramatically this year, then the prospects for the fascists and socialists will be dramatically improved.

I'm a big fan of Bernie Sanders and his brand of democratic socialism.  On the other hand, Trump is just the current incarnation of a strong fascist undercurrent running through the electorate.  The good news is that Sanders and his socialist platform are far more popular among today's youth.   We older Democrats would be wise to consider momentum for change.  As John Cassidy notes today in the New Yorker with reference to Bernie Sanders' overwhelming success amongst the younger voters in Iowa:

It is often easier to inspire people, particularly young people, with an uplifting theme than with a resumé. This, of course, was also the problem that Clinton faced in 2008, when Obama ran on a message of hope and the slogan “Yes, we can.” In recent weeks, the Clinton campaign’s response to the Sanders and his promises of ambitious policy actions has sometimes seemed to be “No, we can’t.” In Iowa, at least, that didn’t prove to be a winning message.

I don't actually think that this is fair to Clinton.  But I see Sanders' policy proposals as the more realistic response to the current precarious economic and political situation.  Clinton is offering more of the same, which is certainly better than a descent into fascism, but possibly insufficient to prevent that from happening.   If we avoid depression, Sanders will beat Trump handily given Trumps' limited support at present.  This is my opinion and receives support from polls such as the one referenced at the beginning of this post.  If the economy collapses, Sanders is our best bet to defeat the fascists as he presents a realistic and hopeful alternative to the status quo.

What is a Recession?

A recession is a somewhat arbitrary declaration that economic growth has slipped below zero on a variety of measures.  Specifically, the National Bureau of Economic Research (NBER) declares the beginnings and endings of recessions, using the following metrics:

• Nonfarm Employment
• Industrial Production
• Real Retail Sales
• Real Personal Income (excluding Transfer Receipts)

But I have to the conclusion recession amounts to a general acknowledgement by the private sector that they've gotten ahead of themselves, and need to cut back. It becomes a socially acceptable time to lay people off, mark down the value of assets, etc. 

It seems that there are vested interests continuously fighting against the declaration of recession, and they can postpone the inevitable.  But over time more and more businesses find themselves putting up a better visible front than is warranted by the underlying business.  This is a natural outcome in our capitalistic system.  Weakness is often hidden.  Eventually, weakness becomes widespread enough that a consensus is formed on admitting a recession so that all businesses can put the bad behind them and start afresh.

The current economy environment provides a wonderful test case.  Clearly, there has been tremendous overinvestment around the globe.  While the global and U.S. economies continue to grow, growth has been much slower than normal and than predicted by all establishment economists.  As Bill McBride of Calculated Risk says, 2% is the new 4% (with regard to GDP growth).  

So there has been tremendous overinvestment and commodity prices are plunging.  Clearly, mining and manufacturing are already in recession, and this cannot be hidden.  Outside of manufacturing, growth continues (in the U.S.), albeit at the new normal rate of 2% instead of at the previously normal rate of 4%.   Some service industries, such as health care, are relative immune to the rest of the economy and therefore bring up the average.  But the average is pulled lower and ultimately the weakness infiltrates even the less sensitive areas of the economy.  

The global economy is not a zero sum affair.  Losses in one part of the economy are not automatically offsets by gains in another part of the economy.  For example, when the value of a corporation, as measured by its stock price, falls by 50%, there is no compensating gain of value anywhere else.  The proceeds of stock sales do not increase the sum of cash in circulation (cash is exchanged from one party to another when a stock is sold).  Rather, the wealth just evaporates.  So when mining and manufacturing sink, the overall economy sinks, and less wealth remains to finance purchases of services and assets.

From time to time a reset is needed in order to reset unaffordable debt and other hidden weaknesses in the economy.  As the Austrian economists say, this is necessary and good.  But, the government can and should counteract the effects of recession, not by bailing out the weak, but by providing a safety net and other public services.

Where Left and Right Agree on the Economy

Conventional economics these days suffers from two fundamental flaws:

• Private and sovereign public debt are inappropriately lumped together in discussion of economic policy.
• Monetary and fiscal policy are inappropriately lumped together as Keynesian or government-directed approaches to managing the economy.

I'm not a fan of the "Austrian" school of economics, but do agree with them on the folly of the current conventional economic wisdom.  Specifically, they point out that monetary policy doesn't work, and that this leads to excessive debt.  The Austrians feel strongly that periodic recessions are necessary and healthy in allowing the economy to recover from the periods of excess debt.  I agree with this to a point, but there is the further issue of the suffering resulting from recession in an economy such as ours.  Unlike the Austrians, I feel that government can and should take action to cushion the pain and limit the damage.

Here is a good short summary of the Austrian position:  The Important Role of Recessions, by Lance Roberts

Lawrence Summers correctly said the economy’s weakened ability to withstand higher interest rates is based on the fact that lower rates in the past have pulled forward demand for goods and services, thereby leaving less demand in the future... 

Today’s economy has a massive level of indebtedness from consumption of days past and a long history of misallocated capital that has tied up funds that could have otherwise been chasing the next great innovation and propelling our economy forward...   

The problem currently is that the Fed’s actions halted the “balance sheet” deleveraging process keeping consumers indebted and forcing more income to pay off the debt which detracts from their ability to consume. This is the one facet that Keynesian economics does not factor in.

Roberts unfortunately lumps monetary policy with fiscal policy and combines the mainstream view on these as Keynesian economics.   I think of the policies he describes as not Keynesian, but rather monetarist.  Monetarism is the school that advocates central bank tinkering with interest rates for the purpose of managing the economy.  In practice, this leads to the situation described by the Austrians.  After so many years of lowering interest rates to fight recessions by encouraging more borrowing, we end up with excessive private debt and zero interest rates.

To make matters worse, monetarism has no solution to unsustainable debt, and the result is that the central bank bails out the lending institutions.  As monetarism does not provide a fiscal safety net, the only way to avoid a crippling reception is engage in such bailouts.  The result is increased inequality and lack of fairness.  Austrians as well as liberal proponents of Modern Monetary Theory (MMT) are equally disgusted by this state of affairs.

The trap that many liberals fall into is to accept monetarism as a legitimate facet of Keynesianism.  Modern Monetary advocates (MMTers) fight against this.  Keynesianism is practical insofar as fiscal policy is predominant, and monetary policy is just part of the mechanics of implementing fiscal policy.   More broadly, we should use fiscal policy to achieve our explicit objectives (population has enough to eat, is educated, has access to medical care, etc.).  Monetary policy should be used to support these objectives, as opposed to serving as an all purpose tool to either revving up the economy by encouraging more debt or throttling down the economy by discouraging lending.  A currency-issuing government is only constrained by real resources, and not by monetary factors.

This perspective is discussed by John Cassidy in the New Yorker in a recent article entitled Printing Money.

Until recently, the textbook prescription for slow growth involved cutting interest rates and introducing a fiscal stimulus, with the Treasury issuing debt to pay for more government spending or for tax cuts (aimed to spur household spending). That was the recipe that the United States, Britain, and other countries followed after Lehman Brothers collapsed, and it helped prevent a deeper slump. Today, however, neither of the traditional policy responses is readily available. The short-term interest rate that the Federal Reserve controls has been close to zero since December, 2008. Janet Yellen, the Fed chair, and her colleagues can’t cut rates any further. And with over-all federal debt standing at more than eighteen trillion dollars Congress would strongly oppose the Treasury’s borrowing more money for another stimulus package. In the E.U., the situation is even more fraught. Growth has been negligible for years, interest rates are at very low levels, and a legal commitment to austerity policies rules out a fiscal stimulus.

 The highlighted passages are political, as opposed to economic, factors.  The point of the article is that these political factors may be based upon faulty economics, as MMTers would argue.  The author begins from the perspective of the conventional wisdom, lumping monetary and fiscal policy together, but sees that this leads nowhere.  He continues,

Lord Turner argues that countries facing the predicament of onerous debts, low interest rates, and slow growth should consider a radical but alluringly simple option: create more money and hand it out to people... It’s a deadly serious proposal, actually, and its author is a sixty-year-old English technocrat renowned for his intellect and his independence... My proposals will horrify many economists and policymakers, and in particular central bankers,” he writes. “ ‘Printing money’ to finance public deficits is a taboo policy. It has indeed almost the status of a mortal sin.” ... a number of liberal economists rallying under the banner of “Modern Monetary Theory” have urged the government to reverse budget cuts, financing the spending with money created by the Fed. In Britain, Jeremy Corbyn, the new leader of the Labour Party, has suggested that the Bank of England could pay for some infrastructure spending by printing money.

Unfortunately, Cassidy doesn't explain MMT very well, and perhaps does not clear up the conflations of public and private debt, and of monetary and fiscal policy.  Perhaps a clearer statement is that governments can and do create money at will to achieve objectives.  The size of the public debt is irrelevant, as is monetary policy.  Whether the government pays for things by printing money or by issuing debt is irrelevant.  The two are interchangeable as he points out with numerous examples.   His title "printing money" is only new as a way of thinking about how governments currently work, and thereby expanding the horizon as to what can and should be done.

Going back to the Austrians, who believe that recessions are healthy and necessary to extinguish bad debt, the MMTers would reply that the government can and should support the citizenry who had no role in the excess debt.  Punishing all for excessive debt incurred by some is neither fair nor efficient.  We can allow debts to fail, without allowing the overall economy to collapse.  Fiscal spending can accomplish this.  (Austrians are right to say that monetary policy cannot accomplish this.)  

This is socialism, and it is the way we operate.  We have a mixed capitalist-socialist economy, and that seems to be what works best.  Yet we pretend that the capitalist system, based upon private-style debt, is how our system works.  Austrians actually believe that it should work that way, but that is contrary to all evidence in my opinion.  Our modern monetary system is in fact largely socialist, yet provides considerable freedom and room for capitalist endeavor.  Governments create money by spending it into economies.  Capitalists leverage government money and work within the government run system to carve out powerful and efficient enterprises.  Each needs the other.

So both the left and the right are screaming that the current system, based upon the conventional wisdom, doesn't work.  And, in this case, the extremes are correct and the center is mistaken.

1. Remove monetary policy from the discussion.  Both Austrians and MMTers agree this doesn't work as advertised.  +1 Austrians, +1 MMT
2. Treat sovereign debt as money (not as something similar to private debt).  +1 MMT
   Gold and silver are not and should not be money.  -1 Austrians

Score:

1. MMT +2
2. Austrian 0
3. Conventional 0

Is Paul Krugman Ever Wrong?

Kevin Drum has a post today complaining about Paul Krugman's frequent bragging about having been right (and his opponents wrong).  That led to some discussion in comments culminating in the following by yours truly.

Here's an example of Krugman being wrong, yet being intelligent enough to change his mind (following his debate with the MMT folks).  First, Krugman in 2003:

There is now a huge structural gap — that is, a gap that won't go away even if the economy recovers — between U.S. spending and revenue. For the time being, borrowing can fill that gap. But eventually there must be either a large tax increase or major cuts in popular programs. If our political system can't bring itself to choose one alternative or the other — and so far the commander in chief refuses even to admit that we have a problem — we will eventually face a nasty financial crisis. 

The crisis won't come immediately. For a few years, America will still be able to borrow freely, simply because lenders assume that things will somehow work out. 

But at a certain point we'll have a Wile E. Coyote moment. For those not familiar with the Road Runner cartoons, Mr. Coyote had a habit of running off cliffs and taking several steps on thin air before noticing that there was nothing underneath his feet. Only then would he plunge. 

What will that plunge look like? It will certainly involve a sharp fall in the dollar and a sharp rise in interest rates. In the worst-case scenario, the government's access to borrowing will be cut off, creating a cash crisis that throws the nation into chaos. 

[Paul Krugman, New York Times, 10/14/2003 http://www.pkarchive.org/column/101403.html ]

Fast forward to Krugman, again in the NY Times, on November 26, 2012:

Still, haven’t crises like the one envisioned by deficit scolds happened in the past? Actually, no. As far as I can tell, every example supposedly illustrating the dangers of debt involves either a country that, like Greece today, lacked its own currency, or a country that, like Asian economies in the 1990s, had large debts in foreign currencies. Countries with large debts in their own currency, like France after World War I, have sometimes experienced big loss-of-confidence drops in the value of their currency — but nothing like the debt-induced recession we’re being told to fear. 

So let’s step back for a minute, and consider what’s going on here. For years, deficit scolds have held Washington in thrall with warnings of an imminent debt crisis, even though investors, who continue to buy U.S. bonds, clearly believe that such a crisis won’t happen; economic analysis says that such a crisis can’t happen; and the historical record shows no examples bearing any resemblance to our current situation in which such a crisis actually did happen. 

If you ask me, it’s time for Washington to stop worrying about this phantom menace [Paul Krugman, New York Times, 11/26/2012 http://economistsview.typepad.com/economistsview/2012/11/paul-krugman-fighting-fiscal-phantoms.html ]

The latter quote could have been straight from the MMT playbook.

Mainstream Agrees Republican Congress Actively Trying to Sabotage Economy

You can't get much closer to conventional wisdom than Ben Bernanke.  He virtually defines the establishment, centrist, insider perspective.  So it's notable that Bernanke has come out with something I've been saying for years, i.e.

I also felt frustrated that fiscal policy makers, far from helping the economy, appeared to be actively working to hinder it.

This quote appears in a fine rant by Bill McBride at Calculated Risk.  McBride has been very optimistic on the economy and seems to feel that all is well, in spite of the fact the lawmakers are trying to sabotage the economy.  I find that unlikely and am consequently much more bearish regarding the economy.

Kevin Drum has more on Bernanke's disgust with Congress here.

Part of the reason that economic nuts are in control of Congress is that the old conventional wisdom, embodied in Ben Bernanke, is a bit nutty itself.  Mainstream economics is based upon these fictions:

1. A currency-issuing government budget is just like a household or business budget.  We hear continually from the mainstream that our government should have a balanced budget, but we don't need to and we never do.
2. The central bank can control unemployment and inflation.  In fact, the central bank has little control under present laws and conventions.  They tinker with interest rates, but amazingly (to the consensus), this has little effect on the economy. 

With the conventional wisdom so clearly incorrect and ineffective in resolving the country's economic problems, alternative explanations are in high demand.  Now that he is out of office, Bernanke can clearly state that he agrees with me -- The elected government leaders should manage the economy via fiscal policy, regulation, and other laws.  

Scientific Classification of Life Less Useful for Laymen

In reading about animal and plant classification systems, I've noticed that the latest trends favor biological ancestry over contemporary morphology.  In other words, the classifications don't make as much intuitive sense because they are no longer based upon (superficial?) physical similarities -- i.e. physical similarities noticeable with our naked eyes.

I hope to add some examples of plants (rosids) and animals (ungulates) when I get a chance.

The New Business Cycle

The 4 Stages

Beginning approximately 2000, the following 4 stages are repeated (cycle of approximately 8 years):

1. Business is apparently good for most (even bubbly), while skeletons are hidden in closets.
2. Skeletons begin to come of the closet.
3. The business admits to being in recession, and most businesses have a skeleton or two to reveal.
4. Political fallout.

Bubble Building Phase

The dot com bubble was the most severe bubble of modern times, with equity valuations soaring to absurd levels.  This was repeated duing the housing bubble 7+ years later, and an energy / stock market bubble in recent years.  The S&P index in comparison to GDP has soared to clear bubble levels:

Skeletons Come Out

Here are a few examples:

• Enron 2001 (& related Arthur Andersen collapse)
• Global Crossing 2001-2002
• Tyco 2002 
• Countrywide 2008
• AIG 2008
• Lehman Brothers 2008

Recession Acknowledged

Eventually, the accoumulation of bad news becomes too much, and a recession is acknowledged by the political and economic establishment.  At this point, the losses become extremely widespread and affect masses of people through employment and asset price effects.  Countless tech firms went bankrupt in 2001, and massive amounts of wealth evaporated.  In 2008-2009, housing prices collapsed and unemployment soared.  

Most companies use this opportunity of an acknowledged recession to write off massive quantities of questionable assets.  Thus earnings of the S&P 500 were negative in the 4th quarter of 2008.

In fact, the negative earnings of 2008 Q4 (-$23.25) is something that has never happened before in the history of the S&P 500.

Political Fallout

Once the recession is acknowledged and the negative consequences reverberate throughout the country, there are inevitably strengthened calls for reform.  The Sarbanes-Oxley Act of 2002 set new or expanded requirements for all U.S. public company boards, management and public accounting firms.  The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 brought the most significant changes to financial regulation in the United States since the regulatory reform that followed the Great Depression.  Also, it was no coincidence that Americans voted for change in a big way in the 2008 election, with a Democratic landslide in Congress and the election of the nation's first black president.

Political Economic Quadrants for 2016

In reviewing my posts from earlier this year, it looks like I've been on to something.  What I have expected has indeed transpired, while the conventional wisdom has been surprised.

Just today we have the following:  US employment costs post smallest increase on record

U.S. labor costs in the second quarter recorded their smallest increase in 33 years amid tepid gains in the private sector... Labor market slack has diminished significantly over the last few years, which is expected to start putting upward pressure on wages...  

Yesterday brought this news:  GDP disappoints; revisions show recovery from recession was even weaker than we thought

instead of growing at an average annual rate of 2.3 percent from 2011 to 2014, the economy grew by only 2 percent. So not only was the economic recovery from the recession tepid, it was even weaker than we thought.

And the latest employment report was weak:  Mixed U.S. jobs report

U.S. job growth slowed in June and Americans left the labor force in droves... The Labor Department said on Thursday nonfarm payrolls rose 223,000 last month after a downwardly revised 254,000 increase in May, with construction and government employment unchanged, and the mining sector purging more jobs. 

April payrolls were also lowered, meaning 60,000 fewer jobs were created during the two months than previously reported. The unemployment rate fell two-tenths of a percentage point to 5.3 percent, the lowest since April 2008, but that was a sign of weakness as 432,000 people dropped out of the labor force...

The labor force participation rate fell to 62.6 percent, the lowest since October 1977

Admittedly, I'm cherry picking the bad news, and most professional commentators still seem to think that the economy will improve, although the trend is clearly more pessimistic:
The post-recession economy is worse than we thought 

Even the Federal Reserve, which has consistently overestimated growth trends, only sees the economy growing between 1.8% and 2% for the full year this year, with long-run potential between 2% and 2.3% growth.

As with the U.S. in Vietnam, we see the Fed declaring victory and moving on. I will proceed under the assumption that the converntional wisdom as to how the economy works has been proven wrong, and that new conventional wisdom is slowly emerging.

Economic conventional wisdom is politically relevant.  Both the Republicans and the Democrats are being forced to adapt their economic principles to the reality of the failed monetary practices of the Reaganomics era.  Beginning around 1982, "the era of big government ended" (Bill Clinton's words in the 1996 State of the Union Address.)  A less intrusive method of managing the economy, as opposed to the previous Keynesianism, was advocated by both Republicans and Democrats during this period.  Monetary policy under the technocratic (apolitical) direction of "the Fed" reigned supreme.  As we enter the 2016 presidential election campaign, the two parties are testing the waters with alternative economic platforms.

Interestingly, Donald Trump has moved to an early lead on the Republican side.  He has been the Republican with the most intriguingly different perspective on the economy.  Trump opposed the Trans Pacific Partnership, for example, unlike most of the other Republicans who follow the big corporate donors.  He is stridently against illegal immigration and other aspects of globalization which have harmed labor in the U.S.

The more intellectual spokesmen for the Republicans favor continued globalization.  To the Republican intellectuals, big government continues to be the problem.  Globalization keeps governments in check by subjecting societies to marketplace discipline.  In spite of populist rhetoric, almost all the Republican presidential candidates are pro-globalization and pro-big business.

The Republicans face a serious divide between the corporatists and the populists.  The Trump supporters stand to gain strength as the economy slumps, but big business will continue to wield more economic power.  While populism versus corporatism presents a wedge issue for each party, the  Republicans are more vulnerable given the strength of the Tea Party populists in the Republican media machine.  Republicans may face decades of internecine conflict.

In the Democratic presidential primaries for 2016, a somewhat similar battle is shaping up between populists and corporatists.  Hillary's position is somewhat similar to the Republican mainstream -- i.e. globalization in general is good (and nationalism/populism is bad although worthy of political recognition).  Bernie Sanders, on the other hand, is a class warrior.

Syriza!!

http://www.interfluidity.com/v2/5965.html

Just want to highlight the linked article.

Another Problem with the Conventional Wisdom

I've posted a couple of times already this year about problems with the conventional wisdom.  As I'm off work this week and have had Bloomberg on TV much of the time (in the background), I'm being bombarded with another item of conventional wisdom that seems way off.  Again, this is not one that is unique to Republicans or Democrats.  Both seem to be accepting this item of bogus conventional wisdom.

The item I am talking about is the effect of (un)employment on the economy as a whole.  The conventional wisdom is that the economy is poised for take off on the strength of recent gains in employment.  Story after story predicts that U.S. consumer spending will take off soon, continuing a self-sustaining spiral of growth.  In reality, spending has actually gone down in recent months, in tandem with decreasing prices.

Every economist should know that employment is a trailing indicator.  Companies hire more when spending is increasing, and vice versa.  With spending decreasing, falling employment is sure to follow.  Apparently this will come as a great surprise to the Democrats, Republicans, and the financial industry.

To some extent, this is a "chicken or egg story".  Which comes first -- higher employment leading to increased spending, or lower spending leading to decreased employment.  But a closer look at current situation reveals that employment is still weak and that recent gains are minor in terms of purchasing power.  For example, note that Average Hourly Earnings of Production and Nonsupervisory Employees are growing at the second lowest rate since 1964.  There is a much higher correlation between wages and spending than there is between employment and spending.  

The other argument supporting the conventional wisdom is that lower prices, especially for gasoline, will boost spending on other products and services.  This is no doubt true to some extent, but so far, after 6 months of plummeting prices, this effect has not been big enough to notice.  What has been noticeable is that the world economy is weak and that many U.S. businesses are experiencing lower exports and profits from abroad.

So imagine that you are a U.S. business.  You may have hired some additional employees over the past year, but revenue growth over the past year has been very low compared to most years, and negative in recent months.  Obviously you are going to reduce hiring.  This applies to even greater extent to large multinationals which are now seeing US wages increase sharply in relation to wages in other countries, due to the strength of the US dollar.

To reiterate the basic point-- With spending decreasing, falling employment is sure to follow.  Apparently this will come as a great surprise to the Democrats, Republicans, and the financial industry.

Hopeful Political/Economic Signs

1. The new finance minister for Greece is a close friend and associate of one of my favorite economists -- James Galbraith.  From The Guardian:

Yanis Varoufakis, it is fair to say, was barely known not that long ago... In the space of three short weeks, he’s been christened Europe’s man of the moment...  As the politician tasked with saving Greece in this, its most difficult hour, what the radical, shaven-haired economist thinks, how he comports himself and what he says are not without consequence. Linked as it is to that of the eurozone, his country’s fate is intrinsically connected to the global economy...  

The luggage of his close friend, the renowned economics professor Jamie Galbraith, who has flown in from Austin where Varoufakis has spent the past three years as a visiting professor, are spread across the room...  Galbraith, with whom he co-authored A Modest Proposal – a tract that proffered various ideas to end the euro crisis, has been quoted as saying that Varoufakis is so sharp he will “be thinking more than a few steps ahead” in negotiations with Athens’ creditors...  

Without a hint of self-deprecation or doubt, he tells me early on that he is “moved by” an internationalist agenda and thus motivated by the concerns of Europe and the world...  “We’ve lost everything,” he says. “So we can speak truth to power, and it’s about time we do.”

A few days later I pass Varoufakis and Galbraith outside the ministry in Syntagma Square. It is late and both are walking in the pouring rain towards a taxi rank. I hear the Greek politician, rucksack on back, enthusing about the surge in his book sales. Despite it all, he is happy.

2. Another one of my favorite economists is the new Chief Economist for the Democrats on the (U.S.) Senate Budget Committee, headed by Bernie Sanders of Vermont. From The American Prospect:

If there’s one indication of the radical new direction in which Sanders plans to take the Budget Committee, consider the most eye-popping minority staff hire so far. As his committee staff’s chief economist, Sanders chose Stephanie Kelton, a leading proponent of Modern Monetary Theory(MMT). It was Kelton who coined the term “deficit owl,”—in contrast to “deficit hawks” and “deficit doves”—to describe those, like her, who “don’t concede we need to balance [the budget] at all,” according to the Washington Post’s Dylan Matthews.

Matthews writes that “owls” such as Kelton and the University of Texas’s James K.Galbraith “see government spending that leads to deficits as integral to economic growth, even in good times.”

MMT has existed far outside the Overton window of fiscal policies pushed by either party.

The Way Forward

Here I explain the likely path from our current dysfunctional political-economic system to a new paradigm.  With the first 6 items below, I describe the factors that make the present system unstable.  Then I will make a brief comment on what might be possible after the next political-economic shock.

1. Reaganomics (the" ownership society") has the prevailing political-economic paradigm for the last 33 years in the United States, and for the last 25 years globally (coinciding with the fall of Communism and the Soviet Union).  This paradigm has been characterized by freeing business from regulation and an increased pace of economic globalization.
2. The share of income going to capital has increased (in the U.S. and other developed economies), while the share of income going to labor has decreased.  Consequently, asset prices (stocks) have appreciated faster than wages.  This has been a self-reinforcing phenomenon, as capitalists take their increased profits and reinvest them, thus boosting shares even higher.
3. As the process described above (increasing asset prices, stagnant labor income) has continued for over 3 decades, it has become hard to find reasonably valued investment opportunities.  Assets are far overvalued in comparison to consumption.  We are now in the midst of the 3rd major stock market bubble in the last 15 years (tech bubble, housing bubble, energy bubble (?)).  Stock valuations currently are on a par with 1929, ahead of housing bubble valuations and behind only the tech bubble of the late 1990s.  
4. Consumer prices continue their 33 year disinflationary trend.  This is the logical consequence of the phenomenon described above -- more money being spent on investment, with less being spent on consumption.
5. Overinvestment and bubbly asset prices are corrected via dramatic price declines (as happened in 2000 and again in 2008).  There is no other likely scenario in the global economic paradigm, where capital continually moves to cheaper locations, and countries devalue their currencies to become more competitive.
6. To change the fundamental 30+ year trend, political changes are required.  These changes are most likely to happen following one of the periodic stock market crashes, especially now that a substantial portion of middle class savings is held in the stock market. 

There are several camps as to how to get to a more stable society:

1. Further reduce the size and power of government.  The Austrian school of economics falls in to this camp, believing that we should return to the gold standard and the laissez-faire economics of the gilded age.  
2. The Monetarist (neo-classical) camp that believes in the preeminence of monetary policy (tinkering with interest rates) as a tool to manage the economy with a minimum of government involvement.
3. The Keynesian camp that believes government action, including fiscal policy (taxing and spending) is needed to manage the economy.

Within the Keynesian camp, the conventional wisdom is with the NewKeynesians.  The NewKeynesians accommodated their Keynesian views with those of the pre-Keynesian neoclassical economists, whose modern day successors are the Monetarists.  In other words, the conventional wisdom is more monetarist than Keynesian.

My favored camp is the PostKeynesians, or Modern Monetary Theorists (MMT) in particular.  In a hopeful sign, MMT economist Stephanie Kelton has been appointed by Bernie Sanders, the ranking member of the Senate Budget Committee, as his new chief economist -- See Bernie Sanders opens a new front in the battle for the future of the Democratic Party.  Excerpt:

Usually, when Democrats hire economists, they hire nice, respectable Keynesians, who use mainstream economic models and often agree with conservative economists on a lot of theoretical matters while drawing different policy conclusions from them. For example, Greg Mankiw, who served as George W. Bush's top economic advisor, and Christina Romer, who served as Obama's, were both influential in developing New Keynesianism, a macroeconomic theory that emerged in the 1980s and arguably dominates the field today. What really set Romer and Mankiw apart was policy, not economic theory.

Kelton disagrees with Romer and Mankiw on economic theory. In fact, she disagrees with just about every economist Bush or Obama ever hired about economic theory. Kelton is among the most influential advocates of Modern Monetary Theory (MMT), a heterodox left-leaning movement within economics that rejects New Keynesianism and other mainstream macroeconomic theories.

The Conventional Wisdom

In my previous post, I noted that something seems to be horribly wrong, in that 100% of economists were completely wrong in a prediction last year.  And now professional forecasters on Wall Street are unanimous in seeing U.S. equities climbing by the end of this year, by an average of 11%.  Let's dig a little deeper to see what is wrong and why.

My initial thought is the "professional forecasters on Wall Street" are hacks.  They are boosters, and should be ignored.  While this is true, there are two more fundamental factors:

• It would be extremely risky for a professional forecaster to go against the conventional wisdom.  
• It is not only "professional forecasters on Wall Street" who have been dramatically wrong about the economy, but also the professionals in government including, especially, the Federal Reserve.

No one in the "financial establishment" has explained why the disinflationary trends of the past 30 years should be expected to turn around.  The obvious driving force is globalization and the accompanying weakening of the bargaining power of labor.  The Fed ignores this and believes that their ineffective monetary policies will result in a return to "normal".  The Wall Street forecasting professionals repeatedly predict a return to "normal", again ignoring the ongoing fundamental weakness of labor.

Something's Rotten

In a poll of 67 economists in April 2014, every single one of them predicted that the 10-year Treasury yield (U.S. government bonds) would rise in the next six months.  Every one of them was extremely wrong.  The 10-year yield fell sharply for six months (and has fallen even more steeply in the 7th - 9th months).  I have invested my life savings in long term U.S. Treasury bonds, and saw these predictions when they were made.  Yet I never seriously considered changing my position.  I was somewhat intimidated, but after a bit of thought concluded that I was right to believe that the 10-year yields would move in the opposite direction of 100% of economists.

The U.S. stock market was extremely overvalued by all serious measures, and the U.S. economy had just experienced a quarter of negative GDP.   This seemed like a no-brainer, and my rationale has been rewarded handsomely, as yields have plunged, and my investment (PRULX - a long term U.S. Treasury bond mutual fund) has soared.  Either I am a freak genius, or there is something dreadfully wrong with "economists".

Today I read the following:

While it may not be an easy ride, professional forecasters on Wall Street are unanimous in seeing U.S. equities climbing by the end of this year. None of the stocks strategists tracked by Bloomberg predicts a retreat in 2015, with the average estimate calling for a 11 percent advance from yesterday’s closing level.

To me, this seems horribly absurd.  U.S. stocks are at 90th percentile levels of overvaluation, according to all reasonable measures of valuation (documentation available upon request).  The global economy is clearly entering recession.  The U.S. economy is sending mixed signals.  Yet every single professional forecaster on Wall Street sees U.S. equities climbing this year.  Moreover, the average increase predicted is 11% -- approximately 4 times the rate of growth of nominal GDP in recent years.

Something is horribly wrong.

The Economic and Political Outlook for 2015

Summary

The global economy is entering a deflationary recession, and the United States will not be immune.  We live in a financially and economically integrated era, and only concerted action can bring an economic recovery.  Unfortunately, the political will is lacking, as the United States is dominated by anti-government Republicans, and other countries practice austerity and currency devaluation in a deflationary spiral. 

The political consequences will result in a paradigm shift to a new model of governance with regard to the economy.  This will be somewhat similar to the way in which the Great Depression of the 1930s resulted in the New Deal and a much bigger role for government in the economy for the next 50 years.  The current era of Reaganomics began around 1980 and enjoyed considerable success for about 20 years.  However, beginning in the year 2000, this era of globalization of the economy, with reduced government regulation and a porous safety net, has been wobbly.  The stage is set for a new era.

Of immediate concern is the direction of governance in the United States.  If I am right and the economy tanks in 2015, the allure of Hillary Clinton, and more of the same from the Reagan-Clinton-Obama era, will be nil.  Either Clinton will have to make a sharp turn to the left, or she will face a populist backlash.  If I am wrong and the tanking of the economy doesn’t occur until mid-2016 or later, this will be bad news for Democrats who will own the crappy economy in the eyes of voters.  This could be similar to the situation faced by Republicans in 2008 as economy crashed shortly before the elections that year.

On the Republican side of things, I have much less certainty.  Republicans seem more likely to do a 180° pivot and boost their favorite parts of the economy (big corporations and other Republican interests).  I can imagine them passing massive tax cuts as well as subsidies to businesses, and such measures could prove effective.  They are equally likely to worry about the deficit in Hooveresque fashion, thereby prolonging the depression.    If Republicans gain more power there will be conflict between the anti-government and pro-business wings, as business will need government help.

Current State of the Economy

The following factors form the basis for my belief that the economy is in the process of tanking:

• The United States stock market is massively overvalued by all reasonable measures.
• The middle class in the United States is heavily dependent upon the stock market for retirement saving.  This situation is similar to the 1930s, when life savings were held in uninsured bank deposits.  Now life savings are held in uninsured 401k-brokerage accounts.
• The global economy is slumping.  Japan is in recession, emerging markets are crashing, Europe is slipping into deflation.
• The global economy is interconnected, and the U.S. is in the center of it all.  Deflation in other countries is resulting in deflation in the United States, as gas and import prices fall.  Similarly, the rising value of the U.S. dollar is making U.S. labor comparatively more expensive, despite the actual fall in U.S. wages in the latest employment report.
• The global financial system is interconnected.  The rising value of the U.S. dollar is squeezing emerging markets that have borrowed trillions of U.S. dollars.  Thus, credit markets around the globe are tightening, while the safe haven of U.S. Treasury bonds is soaring.
• The United States economy has been weak for the last decade.  This was disguised by a housing bubble and, more recently by an energy boomlet.  But labor force participation and wages have stagnated.  There is little room for a slowdown, as evidenced by interest rates approaching zero all around the world.
• Expectations are wildly out of whack.  In spite of all the factors noted above, consumer confidence is up and the conventional wisdom among both Republicans and Democrats is that the United States economy is taking off.

In short, the perfect storm is coming. 

The Day Monetarism Died

We are undergoing a paradigm shift in conventional wisdom regarding macro-economics.  For the last 32 years, the conventional wisdom has been that we can manage the economy via central bank tinkering with interest rates.  That view is no longer plausible.  Continual lowering of interest rates plus the "extraordinary" measure of quantitative easing, has only proceeded to still lower inflation rates -- in direct opposition to the conventional wisdom.

18 months ago I moved the bulk of my lifetime savings to longer term U.S. Treasury bonds.  I did this in response to conventional wisdom that inflation and interest rates were certainly on the rise.  6 months ago, the conventional wisdom was unanimous as expressed here -- http://blogs.marketwatch.com/thetell/2014/04/22/100-of-economists-think-yields-will-rise-within-six-months/ - " a survey of 67 economists this month shows every single one of them expects the 10-year Treasury  10_YEAR  yield to rise in the next six months."

Well I was right and the 67 economists were wrong - big time. Interest rates have plunged over the past 6 months -- almost 6 months to the day since this was published.  The conventional wisdom is the utter fantasy that the central bank can control the economy.  The central bank said that the economy was improving and that their policies would generate inflation.  But they have been proven wrong time and again, and this last episode will be the last hurrah of these Oz-like wizards

The Tortured Logic of an Elite Economist

Kenneth Rogoff is a Professor of Economics at Harvard University, who has served as a chief economist at the International Monetary Fund (IMF), and at the Board of Governors of the Federal Reserve System. He is one of the elite mainstream U.S. economists, with degrees from Yale and MIT. With that in mind, it's interesting to look at a recent column he wrote which puts the incoherence of his economic worldview on display.

The column is entitled, The Exaggerated Death of Inflation and is published in The Guardian, He seems to be responding to Paul Krugman and other liberal economists who argue that inflation is not a concern at the present time in the developed nations.  The point is not unreasonable, but the supporting logic is tortured.

Rogoff's main point is that central banks are powerless to control inflation; it is a political choice (presumably related to fiscal policy which is beyond the control of central banks, although Rogoff doesn't acknowledge this).  Here are Rogoff's exact words:

a country's long-term inflation rate is still the outcome of political choices not technocratic decisions ... No matter how much central banks may wish to present the level of inflation as a mere technocratic decision, it is ultimately a social choice.

Thus, his fundamental point is that central banks can't control inflation.  However, he repeatedly talks about the tremendous progress and powerful tools that central banks now possess.  Quotes:

massive institutional improvements concerning central banks have created formidable barriers to high inflation 

back then, monetary authorities were working with old-fashioned Keynesian macroeconomic models, which encouraged the delusion that monetary policy could indefinitely boost the economy with low inflation and low interest rates. Central bankers today are no longer so naive 

Modern central banking has worked wonders to bring down inflation.

Inflation has been subdued in recent decades by technological and political changes accelerating the pace of globalization, and thus lowering wages in developed countries as more stuff is made in competing low wage developing countries. Rogoff acknowledges this with the following contorted logic:

increasing globalisation and technological advances made it much easier for central banks to deliver both solid growth and low inflation 

He seems to live in a world of economists who all agree that central banks are tremendously powerful and enlightened, so he ends up with this tortured and incoherent piece on how central banks don't really have all that much power.

cross posted at Mike Norman Economics