By Marshall Auerback, a portfolio strategist and hedge fund manager; cross posted from New Deal 2.0
What’s coming in 2011? We asked thought leaders to share their perspectives on the biggest challenges for the year ahead, along with the changes they’d like to see and the hopes they cherish. Marshall Auerback explains how misguided attempts to reduce the deficit kill jobs, squeeze the working and middle classes, and inflate crude oil prices. And a corrupt political system doesn’t help.
The beginning of the year always seems a good time to lay out some broader themes which could develop throughout the year, good and bad, so here goes:
The good news is that the US budget deficit still looks to be large enough to support modest top line growth and sustain and stabilize incomes, even if it’s not large enough to bring the jobs we need. As I’ve argued many times in the past, higher government deficits facilitate private sector deleveraging and continuously add to incomes and savings. It is no coincidence that the financial burdens of households and corporations have continued to fall (and savings rates risen) as government deficits have increased.
Unfortunately, the new Congress appears bent on misguided deficit reduction. By next week, the House of Representatives will have a deficit hysteric majority, with many pledged to a balanced budget amendment. And the world seems to be leaning towards fiscal tightening pretty much everywhere. The unemployment benefits program has been extended, but benefits still expire after 99 weeks, and less in many states. Net state spending continues to decline as state and local governments continue to reduce their deficits.
It is true that state tax collections are up quite nicely these days. But even with the recent improvement many states’ total monthly collections are just getting back to 2007/2008 levels, so they are not in the position to ramp up spending. The commentators who are crowing about the current increase in revenues do not understand the historical significance of the extreme weakness we have seen for two full years. As Philippa Dunne (co-author of the excellent Liscio Report) has pointed out to me, sales taxes began to show signs of trouble in early 2007. Catch-up in the funding of unfunded pension liabilities will also continue to be a drag on demand.
Clearly, much of the emotion surrounding government deficit spending could be rectified if we simply viewed the deficits for what they really are. The budget balance is the difference between total revenue and total outlays. At the federal government level, if total revenue is greater than outlays, the budget is in surplus and vice versa. It is a simple matter of accounting with no theory involved. That’s it. In other words, without any discretionary policy changes, the budget balance will vary over the course of the business cycle. When the economy is weak, tax revenue falls and welfare payments rise, so the budget balance moves towards deficit (or an increasing deficit). When the economy is stronger, tax revenue rises and welfare payments fall and the budget balance becomes increasingly positive. Automatic stabilizers attenuate the amplitude in the business cycle by expanding the budget in a recession and contracting it in a boom (see this for further explanation).
To judge from statements on both the left AND the right, it is clear that very few politicians get this basic accounting point, which increases the odds that these social programs will continue to come under attack in 2011. This has already occurred in the UK over the past few months. There, a Tory-led coalition government has completely drunk the deficit reduction “Kool-Aid”. Instead of the public sector providing employment leadership at a time when the private sector is not yet ready to expand jobs growth, David Cameron’s administration has been cutting jobs and forcing unemployment up (see the UK’s Labour Market Statistics). As the austerity drive deepens, the deflationary impact of these job cuts will undermine private sector employment growth. Not that this will stop the cuts from happening here in the US. This sort of economic vandalism has now metamorphosed into “responsible fiscal action”, if one is to believe the vast majority of the “experts” in the mainstream commentariat.
The attacks on public sector unions reflect another flank in this ruthless pincer movement on middle and working class Americans, as this NYTimes article illustrates. It is fascinating to see how the public narrative in the media has gradually shifted over the past year from Wall Street’s sociopathic practices (which were directly responsible for the creation of the crisis) to the alleged greed of public employee unions and their pension benefits, many of which were the product of agreed wage negotiation packages in which unions were receiving these pension benefits in lieu of increased wage benefits.
During 2008, we were told that the government’s hands were tied and that sanctity of contracts had to be honored. This was when the Federal Reserve authorized 100% payouts to the likes of Goldman Sachs on AIG’s credit default swaps (in effect allowing the Fed to act as an extra budgetary vehicle of the Treasury, which is a violation of the Constitution and shows how patently false the Fed’s claims of independence are). But I don’t seem to recall many Wall Street types going on about the sanctity of contracts when agreements with the UAW were reworked to save GM or now when public employee union pension benefits are under attack. The argument seems to be that the states are suffering from a genuine solvency crisis in which everybody has to make sacrifices, including the “greedy” unions. So why should big financial firms, which would otherwise have been toast but for the munificence of the suffering American taxpayer, be any different? If the attacks outlined in the NYTimes piece reflect a broader trend this year, then it has ominous implications for the country as a whole.
Another worry related to the potential diminution of spending power is the troublesome rise in crude prices. Net demand is not up appreciably, and Saudi production remains relatively low. Peak oil dynamics could well be at work here. In a broader sense, what Paul Krugman describes — “we’re living in a finite world, in which the rapid growth of emerging economies is placing pressure on limited supplies of raw materials, pushing up their prices” — could well prove accurate. Which, in the absence of countervailing support to incomes via fiscal policy or increased private sector activity that increases jobs, means cuts in other areas of discretionary spending. Hardly a healthy trend in a world still constrained by inadequate demand. Crude prices are already up enough to be a substantial tax on US consumers that has probably more than offset whatever aggregate demand might have been added by the latest tax package.
A federal pay freeze has been proposed. The Fed’s zero rate policy and its continuation of “quantitative easing” both serve to reduce net interest income earned by the economy.
Bank regulators continue to impose policies that work against small bank lending, whose wholesale funding costs are substantially higher than their “too big to fail” counterparts. The Dodd-Frank “financial reform” entrenches the dominance of the systemically dangerous institutions at the expense of the 6,000 or so other banks that engage in classic loan intermediation activity — the sort of thing we want our banks to be doing.
Overseas, the euro zone looks set to muddle through with very weak domestic demand. The periodic disruptions to the credit markets have hitherto been mitigated by repeated European Central Bank bond buying of the national debts in the secondary markets, but at the cost of further fiscal austerity being imposed on the periphery countries.
What about the emerging world, which has hitherto been held out as the major repository of global growth? Does China slow as a result of fighting inflation? Or Brazil? Maybe India as well?
Finally, there is the odious problem of political corruption, which manifests itself in many forms, but most recently through the cynical revolving door policy between Wall Street and government. Peter Orszag’s move to Citi after spending months launching broadsides against Social Security from his perch at OMB and then the NYTimes goes beyond cynicism. Nobody expects a former government official to live like a monk after spending time in public service. But the idea that someone would help plan, advocate, and carry out an economic policy that played such a crucial role in the survival of a financial institution and then, less than two years after his administration took office, would take a job that (a) exemplifies the growing disparities the administration says it’s trying to correct and (b) unavoidably call on knowledge and contacts he developed while serving at OMB is sickening in the extreme. That his successor also comes from Citi simply perpetuates the incredulity. All this, under an ostensibly “progressive” Democratic administration.
The revolving door between Wall Street and Washington calls attention to the rotten heart at the core of the American polity today — what James Galbraith has felicitously termed “the predator state”. The state has become too weak and therefore remains another instrument of corporate predation. The revolving door policy (eagerly embraced by this president, much like his predecessors) perpetuates the problem because it enhances the dominance of the so-called “FIRE” (finance, insurance, real estate) sector of the economy. The FIRE sector simply acts as a parasite on the production and consumption core, extracting financial and rent charges that are not technologically or economically necessary costs. Its revenue takes the form of what classical economists called “economic rent,” a broad category that includes interest, monopoly super-profits (price gouging) and land rent, as well as “capital” gains. Its ethos consists largely of denuding the state of any provision of public goods, privatizing the public domain and erecting tollbooths to charge access fees for basic necessities such as health insurance, land sites, home ownership, the communication spectrum (cable and phone rights), patent medicine, water and electricity, and other public utilities, including the use of credit cards or the credit needed to get by. It’s a zero-sum economic activity. One party’s gain (that of Wall Street usually) is another’s loss. It looks like we’ll have much more of the same as we enter into 2011.
“Happy” New Year everybody.