Dizzying dollar dip or delightful drop?

When clubs are trump - Donald Trump doesn’t like it, so maybe it’s good after all. Trump, with a focus on real estate and the value of his holdings, while battling other real estate groups wants his dollar assets as strong as possible to keep him high on the global scale of wealth rankings. But a declining dollar does more than just redenominate the value of ‘The Donald’s’ wealth. It sets our prices in other currency terms and as our prices drop US workers become more competitive and foreign goods become more expensive; this is the process by which the trade gap narrows. Is it really so bad?

The weak dollar: how weak? - The broad dollar index is presented the in the chart above. The dollar is dropping to just about its lowest point since exchange rates were set to ‘float’ in the early 1970s. This chart shows a more compressed recent history. One thing it reminds us of is that the dollar had been weak ahead of the financial crisis and a flight to safety cut the dollar’s drop short.

Dollar reverts to pre-crisis path - But now, as the recovery continues to spread, the dollar has been unwinding its rise and is back to its pre-crisis neighborhood which is a very weak point of valuation.

Benefits and risks of a strong dollar -As the dollar falls, imports become more expensive and Americans have to work longer hours to afford to buy the same goods made abroad. That is a reduction in US welfare. Meanwhile, foreigners can more easily afford US-made goods. In welfare terms the dropping dollar has ‘bad’ consequences as we are giving our goods away for less and paying more for what we buy abroad. That it is why economists generally ‘like’ a strong exchange rate and why a strong exchange rate is more than just a ‘symbol’ of American power. But, at the same time, if the exchange rate is ‘too strong’ while we continue to reap the benefits of exaggerated purchasing power in trade we also begin to erode the basis for the exchange rate’s continuing strength by running progressively larger trade deficits which is also what the US has done.

Too-strong dollar/temporary benefits- In seeing that you can appreciate this period of an overvalued dollar as creating conditions akin to a special sale, like the old-fashioned K-Mart blue-light specials. These ‘specials’ were temporary sales that came and went. K-Mart’s managers would erect a blue light in the store and switch it on; it would pulsate like a light on top of a police car and announce to everyone in the store that the items under the light were subject to special temporary discounts. The policy was meant to bring people into the store since you never knew what would go on sale or when. Of course K-Mart has since been relegated to a much lower tier on the retailing scale and has been replaced by Wal-Mart that advertises ‘everyday low prices’. But for Wal-Mart to deliver on this policy it needs the dollar to be too-strong every day as well. The drop in the dollar (to the extent that it involves a drop Vs China’s yuan) will cause Wal-Mart’s everyday low prices strategy to reflect higher prices than it did before.

Foreigners finance our excess- And so it is with the dollar. When it was ‘overvalued’ we could buy things cheaper, but only temporarily. Since we have run a huge trade gap foreigners have effectively been lending us the funds to make all these great purchases. Now they are beginning to balk. We all know that the period of running up the credit card is a lot more fun than the period in which we pay down the balance, but here it comes. Well, not literally; we are going to continue to ‘run up the balance’ but at a slower pace as the US current account deficit should get smaller but will remain a deficit.

If a high exchange rate is so good why do countries pursue weakness? There are great ‘welfare’ reasons for wanting the exchange rate to be overvalued, but, as we look at history, we find so many cases of countries being involved in the opposite strategy of pursing policies of competitive devaluations. In fact the one clear example of a country trying to fix its exchange rate ‘too high’ is a story of economic failure. It is the case of the UK trying to return sterling to its pre-war parity to gold in the inter-war period. Instead, of this sort of tact we find most countries pursing the strategy of making their currencies weaker to promote their own exports even though that approach makes imported goods more expensive and reduces their wealth in foreign currency terms. Why do that?

Benefits of a lower-value currency- A weak currency approach is a pro-growth strategy that is largely without clear domestic cost or opposing constituency (except for a price-stability-loving central bank, perhaps). It is a relatively effective way to tap into foreign demand and to divert foreign production from satisfying that demand by making your own country’s production cheaper so it can supplant foreign producers in their home market or in sales to ‘third’ markets. The trade-off for a weak currency is to gain output and therefore employment at the cost of having consumers pay higher prices. Consumers pay more for their imported goods and for ‘domestic-made’ goods using foreign-sourced inputs. When growth is hard to attain, a cheaper currency is a vehicle to attain it. This is why the strategy of using ‘competitive devaluations’ is called a beggar-thy-neighbor policy.

Attraction for developing economics -With this insight we can see the repercussions as the US has run a series of huge balance of payments deficits. We have been afforded the opportunity buy stuff from abroad that was cheap to us. In turn exporting nations have been able to grow faster and ride the tide of their strong and rising exports to the US to improve their development. Since some of these countries were not as developed as the US many of them found the expanding jobs market more than ample compensation for the fact that workers there were not being paid fully what their goods were worth. Indeed, some of these countries were so underdeveloped that their domestic wages still rose sharply and despite that remained well below the wage level that exists in the US. Such is the magic of development

The financial angle- Various US trade partners used the technique of acquiring massive quantities of foreign exchange (dollars) to keep their surpluses in trade from creating a dump of dollars on the market that would have reduced the dollar’s value and would have short circuited their export boom. Now some of these same countries bemoan their huge stash of dollars as the dollar’s value has dropped. But all of that has been their doing, just as the weak dollar is an eventual consequence of a too-strong dollar policy.

No sense of pain for developing economics- The strategy of a keeping your currency cheap seems to work best in less developed countries. There the domestic work force does not know what its currency is worth and the spread of jobs creates a boom. That boom results in the increase in wages to levels that will still not pay those workers properly for their services but nonetheless represents a better place than they previously were. To them a cheap currency seems to be a win/win situation as jobs expand and wages rise.

Pain to be felt in the US- But the US is going through this dynamic to a cheaper currency with a bit more pain. We have been used to having an overvalued dollar and to having great purchasing power. We are just finding out what reduced purchasing power means as foreign prices rise. Since we know what prices used to be we feel the drop in welfare more than do workers in a developing country whose ‘welfare shortfall’ created by their undervalued currency comes about relative to a hypothetical situation they never had experienced. But since we in the US have experienced the greater purchasing power of the dollar we will notice when it when it goes away as the dollar drops.

Adjustments all around- The challenge for the countries with less undervalued currencies will be to redirect output toward serving their own now-larger domestic demand in order to keep from losing the employment gains made by their export boom.

One paradise lost but the paradise gained is more growth- And that reveals the benefit that the US will get for giving up some purchasing power. As we have documented in previous reports the US economy is now experiencing the second –strongest revival in GDP goods in this recovery compared to any recovery since 1960. The goods sector is flying and the weaker dollar is one reason why.

Weak dollar is no panacea- The services sector is still lagging, however, and since that sector does not compete with overseas workers the weak dollar is doing nothing to make service sector workers seem cheaper. They sell their output to a domestic audience that is fully encapsulated in the domestic economy except to the extent that these workers may toil in a sector that sells increasingly expensive goods that were made abroad. A weak dollar has not encouraged hiring in services.

The marked STUPIDITY of the double-dip thesis - Ironically, all of the time that the US economy has been in recovery the dollar has been off its cycle peak and this has provided an ongoing boost to output that has been completely misread by the US growth pessimists who have continued to harp about the risk of double dip. Meanwhile, the prospect of a double dip has been becoming more remote with each drop in the dollar’s value. More curious has been the assertion that the drop in the dollar (a drop that extends and cements US competitiveness and stimulates exports as it deflects imports and therefore further stimulates domestic output) has in some way enhanced the prospect of a double-dip! This, of course, is lunacy and has the whole process backward/upside down.

Short circuit thinking- The situation of our enduring balance of payments deficits (which are referred to as a big risk to us) and the condition of the dollar’s strength and ‘over-valuation’ are quite clearly linked. They are part of the same process. And people who bemoan deficits but want the dollar to remain strong simply don’t ‘get it.’

China wants to have its egg-foo-yung and eat it too - This is part of the same puzzle in which China threatens to commit the economic paradox because it wants to have its cake and eat it too. China wants the US to mop up its deficits but it wants the yuan to remain undervalued… Huh- how does that work? Doesn’t China ‘know’ that its import penetration of the US market is due to its extremely low prices made possible by an undervalued yuan and enforced by a policy of continuing to bulk up on FX reserves (i.e. dollar buying). That’s why China’s rants are so toothless. China cannot pursue its development (commercial policy) strategy if it makes good on its financial threat to sell or stop buying dollar assets. In the end China is jawboning and trying to confuse the situation buy making the US seem responsible for what has been China’s foreign exchange-commercial policy of using export-led growth driven by persistent currency weakness. Of course, when China buys these dollars it is expanding the stock of yuan in circulation and to the extent it over-buys dollars it also over-stimulates the yuan money stock. That creates inflation. It explains why China has an inflation problem which it’s not the fault of US policy, despite Chinese protestations. The US has warned China for years that this inflation side-effect was coming while China ignored the warnings.

The good, the bad; avoiding the ugly - So as we consider the dropping dollar and what effect it has, compare it to the period of having had a strong reading. I hope that the interested reader can now see why the strong dollar is ‘good’ but also why a ‘too-strong’ dollar is ‘bad’ and how a period with a ‘too-strong’ dollar takes a toll on the US economy and how that process creates stimulus for competitor economies that must eventually be withdrawn. The dollar–valuation and BOP-deficit issues are both part of the same knotty problem; these are not separate issues.

Pot calls Kettle ‘Black’ -- While China usually presents the situation of large US trade deficits as an issue of US ‘over-consumption’ and of insufficient savings, Fed Chairman Bernanke has presented it as evidence of over-savings and insufficient consumption on the part of China and other counties (the Chairman has not singled out China that I am aware, but I will stay with this example). The effect on the US savings rate occurs partly through the relative price effect because as imported goods are made too cheap relative to ‘true value’ that stimulates consumption causing it to become preferable to savings and crowding saving out. Meanwhile, imported capital makes the excess spending possible without causing interest rates to rise as savings fall. And since an overvalued exchange rate creates a temporary condition of goods that are ‘too-cheap’, over-consuming actually makes sense for a while. But at some point all this excess must find equilibrium again. We can’t keep over-consuming and under saving with an overvalued exchange rate and with China and others on the ‘under-side’ of all these measures where we have overages. At some point the chickens come home to roost and macro-economic policies have to be altered. So our current obsession with cutting the fiscal deficit is becoming linked to this exchange rate issue through the fiscal/international deficit linkage which again is being put in a common spotlight.

Strong dollar policy=wrong dollar policy - At the end of the day I like to remind people that in economics linkages are, in some sense, everywhere. Disturb equilibrium in one place and you will create disequilibria ripples in another as markets to try and deal with the original disturbance. We have been in a dysfunctional persistent disequilibrium for some time. Now, as we are in the process of trying to heal the distortions from our past policy mistakes, try to understand the process that is in train. The polemics of the gold standard or of ceaseless pursuit of a ‘strong dollar’ do not do us any good here. What will do us some good is to understand the right policy and to pursue it without the ceaseless threat of how imperiled the economy has become to a double dip. Nothing in fact could be further from the truth. What would jeopardize the US economy would be to pursue a policy of a persistently misaligned exchange rate, like one that is persistently too strong.

Not all equilibriums are created equal - Economists like to have things in equilibrium, not too-strong and not too-weak. But reality is a bit like dieting in that a period of over-eating sometimes has to be followed by a period of under-eating to restore balance. To follow a period of over-eating by a period of balance is only to make the new weight gain permanent. An overvalued dollar creates that same sort of excess; consider the deficit as the undesired ‘weight-gain’ side-effect. Now we need to put the dollar on a diet to solve our deficit bulge. It’s way too soon to talk about equilibrium because one ‘disequilibrium’ breeds another and we may have to stay in this new disequilibrium mode for some time to work off the accumulated debt excess. And, this ‘diet’ will have consequence for other countries and will impact their policies. Some of them already are screaming with pain. But that is part of their process as well. All who have been part of this process will be part of the new solution and its growing pains as well.

The dollar’s true value- some perspective - We can see this point about equilibriums being different in the chart above (contact me if you want to see this chart) . There we define the dollar’s proper value, or its purchasing power parity level (PPP), as the mean of the real trade-weighted dollar index since exchange rates stopped being fixed rates in the early 1970s. The idea here is that while the float has been ‘dirty’ (with exchange market intervention) exchange markets should get the dollar’s value right over time. Although with persistent foreign exchange accumulation there could be an upward bias to where this chart puts dollar parity. Still what is clear is that the the dollar is now is about as far below parity as it has ever been. Also we can see that the dollar gets to be much more overvalued than it gets to be undervalued. Its peak of overvaluation is +35% while its peak of undervaluation is -15%. Because of this the equilibrium calculation for PPP requires that the dollar stay undervalued for a longer period to make up for its shorter periods of extreme overvaluation. If this history is a guide to the future it is suggested that this is GOOD place to buy dollars since the dollar has not in the past eroded faster than its inflation differential when it has been this weak. On the other hand, maybe the dollar will reach a new lower low in the period ahead since the balance of payments misalignments are huge in the world economy. Moreover, this chart is multilateral and it does not address this issue of against which currencies the dollar might fall and against which it might yet rise.

Bernanke Press Conference

What he said…and what he didn’t

The Fed will be pleased with the Bernanke performance at the press conference. He did not send any obvious confused signals. He embellished on the policy notes in the Fed’s policy statement. He clarified that his remarks were meant to reflect the committee and to reflect divisions where they existed. He took responsibility for his own remarks. It was a stand up and professional performance. He made the Fed’s decisions to continue to maintain the size of its portfolio and to complete the QEII process the feature of this presentation. He followed that with a discussion of the Fed’s outlook. Then he took questions.

Stylized facts and the Fed’s stable inflation expectations hypothesis

The Fed’s Q&A went smoothly. But there were some issues of interest. This is always the case at a press conference. A written statement is controlled but in answering questions sometimes an undiscovered truth slips out. For example, the Chairman toed the line on the notion of inflation expectations being stable except for late in the Q&A when he let it slip that inflation expectations had risen somewhat. This of course did not get into the FOMC statement. Such an admission is the hobgoblin of all Fed fears. As pat of the Fed’s written text it would have an explosive impact. But in the flow of the Q&A give-and-take the impact is different. Bernanke admitted this in a context of an answer to a related question; he actually said that expectations are up a little and that the Fed has some limitations in what it can do. So this is something that the Chairman said and at the same he did not say it. He said it in a context that allowed it to slip by, as part of a response to a different question. But like a ticking bomb in an Alfred Hitchcock movie that the audiences sees and no one else is aware of, it is there in the background, ticking away.

What this reveals is that the FOMC statement and minutes are caricatures of the economy or if you prefer a presentation of ‘stylized facts’. The Fed does not portray each variable exactly as it is but in the way that the Fed construes it sort of Alice in Wonderland style ("When I use a word, it means just what I choose it to mean -- neither more nor less." -Humpty Dumpty). So if expectations are a bit elevated but not so much that they are a ‘clear’ problem the Fed may choose to continue to refer to them as subdued or anchored even as the moorings are loosening. The Fed has made it clear that it is not going to be as preemptive as its rhetoric once-sounded. It is willing to see expectations slip a bit because it is relatively more worried about high unemployment. For that reason it will accept the risk that is implied by the up-creep in expectations. On direct questioning Bernanke would never admit this trade off but it is implicit in what he said and the way he responded in the Q&A session. This is precisely the problem with adoption of a dual mandate, it creates dueling mandates and one keeps getting in the way of the other.

The Dollar

The question about the Fed’s role in the decline in the dollar came up; the Chairman deferred, saying that the Treasury Secretary is the spokesman for the dollar. That is correct. Then he added that the Fed was in favor of a strong dollar and a strong economy adding that to strengthen the dollar the Fed was keeping inflation low and acting to strengthen the economy.

The real fact is that the dollar is weak and that is boosting the economy. A weak dollar raises inflation risks as well. But it is true also that the dollar is in some sense not as much weak from the Fed’s actions as it is back to where it was before the financial crisis began. During the crisis a flight-to-quality boosted the dollar’s value then as recovery took place the dollar went back to where it was before the recession’s onset. It does not require any reference to the Fed’s low interest rate policy or to QE to explain it.

Risk management meets spin

It' always 'the same' and 'always different'.

The trick is figure out which is which.

Right now risk and solvency are linked. There are concerns, perhaps as never before that borrowers are not just 'too indebted' and could be forced to reschedule their debt in response not just to some future (unknown) shock but that even in a best case scenario we would see reschedulings for countries like Greece and Portugal and maybe Spain.

...and oddly the Germans are funding the so-called bailout fund that may be more painful to fall into than to miss.

Meanwhile Ireland took on a load of bank debt to save its banks but that bankrupted the whole country. Germany is playing like it is the nice guy in all of this when, in fact, if countries or banks defaulted the result would be swamp German banks with bad debt - and more than they could stand. Germany's bailout fund for Europe is a back-door bailout of German banks that allows German citizens to rail at financial excesses in other European nations instead of storming down the doors of their own banks!

What is so surprising these days is that today’s debtors seem to extract so few concessions from the Germans given the German plight.

Latin American borrowers played the Debt Card in the 1970-s and 1980s with much more aplomb.

As for other types of risk the main issues (to me) seem to be that for a while we thought we had quantitative systems to disperse risk that instead it turned out to concentrated it.

Risk management (identification) systems (like rating agency ratings) failed also

As a result risk today is not greater it is just more of an unknown and is thought to lurk in places where it should not be and that naturally changes the game.

When you are used to having a gun shoot only one way out of its barrel, then it shoots the other way on occasion, it makes the weapon more difficult to use even in your own defense.

Why we keep spinning our wheels

In economics there is always a lot that we do not know. But it is just as dangerous to ignore what you do not know as to let others know what little you do know. Doctors are good at this. We have some of the poorest nutritional guidelines and most doctors buy into them even though they are wrong. But doctors do not brook renegades. Being a doctor is about respect and you get that by staying in line. So in the science of nutrition we have a great stagnation but doctors who are giving bad advice on diet and exercise continue to be revered. Is that a better state of affairs than we have in economics? Maybe not with the except that most people are unaware of it..

In economics this problem of knowledge and credibility manifests itself in two ways. There are the arrogant ‘you’re wrong and I’m right’ economic presentations. And then there are the ne’er do well know-nothings that offer competing forecasts based on odd-ball contrarianism since, hey, even brainy economists don’t know it all- maybe they don’t even know enough (...to make themselves useful).

The lack of a real perceived wisdom in economics has manifested itself in another sort of perversion which is the politicization of economics. Economists have gotten to be like lawyers. They are in fact the expert witnesses of politicians. They are on one side or another and become the talking head du jour for the cause du jour of the politician du jour. Economists like politicians are divided into schools of thought. You know the conclusion of their research before you read their studies. Like politicians you know where economists stand on an issue, before they answer the policy question.

What this has led to is a lot of confusion. We need to get back to economics and to deal fairly with what we know Vs what we THINK WE KNOW and what we NEED to know.

For example, in my view all this warning about double dip in this recovery was very little about anything we knew. The misplaced worry has served to make the recovery weaker. Democrats, not appreciating the extent of the weakness, attacked the problem with half-effective stimulus program that favored spending that benefited its constituents. The President worsened matters by denying it was a recovery from the VERY FIRST DAY because he wanted to rub the Republican’s noses in ‘their’ recession. That kept people for shifting gears into an optimistic mode.

But on closer look it was the Democrat controlled banking committees that oversaw Fannie and Freddie and pushed them to lending standards that set this crisis in motion in the name of ‘broadening home ownership’. Ratings agencies that wanted fees more than than truth did not help. Banks that wanted their fees and played a treacherous game of hot potato with bad credits were another feature as were the clueless foreign investors. Fed Chairman Alan Greenspan contributed to the view that a house was a house and that even with all the new-fangled lending rules their future behavior and stable investment characteristics would remain the same –against all logic.

Wrapping a bow around and slapping a nice label on a septic tank does make it a nice gift for the one you love. Do not go there this Valentine’s Day. Yes we can find many failings to explain the crisis. But don’t excuse those who have opinions for fees on any level. Don’t think for one minute one party was responsible and the other was not. Don’t think that anyone has been focused on what to do to help the RECOVERY be the best possible. It has been about politics and factions and ideology.

Independent thought and opinion is very little sought out on Wall Street- I can attest to that in my own business. Investors want the current spin and to stick with it. The lesson of the last financial crisis is that there is safety in numbers and in size as well as in sophistication even when it isn’t at all safe at all. A good ‘bad business model’ is like a tumor with more tentacles than can be safely removed. The patient must learn to live with it until it becomes too debilitating. That is what derivative mortgage products were.

So if we now try turn our heads to the economy and what is wrong what do we find from the conventional wisdomists? To the extent that there is a consensus it is this: the economy is too slow. It won’t create jobs. We need more growth. Consumers have been sitting on their wallets and so on.

WRONG. Wrong. Wrong.

Here is a fact a FACT that will amaze you. There is a set of data on GDP that segments the economy into goods and services and structures; it does this for the whole economy not just consumer goods. If we take these data and covert them to indices in the various business cycles guess what we find?

Are you ready?

This recovery, yes this weak and feeble recovery, has produced the SECOND strongest PERCENTAGE increase in GDP-goods of any recovery from the 1960 recession’s recovery onward. Only the recovery from the 1981-82 recession was stronger for the goods sector. Yes, the goods sector in the 2007-2009 recession’s recovery has been better than the 1973-75 recession’s expansion. At the six quarter mark this recovery’s net output of goods lags behind the strongest recovery’s goods output by 17% but is ahead of the next best spending and output by 28%. This has been very impressively strong. GROWTH in spending and output HAS NOT BEEN THE PROBLEM. The problem has been the composition of spending and output.

While Republicans and Democrats chew at one another’s ankles like packs of rabid rats, the truth of the expansion and the economy has gone unheeded and the remedy unexplored.

The truth of the expansion and its disappointing nature is this: the expansion from the 2007-2009 recession has seen the greatest weakness in the services sector of any expansion since at least the 1960 recession. Services spending in the sixth quarter of the expansion is up by 1.3% compared to an average of 5% at this time of the expansion for previous cycles and a median gain of 4.6%. Even the two ‘weak’ recoveries from the 2001 and 1990 recessions posted service sector spending gains of 3.2% and 4.2% respectively at this same time of their respective cycles. What are we doing to kill off growth in our jobs producing sector? This question should be on everyone’s lips. It’s not just that we can’t create jobs but that we are killing growth in the sector that creates jobs best.

So the real question should be not why is spending so weak but why is spending on SERVICES so weak? Until we ask that question we will get nowhere. That is THE crucial question since that is the sector where the jobs are- and for now aren’t.

When you spend a dollar on goods its impact on the economy is deflected almost immediately. Economists call this a leakage. There is a leakage of income abroad because some of the goods you buy were made overseas so the payment to some of the factors of production geos to an overseas entity. Thus ‘leakage; out of the US spending stream diminishes the multiplier for domestic expenditure. Moreover, if you buy a good the proportion of the spending that stays here is more substantially due to the efforts of capital than to labor (in comparison with spending on services). There is less in the way of job creation when monies are spent on goods in place of services even looking just at domestic dollars spent. So if jobs are the issue you want monies spent on services where nearly 100 cents on the dollar spent stays here in the US and in a sector where productivity is lower. Lower productivity means that when you expand that sector you naturally create employment. That sector’s growth has been cut short in this cycle.

So that is the problem. Have either Republicans or Democrats offered solutions based on stimulating services-based businesses? NO. But since services business are land-bound the increased focus on property taxes and mandatory medical coverage (remember these are people intensive businesses) have hurt the services sector relatively more. A manufacturer can locate a plant overseas to avoid these costs or a firm can outsource some production but services cannot do this because they tend to be point-of-delivery operations.

I am against the FORM of this medical ‘reform.’ If heath care is important and if it is construed as a modern ‘right’ then it must be provided and paid for... But why saddle employers with that cost when employers use labor unequally? Doesn’t anyone recognize that when you tie costs to labor it makes labor relatively more expensive and firms will opt away from that added cost? This division in the growth between the two key economic sectors (goods VS services) is all the proof we need that making labor more expensive is a really crappy idea.

When we look at the role of healthcare ‘reform’ on labor costs remember that the program did not save us any money it will cost us money. It pushed more responsibilities on to businesses. Legislation should NOT be permitted to legislate its own cost estimates as this bill did and tie the hands of analysts at the CBO. There are some things we do know about economics and when we do our analysis we should reference those things rather than being prohibited from using them.

When we take on this idea of adversely impacting growth it opens a real can of worms. One added thing that may never be changed is the idea of taxing income. But let’s begin to challenge the idea that taxing income is good or even fair. In a study offered up in early 2009 the folly of income is clearly revealed (see links below).

These studies show that to live the life style of a $123,000-a-year middle class person in Manhattan you need only make $50,000 if you live in Houston Texas…Houston I think we have a problem, to quote Tom Hanks (in Apollo-13 out of context, of course)… or $63,400 if you are from Chicago (Mr Obama), or $72,772 if you are in Boston (Mr Frank)...even living in Queens NY cuts your cost to $85,918 compared to being in Manhattan.

If this is true what are graduated income taxes all about? The regional differences in the cost of living explain a great deal of the variation in incomes. So why treat a guy in Houston at $50K as struggling and guy in Manhattan at $125K as rich?

And what is rich?

Oddly, ‘rich’ is a stock concept and ‘income’ is a flow concept but to get at the rich someone decided to attack income. Interestingly many of the people who make high incomes this year are not the same as the ones who made it the last year. There is a great deal of turnover in the high income ranks- not the upper-upper tiers - but in the space between middle class and ‘THE Rich’ where ’affluence’ comes in varying shades of gray. That’s yet another reason not to tax high incomes. Let the poor guy who makes a high income for one year in five keep more of it.

There is also the need for tax reform for a lot of small businesses that are not incorporated and whose owners apply the individual tax rate. Their treatment should be different under the tax laws than that of the investment banker who is an employee and earns big bucks but who employs no labor. When you hike taxes on the small businessman that does directly go to his bottom line and affect his hiring decision. May of these small businessmen log incomes that count them as ‘rich’ when, in fact, they employ a lot of capital and labor in order to earn their pay.

On balance I hope I have used this space to OPEN SOME EYES. This is not about being a Republican or a Democrat. I dislike both parties. I have been a member of each of these parties at different times in the past. I think John Adams was right and we should not have used them. But now that we have THEY OWN US. The US political system is a duopoly (with some respect to the Tea Party) and it acts like it.

We need to look at what we have become and how this has affected what we are and our economy is. We need to look at it through the clear lens of analysis not from the perspective of a partisan. Banks that everyone claimed were responsible for the financial crisis have recovered first, have gotten the most government help and have restored their bonus pools to what they were in the days of olde. How can that be? Yet people still tell me it will be years before banks are willing to lend freely again because of all the damage done to them in the recession and financial crisis… how is that? Are those low interest rates just feeding banker bonus pools?

What have we created? Why is our political system so little for the people? Why are so many elected representatives millionaires? Why is there no clear analysis brought forth on what the problem is? Why to our elected officials go to Washington only so they can get elected again instead of to enact reforms? Why do we elect such gutless self-centered wonders that they will not look at the facts of an over generous unaffordable Social Security system and deal with how to make it solvent again?

It is not true that we ‘cannot solve our problems’. It is because our leaders will not face them that we do not even address them. They will not admit we have them because if they did they would have to fix them. And if they did than we, the electorate, would get angry and we would not re-elect them. So there it is. It all comes back to us and for whom we vote. And I don’t think it is as simple as elect a Democrat or elect and Republican or to dis-elect an incumbent. It’s much more complicated than that. And as voters we need to figure it out.

Soon.

End for now

New Fed voters- Do they matter?

Sometimes we make too much of the changing of the guard at the Fed. All Fed members are available and contribute to the discussion at all the meetings. But when it comes time to vote only the eligible voters have their say.

It is sometimes easier to be a vocal critic on the sidelines than to be a voter who must cast a public ballot. Moreover, when you know others may dissent that may make one a bit more reluctant to cast a vote in dissent because we know that having one dissenter is not an issue at the Fed but having more than one is much more so an issue. One dissent happens and can be written off to someone being eccentric, hard-headed or doctrinaire. But having two dissents is more of an issue, and hints at a schism. Having three dissents is an indication of severe divisions within the Fed. After all if three dissent how many more may had disagreed but not crossed that line? Were any other dissenters placated to not cross the line? Three is bad number. AND seeing three dissents this year is a possibility…not a certainty but it’s possible. Zero also is possible, but not likely.

Still, for all this talk about dissent and possible dissenters, there seems to be little chance that Bernanke will wind up voting as part of the minority any time soon. In a big picture sense there is a lot of worry about ‘nothing.’ A dissenting vote does not by itself do anything to the Fed or the Chairman’s ability to pursue the policy he desires... unless having a dissent or two …or more bothers him.

A dissenting vote may not even be a sign that the Fed is split in a way that impedes its ability to act. There are some functions that are reserved for the Board of Governors and are not for the FOMC. Since Bernanke has much more agreement and backing on the Board the potential for dissent, which comes mostly from new voting district bank presidents, does not have the same ability to disrupt Fed policy for those decisions that are relegated to the Board (for example, deciding to accept or reject discount rate change requests from the district banks – that is Board decision not an FOMC decision). Decisions at the Fed are by majority - period. The minority dissenting members on the FOMC get to issue separate statements about their dissent and sometimes that can be a bit ‘embarrassing’ but it does not impact policy directly.

The board members include two economists and four others with banking, legal, regulatory or Wall Street experience. Bernanke and Yellen are the economists. For the most part Yellen is identified with liberal causes and is expected to be a supportive of the Fed’s path for continued accommodation. The other board members are not monetary policy specialists and are unlikely to have strong views on the subtle macroeconomic arguments du jour. They are most likely to support the Chairman and his judgment.

Among the district bank presidents we have more economists and more with ideology. Bullard, Pianalto, Ronsengren and Hoenig cycle off the vote. Evans, Plosser, Fisher and Kocherlakota cycle on. All except Fisher are economists. Of the new voters Plosser and Evans are conservative and their economic views characterized as ‘monetarist.’ Fisher has a financial markets background and is less ideological in that sense but he is a ‘hard money’ guy. Kocherlakota has moved over from academics and had written or said things that sounded somewhat divisive with respect to the Fed’s current policy tact; but he has since has said rather pointedly that it is his desire to more or less fit in suggesting that he is not intending to make his point via hard-nosed ideology and dissent.

That raises another issue. Evans who taught at the U of Chicago is a clear conservative monetarist; nonetheless he took the most extreme ‘dove’ position on the Fed (not as a voter as he did not vote , but in his public speeches). He positioned himself to the ‘left of’ Bernanke calling for a raised inflation target ‘for a time’. I nonetheless label him a doctrinaire monetarist given his background. Yet, he found compelling evidence for the Fed to push for more accommodation. Indeed, Bullard who had voted in the last round, was in favor of using the Fed balance sheet as a policy instrument (surrogate monetary base measure) and to apply a sort of monetarist approach to tis size in a novel way. His idea would have provided protection on the upside if the economy began to perform. Bullard, also a monetarist, found a way to support the Chairman although he wanted somewhat more of a framework around policy than just an ongoing ‘easy money’ bent. Therefore as an assenting monetarist, Evans does not stand alone. His stance is unusual but so are the times. As a voter it is unlikely he will turn this view on dime- even on an inflated one. But he does have a framework that could change his vote if the economy were to shift gears fast enough and shift the risks. His stand comes from an ideology that interacts with his perception of the economy’s position – and the economy’s position can change.

Beyond the rhetoric of dissent, the real question is of Bernanke and how much consensus he will seek. One thing dissenters have is the ability to bargain a vote in dissent for some change in language in the Fed’s statement. If there are enough dissenters the Fed Chairman may prefer to try and alter the Fed’s language rather than to risk more ‘widespread’ dissent and the appearance of there being a schism which could cost the Fed ‘something’ in terms of market reaction to its polices.

For now Plosser and Fisher emerge as the most likely to take up the mantle of Hoenig as dissenter. Whether there is one dissent or more than one remains to be seen. If the risks in the economy shift to more growth and less inflation slippage Evans could be pulled out of the dove camp. But it will take some time for him to undergo that transformation. Kocherlakota will remain an enigma until we see how he settles in and if he can find a space of influence as part of the discussion. As we mentioned at the start all members are contributors to the discussion. But if the Chairman is interested in avoiding dissent he will have to listen more closely to those who vote than to those who do not. In the event that Kocherlakota’s views harden or that he thinks the committee is not taking his side of the argument to heart he is a potential candidate to go the way the way and to dissent eventually, though he does not come in with a chip on his shoulder.

More broadly it is the economy that will decide policy. There is already a good deal of debate on how quickly the Fed might actually shift gears. For the moment, Bernanke is full bore on completing the Fed’s Q-easing program. For that program to have full impact this is the right posture for him. But should the economy gain momentum, should job gains begin to look more solid, should the flirtation with deflation (really, with disinflation) take a turn the other way, various changes in view could be put into play.

We have a malleable Fed, at least at the district bank level. The Board seems to be more devoted to the Chairman with the possible exception of Yellen, although time will tell on that one. It would be ‘awkward’ for the chairman and vice-chair to disagree; we say it happen when Paul Volcker was Chairman but he eventually was dealt with a BOARD by the president himself that would disagree with him. Volcker had district bank presidents that supported him and that combination proved to be his undoing. Bernanke is on more solid ground with what seems to be full board support – at least for now.

I could see events beginning to shift votes or to harden dissents if policy did not shift quickly enough as the economy did. I still don’t’ see the economy or risks turning fast enough for the Chairman to lose the support of the Board. That is to me one of the least likely developments for 2011.

Bernanke remains in control. But how much dissent he gets and how he chooses to deal with it are still issues that remain clouded they are the exact pins on which the Fed’s actual policy pronouncements will turn.

Debit ceiling. help me from myself!

Bubble, bubble toil and shovel - The US has -when push has come to shove - shoveled money at its problems. When democrats and republicans are at loggerheads they come up with pile of cash and divide it between their respective interests and distribute it among their faithful followers and let the balance ride in the capital markets. So the US rolled tax cuts forward and it extended unemployment insurance WITHOUT any pledge to get its house in order in the future as 2010 came to close. There was no money to do this, of course, so it all comes out of the capital markets and now we have some oddballs who deign to call themselves conservatives arguing that they will hold the debt ceiling hike ‘hostage’ to some future pledge and action to curtail spending. Oh God, please save me from myself!

Stupid is what stupid does - You can’t do that with the debt ceiling. The plan for future fiscal reform is a good idea, one that is well overdue. Tying it to a debt ceiling hike is a disastrously bad idea. Debt ceiling legislation is STUPID. How does not paying our bills count as a conservative fiscal strategy?

Debt ceiling! The debt ceiling legislation is nothing but an opportunity for grandstanding; for those who have overspend to suddenly sound like they have religion, like a quit-smoker who would lecture current smokers then sneak out for a puff or two on the sly. Congress acts like somebody else agreed to all that spending that requires the ceiling to go up. No, one else agreed to it; Congress itself did it. Congress is acting like it’s bi-polar instead of in bi-partisan denial. You can’t spend then not agree to finance your efforts! Moreover, fooling with the debt ceiling is playing with fire. It is a juvenile act to try to threaten anyone with it. Such threats are the economic equivalent of threatening nuclear war. It’s the one threat you don’t dare follow through. Yet once it’s made it may get people to thinking and wondering… The electorate should take names and remember anyone that joins this movement to use the debt ceiling for political gain. Such people cannot be trusted to hold office.

Thinking about needed reforms... 2011

A new song by the 'Supremes'

My world is emptier because of you, babe...

Chief Justice John Roberts was critical of the partisan warfare that has slowed the appointment of federal judges to a crawl in the Chief Justice's annual report. Chief Justice Roberts writing in his year-end report Friday said that political gamesmanship on Capitol Hill has left some courts burdened with "extraordinary caseloads."

"Each political party has found it easy to turn on a dime from decrying to defending the blocking of judicial nominations, depending on their changing political fortunes," the chief justice wrote. He called on Congress and the president "to find a long-term solution to this recurring problem."

According to the WSJ, the Senate confirmed 19 judicial nominees in December, making a total of 62 since Mr. Obama took office, including Supreme Court Justices Sonia Sotomayor and Elena Kagan. At the same point in Mr. Bush's presidency, the Senate had confirmed 100 judicial nominees.

Not an isolated case: I will continue to point out that this partisanship is ruining the nation. each party has put its own goals ahead those of the responsibility of national stewardship that should take precedence for office-holders.

Below I shall argue that the electoral college and various state-level election requirements have concentrated political power in the hands of the two parties. With this concentration it has been made easier for large corporations to influence policy and harder for third parties to gain a toe hold. Moreover, it has emboldened the parties and their members because of their increased power. We need to take action to return the power to the people or these economic crises will become an enduring feature of a financial system that effectively controls those who supervise the regulators.

Third party efforts are futile - The best example in 'recent' years is Ross Perot. Perot once garnered 39% of the vote in the pre-election polls; eventually he amassed under 20% in the actual election as defectors from his cause probably realized the futility of the effort and chose to 'spend' their votes in ways that would 'matter.' Even with nearly 20% of the actual vote Perot accumulated zero electoral votes. Zero. Nearly twenty percent of the country voted for him and that desire was not reflected in balloting for the presidency. Perot finished a close second in electoral votes in two states. No one cried foul. It's no wonder in more recent times mayor of NYC Bloomberg pushed for term extensions in NYC to extend his stay in office there rather than mount the third-party push for the presidency some urged him to try. Earlier, Al Gore thought he was 'robbed' when he garnered the bulk of the popular vote and did not get elected president. By comparison Perot got nearly 20% and was shut out of the electoral vote-getting completely. Gore should have seen the handwriting on the wall. Gore lost a few percentage points, in the transition from 'popular' to 'electoral' Ross Perot loss one-fifth. One fifth? Hey I'll drink to that...

Partisanship Prevails - The step up in partisanship seems to go back to the view that Al Gore had the presidency stolen from him. Shortly after that election, although the press has not reported it widely, the Bush administration still was having many appointments blocked by democrats when the World Trade Center was destroyed. The White House was at that time operating with many unconfirmed functionaries in place because democrats had blocked their approval. Many of these were for administration officials with security responsibilities. Democrats still were holding up new appointees- not so much court appointees, but cabinet level and other appointees, out of anger over the election results. National security was compromised by partisan bickering. Did it contribute to the 9-11 security lapse? Well, it sure did not help tighten things up.

We should not assume that this sort of aggressive partisan behavior whether undertaken by republicans or democrats is not harmful to the nation. Nor should the old senatorial 'rights' be honored any more. Quite the opposite is true. Having an understaffed security operation and having an understaffed judicial system contribute to lowering the standard of justice, reducing the standard of living and providing a lessening degree security and of freedom for all. There are many other instances of this sort of perversion of our nation's interests performed in the name of partisanship. They include the blocking of Fed appointees ahead of the financial crisis so that the Fed was operating short-handed.

The electoral college flunks the test of time - In 2011 we should push to null and void the electoral college to reduce the strangle hold the two parties have on the country. With only two parties to appease, the two party system also is easier for corporate interests to meddle with in order to control economic outcomes. The electoral college promotes the consolidation of power in the two party system.

There are many reasons to seek to abolish the electoral college. But the college and its distance from democracy was an intended act enshrined in the Constitution itself. It seems to be part of an arrangement that took for granted the rivalries among the original 13-colonies and anticipated divisions lasting into nationhood requiring more experienced hands to choose the president and vice president. One would think with so much better information and with the greater modern emphasis on democracy in America the quaint and distrustful system could be converted to a true democratic effort. The electoral college system was meant to set up the election of officials to be decided in the House of Representatives in what was expected to be the likely event of an indecisive college vote. In doing that that it further entrenched the political parties that were formed and whose own rivalries eventually supplanted the rivalries among states.

John Adams decried the formation of political parties but they were embraced by his rival, the much revered Thomas Jefferson. Adams a patriot, a man of extraordinary character, and a wise man of the first order could see the entanglements from this sort of approach. Jefferson, for all his brilliance, seemed to enjoy the game of politicking more than he feared its backlash. The electoral college provisions subsequently adopted, dovetailed with the partisan approach to entrench the party-system's hold on power.

To wrap our democratic voting process in the mantel of the electoral college is to enshrine the two party system. It's a bit like taking perfectly good mortgages, splitting them into pieces then reissuing them as derivative securities- as though they still are the same things. Such a security may itself be made up of components that are sound but the way they are packaged together changes their properties enormously, as we now know. Similarly, our actual election of the president is not direct but is a derivative of a democratic process, and one that gets substantially subverted before the power of the vote is played out. This is much like in a derivative security. The rationale for the 'college' is based on a phenomenon that does not have much basis in the facts of the modern economy.

Two party system but no fun - In my short lifetime and limited experience (since I do not dabble in politics) I have been the direct victim of the various rules which entrench the two-party system - and so are many of you and perhaps you do not recognize it.

Growing up in Michigan, I became of voting age and assumed that Michigan's methodology for voting was the same as for the rest of the country. I found out in time that such is not true. The methods of voting are left to the states and are a states's rights issue- quite unfortunately. In Michigan I could vote during primary season, walk into the voting booth and vote in EITHER primary but just in one - no cherry-picking; no ticket splitting.

Once I moved to NY, I found that although my tax dollars still paid for the election bills, I was prohibited from the voting booth in the primary season unless I was a partisan. How about that? I pay for it but I am prohibited from using it UNLESS I am a registered something? That sharp slap in the face led me to become a registered voter for the first time in my life at about age 28. Since being in NY I have been a registered democrat and then a registered republican. I found both experiences quite distasteful. I have not been a registered anything for many years now and I am disenfranchised for it.

Why should I have to be register to vote in the primary? If the primary is 'owned' by the party, why doesn't it pay for its execution and planning? Why are public-owned spaces used as a venue? Why do the two parties hold primaries on the same day if these elections are private events?

Especially in this era of strained government finances we need to weed out practices that make no sense and drain the public coffers. Why is the public footing the bill for these partisan activities? Why doesn't the state sponsor elections for the plumber's unions and the UAW as well? Who else might the state want to- or be forced to - pick up the tab for it, even if elections are not open to all based on the current precedent of 'sponsoring' partisan elections?

Isn't this really just taxation without representation? It surely is.

Making the parties responsible for organizing and paying for their primaries makes sense, if THEY own the primaries. If they don't, precluding our participation is an obstruction of freedom and our right to vote. If you think about it, the original electoral college was made to select a president using various insiders instead of using the popular vote. The current system still has that wedge in it but with a stronger link to a democratic solution. Even so it imposes another road-block by making sure that only partisans in 'good standing' can vote to propose the candidates for the general election thereby limiting the choice of the masses to these pre-screened candidates.

However, if we view primaries as the nation's property and if the primary elections are open to all then we can justify paying for them.

Getting rid of the electoral college is a separate matter but with the same intent. The rules of that 'college' all but assure that one of two parties will control the national election. Getting rid of it would be another way to open up politics and reduce the grip of the two-parties that has become a cloying reality.

and...there seems to be less honesty, even when caught red-handed -- There is much less willingness to be a 'stand up guy' in the modern economy. With anonymity on the rise in economic transactions of all sorts and the spread of business on the internet, the credo of 'know your customer' has become less applicable. This is true in politics as well and in the dissemination of political funds. In the choice among doing what is ethical, what is legal or, what you can get away with, too often people are choosing what's behind door number three. This is yet another reason to get the political process back to a more open clear democratic foundation.

With increasing anonymity there is more and more opportunity to do things behind the cloak of door number three. So any action taken to undermine the political duopoly and to short circuit the potential for conspiratorial behavior that structure invites would be a step in the right direction.

Red flag for democracy - Getting the electoral college 'wedge' out of the political process would be a great thing. it could have a major impact on American politics. Maybe ten or twenty years ago this idea would not have seemed as compelling. But no longer can we look at the political system in the US and argue that it is justified by the results and the candidates that it produces. The results have not been good. The sheer volume of monies spent for election are a simple and straight forward red flag to honesty. Can anyone really believe that corporations 'donate' so much money to the political process and expect to get nothing in return? Are we supposed to suspend 'the laws of economics' for political analysis?

Once elected, politicians are far too prone to spending our money and running up the national debt. In the financial crises we saw how political objectives aimed at various constituencies fostered mis-guided policies then led to a bailout of the participating entities that had contributed mightily to the elections of members of the various financial committees in the House and Senate and beyond.

We can see European countries careening into a quagmire of debt. We do have the ability to change this for the US economy and to stop that from happening here. But collusion among the parties is easier with only two in the game; and the more they collude the more they spend. We can increase our choice among parties and complicate political bargaining by eliminating the strangle hold these two parties have under the current system. In part the argument here is for change and for restoring power to the people. The argument also is made to help illuminate the impact of the consolidation of power that occurs when your political system is a duopoly. We need to get people to think about the consequences that flow from our political system. The repeated financial crises we see are no accidents, no coincidences. Are we going to take responsibility or sit back and let it all happen again?

If anti-trust policies could be applied to politics these parties with their high concentration ratios would have been smashed under anti-trust laws long ago. If concentration is bad in economics, why is is it good in politics, where huge sums of monies are at stake? Why do government policies throw up barriers to entry in terms of the local voting requirements and electoral college selection process? Why are new political parties effectively blocked? Why is that tolerable?

These are points to consider as we enter 2011 and have a chance to think about a fresh start.

Let's work to abolish the electoral college as a start, and to reform election laws to increase participation and see where that leads us. We are badly in need of reform. At some point the lax enforcement of rules the poor regulation and the inability of the political system to control corporate America must be seen as a failing. How else can we view the inability to effectively regulate banks after all that went wrong in the financial crisis? If this is not failure of policies what is it? It is long overdue for us to remind our elected officials that they work for us and not the other way around. Parties, if they are to persevere, need to discipline their members for bad behavior or the legislative bodies themselves need to step it up. The role of monies in the election process is in need of a complete overhaul. The problems are many; they are linked to a clear erosion of values. Do we want to stop it?