Ev Ehrlich's Everyday Economics

What’s next?

                The debate over whether to do something as simple as extending unemployment insurance highlight the current economic policy impasse.  The recovery we’ve experienced to date has been tepid and disappointing, and there is no agreement on the way out of these woods, let alone whether  the actions  we’ve taken to date worked.  So, in order to answer the question of “what’s next?,” it’s best to start with the question “what happened?”

                Which reminds me of this story.  I’m walking down 35^th Avenue in Jackson Heights, 1963 or ’64, I figure.  A woman in a Rambler heading west suddenly hits the brakes, and the bus behind her plows into the rear of her car.  The bus driver dismounts his bus, and a second bus pulls up behind him.  The second bus driver also alights and hollers to the first, “I saw the whole thing, man.  What happened?” 

                Well, I saw the whole thing, and here’s what happened.  In a nutshell, the Obama program of 2009 worked, and almost worked, in two different senses.  And, as a result, the Obama Administration needs to do more.

                The first sense, the one in which it worked, is that it averted a calamity.  A new paper by former Fed Vice-Chairman Alan Blinder and Moody’s chief economist Mark Zandi is all the rage this week and puts numbers on the magnitude of the disaster we avoided.   It estimates that GDP in 2010 is fully 11.5 percent higher than it would have been, and unemployment roughly 6.5 percent lower, than if we had done absolutely nothing.  Yes, that’s right -- they estimate the unemployment rate would have reached 16.5 percent by the end of this year in the absence of the two policy responses – fiscal stimulus on an unprecedented scale, and a wholesale bail out of the financial system.  And, much to my agreement, they conclude that most of these effects were obtained not by fiscal policy – by stimulating the economy through tax cuts and spending increases – but through financial policy -- wholesale recapitalization of the financial system, in essence, a substitution of public promises (after all, debt, like love, is little more than a promise) for private ones.  It could have been prettier, but it worked.

                I find these numbers entirely believable, but I suspect that the reactions to the Blinder/Zandi paper will parallel my own – however rigorous their work (likely) is (we’ll know about the details of their modeling effort as the discussion about it develops), humans don’t do dissonance well and very few economists accept results that contradict their world view. 

                Some critics of Blinder/Zandi, for example,  will probably argue that markets would have found a way to wire around the dead spots in the financial system, and that their model is hopelessly unable to depict those kinds of counterfactual developments.  (Go back to my June 3 entry, in which I note economist Casey Mulligan’s belief that university endowments and pension funds would step into the role that financial institutions play, that of matching up savers and investors.  I wonder if he still believes something that stupid.  Can you imagine a university endowment with a trading desk?  Harvard's Trust Fund lost...what?  $12 billion out of 3o-something?  They stopped serving hot breakfast in the studnet cafeterias, no lie.  And that's Harvard, where the smart guys are.)   

                 But I confess to being no better when push comes to shove.  My non-surprise over someone showing massive intervention was needed to bring the economy back from the precipice is rooted in my view of markets.  Believing in markets is not an either-or proposition, like being pregnant or left-handed.  You need to have an idea about where they’re strong and weak.  The constant rebalancing performed by markets is a remarkable thing, but markets alone rarely solve economic problems.  You solve an economic problem – like the ones left behind at the end of 2008 – by intervening to create conditions that subsequently allow markets to make adjustments and fill in the details, much as a doctor uses the body’s natural proclivity to heal itself to bring it improve its health.  When the economy is in some semblance of balance and stability, markets are a good way to keep it there.  But just as the body’s instinct for healing and regeneration doesn’t set broken bones or excise necrotic tissue, there are moment in the economy’s development when order and stability must to be restored so that markets have a framework within which to what they do well – coordinate uncountable numbers of individual judgments.  As Earl Weaver used to say (but not here), “always give the ball player a job he can do.”  Asking markets to fix a financial crash or a massively underemployed economy is not a job they can do.   Would the economy be one ninth smaller today, with an unemployment rate of one-in-six, if we’d tried to do that?  The numbers are so large as to be staggering, but the situation that confronted us was staggering as well. 

                The second sense of my opening statement – the one in which the Obama economic policy hasn’t worked – is that the economy hasn’t resumed “normal” growth, that is, growth that reflects the economy’s long-term trend plus a little extra for the usual up-thrust you see at this point in the cycle.  Back on January 30, I opined that it would, that “jobs are on the way.”  I was wrong – jobs have not materialized in significant numbers.  The reason, I think, is that in the Spring the Eurozone crisis emerged, which knocked the props out from under emerging confidence on the part of businesses and, on the rebound, many households.   It’s like the usual scene in disaster movies, somewhere about 75 minutes into the feature, when disaster appears to be averted but then, suddenly, the second shoe drops.

                Yes, this explanation has the quality of the remark that my one-time boss, Unisys Chairman Mike Blumenthal, made to me when paying off a bet on what the dollar-yen exchange rate would be by a certain day – “I was right,” he said as he handed me one of his Dunhill cigars (the terms of the bet), “it’s only a matter of when.”   I’m essentially saying the same gratuitous  thing, but I stand by it.  Absent the second shoe of Europe, we would have been at least much further, and perhaps substantially, down the path to recovery.

                One item of good news is that many of the preconditions to recovery are in place.  In that sense, the situation today reminds me of where we were in the Spring of 2009, but with regard to the stock market.  The market was then at very low levels, and fear was in the air – the DJIA was slightly over 8,000 when the President took office, and was at 6,600 six weeks later.  But it struck me – and having confessed to when I was wrong, I can now talk about when I was right – that earnings and underlying corporate values were strong and that there were immense amounts of cash cowering on the sidelines.  All that was needed was the assurance that there was going to be a program to revive the banking system and stop the financial madness.  The Administration’s announcement of the TARP program gave the idle cash the jolt it needed to enter the market and bring the DJIA to its current trading range in the low 10,000s by the end of the year.  Besides, as I told a friend (at a Mets game that April), if Citigroup isn’t worth more than a dollar a share, I’ll be using my money to build a fire in a cave, so I might as well buy the stock.  It was a rare moment when I was living five minutes in the future.

                The economy is at a similar juncture.  As I said six months ago, the economy in 2008-09 threw more people out of work than it had to, and there’s now a fairly broad consensus that companies are running incredibly lean.  Job loss is no longer the problem.  Firms aren’t hiring more out of uncertainty than because their people are idle. 

                There’s also a line of argument that the Administration’s anti-business instincts are leading companies to defer their hiring.  There have been occasional moments that would give me some pause if I ran a business larger than ESC Company – the darker side of insurance reform, specifically, more employer mandates (even if it’s far from a “government takeover of the health care system,” a statement that will support a clinical diagnosis of hopeless ideological baggage) or the senseless prospect of regulating broadband infrastructure providers.  But the Administration’s intervention to save the financial system, or to stimulate the economy, or to stabilize the auto industry is not why businesses are not hiring today.  That mischaracterizes those actions – there’s a big difference between short term acts designed to avert disaster and socializing the means of production.  Moreover, it’s a pretty foolish view if Blinder and Zandi are remotely right.

                The problem today is that, as in the Spring of 2009, there is too much cash cowering on the sidelines – this time in our banks and firms.  The corporate sector now has $1.8 trillion on its balance sheets, up by a quarter from two years ago.  This means that almost half a trillion has been drained from the economy in those two years – over a three percent of the economy.  Meanwhile, the total loans and leases held by commercial banks peaked at $7.3 trillion in October of 2008 and fell to $6.5 trillion by March, 2009.  It’s made up about half of that loss since then, but there’s still plenty of cash sitting around waiting to be leant.  Bank non-borrowed reserves, which traditionally have varied between nothing and next to nothing (meaning less than $50 billion), now total over a trillion dollars as well.

                The presence of all this idle cash in both the financial and non-financial sectors is an unmistakable sign that we’re not at the point when we can trust the natural healing forces of markets to bring us back to health.  To be sure, there is no active laissez-faire campaign in the debate today – it takes a special kind of free-market braggadocio to say “we’ve done our jobs, time to go home” when the unemployment and foreclosure rates are as high as they are.

                But, instead, the anti-intervention argument has taken two new forms.  The first is the Palin/Beck characterization of the Administration’s socialist bent.  (I’ll bet the people most irritated by that argument are the real socialists!)  The second, and more pressing, is that we can’t afford it – that we’re about to reach the point at which we undermine faith in our government’s ability to repay what it borrows.  Some smart people think so.   But perhaps the idea that further stimulus in the economy is the problem – which means that we will have to hand its rebound over to the natural healing forces of markets -- was best expressed by a car that passed us on I-270 this weekend.  Written in its back window – and I mean, all across the window, like a swim meet pep sign, in a way that obscured the driver’s rear vision – was the epithet MORE JOBS!!  LESS GOVERNMENT SPENDING!!  I credit the driver with finding a sensational new medium for expressing his policy preferences, but, at least in the short term, he just as readily could have written LOSE WEIGHT!! MORE CHOCOLATE CAKE!! and made just as much sense.

                A contraction of government spending at this moment would lead to further unemployment – that‘s a certainty.  But whether more government spending would create more jobs is less certain, or at least a question over which reasonable people differ.  I think the answer is surely more yes than no, but that relying on simple stimulus alone won’t work.

                Stimulus shows up on the agenda because the economy has low levels of demand.  So the standard view is that you use stimulus to restore that demand.  I’ll agree insofar as it’s foolhardy to cut back on spending at such a moment.  The problem is that this prescription is too mechanical.  It as if the answer to the question “why is demand so weak?” was “because we haven’t stimulated the economy enough.”  But the best way to stimulate the economy right now is to give both non-financial and financial firms the confidence, the incentive, the motivation – all these words are appropriate – to part with the cash they’ve accumulated.

                Which means that there’s still an important role for further intervention to get the economy back to growth.  I can imagine a series of steps that would be helpful.  One is another round of revenue sharing to states and large localities, to offset the contractionary effects of spending cutbacks at that level.  A second is an extension of the exemption on employers’ share of Social Security taxes through 2012.  A third is an expansion of the Earned Income Tax Credit, putting more income into the hands of the working poor and de facto raising paychecks.  (I could even imagine deferring some part of the tax increases on higher-income Americans found in the Obama plan if it helped us move forward.)

               And a fourth is a true program of public investment – of “shovel worthy” as opposed to just “shovel ready” projects – a multi-year commitment to the nation’s infrastructure that also includes a program to improve the energy-efficiency of public buildings (most importantly schools) and housing.  The last item seems like a complete no-brainer to me.  It’s an investment that produces some tangible return and creates a range of jobs – from skilled trades to unskilled labor – in precisely those neighborhoods where jobs are most likely needed most.  A large and multi-year program would be a good idea for several reasons.  For one, if intelligently administered, it would fund worthwhile projects.  But it would also avoid the mistake made in the 2009 program, the sense that the projects to be funded had to be ready right away, as if the crisis was going to go away and we’d miss it if we didn’t act right now.  Now we know better.

                 These policies all serve to revive the demand for goods and services, and therefore for labor.  But their effect on the trillions of idle money in the economy today is at best indirect.  Perhaps they will do enough to resolve the uncertainty that now obstructs lending, investment, and employment.  But we should also be prepared to act against these problems.  One way to do so would be to have the Fed purchase packages of commercial bank loans to small and medium size businesses, on the proviso that the originating banks take a meaningful first exposure to loss.  In essence, the program would pay (bribe) banks into making good loans, but not bad ones.

                We can afford this kind of program.  The challenge of the car on I-270 is misplaced.  For all the talk about a “sovereign debt bubble,” the U.S. isn’t Greece.   The cost of borrowing – the so-called “credit spread” -- to European governments with big deficit problems has risen dramatically, alongside markets’ perceptions of the risk that they will one day renege on their promise to pay.  (And, in the case of Greece, I think they’re right.)  But we’re not Greece.  Our cost of borrowing is incredibly low – the ten-year Treasury bond now yields 3 percent.  That’s a sign that we’re not yet testing the bounds of market tolerance.  Moreover, as I’ve discussed before, perhaps the greatest long-term economic risk we face today is deflation – the prospects of prices continuously falling.  That will make it easier to borrow for the long term.  It also makes a further expansion of the supply of credit – like the small business loan swap I proposed above – an appropriate credit policy instrument.

                 And that goes to the best way to put the trillions in unspent cash in the economy to work – borrow it and spend it.  That’s essentially where it’s going now – companies and banks are buying safe government securities with it.  When they decide instead to use it for investment, they’ll stop giving it to us.  When they do, it will be time to unwind the borrowing and bring the budget back into balance.  That’s going to be a very difficult thing to do, particularly insofar as most of the people who carp the loudest about the deficit have no plan to close it, save Paul Ryan.  But the fact that it will be hard to fix the nation’s fiscal imbalance doesn’t mean that we need to suffer through slow growth and sustained high unemployment now.  Who knows? – maybe the add impetus to close the deficit will lead to good changes – a value-added consumption tax, means-tested entitlements, a tilt towards investment over consumption in the federal budget.  We have the wherewithal to do more – markets are telling us that.  Taking action today has a cost down the line, but it’s a cost worth paying.