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Comments on the Economy of the United States

Prof. Peter Morici - 9/26/2011

1. Courting another Recession

Stocks are dropping like stones tossed into a summer lake, and the economy dances along the precipice of a second recession.

The U.S. economy is imploding thanks to incompetence in Washington and arrogance on Wall Street. President Obama is hardly the victim of his predecessor’s mistakes as much as his own decisions.

The Great Recession was caused by an imbalance of demand between the United States and Western Europe, on the one hand, and China and other Asian economies, on the other. The latter maintain rigged and undervalued currencies—essentially, those restrict conversion of their currencies into dollars and regularly purchase U.S. dollars to keep their currencies and exports cheap in western markets. They also impose all manner of high tariffs and restrictions on western exports into their markets.

During the Bush years, the U.S. trade deficit more than doubled to 5 percent of GDP—thanks to growing imports from China and expensive oil. When dollars earned by producing goods in the United States go abroad to purchase imports but do not return to purchase exports, either inventories build and layoffs result, or Americans must consume more than they produce.

During the final years of the Bush expansion, Americans consumed on a grand scale. Led by China, Asian and Middle East exporters purchased U.S. securities with dollars from their trade surpluses, and New York bankers happily recycled those into creative mortgages that pushed U.S. real estate to unsustainable values. The bankers profited grandly selling mortgage backed securities to foreign and U.S. investors they knew would fail.

For a time, the proceeds from churning property and second mortgages permitted Americans to use their homes as ATMs and consume much more than they produced. In a nutshell that permitted a $700 billion trade imbalance and full employment—the economic equivalent of a perpetual motion machine.

When the house of cards collapsed, the Great Recession resulted. Until oil and trade policy are fixed and the banks made to serve the public purpose and shareholders, as opposed to the interest of traders and senior management, the U.S. economy can’t recover.

President Obama has done just about everything in his power to make matters worse.

He has dramatically slowed development of U.S. oil and gas development at a time when China, rich with dollars from currency market intervention, is driving up the price of all commodities. He has failed to “do business” with Chinese mercantilism. The trade deficit continues to pull down domestic demand, but this time there is no housing boom

He has left the worst perpetrators of the financial crisis, New York bankers, safe in their perches—trading away and contributing to candidates sympathetic to the status quo. Those have found new outlets for their energy and no longer want to make bad loans and sell securities backed by those to unwitting investors.

New York banks enjoy, too much, recycling and trading all those Asian and Middle East dollars, and the big paydays that result, to support real changes in our trade, energy and banking policies. With the support of the Wall Street Journal, bankers are trying desperately to finance either the election of another President sympathetic to their views or the reelection of Mr. Obama. Consider the Journal’s recent pillory of Mr. Romney for advocating realistic trade policies toward China.

And so it goes, the Fed vainly tries to resuscitate a failing U.S. economy but until we get a President who will drill for oil, tax the conversion of dollars into yuan to offset Beijing’s currency market intervention, and split commercial banking from other financial activities on Wall Street, we are simply not getting out of this mess.

2. Operation Twist in the Wind – Don’t Expect Much from Fed’s Effort to Spur Economy

Seeking to boost housing and jumpstart the flagging economy, the Federal Reserve will push down mortgage rates a bit by purchasing $400 billion in long term Treasury securities.

Operation Twist will likely raise short rates even as it lowers long rates, because the Fed will sell Treasuries with maturities of less than 3 years to purchase an equal amount of Treasuries with maturities from 6 to 30 years. Those purchases will be undertaken gradually and completed by the end June 2012

Lowering mortgage rates a bit may help, but it won’t have the salutary effect on home purchases needed to raise real estate prices and get consumers, whose balance sheets remain weak and have lost confidence in President Obama and Congress, to start spending again.

Americans are not suffering from an inability to make things but rather insufficient demand for what the U.S. economy can make.

Fiscal policy is played out—with a federal deficit of about $1.5 trillion additional, borrowing to increase government spending, or cutting in one place to spend in another as the President advocates, will not do much good.

The real problem is the annual $600 billion trade deficit—simply too many consumer dollars go abroad to purchase oil and Chinese consumer goods, thanks to lousy energy policies and China’s artificially undervalued currency, than return to purchase U.S. exports—American made goods and services. President Obama and his Treasury and Energy Secretaries, though well aware of these problems, simply won’t act.

Too little demand equals too few jobs, and not enough buyers to raise home prices by clearing out the excess supply on the market—both foreclosed houses offered by banks and others offered by owners with good reason to change residence.

Without higher housing prices, consumers are too indebted to spend as they did before the Great Recession, and unemployment languishes at 9 percent—and counting part-time workers who would prefer full-time jobs, discouraged adults who have quit looking, and underemployed recent graduates, the figure is closer to 20 percent.

Mortgage rates are already at historic lows—and pushing those down a bit more won’t change the logic of the housing market.

No job and no income, or lousy job and no raise, equals weak demand for houses, and flat or falling prices.

Ultimately, without action by the Treasury on exchange rates and the White House and Energy Department on oil and gas policy, the U.S. economy is not going to move.

Mr. Bernanke, at times, has mentioned the consequences of China’s currency for U.S. recovery—as has the President—but the rules of the game in Washington prohibit him from further commenting on exchange rates, because that is the domain of the Treasury.

No one in the Administration is permitted to comment on the fallacy of shutting down domestic oil and gas production to bank on electric cars, which won’t adequately dent oil import costs for the balance of this decade. Mr. Bernanke is not inclined to take what might be viewed as a partisan position on energy policy.

Further, inflation is heating up—more because China, flush with dollars from sales of yuan to keep its value low, is driving up global commodity prices, than anything the Fed has done. Nevertheless, Operation Twist will attract more Republican criticism that it is causing inflation to creep up.

Monetary policy can’t do much in the current environment, and to avoid damaging the credibility of the Fed, Mr. Bernanke would have done better by sitting on his hands.

3. Fed Might Do Better to Sit on Its Hands

This afternoon the Fed meets to discuss options to jumpstart a moribund U.S. economy. It doesn’t have any attractive options, because leadership from the White House, Treasury and Energy Departments is needed to get the economy going.

Neither operation twist to further lower long terms rates nor statements of greater clarity about its future of Fed policies will do much good.

The U.S. economy is not suffering from an inability to make things but rather insufficient demand for what it could make. Fiscal policy is played out—with a federal deficit of about $1.5 trillion additional borrowing to spend more, or cutting in one place to spend in another as the President advocates, will not do much good.

The real problem is the trade deficit—too many dollars go abroad to pay for imported oil and Chinese consumer goods thanks to lousy energy policies and China’s artificially undervalued currency. The present occupant of the Oval Office and his Treasury and Energy Secretaries, though well aware of these problems, simply won’t act.

Too little demand equals too few jobs, and not enough buyers to raise home prices by clearing out the excess supply on the market—both foreclosed houses offered by banks and others offered by owners with good reason to change residence—simply can’t attract enough qualified buyers .

The Fed is considering operation twist—selling short-term securities on its balance sheet and to purchase longer-term Treasuries, and drive down long-term Treasury and mortgage rates.

Mortgage rates are already at historic lows—and pushing those closer to zero won’t change the logic of the housing market.

No job, no income, or lousy job and no raise, equals weak demand for houses, and flat or falling prices.

The Fed has already indicated it intends to keep interest rates low until mid-2013, and that is about all it can say with certainty.

Ultimately, without action by the Fed on exchange rates and the White House and Energy Department on oil and gas policy, the U.S. economy is not going to move.

Mr. Bernanke at times has mentioned the consequences of China’s currency for U.S. recovery—as has the President—but the rules of the playground in Washington prohibit him from further commenting on exchange rates, because that is the domain of the Treasury.

No one in the Administration is permitted to comment on the fallacy of shutting down domestic oil and gas production to bank on electric cars, which won’t adequately dent oil import costs for the balance of this decade. Mr. Bernanke is not inclined to take what might be viewed as a partisan position on energy policy.

Further, inflation is heating up—more because China, flush with dollars from sales of yuan to keep its value low, is driving up global commodity prices, than anything the Fed has done. Nevertheless, further Fed action will attract more Republican criticism that it is causing inflation to creep up.

Monetary policy can’t do much in the current environment, and to avoid damaging the credibility of the Fed, Mr. Bernanke might do better to sit on his hands.

4. Jobs, Deficits and the Reelection of Barack Obama

President Obama faces three daunting challenges—jobs, deficits and reelection. His actions reveal he places a second term ahead of fixing the economy and federal finances.

If Mr. Obama runs on the economy—he loses. Too many voters are unemployed, underemployed, standing discouraged on the sidelines, or watching their paychecks dwindle for Mr. Obama to win. And most voters recognize, had President Obama’s economic policies permitted the economy to grow as it should, deficits in Washington and state capitals would be much more manageable.

If he runs on handling the financial crisis—he loses. He inherited a mess, but trillions in bailouts for Wall Street, Chrysler and GM rewarded the best paid white collar and blue collar workers for lousy management and worse, while the other 98 percent watch their paychecks shrink in value. Now charges of fraud in his solar energy program and revelations about White House management dysfunction cast a president lacking judgment and leadership qualities.

On both jobs and the deficit, the President seeks to present a sharp contrast with his eventual GOP rival premised on “fairness”—presenting himself as guardian of the working family, and his prospective Republican opponents as champions of privilege.

An additional $447,000,000 in stimulus and tax cuts, over two years, if spent smartly, could create about 2.5 million jobs for that period. However, he proposes paying for teachers by cutting aid to states for health care workers and that won’t create many jobs. Extending the payroll tax holiday for the middle class by taxing those who earn over $200,000 only adds marginally to new spending and few jobs.

Much of what the President wants to do is already in place but about to expire—for example, state aid for teachers, extended unemployment benefits and a significant share of the payroll tax holiday.

The taxes he wants—jacking up rates on high income individuals—would discourage hiring by many smaller businesses like machine shops and restaurants, whose owners already face marginal rates near 60 percent, counting state taxes. The temporary hiring incentives the President proposes, history indicates will be of little benefit.

An infrastructure bank—financed by permitting corporations with profits parked off shore to deposit those in the bank and not pay taxes until withdrawn—is a worthy proposal, but only a small part of what the President wants.

Overall, the economy may gain half a point of GDP and 350,000 jobs, but most of those would vanish after two years.

Republicans see this and won’t pass nearly all of his spending, because they won’t succumb to his foolish funding proposals. However, the President will get the opportunity to paint them as protectors of the privileged at a time of national peril. That smells of demagoguery to me.

And so it goes with deficit reduction. On taxes, the President is quite specific in that he wants families over $250,000 to pay Clinton era tax rates, and give up exemptions for charitable contributions and home mortgages, pay punitive taxes on investments ranging up to 65 percent, and pillory oil companies and small aircraft manufacturers. Yet, he is vague about what revisions he will accept in Social Security, Medicare, Medicaid and other social programs—he wants Congress to do the heavy lifting on those.

All this permits him to say it’s not fair to ask seniors to pay more for health care but not to ask the wealthiest of Americans to pay more taxes—the country can’t afford not to do both.

Mr. President, I can help you find the money to cut the budget and avoid job-killing tax increases.

In 2007, with two wars at full tilt and the Bush tax cuts and prescription benefits for seniors in place, the deficit was only $161 billion—an embarrassing fact to Democrats who blame deficits on George Bush’s tax cuts and spending.

The Democrats took over Congress that year, and since then government spending is up $1.1 trillion but inflation should have only required $200 billion.

Speaker Boehner should simply give the President a list of where the additional $900 billion went—increases in the regulatory bureaucracy and government pay, increased Medicaid and Medicare benefits, and crony spending on solar energy schemes, electric rail from nowhere to no place, and other fanciful industrial policies. Then the President can choose the one half of the additional spending he wants to keep, and he can pick which payoffs to campaign workers, bogus enterprises, and wealthy Democratic contributors he would like to nix.

That would save $450 billion a year—much more than the President’s deficit reduction package would accomplish. It would permit Americans to see where his values lie.

Instead the President proposes to raise taxes on the rich, and the Republicans cry class warfare, even though polls show that plays right into his hand. Voters love class warfare, as long as their class wins.

The Republicans need to change the terms of the debate—give the President genuine choices for cutting spending—and take the dialogue back where it belongs—getting the private sector growing to create jobs.

5. Why Gold Is So High and President Obama So Low

Since President Obama took office, the price of gold has more than doubled to about $1800 an ounce, and public approval of his handling of the economy has more than halved. These are much connected events.

During the 1980s and 1990s, thanks to new technologies and market deregulation by Presidents Carter, Reagan, Bush, and Clinton, the U.S. economy enjoyed a renaissance—falling inflation, stable growth, low unemployment, and decent returns on stocks and bonds.

“Sound as a dollar” took new meaning as central banks around the world sold off gold holdings and increasingly backed their currencies with greenbacks. The dominance of the dollar, in part, inspired Europeans to create a rival currency—the euro.

Holding gold makes less sense when the U.S. economy is doing well and confidence in the rule of law ensures that investors will get solid returns on portfolio investments. After all, gold is costly to hold, and it pays no dividends or interest.

In 2000, the U.S. federal budget surplus was $236 billion, the S&P 500 index hit its inflation adjusted peak at 1520, and gold sold for $280 an ounce.

Since, King Dollar has been shattered by Presidents George W. Bush and Barack Obama. Thanks to big deficits, the world is now awash in dollars and Treasury securities, which function much the same as cash in international finance and commerce. The U.S. economy—overwhelmed by subsidized imports from China, bleeding to pay for expensive foreign oil, and hamstrung by intrusive and often counterproductive new government regulations—can’t grow.

By 2007, the year before the financial crisis and Democrats took control of Congress, George W. Bush’s free spending on agricultural subsidies, military adventures, prescription coverage for seniors, and tax cuts turned Clinton’s surplus into a $161 billion deficit.

Enter Nancy Pelosi and then Barack Obama, and government spending exploded from less than 20 percent of GDP to nearly 26 percent. Increases in the regulatory bureaucracy and government pay, new Medicaid and Medicare entitlements, and crony spending on fraudulent solar energy schemes, bailouts for Chrysler and GM and similar follies push up federal spending by $1.1 trillion in four years. Inflation would have required only $200 billion.

Meanwhile, after nearly two years of economic recovery, real GDP is stuck at 2007 levels, family incomes are falling and the ranks of the unemployed and poor swell every month.

The President doesn’t grasp the magnitude of the structural problems holding down real growth. He refuses to develop domestic oil and gas and genuinely confront Chinese mercantilism. He refuses to address business concerns about overregulation and a generally hostile environment to private enterprise.

In the name of lowering costs, Obama Care mandates the scope of coverage businesses must offer employees, but insurance premiums, drug prices and co-pays are rising at an alarming pace. Mr. Obama simply ignores this failure.

In the Chrysler bankruptcy, the Administration managed to pressure a federal judge to subvert 100 years of bankruptcy law to award company assets, which should have been distributed to creditors, to the UAW and an Italian automaker.

In yet another payment to organized labor for campaign support, the National Labor Relations Board—stuffed with recess appointments—sued Boeing for opening a factory in South Carolina. Now, the President will decide which states are permitted new manufacturing jobs.

He can’t persuade Congress to put a limit on CO2 emissions, so he proposes to curb those by administrative fiat. He punishes the entire oil industry for the sins of one rouge company.

Overreach is so intrusive that it borders on expropriation.
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U.S. companies are investing in China for good reason. Beijing likes capitalism and aspires to global leadership, things Barack Obama appears to distain. And for all their complaints about intellectual property enforcement in China, U.S. investors may enjoy greater security under the law in the Middle Kingdom than in the Middle West.

Over the next several years, GDP growth will likely be no more than 2 percent, perhaps less, and given the paltry targets set for the congressional super committee on budget deficits, the federal spending gap will likely exceed $1 trillion for many more years and social security likely will be broke within two decades.

All that money and U.S. bonds, which function much like money, will eventually drive up inflation. With bonds paying little interest and stocks going no place in the current atmosphere of fear, many investors go where fear always takes them—into Gold!

As the President campaigns around the country for his economic policies, even some liberal Democrats are pushing back. He finds fewer supporters to pay for $457 billion in additional temporary stimulus spending with permanent tax increases and cuts in aid to states to pay for health care.

Gold is high and Mr. Obama’s approval ratings are low, because investors and voters see the economy failing and an American President who cannot learn from his mistakes.

6. Perry Is Right: Social Security is a Ponzi Scheme

When established in 1935, Social Security made its first payments to Americans age 65. These first recipients never contributed and were paid from contributions made by younger Americans. Those Americans and successive generations believed their contributions were investments, and that they would be paid at retirement by the earnings on those investments.

In fact, those younger Americans were paid by the contributions of successive generations of “investors,” as the federal government spent their money to help finance operating deficits. With the ratio of retirees to contributors rising, the Trust Fund will run out of money by 2036, if not sooner.

Such a scheme could only continue if the working age population grew more rapidly than the number of retirees, but it hasn’t because Americans live longer and the birth rate has declined.

President Obama’s claims notwithstanding, Social Security is now a growing burden on federal finances, as the difference between the Trust Fund’s income and what it pays out grows each year. As we approach 2036, either payments will have to be dramatically curtailed, or the government will have to shutdown, on a massive basis, other activities.

Either, Social Security fails, or the United States fails.

In a Ponzi Scheme, first investors, through a mechanism like a chain letter, are paid immediate returns by monies collected from subsequent investors, who are in turn paid by other investors who follow them in time.

Social Security did not even ask the first recipients to put up a dollar, and by any reasonable reading of the definition of a Ponzi Scheme, Social Security qualifies for that appellation.

Social Security can work as long as it finds more and more workers to support the growing number of retirees but it can’t, because the system encourages folks, who once relied on their children and savings to help them through old age, to have fewer children. And by its nature, reduces incentives for savings and investment, thereby slowing economic growth and making it more difficult for each successive generation to support the elderly.

Governor Perry is right to call Social Security for what it is, but he is wrong to think going to a privately funded system—Americans’ contributions would be invested in stocks and bonds—is the answer.

Not enough money could be invested on behalf of young contributors, because the government would still have the burden of paying off the present and next generation of retirees, and so not enough of young folks’ money could be invested for their old age. The government would still have to provide a subsidy.

Second, in the end, there is no getting around the fact that folks above a certain age can’t work, and that some of what is made by the economy—think of it as a slice of a big pie—must be transferred from working age folks to support them. Whether done by the government or through investments, a public vs. a private system only defines how the claim of old folks is defined.

Third, individual investors are not particularly good at managing money, and guaranteeing investors a minimum return, as Congressman Paul Ryan proposed, is just a backdoor to the present poorly run system. Moreover, the U.S. stock market has not returned a dime to investors for more than a decade, and interest on bonds and savings accounts are too low to make the system work.

Fourth, most ordinary Americans are already too heavily taxed by falling real incomes, and ever more acquisitive federal and state governments, to invest enough additional dollars that a truly private system, not guaranteed by the government, would require.

In the end, the only way to make the system work is to ask Americans to work longer—frustrate investors’ expectations for future returns, much like a Ponzi Scheme.

If Governors Perry and Romney want to fix the system, instead of arguing over terminology, they must address the retirement age. It simply must be raised to something close to 70—no exceptions but for the truly disabled.

Americans won’t like that but it beats what President Obama is offering. Characteristic to his thinking on economics, he prefers to believe what his liberal ideology, not the facts, require—and incorrectly insist the system is solvent.

Social Security, by the findings of Mr. Obama’s own Social Security Administration, is insolvent and hence a Ponzi Scheme. Americans would be better served by hearing the truth if they are to have some dignity in retirement.

7. When Will President Obama Put Americans’ Jobs ahead of His Own?

As President Obama campaigns for more government spending—a.k.a. his jobs plan—new unemployment claims provide fresh evidence the economy is stalling and in danger of slipping into a second recession. Big government could easily take unemployment above 15 percent and create a hole too big to ascend.

New jobless claims for the week of September 10 rose to 428,000, up from 412,000 the previous week. Having slipped below 400,000 last spring, these are trending upward. Generally, weekly jobless claims below 350,000 are associated with a healthy economy and above 450,000 with recession. Recent data indicates the economy is at the precipice of a second Great Recession—perhaps worse.

Recent data on car sales and broader retail sales, personal consumption and consumer attitudes indicates Americans are scared. Other than high income folks in the luxury category, a general lack of confidence in the President to adequately get the U.S. economy going is becoming a self fulfilling prophecy of economic decline.

Bad leadership equals bad outcomes.

Household incomes have sunk to their lowest levels since 2007, and the number of Americans living in poverty is rising.

Unemployment is up, even as the economy has managed a modest recovery since Mr. Obama became president. The Labor Department reported no jobs were added in August. Mass layoffs have been announced at major financial houses and banks, pharmaceutical manufacturers, and telecommunications companies. We will have yet to see the impact of those in jobless claims and monthly unemployment reports.

Finance, drugs and telecom are at the core of U.S. competitiveness and recent growth, and with those announcing layoffs a recession can’t be far away.

President Obama wants an additional $447 billion in new stimulus spending, but skeptical voters should ask: How can more $447 billion solve a problem stimulus twice that size failed to fix? How does more spending fit into long terms goals to cut the deficit?

The President responds with tax increases and asks Congress to cut spending in other areas—he is disinclined to do any cutting himself. How can extending the payroll tax holiday for the middle class have much impact if paid for with new taxes on wealthy? Both spend money, and taking from Reginald to pay Rachel is more designed to buy votes than create jobs.

And so it goes, Mr. Obama proposes to send money to the states to keep teachers and educational bureaucrats on the payrolls but wants Congress to cut funds sent to the states to employ hospital staff.

One thoughtful proposal is an Infrastructure Bank. It would let U.S. multinationals remit profits parked abroad, tax deferred, if invested in a fund to finance roads, schools and other construction projects, but we need many more of those kinds of ideas to harness private capital and business development.

If President Obama wants to create jobs he needs to stop telling us more government is the answer—government spending and publically financed health care are just about the only sectors that have grown on his watch and those are bankrupting the country.

If the President wants to create jobs he must tackle the structural issues—beginning with the nation’s sagging infrastructure by unharnessing private capital, However, he must also let oil and gas companies develop domestic reserves instead of the government investing in fraudulent solar energy companies, tackle the trade deficit with China that is destroying millions of American jobs, and finally address rising health care costs and the equity positions of underwater homeowners.

All that is heavy lifting and much less personally uplifting for a President down in the polls, than is campaigning to soak the rich and bludgeon oil companies.

Yet, it might revive confidence in government and the economy if the President really acted to create jobs for all Americans instead of stumping to merely save his own.