View From Down Under

The Republicans are painting Obama as being soft on terror, or having a blind spot when it comes to the war on terror.  Once again, the right wing is dismissing facts in favor of surprisingly effective rhetoric.

First, the facts.  The Obama administration has reached out to other countries, particularly Muslim countries, in a way that previous administrations have not.  He has already visited Egypt, Saudi Arabia, and Turkey.  He will be visiting the world’s largest Muslim country, Indonesia, in March.

These trips are part of a concerted effort to change America’s image abroad, and Obama has been extremely successful at this.  He has restored America’s soft power (for which he received the Nobel Peace Prize).  Perceptions of the US around the world have been enormously improved, particularly in Islamic countries.

The policy of the United States living up to its own values by stopping torture and closing Guantanamo, strongly supported by General Petraeus and other high ranking officers, has been instrumental in this change in perceptions.

Iraq is starting to stabilize, largely due to the surge and other strategies implemented by Robert Gates.  The December 09 quarter saw the lowest US casualty rate of any quarter since the war began in 2003.

Pakistan has been aggressive in pursuing the Taliban within its tribal areas.  With Pakistanis viewing the US more favorably, the Pakistani government is able to take these kinds of initiatives.

In 2009, more Al Qaeda fighters and senior leaders have been killed than in 2008. 

Largely as a result of these efforts, Al Qaeda and fellow organizations have increasingly turned to attacking Muslim civilians.  As these attacks continue, and the perception of the US improves, the number of Muslims supporting Al Qaeda continues to plummet.

As Peter Beinart put it recently:  In countries like Pakistan and Jordan, where al Qaeda keeps slaughtering innocent Muslims, its public support has fallen off a cliff. During the Bush years, the only thing that kept al Qaeda from complete ideological collapse was Muslim hatred of America’s wars in Iraq and Afghanistan, our unblinking support for Muslim dictatorships and for Israel, and our use of torture at places like Abu Ghraib and Guantánamo Bay. Now Obama, by pledging to withdraw U.S. troops from Iraq and close Gitmo, and by eschewing torture … is cutting al Qaeda’s throat.

In short, the US is much closer to winning the war against Al Qaeda now than when Obama took office. 

But apparently, the Republicans would rather have tough talk and less progress.

Popularity: 6% [?]

With the President’s budget last week, he seems to have succumbed to the pressure to cut spending now.  This is bad policy.

Unlike Dick Cheney (at least when he was VP) I do understand that deficits matter.  In the long term, the US needs to reign in its spending and try to have at least balanced budgets.

But not now.  The country is barely starting to recover from a debilitating recession.  US unemployment is still staggeringly high.  The President and Congress should be discussing further stimulus focused on job creation, not arguing over what job creating programs to cut. 

Cutting government spending now risks derailing the recovery.  Nothing I’ve seen in the data suggests a double dip recession, but a concerted push to reduce government spending could be the game changer.  When FDR reduced the deficit in 1937 and 1938, it sent the economy into another devastating tailspin and prolonged the depression.

Does the deficit matter?  Of course it does.  Should the long term goal be a balanced budget?  Absolutely.  But “for everything there is a season…”

A responsible government should run surpluses in good years, and be prepared to move into deficits when economic cycles turn.  Unfortunately, the US has not been a responsible government for some time.  The last budget surplus was Clinton’s final budget in 2000.  Before Clinton’s four balanced budgets, you have to go back to Johnson’s final budget in 1969 to find surplus.  Kennedy, Nixon, Ford, Carter, Reagan, George HW Bush, and George W Bush never had a balanced budget.  Not one.  Johnson managed one. 

Trying to cut government spending is decidedly hard.  There is no apparent political gain from a balanced budget, and no apparent political pain from deficit spending.  (This, BTW, was what Cheney was referring to when he said deficits don’t matter.)  So getting Congress to reduce spending when there is nothing in it for them is near impossible.  Add to this the fact that most of the budget is untouchable, and it is a terribly difficult task.

Ultimately, the best the US can realistically hope for is some long term concerted efforts to control spending until the economy grows enough to make the debt less relevant.  I am not optimistic about this.

But clearly trying to address the deficit now risks sabotaging the recovery.

Popularity: 19% [?]

The Commerce Department released their latest figures on GDP last week – up 5.7% in the fourth quarter.  Big contributors were inventory additions (3.4%) and personal expenditures (1.4%).

Most economists I’ve read suggest we treat this with caution because of the high contribution from inventory growth, which is clearly not sustainable.  As true as this cautionary note is, the numbers are also full of upbeat results.

Personal expenditures are up.  This is in spite of a drop of 0.57% in motor vehicles (against a strong third quarter boosted by Cash for Clunkers).  Clothing and footwear spending is up for the first time in six quarters.

Overall fixed private investment is up for the first time in ten quarters.  You have to go all way back to June 07 to find the last up quarter in private investment.  This has been driven by growth in equipment and software.

Government spending was down 0.2% during the quarter as the stimulus spending stopped growing.  We should expect this to continue to decline as the stimulus plays out.  Remember the GDP numbers measure change quarter to quarter, not absolute level of spend, so as the stimulus spend starts to slow the impact on GDP growth will be negative.

The last bit of good news is that I think this number is likely to be revised up in the next month.  After getting the last one so wrong (initial announcement of 3.5% growth with a revised number of 2.2%), the BEA analysts have likely taken a very conservative view on their estimates this time.

The economy has not “recovered”, and there is a long way to go before the 7 million people who lost their jobs will be back at work.  But I continue to doubt the double dip thesis, and remain bullish on the prospects for the US economy in 2010.

Popularity: 27% [?]

Back in November, I wrote that the recession was over – though it may not feel like it.

This week, the Conference Board released their data on leading indicators.  The index was up again in December, and has “risen steadily for for nine consecutive months.”  Here’s the chart:

The Coincident index has been rising as well, up for five of the last six months.  Building permits, stock prices, consumer expectations, business capital expenditure, industrial production, manufacturing sales – all up.

Interestingly, consumer confidence is lagging, and consumer assessment of the economy is decidedly bad.

A recent Gallup poll shows how pessimistic consumers are on the economic situation.  Asked the open-ended question “Just your best guess, how long do you think it will be before the US economy starts to recover?”  Remember that, from an economist’s perspective, recovery probably began in July/August last year.  Here’s the results:

Fully 85% of the people surveyed expected it would be one year or more before the economy starts to recover.  About half the survey expect it will be three years or more.  Put another way, half of the population thinks the US will be in recession for at least another two years.

Now, it’s possible (in fact, highly likely) that the average consumer’s definition of recovery is different to economic definitions, and the survey respondents are actually answering a different question.  They may think it will be two years before the economy is back to where it was in 2007 (which is also historically pessimistic).  Psychologically, the last 18-24 months experience is much more relevant to most people than experience prior to that.  Recent experience is still felt emotionally while more distant experience is only a memory.

Clearly, to most Americans, it does not feel like the recession is over.  And there are some highly acclaimed economists who are concerned about a ‘double dip’.  But with leading indicators climbing that dramatically, and the rest of the world pulling out of recession as well, a double dip looks less and less likely.

Popularity: 57% [?]

A great friend of mine is not only quite well travelled, but also an extraordinary wordsmith.  While on a recent trip to France, she wrote this:

Having decided not to move here, I moved on in my head to attempting to describe all the countries I’ve been to in a few words.

…

America is brazenly self-confident, often irritatingly cheerful, and utterly naive in a very aggressive way. It carries within itself the full knowledge of its own superiority, as well as a creeping fear that this brings horrible dangers. It’s deeply caring and sympathetic, but lacks empathy for cultures incongruous with its own. In many ways, it is a 19 year old, charging around the world full of passion and idealism while doing everything it can to fill its room with as much stuff as it can fit in there. It covers itself in self-confidence like cheap cologne, and all the while doubt that maybe not everything can be fixed is eating at its insides.

…

Australia is young too, but it’s a rougher kind of young than America. Similar creation stories at similar times, but Australia is so much less idealistic than America. Our creation story has no Independence War, or Civil War or Thanksgiving myth. We made for ourselves myths and heroes out of Ned Kelly and the jolly swagman rather than Washington and Lincoln. Our heroes are people subverting the world around them simply to survive, America’s heroes are idealists who took radical action to make their ideals reality, and subverted reality for a “higher purpose”. America grew a nation out of a rich land, a land of brown loam and mountains, bountiful prairies and huge forests. Australia grew out of red dirt that was dead long before we got there, and forests of gum trees too crooked to build with.

We’re (Australians) a broad, rough, honest people. Irreverent and coarse, blunt and loud. Cynical without bitterness, sarcastic without meanness. Practical with a “that’ll-do” approach to that which we don’t think is that important. A hard creation myth that makes us feel as though we’ve weathered something, a weird cultural love of ‘larrikinism’ and a mass buying into of the myth of ‘mateship’. But buying into those myths makes them real in their outworking, so there’s a kind of glowing pride associated with surviving in a mostly dead country, and a love for the underdog, and a feeling of responsibility to each other as long as you’re ‘mates’. We have a fascination for other places, but never lose sight of our own personal sense of superiority. We’re young but like to think we’re old, and pretend to be less idealistic than we are or want to be. As wonderful as it is to not have to respect something simply because everyone else does, it is sad that we find it hard to respect anything at all. Irreverence as a habit isn’t always the best policy.

Very honest and perceptive descriptions, in my opinion.  Maybe some day, I’ll be able to write that well.

Popularity: 54% [?]

The Labor department released its December employment situation update yesterday.   Non farm payroll down slightly (85,000).  Unemployment rate remained steady, as a result of people dropping out of the job market.

In the last two US recessions, unemployment has lagged economic recovery by much more than previous recessions.  From an article by Mark Thoma in November comes this interesting graph:

The delay in unemployment reduction led both the last two recoveries to be labelled jobless recoveries.  I believe this one will be as well.

Improvement in technology has changed the way much work is performed.  However, most companies do not lay off employees when they improve their systems and processes.  Instead, they tend to either redeploy them or fail to completely capture the benefit of the upgrades.  During a recession, companies are forced to reduce staff.  Often they find that there is the ability to stretch productivity during this time, and as the economy recovers they manage to keep pace with the recovery with a smaller staff.  This process has accelerated since the 1981-82 recession, and I believe is one of the key reasons for the jobless recoveries (although there are other reasons also).

The view from down under is not as pessimistic as many economists (including many much more qualified and eloquent than I), but the prospects for major reductions in unemployment before the mid term elections next November looks grim.

Popularity: 60% [?]

2009 was clearly the year of stimulus.  Governments around the world responded to the financial crisis with very strong fiscal and monetary stimulus programs.  The year also validated stimulus as an effective method of helping economies out of a recession.  This was true in Australia, China, much of Europe, and even the US (although the US stimulus was relatively light and the impact less pronounced).

All of the world’s economies are likely now out of technical recession – with the possible exception of Iceland and one or two others.  However, that does not mean the world’s economies are out of danger.  The possibility of slipping back into negative GDP territory is still real – as was demonstrated when Singapore shrank 6.8% in the fourth quarter vs growth of 14.9% in the third.

The big challenge for 2010 will be how to unwind the stimulus programs without pushing the economy back into recession.  Nobel prize winning economist (and self confessed liberal) Paul Krugman believes the likelihood that the US gets this wrong is “better than even”.  Other economists are also concerned that low underlying growth and withdrawal of stimulus will cause a double dip recession.

There are some lessons from other countries’ efforts to unwind their stimulus.  Australia, which had the mildest recession of any OECD country, has already raised interest rates three times and their fiscal stimulus programs are largely finished.  Stimulus programs included reducing interest rates (by 4% from September 08 to February 09) and cash handouts to low and middle income families in October and December 2008.  Reducing interest rates has a bigger impact in Australia than the US because about 80% of Australian households have variable rate mortgages.  As you can see below, the impact on retail sales was pronounced, spiking as the cash payments were received.  However, since April and the withdrawal of stimulus, retail sales have been slightly negative overall.  (Fortunately, Australian GDP does not depend entirely on retail sales, but it is a major component.)

Clearly the removal of all stimulus for the US economy now would cause the economy to slip back into recession.  That won’t happen, but there is a likelihood that without further stimulus the economy will still falter.  Personally I am more bullish about the odds than Mr Krugman, but the Fed and Congress need to manage the process carefully and some further fiscal stimulus may well be appropriate.

With a bit of luck, the year of stimulus will be followed by year of the gradual unwind.

Popularity: 71% [?]

When I defend the various economic stimulus programs used to fight the latest recession, the typical response from my right wing friends is that government is not the answer to our problems.  The private sector is always better at producing cost effective outcomes, and the less government interference there is, the better.

This is the common understanding of supply side economics.  Lower taxes and less regulation equals higher output, higher government revenue, and better living for all.*

But are the two incompatible?  Does a belief in supply side mean you have to believe the stimulus packages actually made things worse?

The data on economic stimulus is quite clear.  Most economists agree that the US stimulus package has kept the recession from being much worse than it was  – the only argument is by how much.

Recessions are often associated (at their front end) with financial crises and flight from risk.  During good times, investors typically take more risks than they understand (chasing last year’s gains).  They buy equity in highly leveraged businesses which themselves own risky assets (CMOs, Russian bonds, dotcom startups), and often use margin loans to do it.  When things start to unwind, investors flee risky assets.  The resulting collapse in asset values creates uncertainty among both businesses and consumers, who pull back on their own spending and investment plans.  As a result, GDP contracts and recession ensues.

The appropriate government response is to buy risky assets to provide liquidity to the system and prevent financial meltdown (TARP), and to stimulate demand through a combination of lower interest rates and direct government spending  (stimulus).  The 1930s taught us what happens when you do something else.  The fact that the first part of these programs was agreed by President Bush, Barack Obama, and John McCain testifies to the logic.

Only the government is in a position to provide liquidity and stimulus in times of recession.  Not only is it appropriate for the government to do so, it is imperative.

This does not mean government is the answer to everything, or that government should try to ‘micro-manage’ demand over the cycles.  As Bob McTeer, former President of the Federal Reserve Bank of Dallas, writes:  “I don’t get why we can’t be supply-siders in normal times and yet accept that Keynes is relevant for depressions and deep recessions.  Both supply and demand are important.  Why must each side ridicule the other?”

The data I’ve seen supports this view.  In general, less government intervention is better (in economic terms), but there are times when government intervention is appropriate.  I believe government intervention is appropriate where externalities are not properly priced (pollution control); where free riders thwart effective outcomes – otherwise known as ‘public goods’ (fire fighting, street lights, health care); and when economic cycles turn down.  In other (much more eloquent) words:  to establish justice, insure domestic tranquillity, and promote the general welfare.

*This is not actually my understanding of supply side economics.  My understanding of the Laffer curve is that lower taxes only equals higher government revenue if marginal tax rates are greater than t*.  The reduced income tax receipts after the Bush tax cuts suggest the US is somewhere below t*.

Popularity: 96% [?]

The Senate finally passed a health care bill.  Next step is reconciliation with the House bill, but given the vote in the Senate (60-39) and the fact that the Senate is no longer majority rule but requires 60 votes to pass legislation, the final bill is likely to look very much like the Senate bill.  It’s also looking quite likely that a health care bill will be passed before Easter.

The bills have been watered down with compromises so much that much of the real reform the President wanted has been lost.  However, there is some substantial insurance reform: Extending coverage to millions of uninsured; restrictions on denying coverage; etc.

Perhaps the more important reforms longer term are the efforts in the Senate bill to control costs with provisions like pilot programs and bundled payments, and authorising the HHS secretary to implement reforms that will reduce costs longer term (without requiring legislation).  One major piece of cost control missing in the legislation is malpractice reform.  I believe the Republicans missed a golden opportunity for serious reform of medical malpractice.  A single Republican senator willing to back the plan if it included malpractice reform would have marginalized Joe Lieberman and Ben Nelson, and delivered a much stronger bill.

The view from down under is that the US health care system has committed itself to continue to be the world’s most expensive health care system, but the Senate attempts to ‘bend the curve’ are admirable.

Popularity: 63% [?]

The agreement reached in Copenhagen falls far short of the goal of a binding treaty limiting greenhouse gas emissions.  It is a ‘statement of intent’ to try to limit global warming to no more than 2°C, and a plan to help developing nations deal with climate change over the next 10 years.

Despite the President’s assertion that this is a step towards a legally binding treaty, it is more a recognition that a binding treaty to limit emissions is politically impossible – and likely always will be.

A binding treaty has a number of difficulties, not the least of which is that it is impossible to have a global binding treaty without global enforcement, and most governments are reluctant to relinquish any part of their sovereignty (just ask Chinese Premier Win Jiabao).

There are also some complex economic issues with developed vs developing countries.  How much should developed countries pay to developing countries to make up for the greenhouse gases they (developed countries) have already emitted?  How much will reducing emissions restrict economic development?  How can the US or Europe ask to limit new power plants in other countries when their own power production is emitting so heavily?  Should developed countries ‘share’ green technology with developing countries?  Because any compromise will be a political negotiation, it is certain to allocate these costs unfairly.  Even if fairness is somehow achieved, it will be perceived as unfair.  It is very difficult to ask Americans to send money or technology to India or Indonesia so that they can effectively become more competitive in the world economy.

But even a ‘binding’ treaty will be less than binding.  There will continue to be incentives to cheat, and the political reality is that many countries will do so if it is in their interest.  In that environment, a ‘statement of intent’ is a good outcome.

So it looks as though global warming will continue, and probably accelerate, for at least the next decade.

There is hope that things will change.  Europe, the US, and even China are putting large chunks of R&D investment into clean energy technologies.  Over time, it is likely that some of these will become cost competitive, particularly if carbon emissions are taxed or regulated to account for the externality of global warming.

The biggest emitters are China, USA, EU, Russia, India, Japan, and Brazil.  Concerted efforts by this group to reduce emissions is likely – all of them are publicly proclaiming this commitment.  If the rhetoric is indeed followed by reality, I am optimistic that we will see a reduction in emissions in the next ten years.

Whether it is enough to limit warming to another 2° remains to be seen.

Popularity: 65% [?]