There is a quick fix, a full payroll tax holiday for employees and employers.

His small business proposals show he and the rest of Congress still don’t understand that employment is a function of sales.

There is nothing in their proposals to support consumption, which is the only point of any economy.

I suspect they are afraid of the trade gap and fear domestic consumption will hurt net export growth.

Their goal is to have us be the world’s slaves via rising net exports.

This is all very good for business and the stock market, not so good for people who need to work for a living.

These are not your father’s Democrats.

“”The backstop package for Greece and the ECB’s climb-down on its collateral rules set a bad precedent for other euro area states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness, and higher inflationary pressures over time,” said Joachim Fels, head of research, in a note to clients.”"

I agree with the moral hazard theory, however I would counter by saying market is making it in practice impossible (even with backstops and colateral climbdown) for this endgame to occur given the cost/lack of funding it is offering to profligate states??

Yes, under current, limited thinking.

My proposal for the ECB to make an annual payment to each national gov. of 5% of total eurozone gdp on a per capita basis still looks to me as the only proposal that instantly repairs credit concerns and gets to all the problematic issues.

However there is no reason to not quadruple that original proposal to a 20% annual distribution.

Additionally, any nation not in compliance with ‘growth and stability’ requirements would risk losing its annual payment.

This would ensure that national debt to gdp ratios will fall for all member nations who comply with the rules.

It also means any nation who doesn’t comply with the rules risks losing its payment and will be ‘punished’ by markets
while nations in compliance getting their annual 20% payment will be secure in their ability to fund themselves.

Over time the 20% annual payment can be scaled down until it equals their self imposed rules for permissible annual deficits for the member nations as desired.

The 20% annual distribution does not foster increased government deficit spending, apart from removing the ramifications of default and risk of default. In contrast, it provides a powerful incentive to limit national govt deficits to desired levels.

This proposal dramatically strengthens the finances of the eurozone with incentives that are the reverse of what are called ‘moral hazard’ incentives.

This proposal is not yet even a consideration so until then anything short of a dramatic export boom where the rest of the world is willing to reduce its ’savings’ of euro net financial assets by net spending on eurozone goods and services isn’t going to cut it.

>   
>   (email exchange)
>   
>   On Fri, Apr 16, 2010 at 7:44 AM, wrote:
>   
>   Talked to an ECB guy about this proposal. He says ECB will NEVER agree. Says they can’t
>   by law do what you are proposing as he claims it is “monetising” the debt and will be
>   ”inflationary”.
>   

That’s what happens when no one in charge and no one in the medial understands actual monetary operations.

>   
>   Down we go!
>   

Please comment:

We Can Have Low Priced Imports and Good Jobs for All Americans

We can have BOTH low priced imports AND good jobs for all Americans

Attorney General Richard Blumenthal has urged US Treasury Secretary Geithner to take legal action to force China to let its currency appreciate. As stated by Blumenthal: “By stifling its currency, China is stifling our economy and stealing our jobs. Connecticut manufacturers have bled business and jobs over recent years because of China’s unconscionable currency manipulation and unfair market practices.”

The Attorney General is proposing to create jobs by lowering the value of the dollar vs. the yuan (China’s currency) to make China’s products a lot more expensive for US consumers, who are already struggling to survive. Those higher prices then cause us to instead buy products made elsewhere, which will presumably means more American products get produced and sold. The trade off is most likely to be a few more jobs in return for higher prices (also called inflation), and a lower standard of living from the higher prices.

Fortunately there is an alternative that allows the US consumer to enjoy the enormous benefits of low cost imports and also makes good jobs available for all Americans willing and able to work. That alternative is to keep Federal taxes low enough so Americans have enough take home pay to buy all the goods and services we can produce at full employment levels AND everything the world wants to sell to us. This in fact is exactly what happened in 2000 when unemployment was under 4%, while net imports were $380 billion. We had what most considered a ‘red hot’ labor market with jobs for all, as well as the benefit of consuming $380 billion more in imports than we exported, along with very low inflation and a high standard of living due in part to the low cost imports.

The reason we had such a good economy in 2000 was because private sector debt grew at a record 7% of GDP, supplying the spending power we needed to keep us fully employed and also able to buy all of those imports. But as soon as private sector debt expansion reached its limits and that source of spending power faded, the right Federal policy response would have been to cut Federal taxes to sustain American spending power. That wasn’t done until 2003- two long years after the recession had taken hold. The economy again improved, and unemployment came down even as imports increased. However, when private sector debt again collapsed in 2008, the Federal government again failed to cut taxes or increase spending to sustain the US consumer’s spending power. The stimulus package that was passed almost a year later in 2009 was far too small and spread out over too many years. Consequently, unemployment continued to rise, reaching an unthinkable high of 16.9% (people looking for full time work who can’t find it) in March 2010.

The problem is we are conducting Federal policy on the mistaken belief that the Federal government must get the dollars it spends through taxes, and what it doesn’t get from taxes it must borrow in the market place, and leave the debts for our children to pay back. It is this errant belief that has resulted in a policy of enormous, self imposed fiscal drag that has devastated our economy.

My three proposals for removing this drag on our economy are:

1. A full payroll tax (FICA) holiday for employees and employers. This increases the take home pay for people earning $50,000 a year by over $300 per month. It also cuts costs for businesses, which means lower prices as well as new investment.

2. A $500 per capita distribution to State governments with no strings attached. This means $1.75 billion of Federal revenue sharing to the State of Connecticut to help sustain essential public services and reduce debt.

3. An $8/hr national service job for anyone willing and able to work to facilitate the transition from unemployment to private sector employment as the pickup in sales from my first two proposals quickly translates into millions of new private sector jobs.

Because the right level of taxation to sustain full employment and price stability will vary over time, it’s the Federal government’s job to use taxation like a thermostat- lowering taxes when the economy is too cold, and considering tax increases only should the economy ‘over heat’ and get ‘too good’ (which is something I’ve never seen in my 40 years).

For policy makers to pursue this policy, they first need to understand what all insiders in the Fed (Federal Reserve Bank) have known for a very long time- the Federal government (not State and local government, corporations, and all of us) never actually has nor doesn’t have any US dollars. It taxes by simply changing numbers down in our bank accounts and doesn’t actually get anything, and it spends simply by changing numbers up in our bank accounts and doesn’t actually use anything up. As Federal Reserve Chairman Bernanke explained in to Scott Pelley on ’60 minutes’ in May 2009:

(PELLEY) Is that tax money that the Fed is spending?
(BERNANKE) It’s not tax money. The banks have– accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

Therefore, payroll tax cuts do NOT mean the Federal government will go broke and run out of money if it doesn’t cut Social Security and Medicare payments. As the Fed Chairman correctly explained, operationally, spending is not revenue constrained.

We know why the Federal government taxes- to regulate the economy- but what about Federal borrowing? As you might suspect, our well advertised dependence on foreigners to buy US Treasury securities to fund the Federal government is just another myth holding us back from realizing our economic potential.


Operationally, foreign governments have ‘checking accounts’ at the Fed called ‘reserve accounts,’ and US Treasury securities are nothing more than savings accounts at the same Fed. So when a nation like China sells things to us, we pay them with dollars that go into their checking account at the Fed. And when they buy US Treasury securities the Fed simply transfers their dollars from their Fed checking account to their Fed savings account. And paying back US Treasury securities is nothing more than transferring the balance in China’s savings account at the Fed to their checking account at the Fed. This is not a ‘burden’ for us nor will it be for our children and grand children. Nor is the US Treasury spending operationally constrained by whether China has their dollars in their checking account or their savings accounts. Any and all constraints on US government spending are necessarily self imposed. There can be no external constraints.


In conclusion, it is a failure to understand basic monetary operations and Fed reserve accounting that caused the Democratic Congress and Administration to cut Medicare in the latest health care law, and that same failure of understanding is now driving well intentioned Americans like Atty General Blumenthal to push China to revalue its currency. This weak dollar policy is a misguided effort to create jobs by causing import prices to go up for struggling US consumers to the point where we buy fewer Chinese products. The far better option is to cut taxes as I’ve proposed, to ensure we have enough take home pay to be able to buy all that we can produce domestically at full employment, plus whatever imports we want to buy from foreigners at the lowest possible prices, and return America to the economic prosperity we once enjoyed.

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I propose the ECB distribute 1 trillion euro to the national govts on a per capita basis.

The per capita criteria means it’s not a bailout and not a ‘reward for bad behavior.’

It would immediately adjust national government debt ratios substantially downward and ease credit fears.

If there is no undesired effect on aggregate demand/inflation/etc., which there should not be, it can be repeated as desired until national government. Finances are enhanced to the point where they can take local action to support aggregate demand as desired.

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I was asked by a reporter to state how I’d fix the economy in 500 words and replied:

Fixing the Economy

1. A full ‘payroll tax holiday’ where the US Treasury makes all FICA payments for us (15.3%). This will restore ’spending power’ allowing households to make their mortgage payments, which ‘fixes the banks’ from the ‘bottom up.’ It also helps keep prices down as competitive pressures will cause many businesses to lower prices due to the tax savings even as sales increase.

2. A $500 per capita Federal distribution to all the States to sustain employment in essential services, service debt, and reduce the need for State tax hikes. This can be repeated at perhaps 6 month intervals until GDP surpasses previous high levels at which point state revenues that depend on GDP are restored.

3. A Federally funded $8/hr job for anyone willing and able to work that includes healthcare. The economy will improve rapidly with my first two proposals and the private sector far more readily hires people already working vs people idle and unemployed.
In 2001 Argentina, population 34 million, implemented this proposal, putting to work 2 million people who had never held a ‘real’ job. Within 2 years 750,000 were employed by the private sector.

4. Returning banking to public purpose. The following are disruptive and do not serve no public purpose:
a. No secondary market transactions
b. No proprietary trading
c. No lending vs financial assets
d. No business activities beyond approved lending and providing banking accounts and related services.
e. No contracting in LIBOR, only fed funds.
f. No subsidiaries of any kind.
g. No offshore lending.
h. No contracting in credit default insurance.
5. Federal Reserve- The liability side of banking is not the place for market discipline. The Fed should lend in the fed funds
market to all member banks to ensure permanent liquidity. Demanding collateral from banks is disruptive and redundant, as
the FDIC already regulates and supervises all bank assets.
6. The Treasury should issue nothing longer than 3 month bills. Longer term securities serve to keep long term rates higher than
otherwise.
7. FDIC
a. Remove the $250,000 cap on deposit insurance. Liquidity is no longer an issue when fed funds are available from the Fed.
b. Don’t tax the good banks for losses by bad banks. All that does is raise interest rates.
8. The Treasury should directly fund the housing agencies to eliminate hedging needs and directly target mortgage rates at
desired levels.
9. Homeowners being foreclosed should have the option to stay in their homes at fair market rents with ownership going to the
government at the lower of the mortgage balance or fair market value of the home.
10. Remove the ’self imposed constraints’ that are disruptive to operations and serve no public purpose.
a. Treasury debt ceiling- Congress already voted for the spending and taxes
b. Allow Treasury ‘overdrafts’ at the Fed. This is left over from the gold standard days and is currently inapplicable.
11. Federal taxes function to regulate aggregate demand, not to raise revenue per se, and therefore should be increased only
to cool down an overheating economy, and not to ‘pay for’ anything.

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Link:

Seven Deadly Frauds of Economic Policy (June 17, PDF Link)

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“Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
Keynes, Chapter 12, The General Theory of Employment, Interest, and Money

The Fed has failed, but failed conventionally, and is therefore being praised for what it has done.

The Fed has a stated goal of “maximum employment, stable prices, and moderate long term interest rates” (Both the Federal Act 1913 and as amended in 1977).

It has not sustained full employment. And up until the recent collapse of aggregate demand, the Fed assumed it had the tools to sustain the demand necessary for full employment. In fact, longer term Federal Reserve economic forecasts have always assumed unemployment would be low and inflation low two years in the future, as those forecasts also assumed ‘appropriate monetary policy’ would be applied.

The Fed has applied all the conventional tools, including aggressive interest rate cuts, aggressive lending to its member banks, and extended aggressive lending to other financial markets. Only after these actions failed to show the desired recovery in aggregate demand did the Fed continue with ‘uncoventional’ but well known monetary policies. These included expanding the securities member banks could use for collateral, expanding its portfolio by purchasing securities in the marketplace, and lending unsecured to foreign central banks through its swap arrangements.

While these measures, and a few others, largely restored ‘market functioning’ early in 2009, unemployment has continued to increase, while inflation continues to press on the low end of the Fed’s tolerance range. Indeed, with rates at 0% and their portfolio seemingly too large for comfort, they consider the risks of deflation much more severe than the risks of an inflation that they have to date been unable to achieve.

The Fed has been applauded for staving off what might have been a depression by taking these aggressive conventional actions, and for their further aggressiveness in then going beyond that to do everything they could to reverse a dangerously widening output gap.

The alternative was to succeed unconventionally with the proposals I have been putting forth for well over a year. These include:

1. The Fed should have always been lending to its member banks in the fed funds market (unsecured interbank lending) in unlimited quantities at its target fed funds rate. This is unconventional in the US, but not in many other nations that have ‘collars’ where the Central Bank simply announces a rate at which it will borrow, and a slightly higher rate at which it will lend.

Instead of lending unsecured, the Fed demands collateral from its member banks. When the interbank markets ceased to function, the Fed only gradually began to expand the collateral it would accept from its banks. Eventually the list of collateral expanded sufficiently so that Fed lending was, functionally, roughly similar to where it would have been if it were lending unsecured, and market functioning returned.

What the Fed and the administration failed to appreciate was that demanding collateral from loans to member banks was redundant. The FDIC was already examining banks continuously to make sure all of their assets were deemed ‘legal’ and ‘appropriate’ and properly risk weighted and well capitalized. It is also obligated to take over any bank not in compliance. The FDIC must do this because it insures the bank deposits that potentially fund the entire banking system. Lending to member banks by the Fed in no way changes the asset structure of the banks, and so in no way increases the risk to government as a whole. If anything, unsecured lending by the Fed alleviates risk, as unsecured Fed lending eliminates the possibility of a liquidity crisis.

2. The Fed has assumed and continued to assume lower interest rates add to aggregate demand. There are, however, reasons to believe this is currently not the case.

First, in a 2004 Fed paper by Bernanke, Sacks, and Reinhart, the authors state that lower interest rates reduce income to the non government sectors through what they call the ‘fiscal channel.’ As the Fed cuts rates, the Treasury pays less interest, thereby reducing the income and savings of financial assets of the non government sectors. They add that a tax cut or Federal spending increase can offset this effect. Yet it was never spelled out to Congress that a fiscal adjustment was potentially in order to offset this loss of aggregate demand from interest rate cuts.

Second, while lowering the fed funds rate immediately cut interest rates for savers, it was also clear rates for borrowers were coming down far less, if at all. And, in many cases, borrowing rates rose due to credit issues. This resulted in expanded net interest margins for banks, which are now approaching an unheard of 5%. Funds taken away from savers due to lower interest rates reduces aggregate demand, borrowers aren’t gaining and may be losing as well, and the additional interest earned by lenders is going to restore lost capital and is not contributing to aggregate demand. So this shift of income from savers to banks (leveraged lenders) is reducing aggregate demand as it reduces personal income and shifts those funds to banks who don’t spend any of it.

3. The Fed is perpetuating the myth that its monetary policy will work with a lag to support aggregate demand, when it has no specific channels it can point to, or any empirical evidence that this is the case. This is particularly true of what’s called ‘quantitative easing.’ Recent surveys show market participants and politicians believe the Fed is engaged in ‘money printing,’ and they expect the size of the Fed’s portfolio and the resulting excess reserve positions of the banks to somehow, with an unknown lag, translate into a dramatic ‘monetary expansion’ and inflation. Therefore, during this severe recession where unemployment has continued to be far higher than desired, market participants and politicians are focused instead on what the Fed’s ‘exit strategy’ might be. The the fear of that presumed event has clearly taken precedence over the current economic and social disaster. A second ‘fiscal stimulus’ is not even a consideration, unless the economy gets substantially worse. Published papers from the NY Fed, however, clearly show how ‘quantitative easing’ should not be expected to have any effect on inflation. The reports state that in no case is the banking system reserve constrained when lending, so the quantity of reserves has no effect on lending or the economy.

4. The Fed is perpetuating the myth that the Federal Government has ‘run out of money,’ to use the words of President Obama. In May, testifying before Congress, when asked where the money the Fed gives the banks comes from, Chairman Bernanke gave the correct answer- the banks have accounts at the Fed much like the rest of us have bank accounts, and the Fed gives them money simply by changing numbers in their bank accounts. What the Chairman explained was there is no such thing as the government ‘running out of money.’ But the government’s personal banker, the Federal Reserve, as decided not publicly correct the misunderstanding that the government is running out of money, and thereby reduced the likelihood of a fiscal response to end the current recession.

There are also additional measures the Fed should immediately enact, such banning member banks from using LIBOR in any of their contracts. LIBOR is controlled by a foreign entity and it is counter productive to allow that to continue. In fact, it was the use of LIBOR that prompted the Fed to advance the unlimited dollar swap lines to the world’s foreign central banks- a highly risky and questionable maneuver- and there is no reason US banks can’t index their rates to the fed funds rate which is under Fed control.
There is also no reason I can determine, when the criteria is public purpose, to let banks transact in any secondary markets. As a point of logic, all legal bank assets can be held in portfolio to maturity in the normal course of business, and all funding, both short term and long term can be obtained through insured deposits, supplemented by loans from the Fed on an as needed basis. This would greatly simply the banking model, and go a long way to ease regulatory burdens. Excessive regulatory needs are a major reason for regulatory failures. Banking can be easily restructured in many ways for more compliance with less regulation.

There are more, but I believe the point has been made. I conclude by giving the Fed and Chairman Bernanke a grade of A for quickly and aggressively applying conventional actions such as interest rate cuts, numerous programs for accepting additional collateral, enacting swap lines to offset the negative effects of LIBOR dependent domestic interest rates, and creative support of secondary markets. I give them a C- for failure to educate the markets, politicians, and the media on monetary operations. And I give them an F for failure to recognize the currently unconventional actions they could have taken to avoid the liquidity crisis, and for failure inform Congress as to the necessity of sustaining aggregate demand through fiscal adjustments.

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The problem is suboptimal output and employment which is evidence of a lack of aggregate demand.
 

Less important what caused the drop in aggregate demand

• The end of the subprime expansion in 2006 reduced the demand for housing
   
• The wind down of the one time Q2 2008 fiscal adjustment (Q2 2008 GDP was up 2.8%)
   
• The Mike Masters inventory liquidation that began in July 2008 added supply from inventories, reducing output and employment
   
• A shift in the propensity to spend due to the pro cyclical nature of credit worthiness

 

My proposals for restoring aggregate demand:

• A full payroll tax holiday – This tax is taking $1 trillion per year from workers and businesses struggling to make ends meet $1,000 per capita in revenue sharing for the States (approx. $300 billion total).
   
• Federal funding for a $8 per hour full time job for anyone willing and able to work that includes federal health care.
   
• Caveat – Unless our demand for motor fuel is cut in half, restoring aggregate demand will also empower the Saudis to set ever higher prices for crude oil which will cause our real terms of trade and standard of living to deteriorate.
   
• Political options for reducing imported fuel consumption:
   
  • Regressive – utilizing allocation by price (Carbon tax, fuel taxes)
     
  • Closer to neutral – mandating higher fuel economy requirements for new vehicles, offering incentives to trade up to more fuel efficient vehicles
     
  • Progressive – substantially reducing speed limits to discourage driving and advantage public transportation

 

Redirect banking to serve public purpose

• Ban banks from all secondary markets.
   
• Allow bank lending only to serve public purpose.
   
• Do not use the liability side of banking for market discipline.

 

Analysis of current situation

• Our leaders believe they must first ‘get credit flowing again’ to restore output and employment.
   
• Unfortunately the reverse is the case; restoration of output and employment will restore the flow of credit.
   
• Government is removing about $1 trillion per year in payroll taxes from employees and employers who can’t meet their mortgage payments and wondering what is causing the financial crisis.
   
• All moves to date by the Treasury and Federal Reserve have only served to shift financial assets between the public and private sectors. Nothing has directly added to aggregate demand.
   
• Therefore the economy has continued to deteriorate, with only the ‘automatic stabilizers’ slowly adding financial assets and income to the private sector, as the counter-cyclical deficit rises.
   
• The rate of federal deficit spending (not counting TARP and other shifting of financial assets that does not directly alter demand, as above) now exceeds 5% of GDP and seems to have begun moving the economy sideways.
   
• The new fiscal package starts taking effect in April. While modest in size, it isn’t ‘nothing’ and will further support GDP.
   
• Employment will not grow until real output of goods and services exceeds productivity growth.
   
• Fuel prices are already moving higher.

 

Conclusion

• Leadership that doesn’t understand how the monetary system works has needlessly prolonged the recession and delayed the recovery.
   
• They have put a premium on ‘confidence’ as the President spends countless hours in front of the TV cameras, when in fact loss of ‘confidence’ means only that federal taxes can be lower for a given level of federal spending:
  

  lower confidence = less private sector spending = less aggregate demand = lower taxes or higher federal spending to sustain output and employment

• The headline USD trillions they have directed towards the financial sector has accomplished little or nothing beyond burning up expensive political capital and credibility.
   
• They are in this way over their heads, and it’s costing us dearly.
   

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My housing proposal:

1. The government does not interfere with the lawful foreclosure process.
2. If the former owner wants to remain in the house, the government buys the house during the foreclosure sale period from the bank at the lower of fair market value or the remaining mortgage balance.
3. The government rents the house to the former owner at a fair market rent.
4. After 2 years the house is offered for sale and the former owner/renter has the right of first refusal to buy it.

While this requires a lot of direct government involvement and expense, and while there is room for dishonesty at many levels, it is far superior to any of the proposed plans regarding public purpose, including:

1. Keeping people in their homes via affordable rents
2. Not interfering with existing contract law for mortgage contracts
3. Minimizing government disruption of outcomes for mortgage backed securities holders
4. Minimizing the moral hazard issue
• foreclosure was allowed to function normally
• renting at fair market rent is not a subsidy
• repurchasing option at market price is not a subsidy

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1. Immediately suspend all VAT and other national transactions taxes.
2. An immediate one time 1% of GDP fiscal transfer from the national government to regional governments.
3. A national service job for anyone willing and able to work to create an employed labor buffer stock for enhanced useful output price stability.

Regarding troubled banks, insolvent institutions should be taken over by government and reorganized to allow for the assets to be sold in an orderly manner and to avoid business interruption for bank clients. When this takes place, uninsured foreign currency liabilities of the insolvent institutions should all be dissolved.

Unfortunately, national budget deficit myths persist and will likely not allow this type of policy to be implemented.

On a technical level, the BOE should sell UK credit default insurance until the cows come home to get those premiums down and dispel notions of UK default risk.

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1. Full ‘payroll tax holiday’ where the Treasury makes all payments for employees and employers.
• Restores incomes to assist those still working to make their payments, keep their homes, and end the credit crisis.
• Reduces corporate cost structure to help contain prices as demand increases.
2. $300 billion in revenue sharing for the States on a per capita basis with no strings attached.
• Enables States to fund operations.
• Enables States fund infrastructure projects.
3. Fund an $8/hr. National Service job for anyone willing and able to work that includes full health care coverage.
• Addresses unemployment from the ‘bottom up’ rather than the ‘top down’ the way other measures do.
• Provides for a far superior price anchor than the current practice of using unemployment for that purpose.
4. Eliminate the need for the Fed to demand collateral from member banks when it lends to them.
• Demanding collateral is redundant and obstructive to lending.
• Allows the NY Fed to hit its assigned fed funds target.
5. Take action to immediately reduce crude oil and crude product consumption.

(Details available on request.)

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Proposals for the Monetary System

The Federal Reserve should immediately lend to its member banks on an unsecured basis, rather than demanding collateral for its loans. Demanding collateral is both redundant and obstructive. It is redundant because member banks already can raise government insured deposits and issue government insured securities in unlimited quantities without pledging specific collateral to secure those borrowings.

In return, banks are subject to strict government regulation regarding what they can do with those insured funds they raise, and the government continuously examines and supervises all of its member banks for compliance. With the government already insuring bank deposits and making sure only solvent banks continue to function, the government is taking no additional risk by allowing the Federal Reserve to lend to its member banks on an unsecured basis.

With the Federal Reserve lending unsecured to its member bank liquidity would immediately be normalized and would no longer be a factor contributing to the current financial crisis or any future financial crisis.

The government should also remove the $250,000 cap on insured bank deposits, as well as remove regulations pertaining to bank liquidity, at the same time it allows the Federal Reserve to lend unsecured to member banks, as individual bank liquidity will no longer be an issue.

The Federal Reserve should lower the discount rate to the Fed funds rate (and, as above, remove the current collateral requirements). The notion of a ‘penalty’ rate is inapplicable with today’s non-convertible currency and floating exchange rate policy.

An interbank market serves no public purpose. It can be eliminated by having the Federal Reserve offer loans to member banks for up to 6 months, with the FOMC setting the term structure of rates at its regular meetings. This would also replace many of the various other lending facilities the FOMC has been experimenting with.

To address the current financial crisis I recommend the following:

• Declare an immediate ‘payroll tax holiday’ whereby the US Treasury makes all FICA Medicare, and other Federal payroll tax deductions for all employees and employers.
• Give the U.S. State an immediate, unrestricted $300 billion of revenue sharing on a per capita basis.
• Fund an $8 national service job for anyone willing and able to work, that includes child care, current Federal medical coverage, and all other standard benefits of Federal employees.
• Have the Treasury directly fund the debt of the FHLB and FNMA, the U. S. Federal housing agencies. This will serve to reduce their funding costs which will be entirely passed through to qualifying home buyers.
  
  There is no reason to give investors today’s excess funding costs currently paid by those Federal Housing agencies when the full faith and credit of the U.S. government is backing them.
• I would also have FNMA and the FHLB ‘originate and hold’ any mortgages they make, and thereby eliminate that portion of the secondary mortgage market. With Treasury funding, secondary markets do not serve public purpose.
• Penalties for mortgage fraud with Federal agencies should be increased and vigorously enforced.

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Dear all-

As one of the European Commission staff members responsible for macroeconomic analysis in the late 1970s and the 1980s, I am among the “depositaires de la mémoire collective”. So it may not surprising that the emerging pressure for a huge fiscal stimulus on top of the already comprehensive bail-outs of banks and now automobile producers reminds me of the call for “concerted action” in the 1970s and which lead to one of biggest fiscal boosts in post-war economic history, although unequally implemented by the various OECD countries. As some of you will remember the “concerted action” was followed by the second oil shock leading to a large deterioration of the EU’s current external account.

Yes, there is a similar risk today if there is a return to even moderate levels of growth and employment, if there isn’t a policy that also results in a substantial reduction of crude oil consumption.

And, unfortunately, since the effects on domestic demand of a fiscal stimulus normally take at least a year to come through the concerted action impacted on the economy at the wrong time and can now also be classified as the major economic policy failure of the post-war period.

With respect to the present situation I have three concerns or questions:

What will be the delays with which the huge stimulus package(s) will have effect on the real economy?

I have proposed a ‘payroll tax holiday’ for the US, where the treasury makes all FICA payments for employees and employers for an indefinite period of time.

This will have an immediate, positive effect on aggregate demand and will also move to quickly repair most credit quality from the ‘bottom up.’

What the banks and autos, for example, need most are consumers who can afford their mortgage payments and afford to purchase cars. The current ‘top down’ approaches, while perhaps ‘necessary’ don’t address this issue.

The credit losses of today in many cases were not there a year ago, and are in no trivial way a responsibility of government that did not make sufficient fiscal adjustments to sustain aggregate demand. This has yet to be understood, and so instead the victims are often being blamed and punished, and conditions continue to deteriorate.

Is it now appropriate to neglect the huge body of economic analysis underpinning the findings and arguments of Lucas (and Ricardo)? In particular, since the current problem is in large part a lack of cash is there not now a major risk that the fiscal stimulus will go directly into an increase in household and enterprise saving without any effects on demand?

If that is the case, it means a larger fiscal adjustment is in order.

Tax liabilities reduce aggregate demand, government spending adds to it. The higher the savings desires, the lower the tax liabilities need to be to ’support’ a given level of government spending.

Spending by central governments (not the national governments in the eurozone, which is a serious, separate matter) with non convertible currencies and floating exchange rate policies is not constrained by revenues. Operationally, said spending is a simple matter of making an entry in the governments own spread sheet.

Yes, ‘over spending’ does carry the (non trivial) risk of ‘inflation,’ but not the risk of solvency or operational sustainability.

Would anybody actually be able to identify and examine the alternatives for public policy in the present situation, as between say:

Further public acquisition of more or less toxic assets, including even acquisition (wholly or in part) of the mortgaged houses and properties in several of the major economies.

A US payroll tax holiday would immediately begin to reduce loan delinquencies which are the root of the credit issue. banking is necessarily pro cyclical and attempting to change that is a counterproductive exercise.

The place for counter cyclical policy is fiscal policy, as the government is the only entity without a solvency issue (again, national governments in the eurozone do have solvency issues due to current eurozone institutional arrangements.)

It is also clear to me that altering interest rates is at best a very weak force for sustaining aggregate demand with growing evidence that lower rates reduce demand through the personal income channel. With governments net payers of interest, the non government sector is a net saver, and cuts in rates necessarily lower interest income of the non govt sector. At the same time, in a downturn credit worthiness of borrowers deteriorates, and the interest rates borrowers pay does not fall as quickly as rates for savers fall. instead, margins for lenders increase to reflect the increased risk.

Also, all the CB studies i have seen show output and inflation responses to interest rate changes are at best relatively small and seem to have maybe a two year lag, which generally takes them across the next fiscal cycle.

Further nationalization of the failed banks and other corporations, with, of course, the options of re-privatizing them once the markets have stabilized.

My first banking job was in the early 70’s, when US housing starts peaked at over 2.5 million per year, with a population of only 215 million people, and all facilitated by sleepy savings banks run by very modestly paid bankers who did nothing more than gather deposits by giving away small kitchen appliances and make mortgage loans with up to 75% loan to value ratios.

In the latest cycle, US housing peaked at 2.1 million annual units, with a population of over 300 million people, and it was termed ‘gang busters’ and an unsustainable bubble.

Banks are agents of government that exist for public purpose. Let me suggest both theory and experience shows that complex finance preys on the real sector, rather than enhances it.

That said, we do have to play the cards we are dealt, so let me continue by saying the eternal lesson of banking is that the liability side is not the place for market discipline. Instead, market discipline is best applied on the asset side, with (strict) regulation and supervision of capital ratios and asset quality. We have again learned that the ugly way, as we watched interbank conditions deteriorate as the fed agonizingly slowly worked towards making sure its member banks have secure sources of funding at the fed’s target rates. And they still aren’t there yet. It yet to be fully recognized that the Fed demanding collateral when it lends to member banks is redundant- the FDIC and OCC already regulate bank capital and asset quality, and the FDIC already allows the banks to fund all their assets with FDIC (govt) insured deposits.

What is also missed by the media, most mainstream economists, and even senior fed officials, is that monetary policy is about price, and not quantity. fed actions do not alter net financial assets of the non govt sector, as a simple matter of accounting. Fed actions do alter various monetary aggregates, but in general this alteration per se has no further economic ramifications. i recall that after the ‘500 billion euro day’ there was a futile search of the ECB’s numbers published the following week to see ‘where the money went’ and no one could find it.
And the us stock market was moving wildly up or down when the size of a Fed repo operation was announced.

Even today the news continues about the fed ‘throwing trillions of liquidity at the markets’ ‘blowing up it’s balance sheet’ as if that mattered beyond the setting of interest rates.

The same media, economists, and officials also miss the fact that with non convertible currency and floating FX causation runs from loans to deposits. Bank lending is (in general) not constrained by ‘available funds’ as it would be with a fixed exchange rate policy. ‘Giving’ banks ‘money’ (reserve balances) to get them to lend is conceptually absurd, for example, as is criticizing banks for ‘hoarding money.’

These are all throw backs to the era of the gold standard, where there were actual supply side constraints on the convertible currency needed for reserves where depositors demanded that convertible currency for withdrawals. And even the treasury had to compete for convertible currency via interest rates when it borrowed to spend. This is still the case today with the odd fixed exchange rate policies that currently are in force.

The problem with the fiscal stimulus is, I think, that it will take time to get adopted and impact on the economy and that, consequently, it is unlikely to prevent a further deterioration of the overall economic prospects during the next twelve months, a period which may be critical for the overall financial and economic stabilization.

A payroll tax holiday would have immediate, substantial results, as they currently remove about $1 trillion annually from us workers and businesses, and are highly regressive.

Additionally, $100 billion of federal revenue sharing for states to use for their operating budgets would immediately reverse the troubling trend towards the reduction of essential public services due to state revenue shortfalls.

When there is undesired excess capacity, as is the case today, government has the option of directing it towards either public or private goods, services, and investment. The payroll tax holiday directs that output towards restoring private sector goods and services, while state revenue sharing results in increased public goods and services.

The choice is purely political. My proposals are based on what I think are politically desired at this time.

Maybe, and as some observers have already suggested, the Swedish experience could provide some lessons for understanding the issues at present.

I would sincerely welcome a debate on these issues.

For the eurozone, under current arrangements the only entity without a solvency issue is the ECB. What is needed is some channel for the ECB to conduct the type of counter cyclical fiscal policy needed to restore eurozone output and employment. Otherwise, the eurozone will continue to perform well below its potential.

Let me last say that the Fed’s swap lines to many of the world’s CB’s are qualitatively very different from its domestic monetary operations. The funds advanced are functionally no different from purchasing ‘$ bonds’ from the various CB’s around the globe, yet have remained far below all radar screens, including Congress’s. Do you think the US congress would approve a $30 billion loan to Mexico? A $350 billion loan to the ECB? Maybe, but I suspect there would be, at a minimum, much debate. Yet the fed has been allowed to do this, and in ‘unlimited quantities’ for the BOJ, BOE, SNB, and ECB’ without any oversight.

Tax liabilities reduce aggregate demand, government spending adds to it. The higher the savings desires, the lower the tax liabilities need to be to ’support’ that spending.

Sincerely,
Warren Mosler

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(email exchange)

>   
>   On Tue, Nov 25, 2008 at 2:22 AM, Michael wrote:
>   
>   Warren: If you get a moment, I was wondering what your reaction is to
>   this latest Heritage Foundation analysis below. This is certainly an ideal
>   time for our message–new administration, public looking for new
>   answers, skepticism about the downside of deficits, and hugely
>   challenging economic stagnation that almost certainly requires new
>   thinking. –Michael.
>   

You got it!

See below:

How to Successfully Stimulate the Economy

When the economy is struggling, Congress has a tendency to invoke the same tried and failed policies of the past. Typically, these policies promise hundreds of billions of dollars in government spending while doing little to actually revitalize economic activity. The first round of stimulus checks, like those rebates issued in the 1970s and 2001, were a bust, with only a small portion (perhaps less than 30 cents on every rebate dollar) used for consumption. Furthermore, prior government spending on infrastructure such as highways merely transferred–rather than created–wealth.

The 2001 fiscal adjustment was too small to reverse the negative effect of the surplus years that caused the collapse. The 2003 adjustment was much larger and had a larger effect and did result in reasonable growth, but that growth was allowed to bring the deficit down to where it was too small to continue to support growth and employment.

The sub prime fraud driven credit expansion did help prolong the post 2003 upswing, but that boost ended when the fraud was discovered and demand from housing slowed.

During the current period of slow economic growth, Congress should do what it does best: set broad economic policy. Specifically, Congress should concentrate on signaling to investors and workers alike that its principal focus will be on improving pro-growth economic policy, mainly in the areas of tax, energy, and spending policies. The test for distinguishing good stimulus ideas from bad ones should be this: Is the proposal likely to raise the economy to a sustained, higher level of growth?

The broad choice is whether to foster an increase in the consumption of private or public goods.

Tax cuts, for example promote private consumption, where infrastructure spending, for example, is public consumption.

Public consumption can be for short term private consumption (law enforcement, public ceremonies, etc) or for investment in public goods for long term private consumption (building roads for economic investment, monuments for well being investment, etc)

In any case, a growing economy in general requires spending exceed tax liabilities on a continuous basis.

Tax Policy
What can increase risk for investors and businesses? Many factors, of course, but public policy commonly looms largest. For example, tax increases, especially on capital, increase the cost of capital and lower investment returns. When investors are uncertain about whether taxes will increase or stay the same, they can still act as though taxes have risen if they judge the risk of an increase to be nearly equal to an actual increase. And rising uncertainty can have the effect of driving down investments in riskier undertakings. Congress can take the following actions on tax policy:

• Make the Tax Reductions of 2001 and 2003 Permanent.
  Among the first actions Congress can take to address the current economic slowdown is to make a definitive statement regarding the tax increases scheduled for 2009 and 2011. There are projects, new businesses, and expansions of existing businesses that would be undertaken today if Congress signaled that taxes would be lower in three years.

Maybe some, but the problem now is lack of sales. Taxes that are only on profits aren’t all that influential when profits and sales are expected to decline. While after tax income is always welcome, I’m sure most businesses would vote for an increase in sales as more beneficial than a decrease in tax rates? For example, the autos have operating losses, so tax rates would not alter investment decisions?

• Since nearly all major capital undertakings last beyond this three-year period, it is likely that making all or most of the Bush tax reductions permanent would stimulate economic activity today as well as in 2011. If Congress increases taxes, then investors will find more favorable economies to support and business owners will, as much as they can, locate their expanded activities in other countries with more favorable tax regimes.

The lower taxes are needed to increase current output and employment via increasing sales. Countries that have high rates of employment in an environment where business can profit attract investment, as in the US in the late 90’s.

• Accelerate Tax Depreciation

Past economic slumps have proven that accelerating the tax depreciation of capital equipment and buildings or the one-year expensing of business purchases that would otherwise be depreciated over a longer period of time for tax purposes can help during periods of slow growth.

I would suggest that depreciation attempt to follow the actual useful life of assets to not distort investment decisions.

• Lower the Corporate Profits Tax.

In one area of tax policy, there is now nearly universal agreement: Our federal business taxes are far too high. The U.S. tax rate on corporate profits is the second highest in the world. Why is it not the firm policy of this country’s government to ensure that the corporate profits tax is always below the average corporate income tax of other industrialized countries? Such a policy would enhance our competitive standing worldwide and significantly reduce the incentive for U.S. firms to relocate to lower tax countries.

There is a valid argument that corporate profits not be taxed at all, as the profits are passed through to investors, who should show the income on their annual earnings, as with sub S- corps and LLC’s.

The current 30% corp tax rate and 15% dividend tax get pretty close to this but are still higher than the highest personal income tax rate.

By making the 2001 and 2003 tax reductions permanent and reducing the corporate profits tax by 1,000 basis points, an annual average of 2.1 million more jobs would be created. Indeed, 3.4 million jobs above a current law baseline would be created in 2018 by newly energetic businesses.

Only if there is an increase in sales (retail and wholesale).

I don’t think that proposed adjustment reduces taxes enough relative to government spending to return us to levels of output coincident with, say, 4% unemployment.

These tax changes dramatically increase the level of national output, and household income rises as the result of a healthier economy and lower taxes. In fact, the average household would have $5,138 more to spend or save after paying their taxes, and by 2018 this amount would jump to $9,750.

The initial adjustment isn’t that high and investment made without a population that has sufficient income to buy the new output will not result in a healthy economy, but instead more of what we have now.

Energy Policy
Rapidly increasing prices for gasoline and petroleum-based energy slowed the economy and helped bring about our current recession. Additionally, the effects of such increased energy prices continue to impede job and income growth. If Congress acts to expand energy supplies, forward-looking prices will fall and economic activity will shed off the drag stemming from this sector.

Without cutting gasoline consumption first, any expansion will help the Saudis (currently the only crude exporter with excess capacity) should they decide to again hike crude prices.

The Heritage Foundation’s Center for Data Analysis analyzed the economic effects if domestically sourced petroleum increased by 2 million barrels per day, and it found that such an increase would expand the nation’s output–as measured by the Gross Domestic Product–by $164 billion and increase employment by 270,000 jobs annually.

Yes, it may eventually (10 years down the road) expand output by that much, but during the next few years the increased employment and income you predict would increase gasoline consumption and support higher prices that would reduce our real terms of trade and siphon off our real wealth via the export channel, thereby reducing our real standard of living.

If Congress were to announce greater access to proven reserves, mining activity would immediately begin, capital and talent would leave other parts of the world and travel to the U.S., forward-pricing markets would feel the downward pressure on prices as the result of impending supply increases, and ordinary Americans’ concerns over their economic future would lessen.

I’d guess supply increases in petroleum of only 2 million barrels a day pending for 10 years in the future will not offset the immediate consumption increase.

The other, more fundamental issue is whether we want economic growth that increases energy consumption via burning things.

(Though with all the geopolitical problems associated fossil fuels I’ve often thought it would be nice to use them all up as quickly as possible and get it over with, behind us, and move on…)

Spending Policy
While the attention of most policymakers will be on immediate responses to the current slowdown, the seeming unwillingness of Congress to seriously address the enormous financial challenges from entitlement spending should not go unnoticed.

Many investors and organizations that play key roles in the future of the U.S. economy are worried about long-term growth given the fiscal challenges posed by Social Security’s and Medicare’s unfunded liabilities.

The challenge is only that of any future inflation that spending might induce. Clearly, however, that is not a concern as no one has ever published an inflation warning from those programs. And no one has expressed concern that the elderly are consuming too many real resources, or that as a nation we should reduce health care services.

At a time when the economy is slowing and the voice of Congress, as well as its actions, can affect economic activity, policymakers should take concrete steps that will announce their intention to address unfunded liabilities in these important programs. While reforms in these programs may be beyond what this Congress can accomplish, it is possible to signal change by reforming the budget rules.

As above, until there is a case to make that those expenditures will cause politically undesired levels of inflation there is no evidence of a ‘problem’.

Additionally, even if it were deemed future inflation was an issue, taking actions that would reduce aggregate demand today and thereby decrease current output and employment is necessarily counter productive.

Currently, the federal budget functions on a pay-as-you-go system, with a very limited forecast of obligations and supporting revenues. It is impossible for the official budget to predict what may happen over the next 30 years; the five- and 10-year budget windows do not permit Members of Congress or the general public to sense the obligations that are coming beyond that 10-year horizon. However, Congress can take two important steps in addressing the long-term entitlement obligations of the U.S.:

• Show These Obligations in the Annual Budget.
  This could be done by amending the budget process rules to include a present-value measure of long-term entitlements. Such a measure would express in the annual budget the current dollar amount needed today to fund future obligations. Such a measure has been endorsed by a number of accounting professionals, as well as the Federal Accounting Standards Advisory Board.

This would be an interesting exercise that can also include the estimated ‘demand leakages’ that reduce aggregate demand, such as pension fund contribution, insurance reserves, IRA contributions, etc. and add to the need for spending to exceed taxes to sustain output and employment.

I would expect this calculation to show that future government deficits continue to fall short of the projected demand leakages, as has been the case in generally since 1945.

• Convert Retirement Entitlements into 30-year Budgeted Discretionary Programs.
  Such a move recognizes that mandatory retirement funding programs for millionaires that crowd out discretionary spending programs for homeless war veterans.

Government spending can only be ‘crowded out’ by inflation fears due to lack of real output capacity. With today’s excess capacity, and projections of future excess capacity, we can readily afford any additional desired government spending for homeless war veterans.

• do not make any sense at all. If we are to contain entitlement spending and reform the programs driving those outlays, then a paradigm shift will likely be required. Recognizing Social Security and Medicare as discretionary programs helps to force attention on changes that will assure their survival well into the 21st century.

We can readily afford any additional spending as long as there is excess real capacity.

Greater Predictability, Greater Productivity
Serious work by the Congress on tax, energy, and spending policy will create greater predictability for investors and business owners and assure workers that they will have a better chance of improving their wages through increased productivity.

Right, and a long term plan by Congress for its expenditures will be the backbone driver of that growth.

Efforts to enhance this nation’s long-term economic health may very well have immediate, short-run benefits as economic decision makers reduce the risk premium they place on starting new businesses or expanding existing enterprises.

Business has a long history of tagging along on the lead taken by Congress from its direct spending and incentives it puts in place.

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1. Effective immediately have the Tsy make all FICA payments on behalf of employees and employers. Leave this arrangement in place at least until it is deemed that the economy is growing too rapidly.
   
   These payroll taxes currently reduce income by about $1 trillion per year for employees and employers and are highly regressive.
   
   Removing these payroll deductions will immediately add about $20 billion per week of ’spending power’ to the economy on an ongoing basis, and all the funds benefit workers and businesses.
2. Effective immediately distribute $100 billion in unrestricted federal revenue sharing to the states on a per capita basis.
3. Make another $200 billion of federal revenue sharing available to the states for general infrastructure repairs and projects.
   
   This will effectively increase take home pay, remove a cash drain on business, address infrastructure needs, and support employment and income in general.
   
   What Wall St. and Main St. need most are consumers who have the funds to make their mortgage payments and car payments, and be able to buy what the US can produce.
   
   This ‘bottom up’ approach will work, while the current ‘top down’ proposals may eventually show results but will take far longer to reverse the current slowdown.
   
   And while my proposals will result in an immediate recovery, they do not address the energy issue.
   
   Any recovery will drive up energy prices if consumption is not first reduced by both the private and public sectors.

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Initial recommendations for President Obama:

• Offer a $10 per hour national service job to anyone willing and able to work.

• Declare a payroll tax holiday and have the Treasury make all FICA payments at least until the economy is deemed to be ‘overheating.’

• Cut the national speed limit for private ground transportation to 30 mph to immediately reduce gasoline consumption (and save lives).

• Implement needed infrastructure spending for deferred maintenance.

• Suspend the Fed swap line program.

• Suspend a variety of the recent, counterproductive assistance programs to the financial sector.

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Here’s my proposal for banks that are presumably capital constrained:

Offer borrowers a package deal:

The borrower agrees to buy new bank VCP (variably convertible preferred) stock equal to, say, 10% of their proposed borrowings. This creates ‘balance sheet’ for the bank which then has the new ‘room’ to make the loan and then some. (Banks generally have 8% target capital ratios.)

The VCP functions as a ‘first loss piece’ for the bank as well.

Terms of the VCP might include an interest rate equal to the loan rate, and a variable conversion ratio designed to give the borrower all his funds back if he doesn’t default.

The VCP non-dilutive to the holders of common shares.

This VCP proposal can free up and create new balance sheet and raise capital as it services borrowing desires.

Feel free to forward this to everyone you know in banking.

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What do you see happening in the next 6 months?

Negative US GDP likely until the budget deficit gets high enough to reverse it, much like 2001-2003.

Back then the very large (and retroactive) fiscal package turned the tide, not monetary policy.

Doesn’t look like an immediate $500 billion+ fiscal package is in the cards anytime soon.

Particularly with Congress thinking they just ’spent’ $700 billion.

Banking problems lingering on but interbank lending will no longer be an issue.

Lots of traditional bank closures by the FDIC as the slowing economy results in more main stream business failures and loan losses.

Accelerating use by the 4 CB’s of the Fed’s unlimited USD swap lines as those demands grow as well.

If the Fed cut them off, for example, as their total borrowings soar past $1 trillion, their currencies and economies would all head towards collapse.

This is NOT good!

And I’m not always this negative. For the last year and a half I’ve been about the only one saying ‘no recession’ for a while due to government spending, exports, and our pension funds ‘monetizing’ their assets with passive commodity investments. (All this was in past blogs and emails.)

Then something snapped in July/August,

Probably triggered by the collapsing oil prices as Mike Masters successfully got Congress to at least discourage our pension funds from their sector shift to passive commodities.

This also removed aggregate demand, and falling commodity prices also cut the import bill of the US, thereby hurting foreign demand.

Potentially the fall in crude will help the US consumer but that takes a while, especially when the media has driven him into a foxhole, as evidenced by the rising ’savings rate’ (which is mainly the ‘flip side’ of the rising US budget deficit. Government deficit = non government savings, etc.)

Fortunately it is ultimately all self correcting- the automatic stabilizers will increase deficits until they are large enough to turn the world economies.

Except for in the Eurozone where rising deficits can make the member nations insolvent.

Bottom line= we need a US payroll tax holiday NOW to keep it all from getting a lot worse.

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