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.
Category Archives: Proposal
Proposal for the Eurozone
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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fixing the economy
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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Assessing the Fed under Chairman Bernanke
“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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Review of the recession and how to end it
- 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
- The end of the subprime expansion in 2006 reduced the demand for housing
- 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
-
Regressive – utilizing allocation by price (Carbon tax, fuel taxes)
- 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).
- 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.
- Ban banks from all secondary markets.
- 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.
- Our leaders believe they must first ‘get credit flowing again’ to restore output and employment.
- 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.
- Leadership that doesn’t understand how the monetary system works has needlessly prolonged the recession and delayed the recovery.
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Mosler housing proposal
My housing proposal:
- The government does not interfere with the lawful foreclosure process.
- 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.
- The government rents the house to the former owner at a fair market rent.
- 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:
- Keeping people in their homes via affordable rents
- Not interfering with existing contract law for mortgage contracts
- Minimizing government disruption of outcomes for mortgage backed securities holders
- 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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Proposal for the UK
- Immediately suspend all VAT and other national transactions taxes.
- An immediate one time 1% of GDP fiscal transfer from the national government to regional governments.
- 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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Proposal update for Obama
- 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.
- $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.
- 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.
- 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.
- Take action to immediately reduce crude oil and crude product consumption.
(Details available on request.)
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Updated Proposals
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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Response to former EuroCom staffer
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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