Debt Ceiling

Posted in Economics, Politics and Policy at 12:30 pm

A week ago I was convinced that there was a zero chance of the debt ceiling being breached, but over the past few days I’ve become convinced that there is a 90% chance of it happening.

The GOP is currently engaged in a full court press to make the point that breaching the debt ceiling is not the same thing as default. Putting aside the “payment prioritization” nonsense, which has no legal basis and which could not possibly be implemented in the Treasury’s systems, there are some valid reasons why October 17 may not be the date.

Keep in mind these dates:

October 22 – The date the CBO predicts the government will actually start missing payments.

October 24 – Treasury must roll over $24 billion in T-Bills. Technically the interest should be considered an expenditure (unlike the principal) but due to the zero coupon nature of these instruments I’m unclear on the actual govt accounting.

October 31 – Treasury must roll over $115 billion in Treasury Notes and Bonds and make an accompanying $6 billion interest payment.

November 1 – $55 billion in Medicare, Social Security, and military payments are due.

My prediction: The GOP is going to refuse to raise the debt ceiling on October 17 based on the calculation that they have at least until October 22 and possibly until October 31 before an actual default takes place. The morning of October 18 they’ll issue a statement to the effect of “see, we breached the debt ceiling and nothing happened”, followed shortly by a litany of demands that must be met before they agree to a debt ceiling increase, along with a sudden willingness to negotiate over those demands over the following few days.

The wildcard in this scenario, and the one that scares the crap out of me, is how the markets and the overall financial system will react in the days leading up to October 17 not to mention the days after it. This is why I’m still leaving open a 10% chance that a deal is reached at the last minute prior to the passing of October 17. A market panic could force them to abandon this plan at the eleventh hour.


Quick thoughts on corporate tax reform

Posted in Politics and Policy at 9:09 am

Some quick thoughts, with the Apple testimony being all over the press right now (I’ll try to post more details later):

    – Keep the worldwide system
    - Keep the foreign tax credit
    - Do away with the deferral on foreign income
    - Lower the tax rate to a range that’s consistent with that of our major trading partners (e.g., 25-28%)
    - Crack down hard on the use of transfer pricing, IP royalties, and thin capitalization used to shift profits to tax havens

What NOT to do:

    - Move to a territorial system. This would dramatically increase the incentive to shift profits to low tax jurisdictions.
    - Eliminate the corporate income tax entirely. Unfortunately, the “give up” strategy seems to be gaining traction out there, even amongst people who should know better. You can’t eliminate the corporate income tax and instead tax individuals on the distributed income for very practical reasons. People would simply incorporate, shift their assets to the corporation, recast all of their wage/salary/investment income as corporate profit, and defer paying taxes on it essentially forever. In the meantime, they would live by borrowing money from their corporation (the principal would be untaxed and any “interest” they paid back to the company would itself be tax deductible). No matter how many laws you passed banning this sort of structure, people would find ways around it as the incentives are enormous.


Is it worth borrowing money from China to pay for that?

Posted in Economics, Politics and Policy at 9:04 am

The question in the title is becoming the new political meme for why we should cut spending on programs which are otherwise popular amongst voters.

How true is it, however, that we’re borrowing from China for our spending? Or rather, to what extent are we borrowing from China vs elsewhere?

As always, go to the source for the data:

September 2012 US Treasury Bulletin
See Table OFS-2 on page 41 for breakdown of Treasury holdings by type of investor.

Major Foreign Holders of Treasuries

I used March 2012 data for all my calculations since it’s the most recent month for which ALL data points are available.

Here are the results:

Ownership of the National Debt
Federal Government__________ 41.05%
Foreign/International Investors__ 32.95%
Private Domestic Investors_____ 23.19%
State and Local Governments___ 2.80%

- The Federal Government holdings primarily consist of the Social Security fund, but also include federal worker and military pensions plus intra-governmental accounts.
- Foreign/International Investors includes both private investors/institutions and governments.
- Private domestic investors includes banks, insurance companies, mutual funds, pension funds, and individuals.

67.05% of the national debt is owned domestically. Right off the bat, the question should be – “is it worth borrowing money from OURSELVES to pay for that”.

China is the largest of our foreign creditors, accounting for 22.22% of the 32.95% of foreign holdings. Japan is the second largest, accounting for 21.03% of the 32.85%. Brazil is in the third spot at 5.05% of the 32.95%. After that, it drops precipitously, with a few dozen countries splitting the remaining 51.7% of the 32.95%.

So what is the total percentage of the national debt owned by China?


By way of comparison, Japan holds 6.95% of the national debt.

Also interesting is the trend. From July 2011 through July 2012, China’s holdings of the national debt dropped from $1314.9B to $1149.6B while Japan’s increased from $885.2B to $1117.1.

It seems to me that the question “is it worth borrowing from China to pay for that” is highly misleading and disingenuous.


Has anyone even looked at Romney’s tax return?

Posted in Politics and Policy at 1:50 pm

All of this business about his effective tax rate going up and him voluntarily not deducting more charitable contributions was a distraction.

The preliminary return he filed in January:

Preliminary 2011 return
Adjusted gross income: $20,901,075
Total federal tax paid: $3,226,623

What he just released:

Final 2011 return
Adjusted gross income: $13,696,961
Total federal tax paid: $1,935,708

Wow. His taxable income mysteriously decreased by over 7 million dollars!!!!! So his taxes owed also decreased by $1.3 million. Most of the difference is in Taxable Interest and Short Term Capital Gains. Yet when you look at the relevant schedules there’s just a note saying See Statement X. Then you go to the back of the return and look up Statement X, all that is there is a list of his 4 or 5 trusts and an amount for each.

Romney has not released returns for any of his trusts. What he has released is 379 pages of pointers to those unreleased trusts. Zero visibility, zero transparency, little content.


Enough with the square peg and round hole (DSGE)

Posted in Economics at 9:44 pm

Re: Krugman and his sticky wage defense:

Recessions/depressions have nothing to do with “sticky wages” and Keynes went out of his way to point this out.  That’s what makes it so disappointing to see New Keynesians make this argument, for no reason other than to rescue their DSGE modeling methodology.

Here’s why involuntary unemployment is not the result of wages being downwardly rigid.

When someone says that the price of something is too high, in real terms, we must ask “too high relative to what?”  If wages (the price of labor) are too high, relative to what?  To the price of capital?  Can’t be, since the hallmark of recessions/depressions is unemployed labor and capital (e.g., idle factories or low capacity utilization).  So then we ask whether both labor and capital are both priced too high.  Again, relative to what?  To finished goods and services?  Nope.  Two problems – 1) inventories of goods tend to swell during a recession, with unsold goods sitting in warehouses and on store shelves, so they must be overpriced according to this line of thought, and 2) wages and returns to capital represent purchasing power, so cutting wages means even less demand and greater inventory buildups.

What next?  How can labor, capital, and finished goods all be overpriced?  Perhaps the currency itself is overvalued?  Ok, now we’re getting somewhere.  An overvalued currency and slumping exports are both characteristic of recessions/depressions.  However, this is only part of the story.  Exports make up a relatively small percentage of GDP for most countries, and it’s quite common for multiple countries to enter recession/depression at the same time.  So we’re on the right track, but not nearly there yet.  The issue is that money IN GENERAL is overvalued relative to everything else.  The excess supply of everything else (goods/services and factors of production) is the result of and balanced out by the excess demand for money.  In fact, we can take it a step further and ask WHY there is an excess demand for money and the answer is that the demand for money is not a transactional demand but a precautionary one; it is not money itself that is debing demanded but rather the liquidity it provides.  So a change in “liquidity preference” is what causes the economy to remain in a depressed state.

Now we’re right back to what Keynes actually said.  We’re also right back to where many of the positions Krugman advocates do make sense.  But let’s not pretend that it has anything to do with “sticky wages”.


EU Summit Notes

Posted in Economics, Financial Markets, Politics and Policy at 8:52 am

US stock markets rallied 2-3% and crude oil jumped over 9% yesterday in reaction to the latest “plan to have a plan” and “agreement to agree on what has already been agreed” coming out of the EU.

I’m not convinced that this will amount to much more than another short term attempt to boost market confidence that rapidly deteriorates.

Everyone ought to just read the official statement (which is just slightly longer than one page in length) and ignore the speculation from the financial press.

Here are my key concerns:

  1. Debt subordination. The financial press keeps saying that the EU agreed that the Spanish bailout would be an exception that would not subordinate existing debt.  That seems to be true, but if you read the actual statement, it’s an artifact of the EU simply re-affirming that any assistance provided by the EFSF and then transferred to the ESM will not involve subordination.  This is an important point, for reasons that will become clear in a moment.
  2. ESM.  I have a number of concerns here.  First and foremost, the ESM was supposed to go into effect July 1.  That’s tomorrow.  It appears the new target date is July 9.  Is that realistic?  They need to get to a point where the countries providing 90% of capital contributions ratify it in order for it to become operational.  Progress has been quite slow.  Another concern is the size of the ESM – with approximately €500 billion in credit to be available it will not be nearly large enough.
  3. Direct injection of ESM funds into banks. This is the big one.  The question, again, is timing.  It can’t happen until the new single bank regulator is in place, currently targeted for January 1, 2013 (and we know how target dates slip in the EU).  Furthermore, each individual ESM bank bailout will require UNANIMOUS approval.  Is the thinking that no banks will get in trouble over the next 6 months, and that when they do get in trouble there will be ample time to get unanimous approval on terms?

Given the timing of the ESM itself as well as the timing of its power to provide direct assistance to banks along with the subordination issue, I think there is going to be enormous pressure over the next few months to expand both the duration and size of the EFSF while backburnering the ESM.  Alternatively, some new “medium term solution” may emerge to fill the gap between the EFSF and ESM.  It’s unlikely that matters will proceed along the lines currently proposed, with a smooth and seamless transition between the EFSF and ESM.


Spain becomes the 4th EU country to get bailed out

Posted in Economics, Financial Markets, General Musings, Politics and Policy at 7:41 am

Yesterday, the EU agreed to provide Spain with a 100 billion Euro ($125 billion) rescue package.

The money will go into a fund called FROB (Fund for Orderly Bank Restructuring) modeled loosely after the US TARP prgram.  The Spanish government will be responsible for paying back the loan, but they are constrained in how they can use the money; essentially, it has to be used to recapitalize their banks.

It appears this will calm the markets, but for how long?

Why is “calming the markets” always the proximate (and often the ultimate) goal?  Spain has an overall unemployment rate over 24%, with unemployment levels hovering around 50% for the young.  GDP growth was negative in 2009 and 2010, barely positive in 2011, and now has gone negative again for the first half of 2012 with consensus estimates for all of 2012 coming in around -1.5%.  The housing market is in shambles after a boom and bust.  Where are the plans to address crisis-level unemployment and jump start economic growth?  Where are the plans to fix the housing market?

It’s interesting to note the similarities between Spain and Ireland, both of which pursued fiscally responsible policies prior to the financial crisis.  Spain ran budget surpluses in 2006, 2007, and 2008.  In 2009, Spain’s public debt was under 60% of GDP, well below the EU average.   Even now, after the crisis, it only stands at around 68% of GDP.  Like Ireland, Spain is not a tale of fiscal profligacy, it’s a story of a country that experienced the collapse of an asset price bubble followed by a banking crisis.  Awhile back, Paul Krugman noted that Rogoff and Reinhart got the correlation between public debt as a % of GDP and economic crisis correct, but they had the causation reversed.  An economic crisis causes public debt to skyrocket, not vice versa.  Spain is a perfect example.

Where do we go from here?   What will the political repercussions be, both in Spain and in the rest of the EU?  Will Ireland and others demand a renegotiation of their bailouts to remove or reduce the austerity measures attached to them?  What impact will this have on the Greek elections?  Will the contagion spread to Italy next?


Microfoundations of the crisis

Posted in Economics, General Musings at 3:08 pm

Lots of interesting discussion all around regarding neoclassical economics and DSGE models (see recent blog postings by Krugman, Keen, et al).

Let’s cut to the chase:

Between November 2007 and October 2009, the unemployment rate increased from 4.7% to 10.0% and the size of the workforce shrank by almost 9 million jobs.  Many businesses closed or ran idle as sales plummeted.

What exactly caused almost 9 million jobs to be lost over a period of less than two years and output to tumble?

Did workers suddenly decide that they valued leisure over labor to a much higher degree than they previously thought and so voluntarily chose to stop working?

Did workers suddenly decide that they wanted significantly higher wages and so priced themselves out of the market?

Did real capital (plants, equipment, etc.) suddenly become less productive?

Was there some sudden change in technology that rendered production techniques LESS efficient?

Did the available physical quantity of some critical raw material suddenly plummet?

If the answer to the above five questions is “no, obviously not” then DSGE models not only failed to PREDICT the crisis, they are also incapable of EXPLAINING the crisis.

DSGE models rely on an exogenous shock to initiate a change in economic activity (downturn or upswing).  Neither a fall in house prices nor an increase in oil prices counts as exogenous, these are simply markets in action (examples of exogenous shocks here would be tornadoes destroying homes or embargoes against oil producing nations).  So where is the initial exogenous shock?

Once the initial shock (which still hasn’t been identified) occurs, DSGE models rely on various “frictions” to explain how the economy could remain in a depressed state for a period of time rather than immediately returning to a full employment equilibrium.  Sticky wages are probably the most frequent friction assumed.  Before we ask “why wages don’t fall during a recession” we should ask “why should wages fall”.  Every first year econ student is told that the price of labor (the wage rate) is determined by supply and demand and that supply is determined by the marginal disutility of labor (the work/leisure tradeoff) and demand is determined by the marginal productivity of labor.  Why should we simply assume that the “true” price of labor is suddenly lower than the market price and that the reason there’s a discrepancy is because wages are “sticky”?  What if there is no discrepancy and the market price for labor is correct (one would think this would be an economist’s first reaction)?  We are making the hidden assumption that pricing errors are the only thing that can cause a market to fail to clear.  Back to the question of supply and demand – if we are going to argue that the price of labor should be lower, we need to explain why, in terms of the marginal disutility and marginal productivity of labor.  In other words, either workers have suddenly become lazier or they have suddenly become less productive.  Which is it and why?

I would like the DSGE proponents to clearly articulate the cause of the above, without reference to money, finance, or anything else outside the framework of their models.  I want to see the “microfoundations of the crisis” if you will.


Ricardian Equivalence

Posted in Economics at 12:10 am

Krugman, DeLong, et al really need to hit this one head on.




I addressed this in what I thought was a much clearer manner some time ago:


To make it easier to grasp, I’ve put it all in one nice, easy to understand graphic:


This diagram is key to understanding the dispute between so called
freshwater economists and saltwater economists.  When the former argue
in favor of Ricardian Equivalence, they are arguing that any increase
in consumption today necessitates a decrease in consumption in the
future.  This is just another side of the argument that an increase in
consumption necessitates an equal decrease in investment or that an
increase in government spending necessitates an equal decrease in in
private sector spending.

Guess what?  They are right IF the economy is operating at capacity
(on the frontier in the above diagram).  They are wrong IF the economy
is operating below capacity (inside the frontier in the above

Freshwater economists make the assumption that the economy is always
operating at capacity (on the frontier).  This is also the reason why
they dismiss the Keynesian multiplier out of hand.  For an economy
operating at capacity, there is no multiplier effect, just a crowding
out effect, because the economy is already operating at its limit
given the existing constraints of resources and technology.

In effect, freshwater and saltwater economists are describing two
completely different worlds.  The former are describing a world in
which all available factors of production (labor, capital) are fully
employed.  The latter are describing a world in which there are
unemployed workers and idle capital.  We can save the discussion of
WHY there are unemployed resources for another day.  What matters now
is that we start with a model that describes the world as it is, with
the problem we’re trying to solve not assumed away.


From Occupation to……….

Posted in General Musings, Politics and Policy at 8:51 pm

The OWS protesters have gotten everyone’s attention now, and started a conversation (that probably should have taken place in late 2008 or early 2009, but better late than never); it’s now time to move from just occupation to an actual program for moving forward.

Some suggestions:

Get rid of all of the demands that aren’t related to the economy.  Issues like animal rights, gay marriage, and other social issues are creeping into the conversation.  They’re all fine issues that deserve a hearing of their own.  However, with regard to what is trying to be accomplished here, they’re a distraction.

Have both a short term agenda and a long term agenda.  We have a lot of short term problems right now.  Many are symptoms of longer term issues.  Both sets of issues have to be addressed, but sequence and priority is critical.

Keep the agenda points short and concise.  Limit the number of them.  Don’t get mired in the details.

Here’s a good starting point:

Short Term

  • Focus on jobs.  The government should make jobs a top priority until the unemployment rate falls below 5%.  Bring the full power of fiscal and monetary policy to bear, and if necessary, pursue direct works programs.
  • Focus on housing.  The housing market is fundamentally broken.  It needs to be fixed.  The economy will not recover until it’s fixed.  Doing nothing is not an option.
  • Focus on education.  The economy of the future demands a better educated workforce.  People shouldn’t have to become lifetime debt slaves to acquire a college degree and a secure future.

Long Term

  • Realign finance.  Financial institutions should exist to fund productive investment by matching savers/lenders with investors/borrowers.  The economy can’t function without a working financial system.  Unfortunately, it’s been turned into a casino where heads the big banks win and tails the taxpayers pick up the losses.
  • Develop an industrial policy.  Historically, this has meant a combination of trade restrictions like quotas/tariffs with subsidies to business.  That’s not what we need now.  What we need is a policy that takes into account the needs of all stakeholders – importers, exporters, labor, management, business owners both small and large.
  • Save the middle class.  This is what all of the short term and long term agenda points mentioned thus far lead up to.  A vibrant, growing, and upwardly mobile middle class is what has made America great.  For generations, people were inspired by the idea that their children would do better than them.  That idea is fading rapidly.  We need to change that.  It will take action – a large middle class is NOT something that just comes about naturally, it’s not a natural outgrowth of capitalism or any other ism; disabuse yourself of that false notion.

This is the sort of agenda that will resonate with the American people.  The statistics on the decline of the American middle class are indisputable.  When confronted with this, the 1% will have no choice but to remain silent or change the subject.  Keep pushing.