Charge! (Or Not)

Fed Chairman Ben Bernanke testified before congress this week and highlighted one of the big future worries facing the economy.  What will be the impact of all this government borrowing on the near and long term economic look and the financial markets?  Brad Setser put the deficit explosion into perspective in his blog at the Council of Foreign Relations on June 2.

The story is clear. Government borrowing has increased dramatically. It topped 15% of GDP in the last two quarters of 2008. In 2007 and early 2008 it was more like 3% of GDP. But private borrowing has fallen equally sharply. Total borrowing by households and firms fell from over 15% of GDP in late 2007 to a negative 1% of GDP in q4 2008.

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Both charts highlight the risk that worries me the most. In both the early 1980s and the first part of this decade, both the private sector and the government were large borrowers. And in both cases, borrowing rose faster than domestic savings, so the gap was filled by borrowing from the rest of the world. The trade and current account deficit rose. In the early 1980s, the US attracted inflows by offering high yields on its bonds. More recently, it did so by borrowing heavily from Asian central banks, together with the governments of the oil-exporting countries. But now yields are low (even after the recent rise in the yield on the ten year Treasury bond), and need to be low to support a still weak US economy. And China (and others) are visibly uncomfortable with their dollar exposure; banking on their continued willingness to finance a large external deficit seems like a stretch.

The challenge this time around consequently will be to bring down the government’s borrowing as private borrowing resumes.

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What’s that, Lassie? Little Timmy fell down the well?

Lassie I’m not sure what Secretary Tim Geithner is smoking these days, but I’m sure there’s a huge market for it.  Maybe we could tax it then pay off the national debt.   The news of the Treasury Secretary’s trip to China is just developing enough of a surreal feel that I felt like Photoshopping a Buddhist begging bowl on to Beavis and entitling it Timmy Does China.  However, I’m not that skilled at photo shop and I’m still trying to finish this paper on currency regimes so I don’t have the time to be that creatively unpaid.  Let’s just label this a big enough reality disconnect to either be drug induced or a product of Hollywood.  Well, not exactly Hollywood, but CNBC, is that close? This blurb is from a thread today at Market Watch.

U.S. Treasury Secretary Timothy Geithner said Tuesday that China has confidence in the U.S. economy, even as official Chinese editorials and news reports berated Washington for selling a “devalued dollar.”

Geithner, who was wrapping up a two-day visit to China, said officials there shared his positive economic outlook for the U.S. and understood the Obama administration’s need to run higher deficits for a temporary period.

“They’ve got a pretty good feel for what we are trying to do and are very supportive,” he said in an interview with CNBC.

I’m still wondering if the folks in charge of protocal and explaining how other cultures work are understaffed at the White House.  Not since POTUS gave HRH an ipod with his speeches on it has there been such a misread of cultural differences.  Somebody needs to explain to the Treasury Secretary that criticizing your future hosts (who are well known to be hyperconcerned for their national image) for currency manipulation in front of a world wide audience isn’t going to really get them to open up to you.  Giethner’s confirmation hearing was labelled by the WSJ to be a China Bash.

Geithner’s visit to Beijing, his first since assuming the helm of the U.S. Treasury, included scheduled meetings with Chinese President Hu Jintao, Premier Wen Jiabao, and the nation’s top commerce, finance and banking officials.

In the CNBC interview, Geithner downplayed his earlier criticism of Beijing, in which he accused the Chinese government of keeping the yuan at an unreasonably low level against the U.S. dollar in order to boost China’s exports.

He did say, however, that China recognizes the need for a more flexible exchange-rate system, saying such a move “will help them … to use monetary policy to address future growth and inflation challenges.”

Geithner’s comments contrasted with the downbeat look at the U.S. economy reported in China’s state-run media.

I’m actually beginning to wonder if Geithner knows exactly what ‘state-run media’ implies here.  Maybe a refresher from the State Department would have helped him on that too.

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Banking on the Backroom Deal

While, GM’s bankruptcy and Chrysler’s emergence from bankruptcy grab front page headlines, yesterday’s banks withlogo-mr-monopoly issues are positioning themselves at the table to discuss future financial regulation. This comes as some of the premier researchers in financial economics look for systemic solutions. As you know, I’m a huge advocate for finding new regulations that promote transparency of process and recognize the importance of fiduciary responsibility when the financial industry takes on risk. Harvard’s Oliver Hart and University of Chicago’s Luigi Zingales, both NBER researchers, have just produced A New Capital Regulation For Large Financial Institutions. I want to review some of their findings and suggestions in conjunction with two more mundane articles.

The first of these articles is an astounding piece on Alternet that finds information suggesting Larry Summers has been taking kickbacks from big troubled banks. Another article is in today’s NY Times that shows how the banks have been spending a good year–even as they took TARP funds and cheap money from them FED–girding for a fight on forthcoming regulations.

I would think that the big lesson from the last few years is this is not time to go back to business as usual. However, the mindset of those making major decisions in the White House (Treasury Secretary Geithner and CEA head Summers) is this is just a glitch and there’s no chance anything like this could happen again. In other words, we don’t need to look for systemic problems, we just need to send the patients home with some aspirin and they can call back in the morning. This aspirin prescription has been particularly expensive. It is either utterly naive or completely disingenuous to think that pouring money into financial institutions and waiting this out is going to prevent any future occurrence of financial meltdowns. We need to be prepared to offset what may be an elaborate hoax to convince that nothing really needs to change systematically and a major congressional influence- and administration influence- buying spree by the big banks. Even as we see Dow de-list Citibank, we see evidence that Citibank possibly manipulated its stress tests results through Summers.

If the Alternet article is correct, Summers should be in trouble and the trustworthiness of the large institutions should be questioned by a congressional committee. This sure looks like pay-to-play to me. (HT to Dr. BB for the link.) The post by Mark Ames is a must read.

Last month, a little-known company where Summers served on the board of directors received a $42 million investment from a group of investors, including three banks that Summers, Obama’s effective “economy czar,” has been doling out billions in bailout money to: Goldman Sachs, Citigroup, and Morgan Stanley. The banks invested into the small startup company, Revolution Money, right at the time when Summers was administering the “stress test” to these same banks.

A month after they invested in Summers’ former company, all three banks came out of the stress test much better than anyone expected — thanks to the fact that the banks themselves were allowed to help decide how bad their problems were (Citigroup “negotiated” down its financial hole from $35 billion to $5.5 billion.)

The fact that the banks invested in the company just a few months after Summers resigned suggests the appearance of corruption, because it suggests to other firms that if you hire Larry Summers onto your board, large banks will want to invest as a favor to a politically-connected director.

Last month, it was revealed that Summers, whom President Obama appointed to essentially run the economy from his perch in the National Economic Council, earned nearly $8 million in 2008 from Wall Street banks, some of which, like Goldman Sachs and Citigroup, were now receiving tens of billions of taxpayer funds from the same Larry Summers. It turns out now that those two banks have continued paying into Summers-related businesses.

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Vat tu, Barack?

monopoly empty pocketsYesterday’s Washington Post featured an article proclaiming “Once Considered Unthinkable, U.S. Sales Tax Gets Fresh Look”.

With budget deficits soaring and President Obama pushing a trillion-dollar-plus expansion of health coverage, some Washington policymakers are taking a fresh look at a money-making idea long considered politically taboo: a national sales tax.

Common around the world, including in Europe, such a tax — called a value-added tax, or VAT — has not been seriously considered in the United States. But advocates say few other options can generate the kind of money the nation will need to avert fiscal calamity.

At a White House conference earlier this year on the government’s budget problems, a roomful of tax experts pleaded with Treasury Secretary Timothy F. Geithner to consider a VAT. A recent flurry of books and papers on the subject is attracting genuine, if furtive, interest in Congress. And last month, after wrestling with the White House over the massive deficits projected under Obama’s policies, the chairman of the Senate Budget Committee declared that a VAT should be part of the debate.

“There is a growing awareness of the need for fundamental tax reform,” Sen. Kent Conrad (D-N.D.) said in an interview. “I think a VAT and a high-end income tax have got to be on the table.”

A VAT is a tax on the transfer of goods and services that ultimately is borne by the consumer. Highly visible, it would increase the cost of just about everything, from a carton of eggs to a visit with a lawyer. It is also hugely regressive, falling heavily on the poor. But VAT advocates say those negatives could be offset by using the proceeds to pay for health care for every American — a tangible benefit that would be highly valuable to low-income families.

Liberals dispute that notion. “You could pay for it regressively and have people at the bottom come out better off — maybe. Or you could pay for it progressively and they’d come out a lot better off,” said Bob McIntyre, director of the nonprofit Citizens for Tax Justice, which has a health financing plan that targets corporations and the rich.

A White House official said a VAT is “unlikely to be in the mix” as a means to pay for health-care reform. “While we do not want to rule any credible idea in or out as we discuss the way forward with Congress, the VAT tax, in particular, is popular with academics but highly controversial with policymakers,” said Kenneth Baer, a spokesman for White House Budget Director Peter Orszag.

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Hyperventilation on Hyperinflation?

I’ve taken a much needed break from economics and I’m ready to ease back into the research groove. I’m still focused on currency exchange and things related to the monetary policy so I thought I would bring up one of the current global concerns. Will the incredible amount of expansionary Monetary Policy combined with recent stimulus on the Fiscal side lead to a new era of inflation? This actually has been a point of contention for a few months in the econ and finance blogs, but I really haven’t followed it all that closely because the economy has been in such a free fall and I don’t believe we’ve hit a bottom yet. Under those circumstances, a little inflation actually has benefits for an economy. It can send signal to the production market that the demand for goods is higher than the supply which can gin up production and provide some upward momentum to a recovery. Inflation in this sense is just a mild signal to the economy that eventually sends it towards its Full Employment Equilibrium. Some economists are looking way beyond that and believe that the groundwork set in current policy will go on for way too long. This could result in inflation or even hyperinflation.

Hyperinflation is a different animal and is thought to be entirely the result of the overprinting of money by the central authorities. They physically print way too much money and the value of the money declines. There are many historical examples of this; most notably the Wiemar Republic (pre-NAZI Germany). The best Inflation-1923current example is Zimbabwe.

There’s some pretty wild anecdotes about post World War 1 Germany. Families would have to meet their breadwinners at the factory at noon with wheelbarrows ready to catch the morning’s pay so they could rush and buy the daily dinner before prices could change and they couldn’t afford even a loaf of bread. There are also pictures of people (see the one on the left) burning money in stoves to keep warm in the winter since that was cheaper than using the money to buy fuel for the stove. Hyperinflation is inflation that reaches the triple digits annually. Zimbabwe had to stop calculating its inflation rate once it hit triple digits daily! These are both extremes, but there are examples in Latin America and other African nations that show how disrupted an economy can become when money is poured into an economy that is not producing anything to buy. I had a student from Argentina tell me that his parents tell the story of when they had to ensure they had established a price on dinner before they ate or the price would change during the meal.  I’ve also heard similar stories from students from Uganda who returned there over breaks.

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