Dismal Science Insights

Protectionism is NOT the answer

2009-02-15T11:13:00.000-08:00

With the rapidly rising rates of unemployment around the globe, finding work has become harder for the recently unemployed. Today's NY Times reports that not only is unempployment rapidly soaring in the U.S., but soaring globally in every region. In our interconnected global economy, trading goods and services is one way to help create more global output. Based on a country's comparative advantage, countries will export the goods and services where they possess a comparative advantage relative to other nations. This policy, which has been adopted by major developed countries, has lead to vast amounts of global trade.

However, when the world goes into a recession, and job losses begin to mount, union pressure to "Buy American" or buy domestically produced goods and services rises. However, this protectionist thinking does not increase global output and will only ensure higher prices for the countries that maintain this policy since countries will not trade goods for other goods where they do not have the comparative advantage.

Get ready for lower levels of global trade in 2009. With Taiwan's exports reported to be down 42.9% compared to a year ago, America's steep decline in income is surely not helping. Electronics is a chief export of many Asian economies. With Americans worried about when or whether their job will be safe, Americans aren't spending on discretionary purchases like they use to prior to last summer. The IMF needs to convince every nation not to institute protectionist measures to provide immediate jobs to their citizens. For if this were to increasingly occur, higher prices, less selection and lower global output would result.

Atlanta's economy - The Red Book

2009-01-29T16:30:00.000-08:00

On driving home from a client, I recently heard that NPR was searching for stories about local economies--what the people thought. Here's what I've seen in Atlanta lately:

I run every week with about 30 marathoners for weekly training runs. For the last several years, all of the runners were working full time in various occupations. The latest count of unemployed in recent months is now up to three - one former marketing exec at a bank, one former chemist, and one former writer for the local paper. Then there's the one underemployed runner who left the corporate world and hasn't made any substantial entrepreneurial income.

By the latest statistics released by the labor department, Atlanta's unemployment now tops the nation running at 7.6%, which is four-tenths of a percent ahead of the nation. What's new about this recession, is that it isn't just the blue-collar workers who are getting laid off. Everyone in every industry is affected, regardless of title.

While several of my clients use to pay their employees bonuses at year end, no one in the group of 30 announced that they had received a bonus at Christmastime. So much for consumption spending in Atlanta's economy this year. If bonuses accounted for 20-30% of the discretionary spending, Atlanta's economy will be in for a rough ride. Forget about home improvements when there's no excess funding coming in from bonuses or any "wealth effect" feel good from people's 401Ks. Fortunately, no one in our group has mentioned dipping into their 401Ks yet.

Along with no bonus, late payments are another topic. Court reporters are finding that it takes the lawyers a lot longer to pay them for their services that before. Even though the lawyers aren't hurting for cash, it's the trickle down effect. If it takes the lawyers longer to get paid by their clients, they take longer to pay their vendors.

It's close to Spring time in Atlanta. No one has mentioned taking a vacation anywhere this year. Talk of future Marathons has come to be the next local marathon. Sorry airlines, hotels and restaurants. The trickle down will continue to hit your industry also. Funny--I didn't hear any bailouts for these industries.

China's Currency Manipulations

2009-01-23T09:43:00.000-08:00

Today's NY Times has an article, "Geithner Hints at Harder Line on China Trade" describing how Tim Geithner, the forthcoming Treasury Secretary of the U.S., quoted that Obama stated that China is engaging in currency manupulatation by devaluing it's currency compared to the US dollar. Why is this such a big deal? Here's why.

1) The article mentions that the US is increasingly dependent on China to finance it's deficit. In fact, China is the number one nation owning US debt. According to the Treasurey Department's monthly data on major foreign holders of treasury securities, in November 2008, China owned $681.9 billion in US treasuries out of the $3.085 billion owned by foreign countries. Contact me for a graph showing how China has rapidly increased it's ownership of US securities over the last 6 months. (Note that the UK and Carribean banking centers have also increased their ownership sharply in recent months.) In the last 12 months, China, the UK and Carribean banking centers increased their ownership by 49%, 107% and 104% respectively. Overall, foreign ownership is US treasuries is up 32% from Nov.07-Nov. 08. Why? The Obama administration needs nearly a trillion more in deficit spending to build US infrastructure and get the US ecnomy growing again. Borrowing from other nations is one way to increase US economic growth without saddling US citizens with all of the debt.

This week's Economist has an article, "When a Flow Becomes a Flood" that focuses on this same issue. The article says that, "Ben Bernanke, now the Fed’s chairman, then a governor, argued in 2005 that America’s low saving was a passive response to a global “saving glut” washing onto its shores. It was not that America had lapped up foreign capital; rather capital had been thrust upon it. The money flooding in from willing foreign savers had bid up government-bond prices, lowering interest rates and lifting house prices. That encouraged Americans to run down savings and to keep spending." This is exactly what occured in the US as American's conspicuous consumption kept growing by the day.The article concludes saying, "America, Britain and other deficit countries have drowned themselves in cheap credit from abroad. Because the structural forces behind the global saving glut are unlikely to abate quickly, there is a real risk that the dangerous imbalances will persist—with America’s public sector as the new consumer of last resort. " Moral hazard won't end with the bankers but the government's public debt may be the latest victim of moral hazard.

2) When a country (such as China) devalues it's currency, it becomes more expensive for this country (China) to buy foreign made goods (from the U.S.) relative to their own country's goods. In 3rd Qtr. 2008, the US exported over $54.9 billion to China, while importing $250.4 billion, for a trade deficit of $195.4 billion. The trade deficit with China is growing rapidly. In 2002, the US trade deficit with China was only $103 billion for the entire year. So the saying, "here goes the US, here goes China and the rest of the world" is likely to play out. The US can't keep spending unlimited capital forever, not can foreign nations continue forever to own foreign debt unless they believe that it's a safer risk-reweard based investment than they could earn elsewhere. The US needs to continue to fight for free currency exchanges with China to keep trade negotiations on a fair playing level. Globalization expands global economic output to the maximum when all nations engage in free trade in markets where exchange rates float rather than are fixed (or manipulated). China should not have an unfair comparative advantage in trade. Our economy's future in intricately tied to theirs.

Hello Fiscal Stimulus, Goodbye Monetary Policy

2009-01-12T20:08:00.000-08:00

Economists have two types of policy actions available to stimulate economic development--fiscal policy and monetary policy. Fiscal policy can stimulate the US economy by lowering taxes or increasing government expenditures. Monetary policy can stimulate an economy by lowering interest rates and making capital more available to the markets.

With the Federal Reserve lowering interest rates to near zero, faith has not been restored in the financial markets. Business are afraid to borrow and are now beginning massive layoffs after failing to increase profitability through shortened hours. Over half a million jobs were cut in the U.S. in December 2008. Unemployment now stands at 7.2% is predicted to rise to over 8.0% by mid summer 2009. So much for lowering interest rates sharply since last summer in response to the collapsing housing market. This monetary policy approach of lowering interest rates was effective in all of the previous recessions. Strike one!

That leaves the fiscal policy option. At the latest meeting of the AEA (American Economics Assn.), most economists argued for more government regulation of markets--a total reversal of previous economists' sentiment for many decades. If the government lowers taxes, presumably consumers and businesses will spend the extra cash and increase consumption (which is about 70% of GDP.) However, given the weakness of the financial markets, consumers and businesses may save the tax cut, or spend it on imports, neither of which would help the economy grow. So the government must now play the public government spending wildcard to help save the economy. By spending more public monies, the government can create jobs and increase worker productivity (if some of the money is spend on training the workforce or improving technologies). The fiscal stimulus package is expected to have a much larger impact on impacting GDP growth than the lackluster monetary stimulus that we witnessed in the last six months of 2008.

So Obama needs to spend, spend, spend. Budget deficits can grow temporarily while the economy creates jobs and gets the workers back to work and off of the government unemployment roles. Workers mean more tax revenue for the government. After the recession is fixed, the government budget deficit will improve by default.

Brace yourselves for a gloomier 2009

2009-01-02T13:28:00.000-08:00

Now that the holidays are over, businesses are back to work and the children will soon be back to school. If you managed to survive and keep you job in 2008, will you be fortunate enough to have the same employer by the end of 2009? The magnitutde of the financial crisis on consumer behavior will soon be reported within the next few weeks. Many firms are cutting back hours for now, rather than immediately cutting employees. But as more industries, other than banking, automotive and steel request bailouts from the government, expect massive layoffs in 2009 as corporate CFOs try to improve the bottom line in the new year.
Consumers can forget tapping money previously earned from rising housing prices over the 91-06 period, know as "the wealth effect." In the most recently reported month of October 2008, the Case Schiller Index for Atlanta and the composite 20 major cities shows housing prices continuing to fall 10.5% and 10.8%, respectively from a year ago. Since January 2000, Atlanta housing prices have now risen only 20%, while the national average has risen 58%. As prices continue to fall further in 2009, the extra home equity that consumers tapped for home improvements, cars and other major expenses will continue to shrink considerably, just like their IRAs and 529 savings for their children's college funds did in 2008. As the fear of more ponzi schemes and untrustworthy financial advisors grips Americans and global investors alike, large amounts of extra income from previously higher return on investments may take years to be recaptured.

So consumers, take charge and help your country out by spending our way to recovery. But remember to spend it wisely!

Economic impact of higher taxes in 2009

2008-12-28T11:48:00.000-08:00

The gas tax

In today's New York Times, Thomas Friedman's article, Win, Win, Win, Win, Win points out the benefits of higher gas tax to Americans. In fact, most economists would agree that a gas tax is the optimal economic approach to creating greater consumer demand for more fuel efficient cars. When gas prices were over $4.50/gallon this past summer, consumers flocked to buy energy efficient cars that got more than 50 miles per gallon. They also traded their gas guzzlers for electric gars, alternative fuel vehicles, mopeds and motorcycles. Higher final value added prices to consumers create more substitution to more efficient transportation options. If the Obama cabinet wants a greener world, a higher gas tax would certainly move Americans in that direction.

Social security taxes
Currently, the governement taxes 6.2% on earnings up to $102,000 earned by employees with social security taxes. The companies that these workers work for are also charged 6.2% of their employees earnings. But as many OMB projections have shown, social security will go bankrupt by around 2015, at a time when many baby boomers will just about be ready to collect. A few years ago, the government raised the age when social security could be collected from 65 to 67 for people born after January 1, 1960.

When Social Security system was developed in the early 1930, people lived much shorter lives than they do today. Today it's not uncommon to know of several family members living into their 90s or over 100!So if Americans are going to live an additional 20 years beyond what the system was originally developed to provide, either 1) the tax percentage must increase beyond the 6.2% or 2) the $102K upper limit of Social Security could be eliminated thus including more revenue from the wealthy 3) the age that people can begin collecting must rise further, or 4) new rules, based on accumulated assets, could be developed so that we can adequately provide for boomers, Gen Xers, Gen Yers and beyond in their senior years.

Higher prices from Greater Market Power
But higher gas taxes are only the tip of the iceberg. As more and more businesses from all different sectors of the economy consolidate from the aftermath of the 2008 financial meltdown, those remaining firms will gain more market power and be able to charge higher prices to consumers. Over time, business firms occilate between various types of market structures--Monopoly, Oligopoly, Monopolistic Competition and Perfect Competition. In many of the most recent recent recessions, it was the firms in perfectly competitive markets that struggled to survive or closed shop. In 2008, it's not only the firms with the smallest market share, but the giant oligopolists with huge market share that are folding.Take a look at banking and small package transportation in 2008. A handful of large companies who serve these markets domestically has been reduced even further. Those who can lower relative costs and continue to differentiate their services will remain the viable firms.