Monday, May 14, 2012
Take a look at the May 11, 2012 Associate Press article entitled “Calls to toughen regulation follow JPMorgan loss.” [http://news.yahoo.com/calls-toughen-regulation-jpmorgan-loss-212428437--finance.html] I do not expect you to completely understand the article and that is part of my point. The banking industry has become so tremendously complex that it is difficult for people, including bankers, to understand it. In their pursuit of profits, banks use intricate financial instruments with exorbitant risks (such as derivatives and credit default swaps) and they use savvy legal techniques to disguise those risks. Most analysts put much of the blame for the economic decline of 2007-2009 (from which we have not yet fully recovered) on excessively risky lending practices by banks due in part to insufficient regulation of financial markets and the use of complex financial instruments that are not completely understood.
Banks have spent vast sums of money lobbying politicians to reduce regulations of financial markets or to create loopholes that make regulations less effective. JPMorgan Chase, the largest U.S. bank, is widely considered to have one of the most knowledgeable and effective management teams with a chief executive officer, Jamie Dimon, who boasts of the bank’s exceptional understanding of risk management. So the report that JPMorgan Chase recently lost $2 billion in six weeks pursuing an aggressive investment strategy has reignited concerns that bank actions could lead to another financial crisis that might have a devastating effect on the global economy and potentially require another hefty bailout by U.S. taxpayers. The rationale for the taxpayer-funded bank bailouts begun under President George W. Bush and continued under President Barack Obama is that financial markets have become dominated by a few giant banks that are “too big to fail.” Mainstream economists are in general agreement that there were mistakes in the design and implementation of the recent bank bailout packages, but the global economy would be in significantly worse condition if the U.S. government had not taken action to prevent a larger financial collapse.
Many analysts suggest that the problem of banks being “too big to fail” is a direct result of the removal of government restrictions that previously limited the scope of an individual bank’s activities (e.g., by not allowing a typical commerical bank that lends money to households and small businesses also to be an investment bank that engages in risky, speculative behavior) and the removal of laws that limited the size of banks by not allowing them to operate across state lines. In essence, if laws and regulations prevented banks from becoming “too big to fail,” then we could allow the ones that engage in risky behaviors to go out of business without having a huge negative impact on the global financial system.
The new suggestions that financial markets need increased supervision are part of a much larger debate about government regulation. This is another area is which the perspectives of mainstream economists differ significantly from many politicians, business leaders, and voters.
Many people talk about free markets as if they are intrinsically superior to the alternatives. Politicians profess support of free markets as a moral virtue and they imply that government intervention or interference with business activities is unquestionably detrimental to society. U.S. politicians who advocate regulation are ridiculed as un-American. The fundamental flaw with this reasoning, however, is that despite claims to the contrary, almost nobody believes in free markets. In a truly free market, laws, rules, and regulations do not inhibit, restrict, or prevent any transactions for which there are willing buyers and sellers. The phrase “free market” refers to a market that is free of government regulation and intervention. But most people, including libertarians, readily agree that it is appropriate for society to have laws and rules that restrict many market activities. For example, most people support laws that prevent children from purchasing alcohol, tobacco, and firearms. We do not think parents should be allowed to use their children as prostitutes. We want there to be restrictions on the sale and distribution of (at least some) drugs. Most people agree that slavery should be illegal and humans should not be allowed to sell body parts. All of these are government interventions in markets. Since almost everyone agrees with these policies, it is reasonable to conclude that almost everyone thinks the regulation of markets is appropriate.
Society needs to discuss market regulation. But the debate needs to be about which types of regulation are appropriate for different markets, not whether regulation is intrinsically evil. It is fair for people to disagree about the extent to which certain market activities should be allowed. However, it is hypocritical to cite individual liberty as the basis for less gun control, but then to argue against a woman’s freedom to terminate an unwanted pregnancy. I am not taking sides on these controversial issues. Instead, I am suggesting that whichever side you prefer, you need to make better and more persuasive arguments for your position. It is not sufficient to use liberty and freedom as the only justification for less gun control or the right to choose an abortion. Everybody believes in liberty to a certain extent and we all believe in the restriction of freedoms in some situations. We agree that individuals should have the freedom to choose where they live and they should be allowed to apply for whatever jobs they want. And we agree that people should not have the liberty to kill each other or to steal another person’s property. However, there are numerous situations in which people disagree about the relative importance of individual freedom versus potential effects on others in society. For example, opponents of gay marriage suggest that redefining marriage to include homosexuals has negative societal effects that outweigh the freedom of those individuals to choose a marriage partner. Supporters of gay marriage weigh those effects differently, thinking the freedom to choose one’s legal partner is more important.
There are some market outcomes that can be improved by government regulation. For example, regulations implemented since the 1960s have reduced the degree and scope of pollution in the United States. And although regulations are not intrinsically evil, they also are not instrinsically good. Some regulations make markets less competitive, protect special interests, or have other negative results. Society should not vilify the regulation of markets, but instead seek to improve rules and restrictions (increasing some and decreasing others) to obtain the desired results.
Mainstream economists believe markets should be competitive, but it is not important that they be free of regulation. Instead, economists believe better social outcomes occur when markets have a sufficient number of buyers and sellers so that nobody is able to exert undue control or influence over the market. In many cases, government regulation is the key to keeping markets competitive. For example, the U.S. typically does not allow one company to buy all of its competitors so that there is only one producer of a product. These restrictions against monopolies are designed to protect consumers because monopolies tend to charge significantly higher prices than similar markets with competition.
As always, I welcome your questions and comments.
Saturday, February 25, 2012
A mathematician, an accountant and an economist apply for the same job.The interviewer calls in the mathematician and asks "What do two plus two equal?" The mathematician replies "Four." The interviewer asks "Four, exactly?" The mathematician looks at the interviewer incredulously and says "Yes, four, exactly."Then the interviewer calls in the accountant and asks the same question "What do two plus two equal?" The accountant says "On average, four - give or take ten percent, but on average, four."Then the interviewer calls in the economist and poses the same question "What do two plus two equal?" The economist gets up, locks the door, closes the shade, sits down next to the interviewer and says, "What do you want it to equal"?
Thursday, February 23, 2012
Unfortunately, the baby boom generation – my generation – may not be remembered so fondly. An appropriate description for those of us born between 1946 and 1964 might be “The Most Selfish Generation.” I say this because of the wreckless fiscal irresponsibility we have demonstrated over the past 31 years.
Take a look at the red graph below.
In 1981, about the time that baby boomers became leaders in both the public and private sectors, public policies were implemented that have led to a current public debt that exceeds 15 trillion dollars. So in the past 31 years, while baby boomers have been running things, the U.S. public debt has increased by more than 14 trillion dollars. In other words, over the past three decades, the United States has consumed 14 trillion dollars of government services we have not paid for and that we will pass to future generations.
For those of you who were born after 1964, I have two words for you …. You’re welcome. …. 15 trillion dollars of debt (and still counting) … that’s our gift to future generations.
To be fair, money borrowed today does not have the same purchasing power as the dollars of the past. So let’s take a look at the purple illustration below.
When the public debt is adjusted for inflation, the diagram illustrates my case even better. In the first 200 years of U.S. history, the federal government paid its bills (for the most part). In some years we ran modest deficits (you can see the big bump to pay for World War II), but we usually paid our bills. This changed in 1981 when taxes were cut under the leadership of President Ronald Reagan, but there was NOT a corresponding decrease in government services. The ultimate irony is that in his 1981 inaugural address, President Reagan warned of the dangers of public debt, saying:
For decades, we have piled deficit upon deficit, mortgaging our future and our children's future for the temporary convenience of the present. To continue this long trend is to guarantee tremendous social, cultural, political, and economic upheavals.
Yet, Reagan helped create a culture of hypocrisy in which we complain about public debt, but seem to continually demand further tax cuts while steadfastly refusing to sacrifice any of the government benefits we expect.
The military conflicts of the past decade in Iraq and Afghanistan are the first time in U.S. history that we have cut taxes in a time of war. When men and women of mostly younger generations are sacrificing their lives for our country, we – the baby boomers – refuse even to pay the financial costs of supporting them – choosing instead to pass the costs to our children, grandchildren, and future generations. And let’s not forget that while reducing federal government revenues through the Bush tax cuts of 2001 and 2003, we also greatly expanded the size and scope of the U.S. federal government through the implementation of Medicare Part D which subsidizes the costs of prescription medications.
You may notice in this graph, as in the previous two illustrations, that there is a decrease in the U.S. public debt in the late 1990s. It is natural and normal for there to be ups and downs in economic activity over time. Economists call this the business cycle. And the surpluses of the late 1990s correspond to being in a properous part of the business cycle. But these budget surpluses were primarily the result of the short-term willingness of Congress to impose on itself pay-as-you-go (PAYGO) rules that require any new spending to be funded by increased revenues or offset by reductions in other expenditures. But as yet another example of baby-boomer selfishness, these rules were abandoned in 2001 (fiscal year 2002) to allow for the popular tax cuts and the subsequent increases in government expenditures.
A June 10, 2009 New York Times article, "America's Sea of Red Ink was Years in the Making," and an accompanying diagram explain and illustrate how U.S. budget surpluses became deficits. The major components and their relative magnitudes are illustrated by the downward arrows. The contributing factors were:
(1) The early 2000s recession caused reduced tax revenues and increased government assistance (- $291 billion a year)
(2) The Bush policies (tax cuts, Iraq war, Medicare prescription drugs) (- $673 billion)
(3) The late 2000s recession (Dec. 2007-2009) also reduced tax revenues and increased government assistance (- $479 billion)
(4) Wall Street Bailouts (begun under Bush & continued under Obama) (-$185 billion)
(5) Other programs supported by both the Bush & Obama administrations, such as the Iraq war and a patch for the alternative minimum tax (- $232 billion)
(6) Stimulus spending (- $145 billion), and
(7) Other Obama programs (- $56 billion).
A July 2011 diagram (above) from The New York Times series, "Charting the American Debt Crisis," shows (on the right) how much of the $14.3 trillion debt (at the time) was accumulated under each U.S. President and (on the left) who holds the debt.
This should NOT be a partisan issue. At a fiscal forum at Jacksonville University on January 26, 2012, former Republican Senator Mel Martinez joined JU alumnus David Walker, the former Comptroller General of the United States and the founder and CEO of the Comeback America Initiative; and Robert Bixby, the executive director of the Concord Coalition; to convey a similar message: federal revenues [as a percentage of gross domestic product (GDP)] are the lowest they have been and expenditures (as a percentage of GDP) are the highest since 1950. (See the diagram below.) Collectively, U.S. citizens need to pay more in taxes and receive fewer government benefits. But that is NOT a message that we want to hear.
Once again, I say to people born after 1964 … You’re welcome!
There is one notable exception among the voices for fiscal reform who offers a chance at redemption for baby boomers, if you want to call it that.
David Stockman, President Ronald Reagan’s budget director, advocates a one-time surcharge on the wealthy. He explains the idea in an interview he did for 60 Minutes in October 2010. Click the link above to find the interview or simply search for “David Stockman 60 Minutes.”
Sunday, February 5, 2012
Friday, February 3, 2012
Friday, January 6, 2012
Friday, December 30, 2011
Advocates of U.S. Presidential candidate Ron Paul, seem befuddled that his economic proposals do not receive more support and consideration. I am unsure if their criticisms of the U.S. Federal Reserve System (the Fed) are objections to the existence of paper money, central banks, or to the specific operation of the Fed. Monetary policy for an increasingly interconnected world is complex. It is reasonable that most people do not understand it. But it can be understood. Let me try to address a few issues.
Money is anything that is generally accepted to serve as a medium of exchange (i.e., you can buy things with it), a store of value (i.e., you use it to save purchasing power for use at a later time), and a unit of account (i.e., it is used to measure relative prices). Stated more simply, money facilitates commerce. Without money that is widely accepted, easy to carry and exchange, and difficult to counterfeit, economic transactions become much more difficult. Without money, people must rely on barter for exchanges of goods and services. For example, a yoga teacher would trade yoga instruction for everything she wants to buy. Paper money, such as Federal Reserve Notes, has been used since the 7th century because it conveniently serves the functions of money. Although it has no intrinsic value, paper money has historically been one of the most widely used forms of money. Bank deposits, such as those created under the fractional reserve banking systems that are common throughout the developed world, are another form of money of similar importance in modern times.
The reason why politicians other than Ron Paul are not advocating the elimination of the Federal Reserve System is because there is a broad consensus among politicians, economists, and the leaders of finance and business that central banks, such as the Fed, provide a necessary function for a developed society. Prior to the creation of the Federal Reserve System in 1913, the U.S. monetary and banking systems were chaotic and their instabilities impeded commerce and economic growth. Because central banks oversee the money supply and banking system, every country with its own currency needs a central bank. They all function essentially in the same way as the Fed.
The primary benefit of a central bank, such as the U.S. Federal Reserve System, is that it promotes a healthy and stable banking system capable of supporting economic growth. It also ensures that society has an appropriate quantity of reliable money to facilitate commerce.
The simplest refutation of the desirability of returning the U.S. to a gold standard is that the money supply would not typically increase unless the U.S. acquired more gold. A benefit of this is that it would prevent excessive inflation. But it would almost certainly lead to devastating deflation and it would make it nearly impossible for the U.S. to use monetary policy to reduce the duration and severity of economic downturns, such as the recent global recession.
Here is a simple example. As a country’s population increases and its economy grows, it needs a larger money supply. If there are a million people earning $1 per day, the economy needs $1 million per day to pay these workers. If the population doubles to 2 million, but the money supply has not increased because the country has not acquired more gold, then the existing $1 million must be sufficient to pay 2 million people. So people earn fifty cents per day instead of a dollar. With these lower labor costs, prices of goods and services fall, too. An overall reduction in the price level, which economists call deflation, might seem desirable. But it is devastating to an economy. It causes a dramatic reduction in purchases of newly produced goods and services. (Why buy something today if you know it will be cheaper next week, next month, or next year?) Deflation increases unemployment as businesses lay off workers because there is reduced demand for their products as consumers postpone purchases until the future (when they will be cheaper).
Developed modern economies have a money supply that is primarily composed of currency and bank deposits and is overseen by a central bank. This allows the money supply to be adjusted to the changing needs of society. The money supply can be easily altered to accommodate changes in population and economic growth. And because central banks influence the amount of money created by private commercial banks in the form of loans, monetary policy is a primary instrument of macroeconomic policy. In prosperous times, central banks fight inflation by encouraging banks to lend less money to the public and thereby reducing overall spending on newly produced goods and services. When the economy is sluggish, central banks promote economic growth and reduce unemployment by encouraging banks to lend more money and thus increase the demand for newly produced goods and services. (As sales increase, businesses rehire workers they laid off or hire new ones.) Mainstream society wants governments to take action to promote economic prosperity and reduce the negative impacts of macroeconomic declines. (See "The Economic Role of Government" for elaboration.)
Ron Paul seems to have considerable fears about hyperinflation. A few economies (with currencies not backed by gold and a central bank similar to the Fed) have suffered hyperinflation. But this does not imply that such a fate in inevitable. An examination of the U.S. inflation rates since 1956 provides no evidence that Fed policies have caused excessive increases in the price level.
Ron Paul’s opinions of the Fed are viewed by mainstream society the same way it views people who claim the earth is flat, that the sun orbits the earth, that man never went to the moon, that the best way to cure all illness is to drain blood from the body, that there is no such thing as evolution, that the earth is only 6,000 years old, or that President Barack Obama was not born in Hawaii. There is substantial evidence to refute all of those beliefs. But for whatever reason, some people prefer conspiracy theories. There is a lot to like about Ron Paul’s candidacy. But Paul is not taken seriously by mainstream society because many of the policies he advocates are simplistic and seem to be based on wishful thinking rather than reality.
Here are a few resources that may help your understanding of monetary policy:
(1) The Fed Today, a 14-minute video that provides a good introduction to the U.S. Federal Reserve System.
(2) Economic Perspectives, my blog about macroeconomic policy
(3) Wikipedia – decent summaries that may provide answers to many of your questions. The article on the gold standard has a section on its advantages and disadvantages.
Monday, August 29, 2011
Friday, August 5, 2011
Thursday, May 19, 2011
Thursday, April 7, 2011
"US Uncut is a grassroots movement taking direct action against corporate tax cheats and unnecessary and unfair public service cuts across the U.S. Washington's proposed budget for the coming year sends a clear message: The wrath of budget cuts will fall upon the shoulders of hard-working Americans. That's unacceptable."
Tuesday, March 1, 2011
In the March 1, 2009 article "Republican cuts would cost 700,000 jobs: Report," Zachary Roth reports that Mark Zandi, a prominent economic forecaster, suggests that the budget cuts proposed by Republicans will slow economic growth and reduce the number of jobs. The logic is that a primary determinant of the number of jobs is the overall demand for newly produced goods and services, which economists refer to as aggregate demand (AD). And a key source of demand, especially in economic downturns and their recoveries, is government purchases. Less government spending translates into less aggregate demand and fewer jobs.
According to Roth:
A new report by a leading economic forecaster finds that budget cuts passed by the House of Representatives would cost 700,000 jobs over the next two years if enacted.
"The House Republicans' proposal would reduce 2011 real GDP growth by 0.5% and 2012 growth by 0.2%," according to the study, by Moody's Analytics chief economist Mark Zandi. "This would mean some 400,000 fewer jobs created by the end of 2011 and 700,000 fewer jobs by the end of 2012."
Zandi is no left-wing ideologue. He was on the economic team for Sen. John McCain's 2008 presidential campaign, and has advised members of both political parties. His findings point in the same direction as those of an even more pessimistic Goldman Sachs report, leaked last week, which concluded that the proposed cuts would reduce second- and third-quarter growth in 2010 by 1.5 to 2 percentage points.
Although the economy has been growing of late, it's not adding jobs fast enough to start significantly bringing down the unemployment rate, which stands at 9 percent. Writes Zandi: "Imposing additional government spending cuts before this has happened, as House Republicans want, would be taking an unnecessary chance with the recovery."
America already faces a jobs crisis, having lost around 8 million jobs since the start of the recession in late 2007.
Zandi argues that the government does need to cut spending--but that it should wait to do so until unemployment has come down further. "Significant government spending restraint is vital," he writes, "but given the economy's halting recovery, it would be counterproductive for that restraint to begin until the U.S. is creating enough jobs to lower the unemployment rate."
The House proposal cuts spending by around $60 billion from 2010 levels. The Senate and the Obama administration will weigh in before any cuts become law.
Wednesday, February 23, 2011
"Some new data crunches show how the gap between rich and poor has widened into a chasm."
In the February 23, 2011 Yahoo! article, "Separate but unequal: Charts show growing rich-poor gap," Zachary Roth summarizes the Mother Jones article," It's the Inequality, Stupid" that appears in its March/April 2011 issue:
The Great Recession and the slump that followed have triggered a jobs crisis that's been making headlines since before President Obama was in office, and that will likely be with us for years. But the American economy is also plagued by a less-noted, but just as serious, problem: Simply put, over the last 30 years, the gap between rich and poor has widened into a chasm.
Gradual developments like this don't typically lend themselves to news coverage. But Mother Jones magazine has crunched the data on inequality, and put together a group of stunning new charts. Taken together, they offer a dramatic visual illustration of who's doing well and who's doing badly in modern America.
Here are three samples:
â€¢Â This chart shows that the poorest 90 percent of Americans make an average of $31,244 a year, while the top 1 percent make over $1.1 million:
• According to this chart, most income groups have barely grown richer since 1979. But the top 1 percent has seen its income nearly quadruple:
• And this chart suggests most Americans have little idea of just how unequal income distribution is. And that they'd like things to be divvied up a lot more equitably:
To see the rest of these fascinating charts, click on over to Mother Jones.
Thursday, January 6, 2011
Winner Take All Politics: How Washington Made the Rich Richer – and Turned it s Back on the Middle Class.
From the publisher's website:
A groundbreaking work that identifies the real culprit behind one of the great economic crimes of our time— the growing inequality of incomes between the vast majority of Americans and the richest of the rich.
We all know that the very rich have gotten a lot richer these past few decades while most Americans haven't. In fact, the exorbitantly paid have continued to thrive during the current economic crisis, even as the rest of Americans have continued to fall behind. Why do the "haveit- alls" have so much more? And how have they managed to restructure the economy to reap the lion's share of the gains and shift the costs of their new economic playground downward, tearing new holes in the safety net and saddling all of us with increased debt and risk? Lots of so-called experts claim to have solved this great mystery, but no one has really gotten to the bottom of it—until now.
In their lively and provocative Winner-Take-All Politics, renowned political scientists Jacob S. Hacker and Paul Pierson demonstrate convincingly that the usual suspects—foreign trade and financial globalization, technological changes in the workplace, increased education at the top—are largely innocent of the charges against them. Instead, they indict an unlikely suspect and take us on an entertaining tour of the mountain of evidence against the culprit. The guilty party is American politics. Runaway inequality and the present economic crisis reflect what government has done to aid the rich and what it has not done to safeguard the interests of the middle class. The winner-take-all economy is primarily a result of winner-take-all politics.
In an innovative historical departure, Hacker and Pierson trace the rise of the winner-take-all economy back to the late 1970s when, under a Democratic president and a Democratic Congress, a major transformation of American politics occurred. With big business and conservative ideologues organizing themselves to undo the regulations and progressive tax policies that had helped ensure a fair distribution of economic rewards, deregulation got under way, taxes were cut for the wealthiest, and business decisively defeated labor in Washington. And this transformation continued under Reagan and the Bushes as well as under Clinton, with both parties catering to the interests of those at the very top. Hacker and Pierson's gripping narration of the epic battles waged during President Obama's first two years in office reveals an unpleasant but catalyzing truth: winner-take-all politics, while under challenge, is still very much with us.
Winner-Take-All Politics—part revelatory history, part political analysis, part intellectual journey— shows how a political system that traditionally has been responsive to the interests of the middle class has been hijacked by the superrich. In doing so, it not only changes how we think about American politics, but also points the way to rebuilding a democracy that serves the interests of the many rather than just those of the wealthy few.