James Pethokoukis

In an FT piece, Daniel Yergin lists the many competing explanations for the financial crisis: 1) too much leverage; 2) rapid financial innovation; 3) wrongheaded or incomplete regulation; 4) government home ownership policies; 5) high US indebtedness; 6) too much greediness, not enough fear; 7) bubblicious easy credit; 8) hubris from years of global growth; 9) global securitization as a transmitter of crisis; 10) the oil spike; 11) intrinsic evil of capitalism.

Me: The media already has its narrative: markets failed. Now it’s time for government to reassert its authority. That is the political dimension. But there is obviously a policy dimension as a well. And we are seeing the “market failed” explanation play out in Washington where Wall Street is under attack and the housing bubble is being reflated.

The most devastating part of the NYTimes piece on Paul Volcker’s lack of influence on WH economic policy comes into the very last sentence of the piece:

So Mr. Volcker scoffs at the reports that he is losing clout. “I did not have influence to start with,” he said.

Me: I can’t believe Volcker is also too thrilled with what’s been happening lately with King Dollar. Yet the focus of the story is how the WH is ignoring Volcker’s advice to separate banking from investing and trading, a de facto restoration of the 1933 Glass-Steagall Act.

Mr. Volcker’s proposal would roll back the nation’s commercial banks to an earlier era, when they were restricted to commercial banking and prohibited from engaging in risky Wall Street activities. … The only viable solution, in the Volcker view, is to break up the giants. JPMorgan Chase would have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. Goldman Sachs could no longer be a bank holding company. It’s a tall order, and to achieve it Congress would have to enact a modern-day version of the 1933 Glass-Steagall Act, which mandated separation.

Glass-Steagall was watered down over the years and finally revoked in 1999. In the Volcker resurrection, commercial banks would take deposits, manage the nation’s payments system, make standard loans and even trade securities for their customers — just not for themselves. The government, in return, would rescue banks that fail. On the other side of the wall, investment houses would be free to buy and sell securities for their own accounts, borrowing to leverage these trades and thus multiplying the profits, and the risks.

Being separated from banks, the investment houses would no longer have access to federally insured deposits to finance this trading. If one failed, the government would supervise an orderly liquidation. None would be too big to fail — a designation that could arise for a handful of institutions under the administration’s proposal.

Banking expert Bert Ely sees things differently:

Had Glass-Steagall never been enacted, had it been repealed much earlier than 1999 …  the Big Five investment banking firms … might not have become as focused as they did on buying, securitizing, and trading subprime, Alt-A, and option-ARM mortgages. While the large commercial banking companies also engaged in mortgage securitization and originating nonprime mortgages, they did not get as deeply involved in those activities as did the investment banks. Arguably, then, had the separate, distinct investment-banking industry been melded into mainstream commercial banking years ago, today’s mortgage and financial crisis would not be as severe as it is, or may not have occurred at all.

Listened to an interesting talk today by Jared Bernstein, chief economist to Vice President Joe Biden, at a New America think-tank conference on job creation. A few observations:

1) If Bernstein’s talk was any indication, don’t look for much public celebration by the White House if we get some good 3Q and 4Q GDP numbers. As he put it, “Absent robust job growth, it is not a true economic recovery.” He stressed this point several times. I don’t even think you will hear an administration official use the word “recovery” in 2009.

2)  Bernstein trotted out several interesting slides — which I am hoping to get hold of — that displayed the severity of the job market’s woes. It really seems like the big problem is not so much layoffs as it is a lack of hiring. Thus the high numbers of long-term unemployed.

3)  He didn’t hint at much appetite for the grander second stimulus ideas like a job investment tax credit. (CBO would probably score such a plan as costing $75 billion a year or so, according to an earlier speaker.)

Is the decline in the dollar merely a “return to normalcy” story, as many bulls contend, and not a harbinger of a coming currency crisis?

Short version: The 2008 financial crisis and ensuing collapse in confidence drove investors to dollars and dollar-based instruments. And as the crisis has ebbed, investors are rebalancing back toward riskier assets.

Thus the falling dollar should rightly be interpreted as a sign of “new economic optimism,” argues JPMorgan Chase economist Jim Glassman.

Then again, perhaps future economic historians will look back at this stage of the dollar’s decline as the currency calm before the storm. Because at some point, investors may suddenly realize that America’s already somewhat devalued currency should not be trusted.

As Senator Judd Gregg, a New Hampshire Republican and noted budget hawk, said recently, “We’re basically on the path to a banana-republic type of financial situation in this country … You can’t keep throwing debt on top of debt.”

Indeed, the evidence points to a nation fairly far along that path. Healthcare reform is supposed to be deficit neutral — everything paid for via spending cuts or tax increases — while also helping bring government’s overall long-term budget into balance.

But to keep the 10-year price tag under $900 billion, Democrats have quietly shunted $247 billion in spending for Medicare physician payments into a separate bill. And no effort is being made to pay for it.

Just as egregious, though less expensive, is the Obama administration’s $14 billion plan to send a $250 “stimulus” check to 57 million American Social Security recipients in lieu of an annual cost-of-living increase.

See, a 5.8 percent COLA increase was paid last January to compensate for a 5.8 percent jump in consumer inflation driven by surging oil prices in 2008. Then oil prices and inflation collapsed.

“In effect, a COLA was paid on inflation that no longer existed,” notes Andrew Biggs of the American Enterprise Institute.

So even though none of this makes seniors essentially any worse off, Uncle Sucker is still going to cut them a check.

Two examples — one ridiculously expensive, one just ridiculous. But both reveal a nation completely unwilling to deal with current trillion-dollar deficits or long-term shortfalls many multiples of that number.

What confidence should dollar investors have that America will really cut entitlement spending? Very little. Instead, we are more likely to see huge tax increases that could cripple productivity, or further dollar neglect, or a central bank that turns dovish on inflation. Or perhaps all three.

If Washington doesn’t care to support the dollar, why should investors?

Does BaucusCare raid Social Security to pay for healthcare reform? Sure seems like, according to Andrew Biggs of AEI:

Baucus’s plan purportedly would improve the budget balance by $81 billion from 2010 through 2019, and in 2019 itself would cut the deficit by $12 billion. … CBO breaks down the Baucus plan’s budgetary effects into those occurring “on budget” (where the substantive policy changes are) and those “off budget” (meaning through the Social Security program). The Baucus plan’s on-budget provisions would reduce the ten-year budget deficit by a tiny $1 billion and in 2019 would increase borrowing by $6 billion. …

Meanwhile, the Baucus plan’s fiscal skullduggery takes place off-budget. Social Security revenues would increase by $80 billion over ten years, with an $18 billon increase in 2019 alone. Around 3 million individuals would leave employer-sponsored health coverage — which is exempt from taxes — to purchase insurance through a subsidized “exchange.” Leaving employer-sponsored coverage would raise workers’ taxable wages and thereby boost Social Security revenues. Millions more would trade a portion of their insurance benefits for higher wages to avoid a new tax on high-cost policies. By skimming the new Social Security taxes, the Baucus plan appears to significantly cut the deficit when, in truth, it balances only by the skin of its teeth.

This is perhaps the clearest example of “raiding the trust fund” on record.  …  The plan does not simply rely on existing Social Security surpluses but creates new ones to offset higher spending on health coverage. Without new Social Security revenues the plan would not balance and, if the president is to be believed, would face a presidential veto. It’s that simple: no new Social Security taxes, no new spending.

Ed Yardeni runs the numbers:

Nominal GDP rose at a compounded rate of 4.2% from 1999-2009. It isn’t likely to grow any faster over the next 10-20 years. However, extrapolating the same growth rate of per capita retirement spending (5.1%) and adding the higher projected growth of the senior population (3.0%) suggests that social welfare outlays might grow by 8%. That’s significantly higher than the likely growth of nominal GDP (say 5%). Since the tax base can’t grow faster than nominal GDP on a sustainable basis, something has to give on the per capita spending side.

I’m not sure how we are going to pay for the welfare needs of all the Baby Boom seniors. The only logical solution is to continue to extend the retirement age for beneficiaries. Bismarck invented social security and picked 65 as the retirement age figuring that few Prussians would live that long. Retirement is a rather modern concept. In the not too distant past, people worked until they couldn’t, and then passed away soon after. Now we are living into our 70s, 80s, and even 90s.

OK, here is the USCOC’s basic position on climate change from recent congressional testimony:

The Chamber supports the goals of the Committee to lower concentrations of greenhouse gases in the atmosphere, become more energy efficient, and incentivize “green” energy technologies. The Chamber does not categorically support or oppose approaches such as cap and trade or carbon tax, but rather measures all climate legislation on a bill-by-bill basis against five core principles: any legislation or regulation introduced must (1) preserve American jobs and competitiveness of U.S. industry; (2) provide an international solution that includes developing nations; (3) promote accelerated development and deployment of greenhouse gas reduction technology; (4) reduce barriers to the development of climate-friendly energy sources; and (5) promote energy conservation and efficiency.

Me: One reason so many news organizations got suckered by yesterday’s phony press release is that it seemed pretty plausible that the Chamber would come out in favor of a carbon tax.  Plenty of pro-market folks have come out in favor of such a plan, especially if it was revenue neutral, perhaps offsetting payroll taxes.

TaxVox tells us why the budget deficit is much worse that what the government is projecting:

Total federal revenue in 2009 amounted to just 14.9 percent of GDP, the smallest fraction since 1950 and far below the 26 percent of GDP spent by the federal government. That gap will narrow in coming years but CBO projects that it will average more than 4 percent of GDP over the next decade, and that’s only if the 2001-2006 tax cuts expire in 2011 as scheduled. Extending those cuts, even only for President Obama’s broad middle class, will mean deficits as far as the eye can see.

Me: Actually, you are looking at a gap more like 6 to 8 percentage points, long term. That is just unsustainable for any extended length of time.

The great Dan Clifton of Strategas Group nails the difficulties of paying for reform through spending cuts or tax hikes:

But these goals are now in jeopardy as the process moves forward. Doctors want legislation to permanently fix their payments holding a cost roughly of $250bn and Senators are pushing for an expansion of coverage. Both initiatives raise the fiscal cost of healthcare program to roughly $1.2 trillion (violating the total cost goal) and there are no additional options to pay for this expansion (violating the deficit neutral goal). Not only is the cost of spending going up, but the push is now to lower the impact of the revenue raisers as unions push to reduce the tax on high end insurance plans. This provision is one-quarter of the total offsets for healthcare and reducing that further exacerbates the gap between revenues and spending. Also, this is viewed as a key provision to reduce the cost of healthcare and will added further headwinds to passage.

The new Japanese government is redirecting the country’s stimulus plan (WSJ):

The Japanese government said Friday it will scrap part of the previous Cabinet’s stimulus package, freeing up 2.926 trillion yen ($32.38 billion) so that it can redirect the money toward more effective projects to stimulate growth.

Me:  For the cost of the remaining stimulus program in the US, you could cut the cap gains rate by 25 percent for a decade. (Plus it likely wouldn’t cost nearly that much.) Just an idea …