James Pethokoukis

Politics and policy from inside Washington

Washington vs. Wall Street … profits

Jun 1, 2010 17:22 UTC

The U.S. profits story has been a bright one for the American economy.  But it may be dimming, says Ed Yardeni:

The rebound in the NIPA measure of profits is likely to run into some headwinds. Financial firms have benefited from lots of government support and guarantees. Most importantly, in my opinion, have been the FDIC’s guarantees for bank debt and the Fed’s commitment to peg the federal funds rate near zero. These measures dramatically boosted the profitability of financial companies by widening their intermediation spreads. The Fed’s zero interest rate policy also provided them with sizable capital gains on their securities. The suspension of mark-to-market (MTM) accounting a little over a year ago was also a big profits booster. Now Washington has turned populist and seems intent on punishing the very same financial firms that were bailed out. Financial reform legislation includes several measures that could severely reduce the profitability and global competitive position of the U.S. financial industry. Oh, and FASB is back with an insane proposal to bring back MTM and apply it to bank loans.

State capitalism, crony capitalism

May 11, 2010 18:42 UTC

When Ian Bremmer offers to tell you “what comes next, it is wise to pay attention:

I believe that things are going to get worse for free markets before they get better. China might be sitting on a bubble, but it’s not the one that James Chanos is pointing toward, one that will pop as soon as China’s real estate boom goes bust. Nor is it the scenario described by Gordon Chang in which the Chinese people rise up to challenge the Chinese government. I could mention the labor bubble (200 million Chinese men with no hope of finding spouses), the environmental bubble (no water, no arable land, no breathable air), or any of the dozens of other bubbles floating ominously across the Chinese landscape. All of them are serious. None are certain to threaten China’s state capitalist system anytime soon. I’d bet confidently on strong state-led Chinese growth over the next decade. Intensified national pride will only strengthen the system in the near term.

Second, the situation will get much worse for free markets because anemic growth and high unemployment in the developed world will feed a backlash against free market sentiment. We’re already seeing more support for protectionism and a tougher stance on immigration in both Europe and the United States. In America, Goldman Sachs is today’s scapegoat, but China is next in line, whether the subject is currency policy, cyber-security, trade imbalances, product safety, or something else.

All of that makes the recommendation that you and I share — strong government support of basic free market principles — one that looks increasingly vulnerable to populist politics within free market democracies. The problem is even larger in Europe and Japan than in America.


Dear editor friend,
Well and wish to hear the same from you.
You have already a email for my new theory on world economics.
About this article, you have given more spaces on world trade and commerce, currency values, European nations different approach to tackle their economic mess and economic uncertainty.
Which economic theory holds good on now a days.
Only Mixed economy,that is, capitalism,capital growth, more wealth generations, a correct corporate taxes on industrialists, business men, and from new enterprises for more capital, more revenue to government treasuries,government governance, national security and more save and investment on permanent returns by mutual funds, government bonds, post office savings-more popular in Asian nations had saved this world economic crisis.
Indians are prospering day by day on account of some free liberal economy, more IT industries, more outsourcing, more labor in selected fields, more rural and urban growth on many sects had made India and state capitalist country China are created a new milestones to entire world.
Whereas, in many western countries, America,England, Germany are mainly depending stock markets, artificial creation for demand in real sectors, no proper auditing mechanism, election gimmicks on social welfare, less productivity in major industries had contributed a strong negative results and they are facing the past mistakes with terrible financial problems, social inequalities,frustrations, tensions and conflicts, a sudden reemergences of single nation identities,some law and order problems, huge cry on migrants, who asked them to allow more migrants for manual labors, ego on super thinking on other nations are to be corrected at the earliest.
Previously Dollar was talk of the town.
Now Euro is talk of the town.
Now, clashes had happened to these super,world currencies.

Posted by mdspatsy | Report as abusive

The false choice of higher taxes and less spending

May 11, 2010 17:41 UTC

Over at NRO, Kevin Williamson tries to figure out how to reduce the US budget deficit:

I am not, in general, in favor of tax increases, but I think that Chait is correct that conservatives would do better to support a budget plan that combines real spending cuts with tax increases than to support a budget that does nothing to reduce spending but leaves taxes where they are or reduces them. The point being, from my point of view: Reducing government spending is paramount, and it is a much more important agenda item than tax cuts that will only defer the financial reckoning that our spending inevitably entails.

Closing the gap from revenues that equal 15 percent of GDP and spending that equals 25 percent of GDP still looks pretty hard to me. To repeat yesterday’s thought-experiment, say we construct a point-by-point trade-off, equalizing spending and revenue at 20 percent of GDP. I don’t see Republicans supporting a 33 percent tax increase or Democrats supporting a 20 percent spending cut. Lots of readers have made clever suggestions about how we get there, but none of them seem convincing to me. The trade-offs would have to be pretty significant, like collecting that 20 percent of GDP via a flat tax and enacting deep entitlement reform.
Me: First of all, let’s keep in mind that all the scary long-term deficit forecasts assume long-term US growth will be about a third slower than its historical average.  Smart tax policy, along with other pro-growth initiatives, could keep the US economy humming along.  Second, the higher-tax/less-spending austerity policy formulation has a poor track record. It brings weak growth and grumpy voters. More likely countries try to grow or inflate their way out of trouble.

Historical average is meaningless, sorry. One can’t assume the past will repeat itself in these matters. America was industrialized only up to the Mississippi as little as 100 years ago, and the growth that ensued up to the Korean War was based on building up the west and the industry to support that build up. After that followed a lull in economic growth as there was no more easy organic growth. It wasn’t until Nixon relieved the USD from the gold standard and then the policies of Reaganomics that growth approached the numbers from the days of yore – and those numbers were skewed by the growth of debt! In my opinion a fully developed economy like America should really only expect 1% growth + population growth (in America’s case a total of 2%.) For most of the rest of developed nations, that means 0-1%. Forcing up those numbers into 2-4% range in effect really only creates bubbles because the support isn’t there for those growth valuations. And so we’ve seen in the last 15 years… well, really since ’86-87, but I’ll limit to the dot-com build up to be fair

Posted by CDNrebel | Report as abusive

Dealing with debt: America needs a growth experiment

May 10, 2010 15:20 UTC
Europe’s debt problems should inspire Americans to explore just how the U.S. will solve its own fiscal woes. I mean, no one is going to cut us a check like Germany and France just did for Greece. This is a topic I tackle in a piece I just wrote for The Weekly Standard. A few key points:
1) Cutting spending and raising taxes is a risky formula. It doesn’t have a great track record:
Since 1980, some 30 debt-plagued nations have tried to reduce their indebtedness through such austerity measures. In practically all cases, according to a new study by financial giant UBS, the increase in national debt was only slowed, not reversed, by such policy pain.
2) Trying to take more from rich people has its limits. Higher and higher income taxes or even wealth taxes create incentive to find tax havens and avoid productive work or capital allocation.
3) Cutting spending is better than raising taxes. Hey, I even have a study to prove it:
A 2009 study by Harvard University’s Alberto Alesina and Silvia Ardagna. It examined 40 years of debt reduction plans by advanced economies and found that “those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases.” They’re also associated with higher economic growth.
4) Less spending +more growth. This is my money graf from the piece:
But what if (a) government spending tracks current projections over the next 70 years, (b) government revenue as a percentage of GDP stays at its historic average of 18 percent, and (c) the economy were somehow to grow a bit faster than its 20th-century average, about 3.5 percent. Under those conditions, according a recent study by JPMorgan Chase, a much wealthier America (generating $100 trillion in tax revenue rather than $50 trillion) would be able to afford projected spending without raising taxes. The long-term budget gap would vanish. … Indeed, that is typically how successful countries in the UBS study managed to get their books in order; they grew their economies faster than they added debt. … Easier said than done, of course. … And there is no one policy to help make that happen. It will take a full-spectrum effort: lower taxes on companies and capital, pork-free spending on infrastructure and basic research (beyond health care), an education system that teaches students rather than feathering the nests of teachers’ unions. Every aspect of U.S. public policy will need to be optimized for economic growth.

Chinese firms are moving manufacturing plants to the US because land is cheaper here than in Beijing. THAT is growth


Posted by STORYBURNcom2 | Report as abusive

US debt woes could explode in just three years

May 7, 2010 18:35 UTC

The great Jed Graham over at Investor’s Business Daily writes an important piece on America’s debt problems. It is not a long-term or intermediate-term issue, it is a short-term issue:

In the wake of the financial crisis and recession, Moody’s Investors Service has brought new transparency to its sovereign ratings analysis — so much so that 2018 lights up as the year the U.S. could be in line for a downgrade if Congressional Budget Office projections hold.

The key data point in Moody’s view is the size of federal interest payments on the public debt as a percentage of tax revenue. For the U.S., debt service of 18%-20% of federal revenue is the outer limit of AAA-territory, Moody’s managing director Pierre Cailleteau confirmed in an e-mail.

Under the Obama budget, interest would top 18% of revenue in 2018 and 20% in 2020, CBO projects.

But under more adverse scenarios than the CBO considered, including higher interest rates, Moody’s projects that debt service could hit 22.4% of revenue by 2013.

10 reasons to be cautious on economy

May 3, 2010 17:25 UTC

I will say this: As much as I press WH officials to take a victory lap on the economy, they want no part of that — especially not with unemployment at these high levels and the evolving EU debt crisis.  David Rosenberg of Gluskin Sheff gives some more reasons for caution:

1. Markets were unimpressed with the size of the just-announced $145 billion rescue package or the ability of Greece to meet the terms. A bailout of all Club Med countries would, according to estimates I’ve seen, approach $800 billion. This is bigger than LEH.

2. China raised reserve ratio requirements 50bps for the third time this year (to 17%). A decisive slowing in China and the U.S.A. is a crimp in the near-term commodity price outlook.

3. Australia just unveiled a massive new mining tax. This is weighing on material stocks overnight.

4. Possible criminal probe on Goldman weighing massively on the stock price; financials being re-rated by rising spectre of financial re-regulation. Shades of Sarbanes-Oxley. There has never been a financial crisis that was not met afterwards with regulatory reform — it’s how the SEC was created in the first place.

5. ECRI leading economic index just slipped to a 38-week low. With the restocking phase complete and fiscal stimulus waning, prospects of a second half slowdown loom large. Buy the recovery story when ISM is at 30 and policy stimulus in full swing (13 months ago); fade it when ISM approaches 60 and stimulus subsides. Market Vane sentiment is pushing towards 60% too — yikes! Too much priced in. As for the macro scene, the U.S. economy is barely growing at all, net of all the federal stimulus (+0.7% SAAR in Q1). And net of housing impacts, neither is Canada … should set us up for a fascinating second-half.

6. Attempted terrorist attack in Times Square a reminder that geopolitical risks have not gone away.

7. Treasury yields have collapsed nearly 35bps from the nearby highs and are not consistent with the recent move by equities to price in peak earnings in 2011. Junk bonds trading back to par for the first time in three years.

8. The U.S. implicit GDP price deflator receded to its slowest rate in 60 years in Q1 (+0.4% from +2% a year ago) in a sign that this profits recovery is still being underpinned by cost cuts, tax relief and accounting shifts than by anything exciting on the pricing front.

9. The latest Case-Shiller house price index confirmed that we are into a renewed leg down in home prices. Financials, retailers and homebuilders are not priced for this outcome.

10. Initial jobless claims, around 450k, are not consistent with sustained employment growth, notwithstanding what nonfarm payrolls tell us this Friday. A new peak in the unemployment rate and a new trough in home prices stand as the most pronounced downside surprises for the second half of the year


Geez, what a sourpuss. Mr. Rosenberg must be short EVERYTHING. For now I’ll go with Larry Kudlow – way more credibility and he likes what he sees out there.

Posted by Gotthardbahn | Report as abusive

Obama’s deficit commission and the politics of crisis

Apr 27, 2010 16:30 UTC

Good luck to the Obama deficit commission. In my heart, I do not believe Congress will pass huge entitlement cuts (preferable)  or tax increases without a  crisis.  (There needs to be a focus on boosting economic growth.) To quote Milton Friedman in Capitalism and Freedom:

Only a crisis—actual or perceived—produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.

Here is one crisis scenario, as outlined by the Committee for a Responsible Federal Budget:

If low interest rates lead to continued debt accumulation and then suddenly, creditor preferences shift, we could experience a “catastrophic budget failure” as set out in a recent paper by Len Burman of the Maxwell School at Syracuse University and his colleagues at the Tax Policy Center.

Under this scenario, at some point financial markets or foreign lenders decide we are no longer a good credit risk, possibly due to debt affordability concerns. They conclude the United States cannot escape basic economic and financial “laws of gravity” forever. They stop buying our debt securities or demand dramatically higher interest rates due to increased perceived risk. With the sudden shift and large rise in interest rates, the economy goes into a severe recession. (“The longer it takes for the crisis to occur, the worse it will be.”) Unlike the past two years, we cannot, however, borrow to stimulate the economy because the crisis was caused by excessive debt and lost confidence. “In the extreme case, the U.S. may not be able to borrow at any interest rate.” Creditors concerned with hyperinflation or even default will not buy U.S. debt.


What happens after that? The Road Warrior – Hilly Have Eyes scenario?

Seriously. What would the landscape look like after the “unthinkable” happens? I’m curious.

Posted by bryanX | Report as abusive

American job insecurity

Apr 26, 2010 14:11 UTC

Two interesting polls from Gallup show why a few ticks in the unemployment rate here and there are really besides the point. (Thanks to Jim Geraghty of NR.)  This downturn has scarred the American psyche. The first chart shows how worried workers are about finding a comparable job if they ever lose their current one. The second chart shows that they are still pretty worried about losing their existing job.




Last night when Fu Bo appeared at the venue next, “Legal Evening News” reporter noted that is different from the previous game in his dress, a black suit, a dark grey cashmere scarf, this has been a sportswear based coach, in such a way that the game for his meaning something different

Growth is the key to US fiscal recovery

Apr 21, 2010 18:50 UTC

The Obama deficit commission has its first meeting next week. And when the panel  finally releases its report after the election, I am sure it will contain an unsurprising mix of tax increases and spending  cuts as a way of dealing with the deficit. But a new report from the  wealth management group at UBS  looking at public sector debt dismissed that policy prescription:

Although fiscal discipline is important, on its own it has rarely been enough to lower a country’s debt ratio. Fo example, since 1980 some 30 countries have undergone exercises in fiscal discipline and many of them have achieved significant reductions in their debt-to-GDP ratios.

However, the overall level of debt hardly ever diminished. At best, fiscal austerity helped to slow down the increase in debt, the actual reduction of the debt ratio was in practically all cases attributable to higher economic growth (often helped by falling interest rates and privatizations). Unfortunately, the growth outlook for the advanced economies is anything but encouraging over the medium to longer term, especially in comparison with the past two decades.

Now the UBS piece argues that the US will try to inflate its way out of its debt problems. Yet I think the report too easily dismisses the prospect for faster-than-expected economic growth. Remember that all those scary CBO deficit forecasts assume long-term growth of around 2 percent, less than two-thirds its historical average. That ability to generate high growth (or hinder it) is the lens though which every new government policy needs to be examined.


CDNrebel, good points, there are still dividend rates that can fall, it is called ‘ploughback’, another name for going on a financial diet.

Posted by Ghandiolfini | Report as abusive

5 reasons why the Tea Partiers are right on taxes

Apr 16, 2010 15:28 UTC

Here is the new Washington Consensus: American taxes must be raised dramatically to deal with exploding federal debt since spending can’t/shouldn’t be cut. Only the rubes and radicals of the Tea Party and their Contract from America movement think otherwise. And don’t worry, the economy will be just fine.

Don’t believe it. While you will never hear this in the MSM, there is plenty of academic research supporting the idea that cutting taxes and spending is the ideal economic recipe for growth, jobs incomes and fiscal soundness. (This all assumes that America’s amazing turnaround since 1980 isn’t proof enough.)  Just take a look:

1) Tax cuts boost economic growth more than increased government spending. Cutting spending is a better way to reduce budget deficits than raising taxes. “Large Changes in Fiscal Policy: Taxes Versus Spending” — Alberto Alesina and Silvia Ardagna, October 2009:

We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments, those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions.

2) Tax cuts boost growth. Tax increases hurt growth, especially if used to finance increased government spending. “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks” — Christina Romer and David H. Romer, July 2007:

In short, tax increases appear to have a very large, sustained, and highly significant negative impact on output. Since most of our exogenous tax changes are in fact reductions, the more intuitive way to express this result is that tax cuts have very large and persistent positive output effects. … The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment. We also find that legislated tax increases designed to reduce a persistent budget deficit appear to have much smaller output costs than other tax increases.

3) Cutting corporate taxes boosts growth. “The Effect of Corporate Taxes on Investment and Entrepreneurship” — Simeon Djankov, Tim Ganser, Caralee McLiesh, Rita Ramalho, Andrei Shleifer, January 2008:

We present new data on effective corporate income tax rates in 85 countries in 2004. The data come from a survey, conducted jointly with PricewaterhouseCoopers, of all taxes imposed on “the same” standardized mid-size domestic firm. In a cross-section of countries, our estimates of the effective corporate tax rate have a large adverse impact on aggregate investment, FDI, and entrepreneurial activity. For example, a 10 percent increase in the effective corporate tax rate reduces aggregate investment to GDP ratio by 2 percentage points. Corporate tax rates are also negatively correlated with growth, and positively correlated with the size of the informal economy.

4) Tax rates are reaching dangerous levels where higher rates bring in less money. “The Elasticity of Taxable Income with Respect to Marginal Tax Rates” — Emmanuel Saez, Joel Slemrod and Seth Giertz, May 2009:

Following the supply-side debates of the early 1980s, much attention has been focused on the revenue-maximizing tax rate. A top tax rate above [X] is inefficient because decreasing the tax rate would both increase the utility of the affected taxpayers with income above [Y] and increase government revenue, which can in principle be used to benefit other taxpayers. Using our previous example … the revenue maximizing tax rate would be 55.6%, not much higher than the combined maximum federal, state, Medicare, and typical sales tax rate in the United States of 2008.

5) Cutting corporate taxes boosts wages. “Taxes and Wages” — Kevin Hassett and Aparna Mathur, June 2006:

Corporate taxes are significantly related to wage rates across countries. Our coefficient estimates are large, ranging from 0.83 to almost 1-thus a 1 percent increase in corporate tax rates leads to an almost equivalent decrease in wage rates (in percentage terms). … Higher corporate taxes lead to lower wages. A 1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates.

There are plenty more, of course. The Tax Foundation lists a dozen recent studies how harmful business taxes are to growth, jobs and wages. Economist Greg Mankiw has determined America is far from a low tax nation. More like in the middle. And let me add this from economist Scott Sumner:

When I started studying economics the US was much richer than Western Europe and Japan, but was also growing more slowly than other developed countries. They were still in the catch-up growth phase from the ravages of WWII. But since Reagan took office the US has been growing faster than most other big developed economies, and at least as fast in per capita terms. They’ve plateaued at about 25% below US levels, when you adjust for PPP. This is the steady state.  …   Why is per capita GDP in Western Europe so much lower than in the US? Mankiw seems to imply that high tax rates may be one of the reasons. … So I think Mankiw is saying that if we adopt the European model, there really isn’t a lot of evidence that we’d end up with any more revenue than we have right now. … Of course the progressives’ great hope is that we’ll end up like France. But Brazil also has high tax rates, how do they know we won’t end up like Brazil?


This guy seems to be confusing economic growth with creating an economic bubble.

The simple reality is that tax increases lead to higher GDP growth and lower unemployment. And cutting taxes lead to lower GDP growth and higher unemployment.

Take a look at the stark reality yourself.

http://img27.imageshack.us/img27/3633/ta xrates.jpg

Posted by alvagoldbook | Report as abusive