James Pethokoukis

Politics and policy from inside Washington

More 2010 forecasts

Dec 29, 2009 18:12 UTC

Here is an interesting one from MF Global fully adopting the New Normal mantra:

On debt:

The IMF predicts that in 2010 the average government gross debt as a percentage GDP for the 7 major advanced economies will be 109% and 113% in 2011. It was only 84% in 2007 and 77% in 2000. Following the global down turn in the 1990s, average gross debt as a percentage of GDP increased from 58% in 1990 to 80% by 1996. History suggests that post recession, the reduction in government spending is rarely equivalent to the increase catalyzed by the retrenchment in the private sector. Given the breadth and depth of this past recession and lingering risks in the system, the pull-back in government spending will be even less. Moreover, the initiatives of the US government are costly and the passage of the healthcare bill will only increase the financing needs. As the global recovery takes hold it will be increasingly difficult for governments to attract interest in their securities as their yield reside at historic lows. Outside of valuation, fears over defaults will also keep the market wary of government debt. Widening sovereign CDS spreads underscore the market’s already elevated concern. While a widespread tidal wave of defaults is unlikely, poor auction demand in the wake of the recovery and in the face of heavy financing needs will increase trepidation about its possibility.

On unemployment:

2010 will be characterized by a jobless recovery. MFGR sees the unemployment rate peaking in 2010 at 10.5% and closing the year between 9.5% and 10%.  … On the US front, the outlook for taxes is murky and the healthcare initiative which will likely force all employers to provide care or pay a penalty will discourage the expansion of the labour force. Though the Obama administration is extending the capital gains holiday for small businesses, employers need to feel confident that their profit margin will not erode in the future due to tax increases in order to genuinely contribute to job growth. Moreover, budget shortfalls at the state and local government level will cap government hiring. Globally speaking, there has been a significant increase in structural employment that is now part of the new normal. The collapse of the financial markets has led to a permanent shrinkage of the financial industry and the impendingregulation will make financial innovation, a factor that does lead to job growth, very difficult. The manufacturing industry faces the same problem. Globalization will lead to the removal of manufacturing jobs in advance economies and cause a shortage of skilled labour forcing many to look to build other skill sets.

On taxes:

The tax burden in the U.S. and Europe is likely to increase. The on going deterioration in public finances, at both the state and government levels, will put upward pressure on taxes in the U.S. Moreover, the Bush tax cut is expected to sunset in 2011. There is some feeling that Congress will vote to extend lower tax rates, but this is likely to come for earners making less than $250,000. Somehow, the $250,000 income level has become the definition of rich in America. Capital gain and dividend taxes are also likely to rise for high income workers and risk leading to a re-pricing downward of assets. Furthermore, the healthcare bill contains another tax hike on high income workers, and will likely lead to higher healthcare insurance fees. The healthcare mandate will act like a tax by raising the cost of healthcare for many workers. At the state level, California, Illinois, and New Jersey face massive fiscal strain and politicians are reluctant to address pension, healthcare, and wage costs in order to boost the productivity of government workers. Unions are a strong constituent and politicians do not want to upset a large voting block.

On US politics:

Passage of the Democratic healthcare plan will mark an apex in U.S. liberalism. Government policy will shift toward the center into midterm elections. Polling data highlights the falling popularity of the Democratically controlled Congress and President Obama. The NBC/Wall Street Journal poll displayed the Congressional disapproval rating at an elevated 68% in mid December. At the same time, data produced by Rasmussen has shown President Obama’s approval index falling from a peak of +30 on January 22, 2009 to a post Christmas reading of -12. The champion legislation of the Democratic Party, healthcare, is also finding limited support. The recently passed Senate healthcare bill has displayed a high level of public disapproval highlighting anger over the intervention of government into healthcare. Rasmussen’s polling numbers on healthcare show most voters oppose the healthcare plan and just 25% believe they will be better off. The likely and soon to be passed healthcare bill has been passed on a totally partisan basis in the face of growing opposition to government policy. Recent Democratic losses of governorships in New Jersey and Virginia spotlight the tilt of support by the public toward the party out of power. Furthermore, Alabama Congressman Parker Griffith recently switched to the Republican Party from the Democratic Party. The “Blue Dog” feared losing his seat in 2010. The high level of discontent with politicians is occurring in the back drop of “Tea Parties” and grass root movements to stop the reach of government given excessive spending and a high tax burden. Unemployment is still elevated, and income growth is slow. The public is angry over the impact of a stimulus plan which may have saved the financial system from melt down, but did little to improve standards of living. Democrat leaders in Congress have fought for their agenda at all costs, and will now try to reverse their tactics in order to improve their public image. Politicians, at the core, are survivalists and thus policy is likely to move toward the center to attract discontented voters. The Democratic leadership is aware that history is not on their side for mid term election victories and power loss can be expected. For example, during the 1994 mid term election, President Clinton and the Democrats lost 9 seats in the Senate and 54 in the House. In 1946, President Truman and the Democrats lost 12 Senate seats and 55 House seats. Going back further, FDR and the Democrats picked up 10 Senate seats and 9 House seats in 1934, but suffered major losses in 1938 and 1942 with 7 House seats (6 Senate seats) and 45 House seats (9 Senate seats) lost in 1938 and 1942 respectively

The new Washington Consensus: taxes, taxes and more taxes

Dec 29, 2009 15:13 UTC

This depressing WSJ article outlines some possible solutions to America’s long-term fiscal problems:

1) Don’t keep fixing the AMT

2) Let all the 2001 and 2003 tax cuts expire

3) Add a VAT overlay on top of current system

4) Tax Wall Street trading

5) Put an expiration date on business tax cuts and credits

6) Create a commission, like the Greenspan Commission on Social Security, that would cut spending and … wait for it … raise taxes.

This article perfectly encapsulates Washington thinking that fundamental change in how Washington spends America’s tax money is really impossible. So raise taxes through the roof. One more reason to believe a low-growth New Normal is here.


About: WSJ & VAT

It would be wrong, let alone politically impossible, to add a U.S. VAT on top of existing taxes. When Japan instituted its VAT, to assure adoption, it was done along with an overall tax reduction.

But, as a revenue-neutral substitute for the corporate income tax, the VAT in itself would have positive implications for the U.S. economy because it is border-adjustable, i.e., imports would be subject to the tax and exports would subtract the tax. Thus, U.S. corporations and workers would be in a more competitive position at home and abroad. Furthermore, eliminating the corporate income tax would do away with the double-taxation of dividends; the U.S. would become a magnet for foreign investment, and U.S. multinationals would no longer have an incentive to park funds abroad in lower-taxed countries.

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Obama, the banks and crony capitalism

Dec 28, 2009 15:45 UTC

Edward Harrison of Credit Writedowns has a great piece on Obama and crony capitalism:

There is a rather large body of evidence demonstrating that the Bush and Obama Administrations have favored large banks in an unseemly way. The same is true for the Congress and other big business insiders like Big Pharma, the Defense Industry and Health Insurance companies.

Witness these posts from the last month alone:

I could provide you with a far longer list of posts from the January to April period when the Citi and BofA bailouts were conducted and the alphabet soup of liquidity programs began which Bank of America and Citi were prepared to game.

I said in March it’s the writedowns, stupid. When accounting rules were formally changed to reflect the de-facto accounting policies favoring banks, I knew the big banks were on easy street and The Fake Recovery had begun. So, by April, I said Wells profit forecast is a clear bullish sign. Don’t even get me started on the stress tests. They were a sham from the start and were merely a means of recapitalizing the banks via inflated equity valuations. They were neither tests nor stressful, as Bill Black has demonstrated.

More recently, posts by Yves Smith and Bruce Krasting confirmed my long-held suspicions that Fannie Mae and Freddie Mac would be used as a nationalization of America’s mortgage problems via a back door bailout of banks.

The evidence, therefore, tends to demonstrate that we have witnessed an orchestrated campaign by the Bush and Obama Administrations to recapitalize too big to fail institutions by hook or by crook, bypassing Congressional approval if necessary. And when it comes to healthcare, both Congress and the White House have bent over backwards to keep the lobbyists onside. As I see it, our government has favored special interests in the past year of Obama’s tenure to our detriment. … Personally, I don’t buy the line that Obama is a liberal. I consider him more a corporatist (i.e someone who coddles big business).


I meant Will not Greg. The label system is weird here.

One more reason why 2011 looks bad

Dec 28, 2009 15:34 UTC

Interesting analysis from Deutsche Bank, especially the last part which I put in bold (via Econbrowser):

Based in part on CBO estimates, we expect the combined positive effects on the level of real GDP of the tax cuts, transfers, and spending increases in the ARRA package to peak around the middle of next year and then to begin to diminish. Translating these level effects into impacts on the annual rate of growth of GDP yields a boost of 1 to 2 percentage points to GDP growth through mid-2010. That growth effect then drops to zero and eventually turns negative during the second half of the year, subtracting about a percentage point from growth during 2011. This is a key reason why we see growth receding somewhat in 2011 relative to 2010. We have not assumed that a major portion of the Bush tax cuts will be allowed to expire at the end of 2010, but that does pose a downside risk to the forecast.

Me: And here is all that in chart form:



One additional comment: the expiration of the Bush tax cuts in 2011 should actually prove to be a stimulus for the economy in 2010, because it gives individuals and business an incentive to accelerate income, and to realize capital gains and reinvest the proceeds in projects with better returns on investment.

Paul Krugman and the New Normal

Dec 28, 2009 15:26 UTC

Paul Krugman makes his case for the New Normal:

1) Earlier recessions were preceded by sharp rises in interest rates, as the Fed tried to choke off inflation. This produced a housing slump, with a lot of pent-up demand; when the Fed decided that we had suffered enough, it relented, and both housing and the economy sprang back.

2) But later recessions took place in a low-inflation environment, in which booms died natural deaths from overextended credit and overbuilding. Getting the economy growing fast enough to bring unemployment down after these recessions was therefore much harder, since the usual channel of monetary policy — housing — lacked any pent-up demand.

3) So what about our current situation? It’s just like the two previous “postmodern” recessions, only more so, since the bubble before the slump was in housing itself. This suggests a long period of jobless growth; so does the international evidence on the aftermath of financial crises.

That said, there’s been a lot of optimism out there lately, reflected in the steepening yield curve. I’d like to think that’s right. But Ed McKelvey at Goldman (no link) has a new report titled “Recovery more Ho-Hum than Ho-ho-ho”, in which he acknowledges that growth will be good this quarter, but presents evidence that it’s all a temporary inventory bounce.

Goldman Sachs still believes in the New Normal despite rosier growth forecast

Dec 15, 2009 13:58 UTC

Goldman Sachs has boosted its 4Q GDP outlook to 4 percent from 3 percent, yet continues to believe in the gloomy New Normal. Here’s why:

By our estimates, fiscal policy contributed around 2½ percentage points (annualized) to real final demand growth in the second half of 2009. …  The conclusion thus seems to be that fiscal policy has been responsible for most, if not all, of the growth of final demand in the second half of 2009.

While fiscal policy will remain supportive to growth for most of 2010, the size of this boost is set to decline, modestly in the first half and sharply in the second half. (Indeed, our current estimates imply a negative impact in the fourth quarter, although this is obviously subject to new congressional initiatives as the midterm elections approach.) This means that we need an underlying improvement in final demand just to offset the impact of policy through 2010. While we do expect such an improvement, we believe it will be U-shaped rather than V-shaped and hence insufficient to produce an acceleration in final demand growth once the fiscal pattern is taken into account.

Me: Moreover, the firm still thinks job growth will only average 100k a month, not counting census temps. If that number shot up to, say, 250k a month — a level that would really start lowering the unemployment rate, the firm said it might change its view that the private economy was still muddling through at a 2 percent GDP rate without government steroids.