President Ford refused to help New York in 1975, a rejection immortalized as “drop dead.” Historically, the federal government hasn’t bailed out U.S. states and cities facing default. But the EU’s rescue of Greece and the exceptional depth of the recent recession just might change that. Two possible structures for bailouts are budget-avoiding federal guarantees and regulation-bending Federal Reserve bond purchases. Either way, politics may make rescues hard to resist.
Any such action would create huge controversy over constitutional principles of state sovereignty and responsibility. It would also create a potentially hazardous precedent. But that doesn’t make it impossible.
When are big public-sector projects more of a drain than a stimulus for the economy? Strict anti-Keynesians would argue all the time. But even die-hard believers in government stimulus would have a hard time defending the merits of American rail projects. The simple reason: the costs involved are just too high.
Take Amtrak’s plan to improve the rail line connecting the Northeast corridor. The government railroad estimates it would take $117 billion to implement high-speed service. That exceeds the $17 billion cost of China’s longer high-speed train or the adjusted costs of earlier services in France and Japan.
Friday’s U.S. jobs figures provide subdued reassurance. The private sector employment gains of 67,000 in August, together with positive revisions totaling 123,000 for previous months, should dispel fears of an economic double-dip for now. With just one more jobs report before November’s elections, the latest data also offer a glimmer of hope for Democrats.
Continued and fairly steady private sector job growth, together with a surprising decline of 323,000 in long-term unemployment should be reassuring for the unemployed and those fearful of losing their jobs. That’s despite that fact that the end of temporary census employment led to a headline loss of jobs in August. It is also likely to help Democrats in November’s midterm elections, blunting the force of Republican attacks on their handling of the economy.
First ice hockey, now the economy. The annualized second-quarter growth rate of 2 percent in Canada didn’t much beat the 1.6 percent pace in America, but final demand growth at 3.2 percent was much stronger than the U.S. equivalent expansion of 1 percent. That’s an indication that Canada’s economy, though weighed down partly by its neighbor’s weakness, is recovering more robustly.
While Canada’s economy is closely linked to that of its southern neighbor, it has considerable relative strengths. Its banking system is more tightly regulated, so indulged less intensively in the subprime mortgage and derivatives shenanigans that brought the U.S. system to its knees.
You wouldn’t know it to hear officials talk, but the strong yen is not Japan’s main problem. The Bank of Japan’s latest moves on Monday didn’t weaken the currency — though that is one broad objective of fiscal and monetary stimulus. In any case, the trade-weighted yen is weaker than its real 1990-2010 average and Japanese exports are still rising. Export lobbies may have the government’s ear, but intervention could make Japan’s domestic predicament worse.
When the Democratic Party of Japan took office last year, its leaders talked about putting more emphasis on Japan’s domestic economy rather than the needs of major exporters, which had been favored by Liberal Democratic Party administrations since 1955. The DPJ’s first finance minister, Hirohisa Fujii, said at his introductory press conference last September that he was opposed in principle to currency intervention because it could distort the economy.
U.S. Federal Reserve Chairman Ben Bernanke said in his Jackson Hole speech on Friday he would fight deflation — but he ignored the federal deficit. Even Japan has not experienced sustained deflation, while the U.S. deficit remains at record levels. Bernanke’s diagnosis and treatment of a phantom disease are unlikely to produce faster growth.
Sir Ralph Bloomfield Bonington, the quack in Shaw’s “TheDoctor’s Dilemma,” offered a single treatment for all diseases — to “stimulate the phagocytes.” In a similar vein, Bernanke appears to regard the anti-deflationary treatment that the Fed should have applied in 1930-32 as appropriate for all subsequent economic ailments.
South African president Jacob Zuma wants to join the BRICs. The likely deluge of foreign investment from membership of the club representing the biggest fast-growing economies would bring huge benefits. But Zuma has plenty to prove — including that he can avoid the BRICs’ worst failings.
The BRIC concept coined by Goldman Sachs, referring to Brazil, Russia, India and China, has attracted heavy global investment flows. That has speeded the four countries’ growth — although sometimes, as in Russia in 2007, it has also produced dangerous bubbles. With 25 percent unemployment and one of the world’s biggest gaps between rich and poor, South Africa would greatly benefit from a similar surge in foreign investment to employ its people and improve their living standards.
If U.S. railroad Norfolk Southern can issue 100-year bonds, why not the U.S. Treasury? Longer maturities than the current 30-year maximum would reduce refinancing needs and appeal to institutions. But investors might well demand more return for the risks than Treasury would be willing to pay.
Norfolk Southern’s new bonds yield about 0.9 percentage points more than the company’s 30-year debt. There’s a similar spread between yields on Britain’s perpetual War Loan paper and 30-year gilts. Based on the current 30-year Treasury yield of around 3.6 percent, the government would probably expect to sell 100-year bonds at a yield of no more than about 4.5 percent.
The Fed has pointed its policy the wrong way. Spooked by slowing growth, the Federal Open Market Committee decided to loosen money marginally at its latest meeting on Tuesday. This was done by agreeing to reinvest the runoff in the central bank’s agency and mortgage-backed securities portfolio into longer-term government debt.
However, weaker productivity has now joined rising global prices to add to U.S. inflationary pressure. The result is that the Fed has put itself in position to lag any economic shift.
U.S. state and local finances have become truly alarming. At $144 billion the combined budget gap this year for the 50 states is higher than the $133 billion of the previous year. What’s more, last year’s federal stimulus funds, which helped mitigate the gap, will end by December. Since their finances are highly dependent on the economy, if the recovery slows or double-dips, states and local governments could suffer more pain than any other player save the long-term unemployed.
Much of states’ current budgetary problems result from bad decision-making. According to a Federal Reserve Bank of San Francisco study, if California and Oregon had kept per capita state expenditures and taxes constant over the past three years, both states would have had budget gaps for the current year of about 20 percent of state spending. In practice, California continued to increase spending, while Oregon imposed substantial tax increases and restrained spending. Consequently California’s actual 2009-10 budget gap was 37 percent of state spending while Oregon’s was 7 percent.