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The problem is suboptimal output and employment which is evidence of a lack of aggregate demand.
 

Less important what caused the drop in aggregate demand

• The end of the subprime expansion in 2006 reduced the demand for housing
   
• The wind down of the one time Q2 2008 fiscal adjustment (Q2 2008 GDP was up 2.8%)
   
• The Mike Masters inventory liquidation that began in July 2008 added supply from inventories, reducing output and employment
   
• A shift in the propensity to spend due to the pro cyclical nature of credit worthiness

 

My proposals for restoring aggregate demand:

• A full payroll tax holiday - This tax is taking $1 trillion per year from workers and businesses struggling to make ends meet $1,000 per capita in revenue sharing for the States (approx. $300 billion total).
   
• Federal funding for a $8 per hour full time job for anyone willing and able to work that includes federal health care.
   
• Caveat - Unless our demand for motor fuel is cut in half, restoring aggregate demand will also empower the Saudis to set ever higher prices for crude oil which will cause our real terms of trade and standard of living to deteriorate.
   
• Political options for reducing imported fuel consumption:
   
  • Regressive - utilizing allocation by price (Carbon tax, fuel taxes)
     
  • Closer to neutral - mandating higher fuel economy requirements for new vehicles, offering incentives to trade up to more fuel efficient vehicles
     
  • Progressive - substantially reducing speed limits to discourage driving and advantage public transportation

 

Redirect banking to serve public purpose

• Ban banks from all secondary markets.
   
• Allow bank lending only to serve public purpose.
   
• Do not use the liability side of banking for market discipline.

 

Analysis of current situation

• Our leaders believe they must first ‘get credit flowing again’ to restore output and employment.
   
• Unfortunately the reverse is the case; restoration of output and employment will restore the flow of credit.
   
• Government is removing about $1 trillion per year in payroll taxes from employees and employers who can’t meet their mortgage payments and wondering what is causing the financial crisis.
   
• All moves to date by the Treasury and Federal Reserve have only served to shift financial assets between the public and private sectors. Nothing has directly added to aggregate demand.
   
• Therefore the economy has continued to deteriorate, with only the ‘automatic stabilizers’ slowly adding financial assets and income to the private sector, as the counter-cyclical deficit rises.
   
• The rate of federal deficit spending (not counting TARP and other shifting of financial assets that does not directly alter demand, as above) now exceeds 5% of GDP and seems to have begun moving the economy sideways.
   
• The new fiscal package starts taking effect in April. While modest in size, it isn’t ‘nothing’ and will further support GDP.
   
• Employment will not grow until real output of goods and services exceeds productivity growth.
   
• Fuel prices are already moving higher.

 

Conclusion

• Leadership that doesn’t understand how the monetary system works has needlessly prolonged the recession and delayed the recovery.
   
• They have put a premium on ‘confidence’ as the President spends countless hours in front of the TV cameras, when in fact loss of ‘confidence’ means only that federal taxes can be lower for a given level of federal spending:
  

  lower confidence = less private sector spending = less aggregate demand = lower taxes or higher federal spending to sustain output and employment

• The headline USD trillions they have directed towards the financial sector has accomplished little or nothing beyond burning up expensive political capital and credibility.
   
• They are in this way over their heads, and it’s costing us dearly.
   

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My housing proposal:

1. The government does not interfere with the lawful foreclosure process.
2. If the former owner wants to remain in the house, the government buys the house during the foreclosure sale period from the bank at the lower of fair market value or the remaining mortgage balance.
3. The government rents the house to the former owner at a fair market rent.
4. After 2 years the house is offered for sale and the former owner/renter has the right of first refusal to buy it.

While this requires a lot of direct government involvement and expense, and while there is room for dishonesty at many levels, it is far superior to any of the proposed plans regarding public purpose, including:

1. Keeping people in their homes via affordable rents
2. Not interfering with existing contract law for mortgage contracts
3. Minimizing government disruption of outcomes for mortgage backed securities holders
4. Minimizing the moral hazard issue
• foreclosure was allowed to function normally
• renting at fair market rent is not a subsidy
• repurchasing option at market price is not a subsidy

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1. Immediately suspend all VAT and other national transactions taxes.
2. An immediate one time 1% of GDP fiscal transfer from the national government to regional governments.
3. A national service job for anyone willing and able to work to create an employed labor buffer stock for enhanced useful output price stability.

Regarding troubled banks, insolvent institutions should be taken over by government and reorganized to allow for the assets to be sold in an orderly manner and to avoid business interruption for bank clients. When this takes place, uninsured foreign currency liabilities of the insolvent institutions should all be dissolved.

Unfortunately, national budget deficit myths persist and will likely not allow this type of policy to be implemented.

On a technical level, the BOE should sell UK credit default insurance until the cows come home to get those premiums down and dispel notions of UK default risk.

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1. Full ‘payroll tax holiday’ where the Treasury makes all payments for employees and employers.
• Restores incomes to assist those still working to make their payments, keep their homes, and end the credit crisis.
• Reduces corporate cost structure to help contain prices as demand increases.
2. $300 billion in revenue sharing for the States on a per capita basis with no strings attached.
• Enables States to fund operations.
• Enables States fund infrastructure projects.
3. Fund an $8/hr. National Service job for anyone willing and able to work that includes full health care coverage.
• Addresses unemployment from the ‘bottom up’ rather than the ‘top down’ the way other measures do.
• Provides for a far superior price anchor than the current practice of using unemployment for that purpose.
4. Eliminate the need for the Fed to demand collateral from member banks when it lends to them.
• Demanding collateral is redundant and obstructive to lending.
• Allows the NY Fed to hit its assigned fed funds target.
5. Take action to immediately reduce crude oil and crude product consumption.

(Details available on request.)

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Proposals for the Monetary System

The Federal Reserve should immediately lend to its member banks on an unsecured basis, rather than demanding collateral for its loans. Demanding collateral is both redundant and obstructive. It is redundant because member banks already can raise government insured deposits and issue government insured securities in unlimited quantities without pledging specific collateral to secure those borrowings.

In return, banks are subject to strict government regulation regarding what they can do with those insured funds they raise, and the government continuously examines and supervises all of its member banks for compliance. With the government already insuring bank deposits and making sure only solvent banks continue to function, the government is taking no additional risk by allowing the Federal Reserve to lend to its member banks on an unsecured basis.

With the Federal Reserve lending unsecured to its member bank liquidity would immediately be normalized and would no longer be a factor contributing to the current financial crisis or any future financial crisis.

The government should also remove the $250,000 cap on insured bank deposits, as well as remove regulations pertaining to bank liquidity, at the same time it allows the Federal Reserve to lend unsecured to member banks, as individual bank liquidity will no longer be an issue.

The Federal Reserve should lower the discount rate to the Fed funds rate (and, as above, remove the current collateral requirements). The notion of a ‘penalty’ rate is inapplicable with today’s non-convertible currency and floating exchange rate policy.

An interbank market serves no public purpose. It can be eliminated by having the Federal Reserve offer loans to member banks for up to 6 months, with the FOMC setting the term structure of rates at its regular meetings. This would also replace many of the various other lending facilities the FOMC has been experimenting with.

To address the current financial crisis I recommend the following:

• Declare an immediate ‘payroll tax holiday’ whereby the US Treasury makes all FICA Medicare, and other Federal payroll tax deductions for all employees and employers.
• Give the U.S. State an immediate, unrestricted $300 billion of revenue sharing on a per capita basis.
• Fund an $8 national service job for anyone willing and able to work, that includes child care, current Federal medical coverage, and all other standard benefits of Federal employees.
• Have the Treasury directly fund the debt of the FHLB and FNMA, the U. S. Federal housing agencies. This will serve to reduce their funding costs which will be entirely passed through to qualifying home buyers.
  
  There is no reason to give investors today’s excess funding costs currently paid by those Federal Housing agencies when the full faith and credit of the U.S. government is backing them.
• I would also have FNMA and the FHLB ‘originate and hold’ any mortgages they make, and thereby eliminate that portion of the secondary mortgage market. With Treasury funding, secondary markets do not serve public purpose.
• Penalties for mortgage fraud with Federal agencies should be increased and vigorously enforced.

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Dear all-

As one of the European Commission staff members responsible for macroeconomic analysis in the late 1970s and the 1980s, I am among the “depositaires de la mémoire collective”. So it may not surprising that the emerging pressure for a huge fiscal stimulus on top of the already comprehensive bail-outs of banks and now automobile producers reminds me of the call for “concerted action” in the 1970s and which lead to one of biggest fiscal boosts in post-war economic history, although unequally implemented by the various OECD countries. As some of you will remember the “concerted action” was followed by the second oil shock leading to a large deterioration of the EU’s current external account.

Yes, there is a similar risk today if there is a return to even moderate levels of growth and employment, if there isn’t a policy that also results in a substantial reduction of crude oil consumption.

And, unfortunately, since the effects on domestic demand of a fiscal stimulus normally take at least a year to come through the concerted action impacted on the economy at the wrong time and can now also be classified as the major economic policy failure of the post-war period.

With respect to the present situation I have three concerns or questions:

What will be the delays with which the huge stimulus package(s) will have effect on the real economy?

I have proposed a ‘payroll tax holiday’ for the US, where the treasury makes all FICA payments for employees and employers for an indefinite period of time.

This will have an immediate, positive effect on aggregate demand and will also move to quickly repair most credit quality from the ‘bottom up.’

What the banks and autos, for example, need most are consumers who can afford their mortgage payments and afford to purchase cars. The current ‘top down’ approaches, while perhaps ‘necessary’ don’t address this issue.

The credit losses of today in many cases were not there a year ago, and are in no trivial way a responsibility of government that did not make sufficient fiscal adjustments to sustain aggregate demand. This has yet to be understood, and so instead the victims are often being blamed and punished, and conditions continue to deteriorate.

Is it now appropriate to neglect the huge body of economic analysis underpinning the findings and arguments of Lucas (and Ricardo)? In particular, since the current problem is in large part a lack of cash is there not now a major risk that the fiscal stimulus will go directly into an increase in household and enterprise saving without any effects on demand?

If that is the case, it means a larger fiscal adjustment is in order.

Tax liabilities reduce aggregate demand, government spending adds to it. The higher the savings desires, the lower the tax liabilities need to be to ’support’ a given level of government spending.

Spending by central governments (not the national governments in the eurozone, which is a serious, separate matter) with non convertible currencies and floating exchange rate policies is not constrained by revenues. Operationally, said spending is a simple matter of making an entry in the governments own spread sheet.

Yes, ‘over spending’ does carry the (non trivial) risk of ‘inflation,’ but not the risk of solvency or operational sustainability.

Would anybody actually be able to identify and examine the alternatives for public policy in the present situation, as between say:

Further public acquisition of more or less toxic assets, including even acquisition (wholly or in part) of the mortgaged houses and properties in several of the major economies.

A US payroll tax holiday would immediately begin to reduce loan delinquencies which are the root of the credit issue. banking is necessarily pro cyclical and attempting to change that is a counterproductive exercise.

The place for counter cyclical policy is fiscal policy, as the government is the only entity without a solvency issue (again, national governments in the eurozone do have solvency issues due to current eurozone institutional arrangements.)

It is also clear to me that altering interest rates is at best a very weak force for sustaining aggregate demand with growing evidence that lower rates reduce demand through the personal income channel. With governments net payers of interest, the non government sector is a net saver, and cuts in rates necessarily lower interest income of the non govt sector. At the same time, in a downturn credit worthiness of borrowers deteriorates, and the interest rates borrowers pay does not fall as quickly as rates for savers fall. instead, margins for lenders increase to reflect the increased risk.

Also, all the CB studies i have seen show output and inflation responses to interest rate changes are at best relatively small and seem to have maybe a two year lag, which generally takes them across the next fiscal cycle.

Further nationalization of the failed banks and other corporations, with, of course, the options of re-privatizing them once the markets have stabilized.

My first banking job was in the early 70’s, when US housing starts peaked at over 2.5 million per year, with a population of only 215 million people, and all facilitated by sleepy savings banks run by very modestly paid bankers who did nothing more than gather deposits by giving away small kitchen appliances and make mortgage loans with up to 75% loan to value ratios.

In the latest cycle, US housing peaked at 2.1 million annual units, with a population of over 300 million people, and it was termed ‘gang busters’ and an unsustainable bubble.

Banks are agents of government that exist for public purpose. Let me suggest both theory and experience shows that complex finance preys on the real sector, rather than enhances it.

That said, we do have to play the cards we are dealt, so let me continue by saying the eternal lesson of banking is that the liability side is not the place for market discipline. Instead, market discipline is best applied on the asset side, with (strict) regulation and supervision of capital ratios and asset quality. We have again learned that the ugly way, as we watched interbank conditions deteriorate as the fed agonizingly slowly worked towards making sure its member banks have secure sources of funding at the fed’s target rates. And they still aren’t there yet. It yet to be fully recognized that the Fed demanding collateral when it lends to member banks is redundant- the FDIC and OCC already regulate bank capital and asset quality, and the FDIC already allows the banks to fund all their assets with FDIC (govt) insured deposits.

What is also missed by the media, most mainstream economists, and even senior fed officials, is that monetary policy is about price, and not quantity. fed actions do not alter net financial assets of the non govt sector, as a simple matter of accounting. Fed actions do alter various monetary aggregates, but in general this alteration per se has no further economic ramifications. i recall that after the ‘500 billion euro day’ there was a futile search of the ECB’s numbers published the following week to see ‘where the money went’ and no one could find it.
And the us stock market was moving wildly up or down when the size of a Fed repo operation was announced.

Even today the news continues about the fed ‘throwing trillions of liquidity at the markets’ ‘blowing up it’s balance sheet’ as if that mattered beyond the setting of interest rates.

The same media, economists, and officials also miss the fact that with non convertible currency and floating FX causation runs from loans to deposits. Bank lending is (in general) not constrained by ‘available funds’ as it would be with a fixed exchange rate policy. ‘Giving’ banks ‘money’ (reserve balances) to get them to lend is conceptually absurd, for example, as is criticizing banks for ‘hoarding money.’

These are all throw backs to the era of the gold standard, where there were actual supply side constraints on the convertible currency needed for reserves where depositors demanded that convertible currency for withdrawals. And even the treasury had to compete for convertible currency via interest rates when it borrowed to spend. This is still the case today with the odd fixed exchange rate policies that currently are in force.

The problem with the fiscal stimulus is, I think, that it will take time to get adopted and impact on the economy and that, consequently, it is unlikely to prevent a further deterioration of the overall economic prospects during the next twelve months, a period which may be critical for the overall financial and economic stabilization.

A payroll tax holiday would have immediate, substantial results, as they currently remove about $1 trillion annually from us workers and businesses, and are highly regressive.

Additionally, $100 billion of federal revenue sharing for states to use for their operating budgets would immediately reverse the troubling trend towards the reduction of essential public services due to state revenue shortfalls.

When there is undesired excess capacity, as is the case today, government has the option of directing it towards either public or private goods, services, and investment. The payroll tax holiday directs that output towards restoring private sector goods and services, while state revenue sharing results in increased public goods and services.

The choice is purely political. My proposals are based on what I think are politically desired at this time.

Maybe, and as some observers have already suggested, the Swedish experience could provide some lessons for understanding the issues at present.

I would sincerely welcome a debate on these issues.

For the eurozone, under current arrangements the only entity without a solvency issue is the ECB. What is needed is some channel for the ECB to conduct the type of counter cyclical fiscal policy needed to restore eurozone output and employment. Otherwise, the eurozone will continue to perform well below its potential.

Let me last say that the Fed’s swap lines to many of the world’s CB’s are qualitatively very different from its domestic monetary operations. The funds advanced are functionally no different from purchasing ‘$ bonds’ from the various CB’s around the globe, yet have remained far below all radar screens, including Congress’s. Do you think the US congress would approve a $30 billion loan to Mexico? A $350 billion loan to the ECB? Maybe, but I suspect there would be, at a minimum, much debate. Yet the fed has been allowed to do this, and in ‘unlimited quantities’ for the BOJ, BOE, SNB, and ECB’ without any oversight.

Tax liabilities reduce aggregate demand, government spending adds to it. The higher the savings desires, the lower the tax liabilities need to be to ’support’ that spending.

Sincerely,
Warren Mosler

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(email exchange)

>   
>   On Tue, Nov 25, 2008 at 2:22 AM, Michael wrote:
>   
>   Warren: If you get a moment, I was wondering what your reaction is to
>   this latest Heritage Foundation analysis below. This is certainly an ideal
>   time for our message–new administration, public looking for new
>   answers, skepticism about the downside of deficits, and hugely
>   challenging economic stagnation that almost certainly requires new
>   thinking. –Michael.
>   

You got it!

See below:

How to Successfully Stimulate the Economy

When the economy is struggling, Congress has a tendency to invoke the same tried and failed policies of the past. Typically, these policies promise hundreds of billions of dollars in government spending while doing little to actually revitalize economic activity. The first round of stimulus checks, like those rebates issued in the 1970s and 2001, were a bust, with only a small portion (perhaps less than 30 cents on every rebate dollar) used for consumption. Furthermore, prior government spending on infrastructure such as highways merely transferred–rather than created–wealth.

The 2001 fiscal adjustment was too small to reverse the negative effect of the surplus years that caused the collapse. The 2003 adjustment was much larger and had a larger effect and did result in reasonable growth, but that growth was allowed to bring the deficit down to where it was too small to continue to support growth and employment.

The sub prime fraud driven credit expansion did help prolong the post 2003 upswing, but that boost ended when the fraud was discovered and demand from housing slowed.

During the current period of slow economic growth, Congress should do what it does best: set broad economic policy. Specifically, Congress should concentrate on signaling to investors and workers alike that its principal focus will be on improving pro-growth economic policy, mainly in the areas of tax, energy, and spending policies. The test for distinguishing good stimulus ideas from bad ones should be this: Is the proposal likely to raise the economy to a sustained, higher level of growth?

The broad choice is whether to foster an increase in the consumption of private or public goods.

Tax cuts, for example promote private consumption, where infrastructure spending, for example, is public consumption.

Public consumption can be for short term private consumption (law enforcement, public ceremonies, etc) or for investment in public goods for long term private consumption (building roads for economic investment, monuments for well being investment, etc)

In any case, a growing economy in general requires spending exceed tax liabilities on a continuous basis.

Tax Policy
What can increase risk for investors and businesses? Many factors, of course, but public policy commonly looms largest. For example, tax increases, especially on capital, increase the cost of capital and lower investment returns. When investors are uncertain about whether taxes will increase or stay the same, they can still act as though taxes have risen if they judge the risk of an increase to be nearly equal to an actual increase. And rising uncertainty can have the effect of driving down investments in riskier undertakings. Congress can take the following actions on tax policy:

• Make the Tax Reductions of 2001 and 2003 Permanent.
  Among the first actions Congress can take to address the current economic slowdown is to make a definitive statement regarding the tax increases scheduled for 2009 and 2011. There are projects, new businesses, and expansions of existing businesses that would be undertaken today if Congress signaled that taxes would be lower in three years.

Maybe some, but the problem now is lack of sales. Taxes that are only on profits aren’t all that influential when profits and sales are expected to decline. While after tax income is always welcome, I’m sure most businesses would vote for an increase in sales as more beneficial than a decrease in tax rates? For example, the autos have operating losses, so tax rates would not alter investment decisions?

• Since nearly all major capital undertakings last beyond this three-year period, it is likely that making all or most of the Bush tax reductions permanent would stimulate economic activity today as well as in 2011. If Congress increases taxes, then investors will find more favorable economies to support and business owners will, as much as they can, locate their expanded activities in other countries with more favorable tax regimes.

The lower taxes are needed to increase current output and employment via increasing sales. Countries that have high rates of employment in an environment where business can profit attract investment, as in the US in the late 90’s.

• Accelerate Tax Depreciation

Past economic slumps have proven that accelerating the tax depreciation of capital equipment and buildings or the one-year expensing of business purchases that would otherwise be depreciated over a longer period of time for tax purposes can help during periods of slow growth.

I would suggest that depreciation attempt to follow the actual useful life of assets to not distort investment decisions.

• Lower the Corporate Profits Tax.

In one area of tax policy, there is now nearly universal agreement: Our federal business taxes are far too high. The U.S. tax rate on corporate profits is the second highest in the world. Why is it not the firm policy of this country’s government to ensure that the corporate profits tax is always below the average corporate income tax of other industrialized countries? Such a policy would enhance our competitive standing worldwide and significantly reduce the incentive for U.S. firms to relocate to lower tax countries.

There is a valid argument that corporate profits not be taxed at all, as the profits are passed through to investors, who should show the income on their annual earnings, as with sub S- corps and LLC’s.

The current 30% corp tax rate and 15% dividend tax get pretty close to this but are still higher than the highest personal income tax rate.

By making the 2001 and 2003 tax reductions permanent and reducing the corporate profits tax by 1,000 basis points, an annual average of 2.1 million more jobs would be created. Indeed, 3.4 million jobs above a current law baseline would be created in 2018 by newly energetic businesses.

Only if there is an increase in sales (retail and wholesale).

I don’t think that proposed adjustment reduces taxes enough relative to government spending to return us to levels of output coincident with, say, 4% unemployment.

These tax changes dramatically increase the level of national output, and household income rises as the result of a healthier economy and lower taxes. In fact, the average household would have $5,138 more to spend or save after paying their taxes, and by 2018 this amount would jump to $9,750.

The initial adjustment isn’t that high and investment made without a population that has sufficient income to buy the new output will not result in a healthy economy, but instead more of what we have now.

Energy Policy
Rapidly increasing prices for gasoline and petroleum-based energy slowed the economy and helped bring about our current recession. Additionally, the effects of such increased energy prices continue to impede job and income growth. If Congress acts to expand energy supplies, forward-looking prices will fall and economic activity will shed off the drag stemming from this sector.

Without cutting gasoline consumption first, any expansion will help the Saudis (currently the only crude exporter with excess capacity) should they decide to again hike crude prices.

The Heritage Foundation’s Center for Data Analysis analyzed the economic effects if domestically sourced petroleum increased by 2 million barrels per day, and it found that such an increase would expand the nation’s output–as measured by the Gross Domestic Product–by $164 billion and increase employment by 270,000 jobs annually.

Yes, it may eventually (10 years down the road) expand output by that much, but during the next few years the increased employment and income you predict would increase gasoline consumption and support higher prices that would reduce our real terms of trade and siphon off our real wealth via the export channel, thereby reducing our real standard of living.

If Congress were to announce greater access to proven reserves, mining activity would immediately begin, capital and talent would leave other parts of the world and travel to the U.S., forward-pricing markets would feel the downward pressure on prices as the result of impending supply increases, and ordinary Americans’ concerns over their economic future would lessen.

I’d guess supply increases in petroleum of only 2 million barrels a day pending for 10 years in the future will not offset the immediate consumption increase.

The other, more fundamental issue is whether we want economic growth that increases energy consumption via burning things.

(Though with all the geopolitical problems associated fossil fuels I’ve often thought it would be nice to use them all up as quickly as possible and get it over with, behind us, and move on…)

Spending Policy
While the attention of most policymakers will be on immediate responses to the current slowdown, the seeming unwillingness of Congress to seriously address the enormous financial challenges from entitlement spending should not go unnoticed.

Many investors and organizations that play key roles in the future of the U.S. economy are worried about long-term growth given the fiscal challenges posed by Social Security’s and Medicare’s unfunded liabilities.

The challenge is only that of any future inflation that spending might induce. Clearly, however, that is not a concern as no one has ever published an inflation warning from those programs. And no one has expressed concern that the elderly are consuming too many real resources, or that as a nation we should reduce health care services.

At a time when the economy is slowing and the voice of Congress, as well as its actions, can affect economic activity, policymakers should take concrete steps that will announce their intention to address unfunded liabilities in these important programs. While reforms in these programs may be beyond what this Congress can accomplish, it is possible to signal change by reforming the budget rules.

As above, until there is a case to make that those expenditures will cause politically undesired levels of inflation there is no evidence of a ‘problem’.

Additionally, even if it were deemed future inflation was an issue, taking actions that would reduce aggregate demand today and thereby decrease current output and employment is necessarily counter productive.

Currently, the federal budget functions on a pay-as-you-go system, with a very limited forecast of obligations and supporting revenues. It is impossible for the official budget to predict what may happen over the next 30 years; the five- and 10-year budget windows do not permit Members of Congress or the general public to sense the obligations that are coming beyond that 10-year horizon. However, Congress can take two important steps in addressing the long-term entitlement obligations of the U.S.:

• Show These Obligations in the Annual Budget.
  This could be done by amending the budget process rules to include a present-value measure of long-term entitlements. Such a measure would express in the annual budget the current dollar amount needed today to fund future obligations. Such a measure has been endorsed by a number of accounting professionals, as well as the Federal Accounting Standards Advisory Board.

This would be an interesting exercise that can also include the estimated ‘demand leakages’ that reduce aggregate demand, such as pension fund contribution, insurance reserves, IRA contributions, etc. and add to the need for spending to exceed taxes to sustain output and employment.

I would expect this calculation to show that future government deficits continue to fall short of the projected demand leakages, as has been the case in generally since 1945.

• Convert Retirement Entitlements into 30-year Budgeted Discretionary Programs.
  Such a move recognizes that mandatory retirement funding programs for millionaires that crowd out discretionary spending programs for homeless war veterans.

Government spending can only be ‘crowded out’ by inflation fears due to lack of real output capacity. With today’s excess capacity, and projections of future excess capacity, we can readily afford any additional desired government spending for homeless war veterans.

• do not make any sense at all. If we are to contain entitlement spending and reform the programs driving those outlays, then a paradigm shift will likely be required. Recognizing Social Security and Medicare as discretionary programs helps to force attention on changes that will assure their survival well into the 21st century.

We can readily afford any additional spending as long as there is excess real capacity.

Greater Predictability, Greater Productivity
Serious work by the Congress on tax, energy, and spending policy will create greater predictability for investors and business owners and assure workers that they will have a better chance of improving their wages through increased productivity.

Right, and a long term plan by Congress for its expenditures will be the backbone driver of that growth.

Efforts to enhance this nation’s long-term economic health may very well have immediate, short-run benefits as economic decision makers reduce the risk premium they place on starting new businesses or expanding existing enterprises.

Business has a long history of tagging along on the lead taken by Congress from its direct spending and incentives it puts in place.

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1. Effective immediately have the Tsy make all FICA payments on behalf of employees and employers. Leave this arrangement in place at least until it is deemed that the economy is growing too rapidly.
   
   These payroll taxes currently reduce income by about $1 trillion per year for employees and employers and are highly regressive.
   
   Removing these payroll deductions will immediately add about $20 billion per week of ’spending power’ to the economy on an ongoing basis, and all the funds benefit workers and businesses.
2. Effective immediately distribute $100 billion in unrestricted federal revenue sharing to the states on a per capita basis.
3. Make another $200 billion of federal revenue sharing available to the states for general infrastructure repairs and projects.
   
   This will effectively increase take home pay, remove a cash drain on business, address infrastructure needs, and support employment and income in general.
   
   What Wall St. and Main St. need most are consumers who have the funds to make their mortgage payments and car payments, and be able to buy what the US can produce.
   
   This ‘bottom up’ approach will work, while the current ‘top down’ proposals may eventually show results but will take far longer to reverse the current slowdown.
   
   And while my proposals will result in an immediate recovery, they do not address the energy issue.
   
   Any recovery will drive up energy prices if consumption is not first reduced by both the private and public sectors.

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Initial recommendations for President Obama:

• Offer a $10 per hour national service job to anyone willing and able to work.

• Declare a payroll tax holiday and have the Treasury make all FICA payments at least until the economy is deemed to be ‘overheating.’

• Cut the national speed limit for private ground transportation to 30 mph to immediately reduce gasoline consumption (and save lives).

• Implement needed infrastructure spending for deferred maintenance.

• Suspend the Fed swap line program.

• Suspend a variety of the recent, counterproductive assistance programs to the financial sector.

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Here’s my proposal for banks that are presumably capital constrained:

Offer borrowers a package deal:

The borrower agrees to buy new bank VCP (variably convertible preferred) stock equal to, say, 10% of their proposed borrowings. This creates ‘balance sheet’ for the bank which then has the new ‘room’ to make the loan and then some. (Banks generally have 8% target capital ratios.)

The VCP functions as a ‘first loss piece’ for the bank as well.

Terms of the VCP might include an interest rate equal to the loan rate, and a variable conversion ratio designed to give the borrower all his funds back if he doesn’t default.

The VCP non-dilutive to the holders of common shares.

This VCP proposal can free up and create new balance sheet and raise capital as it services borrowing desires.

Feel free to forward this to everyone you know in banking.

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What do you see happening in the next 6 months?

Negative US GDP likely until the budget deficit gets high enough to reverse it, much like 2001-2003.

Back then the very large (and retroactive) fiscal package turned the tide, not monetary policy.

Doesn’t look like an immediate $500 billion+ fiscal package is in the cards anytime soon.

Particularly with Congress thinking they just ’spent’ $700 billion.

Banking problems lingering on but interbank lending will no longer be an issue.

Lots of traditional bank closures by the FDIC as the slowing economy results in more main stream business failures and loan losses.

Accelerating use by the 4 CB’s of the Fed’s unlimited USD swap lines as those demands grow as well.

If the Fed cut them off, for example, as their total borrowings soar past $1 trillion, their currencies and economies would all head towards collapse.

This is NOT good!

And I’m not always this negative. For the last year and a half I’ve been about the only one saying ‘no recession’ for a while due to government spending, exports, and our pension funds ‘monetizing’ their assets with passive commodity investments. (All this was in past blogs and emails.)

Then something snapped in July/August,

Probably triggered by the collapsing oil prices as Mike Masters successfully got Congress to at least discourage our pension funds from their sector shift to passive commodities.

This also removed aggregate demand, and falling commodity prices also cut the import bill of the US, thereby hurting foreign demand.

Potentially the fall in crude will help the US consumer but that takes a while, especially when the media has driven him into a foxhole, as evidenced by the rising ’savings rate’ (which is mainly the ‘flip side’ of the rising US budget deficit. Government deficit = non government savings, etc.)

Fortunately it is ultimately all self correcting- the automatic stabilizers will increase deficits until they are large enough to turn the world economies.

Except for in the Eurozone where rising deficits can make the member nations insolvent.

Bottom line= we need a US payroll tax holiday NOW to keep it all from getting a lot worse.

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Seems at this late hour the payroll tax adjustment is about all that can get the job done to immediately support demand.

Yes, the banking model is to make loans to individuals and business that become illiquid assets and match that with liabilities that are not at risk either.

So if markets put a discount on bank assets due to liquidity, implied is a premium on the liability side of banking due to its unlimited ability to fund itself.

And yes, it’s when, via securitization, for example, relatively illiquid assets are not ‘match funded’ to maturity, liquidity risk is there.

This same liquidity risk is also there when banks are not provided with secure funding due to errant institutional structure that misses that point regarding the banking model.

Beyond that is the risk of default which is a separate matter.

In the banking model this is determined by credit analysis, rather than market prices.

This is a political decision, entered into for further public purpose, and requires regulation and supervision of asset quality, capital requirements, and other rules to limit risks banks can take with their government-insured deposits.

When banks are deemed insolvent by the FDIC due to asset deterioration, they shut them down, reorganize, sell the assets and liabilities, etc.

When it’s due to excessive risk due to a failure of regulation, regulations are (at least in theory) modified. It’s all a work in progress.

I see this crisis differently than most.

We had two thing happening at once.

First, by 2006 the federal deficit had once again become too small to support the credit structure as financial obligations ratios reached limits, all due to the countercyclical tax structure that works to end expansions by reducing federal deficits as it works to reverse slowdowns by increasing federal deficits.

At the same time, while the expansion was still under way, delinquencies on sub prime mortgages suddenly shot up and it was discovered that many lenders had been defrauded by lending on the basis of fraudulent income statements and fraudulent appraisals.

Substantial bank capital was lost due to the higher projected actual losses reducing the present value of their mtg based assets. This is how the banking model works. The banks were, generally, able to account for these losses due to projected defaults and remain solvent with adequate capital.

Outside of the banking system (including bank owned SIV’s - one of many failures of regulation) market prices of these securities fell, and unregulated entities supported by investors (who took more risk to earn higher returns) failed as losses quickly exceeded capital. And with this non-bank funding model quickly losing credibility, all of the assets in that sector were repriced down to yields high enough to be absorbed by those with stable funding sources - mainly the banking system.

But the banking system moves very slowly to accommodate this ‘great repricing of risk’, and all the while the fiscal squeeze was continuing to sap aggregate demand. The fiscal package added about 1% to gdp, but it hasn’t been enough, as evidenced by the most recent downturn in Q3 GDP, which is largely the result of individuals and businesses petrified by the financial crisis.

So yes, there are both issues: the financial sector stress and the lack of demand. While they were triggered by two different forces (loan quality deteriorating due to fraud and the budget deficit getting too small), it is the combination of the two that is now suppressing demand.

The TARP may eventually alleviate some of the lending issues but only addresses the demand issue very indirectly and even then with a very long lag. Just because a bank sells some assets (at relatively low prices) doesn’t mean it will suddenly lend to borrowers who want to spend. Nor does it mean they will want to fund euro banks caught short USDs that have no fiscal authority behind their deposit insurance and bank solvency, and now appear to be in a worse downward spiral than the US. The slowing US economy has reduced the world’s aggregate demand, which was never sufficient to begin with due to too small budget deficits, via reduced exports directly or indirectly to the US.

In other words, I don’t see how the TARP will restore US or world aggregate demand in a meaningful way.

Yes, the US budget deficit has been increasing, but not nearly enough. It’s only maybe 3% of GDP currently, while the US demand shortfall is currently maybe in excess of 6% of GDP.

Cutting the payroll taxes (social security and medicare deductions, etc.) is large enough (about 5% of GDP) and returns income to the ‘right’ people who are highly likely to immediately support demand as they spend and also make their payments on their mortgages and other obligations to thereby support the financial sector in a way the TARP can’t address.

It is the ’silver bullet’ that immediately restores output and employment. But we all know what stands in the way - deficit myths left over from the days of the gold standard that are now inapplicable with our non-convertible currency.

The line between economic failure and prosperity is 100% imaginary.

And not to forget that if we do restore output and employment (without an effective energy policy) we increase energy consumption and quickly support the forces behind much higher energy prices, which reduces are real terms of trade and works against our standard of living.

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There is only one immediate response that will turn the tide that I know of.

The US Congress can declare a ‘tax holiday’ and lower the ‘payroll taxes’ (social security, medicare, payroll deductions) at least temporarily to 0%.

This tax is currently killing about $80 billion a month in aggregate demand- about $1 trillion per year.

This would IMMEDIATELY add maybe 5% to GDP.

The financial sector is immediately supported as the increase in after tax incomes allows workers to make their mortgage payments and pay their other costs of living.

This is ‘trickle up’ economics at work.

Politically, it would look like this:

Rather than Congress taking $700+ billion from taxpayers (and removing that much aggregate demand) and allocating $700+ billion to buy securities from the financial sector which adds no aggregate demand), and hoping for this to somehow ‘trickle down’ to the real economy.

Congress instead lets workers keep their $700+ billion so they can make their mortgage payments and support the real economy as the funds ‘trickle up’ to the financial sector.

There are no ’scare resources’ causing this financial crisis and slow down.

It’s a purely ‘nominal’ event that’s causing the problems.

That’s why a ’solution’ is necessarily ‘easy’ and immediately executable.

All we need to do is change numbers on spreadsheets.

It is only a vote to change those tax rates that is separating the world from an instant return to prosperity.

And once again that vote probably won’t happen due to the absurd myths about government deficits that should have fallen by the wayside decades ago.

Warren

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The short version of my current alternative proposal to the TARP remains:

1. Normalize bank liquidity by allowing Fed member banks to borrow unsecured from the Fed in unlimited quantities.
2. Have the Fed set term lending rates out to 3 months in addition to the Fed funds rate.
3. Extend FDIC insurance to Fed deposits at member banks to keep any insolvency losses at the FDIC.
4. Remove the cap on FDIC insurance to eliminate the need for money market funds.
5. Declare a ‘payroll tax holiday’ and reduce social security and medicare payroll deduction rates to 0% until aggregate demand is sufficiently restored.

This would immediately end the current crisis.

Remaining issues include the increased demand for energy consumption as the economy recovers, and associated price pressures.

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Short version updated for current events.

If you agree, please distribute, including your Congressman, Fed officials, FDIC contacts, etc.

1. Have the FDIC remove the $100,000 cap on deposits and extend insurance coverage to include Fed deposits at member banks.

2. Have the Fed set 1 month, 2 month, and 3 month lending rates for member banks in addition to the fed funds rate, which, with the above, it can now lend to unsecured in unlimited quantities on demand.

This:

• Instantly normalizes bank liquidity, returning it to where it was designed to be all along.
• Largely eliminates the need for banks to use the interbank market.
  functionally replaces the TAF and the Treasury lending facility without their shortcomings.

3. Declare a payroll tax holiday and have Congress put the full faith and credit of the US behind all social security and medicare to eliminate the function of the trust fund regarding solvency.

This supports demand. The taxes can be restored as needed should the economy be deemed ‘too hot’.

• Crisis ends within hours.
• Markets recover instantly.
• Economy recovers instantly.
• Financial sector muddles through as restored incomes and growth allow the institutions to grow out of their issues.

This can be looked as a plan that ‘gives the tax payers their money back’ vs the reverse from the current TARP that has no direct effect on anything in any case.

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Time for something they can all understand that would turn it all around like it never happened: a payroll tax holiday until the economy recovers.

It favors lower income workers.

It’s an immediate add to aggregate demand of over 3% per year annualized.

It lowers costs for businesses to help keep prices in check.

They can phase it back in to cool things down if the economy overheats.

And it would be a good time for Congress to put its full faith and credit behind promised social security checks regardless of the trust fund reserves.

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Under this proposal from treasury, they would ask for offerings from the banks and then take the lowest prices for up to $50 billion at a time.

This means they will be paying more and more for each round of purchases, driving up the prices from current market value.

And if the plan is to spend the entire $700 billion they could drive prices up through the roof.

They would need to limit the prices they are willing to pay somehow.

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>   
>   On 8/3/08, Craig wrote:
>   
>   Ok. And the irony is as prices fall, demand increases again.
>   Until consuming governments get their head around that fact
>   and put some kind of floor under crude prices to incent
>   substitution (which may be beyond their thinking and/or impossible
>   politically), it seems like crude prices are gonna play rope-a-dope
>   with consumers.
>   
>   
>   Craig
>   
>   

Crude will be rationed as is everything else (scarcity, etc.).

The question is how. Ration by price or by other things?

Rationing by price is the most pervasive and means the wealthy (by definition) outbid the less wealthy for the available supply.

Make you wonder why the Democrats support higher prices, as that means they support their supporters going without while the wealthy drive any size SUV they want. Much like wondering why Obama supports Bernanke after Bernanke explained to Congress how he’s keeping inflation down by keeping a lid on inflation expectations after explaining the main component of inflation expectations is workers demanding higher wages, meaning Obama, Kennedy, and the rest of the left is praising Bernanke for doing a good job of suppressing wages.

Non-price rationing is less common but not unfamiliar, such as mandating cars get an average of 27 mpg, minimum efficiency standards for refrigerators, windows, etc. This takes an element of rationing by price away and results in the wealthy consuming less and leaving some for the less wealthy to consume a bit.

So seems to me the logical path for the Democrats would be something like my 30 mph speed limit for private transportation, which is ‘progressive’ and also drives the move towards public transportation with non price incentives as previously outlined. But there hasn’t even been any discussion of a progressive policy response. All seem highly regressive to me.

So I expect the world’s new and growing class of wealthy will continue to outbid our least wealthy for fuel and other resources.

Also, there may be limits to how high we want world consumption/burning of fuels for all the various ‘green’ reasons.

That would mean drilling and other production increases are out, as would be increased use of coal via the electric grid for electric cars.

And, again, it would be the world’s wealthy outbidding the less wealthy for consumption of the allowable annual fuel burn, as somehow allocation by price continues to rule.

Most paths keep coming down to the continuing combination of weakness and higher prices.

Warren

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(comments from my brother, Seth, who was cc’d)

>   
>   I think democrats have lots of business and profits waiting
>   in govt subsidies for wind and solar. If oil prices fall that goes
>   away for now and they can’t produce on the subsidies for
>   them-cynical view but probably true
>   
>   There are also a lot of wealthy democrats and they want their
>   votes. Poor people all vote for democrats anyway-even with
>   declining lifestyles they are not going to McCain. So I think
>   Obama is pandering to the wealthy-it might be who he is-no
>   one really knows.
>   
>   With all of their green talk I have not seen any of them reduce
>   air travel, suv caravans or turn off the a/c in the capital. Just a
>   way to get votes and sound concerned. I saw a tv program
>   about how the chinese olympic swimming building is a green
>   sustainable building. It is 7 acres, pools, 25,000 people.
>   they finally said it uses about 25% less energy than a comparable
>   building would have. That is not green or sustainable, especially
>   since the building was not needed in the first place. I think “green”
>   is about making money, not the environment.
>   
>   
>   Seth
>   

I just can’t allow myself to be that cynical like you new yorkers!

:)

Warren

>   
>   
>   I think I am cynical usually, but this green thing drives me nuts
>   it started 30 years ago but is now all about money
>   when I see some lights turned off in Times Square (even in the
>   daytime) or the 5 huge spot lights on the CBS building lighting up
>   Katie Couric’s 50′ x 30′ poster which are on 24 hours a day turned
>   off, then I will believe it is about resources and not money.
>   there is a long way to go.
>   they advertise expensive green buildings here-I am not kidding-the
>   big thing is thermostats with timers on them and bamboo floors-didn’t
>   we have those 30 years ago??
>   
>   they talked about the oscar ceremony being green this year-the
>   celebrities were all giddy about it-what they did was use red
>   carpet made of recycled fibers????? what is that?
>   absolutely nothing-
>   anyway, time to calm down. too much excitement here
>   seth -
>   
>   

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Interesting no one even mentions anything close to my proposal:

Lower the national speed limit to 30 mph for private ground transportation.

That would:

• Directly cut gasoline consumption as vehicles are far more fuel efficient at 30 mph than 60 mph.

• Directly cut air and other pollutions.

• Reduce long distance driving due to time constraints

• Increase the demand for public transportation due to time savings issues

• Reduce the needed safety features as you can’t hurt yourself all that much at 30 mph

• Lead to much smaller cars and therefore better ‘packaging’ in the cities, reducing traffic and parking demands

• Change relative real estate values currently distorted by relatively cheap fuel

The reduction in consumption could be up to 5 million bpd in the US alone, which would:

• Provide the net supply shock capable of reducing crude and refined product prices

• Improve our real terms of trade and restore our quality of life

• Increase national security by reducing dependence on foreign oil

• Slow environmental degradation

It’s a political choice- ration by price as we are currently doing, or use other methods, some of which we already do, such as fuel economy standards.

This proposal simply adds the price of ‘time’ to burning gasoline for all private transportation, thereby making fuel efficient, cleaner, less resource intensive, alternative transportation more attractive.

Feel free to try to make it happen if you agree!

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