Daily Archives: November 1, 2011
Well it looks like the much touted Euro economic package for Greece may be coming apart more quickly than expected, thanks to the bombshell announcement by Greek PM George Papandreou. Papandreou has decided, apparently without consulting anyone else, that the package should be put up for a vote. As the Wall Street Journal points out, a no vote could be disastrous:
A "yes" vote in the referendum could deflate the massive street protests and strikes that threaten to paralyze Greece as it tries to enact a brutal austerity program to earn rescue loans from the euro zone and the International Monetary Fund.
A "no" vote, however, could bring down the government and cut off international funding for Greece, leaving the country facing a financial meltdown.
Of course the country is already facing a financial meltdown, austerity measures have sparked violent protests for months and the purpose of the package agreed upon by European leaders was designed to help avert a meltdown and save both the Greek economy (as much of it as can be saved), while propping up the Euro.
As you might imagine, the surprise announcement was not favorably met by other European leaders. In fact, it wasn’t met favorably by a lot of Greek leaders who apparently had no idea that a referendum was in the offing.
Jean-Claude Juncker, who chairs meetings of euro zone finance ministers, refused to rule out a Greek debt default.
"The Greek prime minister has taken this decision without talking it through with his European colleagues," he said in Luxembourg.
Asked whether a Greeks "no" vote would mean bankruptcy for Greece, Juncker responded: "I cannot exclude that this would be the case, but it depends on how exactly the question is formulated and on what exactly the Greeks people will vote on."
I think most understand that no matter how the “question is formulated”, a vote against the plan would most likely send Greece spiraling down the drain and the fear is it would take the Euro with it
Markets, which had calmed down after the plan was announced, have had the expected reaction to the Papandreou referendum plan. They’ve headed down:
Greek Premier George Papandreou said he will put the nation’s bailout deal through a referendum, potentially undoing a long-awaited agreement struck last week and sending European stocks down 3.3 percent. The region’s bank shares fell 6.4 percent.
"European leaders feel as if they’ve been blindsided by Papandreou," said Chad Morganlander, portfolio manager at Stifel, Nicolaus & Co in Florham Park, New Jersey.
He said the move underscored the current risk in Europe and threw a wrench into the region’s stability plan.
The Dow dropped 2% on the news.
While our attention is on the Palinization of Herman Cain, we need to really keep an eye on this impending crisis. If Greece has a referendum and the vote is “no”, what Cain did or didn’t do in the 1990s isn’t really going to matter much. We’ll have another financial tsunami headed our way and we’d better begin to batten down the hatches.
Today’s economic statistical releases:
Weekly retail sales: ICSC Goldman reports a 0.7% weekly rise in same-store sales and 3% year-on-year, while Redbook reports a year-on-year rate of 5.2%.
Despite some positive indicators, the ISM Manufacturing Index fell to a weaker than expected 50.8 from 51.6 last month. On the positive side, the key sub-index of new orders, which have been contracting for the last 3 months, show expansion in this report. The prices paid index also dropped substantially as prices for manufacturing inputs fell.
Construction spending in September gained 0.2% over the pervious month, which is still positive, but far slower than last month’s 1.4%. On a year over year basis, spending fell -1.3%.
Most intuitively know you can’t borrow your way out of debt, so it seems like a silly question on its face. But the theory is that government spending creates a simulative effect that gets the economy going and pays back the deficit spending in increased tax revenues. $14 trillion of debt argues strongly that the second part of that equation has never worked.
The current administration and any number of economists still believe that’s the answer to the debt crisis now and argue that deficit spending will indeed get us out of the economic doldrums we’re in. William Gross at PIMCO tells you why that’s not going to work:
Structural growth problems in developed economies cannot be solved by a magic penny or a magic trillion dollar bill, for that matter. If (1) globalization is precluding the hiring of domestic labor due to cheaper alternatives in developing countries, then rock-bottom yields can do little to change the minds of corporate decision makers. If (2) technological innovation is destroying retail book and record stores, as well as theaters and retail shopping centers nationwide due to online retailers, then what do low cap rates matter to Macy’s or Walmart in terms of future store expansion? If (3) U.S. and Euroland boomers are beginning to retire or at least plan more seriously for retirement, why will lower interest rates cause them to spend more? As a matter of fact, savers will have to save more just to replicate their expected retirement income from bank CDs or Treasuries that used to yield 5% and now offer something close to nothing.
My original question – “Can you solve a debt crisis by creating more debt?” – must continue to be answered in the negative, because that debt – low yielding as it is – is not creating growth. Instead, we are seeing: minimal job creation, historically low investment, consumption turning into savings and GDP growth at less than New Normal levels.
Not good news, but certainly the reality of the situation. Deficit spending has been the panacea that has been attempted by government whenever there has been an economic downturn. Some will argue it has been effective in the past and some will argue otherwise. But if you read through the 3 points Gross makes, even if you are a believer in deficit spending in times of economic downturn, you have to realize that there are other reasons – important reasons – that argue such intervention will be both expensive and basically useless.
We are in the middle of a global economy resetting itself. Technology is one of the major drivers and its expansion is tearing apart traditional institutions in the favor of new ones that unfortunately don’t depend as heavily on workers.
Much of the public assumes we’ll return to the Old Normal. But one has to wonder, as Gross points out, whether we’re not going to stay at the New Normal for quite some time as economies adjust. And while it will be a short term negative, the Boomer retirements will actually end up being a good thing in the upcoming decades as there will be fewer workers competing for fewer jobs.
But what should be clear to all, without serious adjustments and changes, the welfare state, as we know it today, is over. Economies can’t support it anymore. That’s what you see going on in Europe today – its death throes. And it isn’t a pretty picture.
So? So increased government spending isn’t the answer. And the answer to Gross’s question, as he says, is “no”.
The next question is how do we get that across to the administration (and party) which seems to remain convinced that spending like a drunken sailor on shore leave in Hong Kong is the key to turning the economy around and to electoral salvation?
A pair of very interesting articles.
First come the Washington Post’s article on Sunday which discusses the problems with the Social Security program in very honest and stark terms.
For most of its 75-year history, the program had paid its own way through a dedicated stream of payroll taxes, even generating huge surpluses for the past two decades. But in 2010, under the strain of a recession that caused tax revenue to plummet, the cost of benefits outstripped tax collections for the first time since the early 1980s.
Now, Social Security is sucking money out of the Treasury. This year, it will add a projected $46 billion to the nation’s budget problems, according to projections by system trustees. Replacing cash lost to a one-year payroll tax holiday will require an additional $105 billion. If the payroll tax break is expanded next year, as President Obama has proposed, Social Security will need an extra $267 billion to pay promised benefits.
Then comes Paul Krugman’s attempt to dismiss it. For his part, Krugman talks about a myth and presents it as fact:
You see, the WaPo makes a big deal of the fact that Social Security is currently taking in less in payroll taxes than it’s paying out in benefits. Yet this means nothing, except as a favorite point used to create confusion by those who want to kill the program.
I’ve written about this repeatedly in the past, but here it is again: Social Security is a program that is part of the federal budget, but is by law supported by a dedicated source of revenue. This means that there are two ways to look at the program’s finances: in legal terms, or as part of the broader budget picture.
In legal terms, the program is funded not just by today’s payroll taxes, but by accumulated past surpluses — the trust fund. If there’s a year when payroll receipts fall short of benefits, but there are still trillions of dollars in the trust fund, what happens is, precisely, nothing — the program has the funds it needs to operate, without need for any Congressional action.
Alternatively, you can think about Social Security as just part of the federal budget. But in that case, it’s just part of the federal budget; it doesn’t have either surpluses or deficits, no more than the defense budget.
It is the latter that is correct. There is no “dedicated source of revenue” per se. Hasn’t been for years. What exists instead is a pile of Treasury bonds … IOUs the government wrote itself. Congress, years ago, spent the money supposedly to be set aside for Social Security.
Krugman then tries to wave away the fact that even if the “dedicated source of revenue” doesn’t exist, heck, it’s a legal and untouchable (entitlement – must be paid, at least under the law as it exists now) part of the budget and the government will fund it.
That means that regardless of revenue, the government must pay.
So tell me again how, given the unfunded future obligations of Social Security, it matters if the money comes from the mythical “lockbox” that has never existed or the general fund? In either case, unless taxes are drastically increased, the money will have to be borrowed. In either case, Social Security is in the negative – paying out more than it is taking in. Nothing changes that.
Krugman’s last sentence is absolute hogwash. Of course it would have a “deficit” if it was a part of the federal budget. It has a set requirement to pay a certain amount out in benefits. It is a mandatory entitlement by law.
The defense budget is discretionary. There his postulation is correct. That budget is whatever Congress says it is each year.
For Social Security, the deficits would come from unmet and underfunded obligations – note the word: obligations- and it would require the federal government to either raise more revenue or borrow to meet those obligations. That is not true of the defense budget. Playing word games and false analogies to try and wave the truth away doesn’t change that.
But it does cement forever the fact that Paul Krugman has become much less of an economist and much more of a hack than I thought possible.