The better question is “what steps can we take to increase sound economic activity?”
Everyone laughs at jokes about economists, yet we still defer to their professional expertise. There is little evidence that economics as a mode of thought has much to say of relevance to us in the current crisis. What prominent economists risked professional reputation to clearly predict or act to prevent the great recession? For the last 60 years the most influential economist in the world has been the Chairman of the Federal Reserve Bank in the US. Alan Greenspan coined the term “constructive ambiguity” to describe his communication as Fed Chairman and seemed to enjoy having markets sift through the meaning of his utterances. He was not only a master at doublespeak, he showed a brilliant sense of timing as he handed the reins off to Ben Bernanke. Bernanke has the bearing of a decent if somewhat befuddled old sage. The public has apparently accepted the notion that it is the Fed Chairman’s duty to mutter obscurities. The very concept of an apolitical Central Bank suggests that we aren’t mature enough to elect politicians who will make responsible economic policy decisions. The maturity of our electoral choices doesn’t look very good. However, the notion that our interests are better served by a central bank with apparently unlimited economic power answerable only to its own interpretation of the public good looks even more suspect.
There are certain principles and patterns that economics can usefully describe. What renders economists impotent is the presumption that economics must limit itself to the description of what is and steer clear of discussing what should be. What is and what should be are not independent topics in human affairs. Economic activity always occurs in a social, moral and political context. Economic initiatives such as taxation, stimulus spending and Fed market interventions always create political and economic winners and losers. The function of economists has largely become merely that of providing intellectual cover for policy makers. They have tended to obscure more than to illuminate. In this crisis we have many displays of policy makers taking monumental decisions with no public accountability. One simply cannot tell if today’s decision is about avoiding accountability for yesterday’s mistakes or about doing what is needed today. The more that we have ceded power and control to the central government the more that economic policy has become a political contact sport.
I have attended several dozen economic briefings from many different presenters in the last several years. They all follow a similar format. Amidst the charts and graphs the presenter tries to tell us when this economic “cycle” will end. They speak as if markets were subject to some inexorable force of nature completely independent of the thoughts, moods, fears and aspirations of the people who are making employment, purchasing and investment decisions. Their polite listeners talk a different language at the bar after the presentation. People lack the confidence to publicly challenge credentialed economists, but they seem to know what the economists do not know or won’t say in public. This is not a mere business cycle that will pass with time like a bad case of the stomach flu. When the “cycle speak” is over, people know that this is an existential crisis; one that cuts to the heart of who we are as people. Here are some of the disturbing trends I hear commonly discussed in more discreet settings.
1. Employment – The stated unemployment rate is 10%. Economists acknowledge that the real rate is 17%, if we include those who acknowledge that they have quit seeking work. During 2008, the recession hit the private sector. Most firms substantially reduced expenses, mostly by cutting pay and letting people go. Everyone has family, friends or neighbors who have lost jobs. The suffering has been real, but I am hearing frequent mention of another troubling employment trend. Those businesses who acted aggressively in 2008 and 2009 have their balance sheets in order and many are having a somewhat stronger year this year than last. They are tentative about investing and hiring, but they consistently report difficulty in finding qualified, reliable applicants. We just added 12 people and I can report first hand that it was not easy to find the caliber of people we need. One observes a strange combination of high unemployment and low employability. We should accept that perpetual unemployment benefits perpetuate unemployment.
2. Federal debt, deficits and unfunded liabilities – Politicians would be very foolish to assume that concern about federal borrowing and spending is a trumped up issue foisted on an ignorant public by Fox News. The public across much of the political spectrum is not buying what the policy makers are selling with their Keynesian rhetoric. The public and their private sector employers are hunkering down and figuring out how to do more with less. Meanwhile federal government expenditures are exploding and deficits are exploding even faster because tax revenues are down. Tax revenues are down because taxpayers’ incomes are down. Lord Keynes’ disciples assure us that federal profligacy is the remedy for private contraction. Taxpayers remember that we have good reasons for not feeling good about British aristocrats.
3. State and local governments – Insiders know that one of the next shoes to drop is state and municipal finance. The press has been reporting that our schools are cutting programs and municipal governments are cutting back services. They are not doing a good job of reporting that the worst is yet to come. Most school districts and municipalities have not actually cut expenses materially. In 2008 and 2009 budget cuts in the private sector typically meant reducing actual expenses by 20%. This actually reduced peoples’ salaries, benefits and jobs. The public sector mindset is still that a draconian cut is when you have to keep overall expenses the same this year as last year. Since salaries and benefit costs are structured to rise over 5% per year as civil servants gain seniority, this means that we do see some public sector positions eliminated, even though there are no material aggregate expense reductions happening. Cutting library hours, eliminating school music programs and muttering dark threats about public safety services represent a good PR strategy for deflecting focus from the fact that no material aggregate expense cuts have been made. Property values are plummeting and taxpayers’ incomes are down. It doesn’t matter which party is in power, the public sector is going to have to figure out what a real expense cut looks and feels like. Wisconsin has avoided this issue so far by a three prong strategy of raiding special purpose funds, borrowing to fund the deficits and using federal “stimulus” funds to pay for expenses that had previously been funded with state and local revenues. The next governor and legislature will have to make the real cuts and this will waterfall down to municipal entities. Even in the midst of a heated gubernatorial campaign it doesn’t seem that anyone is really looking the public sector employees in the eye and telling them that real cuts are coming. People across the state have already turned their financial problems into opportunities. When households and businesses decide that they really can do more with less it is amazing what a fruitful experience this can be. There are plenty of lousy business people around, but there are many examples of companies who took a hiding in 2008, but are actually doing much better today. They made tough decisions, refocused on their central mission and literally built enthusiasm around getting more done by working smarter and staying focused on their core mission. Many who instituted compensation takeaways in 2008 have already restored what was lost. This process must happen in the public sector. The entire sector remains in denial.
4. The Fed Reserve – I am not an expert in the history of the Federal Reserve Bank, but I know enough to see that they have entered very dangerous new territory. The Fed’s traditional policy role has been to use the Fed funds rate to influence short term money market rates. They have also used open market operations (historically meaning the purchasing and selling of treasury instruments) to influence rates. The last several years the Fed has expanded the size of its balance sheet and the scope of its interventions dramatically. Their reported balance sheet has increased from about $500 Billion to $2.5 Trillion. Deflation concerns have caused them to recently express the willingness and intent to further expand asset purchases, yet they also have expressed their intent to shrink their balance sheet when conditions warrant. Fed financial statements don’t really give meaningful insight into what assets they have bought from whom with what intent and at what price. We do know that the intent of purchases goes way beyond managing short term rates. It is likely that many purchases were distressed asset purchases intended to maintain the solvency of deeply troubled sellers. Since we don’t know the prices and how they were set one wonders if some of these purchases are more in the nature of undisclosed capital subsidies to previously unregulated entities deemed to pose a systemic risk. The people with the most meaningful information about this are the market insiders who are selling them these assets. The Fed is no longer making incremental purchases in a narrow band of asset classes in order to signal interest rate direction. It has become the dominant market player across a broad spectrum of asset classes. Who knows what asset classes they will enter next? Buyers, sellers and owners in these asset classes can study all the “economic fundamentals” they want. The relevant fundamental is that the outcome of their decisions will be driven by the behavior of the dominant market player. Every buyer and seller must contend with the likelihood that they are competing with the U.S. Government. Markets are dominated by a non-transparent governmental entity whose governance mechanism is premised on the need to shelter the public from their elected representatives. This public entity provides only sketchy information in its financial statements and believes public sector ambiguity is a civic virtue. The only rational investor decision making tool is insider information which is known only to the large market players which are the Fed’s counterparties. It is hard to conceive of a more treacherous investment climate for small investors. I don’t doubt the sincere intent behind Fed’s action. I fear rather that their broad and deep market dominance reflects their despair over available alternatives. As I grope for ways to explain this issue in laymen’s terms, I am reminded of the vacuum cleaner in the old Beatles movie Yellow Submarine which sucked up everything including itself. If Steven Hawking studied the investment universe I am sure he would give us a memorable name for this inscrutable entity which is drawing all investment matter into its orbit.
So what should we do to improve the situation?
The upcoming elections will be a landslide for the Republican Party. This will improve investor sentiment in the near term, but momentum will not be sustained unless the Republican Party wields its influence more responsibly than it has in recent decades. Regardless of who holds what seats the following steps are necessary for a sustained increase in economic activity.
1. Federal expenses must be very substantially reduced and a concrete plan of federal debt reduction implemented.
2. The Federal Reserve Bank must stop manipulating asset values and begin to unwind its positions in a transparent fashion.
3. State and local governments must embrace the challenge to cut actual expenses by about 15%. This will mean program reductions, job eliminations, pay reductions and reduced benefit costs.
4. The federal government must cease policy initiatives designed to encourage citizens to borrow, spend and consume. People want to pay off debt and we want our government to begin paying off our public debt.
It is easy to dismiss these measures as politically impossible. This is going to require extraordinary leadership. For the sake of our children it can and must be done.