Friday, February 27, 2009

Geithner Calls the Kettle Black

There's an old saying about the pot calling the kettle black, which is used to attribute hypocrisy to an individual who alleges another of behavior which he too is guilty of. Treasury Secretary Tim Geithner epitomized this idiom during an interview with Jim Lehrer:
I am deeply offended by the quality of judgments we've seen in the leadership of our nation's financial institutions. They've caused a very damaging loss of confidence. Financial systems require confidence; they're built on confidence. They've created a deep hole of public distrust and anger, which is enormously damaging.
Mr. Geithner, please meet the kettle. There is no doubt that the banks' horrible decisions over the past few years are key to our economic problems. However, Mr. Geithner is in no position to claim moral indignation at the banks' lack of leadership when he has provided zero leadership ever since he crashed and burned before Congress two weeks ago.

In case you missed it, Wall Street thumbed its nose at Mr. Geithner's purported plan to stabilize the financial sector through a 421-point crash of the Dow Jones Industrial Average---about a 5-percent decline. The reason? The administration led us to believe that Mr. Geithner would deliver a comprehensive plan; in fact, President Obama announced the night before that Mr. Geithner would announce "very clear and specific plans for how we are going to start loosening up credit once again."

Instead, Mr. Geithner
only delivered a broad outline which did not sound much different than the Bush/Paulson plan, but for a "stress test" which---left undefined---seemed like a doorway to nationalization. Mr. Geithner highlighted his plan's ambiguity when he stated, "We're not going to put out details until we are confident that we've got the right structure that's going to achieve these objectives to try and bring private capital in, alongside government financing to help these markets get working again."

As market pundit Larry Kudlow quipped, "President Obama, please meet Treasury man Tim Geithner; Mr. Geithner, this is Mr. Obama; we'll all shake hands and have a cup of coffee together."

Alan Greenspan liked to say that the maxim First, do no harm applies just as much to the Federal Reserve chairman (and, by extension, Treasury secretaries) as it does to doctors. Well, Mr. Geithner did tremendous harm to the financial sector. His purported goal is to ensure the survival of our major financial institutions to maintain a viable credit market, but Mr. Geithner has only hastened their demise by scaring private capital away from those institutions---thereby increasing their need of government assistance.

How, then, did Mr. Geithner attempt to make amends? Well, he really didn't. Instead, he seemingly went into hiding and refused to provide any clarification. Mr. Geithner could have said any number of things; in his Lehrer interview, he stated that "these banks now have very substantial amounts of capital relative to what you would have seen in the U.S. economy going into previous recessions," and "I think [nationalization] is the wrong strategy for the country, and I don't think it's a necessary strategy." Mr. Geithner could have dramatically improved the situation by saying that two weeks ago, but he simply chose to say nothing.

The result, therefore, was what Wall Street considers a four-letter word: uncertainty. Private investors were left speculating without clear guidance about whether the White House would nationalize our banking system, and wipe out the shareholders in the process. The speculation increased as Mr. Geithner remained silent.

Mr. Obama did not help matters because, as blogger Paul Kedrosky noted, Mr. Obama talked himself into---and out of---nationalization within the course of the same speech: Mr. Obama first stated that Japan prolonged its decline by initially refusing to nationalize, whereas Sweden quickly nationalized and recovered much more quickly. This sounds like a clear endorsement of nationalization. However, he then reversed himself by pointing out that our banking system is far more complicated than Sweden's, so nationalization may not work here. His so-called conclusion:
And so what we have to do is we have to pull the Band-Aid off so we don't duplicate what happened in Japan. But we've also got to make sure that in pulling the Band-Aid off we don't just start doing so much damage that things end up getting much, much worse.
Someone needs to gently remind Mr. Obama that while deliberating out loud works well for Senators, the President of the United States is in no position to appear so wishy-washy. He is the leader of the free world, and everyone looks to him for leadership. Statements like these imply that the administration has no idea what to do.

Therefore, it is clear that the administration failed to lead the way to financial recovery following Mr. Geithner's failed speech. Who, then, was in charge? Simple: the rumor mill ran Wall Street, and the financial sector led a broad market sell-off. There was little change in fundamentals; the dominant factor was increasing fear that the White House would nationalize our banking system. This affected not only the "bad banks," but the entire sector, as fear of a domino effect caused investors to flee from the more stable banks---thereby diminishing their stability. This fear spread to all other sectors, largely because no one wants to say the government running our banks. The major stock indices have crashed about 15 percent since Mr. Geithner's testimony. Only one investment did well: gold, which is viewed as the ultimate hedge against uncertainty.

This does not mean that Mr. Geithner should have rushed into a poorly deliberated plan just for the sake of acting. The problem is that Mr. Geithner appeared to have ample time to conjure up a more detailed plan. After all, he was the President of the New York Fed and Vice Chairman of the Fed's Open Market Committee prior to his Treasury Secretary nomination; this means that he worked very closely with Ben Bernanke and Hank Paulson in their initial attempts to stabilize the financial markets. Moreover, one would think that he would have taken full advantage of the "Office of the President-Elect" to get off to a running start. Instead, it appears that he did little or no footwork prior to his confirmation. At the very least, if he had so little to say, he should have done more to control our expectations.

We saw a brief stock market respite this week when Mr. Bernanke quelled fears of nationalization, even though Mr. Bernanke is not even part of the administration: frankly, it reached the point where any guidance whatsoever was better than no guidance. Unfortunately, this respite appears to have been short lived as we now creep back to 12-year lows. Mr. Geithner claimed during the Lehrer interview that the initial sell-off following his testimony two weeks ago was really not his fault:
Well, I think it's important to see this happened against the backdrop of a deepening recession here and around the world, and that is the fundamental cause of the uncertainty you're seeing in markets everywhere and the fragile confidence we see generally.
Well, Mr. Geithner, there is no doubt that we're facing a terrible economic climate. However, inherent in the Obama administration's claim that it can make things better is the reality that it can also make things much worse. You, sir, did make things worse. Even if you refuse any responsibility for the current uncertainty, I would implore you to at least show some leadership and remember that every dollar of private capital you scare away from the banks is a dollar that the taxpayers will wind up replacing.

Wednesday, February 18, 2009

President Obama, please meet President Karzai

The Associated Press reports that President Obama apparently just spoke to Afghan President Hamid Karzai for the first time. Ever.

Ronald Neuman, former U.S. ambassador to Afghanistan under President Bush, speculates: "Holding off on a presidential call may be no more than a sensible decision to wait until the president really knows what he wants to say on crucial issues."

No hurry, Mr. President; it's not like the United States has deployed tens of thousands of American G.I.s to fight a war within President Karzai's borders or anything.

(Note: I know I promised I would shy away from matters of foreign policy. But this is just too ridiculous to ignore.)

Tuesday, February 17, 2009

Mortgaging Our Economic Future

And so, with the stroke of a pen (ten pens, actually), President Obama today signed into law a $787 billion dollar bill he assured us will help get the American economy back on its feet. At best, it will provide a shot-term economic jolt; at worst, it could massively devalue the dollar, contribute to a future inflationary crisis, and help transform America’s economic juggernaut into a Western European sloth.

The best thing that can be said is that it will create a placebo effect that will boost the economy. As I argued in my
previous post, the fundamentals of the bill will not be helpful, but if enough people believe it will boost our economy, then perhaps it may become a self fulfilling prophecy. If John Q. Public believes (rightly or wrongly) that this will help solve our economic woes, we can expect consumer and investor confidence to rise, which will allow America to get back to business. Of course, I suppose it’s beside the point that Congress could have just as easily caused this placebo effect by leaving the first page of the bill blank and spending zero dollars.

The alternative theory is that this bill will grow the economy by spending money that would not have otherwise been spent. The problem is that the government cannot spend money out of thin air—it can only spend a dollar by taking that dollar away from the private sector, either now or in the future. Proponents of the bill would assert—correctly—that this spending bill supplements (rather than replaces) current spending because it is 100 percent deficit spending, which means the private sector does not yet have to pay for it. Unfortunately, the irrefutable implication is that the government must gradually remove this money from the private sector for a long time to come. In short, we are mortgaging our economic future for the sake of the present.

The Congressional Budget Office—a non-partisan federal agency tasked with assisting congressional decisions by providing economic analysis—
predicts that this bill will hurt our economy in the long run. It estimates that the legislation in the short run will “raise GDP and increase employment by adding to the aggregate demand” over the next few years. However, the legislation will “reduce output slightly in the long run.” This is because the resulting debt will “‘crowd out’ private investment” in the long run. Therefore, the CBO predicts reduction in future GDP by as much as .2 percent, reflected largely in lower wages because “workers will be less productive because the capital stock is smaller.”

The bill’s economic effects are even more serious when you account for its potential to devalue our currency, which the CBO report does not seem to consider. Our
national debt stood at $8.95 trillion at the end of 2007, and equaled 65.5 percent of our GDP. The national debt presently amounts to $10.7 trillion and our GDP totals $14.3 trillion, so our national debt is now approximately 75 percent of our GDP. To put these figures in perspective, our national debt has not occupied such a huge percentage of GDP since the early 1950s—while we were paying for World War II!

This would be bad enough, except we’re just now getting started. The Congressional Budget Office already
predicted a $1.2 trillion deficit for the coming fiscal year. President Obama stated that “unless we take decisive action, even after our economy pulls out of its slide, trillion-dollar deficits will be a reality for years to come.” The Treasury is reportedly considering spending as much as $2 trillion to stabilize the financial system. Anyone care to predict what percentage of GDP our debt will consume after all is said and done?

There is no doubt that President Bush and his Republican congressional majorities committed fiscal malfeasance by overspending during the boom years; as a result, our nation’s overbearing debt makes it very difficult to justify spending increases during the bust years. Justified or not, however, the United States is spending it. I can’t help but wonder whether our trading partners who largely finance our debt—with China as our number one creditor—will continue doing so. Yes, our creditors would harm their own economic interests by inciting dollar depreciation, but it would also be masochistic of them to continue buying debt they doubt we can repay without printing more money out of thin air.

This, of course, would result in inflation. The
M2 indicator of our money supply has already increased at an annual rate of about 20 percent since August, so the Federal Reserve will already have a difficult time removing all of this excess liquidity from our system once our economy recovers. Imagine how much worse this situation would become if we're forced to essentially "inflate" our way out of debt.

Combine potential devaluation with classic monetarist inflation, and Americans will watch the price of their goods skyrocket—and our standard of living plummet. Of course, I could always be wrong. I’m still saving up the money to purchase a crystal ball and I don’t have a PhD in economics, but it seems clear that the economic stimulus plan is a recipe for disaster. How can we obtain long-term prosperity by mortgaging our economic future for the sake of temporary “stimulus” that so many people doubt will really work? Make no mistake—I do believe the economy will naturally rebound over the next year or two, due to its cyclical nature. But this “stimulus” plan will have little (if anything) to do with it, and it will simply open the door to future economic pain.

Thursday, February 12, 2009

A Stimulus Plan to Nowhere

I posted the following thoughts on a Facebook note on February 4, and it generated considerable debate. It is particularly timely since Congress is expected to pass the final version of the stimulus bill over the next few days.
The riddle constantly implied through the 2008 election cycle was, “Who could possibly screw up our economy worse than the Republicans?” The answer has become fairly obvious: the Democrats!

I normally abhor the partisan Republican-Democrat finger pointing as the lowest form of political hackery. Unfortunately, the Democratic leadership has spent the past few weeks living up to the odious caricatures of bleeding heart big spenders who place their social agendas ahead of economic reality. Specifically, their introduction of a welfare expansion bill disingenuously labeled economic stimulus has forced me to question their intentions and their competence.

President Obama spent the past few months pledging an economic stimulus bill that will boost our economy through infrastructure spending and tax cuts. I am not a fan of Keynesian-style government spending stimulus because, frankly, I don’t think it works. To make a long story short, government can only spend by preventing private sector spending (now or in the future), and it typically takes years for infrastructure spending to enter the economy due to the enormous planning required before ground can be broken. However, I at least acknowledged that such a bill would cause a “placebo effect”: even if it does not in fact stimulate growth, its enactment will inadvertently stimulate growth by boosting consumer and investor confidence.

Unfortunately, the so-called American Recovery and Reinvestment Act does not live up to President Obama’s description. He promised infrastructure, but Congress instead delivered a wish list of liberal policy objectives aimed at expanding the welfare state rather than growing the economy. The $816 billion House version entails $604 billion in new spending.

This includes $20.0 billion for food stamps, $20.4 billion allocated to the Department of Health & Human Services, $17.6 billion for student financial aid, $29.1 billion for public school programs, $20.0 billion to renovate those same schools, $11.2 billion for housing assistance programs, $19.5 billion for education grants, $27.1 billion for unemployment benefits, $13.3 billion for health insurance for the unemployed, $11.1 billion for “Other Unemployment Compensation,” and $20.2 billion for Medicaid and Medicare.

By contrast, only $30.0 billion is allocated to highway construction.

Feeling a bit swindled, now, aren’t we? Check out
an article by Jim Manzi discussing this in further detail.

This plan does not stimulate economic growth; it simply recycles money. What do I mean? Well, understanding the economic impact of this proposal requires comprehension of the basic economic principle that the government cannot “create” spending; it can only spend money that it takes from the private sector, either through taxes or borrowing. The proponents of this proposal claim that it will redistribute wealth from “the rich” to “the needy,” who will stimulate the economy by using their government payments to purchase of goods and services.

In other words, the plan is for the government to take money away from “the rich,” and give it to “the needy,” who will in turn give it back to “the rich” when they purchase goods and services. This clearly does not grow anything, except for the size of government and the size of our national debt. All this does is transfer the same dollars back and forth between the same people, minus the dollars retained by the bureaucratic middlemen within the federal government. This is simply welfare expansion window dressed as economic stimulus.

Republican Senators actually responded—much to my surprise—with a decent alternative. This bill, priced at $445 billion is about half as large as that passed by the House, and is laced with supply-side tax cuts. It slashes payroll taxes for all workers and income tax rates for lower income earners, as well as substantial tax credits for home buyers. The hallmark of the bill, however, is its reduction of the corporate tax rate from 35 to 25 percent, and small business filing as individuals by the same margin.

Talk about incentivizing growth! The United States levies some of the highest corporate tax rates in the developed world, and most people do not realize that most “individuals” taxed at the 35 percent rate are actually small businesses. This will provide them with a much needed shot in the arm to weather the storm and incentivize growth. More money in their pockets translates into fewer layoffs and pay cuts, and—as experience has consistently shown—higher tax revenues. If you don’t believe me, just check the
official Treasury data for yourself. Cross reference the supply side tax cuts of the 1920s, 1960s, 1980s, and 2000s with those figures, and you’ll see that the subsequent economic growth resulted in higher revenues despite the lower rates.

Of course, the Republican counterproposal was not perfect. It still contained $48.15 billion in welfare expansion, but at least its remaining expenditures contain a far higher proportion of infrastructure than its competitor. I also like the fact that its expenditures cease following either three years or two consecutive quarters of 2 percent GDP growth, whichever comes first. Additionally, it called for a subsequent 2 percent across-the-board spending cut to help balance the budget and a commission to examine the long-term viability of Social Security, Medicare, and Medicaid. Too bad the Democratic majority never took it seriously.

Sen. McCain introduced this counterproposal, and you know what? It really makes me think I underestimated him during the election! Maybe he has a chip on his shoulder to prove that he received an unfair shake in November. If so, I really hope it motivates him to remain a vocal proponent of such beneficial measures—perhaps recreate himself as a Supply-Side Maverick rather than a Campaign Finance/Amnesty/Global Warming Maverick.

Meanwhile, President Obama is doing a pretty amazing job of talking down the economy. He recently stated that failing to pass this bill “will turn a crisis into a catastrophe.” Perhaps President Obama and his Democratic colleagues should turn their attention to finding that Hope they used to get elected in November and leave economic stimulus to the Republicans.

Sunday, February 8, 2009

The Audacity of Reason

Welcome to the inaugural posting of The Audacity of Reason. Its primary purpose is to advocate the reasonable application of economics and law within the public policy arena. As the title implies, I believe that reasonableness is sorely lacking in modern politics. “Reasonable” is, of course, a dangerously ambiguous term, so the integrity of this blog demands that I provide at least a brief ideological synopsis so you understand what I believe “reasonable” is. Although I cannot encapsulate my ideology within a few paragraphs, this should at least give you an idea of where I’m coming from:
  • Politically, I’m a libertarian-leaning Republican based upon the core notion that the primary role of a just government is to protect the people from one another and foreign invaders while restraining itself from meddling in the people’s private affairs. Conversely, I reject the paternalistic view that the government should protect the people from themselves.
  • Economically, I believe supply-side economics is the best path to prosperity and individual liberty. This includes advocacy of low taxes, minimal government, balanced budgets, free trade, and price stability. I believe each of these basic tenets has greater potential to alleviate poverty and promote prosperity than any government program ever could.
  • Legally, I advocate a strict textualist interpretation of the Constitution based upon the original understanding of its provisions, to the degree we can divine such an understanding from the historical record. Consequently, I generally reject the idea of a “living constitution” because a constitution that means whatever we want it to mean really doesn’t mean very much at all. I do, however, keep an open mind for interpreting provisions whose original meaning is unclear.
I hope this elucidates my core political, economic, and legal values. You may be wondering why I don’t have much to say about foreign policy, and that is because I simply don’t know enough about it to discuss it in great detail. My law school education qualifies me to discuss law, and my interest in reading about economics qualifies me to discuss economics. I do have certain ideological predilections when it comes to foreign policy, but I don’t keep up with it as much as I should, so I won’t waste your time by blogging about topics in where I lack a very sophisticated understanding.

With that being said, I’m really looking forward to this opportunity not just to post my views, but to read your comments. I have utmost confidence in the propriety of my opinions, but I recognize that intelligent people can view the same facts very differently, and therefore reach very different conclusions. These topics may lead to heated discussions, but as long as we do our best to maintain a respectful atmosphere, I believe we will all benefit from an ongoing dialogue.