Stimulus, Growth and Recovery: The Debate Continues

There is growing intelligent dissent to the administration’s stimulus policy.  Critics argue that recent growth is the result of market principles.  Edward P. Lazear wrote Monday in the WSJ, that he forecasted a return to growth without stimulus spending.  He goes on to argue, along with others, that  housing programs have had questionable results.  Lazear said that Uncle Sam is fibbing about job growth as well, reporting job retention as if it where job creation.  John Irons of the Economic Policy Institute agrees.  The administration has an incentive to report positive unemployment numbers- the most popular, but also misunderstood indicator.

Unemployment is only part of the overall picture.  Other improving indicators reported this week tell us that the economy is turning around-but for whom? It depends on how you define growth.  A technical definition says that growth is positive GDP.  That means little to most people.  Real growth, theoretically, is an improvement in living standards for the entire country.  That’s why Main Street understands the unemployment rate.  Accordingly, the media use it as the sole judge for growth.  The problem is, as Lazear mentioned,  job growth is the final component of recovery- behind financial stability and GDP growth.  Unemployment lags years behind an actual recovery.   If unemployment is a lagging indicator, Lazear cannot empirically link failed stimulus policy to persistent unemployment.  He says that the administration is ignoring job losses while inflating job creation numbers.  Isn’t he doing the same thing by ignoring market stabilization and GDP growth? 

BEA Released GDP Data This Week 

According to the BEA, GDP is up for a number of reasons.  Look closely at the report.  Exports rose 14 percent over last quarter and consumer spending rose 3.4 percent.  Market Watch reported that positive numbers where in part due to stimulus spending, but as I argued in the past, these gains are only temporary.  The purpose of the stimulus is to stabilize the economy so that private markets can function again.  There is no wider conspiracy.  The government will roll back stimulus as soon as it sees the return of private investment.  There is evidence of this already: government spending actually slowed by 3.5 percent.

Not all the news was good.  Personal income fell and prices rose.  Hopefully this is a temporary trend based on slight price increases and high unemployment.  However, as long as export growth remains positive, I see no need to fear 70s style stagflation.  

Savings and Long-Term Growth

According to the old Solow Model, a country’s savings rate is positively related to long-term growth.  Today, personal savings is around five percent, that’s up from around one percent just four years ago.  This bodes well for long-term growth in the US.  And now is a great time to invest.  As private investment (including people’s savings) replaces public spending in the next few years, markets will rebound.  Private investment will power an upswing in the business cycle, spark growth and reduce unemployment. The sooner the government rolls back stimulus, the better.  In the mean time, citizens can take advantage of great opportunities in real estate and other deflated markets.  This transfer of savings from a stock to a flow will jump-start the economy in way no stimulus could.  It would take tens of trillions of dollars in government spending to match the power of private investors.

Thomas J. Powell

Market Breaks 10,000- Don’t Get out the Champagne Yet

The good news on Wall Street lately has little meaning for the rest of us.  Yesterday, the Dow topped 10,000.  The numbers signify a return to stability more than a return to growth.  Though the market enjoys a modest up swing, hold off on the celebration.  I see at least two explanations for the bullish performance: a market bubble and penny pinching companies. 

A breakingnews.com story put yesterday’s Dow into historical context.  If you take out the dotcom and housing bubbles and assume a nominal annual growth rate of four percent since 1995 (two percent real growth and two percent inflation), the Dow “valuation today would be just north of 7,800.”  Today’s numbers, according to historical analysis, reflect higher than average growth rates.  

Cost cutting companies provide another explanation for recent highs.  Facing devastating market devaluations, companies cut inventories and eliminate jobs.  Profits will then rise relative to previous periods of poor performance.  As companies post gains- stocks rise.  What we are seeing could be more of a new status quo: low growth and smaller companies. Smaller companies mean fewer jobs, sustained, institutional unemployment and lower living standards for all.  

A Lesson in Personal Responsibility- Okay, Get out the Champagne

Congratulations to 76-year-old Elinor Ostrom, the first women to win a Nobel Prize in economics.  Ostrom found that individuals can manage common resources more efficiently than government or private institutions do. 

“What we have ignored is what citizens can do and the importance of real involvement of the people involved — as opposed to just having somebody in Washington … make a rule,” Ostrom told reporters. 

Her work focused on public land and resource use.  Her insights tell us not to rely on government or the private markets to solve our problems.  Those conclusions may be a little abstract, but I agree with the first part.  Efficient economies balance personal incentive with public outcomes.  Governments cannot regulate every aspect of the economy.  Individuals need the freedom to adapt to changing conditions without waiting for a bailout. 

What can citizens do?  Focus on personal initiave.  We, the participants of a private marketplace, can solve our problems by building private industry.  Governments cannot efficiently fund the recovery.  Look at what AIG did with its money.  Cash that didn’t go to sustaining a flawed securities industry went to paying out huge bonuses.  Little of the bailout, or stimulus for that matter, has actually reached worthy projects.  The path to real growth begins when private banks, investors and entreprenuers create capital flow. 

There’s much more to this story.  I just wanted to take a moment to cheers Ostrom and her lesson of personal reasonability.

 

Celebrating the Life of Don Fisher, Gap Founder and BGCA Governor

A good friend to Boys and Girls Clubs of America, Don Fisher, passed away on Sunday. Don and his wife Doris have been making an impact on the kids of the United States, and the world, for more than 50 years.

For me personally as a Club Kid in the 70’s, I am very grateful that Don chose to support BGCA along many other great causes. I believe that it is more important than ever during these challenging times to invest in what works – and BGCA is doing great work throughout our country. Our Clubs are currently making an impact on over 4 million kids this year and we have more than 30 MILLION Alumni touching every corner of our planet.

If you are looking to make a small, or large, investment in something that is a proven solution, perhaps I can challenge you to join Tonya and me in giving to BGCA through our web page at http://www.supportbgca.com. The site allows you to make a gift online and only takes a minute of your time.

Private Capital + Private Enterprise = Economic Recovery, and our individual support of BGCA is a great part of this equation. I thank you for your consideration and hope you will take a moment to learn about the good work the Fishers have done over their lifetimes.

All my best,

Tom

 

Pulling the Unemployed off the Ropes and Into the Fight

As markets continue to produce signs of stabilization over the next quarter, it is unlikely that unemployment figures will show much improvement. With figures the highest they have been in more than 25 years, unemployment appears to have neared its peak. Lowering the rate to levels our economy can adequately support will prove to be a daunting task. But, with a little encouragement the corporate sector certainly has the power to handle it.
Last week, Federal Reserve Chairman Ben Bernanke was quoted by multiple major news sources after he told the Brookings Institute, “The recession is likely over at this point.” According to Bernanke, the economy appears to be growing, but not at a pace that will be sufficient for lowering the unemployment rate. Historically, economic upturns after recessions have been stamped with consumer demand. This time around, however, many Americans may not have the ability to help lead a recovery because they have been completely wiped out financially.
In order to spur consumer-led demand, the corporate sector will again have to make jobs readily available. The unemployed are not the kind of consumers that are needed to invigorate our economy and induce growth. We do not need to turn to an economics textbook to tell us that our broken economic cycle can be patched with more available jobs—this much we know.
Corporations large and small have been forced to adapt to this constricted economy and the majority of them were required to do so through downsizing. Now, company leaders are reluctant to increase their workforce until they are confident there is a significant increase in demand for their products and services. But, one strong possibility that could provide the encouragement needed to get company leaders hiring again is a temporary change in corporate tax policy.
A temporary tax break aimed at equaling the payroll costs of adding new employees would strip the risk for companies that are awaiting a full-blown recovery before they hire. Plus, according to a recent article published in The Wall Street Journal:
“The impact of a two-year program on the federal deficit would be relatively modest. Using a conservative set of assumptions, an $18 billion annual program, which represents 10% of estimated corporate tax receipts in the next fiscal year could create nearly 600,000 good-paying jobs …”

Before they commit to hiring, companies are waiting for consumers to spend. But, before consumers commit to spending, they are waiting for companies to hire. The cycle is stagnant and will remain so until one side is persuaded to change their behavior. A government-sponsored tax break for companies that agree to hire could be the first action taken during this recession that encourages our country’s government, companies and individuals to work together.

Capital River is Frozen; We Can Thaw it

Because of the severe impact of the recession, the stream of capital that once flooded our economy has been reduced to a trickle. The majority of the flow evaporated when banks were forced by the Fed to tighten their lending standards as delinquent loans polluted their books. Consequently, failing to restore the flow is making it extremely difficult for the Fed to take progressive measures toward recovery and has the potential to drop us back into another recession.
According to Bloomberg.com:
“The Fed’s second-quarter survey of senior loan officers, released Aug. 17, showed U.S. banks tightened standards on all types of loans and said they expect to maintain strict criteria on lending until at least the second half of 2010.”

With dropping values in commercial real estate, rising unemployment numbers and a seemingly unending onslaught of delinquent mortgages; banks are not lacking reasons to practice strict lending measures. Earlier this year, through a series of stress tests, the Fed found that 19 of the country’s largest banks needed $75 billion in new capital to protect themselves from mounting losses.
With all of my recent writings and blog postings concerning the benefits of getting our private capital back in the game, I am by no means hiding my agenda for restoring capital flow. The economy will only be repaired once the flow of capital is rejuvenated. It is much easier to lead capital tributaries back into the main stream if they are first flowing. Over the next couple of quarters, banks will continue to deleverage and work toward a balanced lending system. But, without raising more private capital, banks will not be able to establish a lending system that enables credit-worthy individuals and businesses to acquire reasonable loans; which puts an enormous restraint on economic progress.
Our economy is already positioned to attempt to force a jobless recovery, which will certainly create complications in sustaining a recovery. Trying to force a credit-less recovery will only exacerbate our struggles. Dragging our banks through a painful recovery without sufficient capital will only position them to break and lead us right back through more of the same. By identifying ways to put our private capital back into the equation we are positioning our financial system to rise from this recession stronger and more efficient. By investing in private enterprise, we are sparking long-term, mutually-beneficial relationships between capital-producing businesses and banks (while also earning gracious returns on our initial investments). Now is the time to put our private capital back to work.

Without Our Capital, Banks Get the Axe

Our private capital plays an integral part in our local economies—which then all collectively have crucial roles in our country’s financial stability. Because banks have become over-reliant on easy credit, they are now struggling to keep their businesses running by raising capital the old fashioned way. Without our capital, our banks (and more importantly our communities) cannot function properly. Not able to fulfill their debt obligations, banks are closing their doors and falling under the control of the FDIC; which “estimates bank failures will cost the fund about $70 billion through 2013.”
Banks are necessary to ensure that money circulates in our communities. They distribute the money of their depositors to borrowers who have a worthwhile purpose for the money. The banks secure our savings and lend the money to companies or individuals. Banks provide a convenient location for borrowers to acquire funds. Without banks, companies would find it very difficult to borrow large sums of money.
While banks perform their role as intermediaries, they also essentially increase the supply of money. By accepting deposits from its customers and loaning the money to worthy borrowers, banks “create” money. Consider the following simple example. Imagine a customer deposits $20,000 into her bank account. Even though the bills are no longer in circulation, the amount of money in our country does not change as a result of the deposit. Allowing the money to simply sit in the bank’s safe would not earn the bank anything. Therefore, the bank lends $10,000 to an entrepreneur in return for an additional interest fee. The depositor still has a $20,000 credit in her account and the entrepreneur has $10,000, therefore the money supply has increased by $10,000. The entrepreneur purchases supplies with the money and creates a product that he sells for a profit. As long as banks have depositors, they are able play their crucial role of increasing the money supply by making funds available to those looking to find backing for their ventures.
The word “bank” itself is derived from the Italian word “banca,” which referred to the table on which coins were counted and exchanged in the middle ages. “Bancarotta,” from which the word “bankrupt” was derived, means “broken bank.” Originally, if a banker was unable to pay his debts, the authorities arrived to smash his table in half with an axe. Today, the FDIC seizes failed banks and seeks buyers for their branches, deposits and faulty loans—all, for some reason, without smashing anything with an axe.

All my best,

Thomas J. Powell

 

 

Ghost of Recessions Past

Maybe this is all a bad dream, and like Dickens’ Ebenezer Scrooge, a voice from the past is warning financial regulators.
Former Fed chairman Paul Volcker testified in front of the House Financial Services Committee today. Look at the excerpt from his prepared statement. He warns that the Fed’s reaction to the recent crisis may actually increase the likelihood of future collapse. By creating a safety net for the too-big-to fail banks, Volcker argues, we are exposing the financial system to more risk!
Paul Volcker is no stranger to economic crisis. As head of the fed from 1979-1987, Volcker helped steer the economy out of the infamous ‘stagflation’ of the late 1970s. Stagflation was an economic anomaly: high unemployment combined with inflation and negative growth rates. Many hail Reagan’s deregulatory policies as the solution. But this was only a piece of the puzzle. Volcker headed the Fed at a time when the structure of the world economy was undergoing an historic shift. The international monetary system had collapsed and, like today, monetary policy was ineffective at solving the nation’s problems. Volcker oversaw a dynamic shift in how we value currencies and conduct monetary policy.
Why is all this important? Because 82-year-old Volcker is saying the same thing I am. Instead of looking at real changes to the system itself, like Volcker did, regulators continue to recklessly throw money at the problem. Fortunately for us, we are not facing stagflation. The problem today is the steady deflation of our wealth. However, the lesson is the same: let’s look at ways to change the system instead of perpetuating the cycle with safety nets. Volcker suggested re-instating Glass-Steagall. This should reduce big bank’s incentives to gamble our wealth away.
I also agree with his stance that smaller institutions are getting squeezed out of the economy. If the government only backs a small handful of participants, how will smaller private firms compete? Without those firms we will never return to prosperity.
So let’s take a minute to heed Volcker’s advice. It’s more than Obama is doing. Volcker may be one of the president’s chief advisors, but he’s not listening. Unlike Dickens’ tale, this is not a dream. I think Volcker’s advice will haunt the halls in Washington for a long time.

Tom

Too Big to Fail? Here We Go Again…

Today marks the one year anniversary of the collapse of Lehman Brothers, one of the worst financial disasters of our time, as it nearly brought down the international financial system. Yesterday I was reading an article about how the big banks are showing signs of life with their actions and things are starting to move, signalling a possible economic recovery. This makes me wonder about the adage of being “too big to fail.” What is the right decision in this situation?

It appears to me that after the latest cycle, quite possibly and hopefully the worst we will see in our lifetimes, people are hoping that this time things will be different. That once we actually do reach a point of recovery, we won’t make the same mistakes that were recently experienced. This cycle has been painful; it has been gut-wrenching; it has been a lesson I surely don’t want to repeat, as I get it and don’t need to learn it again.

I am very nervous about this thought process. As the saying goes, history repeats itself, and that did not become a quote we all use without good reason. For generations, for decades, for centuries, the animal in human nature causes us to make the same decisions and choose the same paths as before.

Some of our largest banks, which the government determined were too big to fail, received billions in taxpayer TARP funds. Our money kept these institutions afloat and I understand the reasoning behind keeping their doors open, especially using the Lehman example. I am dismayed, however, at the actions of these institutions. By receiving government funds, they are able to continually take on high degrees of risk, knowing there is a safety net underneath them. Prudent due diligence has gone by the wayside with the knowledge of someone is there to catch them. I liken this to the casino industry. If you could borrow $1 Million dollars and gamble it, knowing you would get it back if you lost it PLUS knowing you would get to keep any winnings you made, why wouldn’t you do it? This is exactly the system we have allowed to be established.

And, what about the outrageous salaries and bonus payments we still continue to hear about? I am all for the entrepreneur earning as much as he or she can based on value and return to society, but I am not about taking from you and me, putting a chokehold on getting capital back into circulation while cutting off small business, and then handsomely rewarding the big bank players in the process.

The veritas, the truth, as I see it, is that nothing has really changed, that we are repeating ourselves and that we will all pay the price of the failure to learn what could be a valuable and useful lesson. As we continue through this cycle, which I believe still has more pain to come, I hope for and have faith in the success of the small business, for the will of the entrepreneur, and for the recovery of our great land.

Too big to fail? Ok, I’ll give the government that. But what about keeping the backbone of American capitalism healthy? I’m not saying the answer is in government bailouts for small business, as anyone who knows me knows I believe in complete personal responsibility. I’m only asking for the same access to capital for small business so that it can keep its doors open, giving it time to make the changes and adjustments necessary for its own success. In short, allowing business to help itself.

I have thoughts on how I believe this can be done without the banks, allowing history to repeat itself in the manner I believe will lead to our recovery. I will write more in the coming days, but in short I believe in private capital + private enterprise = economic recovery.

I look forward to sharing more of my thoughts and receiving your feedback.

All my best,

Thomas J Powell