“Uncertainty about future taxes and regulation is enemy No. 1 of economic growth.”
——-Professor Allan H. Meltzer, Wall Street Journal, June 30, 2010

A summary review of Meltzer’s positions on Obama’s policies and programs follows:

There are several negative implications of Obama’s policies—they are short run, political, dedicated to his wants and those of his union supporters, and to winning the next election. What is missing is an announced, fundamentally sound, long term strategy and policies—in conjunction with appropriate experts—to begin to solve the fiscal crisis facing federal and state budgets, but equally important the tax and regulatory environments in which business will operate.

The long-term implications of Obama’s economic program for the economic survival of the country have been ignored for short-term political gains and failed policies. There is no believable program to improve the tomorrows of our citizens and the economy. There is no “Shining City on the Hill.”

The problems facing the country, such as the Gulf crisis, are confronted on a politically driven ad hoc basis without sound coordinated policies, plans, or decisions to bring them to an end at least cost to citizens and the country.

A basic underlying problem that limits the country’s rebound from the crisis is that it fails to understand that it is business, not the unions, that hire the unemployed to build new plants and new technologies. So how to encourage this? Obama must change from an ad hoc personally driven agenda to one that creates a short- and long-term environment of reasonable certainty for businesses with respect to taxes, regulation, deficits, and the future of the overall economy.

Businesses are not going to invest in people or productive assets if their perceived costs of capital are inflated beyond any reasonable hope of profitable use of capital and people. Businesses cannot rationally invest in a current and future environment that features too much politically based UNCERTAINTY.

30 Seconds Outlook Chart
Professor John A Haslem, PhD
August 15, 2010

Chart by John B. Taylor from CBO Long Term Budget Outlook, June 15, 2010

John A. Haslem

The author is responsible for the opinions expressed.

“The attempt to do more than we can will itself be a disturbance that may increase rather than reduce instability.”
——-Milton Friedman, Congressional testimony, 1958

Professor John Taylor, author of the “Taylor Rule,” has done us the favor of summing up what must be done to rectify errors of Bernanke’s loose monetary policy and Obama’s economic policy. Application of the Taylor Rule, if you missed it, measures the extent to which the Fed funds rate deviates from what was working so well during the Great Moderation that began in the early 1980s. This deterioration reflects an interventionist monetary policy that is less rules-based and less predictable. Thus, performance of the economy deteriorated until the Great Recession came upon us.

Let us now turn to Taylor’s (Review, St. Louis Fed, 5-6/10) recommendations for what now must be done in the areas of monetary policy and fiscal policy. He says it best.

“. . . [T]the crisis shows that the government interventions taken before, during, and after the crisis did more harm than good. These interventions were a deviation from what was working well. We got off track. The policy implications are thus clear: Macro-economic policy should get back on track.

For fiscal policy, this means avoiding further debt-increasing and wasteful discretionary stimulus packages, which do little to stimulate GDP. Ten years ago there was a near consensus that such programs were ineffective. Fiscal policy should focus on reducing the deficit and the growth of the debt-to-GDP ratio. Reforming existing  entitlement  programs to  hold  their growth down and limiting the creation of additional entitlement programs are essential.

For monetary policy, it means . . . returning to a policy with four basic characteristics:

First, the short-term interest rate (the federal funds rate) is determined by the forces of supply and demand in the money market.

Second, the Fed adjusts the supply of money or reserves to bring about a desired target for the short-term interest rate; there is thus a link between the quantity of money or reserves and the interest rate.

Third, the Fed adjusts the interest rate depending on economic conditions: The interest rate rises by a certain amount when inflation increases above its target and the interest rate falls by a certain amount when the economy goes into a recession.

Fourth, to maintain its independence and focus on its main objectives of inflation control and macroeconomic stability, the Fed does not allocate credit or engage in fiscal policy by adjusting the composition of its portfolio toward or away from certain firms or sectors . . .. Of course, this means we should exit from the MBS and other special programs as soon as possible. Obviously, we can’t be draconian about this, but the sooner policymakers achieve this goal, the better future policy will be.

Some suggest that monetary policy has to do more things, such as taking actions to burst bubbles. . . . Our most successful past policy during the Great Moderation did not include such attempts to pop bubbles and the economy functioned very well.”

30 Seconds Outlook Chart
Professor John A Haslem, PhD
August 1, 2010

David Beckworth graph of Federal Reserve Bank of Cleveland data

John A. Haslem

The author is responsible for the opinions expressed.

“The distance between the president and the people is beginning to be revealed.”

——-Dorothy Rabinowitz, Wall Street Journal, June 9, 2010

The oil calamity in the Gulf has provided citizens there and else where with a vivid picture of how Obama deals with a crisis.

We need to understand Obamas’s background as it applies to his decision-making. Rabinowitz (WSJ 6/9/10) reminds us that it is based on who he is. His reaction to the oil crisis was entirely predictable, with amazing lack of concern and urgency concerning the explosion that took numerous lives and the subsequent release of vast quantities of oil.

Rabinowitz states so well that what citizens expect from a president is not more campaign rhetoric, but rather a tone and presence that says: “This is Americans’ leader, a man of them, for them, the nation’s voice and champion. . . . What he lacked was the voice—and for a good reason. . . . A great part of American now understands that the president’s sense of identification lies elsewhere, and in profound ways unlike theirs. He is hard put to sound convincingly because he is, at heart and by instinct, the voice mainly of his ideological class. He is the alien in the White House, a matter having nothing to do with delusions about his birthplace . . ..”

The lack of voice for America is certainly revealed in Obama’s overseas “apology tours,” that included the Muslim world, where he “confessed” the moral failures of America in its arrogance and insensitivity and the source of injustice and oppression in the world.

We all remember America’s embarrassment with his banal gift to England’s prime minister. Then there was the insulting welcome to Israel’s prime minister. Then there was the return of the White House’s bust of Churchill, which was a American reminder of this great leader during our war to save the free world. He senses no understanding of America’s connections with our historic allies.

We are also told there are no Islamic terrorists, but rather there are only criminals deserving of trials in American courts. His administration is filled with radical “czars,” a leftist staff of political opportunists and unseemly deal makers, and a cabinet lacking in experience and emotional attachment to the American people—thus the choice of Napolitano for her leftist appeal and certainly not for her managerial experience and skill.

These behaviors are consistent with Obama’s management of the oil crisis that has destroyed so many jobs and ecosystems. He says the problem is BP’s to fix. Then he uses his worn “Bush card” to shift blame for failure of his own oil industry regulators. Then he fails to lead a coordinated effort to use private and government craft and personnel in a serious effort to contain the slick. Then he refuses offers of experienced help from other countries due to union opposition. Then when shifting blame fails to provide political cover, he walks on the beach to show his concern. Then when this lame reality show doesn’t provide political cover, he tells his attorney general to investigate BP for criminal negligence.

The timing of Obama’s attempt at assigning legal blame could not have been less presidential. Once the oil flow is stopped, an impartial and informed commission (not his leftist no experience commission) should be constituted to assess what went wrong and why, and then proceed to engage the industry in prescribing new standards, requirements, and regulations for shallow and deep drilling. An industry commission would actually have the best information and know how. That is, to use the process that works with airline crashes. Then, deep drilling should return to the job of meeting our needs for domestic energy.

30 Seconds Outlook Chart
Professor John A Haslem, PhD
July 15, 2010

John A. Haslem

The author is responsible for the opinions expressed.

“History clearly shows the government that stimulates the best, taxes, spends, and intrudes the least.”

——-Jason E. Taylor and Richard K. Vedder, The Orange County Register, May 24, 2010

Huge differences exist between Obama’s Keynesian economists and macro-economist Robert Barro on the impacts of the stimulus. In sum, Barro’s research indicates the long-term results of the fiscal stimulus will be negative—”public spending crowds out private spending.” On the other hand, we are experiencing what Obama’s policies have created.

Evidence concerning the damage of the stimulus and related governmental actions is seen in the following examples:

1. Unemployment has remained at very high rates for a long period of time.
2. ObamaCare increases labor costs and the deficit.
3. Cap and Trade would increase labor costs and the deficit.
4. Fear of Fed induced inflation through loose monetary policy has caused large increases in gold prices.
5. The costs of ObamaCare have been grossly underestimated and they will push annual deficits to more historic highs.
6. Increases in length of unemployment insurance coverage also lengthen the period until the unemployed seek jobs.
7. Consumer and business confidence have experienced large declines.
8. Stock prices in real terms have declined with increased government involvement in the economy and with expectations of increased inflation.
9. Current high levels of government spending and the resulting increases in already huge annual deficits are on an unsustainable path.
10. The economy and markets are fearful the Fed’s loose monetary policy with very low interest rates over several years foretells hyper-inflation—as does fear the Fed will use inflationary measures to finance the deficit.

Taylor and Vedder conclude: “. . . [T]he lesson from 1945-57 is that a sharp reduction in government spending frees up assets for productive use and leads to renewed growth.”

30 Seconds Outlook Chart
Professor John A Haslem, PhD
July 1, 2010

Chart by John B. Taylor from CBO Long-Term Budget Outlook

John A. Haslem

The author is responsible for the opinions expressed.

“The current [financial] crisis has its roots in the transformation of the banking system…”

——-Gary Gorton, Federal Reserve Bank of Atlanta 2009 Financial Markets Conference, May 11-13, 2009

Professor Gorton’s major study finds that the financial crisis that began in August 2007 is a banking panic that involved two major changes in the banking system. “First, derivative securities have grown exponentially . . . and this has created an enormous demand for collateral . . .. Second, there has been the movement of massive amounts originated by banks into the capital markets in the form of sec utilization and loan sales.”

Over the past 25 years. the traditional definition of banking has been altered by introduction of the “shadow banking system.” This change evolved to meet the needs of a modern credit economy. This evolution was due to increased nonbank competition, decreased regulation, and innovation in financial products. Asset securitization provides a more efficient way to finance loans, and the growth of derivatives requires huge increases in demand for collateral.

The problem is that “shadow banking” was not understood to be “banking.” While its development was noted, the vulnerability of shadow banking to financial panic was not. Data covering these newer activities were not generally available. Regulators did not collect measures of collateral usage in derivatives or loan settlements, securitization, and repo market participants, rates and sizes, and “repo haircuts” (increases in repo margins).

The banking panic was a systemic event because the system was insolvent and could not honor its commitments. But, the panic appeared in the “shadow banking” corner of the banking system, not the traditional regulated banking system. Subprime mortgage securities were shocked by the fall in housing prices, but the source was not identified. Worry about bank solvency and liquidity caused repo dealers to increase “repo haircuts” by demanding more equity collateral.

Banks could not raise needed capital and were forced to sell assets to gain liquidity. The market could not absorb the amount of assets to be sold, and the banking system was therefore insolvent.

The need is for regulation that encompasses both traditional and “shadow” banking. This will require understanding the role of shadow banking in banking and in the banking panic. The success of new regulation will depend on the existence of bank debt that is “informationally insensitive.” That is, senior tranches of approved asset classes should be government insured (like demand deposits), along with government supervision and examination of these activities.

Gorton concludes: “The economy has evolved to the point where more of this type of debt [informationally insensitive] is needed by firms rather than consumers. The ‘banking’ in question is that provided by the shadow banking system, via securitization and repo. This is banking. Policies need to be adopted to create a sufficient amount of the needed debt so that companies can engage in banking safely.”

John A. Haslem

The author is responsible for the opinions expressed.

“I do not think it is overstating things to describe our current budget situation as a crisis.”

——-Arnold Kling, The American, May 4, 2010

A major budget and deficit crisis is upon us, yet do you see any corrective action by Obama and Congress? One only has to understand the deficit implications of ObamaCare to know the answer is negative.

To gain appreciation of the current size of the Federal debt relative to GDP, it is useful to remember that after World War II the ratio was over 100% and we recovered from this war burden. In 1950-54 the ratio decreased to 59.5% due to a large surplus in 1948 and large increases in GDP in 1948-49. This latter ratio yet remains the highest in all five-year periods since then.

Proper calculation of the ratio of Federal debt to GDP does not lie in the ratio of the Federal interest rate to the GDP growth rate, which implies tax revenue grows at the same rate as GDP. As Kling reminds us, the correct approach to computing the Federal debt to GDP ratio requires a comparison of the Federal interest rate to the growth rate of tax revenue. The interest rate is computed as the ratio of the period interest expense to outstanding debt at the end of the previous period.

The first step is to compute the “primary surplus,” which is the difference between tax receipts and government purchases. A primary surplus reduces the ratio of government debt to GDP. Also, when the GDP growth rate is higher than Federal interest rate, the ratio of debt to GDP falls. On the other hand, a “primary deficit” increases the ratio of debt to GDP. In addition, when the GDP growth rate that is lower than the interest rate, the ratio of debt to GDP increases.

The implications of this analysis are not pleasant to behold. In fiscal 2009 the ratio was 53%, but the current CBO estimate is that the ratio of debt to GDP will be at least 90% by 2020 and increasing thereafter.

We have no history of reducing the ratio of debt to GDP solely through economic growth. It is therefore essential that we use fiscal discipline and reform to restore a primary surplus. There are several roadblocks to this in huge entitlements and also in high taxation at state levels that reduce potential for tax increases.

John A. Haslem

The author is responsible for the opinions expressed.