Larry Summers Describes The Problem Of Achieving Financially Stable Growth With Full Employment

This article by Larry Summers argues that it will be difficult to achieve a full employment economy in the industrial world along with financial stability.   He claims that the basic assumptions of classical macro theories, as well as the new Keynesian theories, have proven to be inadequate.  Both of these theories assume that flexible prices will enable the economy to arrive at a full employment equilibrium over time.  Interest rates have dropped about as far as they can and a further decline in wages and prices leads us into a deflationary spiral that is difficult reverse.  Moreover, the IMF and the CBO continue to lower their forecasts of the level of potential GDP.  This calls to question the assumption that output will rise the trend line that existed prior the Great Recession.  That is, we may be in for an extended period of lower economic growth than we have anticipated.  Summers reviews the data that support his hypothesis and he considers possible solutions to the problems that he views in the global economy.  He concludes that normal monetary policy cannot produce a full employment economy without creating the kind of financial instability that led to the financial crisis.  In fact, the collapse of the financial system may have been predictable in hindsight.  Unsustainable credit risks had masked the difficulty of sustaining adequate economic growth.

In the US, the economy looked pretty good between 2003 and 2007, leading up to the financial crisis.  Low interest rates were an important factor in achieving a reasonable growth rate. However, low interest rates encouraged investors to take on greater risk to increase the yields on their investments.  The banking system obliged by extending credit to high risk borrowers.  That led to a real estate boom that eventually collapsed and produced the Great Recession.  Summers extends this analysis even further into the past.  He argues that unsustainable credit growth had been fueling the economy for the last 20 years in the US.  That leads Summer into an analysis of the factors in the economy that required unsustainable credit support to maintain full employment.  That is, the forces that were reducing potential output without support from credit expansion.  In doing so, he turns Say's law, which holds that supply creates its own demand, on its head.  He concludes that falling demand leads to falling supply.

To support his hypothesis he shows that there has been a steady and substantial decline in real interest rates since 1985.  They reached a trough in 2011 where the real interest fell to fell to zero.  The implication is that the full employment real interest rate may be much lower than it has been in the past.  Therefore, monetary policy will have difficulty maintaining full employment and production at potential GDP without increasing the risk of financial instability.  Increased inflation would lower the real interest rate but that does not lower the risk of financial instability.

If monetary policy has reached its limits, fiscal policy, along with a reduction in income inequality that redistributes income to households with a higher propensity to consume,  is the only solution available that does not increase the risk of financial instability.

Summer's analysis is receiving more attention within the economics profession and among policy makers.  It will be strongly resisted, however, because it flies in the face of a dominant ideology, and it would reverse the policies that have been promoted by those who have benefited the most from the current arrangement in the US and in England.  Reagan and Thatcher are alive and well in both countries.  The mid term elections are likely to increase the political power of the party that worships at the Reagan alter and the party of Thatcher controls the UK economy.

Federal Reserve Announces End To Quantitative Easing

The Fed announced today that it would end its purchase of treasuries and mortgage securities.  It concluded that the economy had recovered sufficiently and that inflation was close to its 2% target.  This article provides a good overview of quantitative easing and what it accomplished.  It kept the interest rate on mortgages low and that helped to keep the housing market afloat.  It also made it less expensive for corporations and households to lower the cost of debt service.  The economy has had a moderate recovery but it still operates below its potential.  Job creation has improved but not as much as most would have liked.  The biggest winners from the program may have been holders of corporate stock.  The PE ratio is not as high as it was during the dotcom boom but it is high relative to historical averages.

Corruption Of State Attorney Generals Has Become A Big Business

Two decades ago 40 state attorney generals banded together to sue the tobacco industry.  They won a $206 billion settlement from the tobacco industry.  That got the attention of corporate executives.  Corporations are now lobbying state attorney generals to protect themselves from harmful litigation.
This article describes the ways in which the lobby industry has been organized and how attorney generals have benefited from the lobbyists.  Legislators are no longer the sole beneficiaries of the goodies provided by corporate lobbyists.  State attorney generals have gotten into the game and some familiar patterns have developed.

One of the familiar patterns is the revolving door.  Attorney generals frequently join a lobbying firm after leaving office.  That gives them an incentive to be "cooperative" while they are in office because that makes them more attractive to law firms that represent corporate interests.

The AG's have also organized themselves to attract and distribute corporate campaign contributions.  Republicans formed the Republican Attorney General's Association (RAGA) and the democrats followed with the DAGA.  Donations from corporations, either directly or indirectly, go to these organizations.  In turn, each of them provide funding for AG election campaigns.

The AG's also join an organization of former AG's when they leave office.  The alumni organization is often targeted by lobbyists and many work for law firms that represent corporate interests.

As one might imagine some of the law firms that represent corporate interests become better at it than others and their work is described in this article.

A strange kind of game tends to develop over time.  AG's have in incentive to take actions which raise the threat to some corporations.  That makes corporations more anxious to raise the stakes in the lobbying game that gets played.  Corporations often try to prevent AG's from organizing together on law suits like they did in the tobacco case;  they also try to block legal action at the state level.  Some AG's who have been highly favored by a particular lobbyist have tried to prevent their peers from joining together on a legal action.

In addition to being hosted at fancy venues by lobbyists, many AG's have would like to further their careers outside of the lobby industry.  Some want to run for higher state or national office. Several of the AG's investigated in this report are being championed for higher office by lobbyists and the corporations with whom they have developed a "personal relationship".

This investigative report by the NYT is a good example of what journalism is capable of doing in a democratic society.  It would not be possible in many nations.  It includes details from emails that would be an embarrassment to those involved if this information was widely distributed.  Unfortunately, only readers of the NYT will be informed by the information provided in this article.  It will not be picked up by the local press in most affected states.

An Interview With Adair Turner On The New Economy That We Created

This link is to a post and a video interview in which Adair Turner describes the four broad changes that he sees in the economy.  It is referred to as "money manager capitalism".  The four broad changes in the economy are: growth in inequality, increase in wealth to income ratio, increase in debt to GDP ratio, and historically low interest rates.

Ben Bernanke argued that low interest rates are the result of a "savings glut".  Turner believes that there has been decline in investment demand which keeps interest rates low.  He uses Facebook as an example of the high tech industry that we have today which is very different from what we had in the past.  Facebook has a market capitalization of around $180 billion.  It required around 5,000 man years of software engineer labor to build its enterprise.  Henry Ford required a much larger capital investment to develop the Ford motor company.  (He also needed a very large workforce to manufacture his product).  The low demand for capital investment has enabled investors to borrow money at low interest rates to leverage their investment in financial products and in real estate. 

Turner also explains why real estate has returned as a major source of wealth.  In the past real estate derived its value from producing food, or as a source of natural resources.  We are experiencing a boom in commercial and residential real estate in places like London, NY, Vancouver, Paris etc.  That is because real estate is a positional good.  Wealthy individuals want to live in high prestige locations.  Moreover, the demand for property in high prestige areas is international.  There is a finite supply of high prestige locations and an infinite supply of money which is created when banks issue loans.  Much of the investment in real estate is used to generate rent income.  Rent income has been increasing as a percent of income in the US, England, France and Canada.  We are experiencing a return of the rentier society in which real estate is a major source of income and asset appreciation.

Turner was asked about the situation in Europe and he compared the EZ to Japan in the 1990's.  There is a huge private and public debt overhang and the politics of the EZ are much more complicated than that of Japan.  It has been difficult for Japan to deal with its debt overhang but it is much more difficult for the EZ to respond to its economic problems.  He sees immigration as one of the major political issues in Europe.  Immigrants want to find jobs and they compete with low skill labor for low wage jobs.  Much of the anti-EU sentiment comes from those who compete for jobs with immigrants.  The free movement of labor is one of the basic features of the EU and that is why there is so much populist opposition to the EU in England.

Why Did Steve Balmer Pay $2 Billion For A NBA Team?

Steve Balmer paid $2 billion for the LA Clippers.  The was almost for times the previous record for a NBA franchise set in May when the Milwaukee Bucks were sold for $550 million to a couple of hedge fund managers.  This article describes the unique tax advantage that is available to owners of sports franchises.  Balmer can save around $1 billion in taxes through that loophole.

The tax loophole allows franchise owners to deduct goodwill from the other taxable income.  Goodwill is the purchase price of the asset less the value of the cash and fixed assets in the LA Clippers.  If it is assumed that the value of the Clippers is around $500 million, and subtract that from $2 billion, Balmer has $1.5 billion of goodwill.  At a reinvestment rate of 7%, that gives him a tax credit of $1 billion that can deducted from his other taxable income over 15 years.  Its certainly one of the factors that influenced his decision.

NBA owners also share in the rights that are sold to media providers.  The NBA just closed a $24 billion deal with ESPN and Time Warner.  NBA games will be available over the Internet from Time Warner's cable operator (Comcast).  The LA Clippers will share in that revenue without having to compete for it.  Balmer purchased an annuity along with the team. 

The NBA deal is not unique.  Media rights for sports rose 18.7% last year.  The NFL just signed a deal with Direct TV for its Sunday Package.  The eight year deal for $12 billion is twice the value of its previous deal.  If one wants to have every Sunday NFL game available for viewing one must have a Direct TV contract.  Media rights have also risen dramatically in England for teams in its top soccer league.  Its a great time to own a sports franchise.  Consumers can't get enough sports on TV and advertiser love to be associated with sports.

Spending On Frivalous Luxuries Is Not The Reason For Household Budget Problems

Many people believe that we spend too much on unessential luxuries like lattes and that our budgets would be fine if we cut back on foolish spending.  This article tells us why that is not our problem.  Our spending on essentials like healthcare insurance premiums, rent/mortgage payments, education and day care expenses is the problem.  Those items consume most of our budgets and the prices for those necessities have been rising.  For example, our daughter just had her first child.  In order for her to maintain he job as a teacher she needed $2,000 per month for day care.  Many families are faced with the problem of giving up one of the jobs or paying for daycare.

Managing Democracy To Save Plutocracy

Paul Krugman claims that plutocrats only tolerate democracy when it can be made to work for them.  So how do the plutocrats make democracy work for them?  Krugman provides his list of tactics which have been effective for a long time.  He argues that underneath much of political and economic issues that we debate is the more general problem of plutocracy versus democracy.  The plutocrats are small in number but they are organized to protect their interests.  In general, they must convince others that what's good for the plutocrats is good for them.  They are pretty good at this game.