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As the Economy Improves, Give Some Credit to Globalization

Monday, June 3rd, 2013

The economic news and data have turned distinctly upbeat. With unemployment down, consumer confidence up, and personal debt back to normal levels, it was no surprise when last week’s revised report on first quarter GDP showed consumer spending rising at twice the rate of the preceding three quarters. Housing investment is now increasing at a 14 percent rate, following a 25 percent drop in home foreclosures compared to the first quarter of 2012 and many months of rising housing prices. Business investment is still sluggish, but corporate profits are strong, and the stock market is setting new records. These positive reports also explain why markets barely moved when Federal Reserve chairman Ben Bernanke noted recently that the Fed’s aggressive program to keep interest rates low might wind down sooner than expected.

The biggest drag on the economy, as usual, is government. If not for Washington’s misguided sequester cuts, tax increases and continuing layoffs by state and local governments, GDP would be growing at a healthy three to five percent annual rate.  Even so, conditions are improving enough to sharply drive down the deficits projected for the next two years. With Europe stuck in a double-dip recession, the United States once again finds itself a prime engine of global growth.

Credit for much of this turnaround goes to the Fed, and some of it is luck. But business attitudes and orientation count here, too. In particular, American policymakers and businesses have been committed to globalization for the last two decades, especially compared to their European counterparts.  And this deep engagement in global markets is a critical factor in the economy’s renewed strength. Not only are exports one of the brighter points in the current recovery.  In addition, years of sustained competition in global markets have made many U.S. industries markedly more efficient and innovative than their rivals in other advanced economies.

Bill Clinton deserves some thanks for all this.  He not only articulated the need for Americans to actively engage in world markets, clearly and convincingly. He also made that attitude concrete by corralling bipartisan majorities to enact NAFTA, create the World Trade Organization, and draw China and other large developing nations into a global trading system. American multinational companies may be best known today for their byzantine strategies to minimize their U.S. taxes. But their many years of investing in foreign markets at higher levels and rates than firms from other major economies count for a lot more.  Once there, they have had to compete with lower-cost producers in markets those producers know better than they do. This intense competition has forced U.S. multinationals to come up with new efficiencies and innovations, which they also have applied to their U.S. operations and markets.

The falling U.S. trade deficit provides clear evidence that all of this matters. In the first quarter of this year, for example, our trade imbalance was $22 billion less than it was a year earlier. This may seem remarkable, since stronger growth here than in Europe and Japan would suggest a rising U.S. trade deficit as imports rise and exports fall. It’s true that some imports are up — but so are most exports, including high tech goods that account for 19 percent of all U.S. exports.  The main reason, though, is globalization as U.S. companies that have spent years setting up shop around the world now tap into fast-growing markets across the developing world.

Consider whom we now trade with.  Our traditional major markets of Europe and Japan now account for just 25 percent of U.S. exports. They’re overshadowed today by the 32 percent share of our exports which go to our NAFTA partners, Canada (19 percent) and Mexico (13 percent). Another 12 percent of U.S. exports go to the rest of Latin America, seven percent to China, and 13 percent to the rest of non-Japan Asia. In fact, American firms export nearly half as much to Africa and the Middle East as they do to Europe.

President Obama is now doubling-down on the commitment to globalization. Last term, he got Congress to approve new free trade pacts with South Korea, Colombia and Panama. This term, he’s pressing for a major new trade deal with Pacific Rim countries and another with the European Union. The negotiations for the first deal, the Trans-Pacific Partnership Agreement (TPP) began in 2010. Now, the President is pressing all interested parties — Australia, Brunei, Chile, Canada, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam, along with the United States — to complete the deal within one year. That’s an ambitious deadline, since TPP would lower or end many thorny domestic barriers to open trade. Among these are regulations and other impediments to competing in service-sector businesses, with state-owned enterprises, and in areas of government procurement, as well as health and safety regulations targeted at foreign competitors. And if we and the ten other Pacific Rim countries can strike the deal on TPP, Japan and South Korea would probably join too, and further expand its impact.

Completing a new free trade pact between the U.S. and the EU within the President’s two-year deadline will be equally daunting. Here, too, the issues include many of the toughest for trade in the 21st century, encompassing barriers rooted in the domestic regulation of services as well as health and safety, labor and environmental rules, agricultural subsidies, data privacy, and anti-trust policy. These are very difficult matters not only for the regulation-prone countries of continental Europe, but for the United States as well. Nevertheless, German Prime Minister Angela Merkel and the UK’s David Cameron are both on board with Mr. Obama. Alas, France’s President Francois Hollande is less enthusiastic, and the president of the European parliament, Martin Schulz, has warned that any deal must “put the European model at its core,” especially with regard to “labor unions and social rights.”

Both sets of negotiations will test everyone’s patience and political limits. But the process will recommit the United States to the path of liberal internationalism that has helped drive American prosperity for more than 65 years. And if they succeed, the result will not only reassert America’s global economic leadership.   The new agreements should also permanently raise the incomes of tens of millions of people here and abroad, along with the sales and profits of tens of thousands of U.S. and foreign companies.

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Is This the Final Countdown to a Global Financial Calamity?

Wednesday, November 9th, 2011

Ground zero of the European sovereign crisis has moved from Greece to Italy, and that’s very bad news for Europe, the United States, and most everywhere else. For a year, Angela Merkel and Nicholas Sarkozy have looked for some way to both prevent Greece from defaulting outright and reassure bond investors that Italy’s sovereign debt will remain sound. This week, the price that Italy pays to borrow money soared as global investors determined that holding Italian bonds is increasingly risky. The salacious Silvio Berlusconi is on his way out, but that won’t change the market’s judgment that Merkel and Sarkozy’s stratagems have failed. Europe now faces a real and present danger that major banks across Germany and France, along with Italy and Greece, could fail soon. Such a meltdown would take down the American expansion with it.

It’s still premature for a post mortem. But for the past year, domestic European politics, not international finance, has squeezed the acceptable options to solve the Eurozone’s metastasizing sovereign debt problems. Merkel and Sarkozy have long known that their countrymen and women would pick up pitchforks if their governments moved to bail out big banks a second time. If that wasn’t enough to inspire street demonstrations, the contemplated bailout this time would go to stabilize financial conditions in other countries. So Merkel and Sarkozy came up with a plan that appeared to spare French and German taxpayers. Unfortunately, it also couldn’t pass a laugh test by worldwide investors:  The plan has Eurozone financial stabilization board raising $1 trillion from those investors to back up Italy’s debt, with a pledge that Eurozone governments would guarantee the first 20 percent of any losses. Think about it: Italy, Greece, Ireland, and Portugal , all hanging by a thread or worse, would help the rest of the Eurozone cover the initial losses from bonds used to bail out Italy, Greece, Ireland and Portugal — and if things go south, probably Spain as well.

The $1 trillion commitment kept a meltdown at bay for a few days, much as the Bush Treasury’s commitment to spend $700 billion to bail out Wall Street staved off a market collapse after Lehman failed. The original Paulson plan also didn’t pass the laugh test, but no one doubted that the U.S. Government could raise the $700 billion. This time, the Eurozone’s $1 trillion commitment has bought them at most a few weeks of breathing space, as investors wait for Merkel and Sarkozy to come up with a real plan to raise it. But those investors already are eyeing the exits. Interbank lending to Europe’s biggest institutions dried up this week, just as it did here in the days before Lehman sank. And interest rates on Italian bonds are now so high that, according to the industry’s financial models, Rome will be unable to service its debt much longer.

All of this means that neither global investors nor European taxpayers are prepared to bail out the Eurozone. Even at this very late date, however, there are ways out of this mess:  Under the least bad of the options left, the European Central Bank (ECB) would become the Eurozone’s bond buyer of last resort.  The ECB could pay for them by printing enough Euros, for starters, to stabilize Italian bond markets. It wouldn’t be pretty. The Euro would weaken. European interest rates might edge up as Europe slowed. And the ECB would have to come up with another credible plan to withdraw the excess Euros once the crisis passed. But the alternative is much worse.

In a period of worst case scenarios, here’s what could well happen later this month. Start with the fact that Italy alone has $2 trillion in outstanding government debt. Most of those bonds are held by Italian, French and German banks, including the biggest banks in the world. Anything approaching an Italian default would wipe out the capital of those banks, leaving them insolvent; and most of the Eurozone economies would grind to a halt.

It gets worse, because a financial meltdown centered on sovereign debt is much more dangerous than one triggered by mortgage-backed securities. In effect, a sovereign debt crisis strips sovereigns of their ability to act to contain the crisis. With Italy and Greece in default, for example, who will believe those governments as they move to head off general bank runs by, say, guaranteeing money market balances as the United States did successfully in the days after Lehman?  And if the biggest banks in France and Germany go down, Sarkozy and Merkel wouldn’t have the credibility to do much about it either.

The bad news doesn’t end with Europe. Our own big financial institutions, along with those in Britain and Japan, have thousands of deals going that involve the major banks in Germany, France and Italy. Overnight, all of those deals become suspect, which could spread financial panic beyond the Eurozone. And remember the credit default swaps that destroyed AIG?  No one knows precisely how many of those “guarantees” are out today against Italian government bonds and the commercial paper of French, German and Italian banks. The fact that no one knows could be a big problem in itself, since that, too, could breed a broader financial panic. In any case, there’s little doubt that those credit default swaps involve, at a minimum, hundreds of billions of dollars, Euros and pounds. That would leave American, European and Japanese financial institutions on the hook for those losses. And if they can’t make good on them, they could go down as well. Their only hope would be another bailout — if Congress could approve one before the Tea Party and Occupy Wall Street folks pick up their pitchforks.

All this is not yet inevitable. But much of it might well unfold, and probably in a matter of weeks, unless the Eurozone’s leaders face the grim music and finally find their way to a real program to head it off.

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The Cost of Playing Games with the Full Faith and Credit of the United States

Thursday, June 2nd, 2011

I spent last week in Rio attending a meeting of the IMF’s advisory board for the Western Hemisphere — and returned this week to Washington for the latest round of threats and charges over raising the U.S. debt limit. The contrast was, at once, disturbing and farcical. At the IMF meeting, former finance ministers, prime ministers and other ex-economic policy officials tried to unravel the grim implications for all of us if (when) Greece, Portugal or, in the worst case, Spain is forced to default on their sovereign debts. Back in Washington, congressional Republicans laid out their terms for not driving the United States into a voluntary default on its sovereign debt. Perhaps holding onto a child-like faith that bad things don’t happen to the United States, under God, they spelled out terms which everyone knows will never be accepted by President Obama and a Democratic Senate. The irony is that the GOP gambit of holding out a potential debt default if they don’t get their way could, in itself, make long-term control over deficits much harder.

The reason lies in the powerful influence of worldwide investors on our interest rates. Thankfully, global capital markets still have confidence that our two political parties can settle this dispute on reasonable terms, and that in time the United States will regain control over its deficits and debt. We know that confidence is still there, because the interest rates and yields on U.S. Treasury bills, notes and bonds all remain near historic lows. If there were real doubts about our capacity to control long-term deficits, those interest rates would be rising as investors demanded higher returns to offset the risk that we’ll fail. This confidence makes sense, because we succeeded at the same task twice before, in the 1980s and again in the 1990s. It took several years of squabbling and compromise, but President Reagan and a Democratic House agreed to raise taxes, cut defense and reduce Medicare and Medicaid spending in the 1980s — and the same pattern played out again a decade later with President Clinton and, first, a Democratic House and then a GOP one. That combination of revenues, defense and health care was, and remains today, inevitable, since those are the only pieces of fiscal policy big enough for cuts and reforms that can make a significant difference for deficits.

But neither Reagan nor Clinton faced opponents prepared to hold the full faith and credit of the United States hostage to their own partisan approach to the deficit. To make this gambit appear respectable, House Majority Leader Cantor even claimed last week that major players on Wall Street had assured him that a U.S. default would be a matter of economic indifference. The only explanation is that Mr. Cantor, without realizing it, was talking to short-sellers getting ready to bet billions that U.S. stocks and bonds might crash — as they will if we actually do default.

Happily, worldwide investors are probably correct that the likelihood of a U.S. debt default is still very, very small. If it ever came close to that, the real players on Wall Street would face down the U.S. Congress. But cutting it close may turn out to be very expensive, too.

Let’s perform a small thought experiment. A Tea-Party infused GOP takes us to the edge of default and then pulls back. A really close call, however, would almost certainly make worldwide investors nervous. They would begin to question whether our politics truly are up to the task of dealing with our deficits, so they add a small risk premium to our interest rates. Let’s say — and this would be optimistic in this scenario — that short-term rates on Treasury bills go up one-half of a percentage-point; medium-term rates on Treasury notes rise three-quarters of a percentage-point, and long-term rates on U.S. bonds increase by 1.25 percentage-points.

Now, let’s be optimistic again and assume that Congress and the President eventually agree to cut the 2012 deficit by 10 percent — $108 billion off of the current projection of $1.081 trillion. That will leave a 2012 deficit of $973 billion to be financed. The small increases to interest rates would add about $7 billion just to the first-year interest costs of the 2012 deficit. And that’s just the beginning: All publicly-held Treasury bills also have to be refinanced in 2012 — nearly $2 trillion worth at last count. The tiny 0.50 percentage-point increase in those rates would add another $10 billion to next year’s interest costs. That comes to $17 billion in extra interest costs in just the first year, and just on publically-held debt. Those premiums would become embedded in those interest rates, adding much more to our interest costs, year after year, as additional deficits have to be financed and some $7 trillion in publicly-held Treasury notes and bonds come due for refinancing. A single refinancing of that current stock of publicly-held Treasury notes and bonds, with the new risk premiums, would add more than $50 billion, per-year, to interest costs. And the actual risk premiums demanded by global investors could be significantly higher than we assume here, and so that much more expensive.

These incremental increases in interest rates also wouldn’t be confined to U.S. Treasury rates; they would be transmitted immediately to other interest rates, from mortgages to credit cards. That means the expansion would further slow, American incomes and the government’s revenues would grow less, and, lo and behold, the deficits would be even bigger.

That’s the math. Even if congressional Republicans don’t mean it, the political games they’re playing today with a U.S. debt default, purportedly in the name of fiscal responsibility, could make U.S. deficits and debt even more unmanageable, and U.S. prosperity more problematic.

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Why Big Banks Want Americans to Pay More for Everything

Thursday, April 7th, 2011

Once again, the nation’s big banks are working hard to have their own way with some of the most consequential issues before Congress. Tucked into the small print of Paul Ryan’s budget plan for 2012 and beyond are provisions to roll back the key regulatory steps taken to make another financial meltdown less likely, especially higher capital requirements tied to the riskiness of a bank’s investments. That’s not their only fight these days: They also are trying to roll back a critical debit-card reform enacted last year and just now about to go into effect. If they succeed — and the Washington airwaves are saturated with ominous ads calling for the rollback — it could cost many Americans nearly as much as what they have at stake in the ongoing squabbling over the 2011 budget.

The bipartisan debt and credit card reforms passed last year put the first real limits on how much the card networks and the large banks that issue nearly all cards can charge merchants when a consumer pays with a debit card. These charges are called “swipe fees,” and while they apply to all credit card as well as debit card transactions, the 2010 swipe-fee reforms apply only to debit card transactions. But if they save consumers as much as economists estimate, these reforms could well be extended to all credit card transactions too. And that could save the average American household some $230 per-year.

This is worth dwelling on, because it involves an ostensibly free market which, behind the curtain, a few huge companies actually manage to a significant degree — and now, behind the scenes, they’re also trying to manage the legislative process.

The facts, in a nutshell, are as follows. Merchants pay the three credit and debit card networks that account for some 80 percent of all charges a fee for every transaction using one of their cards that ranges from 1.5 percent to about 3.2 percent of the value of the transaction. A fee at some level makes perfect sense, since people buy more when they can charge or debit it, which benefits the merchants. But there’s no real economic basis for the actual levels of the fees. Less than 20 percent of the fees go to cover the actual costs of transaction for the banks and the credit card networks. Most of the rest goes to the four big banks that account for nearly 70 percent of all card transactions, with some going into higher profits and some for the advertising and rewards programs used to attract more customers.

We studied these fees last year. We found that in 2008, merchants paid swipe fees totaling some $48 billion. Those costs were tacked on to the price of everything they sold – clothing, computers, gasoline, restaurant meals, airline tickets, medications and so on. Moreover, the credit card networks forbid merchants from charging anyone using their cards a higher price to cover the fee, than those who pay cash. So, everyone pays for the swipe fees in higher prices every time they buy anything, whether or not they even use a credit or debit card.

We found that 56 percent of the swipe fees paid by merchants get passed along in higher prices, which in 2008 came to about $26 billion or $230 per-household. This year, it will be more, because we’re all charging more. And if the swipe fees were limited to the actual costs of processing debit and credit card transactions, plus normal profits, the lower prices for everything would expand real demand enough to create nearly 250,000 more American jobs.

In truth, the credit and debit card system operates more like a cartel than a genuine market. The fees are set by three companies that together account for 95 percent of consumer charges and two-thirds of business charges — Visa, MasterCard and American Express. Their actual customers are the banks that issue the cards, because the more cards are issued, the more swipe fees are generated. Moreover, four banks account for 70 percent of all cards and charges: JP Morgan Chase, Bank of America, Citigroup, and American Express (all of which, by the way, also collected taxpayer bailouts).

Since each of the networks and each of the banks account for a good slice of any merchant’s business, merchants have little option but to deal with them — again, much like a cartel. So, merchants can’t put normal market pressures on the networks and the banks to lower the fees by exiting the system. And since the networks forbid merchants from charging different prices based on whether a customer uses a card or cash, consumers have no incentive to pressure the networks and banks to lower their fees by using cash instead.

This not only produces higher prices, but higher prices that are applied in particularly unfair ways. More than half of all lower and moderate-income Americans don’t carry credit or debit cards at all. Yet they pay the higher prices along with everyone else. And most middle-class Americans with credit or debit cards pay higher prices to finance rewards programs largely restricted to more affluent card users.

So, last year, Congress gave the Federal Reserve authority to set rules for the swipe fees on debit card transactions. When Australia did much the same to cover both credit and debit cards, swipe fees there fell to 0.50 percent — and the system continued to work fine. The new rules are nearly ready to be issued here, and that’s what the banks and credit card networks are working so hard to stop. It will be another political test of whether big finance really can get anything it wants from Washington, regardless of the cost to everybody else.

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The Quiet Role of Class in the Coming Budget Battle

Thursday, December 2nd, 2010

The political struggle over how the federal budget will shape American government is now in full swing and likely to dominate Washington for the next two years. This week, the President joined the battle by proposing a two-year freeze on federal pay, his symbolic version of Bill Clinton’s maxim that “the era of big government is over.” In doing so, he aligns himself with growing public skepticism about the value of much of what Washington does. Yet, the anger driving the public debate isn’t really about federal spending much less federal pay. It’s about continuing high unemployment and stagnating incomes, because if Washington can’t get that right, what credibility does it have to manage everything else the public pays for? 

There’s another, more subliminal factor feeding the public’s anger about taxes and spending, and the only accurate term for it is economic class. Most Americans are fine with rich people getting richer, even when they get richer faster than everyone else — as long as the rest of us make progress too. But that’s clearly and painfully not the case today — the stock market and corporate profits are way up and multi-million-dollar Wall Street bonuses are back; while high unemployment won’t budge, wages are down, and the value of most people’s homes keep falling. On top of that, it was middle-class Americans who financed a recovery, through taxpayer bailouts and emergency spending, which so far seems to benefit only the wealthy. These factors alone should give Republicans pause as they prepare to block the extension of unemployment benefits and hold tax cuts for the middle-class hostage to preserving the tax cuts for the well-to-do.

The bigger political question is how most Americans would feel about the GOP’s hard-line positions, if they realized how much the economy in recent years has tilted to favor the wealthy. Recent data from the Federal Reserve document this tilt. In 2007, for example, the top one percent of Americans owned about 35 percent of all of this country’s assets or wealth — including houses, stocks, bonds, businesses, and so on — and the top 10 percent owned 70 percent of those assets.

The distribution of financial assets is even more skewed: In 2007, the top one percent owned 43 percent of the total value of all bank accounts, stocks and bonds, business equity, mutual funds, pensions, and retirement savings; and the top 20 percent of Americans owned an astonishing 93 percent. Ownership of only one type of asset is still spread around fairly broadly: With 70 percent of Americans being homeowners, the bottom 90 percent owned 40 percent of the total value of all residential real estate in 2007. But that fact is no longer evidence for the conservative trope that good times for the wealthy presage good news for everyone else: Since 2007, the housing bust has destroyed about 30 percent of the value of American homes, and it was triggered by Wall Street geniuses who took the taxpayer bailouts and now are pocketing multi-million dollar bonuses.

The tilt towards the wealthy is also much less steep in most other societies. While the top 10 percent of Americans own 70 percent of this country’s wealth and assets, the top 10 percent of Britons own only 56 percent of the wealth of their nation, the top 10 percent of Canadians own just 53 percent of their country’s assets, and the top 10 percent of Germans hold but 44 percent of the assets of their nation.  

The gap in incomes also has grown substantially over the last generation, and that suggests that the wealth disparities will only continue to increase. From 1982 to 2006, for example, the share of all annual income claimed by the top one percent of Americans increased from 13 percent to more than 21 percent; and the top 20 percent of us took home more than 61 percent of all the income earned here in 2006. Put another way, 80 percent of Americans have to divvy up about 38 percent of all the income generated in our economy. To be sure, a modestly progressive tax system ensures that the top one percent and the top 20 percent both contribute slightly larger shares of all federal revenues than they collect as income. But their share of federal revenues is also much smaller than their fast-growing share of the nation’s wealth.

These disparities have grown not from our politics, but from the way the economy is evolving. For example, our economy is increasingly capital-intensive — just consider, for example, how much more technology-dense most offices and workplaces are today, compared to just 20 years ago. Since capital is the source of more wealth creation than before, the wealth of those who own most of it has been growing faster. Incomes also are linked closely to the ability to work with all of that capital, increasing the income share of the top 20 percent of Americans with the most advanced skills and education. It is certainly not the burden or responsibility of government to alter the economy’s natural course. But when that course precludes meaningful economic progress for most people and creates profoundly undemocratic disparities in wealth and incomes, it surely becomes the government’s responsibility to ensure that the majority can genuinely thrive in that economy.

That’s a budget battle that President Obama could champion with confidence. For example, a good handful of subsidies for various industries would pay for low-cost access to college and graduate training for any young American with the drive and ability to see it through — as Britain, Germany and other countries, all with much smaller disparities of wealth and incomes, do. A small tax on financial transactions could float a new program of low-cost loans for homeowners with troubled mortgages, and so help stabilize the housing values that comprise the only asset of most Americans. Even a modest reform of the “carried interest” tax preference for hedge funds and private equity funds could more than pay for grants to community colleges to provide free computer training for any working person who wants it. And surely it’s time for the new realities of wealth and incomes in the United States to provide part of the framework for reforming our taxes and entitlements.

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The Troubling View from the IMF Meetings

Tuesday, October 12th, 2010

The International Monetary Fund held its annual Washington meeting last weekend, so I spent a balmy Sunday discussing the potential pitfalls for the U.S. and world economies. I attended as an American representative on the IMF’s advisory board for the Western Hemisphere; and in that group and beyond, almost no one could see a clear path to worldwide prosperity. Yet, few delegates seemed open to their own countries accepting any costs to enhance the prospects of global growth or even to protect the world from another meltdown.

The weekend’s favorite topic was the slow growth unfolding in the United States, Europe and Japan — too slow, that is, for the large developing countries that depend on us to buy their exports and so support their employment. The upshot is new concerns about a “currency war” breaking out in the developing world, and perhaps beyond. Already, many countries are intervening to keep their currencies relatively cheap and so make their exports more price-competitive than their neighbors. Of course, the only certain way for a country to keep its exports competitive is to produce better goods and services than its rivals. But that can involve reforms in investment, education and business-formation policies, all much harder to pull off politically than temporarily managing an exchange rate. The catch is that when everyone tries to keep their currencies cheap at the same time, no one ends up better off — and the next step is protectionism. If that sounds far-fetched, consider that one of the first orders of business in the new Congress will be legislation to punish Beijing for its cheap currency by slapping new tariffs on Chinese imports.

Forgotten in all these machinations is the supporting role that artificially cheap currencies played in the financial crisis. The strong dollar, compared to almost everyone else’s currencies, made Americans outsized consumers of everyone else’s exports — in 2007, U.S. imports totaled $2.2 trillion, or more than the entire GDP of all but five countries. But most of the dollars we spent on imports came back here, since the United States is the only place where dollars are the legal currency to buy stocks or companies. Those dollars helped swell the liquidity that financed the reckless leveraging by mortgage lenders and Wall Street, which all came crashing down in 2008. And when economists today say we have to redress “global imbalances” to avoid another crisis, they’re talking about the same dynamics. Yet, today’s competitive currency devaluations put us right back on the same path.

The weekend’s next favorite topic was the current political fashion for tight budgets, especially in the advanced countries. Since those are the same countries with slow growth, the talk turned to technical moves by the Federal Reserve and perhaps other major central banks — so-called “quantitative easing” — to expand credit even as interest rates already are near zero. This cheap new credit, of course, could someday be the kindling for the next bubble.

Moreover, it was hard to find anyone at the meetings who believes that the financial reforms taken thus far, here and around the world, are enough to avoid another meltdown. The good news is that the Financial Stability Board — that’s a rule-setting body for the major central banks — is set to issue another set of requirements for big finance, which will go well beyond what anyone else has done so far.

Of course, it’s unlikely that the world’s big banks will accept significant restrictions from the FSB, following their success in watering down new limits everywhere else. And even if they did, those rules won’t help contain the current flash point in the global capital system, the sovereign debt problems of Greece, Spain, Portugal and Ireland. A default by Spain, for example, would leave major French and German banks insolvent. They also would be unable to meet their obligations to U.S. and British banks, setting the stage for another financial meltdown.  Now, even if Greece goes down, as most financial experts privately expect, Spain and the rest may still avoid the worst. But if the worst does happen, the EU-IMF contingency bailout program might well not stem the tide. At least, that’s the current judgment of global investors, who have bid down the prices for Greek, Spanish, Portuguese and Irish bonds to levels near those before the EU and IMF announced their program months ago.

Behind all of these problems, the core issue remains the persistent slow demand and growth across much of Europe, Japan and the United States. The unavoidable fact is that the financial crisis has left countless tens of millions of households in the advanced countries poorer, and therefore reluctant to spend like they used to. The only recourse is to help people rebuild their incomes and wealth through direct measures to stabilize housing prices (the source of most people’s wealth) and to induce employers to hire more people. As usual, the world’s dominant economy and its President will have to take the lead. And that, I suspect, was the main topic of discussion this past weekend at the White House, just a few blocks down the street from the IMF meetings.

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Why We Learned So Little from the Collapse of Lehman Brothers

Thursday, September 16th, 2010

On the second anniversary this week of Lehman Brothers’ spectacular collapse, it’s instructive — okay, frustrating and dispiriting — to see what policymakers learned from it.  Based on what unfolded then and the trillions of dollars lost, you would expect that even conservatives could now acknowledge that unregulated financial markets are not always the optimal arrangement.  Yet, that’s not how it’s worked out.  By now, everyone also should recognize that when markets crack-up, government is the only game in town that can contain the damage and head off a repetition.  Yet, as a rule, conservative Washington still doesn’t.  And by now, when virtually everyone should appreciate the dangers of over-leveraging, policymakers across the political spectrum still don’t get it.

 All of this leaves the U.S. and global economies exposed to another financial crisis and the truly terrible economic costs that would follow it. 

This has become a period when simple-minded political ideology regularly trumps real economics.  After a long succession of gruesome financial meltdowns over 20 years — Japan, Sweden, East Asia, Spain, and now America and Europe — the leading ideology still offers knee-jerk reverence for markets largely unfettered by public standards or rules.  Those now poised to take over at least one house of Congress wouldn’t support even the tame financial regulation approved earlier this year.  That’s despite the fact that the new law forgoes setting common standards, rules or other meaningful regulation of most trading in large blocks of asset-backed derivatives.  Those are the precise transactions which proved to be so dangerous for Bear Stearns (RIP), Lehman Brothers (RIP), Merrill Lynch (RIP), AIG and the rest of us.  Just as it was before Lehman and the rest imploded, most investors and regulators still won’t know which banks are carrying out those large trades, what those trades consist of, and how heavily they borrowed to carry them out.

The still-reigning ideology also won’t tolerate regulation to stop flash trading, which allows a handful of giant institutions to see incoming orders a few milliseconds before ordinary investors, and has repeatedly triggered huge, sudden share price declines.  It also won’t countenance regulation of so-called “dark pools” or private deals between firms to move large blocks of securities without anybody else knowing about it.  As the world learned painfully two years ago, markets that aren’t transparent become vulnerable to devastating panics when an outside shock hits them.  We haven’t even been willing to direct the big banks (and the hedge funds that masquerade as them) to divest themselves of the same risky assets that crushed Lehman two years ago.    

We’re not doing much better with international regulation.  This week’s news from Basel was a new agreement among the major countries to “triple” the capital reserves that banks hold against future losses.  But market insiders know that these standards, along with parallel ones in our own financial reforms, won’t hold off another crisis.  As the always-rigorous Martin Wolf of the Financial Times put it, “tripling almost nothing does not give one much.”  The punch line here is that the lame new standards don’t even take full effect until 2019.  It is little wonder that bank shares rallied when the “tough” new standards were announced.

So at last until the next global meltdown, risky derivative and dark pool transactions, as well as continuing rounds of flash trading, will continue to depend on outsized leverage and unfold beyond the purview of most investors and regulators.

Here’s a final irony:  The only reason that investors let banks get away with such low capital reserves, high leverage and risky transactions is that the banks and everyone else knows that if the worst happens, governments will bail them out.  At the same time, the same financial institutions and their ideological fellow-travelers in Washington won’t stand for new rules that would actually reduce the likelihood of another eventual bailout. That’s as good an example as any of socializing risk for private gain, and a convincing demonstration that Washington and Wall Street learned little from the economy’s near-death experience two years ago this week.

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Deciphering the Crisis in Greece and Its Significance for America

Wednesday, May 12th, 2010

With the world’s stock and bond markets thoroughly roiled by Greece’s sovereign debt problems, it’s only natural to ask the perennial question, how does it affect us? The outlines of the crisis are certainly familiar. As I’ve been warning in this space for more than a year, governments around the world would inevitably face serious fiscal problems, dealing with the daunting debts accumulated from the huge bailouts for the financial meltdown and the large stimulus programs for the subsequent deep recession. In countries that began with large deficits and national debts, such as Greece, Portugal, Spain and Italy, those fiscal stresses have become very serious. Here, in the United States, we’re just beginning to hear calls for deficit reductions. If recent history is any guide, we will ignore the problem for several more years, until voters finally demand that Washington take real action.

Greece can’t wait, despite the recent violent protests there against budget austerity. Greece is also burdened with a relatively weak and uncompetitive economy, so it cannot generate strong growth to help ease the problem. Moreover, the organization of the Eurozone denies Greece, along with other member-nations with high and fast-rising public debts, two standards measures to boost competitiveness and help countries grow out of their mess. Greece can’t depreciate its currency to make its exports cheaper in foreign markets, since it shares the Euro with many other countries uninterested in a sharp depreciation that would leave them poorer. Greece also can’t cut its interest rates to spur domestic investment and attract capital from other EU countries, since the European Central Bank (ECB) sets the interest rates for everyone in the Euro Area.

That’s why Greece has been headed for a default on its government bonds. The hitch is that a Greek default would shatter the EU’s grand myth, that their (partial) economic union enhances the efficiency and competitiveness of its members enough to protect them from such crises. Moreover, if the EU stood by as Greece sank, international investors would dump the public bonds of other debt-burdened EU countries, starting with Portugal, Spain and Ireland. All of this would drive down the value of the Euro, especially relative to the currencies of the EU’s two major trading partners, the United States and China. By the way, that would be both bad and good news for us. A stronger dollar would make our exports more expensive in Europe, undermining the President’s hopes of relying on exports to help drive growth at home. But a stronger dollar, along with the threat of a sudden crisis for the Euro, also draws more foreign capital to the United States, which helps keep our interest rates low.

So far, the EU and the IMF (prodded by us with promises of a larger U.S. financial contribution) have headed off a Greek default, by unveiling a $1 trillion bailout plan consisting mainly of loans and a pledge by the European Central Bank to accept Greek bonds as collateral for loans to the European banks that buy those bonds from the Greek government. The fund is big enough to rescue Portugal and Spain as well, a smart move since serial debt defaults pose the greatest danger of all.

The announcement of the plan strongly recalls the original TARP bailout. Both plans were pulled together hastily to signal government’s determination to head off a collapse. In both cases, the signal is more important than the actual plan, since neither makes much economic sense. The EU plan depends, first, on taxpayers across northern Europe agreeing to shoulder much of the costs to rescue Greece and, second, on Athens following through with deep spending cuts and sharp tax increases that are bitterly opposed by most Greeks. Even if all of that came to pass, the plan has more fundamental flaws. It purports to respond to Greece’s public debt crisis by expanding the debts of Greek and other European banks as well as other EU governments — as if international investors will generously overlook Europe piling up even more debt than today. And if Greece does follow through on the draconian austerity measures contemplated in the plan, its economy will sink further, requiring even more public debt. In short, the bailout plan is a fantasy; and Greece and Europe will face another round of this debt crisis not long from now.

The improbable shape of the EU bailout does recall our own, original TARP plan. Just as the EU bailout does nothing to address Greece’s lack of competitiveness, the TARP in its various versions has never addressed the forces and factors that drove our financial crisis. So, 20 months later, our large banks are still not strong enough to resume normal lending to American businesses. Their continuing vulnerability also makes Europe’s current debt problems even more serious for us. Greek bonds — along with the bonds of Spain, Portugal, Ireland and Italy — are held mainly by financial institutions. German and French banks are the most exposed, but ours are well in the mix, too. Those bonds have been declining in value for weeks, taking their toll on bank balance sheets. A formal default by Greece would hit all of them; and serial defaults by Greece, Portugal and then Spain — and possibly Italy — would trigger another worldwide financial crisis.

This time, we would have few policy tools left to stop a downward spiral — and Congress almost certainly would fiercely oppose another huge taxpayer bailout, especially Republicans in the midst of a populist purification process that already has purged Bob Bennett in Utah and Charlie Crist in Florida. This is all speculative — thank goodness — but we could find ourselves with very few options to address a crisis that ultimately could lead to another Depression. Our best hope for now is that Greece and the Eurozone will somehow muddle through, much as we did in 2009.

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How Toyota and Goldman Sachs Stumbled — and We Could, Too

Tuesday, May 4th, 2010

Powerful and wildly-successful institutions sometimes act like teenagers and addicts, unable to recognize their own self-destructive behavior. This year’s top two examples are Toyota and Goldman Sachs. After investing decades to develop a sterling reputation for safety and quality, Toyota squandered its brand not by accident, but by myopic design: In a benighted chase for higher profits, Toyota’s top brass demoted vehicle safety from its long-time perch as the firm’s number one operational measure, to number four. Everyone inside the firm got the message — and now consumers around the world have as well. So, Toyota will spend years working to reclaim part of the worldwide market share it threw away.

Goldman Sachs may pay an even dearer price. It, too, spent a very long time building a world class reputation that married extraordinary market acuity with honest dealing. The self-immolation of that brand probably began with its principals’ decision to jettison their partnership and become a publicly-held company. This shift in the firm’s legal organization not only allowed them to cash in; it also transformed Goldman’s business and culture. Its flagship business of investment banking — giving advice and assembling financing for mergers, buyouts and takeover — receded so sharply that in recent years, it has accounted for just 10 percent of the firm’s revenues. In its place, Goldman became a giant hedge fund that creates and trades exotic financial products for both its clients and itself. What we know now is that once the top brass’s financial positions were no longer tied to the firm’s long-term value, as it would be under a partnership, a seemingly insatiable drive for huge, short-term profits led them to create products which they simultaneously hawked to their largely institutional clients of pension funds, endowments, banks and other financial institutions, even as they took financial positions against the very same products.

Coming back will be harder for Goldman Sachs than for Toyota. Toyota has to reengineer its operations — a serious challenge — in order to restore the core position of safety and quality. But automobile recalls are routine, even if the extent and reasons in Toyota’s case were not; and several years from now, a reconfigured Toyota could be back on top. But Goldman faces years of civil suits by government regulators, their own shareholders and their former clients, as well as possible criminal charges — and not just in the United States. Goldman faces the same treatment in other countries — starting with Greece, whose fiscal problems Goldman allegedly helped to hide using financial maneuvers like those employed by Enron in its final, desperate year. Based on what has happened to other firms that found themselves caught up in extended legal problems, the most important costs to Goldman will not be the legal fees, fines and settlements, but the “distraction factor.” For years, its top executives will find themselves absorbed in defensive moves and stratagems to beat their various raps — while their rivals at other firms focus on the subtle shifts in markets and the economy that can presage large changes. And this doesn’t even count the herculean task of rebuilding a brand that now stands for both self-dealing and double-dealing.

Without realizing it, administrations, congresses and political parties also can turn self-destructive. The GOP brand in economic stewardship, for example, certainly suffered serious damage from the policies of a Republican President and Congress that ultimately culminated in the worst economic crisis since the 1930s. Yet, even with 60 percent of the country still blaming the Bush administration for the bad economic times, and the public directing the worst of their outrage at Wall Street, Washington Republicans remained committed to a “strategy” of stopping the Obama administration from reforming Wall Street.

Then there’s the matter of the national debt. Eighteen months ago, in this blog, I warned that Wall Street’s meltdown was only the first stage. Stage two was the deep recession triggered by the financial meltdown; and stage three would be the fiscal crises created by the bailouts and stimulus used to address the first two stages. That all has come to pass; the open question is how self-destructive our response will be. We pulled the financial system back from a collapse that would have ushered in another Great Depression, with only a normal quota of self-inflicted wounds — like letting Goldman and JP Morgan Chase claim full payment on deals with AIG which the taxpayers rescued, and not forcing them and other bailed-out institutions to use their new, taxpayer-financed capital to expand lending to businesses. The American brand is successful pragmatism: Figure out what needs to be done, and then go do it. But what needs to be done here is to reconfigure the tax system so it produces more revenues while leaving the economy more efficient — think of tax simplification that jettisons lots of special interest tax breaks — and to reshape current “entitlement” spending for not only elderly people, but also for influential industries and for districts and states whose members of Congress have risen to the leadership.

If we cannot get past the partisan warfare, the United States in a few years could find itself in Toyota’s place, with a tainted brand and smaller political market share. Our Treasury bills and bonds are very unlikely to ever default, as Greece nearly did this week (and still could do, if the bailout fails in any significant way). But the normal politics-of-least-resistance will never reconfigure taxes or reshape spending. Instead, it will lead us to a place where we have to pay out more and more to attract foreign investors, and those higher interest rates could consign the American economy to years of very slow growth. That’s what can happen to a great nation that insists on acting like a child or addict, blind to its own self-destructive behaviors.

Read Dr. Shapiro’s related Huffington Post piece: Goldman Scandal Erodes Case for Cap and Trade, April 28, 2010.

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A New Progressive Economic Strategy, Part 4: The Global Economy

Thursday, April 29th, 2010

In a global economy, even the world’s largest economy by a factor of three (that’s us, compared to Japan and China) cannot by itself ensure job opportunities for everyone and healthy incomes gains for everyone who works hard and well. We may wish it were otherwise, but the United States and the forces of globalization now share control over America’s economic path. The challenge is to work with those forces to benefit average Americans, and to exercise the global leadership required to ensure that other countries work with us to promote the growth and stability of the global system. This part of the progressive agenda has many elements, including efforts to advance open trade in ways that help average workers, steps to promote innovation and protect the rights of American innovators around the world, and responsible regulation of finance while promoting free flows of global capital.

In one way or another, just about every economic activity in America is touched by global forces, whether it’s the operations of foreign companies, investors, innovators, consumers, or governments. We’re still the world’s largest economic actor by a long shot; but the global economy has grown too large, complex and fast-changing for even us to dominate, much less direct. Let’s start with trade. Twenty years ago, 18 percent of all the goods and services produced in the world were traded across national borders — today, in a global economy two-thirds larger (adjusted for inflation), one-third of everything produced anywhere is traded — some $20 trillion worth per-year. Most of this rapid increase is tied to the explosive modernization of China and other large developing countries, and the fast-expanding consumption of their people.

America can generate good jobs and rising incomes for average families only by working with this historic expansion of worldwide trade. Progressives should be committed not only to equip American workers and companies with what they need to compete in a global trading system, but also to open markets here and around the world, especially in services and agriculture. The first commitment involves many of the initiatives described in earlier essays, including access to free IT training, health care reforms to reduce business costs, and tax reforms to make American companies more competitive.

In exchange, progressives should push to conclude the Doha trade round to open foreign markets to services, where U.S. companies excel, to negotiate fair, free trade status with burgeoning economies such as Korea and, in time, with Japan; and to hold China and other fast-growing emerging markets to their WTO promises to open their markets. In all of these cases, American firms and workers would gain, because our markets already are far more open than most others in the world. And there’s no one else who can lead effectively here, since no other country has as much leverage with the holdouts in the EU and the developing world.

America’s greatest exports are its new ideas, whether they’re embodied in new software code, breakthrough pharmaceuticals and medical devices, new business services, genetically-enhanced foods, new forms of entertainment, or the latest-generation equipment. In fact, America’s unique role in globalization is being the world’s largest source of economic innovations and the testing grounds for adopting them on a large scale. To be sure, innovators come from every part of the globe; but for the last generation, American inventors, entrepreneurs and companies have dominated the development of most (not all) critical new technologies and new ways of doing business. And the effective application of new ideas is the principal source of most of the competitive edge American companies retain in many global markets.

To help keep all of this going, our new economic plan has to actively spur continuing economic innovation through tax reforms, a larger federal commitment to basic research, and by maintaining the healthy competitive pressures that spur innovation and their broad adoption. In this context, too, American workers need access to the skills required to use these innovations and perform effectively in workplaces dense with advanced technologies. These steps not only can help average families succeed as new ideas unfold; they also support America’s place as the world’s largest domestic market for innovations, which in turn will spur additional investments to develop their next generation.

A progressive economic program should include two initiatives in this area. First, since innovation is the essence of our competitive advantage in the world, we need a no-holds-barred campaign to cajole or coerce every other nation to respect the intellectual property rights of American innovators and companies. In addition, we need to reclaim the global leadership we exercised in the 1990s in addressing climate change by enacting measure to fix a strict and environmentally-appropriate price on carbon emissions, preferably with a carbon-based tax that recycles its revenues in other tax cuts. This would not only be part of America’s responsibility for broad economic leadership, it also could spur to a dramatic degree American companies to develop new, climate-friendly fuels and technologies, and then broadly adopt them.

A progressive economic plan also has to take serious account of the global financial system. American companies are the world’s largest foreign direct and portfolio investors, with operations and other investments spread across the developing and advanced world. The United States is also the world’s largest single recipient of direct investments by foreign companies and portfolio investments by foreign funds and governments. So, we have an enormous stake in a healthy and stable financial system, here and around the world. And in the wake of the recent meltdowns, the central issue here is how best to regulate finance, here and around the world.

Based on the recent crisis, the basic terms of regulation seem clear. First, require that all financial institutions hold more capital, relative to their investments, and adjust those stricter capital requirements for the riskiness of a bank or fund’s portfolio. That should help end their risky practice of making huge wagers, for example in asset derivative or interest rate futures, using almost entirely borrowed funds. Second, make sure that every transaction in finance, involving any kind of instrument, occurs on a public exchange or through a publicly-chartered clearinghouse. That can ensure that every trade or purchase is transparent and subject to the same disclosure and soundness rules. Third, end self-dealing compensation practices that just encourage the most risky wagers, for example by paying out bonuses long before anyone knows whether the transaction will actually work out. And none of these sensible changes would impede the free flow of investment and money — in fact, they should enhance America’s premier position in the global capital system.

The good news here is that the regulatory plans passed by the House and being considered this week in the Senate both contain versions of these three basic changes. The bad news is that they’re all weaker than needed — so, it’s up to progressives to strengthen them.

That leaves the sticky matter of “Too Big to Fail,” or what to do about funds or banks whose failure could trigger another broad crisis. We have two alternatives: Break them up, so no bank or fund can jeopardize the stability of the entire financial system. In its’ favor, there’s little evidence of real economic benefits derived from the huge size of the institutions that dominated the sector before the crisis, much less the even greater size of the behemoths that dominate it now. Many conservatives like this approach, from Alan Greenspan to Mervyn King (he runs the Bank of England), because it avoids the alternative, which would be a new process to take over the investment activities of any large player at the first sign of trouble. Either way, the plan should reject out-of-hand the current, reckless GOP position:No prophylactic break-ups, no new process to take them over when they’re in trouble, and no future bailouts. That would be a formula for a global depression the next time that big finance implodes.

There’s more to consider as well for a progressive plan to help Americans make the best of globalization, from sensible immigration reforms to measures to help recognize asset bubbles before they get out of hand. In one way or another, we will return to those issues later, along with some others. For now, we conclude this four-part series hopeful that somewhere out there, in Washington or beyond, there is a growing recognition that now is the time for progressives to rethink our national economic approach and reconfigure the economic agenda.

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