“Unless there are offsetting measures...."

Oh boy. Waiting for the other shoe to hit us in the head.

You know, Jack, we've been kicking around the state of the world for years on this blog. Especially the financial well-being of Portland and the rest of America. Here's the image
I'm getting lately. I'll tell it as a story.
I once came upon a tavern fight outside my local hangout back in the wild days. It was a blur of activity and mayhem, including one friend who was being beaten with his own crutch.
That was the Bush administration and I jumped in and did everything I could think of. I walked into that brawl and said, "Time out. We're going to a network commercial." It was such a weird thing to say that everyone stopped fighting. I said it was over, but then one young man said, no, it's not. The person who was being beaten with his own crutch, had used it himself to break off this young man's upper teeth about halfway down. All of them.
I stepped back realizing that this changed things. I walked away from the fight and went inside. Perhaps I had bought them a little time as the sirens were on the way, but I sensed the scenario was not resolvable by me so why try?
I have that feeling now. I'm emotionally walking away from this fight because I see that I can't stop it. I used to get riled up when a jerk like Dick Cheney would say, "Reagan proved that deficits don't matter." I'm so far beyond anger about this now. It's just a tragedy and as bad as I think it'll be, I'm sure it will be worse. Things are already happening that I never thought I'd see with numbers that are so far beyond crazy that I can't believe my eyes. I can't believe this is reality. Derivatives? Imaginary trillions that never existed but are now real debt? This is going to get nasty in a way that will be featured in world history. I'm guessing something as heavy as World War 2 or more likely the Revolutionary War.
I thought we could correct the trends here, but I see we're heading for a day of reckoning. We're locked into a financial armageddon. I can hear the sirens approaching.

To understand why this is happening you need to understand the economics and conflicting policy goals.

The U. S. economy needs more spending. Consumers have reduced demand for goods and services because of unemployment and lack of debt capacity, and business is sitting on $2 trillion of cash because of lack of investment opportunity. The Feds must step in with increased spending and/or tax cuts, which mean incrased deficits.

The U. S. economy also needs lower deficits, because the high deficit produces uncertainty and higher risk and higher interest rates which retard economic growth. This means higher taxes and lower spending.

The U. S. economy also needs to reduce income and wealth inequality. This is not class warfare, but recognition of the fact that a growing economy needs income growth for the lower and middle income groups. Of the BRIC countries, Brazil, India and China are experiencing very high growth because the lower and middle income groups are the ones who are prospering. The U.S. needs policy which will direct economic growth to the lower and middle income groups, which will tend to make economic growth more sustainable by replacing government spending with private spending.

As you can see, economic policy which increases demand and economic growth also increases the budget deficit which causes uncertainty and risk, and reduces investment and economic growth. Balancing these goals with the right policy is difficult. However, the original Obama plan, continuing the tax rates for low and middle income families, and allowing them to expire for high income families, and allowing a small decrease in the Estate Tax seems like the right balance. Allowing taxes to rise on the wealthiest Americans would have sent the signal to financial markets that the U.S. is becoming more serious about controlling its budget deficit. This is why the "Compromise" is such bad government.

It is also bad politics, as seen by the many posts on this Blog. A political leader cannot go back on a key element of their campaign without substantial consequences. In my opinion Obama is more wedded to the idea of bi-partisanship then anything else, and he wanted to show bi-partisan policy could be enacted even at the cost of electoral credibility. It is tragic that after two years of obstruction he does not realize that the opposition will have none of this. Mr. Boehner said recently he will not even entertain the use of the word "Compromise". The Republican strategy of blocking almost all government policy worked very well for them in the 2010 election. They also elected many legislators who are rigid idealogues. Why would any rational person expect compromise and bi-partisanship going forward?

So the "Compromise" is neither good government nor good politics. Mr. McDonald's comments are very illustrative of this. Sooner or later Mr. Obama is going to have to stand up and fight for the principles upon which he was elected, or join Carter and George H. W. Bush, decent and principled men who never showed the leadership necessary for re-election.

So I guess we get to put the "full faith and credit" stuff to work. I am still amazed why bonds haven't taken a bigger crash than they have in the past month. The Fed buying paper sure hasn't helped, so they're running out of tricks (or whatever they're calling QE now).

As far as Congress showing any discipline I ain't seeing it so far with latest $1T budget with no cuts, more pork and earmarks. So they don't have a clue either.

Re-fi your house now if you need to.

"decent and principled men who never showed the leadership necessary for re-election."

Pray tell, can you name one of those in the past 20 years? I mean not someone who just talked but actually had power.

As far as running deficits, it will catch up with us. Since you mentioned Carter you may want to look at what Volcker had to do to fight stagflation, so just running deficits because you have no other clue isn't a game winner.

"economic policy which increases demand and economic growth also increases the budget deficit"

One more history lesson, look at what Clinton did with the deficit after he lost the House in '94. I'd disagree with you.

Everyone talks about the deficit, federal debt and interest rates on Treasurys as if they matter, and to that extent they undoubtedly do. But it's worth contemplating whether, ultimately, they matter in exactly the way we all think about them. For example: while the United States could choose to default on its obligations, there is no reason it would actually need to. It can issue new bonds. It can pay its debts the same way it pays everything else: by making entries in accounts. Higher interest rates on Treasurys? The Fed can buy up Treasurys as it has done and remit the interest it receives to the federal government, as it has done. Net interest cost: zero. Is inflation a constraint on these actions? Not when unemployment is high and there is excess productive capacity. And extra money in the system can be removed through taxation and additional Treasury sales. As long as the US is dealing in its own fiat currency, all these options are available. You can't dismantle our social safety net by talking this way, though.

The history lesson that I think is relevant here is not the period after 1994 but 1993. Clinton inherited a weak economy and rising deficit that was unsustainable and threatening financial stability. He raised taxes, but only on the highest income group and the program did not receive the support of a single Republican.

The result was that the economy grew, the deficit eased and the wealthiest Americans did very well because of growth in business income. If one wants to look at history, then the tax rates on the wealthiest Americans at the end of the Clinton Administration, which is what we would have today in the absence of the "Great Compromise" are certainly not a hindrance to economic growth, increased employment and movement to a balanced budget. In fact, history would say those rates are just about right.

Bill, I'm with you on this one.
Maybe it is time turn my life savings into gold bullion, or like the wealthy in 1500s Spain, into gold chains with easily detachable links for easy spending and or exchange.
Merry Merry, every body!

"The Fed can buy up Treasurys as it has done and remit the interest it receives to the federal government, as it has done. Net interest cost: zero. Is inflation a constraint on these actions? Not when unemployment is high and there is excess productive capacity."

They'd have to pay higher for them once interest rates click up so the effective yield would probably be zero (The diff between a higher price and TVM of interest received.) It's a shell game, but it's getting more like musical chairs since people are wondering who's gonna get stuck with paper that is worth less (look at the 20 yr T-bills in the past 3 weeks, they've crashed.)

Ultimately the issue is going to be loading the economy with an excess of dollars chasing goods. Again, if you look at the price of hard assets like gold/oil you can start to see what happens. In addition, manufacturers are more likely to eat the increase costs of raw materials and take it out of profit instead of raising the consumer pricing which constrains their ability to buy and expand.

Originally this whole thing got started with tax cuts vs. stimulus and deficits. I can live with deficits, but disagreeing with Krugman (he thinks the only reason it doesn't work is because we haven't done enough of it - he'll never lose that argument) stimulus spending is only about 10% as effective as tax cuts. With tax cuts at least you leave the money in the consumers hands (to pay bills or buy more).

With stimulus, it gets skimmed by govt agencies and then a smaller portion goes to the short list of favored contractors to actually do work. I used to believe in stimulus, but that was before Paulsen got hold of it.

Just using Oregon, we got $1.8B in stimulus last year. Where'd it go? Shoring up benefits. Either that or something stupid like TriMet spending $750 on 4 miles of track (or $10M at a time to G-E or Homer) while we have no money for school repairs or the Sellwood bridge.

Congress, as it has evolved into it's current incarnation, is structurally incapable of ever fixing the deficit. It won't be fixed without a titanic crisis that basically "breaks" Congress, one that goes down in "world history" as Bill says.

Since the finanical crisis of late 2008, I find it hard to even follow what is going on in DC. It all seems next to irrelevant. It's why I can't feel too disappointed with Obama. He wants the deck chairs at one end of the titanic, and someone else wants them at the other end. Who cares?

Allan, the Fed can't finance the Treasury. The dollar would be dropped as the world's reserve currency (other countries are already discussing this), and then we'll just be Zimbabwe, printing money nobody wants to fund government operations. We're pushing it as it is.

Steve, there is a great deal of what you have said above that is open to challenge.

First of all, higher interest rates don't make the prices of Treasury obligations go up. In fact, it's exactly the opposite, as a moment's reflection will convince you. So as rates rise, open market purchases will be cheaper to keep the yield at the market level. Not that it makes any real difference, since these operations are essentially self-dealing. Maybe you were saying something different. If so, perhaps you could clarify.

Too much money in the system may be a concern one day; it certainly isn't now, and it's hard to see that day coming soon. In fact, money continues to disappear as housing prices decline and consumers and businesses de-leverage by paying off their debt. But in any case when there is too much money in circulation, the Fed has ways of sopping it up. Higher taxes are an easy solution that also contributes to better social policy (lower deficits, more fiscally sound programs). This is of course the opposite of the real Republican program, which is to keep deficits high based on the expectation that it is the only way to constrain public spending. So the prospect of inflation through money supply increases is not something that has to determine fiscal policy today, but it is politically contentious.

You mention gold and commodity prices as an indicator of inflation. But those are very thin markets that are easily influenced by a few players. Their history is one of high volatility and wide swings. Better to look at the CPI, published today. It shows essentially no inflation.

Please give us a source for the proposition that government stimulus is only ten percent as effective as tax cuts. The economists I am familiar with all assert that government spending is more efficient. We certainly have not seen any evidence to support your argument with ten years of massive deficits resulting from tax cuts.

Krugman at least has the advantage of having predicted that the first Obama stimulus was too small and too much oriented to tax cuts to do the trick. (In fact, if you could have invested in derivatives over the last few years based on Krugman's predictions, you would have done quite well.) That's not to say he's 100% right, and one of the problems we have is the absence of rigorous science to support one point of view or another.

Of course, with government spending, you'll never please everyone. We all have different priorities, and I think all essentially want government spending to be effective and not to involve fraud, waste and abuse. Personally, I'd like to see something with a real "investment" quality: infrastructure and education that will position us to have a stronger private sector in the future.

With respect to how government stimulus money has been spent and is being spent in Oregon, you can get pretty thorough information by googling it. But remember this: for government spending to be effective as stimulus, it doesn't have to be well spent. It only needs to be spent. (The same is true, of course, of money in private hands as a result of tax cuts, or of government welfare handouts, or program spending by the government. The difference is that, where tax cuts are concerned, there is evidence that the wealthy, who receive the lion's share, tend not to spend it, so that doesn't help.)

Lastly, there was no Paulson stimulus. Those were bailouts, with a different structure, purpose and effect.

Allan, the Fed can't finance the Treasury.

Somebody better tell Japan.

You know what really worries me? It's the weak position we're in going forward. Just because we've plundered the world with a completely avoidable greed-fest, just because we've allowed these bankers to take us to the brink, giving them more casino chips when they had gambled their way into failure, doesn't mean that we won't face something real.
We could encounter a problem where you do bet the house, where you run up trillions of dollars in debt because you absolutely have to, to deal with a real emergency. It could be a pandemic, it could be a super-volcano or a 9.0 quake in the Pacific Northwest. There are plenty of problems that can come along that require massive amounts of capitol to beat down.
That could be when we really see how crazy it was to waste all of this on derivatives. Little side bets so that foreign bankers and Wall Street can generate their annual bonuses. Little financial scams that have now grown to a thousand trillion dollars worth of financial exposure.

"for government spending to be effective as stimulus, it doesn't have to be well spent. It only needs to be spent."

Not necessarily. If OR is smart enough to realize they are building up PERS reserves and uses all of the money for that, then a lot of that money won't get spent until it is taken out later.

"It only needs to be spent."

That's my other issue, if we spend it to build empty condos or 5 mph streetcars, beyond the immediate construction jobs are we really increasing our wealth? Worse yet, we don't use it to make better graduates from the school system (another discussion about how school funding should be spent.)

Or if Hank P took it to give to AIG to give to G-S, it makes for great bonuses and propping up the stock price which is not really wealth, just propping up numbers in an account.

If we left it in taxpayers pockets to invest (either buying things or paying bills), the ripple effect / lasting time factor of the money would be a lot greater. They'd buy things, giving manufacturers profits which they'd invest in plant and hiring people. Hiring more people means wage pressure and raises.

"But in any case when there is too much money in circulation, the Fed has ways of sopping it up. Higher taxes are an easy solution"

The Fed doesn't control taxes and higher taxes aren't an easy solution. Congress won't raise taxes until the economy is screaming in pain and literally everything else has been tried.

"Somebody better tell Japan."

Japan's population buys their bonds, because they are strong savers in an export economy. Despite some QE, never did the Bank of Japan reach the level of simply monetizing the national debt. Anyway, Japan has been in a cultural and economic deflationary funk for more than 20 years. Is that what we should aim for?

Bill McDonald-

Agree with your point about derivatives.

Is there in your mind any distinction between derivatives as we knew then from 1996 to 2008 and carbon offsets or "cap and trade" for carbon?

"higher interest rates don't make the prices of Treasury obligations"

They make fixed-rate instruments cheaper which means you have to sell that much more in 2010 to cover the 2007 T-bills you sold.

"Higher taxes are an easy solution that also contributes to better social policy"

I can't comment on whether more taxes makes better policy, but it doesn't sop up money since it still gets spent no matter how wisely or stupidly, unless we used to to actually took it out of circulation, but I don't see the flow of Treasury paper slowing down anytime soon.

"That's not to say he's 100% right, and one of the problems we have is the absence of rigorous science to support one point of view or another."

With Krugman, if it doesn't work we just haven't spent enough, otherwise he's right. So how can you say Krugman is ever wrong?

"I'd like to see something with a real "investment" quality"

If I ever see that, I'd be for a tax increase. Unfortunately, investment quality govt spending is always at the bottom of the list. Frippery (like condo projects) and lost money (like defense spending) are the top slice.

"Please give us a source for the proposition that government stimulus is only ten percent as effective as tax cuts."

Conjecture on my part. My main point is $1 in govt will be less effectively spent than $1 left in a consumer's pocket.

"The economists I am familiar with all assert that government spending is more efficient."

That I'd like to see references with numbers on.

"Better to look at the CPI"

The CPI uses the bushel basket approach which means what they show is a smaller percentage of total spending. Example, prop tax go up 3%/year. Water rates went up 30% in the past two years (that is not minor - on an apartment at $50/month that equals one month rent per year to Randy's slush fund.)

Can you say "quadrillion?" It's coming.

To modify a famous saying: "Pretty soon you're NOT talking real money."

The guys at the Angry Bear economics blog discovered, while researching their book "Presimetrics", that higher marginal tax rates go along with higher GDP growth, all the way back to 1929 (when the government started recording GDP). See http://www.presimetrics.com/blog/?p=253 . They've admitted that this is counterintuitive and goes against generally accepted economic theory, and have been struggling to come up with an explanation - http://www.angrybearblog.com/2010/12/why-economy-stubbornly-insists-on.html .

If history is any guide, extending the Bush tax cuts will depress GDP growth, which adds insult to injury, given the negative effect that increased deficits will have.

Like them or not, facts are facts. But facts won't deter people from arguing for their beliefs, no matter how unsupported by facts they may be.

"Like them or not, facts are facts."

So is the "fact" that every one who drinks water dies. You going to stop drinking water?

You're confusing coincidence with cause. Besides JFK and Reagan cut tax rates and we seemed to do OK then. If you read it he only said increasing rates caused it, he didn't prove decreasing top marginal rates also didn't preclude growth (aka disproving the null hypothesis.)

It's true that correlation does not equal causation. That doesn't mean we should ignore correlation, especially when just about everybody believes the two datasets are linked (in this case, marginal tax rates and GDP growth).

I don't want higher taxes any more than you do, but it's my nature to question assumptions, and I'm questioning the article's assumption that the tax cuts will spur growth, based on the 80-year trend that runs counter to that.

What I predict is that the top 1%, rather than investing their outsized share of the cuts in something worthwhile and constructive, will put their money into speculative schemes (The Fed's ZIRP encourages that), increasing the risk of another financial meltdown.

The rest of us will put most of our share into paying down debt. That will help the megabanks' bottom lines and increase their executive bonuses, but won't stimulate the economy very much.

What I think would be more effective is something like the WPA to put the 99ers back to work while actually building things of lasting usefulness, like Timberline Lodge. But the banksters have Obummer on a short leash, so that ain't gonna happen, is it?

Here's an answer to the supposed Angry Bear paradox. With higher marginal tax rates, the wealthy have a relative disincentive to sell appreciated assets, and thereby recognize income. If they sell appreciated assets, they send Uncle Sam his piece of the action, and either consume or re-invest the after-tax proceeds.

If they don't sell their appreciated assets, they keep more of their assets invested which increases productivity and GDP growth, and results in a higher standard of living.

If we didn't have relatively low marginal tax rates for the wealthy, the top 1% wouldn't have increased their share of income taxes paid from 19% in 1980 to over 40% in 2007. That's the real paradox.

"especially when just about everybody believes the two datasets are linked"

I'd like to see data then to show that there is as strong a correlation the other way then (i.e. tax decreases don't cause growth).

My issue with AngryBear is his conslusion oversteps the premise.

BTW - Everyone doesn't mean everyone (-1 for me.)