Up and Down Wall Street
.On Borrowed Time

.Heavy debt loads slow the U.S. economy now and pose threat to the future

Can a stimulant become a depressant? As with alcohol, government borrowing and spending initially can give a boost, but later becomes a drag. America has hit the downside of that progression.

So says Lacy H. Hunt, chief economist of Hoisington Investment Management (whose eponymous head, Van R. Hoisington, recently was interviewed in the print edition of Barron's.) The deficits that had aimed to stave off a rerun of the Great Depression after the 2008 financial crisis now are having a depressing effect on the U.S. economy, Hunt contends.

Catching up with Hunt on the road after meetings with Hoisington clients, he expounded on his latest quarterly review, "High Debt Leads to Recession," a conclusion that runs counter to economics as it is taught in most institutions of higher learning. For most of us who studied the conventional Keynesian economics as taught in the textbooks of Paul Samuelson and his successors, government spending "primes the pump," to get money back into the economy after the flow of spending had been turned off by a private sector, which was intent on saving "too much." As a result, resources sat idle, especially the unemployed. Borrowing and spending by government would expand national income by a multiple of its expenditures.

Actually, the opposite is happening. The multiplier from government spending is no better than zero, Hunt says on the basis of econometric evidence. If the economy is "shocked" with a deficit, gross domestic product will get a lift for three-to-five quarters. After 12 quarters, however, the original stimulus is spent, literally and figuratively. But the debt that was incurred to finance the spending remains, and has to be repaid, with interest. That requires a shift of assets from the private sector to the public sector.

Japan provides an example of this process. That nation's government debt has expanded during its "lost decades" to 200% of GDP from 50%. Meanwhile, nominal GDP in yen terms is basically unchanged. In other words, Japan's debt has quadrupled but has nothing to show for it -- except higher interest costs, which has to come out of the private sector.

Hunt cites the now-familiar conclusion that debt-to-GDP ratios over 90% retard growth from economists Kenneth Rogoff and Carmen Reinhart, authors of the popular This Time is Different: Eight Centuries of Financial Folly, who also presented that conclusion in a 2010 National Bureau of Economic Research working paper, Growth in the Time of Debt.

Hunt also points to an even more exhaustive study on the effects of debt from Stephen G. Cecchetti, M. S Mohanty and Fabrizio Zampolli from the Bank for International Settlements, presented at the Federal Reserve's Jackson Hole confab last year, The Real Effects of Debt, which takes into account the retarding effect of not only government but also corporate and household debt. Those imply "that the debt problems facing advanced economies are even worse than we thought," especially when unfunded future liabilities in the form of promises given by governments in retirement and medical benefits are counted.

So, I asked Hunt, is there any way out of this apparent debt trap? Nothing that's politically popular, he says. Without tackling the unfunded liabilities of Social Security and Medicare -- which total some $59 trillion, dwarfing the U.S. bond debt of $15 trillion -- there's little if any anything that can be done. Federal outlays -- which total 25% of GDP, unprecedented except in World War II -- are headed to 40%, according to economist Barry Eichengreen of the University of California at Berkeley. Absent the political reforms needed to rein that percentage in, he writes, "The United States will suffer the kind of crisis that Europe experienced in 2010, but magnified," Eichengreen writes.

The solution to the U.S. debt problem requires robust economic growth, not the downward spiral that Europe's most indebted economies, such as Greece, now are experiencing. Government spending has negligible or negative long-term impact on growth, Hunt says, based on econometric evidence. So-called tax expenditures, the most prominent being the mortgage-interest deduction, do little if anything to spur growth. But changes in marginal tax rates have significant multiplier effects.

What's needed then, says Hunt, a comprehensive package of shared sacrifice along the lines of the Bowles-Simpson plan, which was unveiled a year ago and shelved. Since then, the U.S. has had a contrived crisis over the debt ceiling and a less-than-super committee that couldn't make basic choices about spending. Hunt says his package would consist of cutbacks on government spending and tax expenditures, which slow growth, with stable or lower marginal tax rates. At minimum, stabilize policies so businesses can plan and invest and hire.

This dire long-term view of U.S. finances seems at odds with Hoisington's continued position in the longest-term Treasury bonds. And those long Treasuries produced 30% total return in 2011. For the deflation pressures from various sources, including heavy U.S. total debt, Hunt looks for Treasury bond yields to fall still further, from just 3% currently. But, he adds, his firm is ready to switch tacks if and when debt problems push yields higher.

When the facts change, Hunt says Hoisington Investment Management's portfolios will change, alluding to Keynes's famous dictum. That may be the only thing on which Hunts agrees with Keynes.

Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved

January 16, 2012 7:14 pm

We are all going to hell in a shopping basket

It is far too easy to blame the crisis of capitalism on global finance and sky-high executive salaries. At a deeper level the crisis marks the triumph of consumers and investors over workers and citizens. And since most of us occupy all four roles, the real crisis centres on the increasing efficiency by which we as consumers and investors can get great deals, and our declining capacity to be heard as workers and citizens.

Modern technologies allow us to shop in real time, often worldwide, for the lowest prices, highest quality, and best returns. Through the internet we can now get relevant information instantaneously, compare deals and move our money at the speed of electronic impulses. Consumers and investors have never been so empowered.

Yet these great deals come at the expense of our jobs and wages, and widening inequality. The goods we want or the returns we seek can often be produced more efficiently elsewhere by companies offering lower pay and fewer benefits. They come at the expense of main streets, the hubs of our communities.

Great deals can also have devastating environmental consequences. Technology allows us efficiently to buy low-priced items from poor nations with scant environmental standards, sometimes made in factories that spill toxic chemicals into water supplies or release pollutants into the air. We shop for cars that spew carbon into the air and tickets for jet aeroplanes that do even worse.

Other great deals offend common decency. We may get a low price or high return because a producer has cut costs by hiring children in South Asia or Africa who work 12 hours a day, seven days a week, or by subjecting people to death-defying working conditions. As workers or as citizens most of us would not intentionally choose these outcomes but we are responsible for them.

Even if we are fully aware of these consequences, we still opt for the best deal because we know other consumers and investors will also do so. It makes little sense for a single individual to forgo a great deal in order to besocially responsible” with no effect. Some companies pride themselves on selling goods and services produced in responsible ways but most of us don’t want to pay extra for responsible products. Not even consumer boycotts and socially responsible investment funds trump the lure of a bargain.

The best means of balancing the demands of consumers and investors against those of workers and citizens has been through democratic institutions that shape and constrain markets. Laws and rules offer some protection for jobs and wages, communities, and the environment. Although such rules are likely to be costly to us as consumers and investors because they stand in the way of the very best deals, they are intended to approximate what we as members of a society are willing to sacrifice for these other values.

But technologies are outpacing the capacities of democratic institutions to counterbalance them. For one thing, national rules intended to protect workers, communities, and the environment typically extend only to a nation’s borders. Yet technologies for getting great deals enable buyers and investors to transcend borders with increasing ease, at the same time making it harder for nations to monitor or regulate such transactions.

Goals other than the best deals are less easily achieved within the confines of a single nation. The most obvious example is the environment, whose fragility is worldwide. In addition, corporations routinely threaten to move jobs and businesses away from places that impose higher costs on them – and therefore, indirectly, on their consumers and investors – to morebusiness-friendlyjurisdictions.

Finally, corporate money is undermining democratic institutions in the name of better deals for consumers and investors. Campaign contributions, fleets of well-paid lobbyists, and corporate-financed PR campaigns about public issues are overwhelming the capacities of legislatures, parliaments, regulatory agencies and international bodies to reflect the values of workers and citizens.

The US Supreme Court has even decided that, under the First Amendment to the Constitution, money is speech and corporations are people, thereby opening the floodgates to money in politics.

As a result, consumers and investors are doing increasingly well but job insecurity is on the rise, inequality is widening, communities are becoming less stable and climate change is worsening. None of this is sustainable over the long term but no one has yet figured out a way to get capitalism back into balance. Blame global finance and worldwide corporations all you want. But save some of your blame for the insatiable consumers and investors inhabiting almost every one of us, who are entirely complicit.

The writer is a professor of public policy at the University of California at Berkeley, and was US secretary of labour under President Bill Clinton

Copyright The Financial Times Limited 2012.

Does Austerity Promote Economic Growth?

Robert J. Shiller


NEW HAVEN – In his classic Fable of the Bees: or, Private Vices, Publick Benefits (1724), Bernard Mandeville, the Dutch-born British philosopher and satirist, described – in verse – a prosperous society (of bees) that suddenly chose to make a virtue of austerity, dropping all excess expenditure and extravagant consumption. What then happened?

The Price of Land and Houses falls;

Mirac’lous Palaces, whose Walls,

Like those of Thebes, were rais’d by Play

Are to be let; . . . .

The building Trade is quite destroy’d

Artificers are not employ’d; . . .

Those, that remain’d, grown temp’rate strive

Not how to spend, but how to live . . .

That sounds a lot like what many advanced countries have been going through, after financial-crisis-induced austerity plans were launched, doesn’t it? Is Mandeville a genuine prophet for our times?

Fable of the Bees developed a wide following, and generated substantial controversy, which continues to this day. The austerity plans being adopted by governments in much of Europe and elsewhere around the world, and the curtailment of consumption expenditure by individuals as well, threaten to produce a global recession.

But how do we know if Mandeville is right about austerity? His research method – a long poem about his theory – is hardly convincing to modern ears.

Harvard economist Alberto Alesina recently summarized evidence concerning whether government deficit reduction – that is, expenditure cuts and/or tax increases – always induces such negative effects: “The answer to this question is a loud no.” Sometimes, even often, economies prosper nicely after the government’s deficit is sharply reduced. Sometimes, just maybe, the austerity program boosts confidence in such a way as to ignite a recovery.

We have to examine the issue with some care, understanding that the issue that Mandeville raised is really a statistical one: the outcome of government deficit reduction is never entirely predictable, so we can ask only how likely such a plan is to succeed in restoring economic prosperity. And the biggest problem here is accounting for possible reverse causality.

For example, if evidence of future economic strength makes a government worry about economic overheating and inflation, it might try to cool domestic demand by raising taxes and lowering government spending. If the government is only partly successful in preventing economic overheating, it might nonetheless appear to casual observers that austerity actually strengthened the economy.

Likewise, the government’s deficit might fall not because of austerity, but because the stock market’s anticipation of economic growth fuels higher revenues from capital-gains tax. Once again, we would see what might appear, from looking at the government deficit, to be an austerity-to-prosperity scenario.

Jaime Guajardo, Daniel Leigh, and Andrea Pescatori of the International Monetary Fund recently studied austerity plans implemented by governments in 17 countries in the last 30 years. But their approach differed from that of previous researchers. They focused on the government’s intent, and looked at what officials actually said, not just at the pattern of public debt.

They read budget speeches, reviewed stability programs, and even watched news interviews with government figures. They identified as austerity plans only those cases in which governments imposed tax hikes or spending cuts because they viewed it as a prudent policy with potential long-term benefits, not because they were responding to the short-term economic outlook and sought to reduce the risk of overheating.

Their analysis found a clear tendency for austerity programs to reduce consumption expenditure and weaken the economy. That conclusion, if valid, stands as a stern warning to policymakers today.

But critics, such as Valerie Ramey of the University of California at San Diego, think that Guajardo, Leigh, and Pescatori have not completely proven their case. It is possible, Ramey argues, that their results could reflect a different sort of reverse causality if governments are more likely to respond to high public-debt levels with austerity programs when they have reason to believe that economic conditions could make the debt burden especially worrisome.

That may seem unlikelyone would think that a bad economic outlook would incline governments to postpone, rather than accelerate, austerity measures. And, in response to her comments, the authors did try to account for the severity of the government’s debt problem as perceived by the markets at the time that the plans were implemented, finding very similar results. But Ramey could be right. One would then find that government spending cuts or tax hikes tend to be followed by bad economic times, even if the causality runs the other way.

Ultimately, the problem of judging austerity programs is that economists cannot run fully controlled experiments. When researchers tested Prozac on depressed patients, they divided their subjects randomly into control and experimental groups, and conducted many trials. We cannot do that with national debt.

So do we have to conclude that historical analysis teaches us no useful lessons? Do we have to return to the abstract reasoning of Mandeville and some of his successors, including John Maynard Keynes, who thought that there were reasons to expect that austerity would produce depressions?

There is no abstract theory that can predict how people will react to an austerity program. We have no alternative but to look at the historical evidence. And the evidence of Guajardo and his co-authors does show that deliberate government decisions to adopt austerity programs have tended to be followed by hard times.

Policymakers cannot afford to wait decades for economists to figure out a definitive answer, which may never be found at all. But, judging by the evidence that we have, austerity programs in Europe and elsewhere appear likely to yield disappointing results.

Robert Shiller, Professor of Economics at Yale University, is co-author, with George Akerlof, of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.

Self-interest, without morals, leads to capitalism’s self-destruction

Jeffrey Sachs

January 18, 2012 3:26 pm

IMF requests $500bn for bail-out loans

Christine Lagarde

The International Monetary Fund has asked its member countries for an extra $500bn to help fight what it says will be a $1tn global demand for bail-out loans over the next two years.

The estimate, presented by Christine Lagarde, IMF managing director, to the fund’s executive board earlier this week, would most likely be financed by voluntary ad hoc loans rather than requiring all IMF member countries to contribute. The IMF currently has $387bn in immediately available resources.

Following the meeting, of the 24-member executive board, which represents the IMF’s shareholder countries, Ms Lagarde said: “I welcome the recognition of the importance of ensuring adequate Fund firepower to help defuse the current global economic weaknesses and regional challenges.”

Ms Lagarde added: “To this end, Fund management and staff will explore options for increasing the Fund’s firepower, subject to adequate safeguards.”

People familiar with the board discussions said the US – which has already ruled out increasing its own contribution – was most sceptical about the request. The big emerging markets like India and Brazil were more supportive, though emphasised that Europe should be taking the lead in financing its own rescues. The UK took a moderate position, with the eurozone countries the most enthusiastic.

Although the IMF staff did not break down the likely $1tn requirement into regions, the eurozone is likely to account for the bulk of extra bail-outs. An extra $1tn would fund at least reasonably-sized lending programmes for Spain and Italy, whose governments are currently struggling to maintain solvency.

Because the IMF needs to keep a buffer of cash on hand, IMF members will have to put in $600bn in contributions to increase firepower by $500bn. The IMF said that the recent eurozone pledge of around $200bn to the fund would form part of the increase.

Eswar Prasad, fellow at the Brookings Institution think-tank and former head of the fund’s China division, said: “The IMF is making a concerted attempt to transform itself into a deep-pocketed, credible loanmaster and disciplinarian for economies of any size that find themselves in economic distress.”

Contributions to the IMF usually have a budgetary cost of nil, as in essence they involve shifting national reserves from one place to another and IMF member governments receive interest on their contributions. A new round of financing will probably take several months to complete.

Ad hoc loans would not immediately affect countries’ voting power in the IMF, which is determined by a separate contributions process, and would be at the countries’ discretion. The last such round of contributions was made in 2009 to combat the global financial crisis, when around $500bn was raised.

Recently the US administration has faced fierce opposition in the US Congress to increasing its contribution. Having previously said that the IMF was adequately financed, the US administration has more recently said that more funds for the institution would be welcome, but emphasised that it will not give more itself.

The UK has also been placed in a difficult position, with resistance within the Conservative party and from the Labour opposition to increasing its contribution to finance bail-outs in the eurozone.

Copyright The Financial Times Limited 2012.

January 16, 2012, 4:36 pm

Daily Aspirin Is Not for Everyone, Study Suggests


Stuart Bradford

Nearly a third of middle-aged Americans regularly take a baby aspirin in the hope of preventing a heart attack or a stroke or lowering their cancer risk. But new research shows that aspirin is not for everyone, and that in some patients this so-called wonder drug is doing more harm than good.

“I stop a lot more aspirin than I start,” said Dr. Alison Bailey, director of the cardiac rehabilitation program at the Gill Heart Institute at the University of Kentucky. “People don’t even consider aspirin a medicine, or consider that you can have side effects from it. That’s the most challenging part of aspirin therapy.”

Last week, researchers in London reported in the Archives of Internal Medicine that they had analyzed nine randomized studies of aspirin use in the United States, Europe and Japan that included more than 100,000 participants. The study subjects had never had a heart attack or stroke; all regularly took aspirin or a placebo to determine whether aspirin benefits people who have no established heart disease.

In the combined analysis, the researchers found that regular aspirin users were 10 percent less likely than the others to have any type of heart event, and 20 percent less likely to have a nonfatal heart attack. While that sounds like good news, the study showed that the risks of regular aspirin outweighed the benefits.

Aspirin users were about 30 percent more likely to have a serious gastrointestinal bleeding event, a side effect of frequent aspirin use. The overall risk of dying during the study was the same among the aspirin users and the others. And though some previous studies suggested that regular aspirin use could prevent cancer, the new analysis showed no such benefit.

Over all, for every 162 people who took aspirin, the drug prevented one nonfatal heart attack, but caused about two serious bleeding episodes.

“We have been able to show quite convincingly that in people without a previous heart attack or stroke, regular use of aspirin may be more harmful than it is beneficial,” said Dr. Sreenivasa Seshasai of the Cardiovascular Sciences Research Center at St. George’s, University of London.

The findings are likely to add to the confusion about who should regularly take aspirin and who should not.

Research shows that among men who have had a heart attack, regular aspirin use can be lifesaving, lowering the risk of a second heart event by 20 to 30 percent. It also reduces the risk of a recurrence among women who have had a stroke caused by a blood clot.

Aspirin works by interfering with the blood’s clotting action. In blood vessels narrowed by heart disease, fatty deposits can burst, leading to the quick formation of a clot that blocks the flow of blood to the heart or brain. Regularly taking an aspirin helps prevent the clot from forming.

In 2007, the United States Agency for Healthcare Research and Quality reported that 19 percent of Americans regularly took aspirin, including 27 percent of those ages 45 to 64 and about half of those 65 and older.

Yet many current aspirin users have never had a heart attack or stroke, and take aspirin in the hope of preventing one. Among middle-aged aspirin users, the 2007 report found, 23 percent didn’t have established heart disease. Among older aspirin users, 41 percent didn’t have a history of heart disease or stroke.

For people without heart disease, guidelines from the United States Preventive Services Task Force and other national groups say aspirin therapy should be decided case by case, depending on the individual’s risk factors and family history.

But Dr. Seshasai said the new findings didn’t necessarily mean that healthy men and women should immediately stop taking aspirin. People with a strong family history of heart attack or stroke may benefit by continuing the regimen, and they should raise the question with their doctors.

“The decision to treat such individuals with aspirin should be made on a case-by-case basis, taking into account the likely risk of heart attack or stroke in the future,” he said. “However, as the risk of major bleeding episodes increases proportionately with an increase in benefit, physicians and patients must make carefully considered choices regarding long-term aspirin treatment.”

But some experts say the problem is that not every doctor has caught up with the latest science, and many patients decide on their own to take aspirin.

“They hear aspirin is good, so they take an aspirin,” Dr. Bailey said. “They don’t think of it as something that could potentially cause harm.”

Copyright 2012 The New York Times Company