The American economy

Comeback kid

America’s economy is once again reinventing itself

Jul 14th 2012
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ALMOST the only thing on which Barack Obama and Mitt Romney, his Republican challenger, agree is that the economy is in a bad way. Unemployment is stuck above 8% and growth probably slipped below an annualised 2% in the first half of this year. Ahead lie the threats of a euro break-up, a slowdown in China and the “fiscal cliff”, a withering year-end combination of tax increases and spending cuts. Mr Obama and Mr Romney disagree only on what would make things worse: re-electing a left-wing president who has regulated to death a private sector he neither likes nor understands; or swapping him for a rapacious private-equity man bent on enriching the very people who caused the mess.



America’s economy is certainly in a tender state. But the pessimism of the presidential slanging-match misses something vital. Led by its inventive private sector, the economy is remaking itself (see article). Old weaknesses are being remedied and new strengths discovered, with an agility that has much to teach stagnant Europe and dirigiste Asia.


Balance your imbalances



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America’s sluggishness stems above all from pre-crisis excesses and the misshapen economy they created. Until 2008 growth relied too heavily on consumer spending and house-buying, both of them financed by foreign savings channelled through an undercapitalised financial system.



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Household debt, already nearly 100% of income in 2000, reached 133% in 2007. Recoveries from debt-driven busts always take years, as households and banks repair their balance-sheets.
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Nonetheless, in the past three years that repair has proceeded fast. America’s houses are now among the world’s most undervalued: 19% below fair value, according to our house-price index. And because the Treasury and other regulators, unlike their euro-zone counterparts, chose to confront the rot in their financial system quickly, American banks have had to write off debts and raise equity faster than their peers. (Citigroup alone has flushed through some $143 billion of loan losses; no euro-zone bank has set aside more than $30 billion.) American capital ratios are among the world’s highest. And consumers have cut back, too: debts are now 114% of income.



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New strengths have also been found. One is a more dynamic export sector. The weaker dollar helps explain why the trade deficit has shrunk from 6% of GDP in 2006 to about 4% today. But other, more permanent, shifts—especially the growth of a consuming class in emerging marketsaugur well. On the campaign trail, both parties attack China as a currency-fiddling, rule-breaking supplier of cheap imports (see Lexington). But a richer China has become the third-largest market for America’s exports, up 53% since 2007.




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And American exporters are changing. Some of the productsBoeing jets, Microsoft software and Hollywood films—are familiar.


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But there is a boom, too, in high-value services (architecture, engineering and finance) and a growingapp economy”, nurtured by Facebook, Apple and Google, which employs more than 300,000 people; its games, virtual merchandise and so on sell effortlessly across borders. Constrained by weakness at home and in Europe, even small companies are seeking a toehold in emerging markets. American manufacturers are recapturing some markets once lost to imports, and pioneering new processes such as 3D printing.



Meanwhile, what was once an Achilles heel is becoming a competitive advantage. America has paid dearly for its addiction to imported oil. Whenever West Texas Intermediate climbs above $100 per barrel (as it did in 2008, last year and again this year), growth suffers. But high prices have had an effect, restraining demand and stimulating supply. Net imports of oil this year are on track to be the lowest since 1995, and America should eventually become a net exporter of gas.




Many countries have shale gas, but, as it did with the internet revolution, America leads in exploiting it. Federal money helped finance development of the “frackingtechnology that makes shale gas accessible, just as it paid for the internet’s precursors. However its use was commercialised by a Texas wildcatter called George Mitchell, the sort of risk-taker America has in abundance. In Europe shale gas has been locked in by green rules and limited property rights. In America shale has already lowered consumers’ energy bills and, by displacing coal, carbon emissions.
In future, it will give a spur to the domestic manufacture of anything needing large amounts of energy.




America’s work-out is not finished. Even when the results are more visible, it will leave many problems unsolved. Because the companies leading the process are so productive, they pay high wages but do not employ many people. They may thus do little to reduce unemployment, while aggravating inequality. Yet this is still a more balanced and sustainable basis for growth than what America had before—and a far better platform for prosperity than unreformed, elderly Europe.




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Of cliffs, and other perils



What should the next president do to generate muscle in this new economy? First, do no harm. Not driving the economy over the fiscal cliff would be a start: instead, settle on a credible long-term deficit plan that includes both tax rises and cuts to entitlement programmes. There are other madnesses brewing. Some Democrats want to restrict exports of natural gas to hold down the price for domestic consumers—a brilliant strategy to discourage domestic investment and production. A braver Mr Obama would expedite approval of gas exports. For his part, Mr Romney should back off his promise to brand China a currency manipulator, an invitation to a trade war.




Second, the next president should fix America’s ramshackle public services. Even the most productive start-ups cannot help an economy held back by dilapidated roads, the world’s most expensive health system, underachieving union-dominated schools and a Byzantine immigration system that deprives companies of the world’s best talent. Focus on those things, Mr Obama and Mr Romney, and you will be surprised what America’s private sector can do for itself.

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Markets Insight
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July 11, 2012 12:02 pm
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Current debt crisis merely a warm-up act
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By Jamil Baz




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However, after five years, we are in a worse place than when we started. One would have thought that the recent deleveraging caused debt ratios to collapse.


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Yet, after the financial maelstrom of the past five years, debt ballooned to a weighted average of 417 per cent of gross domestic product from 381 per cent in June 2007 in the 11 economies most under the market microscope.



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Strikingly, in each of Canada, Germany, Greece, France, Ireland, Italy, Japan, Spain, Portugal, the UK and the US, the ratio of total (public and private) debt to gross domestic product is now higher than it was in 2007.



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There are variations, and it is notable that debt in the US has increased the least, from 332 per cent of GDP five years ago to 340 per cent today – although we shouldn’t draw too much consolation from that, as the statistics do not include social entitlements such as Medicare or Social Security. Add in these off-balance sheet items and the ratios would look much worse.



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Deleveraging is proving impossible to execute. The world is still staggering under a mountain of debt, the costs of which extinguish the “animal spirits” which ought by now to be coming to the rescue. Based on this analysis, we can make five predictions.





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First, as deleveraging has not even started yet, the crisis of the world economy has not begun either. All the perceived unpleasantness of the past few years is merely a warm-up act for the greater crisis still to come. The need to get debt levels down is as pronounced as ever in the eurozone, particularly in southern Europe, but also in the US and Japan.



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Second, it will take a minimum of 15 years or so for the economy to reach escape velocity and attain a level consistent with healthy growth scenarios. This is because debt levels need to come down by at least 150 per cent of GDP in most countries. History suggests you cannot reduce debt by more than 10 percentage points a year without unleashing major social and political dislocation.




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Third, when we do finally start cutting our debt, the economic impact will be massive. Countries such as Japan and the US need to increase their primary balance by more than 10 points of GDP, in order to stabilise the ratio of public debt to GDP to 2007 levels: considering negative feedback loops between deficit cuts and growth, each stands to lose more than 20 per cent of GDP against trend.




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And this does not account for the required private deleveraging. The precise level of economic devastation is a function of the so-called multiplier, which measures the impact of spending reduction on economic growth. The International Monetary Fund has calculated that, under current circumstances, the multiplier can be as high as two: every dollar cut from the deficit will lead to a two dollar reduction in GDP. The multiplier is as much as four times higher than in pre-2008 conditions.



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Fourth, risky assets are set to perform badly for a long period. Corporate profitability is highly correlated with changes in leverage: reduce debt to meaningful levels and profitability will fall. The equity risk premium on indices such as the S&P 500 is at historically low levels and needs to rise dramatically in order to compensate investors for multiple market risks, ranging from sovereign default to inflation, deflation and geopolitics.



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The fifth point is that there is no magic bullet. In the past, policy makers had various instruments to cushion the impact of  measures taken to stabilise debt levels: they could cut interest rates, for example, or allow their exchange rates to fall, leading to export-driven recovery. But in an era of low or zero interest rates, with most countries competing to devalue their  currencies, such policy tools have lost effectiveness, hence the high multiplier.


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Even inflation, long touted as a backdoor solution to debt reduction, will not help. It would send bond yields sky high, compounding the costs of servicing debt and killing off any recovery. And off-balance sheet entitlements, the biggest item that needs trimming, are inflation-adjusted.



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How do asset classes rank on the totem pole if this scenario plays out? Bonds of solvent governments and corporates should do well in a deflationary environment where rates are kept lower for longer; stocks should revert to new lows; and currencies of highly leveraged, growth-sensitive markets should be sold.




.In the words of an old Austrian adage, the situation is hopeless, but not serious. It is not serious, as politicians simply fail to acknowledge the elephant in the room, namely leverage, introducing instead a succession of policy gimmicks. It is hopeless, in that virtue is not likely to be rewarded for a generation.




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Jamil Baz is Chief Investment Strategist at GLG Partners, part of the Man Group



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Copyright The Financial Times Limited 2012.

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Europe’s Divided Visionaries

Barry Eichengreen

10 July 2012
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BERKELEYEurope’s leaders, unlike former US President George H. W. Bush, have never had trouble with the “vision thing.” They have always known what they want their continent to be. But having a vision is not the same as implementing it. And, when it comes to putting their ideas into practice, the European Union’s leaders have fallen short repeatedly.


This tension between Europeans’ goals and their ability to achieve them is playing out again in the wake of the recent EU summit. Europe’s leaders now agree on a vision of what the EU should become: an economic and monetary union complemented by a banking union, a fiscal union, and a political union. The trouble starts as soon as the discussion moves on to how – and especially when – the last three should be established.


Banking union, Europe’s leaders agreed, means creating a single supervisory authority. It means establishing a common deposit-insurance scheme and a mechanism for closing down insolvent financial institutions. It means giving the EU’s rescue facilities the power to inject funds directly into undercapitalized banks.


Likewise, fiscal union means giving the European Commission (or, alternatively, a European Treasury) the authority to veto national budgets. It means that some portion of members’ debts will be mutualized: individual governments’ debts would become Eurobonds, and thus a joint obligation of all members. The Commission (or Treasury) would then decide how many additional Eurobonds to issue and on whose behalf.


Finally, political union means transferring the prerogatives of national legislatures to the European Parliament, which would then decide how to structure Europe’s fiscal, banking, and monetary union. Those responsible for the EU’s day-to-day operations, including the Board of the European Central Bank, would be accountable to the Parliament, which could dismiss them for failing to carry out their mandates.


Vision aplenty. The problem is that there are two diametrically opposed approaches to implementing it. One strategy assumes that Europe desperately needs the policies of this deeper union now. It cannot wait to inject capital into the banks. It must take immediate steps toward debt mutualization. It needs either the ECB or an expanded European Stability Mechanism to purchase distressed governments’ bonds today.

  
Over time, according to this view, Europe could build the institutions needed to complement these policies. It could create a single bank supervisor, enhance the European Commission’s powers, or create a European Treasury.


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Likewise, it could strengthen the European Parliament. But building institutions takes time, which is in dangerously short supply, given the risk of bank runs, sovereign-debt crises, and the collapse of the single currency. That is why the new policies must come first.


The other view is that to proceed with the new policies before the new institutions are in place would be reckless. Mutualizing debts before European institutions have a veto over fiscal policies would only encourage more reckless behavior by national governments.


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Proceeding with capital injections before the single supervisor is in place would only encourage more risk taking. And allowing the ECB to supervise the banks before the European Parliament acquires the power to hold it accountable would only deepen the EU’s democratic deficit and provoke a backlash.


Europe has been here before – in the 1990’s, when the decision was taken to establish the euro. At that time, there were two schools of thought. One camp argued that it would be reckless to create a monetary union before economic policies had converged and institutional reforms were complete.


The other school, by contrast, worried that the existing monetary system was rigid, brittle, and prone to crisis. Europe could not wait to complete the institution-building process. It was better to create the euro sooner rather than later, with the relevant reforms and institutions to follow. At the slight risk of overgeneralization, one can say that the first camp was made up mainly of northern Europeans, while the second was dominated by the south.


The 1992 exchange-rate crisis then tipped the balance. Once Europe’s exchange-rate system blew up, the southerners’ argument that Europe could not afford to postpone creating the euro carried the day.


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The consequences have not been happy. Monetary union without banking, fiscal, and political union has been a disaster.



But not proceeding would also have been a disaster. The 1992 crisis proved that the existing system was unstable. Not moving forward to the euro would have set up Europe for even more disruptive crises. That is why European leaders took the ambitious steps that they did.


Not proceeding now with bank recapitalization and government bond purchases would similarly lead to disaster. Europe thus finds itself in a familiar bind. The only way out is to accelerate the institution-building process significantly. Doing so will not be easy. But disaster does not wait.




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Copyright Project Syndicate - www.project-syndicate.org


Move America’s economic debate out of its time warp

Jeffrey Sachs

July 12, 2012



America’s economic debate is stuck in a time warp. On the one side, Mitt Romney’s conservative advisors defend tax cuts for the rich and spending cuts for the poor as if we hadn’t just lived through 30 years of failed Reaganomics. On the other side, Paul Krugman defends crude Keynesianism as if we’ve learned nothing in recent years about the severe limitations of short-term fiscal stimulus. Both sides merely raise their decibel levels at each announcement of bad news, as with last Friday’s data showing the failure of the US economy to generate sufficient new jobs in June.




The two sides of the debate live in timeless and increasingly irrelevant ideologies. The prescriptions of free market economics peddled by the Republicansslash taxes and spending, end financial and environmental regulations – are throwbacks to the 1920s, far more naïve than even modern conservatives such as Milton Friedman and Friedrich Hayek, who recognised the need for government intervention for the poor, the environment, health care and more.


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Today’s free market ideologues are uninfluenced by the lessons of recent history, such as the financial crisis of 2008 or the devastating climate shocks hitting the world with ever-greater frequency and threatening far more than the economy. Their single impulse is the libertarianism of the rich: the liberty to enjoy one’s wealth no matter what the consequences for the economy or society.




The other side is only a little better. In Paul Krugman’s telling, we are in the 1930s. We are in a depression, even though the collapse of output and rise of unemployment in the Great Depression was incomparably larger and different in character from today’s economic stagnation. Krugman channels Keynes, yet Keynes lived in a very different era.




In Krugman’s simplified Keynesian worldview, there are no structural challenges, only shortfalls in aggregate demand. There is no public debt problem. There is no global competitiveness challenge, since “competitiveness” is a myth when applied to national economies. Fiscal multipliers are predictable, timeless, persistent, and large. All growth reversals can be solved through larger deficits.



Politicians can be trusted to design short-term stimulus spending programmes of hundreds of billions of dollars. Tax cuts are about as good as increases in government spending, and short-term boosts in spending are about as good as long-term public investments. Not one of these conclusions stands scrutiny.




Why have we come to this vacuous debate between a free-market extremism and a Keynesian superficiality that addresses none of the subtleties, trade-offs, and uncertainties of the real situation?



There are probably two main reasons. First, the world is noisy and overloaded with media messaging. Getting heard seems to require a short, sharp and exaggerated idea endlessly repeated: economics as a media brand. Second, the world is facing novel problems at the global level, and novelty is hard to factor into economics, which is a rigid, ideological, theoretically based, and largely backward-looking field.




Here are some of the new problems of macroeconomic significance.




First, the financial markets are global while regulation is at best national (and sometimes almost non-existent or criminal). This is killing the euro, but it is also undermining financial regulation and monetary policy everywhere.


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The US and UK are far more interested in defending Wall Street and the City than in fixing the global regulatory landscape. Germany has been much more interested in coddling its errant banks than in fixing the eurozone banking system.


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Second, the world of work is being fundamentally transformed. Low-skilled work is the work of offshore workers, or immigrants, or machines. In high-income countries, the only route to middle class jobs is through education, skills and active labour market policies that match jobs and needs. Germany and other countries of northern Europe have generally succeeded in creating these institutions. The US and southern Europe have generally failed. Keynesian aggregate demand cannot create long-term employment for the low-skilled workers left to sink or swim in today’s globalised labour market. Only temporary bubbles (such as the dotcom bubble of the late 1990s or the housing bubble of the 2000s) briefly employ the low-skilled, but soon they unemployed again when the bubbles burst.




Third, tax collections today are little more than a Swiss cheese of tax evasion and tax havens for the rich and corporations. VAT and payroll taxes can still be collected while capital income of all kinds increasingly escapes taxation. These trends greatly exacerbate the market forces pulling to increase inequality of wealth and income.





Fourth, we are in the age of the Anthropocene, where global growth is limited by natural resources, climate change and hazards. If the world economy grows at 4 per cent or more, oil prices soar above $100 per barrel and food prices hit historic highs. This fact is of fundamental importance yet not properly part of any country’s economic strategy. The American illusory answer, hydrofracking of natural gas and more offshore drilling, will not solve the heat waves, floods, droughts and other disasters hitting the US and much of the world this year. Nor will it do much to ease the worsening resource constraints that will squeeze economic growth until we shift to new and sustainable technologies.




Fifth, the combination of falling tax collections on capital income and the rich, and rising costs of retirement and health care for a quickly aging population, poses serious long-term solvency challenges for most of our governments. These challenges can be met but require a long-term financial outlook and new approaches to pensions and healthcare delivery.




Sixth, in a world that requires serious regulation – for the environment, land use, financial markets and more – there are bound to be problems in coordinating public policies with private investments, and across sectors of the economy. Coherent economic strategies can help to break through investor pessimism and stagnation. Well-designed public investments (eg in infrastructure) can unlock significant private investments as well.



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In short, we need new economic strategies to overhaul broken systems of finance, labour markets, taxation, ecological management, budget management and investment incentives. Those challenges cannot be fixed through lowering taxes on the rich or higher fiscal deficits to create aggregate demand. The new approaches must be long-term, structural, sensitive to inequalities of skills and education, aligned with the need for more sustainable technologies and “smarterinfrastructure (empowered by information technology) and congruent with long-term demographic trends. It’s time we moved beyond the Republican Party economics of the 1920s and the Democratic Party economics of the 1930s, to a new macroeconomics for the 21st century.