Economic policy failure

Recently Press Secretary Robert Gibbs made an unsuccessful attempt to pin blame for the Obama Administration’s failed economic policies on the "professional left." Gibbs said "those people ought to be drug tested" and "they wouldn’t be satisfied if Dennis Kucinich was president".

This is ridiculous, of course. It angers me. Blaming others for your own failures is a telltale sign of a presidency in trouble. Nate Silver puts it well:

One problem that Obama is having — and not just on the left, although it might be most acute there — is the dissonance between the grand, poetic narratives of the campaign trail and the prosaic and transactional day-to-day grind of governance. To some extent, this is intrinsic to the nature of the respective activities. Still, for the 70 million who voted for Obama, there was a sense that — after a difficult eight years for a country challenged by two wars, two recessions, Hurricane Katrina, and the worst act of terrorism in history — things might finally start to be different. That change had come…

But Obama was never really able to capitalize on that momentum.

Look, I’m not on the left and I have also been critical of the Obama Administration for many of the same failings as the so-called "professional left." As Yves Smith said: "It’s the policies, stupid."

For those of us who are civil libertarians, Glenn Greenwald puts it well:

You may think that the reason you’re dissatisfied with the Obama administration is because of substantive objections to their policies: that they’ve done so little about crisis-level unemployment, foreclosures and widespread economic misery. Or because of the White House’s apparently endless devotion to Wall Street. Or because the President has escalated a miserable, pointless and unwinnable war that is entering its ninth year. Or because he has claimed the power to imprison people for life with no charges and to assassinate American citizens without due process, intensified the secrecy weapons and immunity instruments abused by his predecessor, and found all new ways of denying habeas corpus. Or because he granted full-scale legal immunity to those who committed serious crimes in the last administration. Or because he’s failed to fulfill — or affirmatively broken — promises ranging from transparency to gay rights.

That is not change you can believe in. But, more than that, I am concerned about the economics – the corporatist policies the Obama Administration has put in play.

Early on in this crisis, I had advocated a number of policy paths which I think would have been infinitely superior to the ones actually chosen by the Bush and Obama Administrations, especiallyregarding limiting the socialization of losses. I am talking about massive fiscal stimulus, big bank pre-privatization, a move away from the asset-based economy and the accumulation of debt, and a reallocation of resources.

Quite frankly, none of these suggestions have been taken on. As I discussed in March when making a few comments on this blog’s harsher tone about the credit crisis, the prevailing view in policy circles seems to be that we are in full recovery mode now, the remedies we put in place having been highly effective. Therefore, we can put in a few minor tweaks to the financial system, use our propaganda machine to tout them as the largest regulatory changes since the Great Depression, and then return to business as usual.

I find this narrative very unsettling and the complacent view it represents as likely to lead to another systemic crisis in short order. But the mindset is fixed. This is the reality of our policy making elite.

–Throwing in the towel on policy makers, Apr 2010

The reason I finally threw in the towel on Obama is that many of us warned all along the way that we would be where we are today. So, I don’t expect anything but petulant finger-pointing from the likes of Robert Gibbs now that things are going wrong.

Let me share a few quotes to show you what I’m talking about.

On Japan as a bad banking rescue model to follow and Sweden as a better model where I was probably the first major blogger to out this as the right approach:

This is an immense task that the Swedes took on. Their entire banking system was effectively insolvent. Yet, they were able to fashion a workout scheme that had bi-partisan political support, did not unfairly reward shareholders, dealt with moral hazard, separated regulatory and workout roles so as to reduce conflicts of interest, and that quickly wrote down valuations and liquidated the bad debts as opposed to dragging the process out. The Swedish authorities should be especially commended for dealing with the liquidity and solvency concerns simultaneously, while keeping moral hazard to a minimum.

I thoroughly suggest you read this memo, save it and pass it on to your local elected official. It should be mandatory reading for the BoE, the Fed, the ECB and key government officials in the UK, US, Ireland, and Spain where the magnitude of the housing bubble is largest. See the link below for the full article.

Why this plan has not been more widely discussed remains a mystery.

–The Swedish banking crisis response – a model for the future?, 13 Aug 2008

On state and local governments’ anti-stimulus:

In the United States, there is a bit of a problem: state and local governments. They will not, and often cannot, spend. In fact some will be cutting. Will local government budget cuts undercut federal fiscal stimulus?

To answer that question, we need to know why local governments in the U.S. are not spending more money. The answer is two-fold. First, state and local governments don’t have access to a printing press. It’s not like they can tell their teachers, “wait a minute, let me just run out back and print off a few dollars to pay you.” The federal government intends to do exactly that – print money. This is what is commonly known as inflation, now given the hifalutin designation of quantitative easing. So inflating one’s way out of crisis is not an option on the table for municipalities.

On the other hand, they are even more hamstrung by their own self-imposed rules. In recent years, state governments have tried to exercise fiscal responsibility by balancing the budget. Politicians are so eager to put their hand in the till that legislatures were forced to enact balanced budget amendments that forbade deficit spending to keep spending down…

At a minimum, cutbacks at the state and local level would be very much working at cross purposes with federal stimulus. Ostensibly, state governors could play chicken with the Federal Government if they don’t get some bailout money. How the Obama Administration chooses to tackle this problem will be a contentious issue going forward.

Stay tuned.

–Will federal largesse be countered by state and local cutbacks?, 2 Jan 2009

On a too-small poorly crafted stimulus and eventual deflation:

[T]his will NOT be enough stimulus to provide the economy the boost it needs. Moreover, Krugman asserts that the lesson learned if it comes up short is that government spending does not work. Therefore, Obama will be less likely to receive monies if he tries to add stimulus a second go ’round…

I see this scenario as very negative for the U.S. economy. First, you have huge government spending that requires additional borrowing by the U.S. government. But, this spending does not give the economy the needed jump start to pull out of the deflationary spiral. In a worst-case scenario, one could see interest rates rising, inflation going negative, meaning real rates are even worse, while the economy stagnates and unemployment rises. This is the stag-deflation scenario of which Nouriel Roubini warns.

–Obama’s stimulus bill is a tough sell so far, 7 Jan 2009

On the re-emergence of deficit fetishists and a double dip:

1. The private sector (particularly the household sector) is overly indebted. The level of debt households now carry cannot be supported by income at the present levels of consumption. The natural tendency, therefore, is toward more saving and less spending in the private sector (although asset price appreciation can attenuate this through the Wealth Effect). That necessarily means the public sector must run a deficit or the import-export sector must run a surplus.
2. Most countries are in a state of economic weakness. That means consumption demand is constrained globally. There is no chance that the U.S. can export its way out of recession without a collapse in the value of the U.S. dollar. That leaves the government as the sole way to pick up the slack.
3. Since state and local governments are constrained by falling tax revenue (see WSJ article) and the inability to print money, only the Federal Government can run large deficits.
4. Deficit spending on this scale is politically unacceptable and will come to an end as soon as the economy shows any signs of life (say 2 to 3% growth for one year). Therefore, at the first sign of economic strength, the Federal Government will raise taxes and/or cut spending. The result will be a deep recession with higher unemployment and lower stock prices.
5. Meanwhile, all countries which issue the vast majority of debt in their own currency (U.S, Eurozone, U.K., Switzerland, Japan) will inflate. They will print as much money as they can reasonably get away with. While the economy is in an upswing, this will create a false boom, predicated on asset price increases. This will be a huge bonus for hard assets like gold, platinum or silver. However, when the prop of government spending is taken away, the global economy will relapse into recession.

–The recession is over but the depression has just begun, 1 Oct 2009

On premature victory laps and a catastrophically myopic mindset:

I am glad [Andy Xie] is hopeful that Obama sees the folly in more bailouts and malinvestment. Perhaps he is on to something. However, I do not expect the mindset to change whatsoever. Bank profits are back at record levels and the worst of the panic is now over. You don’t get a change in mindset in that environment. More likely, you get a victory lap.

I expect the following to occur:

1. Public pressure to withdraw monetary and fiscal stimulus will work and stimulus will be reduced quicker than many anticipate – beginning sometime in early 2010. The Fed has already said it will stop buying mortgages in March and the Obama Administration is now focused on deficit reduction as evidenced by the paltry jobs bill just passed.
2. The fiscally weak state and local governments will therefore receive little aid from the federal government. This will result in budget cuts, tax increases, and layoffs by the end of Q2 2010.
3. At the same time, the inventory cycle’s impact on GDP growth will attenuate. By the second half of 2010, inventories will not add considerably to GDP.
4. Meanwhile, the reduction of Fed support for the mortgage market will reveal weaknesses there. Mortgage rates may increase, decreasing housing demand.
5. Employment will be weak in this environment, leading to another spate of defaults and foreclosures.
6. The foreclosures and weak housing demand will pressure house prices and weaken lender balance sheets, especially because of second-lien exposure. This will in turn reduce credit growth.

I expect the weakness in GDP from this scenario to be evident sometime in the second half of 2010.

–The mindset will not change; a depressionary relapse may be coming, 5 Mar 2010

And I would be remiss if I didn’t link directly to the premature victory laps people were taking earlier in the year. See my list here after the initial book reading list. Also see here.

We could still get out of this, by the way. I am not predicting a depressionary relapse immediately. The economy is rolling over. But I see only a 50-60% chance of a double dip later this year or in 2011. I do think we will have what I would call a double dip by 2012 or 2013. But, hopefully, by then the banks would be more solvent and households less indebted. If we have a relapse now, stocks will go much lower, unemployment higher and we would certainly label this a depression. Of course, blaming people for your own mistakes isn’t going to prevent this, is it?

Now, Nate Silver goes on to cite Republican obstructionism and an ever-deepening jobs crisis as two reasons the President has not retained his momentum. That’s probably fair. The economy has a lot to do with Obama’s falling poll numbers. I said as much in January, making a comparison to Reagan and Clinton.

However, later in that post I said I also tend to think of Obama as Herbert Hoover more than FDR. Here’s a question: would FDR have made the ‘radical’ choices he did after 1933 had he been President in 1929? No one knows, of course. But, it was certainly easier to make draconian change after a depression was obvious. Obama like Hoover has not witnessed the spectacle of 4 years of economic carnage crushing the human spirit as FDR had done when he became President. But Obama’s people have done him a huge disservice in under-playing the economic misery which this crisis has wrought. And this is the source of his political misery – not the "professional left."