Federal Reserve

While America’s losses mount, the top 1% makes huge gains

Posted on by j.giglio

Several weeks ago, the Federal Reserve decided not to cut back, or taper as the finance mavens say, the billion-dollar bond buying program known as quantitative easing, which is a euphemism for printing money. A gradual reduction of QE had been expected since June, when Fed chairman Ben Bernanke said the economy was getting stronger and he might reduce the monthly purchases by the end of the year.

But the Fed got cold feet and changed its mind because its leaders don’t believe that economic activity and labor market conditions are strong enough to merit reducing the bond purchases. Economic growth is lackluster. The unemployment rate is too high, labor force participation is at a 34-year low and too many newly created jobs are low paying and/or part time. Consequently the Fed will continue buying $85 billion of Treasury and mortgage bonds each month and remain committed to holding short-term rates near zero at least so long as the unemployment rate remains above 6.5 percent.

So the training wheels stay on the bicycle and continue to feed an addiction to cheap money.

After five years of depending on a monthly injection of liquidity, it may well be that QE will become a permanent tool of the Fed for managing the business cycle and garden-variety recessions. Since it began in the Paleozoic era, circa late 2008, the Fed has hoped that QE would stimulate economic growth and hiring by holding down interest rates and encouraging households and businesses to spend and invest.

But given that the wealthy own a disproportionate amount of equities, the stock market’s gains are unequally distributed. While a rising stock market may make people feel wealthier, the run-up in their pension accounts -thanks to the stock market reaching new highs – does not send the average American running to the nearest retail store.

Corporations are using the record-low interest rates to take on new debt for acquisitions, increase dividends, and engage in share buybacks rather than investing in the real economy, which has certainly not helped the labor market. Of course, thanks to the Fed, the interest rate paid on the national debt is at a historic low of2.4 percent, according to the Congressional Budget Office. This keeps debt service costs down and understates the budget deficit.

The danger is that as everyone becomes addicted to cheap money, the Fed’s moves are setting the stage for a new bubble. Printing money floods the market with more dollars, which makes dollars worth less, which means that tangible assets priced in dollars, such as oil and food, end up costing more.

Prolonged low interest rates and an abundant money supply have punished savers and retirees. Their money has generated little return, which forces them into high-risk investments to try and keep up with inflation. The younger generation hurt by high unemployment is not increasing its consumption to make up for the decline in spending among older Americans. And as middle America struggles with rising food and gas prices, weighed down by high unemployment and stagnant wages, the gap between the wealthy and everyone else is growing.

While the question of whether the Fed’s monetary policy has helped the real economy and the average American remains unanswered, a new study from the University of California at Berkeley finds that the top 1 percent have captured 95 percent of the gains during the so-called recovery. Additionally, according to the Census Bureau, middle-class incomes have largely remained stagnant even after the recession ended. With high unemployment, corporations are under no pressure to increase workers’ mcomes.

The gap between the top 1 percent and the rest of the country is the greatest it has been since the 1920s. A large reason for this growing disparity is that the wealthiest households have benefited far more that ordinary Americans have from the Dow Jones Industrial Average more than doubling in value since it bottomed out in early 2009.

So much for the presumption that once the Great Recession ended, the American consumer would once again fuel economic growth.

originally published: October 5, 2013

 

America needs jobs

Posted on by j.giglio

America is stuck in the worst economic, political and social crisis since the Great Depression. Despite the unemployment rate dropping 2.5 percentage points from its peak in October 2009, the labor market remains bleak and it is becoming ever clearer that the federal government needs to act aggressively to fix the problem.

The drop in the official unemployment rate is partly due to people who have stopped searching for a job. If a person has not worked or looked for work in the past 12 months, he or she is no longer included in the official government statistics.

The recession officially ended in June 2009, but job growth has remained painfully slow. It took 15 months after the 1990-1991 recession and 39 months after the 2001 recession for employment to recover to precession levels. At the recent pace of job creation, it will take years for employment to recover from the Great Recession that started in 2007.

The President’s Council on Jobs and Competitiveness has estimated that we will need more than 20 million jobs by 2020. The American economy has never created jobs at that rate in peacetime.

The Commerce Department says the American economy grew at an annualized rate of only 1.8 percent in the first quarter of 2013. Gross Domestic Product needs to grow by 3 to 4 percent annually to reach its productive potential. The economy is failing to generate enough jobs to support sustainable growth.

About 150,000 new jobs have to be created each month just to absorb new entrants to the labor force. Left to current market forces, America faces a serious job deficit that will last for at least the rest of this decade.

Frustrated with the slow American recovery from the recession, the Federal Reserve has kept interest rates near zero since late 2008 and is currently buying $85 billion in Treasury and mortgage bonds each month. The efforts are meant to increase spending, investment, hiring and overall growth.

But the Fed has done almost all it can with monetary policy. The American economy needs fiscal stimulus to restore a satisfactory level of employment and income.

The first order of business is to pick the low-hanging fruit to jump-start job growth and compensate for the pressures to outsource American jobs that leave society to pick up the cost of unemployment.

For starters, offer private firms tax benefits for hiring new workers. Right now, those firms receive tax benefits for buying new plant and equipment – even if it replaces existing workers – but no tax benefits for hiring. So fiddle with the tax code to change these tax regulations 180 degrees.

Experts from all quarters agree on the importance of investing in America’s physical and communications infrastructure. This is about as controversial in economics as antibiotics are to doctors. Such investments in income-producing capital assets, not consumption spending projects, would yield positive economic returns and create jobs for years to come. Financing these investments by borrowing is no different than a business building a new plant or a family building a new house. If nothing else, such investments will remove constraints on infrastructure capacity that currently depress economic growth by making it more expensive to move goods and services.

Finally, the military can help solve the shortage of workers with technical skills that businesses often cite. The armed forces have infused technology into nearly every aspect of their operations, and they should train people- who would be paid as federal employees during training- for private sector jobs. The military has a distinguished record of preparing and certifying individuals across a full spectrum of occupational specialties that are in demand by the private sector. It should also be empowered to contract with community colleges for the additional space and instructor capability needed to accommodate the increase in trainees.

How do you detect a society in real trouble? One sure-fire sign is persistently high unemployment. America needs an aggressive, comprehensive strategy to bring employment back to pre-recession levels and prepare workers for 21st-century jobs.

originally published: July 16, 2013

Another housing market of cards

Posted on by j.giglio

Rising home prices have some concerned that we could be building another house of cards. Housing prices are up 8.1 percent over last year, according to the S&P/Case-Shiller price index.

Sales have been improving too. The National Association of Realtors estimates that 4.65 million previously owned homes were sold in 2012, up 9.2 percent from 2011. Some of the numbers are truly eye-popping. Phoenix home prices were up 37 percent, followed by Las Vegas, where prices rose by 30 percent.

The question is whether the housing recovery is caused by rising demand from people who are doing better economically, or big investment companies, private equity firms, hedge funds and foreign buyers betting on the housing market’s recovery by buying homes, renting them for short-term profit and holding them for long-term price appreciation.

They are buying in places like Florida, Georgia, Arizona, Nevada and Califomia,places where home prices fell the most during the Great Recession.

In the process, they are helping fuel the home price surge, bankrolled by cheap credit made available by the Fed’s zero interest rate policy. They are also shrinking inventory, crowding out local buyers, and making homes beyond the economic reach of first-time home buyers.

It’s like the story about a soapbox orator speaking to a Wall Street crowd about the evils of drugs. When he asked if there were any questions, an investment banker asked, “Who makes the needles?” Never  miss an opportunity.

In the early 2000s, America saw the creation of a housing bubble, encouraged by low interest rate policies implemented in the wake of the 2000 stock market crash and recession that was caused when the dot-com bubble burst. Low interest rates reduced mortgage costs. This stimulated demand for houses and drove up prices.

Rising prices led to the perception that houses were more than just a place to live, they were an investment whose value seemed likely to keep rising, building wealth and funding the homeowner’s retirement. That perception further increased demand for houses, driving prices still higher.

In 2005, Federal Reserve Chair Ben Bernanke said, “House prices have risen by nearly 25 percent over the past two years … at a national level these price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas.”

Since the consumer price index we use to measure inflation excludes assets like homes and securities, the index’s nearly flat trend during the middle of the last decade made it easy for the Fed to convince us to be more worried about deflation than inflation and helped justify its decision to keep interest rates low.

China and other low-wage countries were happy to help the Fed keep rates low. By exploiting their non­-union labor forces, they continually reduced the prices of their exports, which Americans bought in ever-increasing numbers. Then they took the proceeds and bought up the U.S. Treasury debt being issued to fund two wars in the wake of large Bush administration tax cuts.

Ours was a nation awash with capital, much of it debt-based, seeking investments that offered generous yields. Home prices peaked in May 2006, stalled and then fell. The American economy officially slipped into recession at the end of 2007.

The housing bubble burst in the fall of 2008, experiencing its Wile E. Coyote moment. Many financial institutions had to write off billions in toxic or worthless mortgage assets. All the large American financial institutions- including Bank of America, Citigroup, Wells Fargo and insurance giant AIG­ ended up getting bailed out by taxpayers. When the housing bubble burst, the 2008-09 recession affected nearly every business in the U.S. and then worldwide.

Let’s hope Wall Street’s speculative housing bet facilitated by the Federal Reserve’s zero interest rate policy doesn’t lead to another crash in which the rise in home prices is not supported by economic fundamentals and ordinary people ultimately bear the cost.

originally published: May 18, 2013

It’s a wonderful life

Posted on by j.giglio

Those of you who’ve seen Frank Capra’s classic 1946 movie “It’s a Wonderful Life” (at least once, since it’s been a Christmas Holiday perennial on television for decades) will remember one of its most famous sequences.

George Bailey (played by James Stewart) runs a one-horse Savings and Loan bank in the All-American town of Bedford Falls. And one day he’s confronted by a group of his depositors who’ve come to withdraw their savings money because they’ve become nervous about its safety, the classic run on the bank.

He tries to clue them in on the realities of the banking business, explaining that he doesn’t keep their savings in a safe in his back office. Instead, he’s used most of the money to grant each of them affordable mortgages on their homes.

Sam’s money is in Chuck’s house. And Chuck’s money is in Dick’s house. And Dick’s money is in Sam’s house … So it goes.

With each of them able to own the homes they live in instead of having to pay rent to Old Man Potter, the hard-hearted villain who owns the leading commercial bank and most everything else worth owning in town.

What George was trying to describe to his nervous depositors is how the home mortgage and banking business worked in the “Good Old Days.”

If “It’s a Wonderful Life” were made today, its description of banking would have to be updated to reflect last month’s goings on in Cyprus. To secure a 10 billion euro bailout, Cyprus slapped a tax on deposits that ranged from 9.9 percent on amounts above E100k to 6.75 percent on deposits under E100k which translates into $130,000 (the limit for deposit insurance). It then revised the terms of the proposed haircuts to reduce the levy on smaller depositors and raise them on larger ones. In other words, they would tax the bank accounts of citizens and businesses to recapitalize the banks. Afraid that the government was coming for their cash, Cypriots ran to the bank. Much was made of the government’s attempt to get its pound of flesh from bank accounts; people had to wonder if their own money was safe. We were told Cyprus was an isolated case and it could not happen here.

But how does Cyprus compare to what’s happening to American depositors and savers? The Federal Reserve’s zero interest rate policy (ZIRP) is not a tax, but it reaches into the average American’s pockets.

And it is done for the same reason as the bank bailout in Cyprus: to save the financial system. Average Americans are earning next to nothing on their bank deposits, which are actually losing ground to inflation. Yet they can’t borrow from the bank at these ridiculously low interest rates. Maybe Cyprus doesn’t look so bad after all.

ZIRP sets a dangerous precedent. It suggests that governments are not above taking money from depositors to pay for bailout packages. If deposits are not safe from politicians, why should you trust any bank?

ZIRP has been confiscating the savings of Americans for the past five years.

The average interest on a savings account is less than 0.25 percent, a 10-year government bond yields less than 2 percent and inflation adjusted returns on six-month bank CDs are 0 percent. Average Americans have no safe place to park their money and collect a decent return. Is the difference between these returns and normal interest rates equivalent to a tax? In Cyprus, it was a one- time hit to depositor, in America it happens more slowly.

This blow to traditional savers harms the working class, discourages savings and induces some to speculate in the stock market and reach for higher yields on riskier investments. In America, savers aren’t an endangered species; they’re all but extinct.

originally posted: April 20, 2013

The Federal Reserve and paper money

Posted on by j.giglio

A couple of weeks ago, the Federal Reserve announced that it will continue printing money to keep interest rates near zero until the headline unemployment rate drops below 6.5 percent, provided inflation does not rise above 2.5 percent. The Fed expects to continue this policy until the end of 2015.

The Fed is focusing on job creation by putting its foot on the monetary accelerator to spur consumer spending and housing purchases. Last month’s jobless rate was 7.7 percent, down from previous levels but still high by historical standards. Even though the recession officially ended in December 2009, unemployment has not been below 6.5 percent since September 2008.

The headline unemployment rate to which the Fed has attached itself actually declines as more people abandon hope of finding a job. The unemployment rate dropped to 7.7 percent in November because about 351,000 people left the workforce. lf the same percentage of adults were in the workforce as four years ago, the headline unemployment rate would be 11.1 percent.

To further accelerate hiring, the Federal Reserve also announced that it would continue its monthly buying binge of $85 billion in long-term Treasury bonds and mortgage-backed securities. To do this, you have to print a whole lot of money.

The Fed’s objective is to push long-term interest rates even lower. It’s not easy, considering that the 10-year Treasury bond is trading at 1.8 percent – less than inflation, which has averaged 2.3 percent over the last four years. Years after moving interest rates to near zero in December of 2008, the Fed is still redistributing income from savers and to borrowers.

The Fed’s catechism is that this will reduce already-low mortgage interest rates, which will help spur a housing recovery, which will lead the economy out of its doldrums. So much for claiming the government doesn’t pick winners and losers in the economy.

Sure, the housing market is on a slow road to recovery. But tight credit is standing in the way of a more robust housing recovery. Too many potential homebuyers cannot access interest rates that are at near­ historic lows. Potential buyers need pristine credit to get a mortgage because banks are afraid of owning the loan again if a borrower defaults.

If the federal government were serious about fixing the housing market, it would arrange massive refinancing at today’ s low interest rates for those who owe more on their homes than the structure is worth. That would give millions of homeowners more spending cash to lift the economy. We did, after all, spend more than 700 billion taxpayer dollars to bail out the banks without nailing any hides on the shed door.

The Fed’s near-zero interest policy also masks the real cost of financing trillion-dollar annual deficits that have become the norm. Low interest rates are an incentive for the federal government to continue borrowing at record levels. If the Federal Reserve were serious about getting the Obama administration and Congress to address the debt and enact fiscal policies to stimulate the economy, it would not keep enabling them with cheap money.

The flood of money from all over the world has helped push down the interest rate the U.S. Treasury pays to 50-year lows. But this ability to borrow enormous sums at incredibly low interest rates cannot and will not last forever, even if no one can say exactly when the day of reckoning will arrive.

Even the mighty U.S. government cannot assume it will always be able to cheaply borrow whatever it needs. Future Americans sending an unprecedented chunk of their incomes overseas to pay down debt means spending much more on our past than on our future. We should invest in education, R&D, infrastructure and addressing the job-skills deficit, not in robbing future generations of the opportunities we enjoyed.

originally published: December 27, 2012

We can’t solve today’s problems with yesterday’s solutions

Posted on by j.giglio

The Federal Reserve recently launched open-ended quantitative easing (QE3), injecting large amounts of money into the financial markets for the third time since 2008. “Quantitative easing” is government­ speak for printing money.

The plan is to buy $40 billion in mortgage-backed securities every month, for as long as it takes, until the economic recovery strengthens and the job market is back on its feet. It amounts to another high­ risk, low-reward gamble with our economic future, and transferring wealth from the least privileged to the most.

With a slow jobs recovery and anemic economic growth, perhaps QE3 is evidence that previous efforts have failed.

The Fed also laid out its plan to maintain near-zero interest rates until the middle of2015.

The Fed is supposed to use monetary policy to ensure both maximum employment and price stability. It is currently focusing more on jobs than the inflation critics say quantitative easing will create down the line.

To the Fed’s way of thinking, inflation is under control. The so-called core inflation measures have been within the 2 percent annual rate that the Fed considers acceptable. Of course, that’s because the number excludes volatile energy and food prices.

Federal Reserve Chairman Ben Bernanke calls this “a Main Street policy” that will boost the economy and help the labor market improve significantly. The conceit here is that expanding the money supply will somehow jump-start investment, production and consumption.

It’s hard to see how these policies will protect the average American worker from structural problems such as competition with low-wage countries, technological advances and the relentless corporate drive to cut costs.

What an acceptable unemployment rate is remains an unanswered question in the context of price stability. The headline rate has dropped to 7.8 percent, but that’s because since June, half a million Americans have stopped looking for work. And what happens when the Fed starts to sell all the bonds it has bought when the economy finally recovers and interest rates are rising? Does this abort the recovery by further driving up interest rates?

Monetary policy produces winners and losers. Low interest rates are good for borrowers, like the federal government itself, which has saved trillions of dollars in interest payments in the four years since the Fed started aggressively expanding its balance sheet. But declines in the middle class’ real income have been especially severe during that time.

Printing money floods the market with dollars, which reduces their value and means that commodities such as oil and food end up costing more. These increases are most harmful to those with the lowest incomes. All of this increases income inequality, leading to weak aggregate demand and more unemployment.

Low interest rates are bad for people on fixed incomes who are trying to live off their savings. If you are a saver, you should be unhappy because interest on your savings and pension accounts won’t keep up with inflation, forcing you into high-risk assets such as the stock market to try to keep up.

Driving up stock prices independent of weak corporate earnings would surely put a smile on Bernanke’s face. Jobs are not created out of thin air; corporations need to increase sales to grow their earnings. Sadly demand is not there.

Einstein, who for some strange reason is more widely quoted than read, said, “We can’t solve today’s problems by the same type of thinking we used when we created them.” The Fed told us in 2007 that the sub-prime mortgage debacle posed no danger of an economic crisis; the folks who helped create the economic crisis are not the ones to get us out of it.

originally published: November 13, 2012

Invest in capital partnerships

Posted on by j.giglio

There is a simple reason for the federal government’s dismal financial outlook: its outlays are growing far faster than its revenues. Typical solutions for this problem involve some combination of slowing the rate of spending growth and increasing revenue collections.

It’s a sound strategy, but its implementation encounters major political problems. As that prolific author Anonymous said, “Watching the Republicans and Democrats argue over these issues is like watching two drunks fight over the bar bill on the Titanic.”

The problems associated with actually cutting spending and increasing revenues make major capital investments- the kind that can create new jobs, boost productivity and create tangible assets that can continue promoting economic activity long after the federal dollars have been spent- another option for solving our daunting problems.

Raising revenue usually means boosting tax rates or eliminating tax deductions, like the one for home mortgage interest. This is politically difficult to achieve, given the perception among many in Congress that voting for tax increases is tantamount to announcing your forthcoming retirement from elective politics.

Similarly, slowing spending growth probably means cutting Social Security, Medicare and Medicaid, all of which are bound to be opposed by retirees- a large and growing component of the nation’s voters.

How else can we boost gross domestic product (“GDP”) so the federal government can grow its way out of the economic crisis?

One option is to have the Federal Reserve work overtime to pump up the nation’s money supply. If this leads to a rise in prices, the same number of widgets sold tomorrow would produce more income for the widget firm and more tax revenue for the government.

Inflating the current dollar value of GDP will generate more revenue with no change in tax rates (which is why it’s been so popular throughout history among many national governments). However, raising prices will reduce the buying power of federal outlays. Total outlays will have to be increased to keep up with higher prices, leaving us right back where we started.

Increasing GDP without raising prices would progressively narrow the gap between the growth of total outlay dollars and the growth of total revenue dollars. This would be the macroeconomic equivalent of being home free. Major capital investment is a way to get there that has a proven track record.

A too-often forgotten legacy of President Roosevelt’s New Deal was massive federal capital investment in economic growth projects like rural electrification, the Tennessee Valley Authority and Boulder Dam, not to mention hundreds of commercial airports like LaGuardia and JFK in New York City, thousands of modern post offices, schools and local courthouses. Two decades later President Eisenhower, the Republican New Dealer, began building the 41,000-mile Interstate Highway System.

America has been living off these investments ever since. Their contribution to decades of job growth and increasing national prosperity has been so enormous that we’ve come to take them for granted.

Now is the time to again develop a series of major capital programs to create jobs and build a better, stronger, more prosperous nation.

Capital investment programs can generate the kind of near-term, non-inflationary economic growth needed to solve our looming financial problems without having to raise taxes or cut popular middle­ class benefit programs. They can, in fact, enable us to grow our way out of financial trouble.

But escalating federal budget deficits and skyrocketing debt, even at historically low interest rates, raise questions about government’s ability to come up with the start-up dollars. One solution is to recruit private firms as active partners to help start, fund, and run as many of these programs as possible.

If properly structured, such public-private partnerships could tap into the billions of dollars in private capital hungering for low-risk investment opportunities that offer decent rates of return. These New­ Deal style programs provide such an opportunity, greatly minimizing the need for scarce government dollars.

If the common-sense approach of cutting spending and raising revenue isn’t politically feasible, a partnership between the federal government and the private sector to embark on a program of major capital investments is the best route to growing our way out of a daunting fiscal mess.

originally published: September 29, 2012