NDN Blog

The Eurozone Crisis is Back, and All of Us Are in its Crosshairs

Once again, the Eurozone debt crisis threatens to suck the oxygen out of the global economy.  Two years of austerity across most of Europe continues to produce the predicted effects:  We learned this week that Europe’s private sector keeps on contracting.  Moreover, global investors began to bail again on Spain, driving interest rates on 10-year Spanish government bonds to an unsustainable 7.6 percent.  Greek, Portuguese and Irish public finance faced comparable rates, so they have to rely on bailouts.  Yet, there isn’t nearly enough money in those bailout facilities to rescue Spain, too.  That’s why this week, Moody’s downgraded its outlook for the region’s strongest economies, Germany and the Netherlands.   If anything, that move was cautious.  If Spain spirals into default, it would likely trigger a continent-wide banking crisis, followed in all likelihood by a real Depression.  It also could upend our own economy on the eve of the election.  

It’s a crisis with lots of nubs.  For one, Spain is in the middle of the world’s sharpest housing contraction and a recession currently forecast to last into 2014.  That what happens when austerity dramatically slows public spending while the nation’s private banks are writing down tens of billions of Euros in mortgage loans gone south.  The result is that government revenues have been falling faster than government spending, piling up more debt – and now several of the country’s provincial governments say they also cannot keep on going without major support from Madrid. 

That is why foreign investors see a growing risk that, sometime soon, Spain’s government won’t have the money to service its fast-rising debts.  The 7.6 percent interest rate on new Spanish debt is the market’s current demand to offset that risk.  But unless Brussels and Berlin step in with new, credible assurances for those holding Spanish bonds, the interest rate will keep on rising until everyone begins to dump the bonds.  Madrid would have to try to borrow even more money, and if it cannot, a sovereign debt default would quickly follow.

Eurozone leaders have tried to head off all of this, but only through a series of indirect and inadequate measures.  The immediate threat from a major sovereign debt default is the collapse of dozens of large banks with large holdings of those sovereign bonds.  German and French banks, for example, hold $600 billion in Spanish bonds.  The Eurozone could have followed the basic rule of monetary unions, and used the European Central Bank (ECB) to guarantee those bonds in some way.  That’s what the Federal Reserve has done for a century here (and the Treasury did it for 50 years before the Fed was created).  Yes, it would be harder for the Eurozone to pull that off, since it has no single national government.   But it does have a single central bank. 

Yet, Angela Merkel has consistently vetoed that course, preferring instead to build a new political and economic environment that could head off future defaults.  So, while Greece and Spain slowly sink, with Italy not far behind, Merkel pursues continent-wide banking regulation to discourage future bank runs from one Euro country to another.  She also is pushing for continent-wide fiscal arrangements to head off the large deficit spending down the road that can cripple an unproductive economy when bad times strike.  For the current crisis, she has agreed to spend €100 billion from the Eurozone to pay the bills of Greece’s government this year.  She also has allocated another €100 billion to bail out the balance sheets of Spanish banks.  And she has allowed banks in Germany, France, Italy and elsewhere to use their Spanish and Italian bonds as collateral from hundreds of billions of Euros in low-cost loans from the ECB.  

This week, the markets rendered their latest judgment on those steps.  The sky-high interest rates now in Greece, Spain, and looming in Italy tell us that all of Mrs. Merkel’s handiwork will not be enough to head off a sovereign debt default.  The results could be disastrous for many major European banks and the Eurozone economies.  How bad could it be?  Even before facing final default, Greece has seen its GDP shrink by 25 percent, its average wage fall by nearly 20 percent, unemployment rise past 20 percent, and government pensions cut back 30 percent.

One final word.  On this side of the Atlantic, the political season has made every development fodder for campaign attacks.  So, we can count on the President’s opponents charging that America under his leadership is following the path of Spain and Greece.  That is nonsense.  The Eurozone faces a crisis of confidence about the capacity of its less productive economies, burdened by deep recessions and large debt overhangs, to honor their future debts.  The irreducible proof is the rising risk premium on new Greek, Spanish and Italian bonds.  There is not the slightest hint of such doubts about the United States.  The interest rate on 10-year U.S. Treasury bonds is 1.75 percent, less than one-fourth Spain’s level, and actual yields are even lower.  And while Europe is deep into a double-dip recession with fast-rising unemployment, we have had more than three years of slow but steady growth and job creation.  

To be sure, a European banking crisis triggered by a sovereign debt default, one which spread from Spain to Italy and then across the continent, would almost certainly end our own expansion.  American exports to Europe – our largest foreign market -- would fall sharply.  American banks would be hit by losses on thousands of investments and other deals that involve European banks which such a crisis will take down.  So, in the end, our presidential election could turn on events entirely beyond the influence or control of either President Obama or former Governor Romney.  Not even their legions of consultants and operatives, and the stream of billionaires funding the campaign’s television wars, will be able to override the economic consequences here at home of either a full-blown Eurozone meltdown or, for that matter, the successful resolution of the crisis.

The LIBOR Mess Could Be the Biggest Financial Fraud in History

If our financial policies were based on recent experience, the debate over government regulation versus self-regulation by Wall Street would be settled.  Yet, the refrain that “the big banks know best” remains the default position of most American conservatives and many policymakers.   This childlike faith will be tested by the new scandal swirling around some of the most basic interest rates in the global economy, the LIBOR or “London Inter Bank Offered Rates.”  This past week, Barclays Bank admitted that it secretly manipulated LIBOR rates for years, all to pad its own bottom line.  And Barclays is not some lone, bad apple.  Investigators here and in London, Brussels and Tokyo are hard at work looking into reports of similar manipulation by other big players, including Citigroup, Deutsche Bank and J.P. Morgan Chase.  This could turn into the largest consumer fraud ever seen.

It will take months for the general public to catch on to what this latest scandal is about.  It starts with one basic fact: LIBOR interest rates are not set by the supply and demand for credit, like many other rates.  Instead, every morning, representatives of the 18 largest Western banks report on what they would be willing to pay to borrow funds from each other (“Inter Bank”) in the future.  Under LIBOR rules, the four highest and four lowest estimates are eliminated, and the average of the rest becomes the official rate.  For example, in 2007, the LIBOR rate to borrow three months in the future, in dollars, averaged 5 to 5.5 percent.  

LIBOR rates are a very big deal, because they are benchmarks for countless other interest rates.   The majority of adjustable rate mortgages, for example, are set at a LIBOR rate plus 2 or 3 percentage points.  So are millions of student loans, auto loans, and credit card finance charges.   LIBOR rates also are used to set or reset small business loans, futures contracts, and interest rate swaps.  All told, an astonishing $360 trillion in loans around the world are indexed to LIBOR.   That is more than five times the value of the world’s entire GDP this year. 

One reason that LIBOR has such a far reach is that there are numerous LIBOR rates for different purposes.  Each rate has a time frame – rates for loans one day from now; one month, three months and six months out; one year, five years and ten years from now, and so on.  There are 15 such time frames, all told.  In addition, separate LIBOR rates also are provided for dollars, Euros, yen, and seven other currencies.  The integrity of these LIBOR rates, however, depends entirely on the honesty of banks reporting the rates they actually would be willing to pay.  Inevitably, we got what we should have expected. 

So, when Barclays (and almost certainly others as well) had investments that paid off, or simply paid off more, when interest rates rose, it simply reported a higher figure to LIBOR in order to nudge up the average.  And that usually led to higher interest rates for millions of other businesses and people with loans indexed to the LIBOR.  Sometimes, it worked the other way.  In late 2008, Barclays (and probably others) low-balled the rates they reported for LIBOR averaging.  The purpose was to make themselves look more sound than they actually were, since they would be willing to borrow only at low rates.  They presumably figured that might reassure their shareholders and perhaps even dampen public demands for tighter regulation.  

For several years, academics and a number of market followers warned that something funny was going on with LIBOR.   The evidence was not hard to find   For example, the “spread” or difference between U.S. Treasury rates and LIBOR rates for loans of the same time frame began to widen.  From 2000 to 2006, LIBOR rates averaged one-quarter of one percentage point above Treasury rates, and the two rates moved up and down together in lock step.  In 2007, however, that spread more than doubled to nearly two-thirds of a percentage point, and their movements up and down did not track each other so closely.  By 2008, the difference in the rates was five times what it was in 2000-2006, averaging 1.3 percentage points, and the up-and-down movements of the two rates no longer tracked each other.

All of the obvious parties that might have done something about it – the Fed and the SEC, for example, or the Financial Services Authority in Britain – apparently looked the other way.  This tolerance for sub rosa interest rate manipulation has cost millions of ordinary Americans and Europeans a great deal of money.  Early analysis suggests that for several years, the LIBOR was off by an average of 30 to 40 basis points.  (100 basis points equal one percentage point in an interest rate.)  That is enough, for example, to add $300 to $400 to the annual cost of a $100,000 loan.  

In 2007 and 2008, Americans held $11.1 trillion in outstanding residential mortgage debt.  At the time, between 30 percent and 40 percent of that debt carried adjustable rates.  If the bankers’ manipulations of the LIBOR was responsible for raising LIBOR rates by just 20 basis points in that period, their shenanigans added between $6.6 billion and $8.9 billion to the yearly interest paid by American homeowners.  And those mortgages account for less than one percent of all of the financial assets and instruments affected by manipulated LIBOR rates.  

LIBOR hearkens back to a time when finance operated like a gentlemen’s club, and its leading members behaved honestly.  That is a universe away from the current Wall Street culture and behavior.  They take out bets and pay themselves fortunes for doing so, even when they cannot make good on those bets without taxpayer bailouts. They create securities they know are likely to fail, on behalf of clients prepared to bet against those instruments – and then pawn off the same securities on other clients as safe investments.  And now, we also know that when they bet on interest rates rising or falling, they stacked the LIBOR deck to nudge rates in the direction that made them money.  And they left everybody else with the bill.    

So long as big finance will do almost anything to goose its own profits and bonuses, “self-regulation” is a dangerous myth.  It should give way to sound law enforcement, which in economic terms means more government regulation. 

A New Economic Challenge Facing Europe – and the United States

I spent much of last week in Geneva, Switzerland.  Even in that city of global institutions, in the European country most untouched by the continent’s sovereign debt crisis, most conversations found their way to hand-wringing over Europe’s economic decline.  As the Eurozone governments struggle to save their common currency, it is increasingly clear that the misguided austerity policies of many European governments have exacted large tolls on employment and growth.  Moreover, Europe’s economic problems will last much longer than the current debt crisis, even if it ends better than anyone now imagines.  One reason is that capital investment, the foundation of future growth, has been depressed since the crisis of 2008-2009. 

With capital investment persistently slow across most of Europe, political and economic leaders need to ask themselves, where would additional investment produce the greatest benefits?  One part of the answer is the same for Europe as it is here, in the United States.  Perhaps the single most important area of investment today lies in the telecommunication infrastructure, networks and devices on which business and social activity increasingly rely.  Earlier this year, NDN issued a new study I wrote with Kevin Hassett of the American Enterprise Institute on one aspect of this development.  We investigated the impact on job creation in the United States associated with the transition from 2G to 3G infrastructure and devices.  We found that this shift created almost 1.6 million jobs from April 2007 to July 2011, even as overall U.S. employment fell by nearly 5.3 million jobs over the same years.   

The current transition to 4G networks and devices should produce a similar economic bounce, so long as the necessary policies and capital investments are there to help drive it.  For example, since 4G involves more intensive data streams, the transition requires additional spectrum.  It will take strong White House leadership to ensure that the private investment needed to build out more spectrum and related, next generation IP broadband infrastructure are available to support 4G services.  In the process, these advances will promote the President’s larger goals of a strong recovery, job creation and universal broadband.  

Like the economy they enable, these technologies are inherently global.  So, the same dynamics apply to Europe, even in its current straits.  Throughout much of the 1990s, Europe had a real edge over the United States in advanced telecommunications, especially in the mobile or wireless space.  That is no longer the case.  Europe’s transition to 4G, for example, has been much more rocky than ours.  In its latest Digital Agenda report, the European Commission noted that while people and businesses in Europe “are generating enough digital demand to put Europe into sustainable economic growth,” this potential is undermined by a “failure to supply enough fast internet, online content, research and relevant skills.” 

Two years ago, the European Union set a goal of doubling its public investments in advanced telecommunications facilities and skills by 2020, which assumed annual growth in these areas of about six percent.  So far, the actual growth has averaged just two percent.  Moreover, private capital spending on 4G infrastructure across Europe also has lagged the United States.  In 2011 and 2012, American telecom companies invested more than $25 billion per-year in wireless facilities alone.  Yet, since 2007, comparable investments across the European Union, with a GDP slightly larger than ours, have been 15 percent to 40 percent less than in the United States. In response, European Digital Affairs Commissioner Neelie Kroes, warned recently, “Europeans are hungry for digital technologies and more digital choices, but governments and industry are not keeping up with them.  We are shooting ourselves in the foot by under-investing.”

The substantial effects on employment which we documented from the transition from 2G to 3G, and now from 3G to 4G, are signs of larger dynamics at work.  Across professions, industries and nations, Internet technologies have become integral parts of most economic activities and operations.  Moreover, with the advent and dispersion of 4G technologies, wireless Internet has begun to assume a pivotal role in these operations and activities.  National policy and business strategies ignore these developments only at great cost.  

To be sure, both Europe and the United States face special and more immediate challenges today, which neither has yet mastered successfully.  But the task of promoting investment in 4G infrastructure and networks is well within the capacity and understanding of all modern governments and businesses, and should be a national priority.  Fifteen years ago, in the transition to 2G, the United States followed Europe’s example, to America’s benefit.  Today, it is Europe’s turn to follow our spectrum policies and investment strategies. 


How Much Credit Can Obama Claim on the Economy?

Presidents regularly get the credit or blame for developments beyond their control.    Sometimes, they also get no credit or blame for the decisions they do take.  Barack Obama fits both molds.   A fresh example of the second pattern is the President’s surprising semi-breakthrough on European debt, at this week’s G20 meeting in Los Cabos, Mexico.  For months, President Obama and Treasury officials have quietly urged Eurozone leaders to do what it takes to avoid a sovereign debt meltdown, before they tackle long-term reforms.  This week, it looks like it might pay off.  According to reports, Obama emerged from a private huddle with German Chancellor Angela Merkel with her grudging agreement to use Eurozone funds to directly support Spanish and Italian bonds.  For the first time since the crisis began more than two years ago, the country with the deepest pockets has tacitly agreed to stand behind the full faith and credit of its member countries.  If these reports are true, this week’s agreement should hold off a full-blown debt crisis for a while, and with it the prospect of a deep global recession this year.   Yet, how many Americans will give Obama any credit for all this, come November?  

In a similar fashion, Mr. Obama inherited an economy seized by an historic financial meltdown.  His predecessor mismanaged the crisis so badly that it drove the country into the worst recession in 80 years.  Steeling himself against opponents united only by their partisanship, the President unleashed a flood of fiscal and monetary stimulus to arrest America’s downward spiral towards genuine depression.  Six months later, growth resumed and private employment began to increase.  Yet, in November, how much credit will voters give the President for avoiding the worst case scenario?

Instead, the President finds his reelection threatened by an economic reality he can do little to change — namely, that an economy shaken by financial crisis usually recovers very slowly.  In principle, to be sure, his administration might have done more to overcome the economic drag he inherited from Bush.  He might have pressed harder to stabilize the housing market with short term loans for homeowners facing foreclosure.  He might have tried harder to nail down a grand bargain for long-term fiscal balance.  

But the President also recognized the new political reality following the 2010 elections.  However hard he pressed or pushed Congress, neither deal was possible with Tea Party members calling the shots in the House, and Tea Party activists threatening to take down any Republican willing to work with the “enemy.”  Obama did successfully block the hard right program of slash-and-burn budget austerity, which almost certainly would have plunged the economy back into recession, as it did in Britain.  But once again, come November, how much credit will he get for avoiding another downturn? 

This President has shown that he can take care of himself politically.  He may not be able to point to the dismal hand he inherited from Bush, at least not without seeming to whine.  But he can point voters to the numerous troubling aspects of Romney’s economic record in Massachusetts and Bain Capital.  Obama also has the political advantage in many policy areas, since the public generally favor his approach to taxes, Medicare and Medicaid, higher education, and the deficit.

Unhappily, however, the economy is still far from safe and sound.  This week’s news from the G20 meeting will not settle the Eurozone’s economic problems. That leaves the President’s reelection still hostage to the sovereign debt crisis. On top of the Obama-Merkel meeting of minds, the other good news is that Greece’s new government should be able to avoid a precipitous default and chaotic exit from the Euro.  Eventually, Greece almost certainly will default and leave the Euro, but hopefully not before the Eurozone has prepared for it.  

The question remains, then, of what additional arrangements Frau Merkel will accept to reassure international investors that Spain and Italy will not follow Greece’s path.  Time is short, because Europe is already in recession, and such deals are usually pricey.  Moreover, at this moment, European leaders cannot even agree on whether the next step should be uniform banking regulation, a fiscal union, or expanded political authority for the Eurozone.  All of these measures are important for the Eurozone to become a stable economic entity.  But first, the Eurozone has to survive.  That will require what the President has called for all along – measures such as Eurobonds or central bank authority to guarantee that after Greece, no other Eurozone country will ever have to default.

Statement on Federal Reserve Report

Since late 2008, NDN and I have urged Congress to help Americans stay in their homes by taking steps to reduce foreclosure rates and stabilize housing prices.  These recommendations reflected basic economics: The worst recession in 80 years would inevitably exacerbate the housing bust as abnormally high foreclosure rates drove down housing values.  This, we predicted, would leave all American homeowners poorer.  Moreover, this “negative wealth effect" would dampen both consumer spending and business investment, producing a persistently slow expansion.  Congress refused to take steps, and unfortunately we were right about the results. 

Today, the Federal Reserve confirmed the negative wealth effect we have warned about.  The Fed calculates that U.S. families' median net worth fell by nearly 39 percent from 2007 to 2010.  Average net worth, which is pulled upward by high-net-worth people at the upper end of the spectrum, also fell by nearly 15 percent.  Moreover, the decline in people’s home equity accounted for 82 percent of the decline in the total median net worth of American homeowners.

Congress must finally act to relieve these pressures.  American taxpayers today own Fannie Mae and Freddie Mac.  One step Congress could take would be to direct Fannie and Freddie to provide temporary bridge loans to homeowners whose mortgages they hold and which are in danger of foreclosure.   To be fair to all homeowners, those who accept these loans would return to the taxpayers 20 percent of any eventual capital gain, in addition to repaying Fannie and Freddie for the loans.  This simple measure will help stabilize everyone’s housing prices and stem the negative wealth effect, producing at last a much stronger and more sustainable expansion. 

Update - Watch Rob talking about the report on the NewsHour tonight! (SR)


An Economic Program for the Fall Campaign and the Next Four Years

With the presidential election turning on the economy, the debate has focused on what’s right or wrong with the current recovery, and who’s responsible.  They agree that growth is too slow and deficits are too high; and unsurprisingly, President Obama blames the GOP for both while Mr. Romney blames the President.  The President’s arguments are stronger, especially given Romney’s risible claim that he can balance the budget and cut taxes another $5 trillion at the same time.  The larger point is that the high deficits and tepid expansion are legacies of the financial meltdown, and resolving them would only allow economic policy to finally move past 2008-2009.  The next stage of the economic debate, then, should focus on the two critical issues that have bedeviled middle-class Americans for more than a decade — namely, historically-slow jobs growth, and stagnating incomes.  

A presidential campaign can accommodate only a handful of big ideas.  Here, then, are three new policy initiatives to help reignite job creation and income gains:  1) reduce the cost of creating new jobs by reforming payroll taxes; 2) restore the foundation for middle-class wealth by stabilizing the housing market; and 3) enable everyone to become more productive by providing universal, low-cost access to college education and worker training. 

Tax reforms offer the best way to reduce the cost of creating new employment and keeping those already employed in their jobs.  The focus of such reforms is not the tax on corporate profits.  Yes, the corporate tax is an inefficient mess, but reforming it will do little for those looking for work.  The right target for job creation is the payroll tax, because it directly increases the labor costs of every employer.  The idea here is to stimulate job creation and employee retention by cutting the employer side of the payroll in half, and on a permanent basis.  And we can replace the revenues lost to Social Security with a carbon-based pollution tax. 

The second idea could help address slow job creation and the slow expansion, as well as widening inequality.  Employers have been creating relatively few new jobs not only because of the cost of doing so.  Employers also are not  confident about when Americans will begin to spend again like they used to, creating the demand for the goods and services which additional workers could produce.  The simplest way to boost demand is more budget stimulus – and good luck with that.  A more efficient way, however, is to remove any factors holding back normal consumer spending.  It’s not unemployment, with the jobless rate already down from 9.8 percent to 8.2 percent.  Rather, what continues to hold back tens of millions of consumers is the hard fact that the housing bust has left them substantially poorer.

So far, the bust has cost most homeowners one-third of the value of their homes.  This is a big deal economically, because home equity is the main form of wealth or saving held by most of the middle class.  Consider the following: The bottom 80 percent of Americans, measured by income, own just 7 percent of the value of the country’s financial assets – but they also hold 40 percent of the value of all residential real estate.  The sharp drop in housing values, therefore, wiped out most or all of the home equity built up by tens of millions of Americans.  Before most people begin spending again at the rate required to boost business investment and hiring, housing prices have to stabilize and begin to move up. 

 Washington spent more than $1 trillion to stabilize the financial markets, which generate most of the wealth of the top 1 percent to 20 percent of Americans.  For much less, we can stabilize the housing markets which generate the wealth of everybody else.  The most direct way to do this is to keep people in their homes by bringing down the current abnormally-high foreclosure rates.  Fannie Mae, which taxpayers now own, could extend low-cost, two-year loans to millions of homeowners facing foreclosure.  The funds could be used only for mortgages held by Fannie Mae.  And to control the moral hazard lurking in such relief, 20 percent of any capital gain earned from eventually selling those homes would go back to taxpayers.  

The third initiative would ensure that everyone can build the skills needed to earn a rising income by providing low-cost access to college education and worker training.  First, we could replace student loans with an expanded and upgraded form of national service:  Two years of service in the military or the Peace Corps, or three to four years service in Americorps, would earn any young person in-state tuition at a public college or university for four years.  Young people considering college would be asked to give something of themselves back in service to the country, and would no longer have to face huge debts that can take decades to work off.  In addition, every working American should have access to additional training in the information technologies integral to virtually all industries and jobs.  The plan here is one that Mr. Obama supported when he was in the Senate – provide grants to community colleges to keep their computer labs open and staffed in the evenings and on weekends, so any adult can walk in a receive free instruction. 

This agenda is forward-looking rather than present-oriented, so it does not address the deficit.  In truth, everyone knows perfectly well what to do about it.  Simpson Bowles, Domenici-Rivlin, the Senate Gang of Six all rely on the same formula: Raise new revenues, reform Medicare and Medicaid, cap discretionary spending, and reduce defense spending.  This approach, which President Obama supports, broke the deficit logjams in the 1980s under Ronald Reagan and the 1990s under Bill Clinton.  The only thing standing in its way today is the intransigence of extreme conservatives who would rather see the U.S. default on its sovereign debt than consider raising taxes.  We can only hope that the public will continue to rally around this balanced approach and convince House Speaker John Boehner and Senate GOP leader Mitch McConnell. Once that is done, we can turn to the real business of restoring jobs and income gains.

A Primer on the Eurozone Crisis and How It Could Affect Us

The economic viability of the Eurozone continues to slowly leech away.   The latest iteration of the crisis originated again in Athens.  Last week, voters there chose parties on the left and right that agreed on one thing:  No more austerity, including measures already agreed to in exchange for another bailout this summer from the European Union (EU) and the International Monetary Fund (IMF).  The popular revolt against austerity could not have been a surprise.  Greece has seen its GDP shrink 20 percent, its unemployment rate reach 22 percent, its state pensions and government salaries slashed by 30 percent, and the real hourly wages of Greek workers decline 15 percent.  Yet more austerity, designed to assure global investors that Greece will not default on its debts, could mean another 15 percent decline in wages and another 10 to 15 percent drop in GDP.  The Eurozone plan, in short, asks the Greek people to accept an extended depression and sharply lower incomes in order to reassure European bankers.  

To be sure, most governments have to reassure global investors that their bonds are sound and their private sectors produce healthy returns.   What is unique here is that until the financial crisis blew Greece’s cover, it had deliberately misled the EU and global markets about its deficits and debt.  Using a scheme concocted by its Goldman Sachs advisors, the Greek government moved a significant part of its deficits and outstanding debt off its balance sheets.  And Goldman’s scheme was so complex and exotic that nobody grasped the deception.  Without hard guarantees from the Eurozone, foreign investors are unlikely to trust Greece for a long time. 

This Eurozone crisis has other singular features.  Most important, the basic arrangements of the Eurozone hobble Greece’s efforts to recover.  In good times, the euro gave Greece greater access to capital markets than it could ever manage on its own.  But in the bad times that have followed, Greece has found itself carrying crippling debt and unable to devalue its way to competitiveness.  So, Greece is forced to depend on EU bailouts and the willingness of the European Central Bank (ECB) to accept Greek bonds as collateral for new loans to European banks.  The price for these concessions has been drastic austerity.  Imposing more austerity on an economy already in a deep downturn was a formula for economic depression and political upheaval – and Greece now has both. 

What does this mean for the U.S. economy?  The crisis could reach a climax in matter of weeks, dealing another nasty shock to the recovery.  Both sides, however, have good reasons to delay the day of reckoning at least one more time.  That means that it is just as likely that the next president will have to deal with this shock.  So, if not next month then early next year, it seems likely that the Greek government will formally reject more austerity.  With their credibility on the line, the EU and IMF will almost certainly suspend future bailout payments, and the ECB will dial down its indirect supports for Greek bonds.  Without those measures, Greece will default on its sovereign debt in a matter of days. 

Even if the result is inevitable, a delay of several months will let everyone prepare for a Greek default and exit from the Eurozone.  The Eurozone has no rules or provision for kicking out a member.  But without the Eurozone’s continued support, Greece will have to quit:  Only by leaving can Greece reissue the drachma and let it devalue sharply.  Everything Greek will be available at fire sale prices, which will attract foreign investors and make Greek exports price competitive.  Greece and its people will be left a lot poorer, but that’s also now inevitable. 

For everyone else, the main danger is contagion.  Once the Eurozone lets Greece go, global investors may decide it is time to get out of all risky, European sovereign debt.  That would include the huge markets for Italian and Spanish sovereign debt – and if that happens, the crisis would quickly go global.  Every bank in Spain and Italy carries large portfolios of its own governments’ bonds.  That’s why many big depositors at those banks are already shifting their funds to German banks.  Already weakened, the Italian and Spanish banks would be bankrupted by a sharp drop in the value of their government bond holdings.  The Eurozone’s emergency bailout facility can spend up to € 500 billion buying up falling government bonds and providing capital to faltering banks.  But if Italy or Spain teeters on default, that won’t be nearly enough to rescue them. 

That would bring the world, including the United States, back to 2008.  French and German banks also have huge holdings in Spanish and Italian government debt.  Our banks do not.  But once again, nobody knows how many credit default swaps our institutions have issued for European sovereign debt and the Eurozone banks that hold them.  If U.S. financial institutions issued those swaps in large numbers, or simply have large transactions going with European banks caught up in the contagion, the meltdown could lead to a new American financial crisis.  After this week’s revelations about the reckless bets taken out and lost by J.P. Morgan Chase, there should be little doubt that our financial system would be very exposed to a full-blown Eurozone crisis. 

The Eurozone could have resolved all of this some 18 months ago, and at relatively modest cost.  That would have required that German Chancellor Angela Merkel accept the basic rule of every monetary union, that the full faith and credit of the whole stands behind the full faith and credit of its parts.  And the instrument for doing so would have been the ECB.  But that posed short-term term political costs for Merkel. 

Last week, the President of the Federal Reserve Bank of Kansas City, Esther George, noted in the Globalist that, “the current [Eurozone]crisis is following much the same pattern of previous financial crisis – an inability or unwillingness to see the warning signs and take preventive action, followed by massive damage …”  So, we have been have been here before, substituting the ideological blinders of Henry Paulson and his colleagues in Bush administration for those of Merkel and her confederates.  We all know how that worked out last time. 

A New Way to Boost Job Creation -- and Help Save the Planet

U.S. growth slowed sharply in the spring of both 2010 and 2011; but it looks like this year, the economy may have fin ally shaken its good-weather jinx.  New home sales are up and foreclosures are down.  Housing prices are still falling, but at a progressively slower rate which may signal that home prices are bottoming out.   Businesses added only 130,000 new jobs last month, but the jobless rate and first-time jobless claims keep falling.  Perhaps, it’s a case of, “been down so long it looks like up to me.”  But it is a recovery.  Yet, it can still use a boost.  As the Financial Times wrote last week, “in the US, the case for fiscal stimulus is strong.”   

That case is based on what economists call the “output gap.”  An output gap is the difference between the value of everything the economy produces, and what it would produce if it operated at peak efficiency, making the best use of its available labor and productive capacity.   This output gap today is probably 5 to 6 percent of GDP, or a growth shortfall of $770 billion to $930 billion.   That’s why the Federal Reserve continues to keep short-term interest rates near zero, and why global investors have kept U.S. long-term rates at historical lows.

Such a large output gap also helps explain why job growth is so slow.  In the 34 months since U.S. growth first resumed in July 2009, private-sector jobs have increased by just 3 percent.  Compare that to nearly 12 percent gains in private sector jobs in the first 34 month following the deep recession which ended in November 1982.  Part of the reason for much slower job creation this time lies in the “batten down the hatches” response by most middle-class Americans to the destruction of much of their wealth in the housing crash.  However, another part of the reason lies in structural problems evident in the last expansion.  In the first 34 months following the 2001 recession, private sector employment grew by less than 1 percent -- and whatever caused such tepid job creation has not gone away.  

So, the American economy needs today a dose of short-term stimulus plus initiatives to help spur job creation on an on-going basis.  And whatever is done cannot make long-term deficits worse.  The candidate who can solve that puzzle would earn the White House.  

Here are some ideas as a start.  First, shift the tax burden off of job creation and work, with a big, permanent payroll tax cut.  That will reduce what employers pay when they create jobs and what workers and companies pay when people work.  Over the next 10 years, payroll tax revenues for Social Security retirement will average $770 billion per-year.  Cut that in half, and you reduce the tax burdens on job creation and work by some $385 billion per-year.  

The government can raise that kind of money in only three ways – higher income taxes, a new value-added tax, or a new energy tax.  Nobody has ever claimed that higher income taxes or a new VAT help create jobs – but the right energy tax just might do so.

The right energy tax here is a carbon-based fee.  It could be phased in over several years, which combined with lower payroll taxes would give the economy some short-term stimulus targeted to both job creation and consumption.  It could be phased up until it replaced all of the lost payroll tax revenues, ensuring that it wouldn’t make deficits worse over the long-term.  And most Americans would be no worse off with the higher energy prices, because their payroll tax payments would shrink by at least as much.  

Business, including big energy companies, also could come out ahead.  One of the few things that economists, energy experts and environmentalists generally agree on is that a carbon-based tax is the most efficient way to limit climate-warming, greenhouse gases.  That means a broad carbon tax program could preempt future EPA regulation of greenhouse gases – just like the cap-and-trade program that passed the House of Representatives in 2009 did.  

A broad carbon-based tax would make all low-carbon fuels – solar, wind, biomass, and nuclear – more price competitive.  Embed those price changes in an economy as innovative as ours, and entrepreneurial resources and energy would quickly flow into ventures to improve those fuels and make them widely available.  All of those new ventures would create new jobs.   

Finally, we could give this whole process a turbo-charge.   Today, any family or small business can generate its own energy by installing solar panels, as can farmers and larger businesses with larger solar or wind facilities.  And when they generate more energy than they can use, they can sell the excess back to the local utility.  Few families, farmers or businesses do so today, because fossil fuels are still relatively cheap, and the alternatives require hefty initial investments.  

The carbon tax itself will make those fossil fuels less price-competitive, relative to the cleaner alternatives.  Moreover, as Germany and Britain have demonstrated, entrepreneurs will buy and install solar or wind energy for homes and businesses at no charge – so long as government guaranteesw that the utilities will pay a decent rate for the excess power, and the entrepreneurs can get a reasonable cut of those payments.

The mechanism to create those conditions is called a “feed-in tariff,” and Germany and Britain borrowed it from a U.S. program enacted under Jimmy Carter.  It didn’t work here last time, because alternative fuels weren’t sufficiently developed, and oil prices fell sharply in the 1980s and 1990s.  Both of those stumbling blocks no longer apply today.  

In a country as innovative and entrepreneurial as the United States, the combination of a carbon-based tax and a feed-in tariff should drive enormous new investments and advances in renewable energy, with unknown but possibly large-scale economic benefits.  And a widespread dose of decentralized, renewable energy production would create a lot of new jobs just to install and maintain the equipment.

Everybody wins.  The economy gets a short-term boost as taxes on job creation and work go down.  The revenues for social security are replaced with a new arrangement that reduces the risks of climate change, without restrictive new regulation.  Innovation accelerates in areas likely to generate lots of new jobs down the line.  In a sensible political environment, it could be the kind of idea that a smart politician might use to win the presidency. 

Is the United States Really Facing Economic Decline?

A growing chorus of pundits and politicians, along with a few policy intellectuals, are pressing a new debate over whether the United States is in economic decline.  The question is usually posed as a yes-or-no proposition, but the economic facts tell a more complicated story.  The United States is experiencing an economic transition; and while that transition may actually make American stronger economically, it involves serious and unanticipated costs for the majority of Americans.  The result is a real specter of decline that threatens not the U.S. economy, but the American middle class.  The best answer, therefore, lies in helping the middle class without running roughshod over the economy. 

The current sense of economic decline is closely linked to new concerns about economic inequality.   As we have discussed in this space before, income inequality has been gaining steam for nearly 30 years.  From 1977 to 2007, the share of income earned in the United States which the top 1 percent claims every year soared from 8.7 percent to 23.5 percent.  Yet, until the last decade, most middle-class Americans and those striving to join them still made progress.  From 1983 to 2000, Americans in the third income quintile, smack dab in the economic middle, and the two quintiles below them saw their real incomes grow, year after year, by an average of 1.3 percent per-year.  To be sure, those in the fourth income quintile did a little better, registering annual income gains of nearly 1.7 percent, and Americans in the top-earning quintile did better still with annual gains of more than 4 percent.  And, of course, the top 1 percent way outpaced everyone else by a country mile:  Their incomes grew by an average of nearly 10 percent year after year from 1983 to 2000.   So, steady progress for most middle-class Americans accompanied growing inequality. 

That progress ended a decade ago.  From 2000 to 2007, the middle-class and those below them saw annual income gains averaging less than one-half of one percent; and those meager gains turned to big income losses in the financial crisis, deep recession and slow recovery which followed.  The sense that the economy itself is in decline has been reinforced by comparable income stagnation and then losses by those in the fourth quintile.   Only the top 10 percent, and especially the top 1 percent, saw healthy income gains from 2000 to 2007.  And while the wealthy suffered big setbacks when the markets crashed in 2008, those markets have recovered, as have those incomes. 

Yet, for all those problems, the evidence also shows that the overall economy is not in decline.  Over the last 10 years – and the last 15 and 20 years, too -- the United States has posted the strongest growth and, by far, the greatest productivity gains of the large advanced economies.  From 1990 to 2010, through two serious recessions and one mild downturn, the American economy grew by an average of more than 2.6 percent per-year.  That growth compares to annual averages of less than 1.5 percent for Germany and Japan, 1.8 percent for France and 2.4 percent for Britain.  And those differences were just as large for the last decade.

Over the same two decades, multifactor productivity across the U.S. private economy increased by more than 60 percent.  The Bureau of Labor Statistics reports that real U.S. output, per-hour worked and dollar invested, grew at an average annual rate of 2.2 percent in the 1990s and then accelerated to 2.6 percent per-year from 2001 to 2010.  That’s the best record in 50 years.  The OECD has its own measures for multifactor productivity.  It also reports that over this period, the average annual productivity gains of the American economy outpaced those of Japan by 30 percent, those achieved in France by 40 percent, and those seen in Germany by an astounding 70 percent.  

We have some idea about why this is happening.  Much of it, as expected, involves innovation.  Especially critical here are the successive advances in information and communications technologies and, even more important, their successful application by virtually every business across the U.S. economy.  This is the essence of an on-going transition to what is popularly dubbed the “idea-based economy.”  Stated a bit more precisely, the American economy is developing in ways which increase the intellectual capital and consequent value embedded in most economic goods, services and activities.  This has been happening not only in manufacturing, but across service industries from retailing and hospitality to traditional business services.  There is even evidence that public organizations, including education and government itself, have begun to successfully absorb these new technologies and new ways of doing business.   And for many reasons, the United States is better than Japan and most of Europe at broadly applying these technological and organizational innovations. 

That’s why the productivity advantages of the U.S. economy, compared to most other large advanced economies, have actually increased.  The result is that per capita income in 2011 was between 26 percent and 40 percent higher in America than in Germany, France, Britain, or Japan.  And those gaps take account of the cost of living in each country, as well as the sharp income declines seen here in 2009 and 2010. 

Setting aside the sustained recklessness of America’s most sophisticated financial institutions, the U.S. economy has clearly performed well for the last generation.  Yet, for reasons we do not fully understand, this ongoing transition to a highly-productive, idea-based economy is altering how the benefits of that productivity are distributed.  A piece of the answer lies in the changing value of people’s skills.  Those who can neither produce new ideas that generate value, nor work efficiently with ideas and the technologies that manage them, find themselves struggling in every sector.  Their numbers include most of the bottom 40 percent or so of American workers.  Beyond that, much of the value of the strong productivity gains produced by this economy is eaten up by rising fixed costs for most businesses, especially the fast-rising costs for energy and health care seen since 2000.  The people whose incomes are squeezed by those forces include the rest of America’s middle-class.

The best response here is to lift up the middle class without undermining this productive economy.  That means expanding public and private investments in research and development, infrastructure and, above all, the education and skills of working people.  It also means serious measures to ease the burden of health care and energy costs on businesses and families.  Through taxes, regulation or new incentives, it’s time to drive much greater energy efficiency in American workplaces and homes, and to bend the curve of rising health care costs.  That is where the next President will have to start, if he hopes to head off the real decline of the American middle class.


The Costs of Overturning the President’s Health Care Reforms

Partisan politics and constitutional principles received equal billing in last week’s showdown over health care at the Supreme Court.  Much of the commentary has tried to interpret the questions, gestures and tone of the Justices, in hopes of divining which party and vision of government will likely prevail.  Such divinations are notoriously unreliable in controversial cases.  But whatever the Justices decide, the decision will have enormous long-term economic effects on how much medical care average Americans receive and how much they pay for it.  

It has been clear for some time that without major reforms, the U.S. health care system will soon impose unmanageable burdens on millions of middle-class Americans.  By 2016, the average family is expected to earn about $54,000.  In that year, moderately-priced, family health-care insurance coverage will cost about $14,700.  Employers will pick up much of that tab for most middle-class families.  But all of those employer payments come out of people’s wages and salaries.  So, adding the value of that coverage to the average family’s income in 2012 -- $54,000 + $14,700 = $68,700 – we see that the cost of the health care insurance alone will soon claim more than 21 percent of an average family’s annual resources.

On top of that, by 2016, the average family’s co-payments and other uninsured expenses are expected to come to another $5,100.  Our average family also will pay taxes to help cover other people’s health care – 2.9 percent of their wages for Medicare ($1,566), plus perhaps $1,000 more in federal and state taxes for Medicaid and Medicare costs not covered by the payroll tax.  Add all of that to the cost of their insurance, and health care will claim $22,366 from an average family in 2016, or 32.5 percent of their adjusted income of $68,700.

Why should the average American family have to pay nearly 33 percent of its income for a health care system which by 2016 should claim about 18 percent of GDP?  Part of the answer is that the average worker earning $68,700, a manager making $150,000, and the CEO earning $5 million all pay roughly the same $14,700 for their family coverage.  The result is that middle class families spend a much larger share of their income on health care than wealthier families.  

One of the reasons why health insurance costs middle-class families so much, however, is that their bill includes a good share of the costs of treating those without insurance.  The tab for treating the injuries and illnesses of more than 50 million Americans with no public or private coverage will come to about $68 billion this year.  Government picks up some of those “uncompensated costs,” and doctors and hospitals eat some of their costs.  But most of the rest is passed along in lower payments to insurers, who in turn pass along those losses to their customers in higher premiums or reduced coverage which drives up out-of-pocket costs.  A reasonable estimate of the costs of treating the uninsured which are passed along to average policyholders is about $300 per-person, or some $1,200 for an average family.

The President’s plan to end those pass-along costs by mandating universal coverage was, of course, the central issue in this week’s arguments at the Supreme Court.  And behind the high-minded debates over principle lies the harsh politics of who is to pay for it.  The President’s reforms shift most of the costs of the uninsured to the government by expanding Medicaid and providing subsidies to uninsured people and families mandated to get coverage.  These costs ultimately will be financed through non-payroll taxes – the personal and corporate income tax – which in turn fall disproportionately on higher-income Americans.  That is the choice, and it helps explain the vehemence of the partisan battle over the mandate:  The President’s reforms will shifts tens of billions of dollars in annual costs from middle-class families with private insurance to more affluent taxpayers. 

The good news for the well-to-do if the President prevails is that the new reforms also include measures to contain the future costs of covering those without easy access to insurance.  To begin, covering the uninsured should reduce the cost of their care, at least over the long-term.  Uninsured people are much more likely to suffer strokes, for example, because they are much more likely to have undiagnosed hypertension, diabetes and high cholesterol.  Or, among people with cancer, the uninsured today are much more likely to be diagnosed later, and so require the most expensive interventions.  Uninsured people also are less likely to fully recover from many injuries, making them more likely to suffer subsequent medical problems that require more treatment.   Ensuring that everyone has insurance, therefore, should reduce those costs. 

The reforms also include a package of measures that may begin to slow the health-care inflation which for years has been eating away at everyone’s insurance coverage.  These measures range from the push to establish uniform electronic medical records, to a more results-based reimbursement process for doctors and hospitals, and steps to encourage them to adopt more cost-efficient medical protocols and practices.  To be sure, the reforms do not include the most controversial and partisan cost-saving measures, including tough medical malpractice reforms and an option for public insurance in places where competition among private insurers is weak.  Still, they are a beginning.  

After Bill and Hillary Clinton’s push to reform health care failed in 1994, it was 15 years before another President and Congress took up the issue again.  If the Supreme Court unravels what they did, it almost certainly will be many more years before anyone tries again.  The economic consequences of that scenario would be inescapable.  The number of uninsured people and families will continue to grow.  The costs of their treatment will continue to squeeze coverage and increase the costs of private insurance for most middle-class families.  And without measures to “bend the curve” of medical cost increases, average families will find themselves forced to spend one-third or more of their real incomes on their health care.  

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