US debt is falling: does this prove austerity does not work?

It’s a bit odd isn’t it? How can you reduce debt by spending more? That great raconteur of our times George Osborne likes to point out the evident ridiculousness of such an idea. With that cheeky grin of his, he says: “I don’t believe you can cut debt by spending more.”

And yet, despite the silliness of the very suggestion, UK debt is not falling. It is not like that in the US, however, where the government has been far more Keynesian in its approach.

The US deficit this year is expected to be $642 billion, or so estimates the Congressional Budget Office. To put that in context, last year the deficit was $1.1 trillion. It will, in fact, be the first time since 2008 that the US deficit is less than $1 trillion. And, by the way, not so long ago the Congressional Budget Office was projecting a deficit of almost $200 billion more than that.

Looking forward, the deficit is expected to fall even further, dropping to $378 billion in 2015.

The good news does not stop there, however. US household debt has fallen from $12.7 trillion in 2008, to $11.2 trillion at the end of last year. In fact, according to IMF data, US household debt to income has fallen from a ratio of 1.3 in the mid-noughties to around 1.05. In fact, the ratio is now higher in the Eurozone.

Back to the public deficit, and two main factors explain the fall. The expiry of George Dubya Bush’s payroll tax credit means more income is coming in. Recovering US housing prices mean the US government expects a windfall from Fannie Mae and Freddie Mac.

You would expect cheers over the news in the US, wouldn’t you? Well no doubt Mr Obama is cheering, but oddly economists and politicians on the left and right are fretting.

On the right they don’t like it. They fear that they are losing the moral high ground. How can they demand tax and spending cuts to get debt under control when it is falling so fast anyway? The truth is that the arch Austerians have a philosophical problem with any form of government spending except on perhaps on law, order and defence. They want to see cuts, whatever is happening to debt.

On the left, they don’t like it because they think the US needs more government spending; it needs more Keynesian policies, and the fact that debt is falling is symptomatic of a lack of government stimulus.

In the longer term two problems remain.

By the mid-2020s government debt is expected to rise again as the baby boomer generation retires – this problem can be overcome, however, by raising the retirement age.

A more serious challenge may relate to the burgeoning level of student debt. Nobel Laureate Joseph Stligtz reckons this is the next debt crisis in waiting. See: Student Debt and the Crushing of the American Dream

© Investment & Business News 2013

The one trillion dollar coin and the conspiracy theory of wicked banks

Germany’s head central banker calls it the work of the devil. Last year, Jens Weidmann, Germany’s answer to Mervyn King, told a story from ‘Faust’. A king is running out of money, and the devil disguised as fool persuades him to solve his problem by printing new money. The result was hyperinflation. And that, says Mr Weidmann, is why QE is like the work of the devil.

It is just that QE is not really money printing at all. When the Bank of England buys government bonds it is assumed that it will sell the bonds at a future date.  So if QE looks as though it is leading to inflation, the effects can be reversed.

That’s the theory.

The reality is that that QE doesn’t seem to be doing an awful lot. Sure it may have stopped the recession from becoming  worse, but given the sheer size of this measure – £375 billion in the UK so far – it seems remarkable how low inflation is, and how tiny growth is.

The snag is that debt is the key to the banking system we have these days.  When we borrow money from a bank, we spend it and the recipient of our money pays it into a bank. So when a bank lends money, the money it lends reverberates around the economy. In this way, by their lending, banks create money.

But if we all suddenly decide to borrow less, or if banks decide they can’t afford to lend so much, the broad money supply may well contract faster than an anaconda on speed. QE has had the effect of mitigating this contraction. But it certainly has not had the effect of creating massive growth in the broad money supply.

Perhaps then it is time to really engage in money printing and hand the resulting money out across the land. Milton Friedman pretty much suggested such an idea once. He said that in times of a depression if all else fails, why not scatter money from a helicopter. Before he was chairman of the Fed, Ben Bernanke once said he thought Friedman may have been right.

But that’s where the devil comes in: wouldn’t money printing in this way just create inflation?

For that matter, this whole idea of running a large government deficit is also seen as pretty much akin to devil worship – by some.

Well, maybe. But explain why it is that in times of war – World Wars 1 and 2 for example – governments suddenly found that they could print money to fund the war effort, and could run-up huge deficits. And why is it that the post war periods were not followed by inflation, rather than economic boom, which was often the result. Sure, Germany had hyperinflation, but that was down to the Treaty of Versailles. The UK limped along in the 1920s, but that was largely because adherence to a gold standard removed the Bank of England’s ability to create money. The argument continues to say that periods in history when governments ran surpluses were invariably followed by economic depression. See: conspiracy theories, free lunches, and the theory that banks are destroying wealth .

Some go further – they say the insistence that governments run prudent fiscal policy is a conspiracy, forced upon us by banks who are trying to protect their nice little way of making money. Is the conspiracy theory right? Probably not. But the point is that there is an alternative idea to the established view. The idea suggests that instead of the money supply growing via debt created by banks, the government boosts the money supply by creating new money, and banks’ ability to create credit is then curtailed by legalisation.

The argument may or may not be right. But we may be getting an opportunity to test the theory soon.

As US politicians refuse to compromise, and Republicans and Democrats blame each other for the US’s woes, Obama may have come up with a solution.

Under US law the US government cannot print money – that job is entrusted to The Fed. Except, thanks to legislation from 12 years ago, the government is allowed to create platinum coins. The legislation was designed simply to enable the US government to create commemorative coins.

So why not make a one trillion dollar platinum coin, deposit it with the Fed, and then withdraw money against it, thereby abolishing the US government’s need to have approval from Congress before raising its fiscal debt? Friedman and Bernanke will get their money drop, and the conspiracy theorists will have their chance to put their theories to the test.

But such a measure, unlike QE, can’t be reversed. Critics say such a move really would create inflation.

Paul Krugman, the Nobel Laureate who pens a highly influential blog for the ‘New York Times’, has suggested he is in favour of the idea. But it seems he really sees this as kind of a warning shot. He doesn’t really want to see a one trillion dollar coin; rather he reckons the threat of taking such an action will be enough to ensure that the Republicans compromise with Obama.

Perhaps what we can say is that that we are seeing a very interesting development in the story of our times.

©2012 Investment and Business News.

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Will China’s next leader be an Obama or a Gorbachev?

This column has said some pretty positive stuff about China’s Premier Wen Jiabao in the past. Mr Wen is a smart guy. He was once seen at the annual conference of the world’s leaders at Davos, carrying a worn, and obviously much loved, copy of Adam Smith’s Wealth of Nations. He has repeatedly warned of bubbles forming in China’s economy, of the need to get consumer spending up and imports up, and for China to become less reliant on export led growth. He has warned of the dangers of a property bubble, and even dropped hints about China’s currency, the yuan, being allowing to trade freely – music to the ears of US politicians (not  that they want their ears to receive music, when there are cheap political points to be had by slagging off China at every opportunity).

It is just that reports have been circulating about Mr Wen’s fortune. He is a rich man, and so it appears is his family, and their wealth appears to have been acquired during the last ten years while he occupied a powerful position in China.

How did he acquire such wealth?

While Mr Web is important, he is not China’s most powerful man; that description belongs to Hu Jintao, the President.

As you probably know, China is about see a once in ten years’ transfer of power.

Messrs Wen and Hu will be off, eating grass, gardening, or perhaps pulling strings in the background.

This week, Mr Hu gave his state of the nation speech – an annual event, which on the eve of the power transfer took on more meaning than usual.

His speech was notable for two reasons. Chinese media coverage may have been notable for another reason.

Mr Hu talked about the target of seeing average wages in China double over the next ten years. If this can be achieved, it will be good news indeed. Good news for China’s  workers of course, good news for western companies – including the likes of Tesco and Marks and Spencer – and good news for the global economy, which needs to see a more evenly balanced Chinese economy.

Some say it will be bad news for Chinese manufacturing, as rising labour costs mean it will lose its competitive edge. So, goes the argument, jobs will be lost to the likes of Indonesia and other countries in South East Asia. Jobs may even be lost to the US, and indeed a report today said that Foxconn – the company which makes Apple’s products in China (as well as products for rivals) – is looking at setting up TV assembly plants in LA and Detroit.

But then again, Chinese manufacturing is moving up the value chain, and data indicates that despite rises in Chinese wages, Chinese productivity per unit of labour is rising.

But the second reason for noting Mr Hu’s speech is the emphasis he placed on fighting corruption or ‘graft’, as he called it.

He said: “Combating corruption and promoting political integrity, which is a major political issue of great concern to the people, is a clear-cut and long-term political commitment of the party. If we fail to handle this issue well, it could prove fatal to the party, and even cause the collapse of the party and the fall of the state. We must thus make unremitting efforts to combat corruption.”

He continued: “All those who violate party discipline and state laws, whoever they are and whatever power or official positions they have, must be brought to justice without mercy.”

And guess where the TV camera went when Mr Hu expressed those words. Why, straight to the face of Wen Jiabao.

Writing in the Telegraph, Ambrose Evans-Pritchard suggested the changeover in power will lead to a lurch back to the left, and the anti-reformists will gain control. See: China’s Hu Jintao clings to socialist economy in Mao nostalgia speech

Maybe. The truth is that we don’t know. Take Bo Xilai; he is the disgraced former high flyer in Chinese politics, whose wife was found guilty of murdering British business man Neil Haywood. When Mr Bo was a commerce minister, he was considered to be something of a liberal. When he was promoted to Party chief in Chongqing his views seemed to change out of all recognition, bringing back memories of Mao. So who knows what China’s new generation of leaders will say once they gain power.

But what we can say is that China is entering an important period. For growth to continue, China needs more free markets, more enterprise, and more dynamism.

But does more capitalism lead to more calls for democracy? In ancient Greece, the military innovation called the phalanx meant ordinary soldiers became more important; more vital to military success. Some say the development of the phalanx led to the development of Greek democracy. In China, workers are set to become more important for continued growth. Will their greater economic power, mean they will demand more political power?

What is for sure is that no Chinese senior politician wants to be remembered as China’s Mikhail Gorbachev. Mr Hu’s likely successor Xu Jinping and Mr Wen’s likely successor Li Keqiang don’t want to be seen promoting the Chinese equivalent of perestroika and glasnost. So somehow they must find a half-way route. Reform, but not too fast. And finding that will prove to be very hard indeed.

©2012 Investment and Business News.

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Obama thrashes Romney with a score draw

It all boils down to checks and balances.

Obama has won himself another four years in office, but Congress is still split.

If you are pro Republican, that’s a relief; at least President Obama can be held in check. If you are a Democrat that’s a blow, a major blow. Will Congress make Mr Obama a toothless President?

If you are a credit ratings agency, right now you may be looking forward to a spot in the limelight as you prepare to downgrade the US’s credit rating.

But before the why and wherefores are considered, let’s get rid of some nonsense.

Critics of Obama say taxes need to rise. They say his victory in the election is a disaster for the US economy because it means higher taxes. But answer this question: if the problem with the US is that taxes are too high, how is it that by some measures US taxes are close to their lowest level since the end of World War 2?

In 1965 the US government tax receipts accounted for 24.7 per cent of GDP. Today they account for 24.8 per cent of GDP. Across the developed world over the same time period, tax receipts rose from an average of 25 to 34 per cent of GDP. Across the industrial world, only in Chile and Mexico are tax receipts to GDP lower.

There are lots of reasons why the economy in the US has not performed well in recent years, but please don’t say it was because taxes were too high.

The snag is that the US constitution has been designed, quite deliberately, to reign in the power of the President. Major legalisation has to go through Congress. And Congress itself is divided into Senate (where Democrats have a small minority) and the House of Representatives, where Republicans have a larger majority.

There is actually another tier too, The US Supreme Court. Currently, five judges in this court were appointed by Republican Presidents, and four by Democrat Presidents.

This system of checks and balances has largely made Mr Obama, well alas the spam checker will not allow the appropriate word, but it begins with an imp, followed by an ot, and ends with an ent.

This is especially a problem when it comes to the fiscal ceiling. When US debt rises above a certain level, the US Congress has to give its assent. If it refuses, the US has to stop borrowing. 12 months ago, the US approached this fiscal ceiling, and Congress went down to the wire in giving its approval. During this period of uncertainly, Standard and Poor’s downgraded the US credit rating.

On 1 January, the fiscal ceiling is not up for renewal, but the compromise agreed by Congress is.  As things stand taxes will rise, spending will fall, and the US may well fall into recession as a result.

The question is: how will Republicans in Congress react? Will they look at the electoral college, see that Obama has won by a pretty convincing margin and then conclude they have to obey the will of the people and assent to Obama’s plans? Or will they look at the popular vote, note that in terms of votes cast across the US Obama and Romney were pretty much neck and neck, and say that means it’s their duty to thwart Obama at every opportunity?

Obama’s error was not to take advantage of the Democrats’ majority during the first half of his first term in office. He can only hope that in two years’ time, Democrats will gain control of the House of Representatives again.

As for the Supreme Court, no less than four of the nine judges are over 70, split 50/50 between Republican and Democrat appointees. Some of these judges will inevitably step down and Obama may have the opportunity to change the balance of power in the Supreme Court.

In the long run, however, demographics are at work. In 2000 18 per cent of US citizens under 18 were so-called Hispanics. In 2010 that number was 23 per cent. Hispanic populations are especially significant in Texas (up to now a Republican stronghold) and Florida (a key state in this election).

Ronald Regan once said all Hispanics are Republicans, but they just don’t know it. Certainly under the former B movie actor, a sizeable minority of Hispanic voters put their X in the Republican box. However, the rise of the Tea Party has put many of these former Republican voters off.

Looking forward, it seems that demographics mean that we will either see many more Democrat Presidents, or the Republicans will be forced to move to the left, or perhaps (but unlikely) we will see the emergence of a third political party.

©2012 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here