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The Daily Reckoning | Thursday, March 25, 2010

Characteristics of an Economic Depression

Scary stats from the land of the rising debt

Joel Bowman Reporting from Taipei, Taiwan... Markets proved they could still fall yesterday. After having rallied for 15 of the previous 18 sessions, we were beginning to wonder if it were still possible... In an interesting turn of events, investors actually succumbed to the harsh economic realities of the day. There's no telling how long this momentary lapse of unreason may last, of course, but we'll take what we can get while we can get it. The primary catalyst for the relatively minor pullback in stocks was a relatively major slump in the sale of new houses. Figures from the United States Department of Commerce revealed that, during the month of February, new home sales decreased 2.2% to an annual pace of 308,000, a record low. Pundits blamed blizzards, unemployment and foreclosures for the depressing statistic. The infamous "Snowmageddon" weather earlier this year may have been uncharacteristically severe...but the level of unemployment and the alarming rate of foreclosures are characteristically severe...characteristic of a depression, that is. In other words, the former variable may be fleeting, but it would be unusual, to say the least, if the latter two magically improved with the turn of the season.  Officially, unemployment is hovering around a quarter-of-a-century high, near 10%. The broader "U6" figure - which also factors in "discouraged workers," "marginally attached workers" and those who want to work full time, but cannot due to economic reasons - is closer to 17%. And that's not even the worst estimate. The alternate rate provided by John Williams of Shadow Government Statistics, sits just shy of 22%; again, figures one might deem as characteristic of a depression. As for foreclosures, RealtyTrac Inc. forecasts that figure will reach a record 3 million this year. Other sources give much higher estimates, citing a worsening job scenario and the expiration of first-time buyer tax credit as points of lingering concern. Meanwhile, as Wall Street indexes march ever higher, American home "owners" continue to receive their marching orders. The city of Las Vegas, for example, recorded over 3,000 foreclosures in February, up almost 30% from the previous month. Spring, a small town in Texas, witnessed a 45% spike from January. And in Janesville, Wisconsin, even would-be politicians can't afford to keep a roof over their head. According to a local paper, a candidate for city council K. Andreah Briarmoon has already lost one of her local properties...with three more already in foreclosure. Not content with personal bankruptcy, Briarmoon now has her sights set on running for local office. As the paper reports, "Briarmoon has been campaigning on a platform urging the city to buy properties at sheriff's sales and sell them back to the former property owners on land contracts at much lower interest rates." There's nothing wrong with someone wanting more than they can afford...it's when they get it that the cracks begin to appear. All over America, banks made loans they couldn't afford to make to people who couldn't afford to repay them. The solution, as fellow reckoners have already guessed, would be to allow the market enough space to establish real world price discovery. Prices must be permitted to fall to "affordable" levels, in other words; levels that would inspire some level of market clearing. Alas, what is good for the economy and what is politically expedient is rarely one and the same thing. The voting public, by and large, won't tolerate a "leave alone" government. They want their elected leaders to "do something," to step in and relieve them from the financial pains of a generation worth of overconsumption. In short, they want their government to force someone else - anyone else! - to pick up the tab for them. A recent survey conducted by Bloomberg reveals as much: "Nine of 10 Americans believe that cutting the deficit, which is projected to reach a record $1.5 trillion this year, will require sacrifices from middle-class Americans. Still, when asked about a range of potential tax increases and spending cuts to address the problem, the large majorities of Americans favor tax increases that only affect the wealthy." In other words, almost everyone is in favor of cutting the deficit...as long as it's someone else doing the cutting. Meanwhile, they still need the government to pitch in and save the auto industry...the banking industry...their local plants, hospitals and schools. They need universal healthcare and "green jobs" initiatives. They need welfare programs, safety nets, longer holidays and shorter working hours and a community hall. They need the government to stimulate the economy, to get it out of this slump. They don't realize that the more the government does, the more it guarantees the opposite. In today's column, guest essayist Robert Murphy, of the Mises Institute, revisits a period in history that sorely needs re-examining. Please enjoy...

The Daily Reckoning Presents

Krugman's Hoover History

Robert Murphy At his popular New York Times blog, Paul Krugman is at it again, offering a very misleading analysis of deficit spending. Without technically lying, Krugman perpetuates the myth that Herbert Hoover insisted on budget austerity in the midst of the Great Depression. Then Krugman interprets a chart with adjectives that show his eyes can only see what his Keynesian theory will allow. Bad Hoover History Krugman writes, More than a year ago I coined a phrase that seems to have made its way into the econolexicon; writing about how cutbacks at the state and local level would tend to undermine fiscal stimulus at the federal level, I said that we had fifty Herbert Hoovers. But I was wrong. Via Mark Thoma, we have at least fifty-one - because we have to add David Broder to the list. Before I get there, let's note that fears about fiscal drag at the state and local level have, in fact, proved justified. Aizenman and Pasricha have a fairly definitive analysis; you can get the quick and dirty version just by looking at government purchases of goods and services... Krugman then produces a chart (which we'll get to in a moment) showing that federal spending has risen while state and local government spending has fallen. He concludes, And David Broder thinks this is a good thing, that Washington should be more like the states. What amazes me is that Broder doesn't even seem to be aware that there's an argument on the other side, let alone that most economists are dismayed by the effects of fiscal austerity. If Broder is a guide to Beltway conventional wisdom - which he usually is - we've got a big problem. This notion of Herbert Hoover engaging in merciless budget cutting has become quite entrenched in the pro-deficit community. The idea is that the reason the Great Depression was so awful was that Herbert Hoover was afraid to engage in sufficiently stimulative fiscal policy, at the same time that the gold standard prevented the Federal Reserve from implementing sufficiently expansionary monetary policy. According to this view, FDR came sweeping into office and increased the deficit, which pulled the US economy back from the brink. But then - alas - Roosevelt too succumbed to the irrational deficitphobia, and his attempt to balance the budget plunged the nation back into deep recession in 1937. I have already documented the theoretical and empirical problems with this narrative, when Christina Romer gave a version of it to defend the Obama administration's plans for "stimulus" spending. Let's go back to Krugman's original "Fifty Herbert Hoovers" column to see exactly what his point is: No modern American president would repeat the fiscal mistake of 1932, in which the federal government tried to balance its budget in the face of a severe recession. The Obama administration will put deficit concerns on hold while it fights the economic crisis... It's true that the economy is currently shrinking. But that's the result of a slump in private spending. It makes no sense to add to the problem by cutting public spending, too... The priority right now is to fight off the attack of the 50 Herbert Hoovers, and make sure that the fiscal problems of the states don't make the economic crisis even worse. After reading Krugman's piece, the casual reader would be quite confident that the Hoover administration slashed spending in 1932. Such a reader would probably be surprised to learn that the "fiscal mistake of 1932" was a reduction in spending of about $63 million, or 1.3 percent of the prior year's budget. Krugman's column mentions nothing of the tremendous hike in tax rates at this time, such as the top income tax rate which jumped from 25 percent to 63 percent (!) in 1932. (See my book on the Depression for more details.) Yet these are just the minor surprises. The real surprise would come if the reader saw a compilation of federal budget deficits as a share of the economy, and saw that the Hoover administration (a) came nowhere near a balanced budget after its attempt at "fiscal austerity" and (b) saw the deficit grow as a share of GDP after the stock market crash in every single year Hoover remained in office. See for yourself, keeping in mind that government budgets are calculated with respect to fiscal, not calendar, years: Isn't that extraordinary? The Keynesians typically measure budget deficits as a share of the economy. Yet despite the merciless budget- austerity measures implemented in calendar year 1932 (which show up in fiscal year 1933), the budget deficit as a share of GDP was actually at a record high for the Hoover term. To be clear, the budget deficit in absolute terms shrank just a tad, from $2.7 billion dollars in fiscal year 1932 to $2.6 billion in FY 1933. But the size of the economy itself imploded - due in part to Hoover's obscene tax-rate hikes, but also to the general deflation. (From June 1932 to June 1933, the consumer price index fell a whopping 6.6 percent.) So in real terms, federal spending went up every year of the Hoover administration, even after the alleged budget bloodbath of 1932. Of course, Krugman could come back and argue that although the budget deficit went up, it was too little, too late. After all, Hoover was apparently in the grip of the liquidationists, and so maybe his budget deficits were tiny in the grand scheme of things. To get a sense of just how big Hoover's deficits were, we can compare the table above to the first term of George W. Bush. (Note that the federal government's fiscal years now start on October 1, compared to July 1 back in the 1930s.) Isn't that interesting? After Herbert Hoover engaged in his merciless austerity programs, which recklessly placed the goal of a balanced budget above the need for countercyclical stimulus spending, the deficit was 4.5 percent of GDP. And yet during the first term of the George W. Bush administration - when Krugman and others denounced him for reckless tax cuts while starting a war - the budget deficit peaked at 3.6% of GDP. Yes, yes, the clever Keynesian can always wriggle free from the handcuffs and escape the trap we've set for him. You see, the economy needed massive budget deficits in the early 1930s, whereas there was no such "output gap" in 2004. But my point here is this: Krugman's assessment of a merciless austerity budget, versus a reckless spending orgy, has nothing to do with the actual numbers. No, Hoover's budget deficit must have been too small, because the economy kept getting worse. Just like Obama's stimulus package must have been too small, because the economy got worse than any of Obama's advisors had predicted. Believing Is Seeing Krugman's habit of looking at the data and seeing whatever "facts" his Keynesian theory requires is beautifully illustrated in his commentary on a chart contrasting federal with state and local government spending: [L]et's note that fears about fiscal drag at the state and local level have, in fact, proved justified. Aizenman and Pasricha have a fairly definitive analysis; you can get the quick and dirty version just by looking at government purchases of goods and services: The...green line shows the rate of growth of federal G, which did shoot up, although it's starting to fade out. The red line shows state and local G, which moved in the opposite direction. And the blue line in the middle shows the total, which did nothing much. Now, this omits tax cuts and transfer payments, which presumably did something. But I think it's fair to say that state and local cuts largely offset federal stimulus. Now here's what's really interesting: Try to match up Krugman's commentary with the actual lines in that chart. You will find it rather difficult. First of all, Krugman is trying to show that the boost in federal spending was largely offset by the drop in state and local spending; that's why he says the blue line "did nothing much." Well what does Krugman consider to be "nothing much"? As we can see from the chart, the blue line - spending at all levels of government - did in fact go up as a result of the immense increase in federal government spending. The recession officially began in December 2007. From the 4th quarter of 2007 through the 4th quarter of 2009, spending at all levels (the series Krugman is measuring above as the blue line) increased by 4.4 percent. Now Krugman wants to say this increase amounts to "nothing much." OK, fair enough. But what then should we say about the drop in state and local spending? Over the same time period, state and local spending (the series Krugman is measuring above as the red line) fell by 0.4 percent. So if the increase in total spending of 4.4 percent since the start of the recession is "nothing much," then the drop in state and local spending of 0.4 percent must be much ado about nothing, I would think. You can check that my figures make sense, by simply eyeballing Krugman's own chart. The shocking "fifty Herbert Hoovers" at the state and local levels only very briefly managed to make their year-over-year growth rates negative. In other words, the red line in Krugman's chart just dips below the zero line very modestly in late 2008 and early 2009. In fact, pretend for a moment that you didn't know when the huge fiscal crisis in state and local spending hit the United States, and all you had to work with was Krugman's chart. Looking at the red line, wouldn't you have thought the plunge from 2001 to 2003 was far more dramatic? And wouldn't you have thought the negative growth rates from late 2004 through early 2005 were an indication of more severe fiscal austerity than the relatively modest dip of recent vintage? Conclusion Paul Krugman loves to buttress his commentary with statistics and charts. But very often his own data don't agree with the story he's selling. This doesn't mean Krugman is consciously lying; he might honestly "see" his interpretation jumping out of the numbers. But rival explanations - for example ones that claim government deficit spending doesn't help an economy - fit the evidence far better. Robert Murphy for The Daily Reckoning Joel's Note: In addition to being an adjunct scholar of the Mises Institute and a faculty member of the Mises University, Robert Murphy is also the author of The Politically Incorrect Guide to Capitalism and The Politically Incorrect Guide to the Great Depression and the New Deal, among other titles.

Bill Bonner

The Economics of Being Nice

Bill Bonner With the rest of today's reckoning from Paris, France... Dear readers get a break today.  We're on our way back to the USA. No time to check the markets... Here's something for the "miscellaneous" file, something we found in the paper this morning: A team of Canadian researchers wanted to know if people who bought "green" products were nicer than other people. They did a study of it and came to the conclusion, as reported in The Financial Times, that "those who bought supposedly ethical products were more likely to lie, cheat and steal and less likely to take the chance to be kind." Hmmm... From this, they drew the wrong conclusions. They came to believe that there was a finite amount of niceness in the world and that those who take the trouble to buy ethical products use up much of their allotted stock. Of course, even horrible people can be nice. And nice people can be horrible. After all, Hitler was nice to his secretaries and his dogs. But that doesn't mean that those who are nice to their secretaries and their dogs have to incinerate Jews and gypsies. Or even yell at waiters. Where the researchers and commentators go wrong is in the beginning. They think that buying an 'ethical' mutual fund...or a 'green' car...is a form of being nice. It is nothing of the sort. It is a substitute for being nice. Being nice is not always easy. Many people have a hard time with it. Others judge it not worth the effort...or even counterproductive. Niceness was probably as useless to Attila the Hun as virtue is to a prostitute or integrity is to a politician. Still, most people manage to be nice most of the time...and a few - including our own mother - manage to do it practically all the time. We have never heard our mother say a word that wasn't nice. She has never had an unkind thought, as near as we can tell. Nice people don't have to pretend to be nice by buying supposedly ethical products. They are nice; that's what counts to them. The person who buys ethical products, on the other hand, is a scalawag and a hypocrite. He is not really nice at all, which is what the researchers really discovered. "Love afar is spite at home," wrote Emerson. He was talking about people who are nice to mother earth...but nasty to their own mothers. Or people who are nice to 'humanity'...but mean to their next-door neighbor. Or people who whine about starving children they have never seen and 'underprivileged' people they hope they'd never have to meet. He was talking about people who buy a cup of "fair trade" coffee and don't leave a tip... Emerson knew there was no limit on niceness. He was talking about dreadful people who weren't nice. The do-gooders. The meddlers. The improvers. The health care Democrats. And the "no child left behind' Republicans. He was talking about all the bleeding hearts whose own hearts are as black and hard as a lump of coal. Speaking of health care...this, from Ron Paul: Following months of heated public debate and aggressive closed-door negotiations, Congress finally cast a historic vote on healthcare late Sunday evening. It was truly a sad weekend on the House floor as we witnessed further dismantling of the Constitution, disregard of the will of the people, explosive expansion of the reach of government, unprecedented corporate favoritism, and the impending end of quality healthcare as we know it. Those in favor of this bill touted their good intentions of ensuring quality healthcare for all Americans, as if those of us against the bill are against good medical care. They cite fanciful statistics of deficit reduction, while simultaneously planning to expand the already struggling medical welfare programs we currently have. They somehow think that healthcare in this country will be improved by swelling our welfare rolls and cutting reimbursement payments to doctors who are already losing money. It is estimated that thousands of doctors will be economically forced out of the profession should this government fuzzy math actually try to become healthcare reality. No one has thought to ask what good mandatory health insurance will be if people can't find a doctor... Finally, a dear reader from India writes: India is a very exciting place. Although I am Indian by origin, I made a choice to relocate here because of the opportunities I see. India will give you the feeling of a true, bottom-up free market. Free markets are chaotic, messy and "unplanned" because they are organic. They are driven by the needs of people, seeking their own aspirations and self interest and are not driven by the needs of some megalomaniac government. The infrastructure will come, it will come as people will pay for it because someone needs to profit from it. I don't think you will see too much of "build it and they will come" in India. So no maglev trains in India for now. Having said that, I think that India will go through its cycles as any free market does. To that end, I think that the risk-reward in the equity markets in India is turning unfavorable for the next couple of quarters. The global demand-supply balance in REAL goods and services was altered in a big way by the financial crisis. The full impact of the shift has not been felt by companies. I foresee, tremendous pain for companies throughout the world as they come to terms with a world driven by demand weakness in the US, Europe and Japan (and now a potential bubble burst in China).  Regards, Bill Bonner, for The Daily Reckoning