Wednesday, August 17, 2011

Is the Other Shoe Dropping?

Just when U.S. economy began to stabilize and shows signs of recovery out of the Late-2000s recession, politically and ideologically driven fiscal policy debates heat up again like a wild fire that threatens to set the economy back to a much feared double-dip recession.  After contentious and protracted political battles for months, U.S. Congress passed the complicated Budget Control Act of 2011 on August 2nd at the last minute to kick the can of “2011 United States debt ceiling crisis” down the road.  Shortly after, as agreed and stipulated by the bill, a congressional “Super Committee” (the formal name is the Joint Select Committee on Deficit Reduction) was created which has until Nov. 23, 2011, the day before the Thanksgiving Day, to recommend (a simple majority suffices) to the full Congress for an additional deficit reduction of $1.5 trillion dollars or more over next ten–years.

This carefully chosen (by four House and Senate leaders of the two political parties) 12-members “dream team” is consisted of: for Democrats, Senators Pat Murray of Washington (committee co-chair), John Kerry of Massachusetts, Max Baucus Montana, and House Representatives Xavier Becerra of California, James Clyburn of South Carolina, and Chris Van Hollen of Maryland; and for Republicans, Senators Jon Kyl of Arizona, Pat Toomey of Pennsylvania, Rob Portman of Ohio, and House Representatives Dave Camp of Texas (committee co-chair), Dave Camp and Fred Upton of Michigan. 

If you take a look of committee members’ credentials and stands, you would agree that this is the first positive response to the call for “balanced approach” by President Obama throughout the crisis (you know I am being sarcastic, don’t you?) The sixty four trillion dollars question is how the next episode of this political reality TV show is going to be played out?

You might ask why the gridlock?  The answer is pretty obvious and a familiar one: the Democrats want no cuts to entitlements and the Republicans want no increase to taxes.  At the same time, the majority of people would agree that the rational and most sensible solution to the long-term debt problem is the opposite: cuts in run-away dominant expenses (in entitlements) and increase of total revenue through taxes.  But if you were to run on such a platform, do you think you will be elected to any public offices?

You might ask how much is too much debt?  Technically, the debt ceiling mentioned above applies to the total federal debt (thus excludes state and local debts) or gross debt that reached about $13.6 trillion or a little over 90% of GDP at the end of Sept 2010. By this latter measure of debt-to-GDP ratio, Japan, the third largest economy in the world (by GDP), has the dubious honor of being the highest which had reached 225%.  Singapore, one of the most well-off nations in the world (by GDP per capita) has a debt-to-GDP ratio of about 100%.  All these only suggest the difficulties with the single index approach. Note the gross debt consists of two components: public debt – debts held by investors other than federal government (e.g., treasury bonds held by Chinese government), and intra-governmental debt held by e.g. Social Security and Medicare Trust Funds (operated by federal government).  To add more to the confusion, there are also debates among the economists if and how the intra-government debts should be accounted for.  At the end of Sept 2010, the latter part was over $4 trillion, more than 30% of the total debt. 

Let us accept for the moment the notion that the total debt is too high, you might ask then the most important question what should we do and what should we tell the government do?  The truth is no one is really sure but that never stopped many from offering opinions as if they do know for sure. 

In reality, the government has two powerful tools – monetary and fiscal policies. The former belongs to the independent Federal Reserve which has pretty much used up its ammunitions with its continuing “zero interest rate” policy and Quantitative Easing in response to the recession started by the 2007 financial crisis.  The latter is under the control of executive and legislative branches – the congress and the president.   It is necessarily political and is where all the confusions and actions have been.
The essence of the current debt debate is simply the question of austerity or stimulus.    Unfortunately, economists (Nobel laureates included) do not have a solid grasp of the problems and solutions nor consensus.  It gives politicians and media a huge platform to play their agenda as we are all participating, like to or not, in this giant new social economic experiment.

So far, the best available diagnosis of the problem we have been facing appears to be the Balance Sheet Recession.  It is a notion developed by Richard Koo years ago from the experience with the Great Recession (aka the Lost Decades) of Japan starting in 1990. Richard is an American educated economist and now the Chief Economist of Nomura Research Institute in Tokyo.  He has suggested that what U.S. and Europe have been going through is a replay of what Japan has which is not the familiar traditional recessions of the past decades. The symptom and underlying dynamics is vastly different in that the private sector is not spending because the overriding priority for them is to pay down the debts on balance sheets (that is, income minus liability) that arose from the burst of their asset bubbles.Below is Richard Koo’s April 9, 2011 presentation at a Panel in INET's Bretton Woods Conference.

Richard Koo’s recommended treatment is clear for the balance sheet recession when private sector is not spending and waiting for demand.  He argued convincingly with Japan as an example that government, as the only remaining player, must provide stimulus to keep the economy going.  He also argued that austerity is the wrong medicine which could result in a spiraling down of economy.  Unfortunately, that is exactly where the wave is heading and against which we are swimming.  I am for having disciplines in fiscal policy. But it is not a question of big or small government; it is a question of smart or stupid government!

In the 1957 movie classic 12 Angry Men, justice were served because one cool headed juror #8 (played by Henry Fonda) prevailed.  Will the 12 member Super Committee produce something good?  In real life, with the two-party construct in our political system, there is a strong tendency for adversarial framing in conflicts by the opposing parties, not unlike what happens in our justice system.  As a result, it is very difficult for resolution of this protracted political conflict to even pass the antagonism. Grounded and rigorous reasoning gets drawn out by 30 seconds sound bites and videos which is not the way to help solving a complex problem.

Despite the built-in trigger, the Budget Control Act of 2011 contains no credible threat of mutual destruction.  I am thus not optimistic that the Super Committee and the congress can come to any meaningful and productive resolution; a “hung jury” would be the more likely outcome.  After all, these are merely elected politicians who are supposed to represent us, the 300 millions imperfect, confused, frustrated, and sometimes angry ordinary people.  Should we be surprised about how we get ourselves into this situation?  A situation which Chinese describes as 盲人騎瞎馬 (南朝宋.劉義慶《世說新語.排調》) - the blind rides a blind horse (a similar metaphor in the West would be the blind lead the blind)?  Will we get ourselves out of this mess in time?  What I did not tell you was the second half of the quote “盲人騎瞎馬 - the blind rides a blind horse”.  It is “夜半臨深池 – coming to the edge of a deep pond in a dark night.”  May God bless us all!

Talk to you soon!

No comments: