Comments on the News

SPEAKING SOFTLY AND ...

2009-06-10T17:50:00.000-07:00

Treasury Secretary Tim Geithner’s speech at Peking University last week seems to have been better received there than in Washington. Some currency hawks are lamenting that he saw the need to go to apologize (again) for stating the obvious fact that China has been manipulating its currency for a long time now.

In fact, the speech does not include any apology (though private conversations with official Chinese might have). Nor did it represent what some in the media portrayed as a backtracking from the Obama campaign’s tough line on China. On the contrary, it is a thoughtful, reasoned explanation for the need for China and the US to work closely together to “lay the foundations for more balanced, sustained growth of the global economy once this recovery is firmly established.” The speech should be studied carefully, in my view. The text can be found at http://blogs.wsj.com/chinajournal/2009/06/01/full-text-of-geithners-speech-at-peking-university/.

In fact, I found a lot to admire and agree with in this speech. For example:

§ It rests quite clearly on the expectation that Beijing will start to assume responsibility for the health of the global economy.
§ Geithner made clear that sustainable growth in China “will require a substantial shift from external to domestic demand, from investment and export driven growth, to growth led by consumption.”
§ At the same time, the US will have to increase its savings (i.e. reduce the rate of consumption growth) and should be expected to reduce its current account deficit (the broad measure of borrowing from abroad) as the recovery proceeds.
§ Its global perspective: “China and the United States individually, and together, are so important in the global economy that what we do has a direct impact on the stability and strength of the international economic system. Other nations have a legitimate interest in our policies and the ways in which we work together, and we each have an obligation to ensure that our policies and actions promote the health and stability of the global economy and financial system.”

With respect to the value of the renminbi – a major nexus between Chinese and American growth strategies – Geithner called for a “more flexible exchange rate regime.” There’s not much new in this. Since the days of John Snow, Treasury has used that phrase as code for a stronger RMB. Indeed, only that meaning makes Geithner’s key sentence other than nonsense. He said: “Greater exchange flexibility will help reinforce the shift in the composition of [Chinese] growth, encourage resource shifts to support domestic demand, and provide greater ability for monetary policy to achieve sustained growth with low inflation in the future.” That had to refer to a stronger RMB, not one subject to greater fluctuations.

So, unlike some others. I see in Geithner’s speech most of the elements of a sensible approach to the vexatious currency problem. He has lowered his voice, especially compared to Henry Paulson’s histrionics. He has placed the central issues – sustainable growth strategies for China and the US – on the table for the Strategic and Economic Dialog. He did not back down on the need for a substantial revaluation of the RMB as crucial to a sustainable global recovery.

He’s speaking wisely and more softly. To make the Rooseveltian strategy complete, all he needs is a big stick, some means of compelling Beijing to make politically hard decisions. John Snow at one point told a business delegation in his office that they “should hold our feet to the fire so we can hold the Chinese feet to the fire.” That, I believe, is the most important function of the Currency Reform for Fair Trade Act of 2009 (H.R 2378 and S. 1027). Let’s hope the Secretary will prove willing and able to use it.

DEFLATING EXPECTATIONS

2009-05-11T08:03:00.000-07:00

In the view of the latest issue of The Economist, “inflation is bad, but deflation is worse.“ (See The greater of two evils,” May 9-15, 2009.) An editorial reasoned that “inflation is distant and containable, while inflation is at hand and pernicious.”

It concludes darkly that we might be in for a “malign” form of deflation similar to the 1930s “... because demand is weak and households and firms are burdened by debt. In deflation the nominal value of debts remains fixed even as nominal wages, prices and profits fall. Real debt burdens therefore rise, causing borrowers to cut spending to service their debts or to default. That undermines the financial system and deepens the recession.”

“Deflation robs a central bank of its ability to stimulate spending using negative interest rates,” the editorial went on. Moreover, using interest rates to combat deflation can slow the reaction of central banks when inflation once again becomes the issue.

By deflation, The Economist correctly means “persistent price declines” rather than passing ones that reflect temporary imbalances in the market. It focuses on the growing gap between the potential for global economic production and actual output as the source of the problem.

That production gap surely stems from other causes that The Economist overlooks. It’s not just debt-burdened households in the US and Western Europe that are not consuming; it’s also cash-rich households in Asia. Deflation surely stems in part from chronic underconsumption and over-reliance on export-led growth elsewhere. At the heart of this syndrome lies mercantilist price-fixing in the form of undervalued currencies.

So, why not go to the source – one of them anyway? Work out a new Plaza Accord with China, Japan and the others with misaligned currencies. This will help them bring their currencies into line with market forces, reduce their overdependence on exports to unwilling or unable consumers abroad, and stimulate demand at home to sop up some of that unused production capacity. That at least would be a step away from a repetition of the 1930s deflation and toward effective international cooperation to put the world economy on a sustainable growth path.

TAX OVERSIMPLIFICATION

2009-04-19T13:22:00.000-07:00

On Tuesday of last week, President Obama gave a terrific speech at Georgetown University, explaining and defending his approach to the economic crisis better than at any time to date. His message for Americans was that:

“… each action we take and each policy we pursue is driven by a larger vision of America's future - a future where sustained economic growth creates good jobs andrising incomes; a future where prosperity is fueled not by excessive debt, reckless speculation, and fleeting profit, but is instead built by skilled, productive workers; by sound investments that will spread opportunity at home and allow this nation to lead the world in the technologies, innovations, and discoveries that will shape the 21st century. That is the America I see. That is the future I know we can have.”

For a short while I felt much better about the prospects for a new-style American economy. Obama’s ringing statement was at least the beginnings of the sort of national strategy I’ve been seeking for several years now. Some of what has passed for “stimulus” thus far might not serve the President’s “larger vision.” But this strong statement set forth a real test for future policy – it should promote future investment, economic growth, jobs and incomes. Bravo!

Then the following day (not coincidentally, April 15), the President set an objective for change in a major policy area that left me scratching my head. He directed his Economic Recovery Advisory Board headed by Paul Volcker to come up with recommendations for tax reform by the end of this year. In doing so, he left the impression that he sees the big problem as the “monstrous” complexity of the tax code.

The focus on tax and the sense of urgency are commendable. The code does run to over nine million words. Compliance is a nightmare for average citizens and a challenge even for smart CPAs. It’s full of special-interest gifts and replete with essentially failed social policy (think of the many provisions related to health care, savings, and retirement).

Yet you don’t have to be a cynic to be skeptical about the benefits of tax simplification, particularly as they relate to our central problem: as a country we don’t produce enough to satisfy our needs and pay down our debt to the world. Simplification of the tax code, even if it were to materialize as intended, would not by itself address this problem. Our code is not just overly complex; it rewards the wrong behavior. Alongside simplification, let’s hope that Volcker will broaden the agenda to include:

a) lack of any border-adjustable consumption tax. Such a tax – like a value added tax or a national sales tax – can be rebated when goods are exported and imposed when they are imported. Virtually every US trading country does this, and it’s allowed by international law. The unsurprising result is that we have a persistent, massive trade deficit.
b) relatively slow depreciation rates. The US forces businesses to recoup the cost of investment, particularly major ones, over relatively long periods, thereby increasing the cost of capital. The result is to steer investment away from the US to a more generous country, such as Canada.
c) high corporate income tax rates. In 1986 when the US last undertook an overhaul of the tax code, one objective was to reduce the marginal corporate tax rate to match or overmatch the rates in the OECD area. We succeeded in that, but the world did not stand still. Within a short time, the US once again had the highest marginal rates in the developed world.

Simplification is not the be all and end all of tax reform. If we’re serious about regaining international competitiveness and the long-term integrity of the dollar, we need to aim for more than mere simplification of that monstrous tax code. Let’s get a first-class tax system for now and for the future.

WORKING ON THE RAILROADS

2009-04-18T10:42:00.000-07:00

WORKING ON THE RAILROADS

A much ballyhooed element in the Obama stimulus package is the $8 billion dedicated to inter-city rail projects. That’s an impressive sum compared to the paltry investments of the past, and it’s to be complemented by an additional one billion dollars in each of the next five years. It’s an example, say some, of the sort of transformative change that the administration is seeking to bring to this country. Thirteen billion dollars is a big enough pie, reports The Wall Street Journal on April 16, to spark a fierce competition among states from coast to coast to secure a bigger slice for themselves.

Meanwhile, across the Pacific, China has committed to build its own high-speed rail system by 2020. The Shanghai - Beijing link, the longest such line in the world, is almost complete and will cut the trip to five from eleven hours. Even relatively small provincial cities – eleven in Hebei Province alone -- will also be networked together, unleashing a vast potential for development. The cost? A cool five trillion renminbi, or almost $700 billion at current exchange rates, by 2020, most of it planned for the next few years.

Even if construction costs weren’t substantially lower in China, the vast discrepancy in ambition is glaring. My point isn’t that we ought to try to match the Chinese in the scope of our commitment to inter-city rail – though I would love to see that. The payoff of a major commitment to rail transportation is alluring. Lower green-house gas emissions. Less congestion on the highways. An end to a lot of short-haul air travel. Reduced demand for imported oil and gasoline. In short, a big step forward in the greening of America’s transportation system, which is a far greater polluter than our much maligned manufacturing sector.

Instead, what is most striking are the economic benefits that China is already seeing from its commitment to fundamental rather than incremental change in rail transportation. All across China factories are reportedly gearing up to produce steel track, locomotives, rail cars, switches, electronic equipment, and more to satisfy the half-trillion dollar market. The Chinese pie is big enough that investors are eager to produce all that’s needed to supply the burgeoning rail system.

Our incrementally bigger but still woefully inadequate investment, by contrast, is so limited that we will in all likelihood end up importing a good portion of what we eventually do install. That would deliver little of the vision the President laid out earlier this week at Georgetown University of a “future where sustained economic growth creates good jobs and rising incomes.”

In the 19th century, a few thousand Chinese workers were brought to America, to our shame sometimes by duress, to build the transcontinental railroad, using foreign capital and mostly American-made equipment. In the 21st century, more than 100,000 Chinese workers are building their own first-class rail system with their own capital and Chinese-made equipment. We should learn a lesson or two about the multiplier effects of high ambition and get to work on our railroads in earnest.

SCARY TACTICS

2009-03-30T07:09:00.000-07:00

Growing up in the 1950s, I learned a lot about scare tactics. In those days, some people imagined a Commie under every bed, as the phrase went. Only in retrospect did I learn
of the many careers derailed and lives ruined from Hollywood to Foggy Bottom by such irresponsible hysteria. These days, it’s not Commies but protectionists – aka fair traders, trade skeptics, populists, nationalists, etc. – who are thought to be crowded into America’s sleeping quarters.

Almost daily, we get new warnings about the dangers of “protectionism.” The WTO, the World Bank, The Economist, The New York Times, The Washington Post, a host of ivory tower academics, and other apologists for the globalization model that helped bring us to the current ruinous conditions, all denounce protectionism wherever they see it – and they seem to see it everywhere.

The common, usually unstated, assumption in this hysteria is that anything that reduces import levels constitutes protectionism and therefore, especially in these troubled times, is to be shunned. In these tirades, illegal actions are indiscriminately lumped together with legal challenges to illegal measures. But, dumping is a beggar-thy-neighbor action; antidumping is by agreement the corrective measure. Subsidies can be trade distorting and injurious; when they are, countervailing duties are by agreement the corrective measure. Violation of any WTO rules surely is protectionist; seeking a remedy under established dispute settlement procedures just as surely is not. But the press and the experts they choose to cite, including the very guardians of the institutions charged with making the trading system work, use such a broad brush that it takes all of them to lift it.

Let’s slow down and think about this for a moment. Any thing that reduces imports is a danger to the trading system? A recession? A new and better product? Investment in expanded production capacity? Increased domestic savings? Obviously not.

Everyone knows that in the 1930s, when the law of the jungle prevailed in international trade, competitive protectionism deepened the depression. The system of trade laws and contractual obligations established since 1933 have reduced the scope for such ruinous behavior. Some, but only some, recognize that competitive currency devaluations were at least as significant an element in the beggar-thy-neighbor race among nations in the ‘30s. If you are opposed to trade-distorting practices – and I am -- you would work to end mercantilist currency policies, a particularly malicious form of protectionism. Persistently undervalued currencies not only create an artificial two-way trade advantage but leave the protectionist governments with a stash of hard currencies – free money, in effect – to use however they see fit. I don’t hear much talk from the average “free trader” about this practice. Yet, unlike trade protectionism, currency protectionism is beyond the reach of current rules and institutions.

So, as we head into the G-20 summit in London this week, let’s be impeccable with our word, clear in our reasoning, and discerning in our diagnoses. Let’s stop sowing distrust, killing dialog with name-calling, and diverting attention from real issues. This international economic system no longer works very well. It can only be remade by a concerted effort of statesmen of high intellect, uncommon inventiveness and profound good will. The constant drumbeat of fear based on false assumptions and hysterical misreading of events hinders, not enhances, their work.

Charles Blum

CONFIDENCE GAMES

2009-03-16T13:46:00.000-07:00

If you thought that monumental greed, unbridled ego, colossally poor judgment, and grossly negligent regulatory “oversight” accounted for most of the financial meltdown, you might be mistaken. At least Steve Forbes wants you to accept a much simpler explanation. “Mark-to-market accounting,” he asserts, “is the principal reason why our financial system is in a meltdown.”

I’m no CPA, but as I understand it, mark-to-market requires a financial institution to reduce the value of an asset on its books when the market value of that asset – what someone else is willing to pay for it at this moment – falls.

This is, of course, highly inconvenient and might have serious consequences for those high-flying financial institutions that threw caution to the winds in pursuit of competitive profits (and fabulous bonuses for certain personnel), even if they existed only on paper. But the solution to their problem is to allow them to invent a more flattering value based on some phony market situation sometime in the past?

Bernie Madoff made up tens of billions of dollars in phony profits and lived the high life. Ramalinga Raju made up a billion dollars in bank deposits and more than 10,000 employees and lived the high life. Both used phony numbers to make their con games work. The longer they were able to keep their scams going the greater the losses their victims had to suffer.

Now Forbes wants the SEC to enable the banks to do the same thing. Only this time it would not be part of the problem, it’s supposedly a major part of the solution. Is he kidding?

If some banks are “too big to fail,” all of them are too human not to fail in some judgments at some point. Why should the government create moral hazard by insuring their losses and, as AIG and others seem to have managed, their bonuses, too? We need less accounting gimmickry, more transparency, constant and effective oversight, and swift and certain justice – and we need all that now more than ever.

Charles Blum

RR’s 3 R’s

2009-03-16T06:58:00.001-07:00

There are a few preliminary signs that the Obama administration is preparing to take a fresh look at the trade policy that helped get us into the global mess we’re in. Thus far, nothing revolutionary has emerged, just a hopeful emphasis on enforcing our legal rights and a healthy skepticism about new agreements for agreements’ sake.

In addition, there are signs of fresh thinking being undertaken at the Office of the US Trade Representative, my old agency. This will take time, and I’d urge them to take the all the time needed to get it right.

For starters, though, it might be instructive to reexamine the rhetoric and record of Ronald Reagan. Though sometimes derided as simplistic, Reagan at his best was a principled pragmatist. Nowhere was that more in evidence than in his trade policy.

Reagan believed and publicly argued that “free trade must be fair.” In other words, free trade and fair trade were complementary, not polar opposites.

He made this clear in his radio address of August 2, 1986. (The transcript can be read at http://www.reagan.utexas.edu/archives/speeches/1986/080286a.htm.) In just a few minutes, Reagan laid out three characteristics of his trade policy that are still on point:

• Reciprocity: “Free and fair trade with free and fair traders” was his motto to get the best treatment in trade, a nation would have to give it to others. In fact, reciprocal market access was the essential feature of Cordell Hull’s reciprocal trade agreements that helped lift the world from the Great Depression and later formed a major foundation for the General Agreement on Tariffs and Trade negotiated in 1947. It’s plain wrong to consider reciprocity as a code word for protectionism. In fact, reciprocal trade undid the 1930 Smoot-Hawley tariffs and opened the way to sustained economic growth in the world.
• Respect for Rules: In another context, Reagan famously said “trust, but verify.” That’s why we must not only have trade rules but also be willing to enforce them. Reagan objected to countries that didn’t “play by the rules” and that got an “unfair advantage” by subsidizing their industries. On the other side of the coin, protectionism – transgression of the agreed rules – invited retaliation by aggrieved trading partners and was to be avoided.
• Results-Oriented: A free and fair trade policy was expected to produce fair and equitable results. A key to good results was “toughness.” Reagan said: “We’ve been tough with those nations who’ve been unfair in their trading practices, and that toughness has produced results.”

Reciprocity. Respect for Rules. Results-oriented. Sounds like the making a pretty good trade policy for the Obama administration, too.

Charles Blum

LIVING AND DYING BY THE SWORD

2009-03-16T06:56:00.000-07:00

According to a Washington Post dispatch today from Shanghai, Chinese exports plummeted by 25 percent in February. Economists reportedly were “shocked” by the news.

Shocked? Like Captain Renault in Casablanca? No, really shocked. Two Merrill Lynch economists called the $64.9 billion export level an “ugly number” and lamented that “the export slowdown has finally come to China.”

Now, wait a minute! One of my intellectual heroes, Herb Stein, said famously that “if a thing cannot go on forever, it will stop.” A mercantilist trade boom predicated on artificially cheap export prices and the recycling of dollars into consumer debt for buyers of the same goods cannot go on forever. It is stopping now. Not a shock. Not even a surprise. A certainty.

Even the New York Times editorial page got it partly right today I opining that China’s leaders “need to understand that export-led growth no longer works for them or the world.” Of course, the Times went on to urge the Obama administration to back off on China’s undervalued currency, one of the pistons driving the country’s export machine.

The China-based economists don’t see everything as lost, however. They credit Beijing for vigorous – one expert calls them ”drastic” -- measures to help the domestic economy. Aside from a 5 percent tax break on small autos, however, much of the stimulus is aimed at more investment rather than more domestic consumption. More investment in production facilities will only add to the burden of overcapacity, deflating prices and creating surpluses that will seek a market outside of China. If that’s what easy credit results in, China’s “drastic” measures might just be making a bad situation worse.

Live by the sword, die by the sword. The current global economic model is broken. Export-led growth won’t work for large economies. As the Times correctly said, neither China nor the world benefits. At least from this time forward, there is absolutely no basis for anyone, not even professional economists and editorial writers, to be “shocked” by perfectly predictable developments.

Charles Blum

MUDDLING THROUGH QUICKSAND

2009-02-01T11:16:00.000-08:00

In his February 1 column in the New York Times, Tom Friedman laments that thus far the government response to the economic crisis is akin to pouring water into a hole, waiting for the sound of it splashing against the bottom, but hearing nothing. I have another image that’s been in my head since as a young boy I saw a Tarzan movie my family’s first TV set – quicksand.

When caught in quicksand, I recall hearing Tarzan urge, you must master your instincts, as struggling only draws you in deeper until you are submerged. Be calm, make a plan, and get the help you need. By all means, stop flailing about.

That seems good advice for the Senate as it considers its stimulus package this week and for the conference committee that will take up the matter soon afterwards. The instinct to do as much as possible may not prove helpful. I cringe when I hear the argument that the biggest danger is doing too little, not too much. Doing too much of costly programs with a dubious stimulative effect and stretching expenditures out over eleven fiscal years simply set up the need for additional, probably quite substantial, new spending measures to help do what this bill is supposed to. The Congressional Budget Office estimates that only $107 billion of the $819 billion approved by the House would actually reach the economy in the fiscal year ending on September 30, 2009. Only $236 billion more would be spent in FY 2010. More than a third of the total would not become available until after October 2010, some of it not until 2019. If the CBO analysis is even remotely correct, we’ll end up sinking deeper into, and being buried beneath, the quicksand of debt as we pile one new stimulus upon another.

A second problem with the stimulus package in its current form is that it aims to do increase in the short run precisely the behavior that we need to cut back on in the longer run. Today, we want to stimulate consumer spending; tomorrow, we want to reduce our over-reliance on consumption as the major engine for GDP growth. Today, we need to borrow from foreign creditors; tomorrow, we have to stop that and start paying our own way again. These and other contradictions between immediate and longer run objectives were neatly summarized last week by Marina Whitman in an op ed piece in the Wall Street Journal.

Those two considerations suggest first that we need to get more public investment into the stimulus package now. In addition to the “shovel ready” highway and transportation projects – a paltry $46 billion of the $819 billion House bill – why not get started on a radical expansion of urban mass transit and high speed inter-city rail links to unclog our streets and air lanes and thereby reduce our fuel consumption and green house gas emissions?

Second, the stimulus ought to provide powerful incentives to private investment, too. It’s clear to all that government spending will not be enough to fund anything like a full recovery of our battered economy. Why not get started right now on a new investment boom by expensing new investment, at least in energy production and transportation, and giving a bonus to those who invest in the next year or two? Why not charter a national infrastructure bank and fund it privately, limiting the government expenditure to a guaranteed annual return? Why not set up a national energy development bank and fund it the same way? Such steps would leverage public expenditures, maximize the role for private capital (foreign as well as domestic), and stimulate real demand for materials, components, finished capital goods, services from engineering to transportation, and labor.

No one expects the Congress to devise a perfect a plan under duress. Time is of the essence. But a little more thought right now might give us a viable exit plan from the fiscal quicksand in which we’re trapped, setting the stage not just for a cyclical recovery but also for a genuine restructuring of the American economy. The whole world is watching and praying that we get it right.

Charles Blum

TRADING DOWN?

2009-01-22T18:04:00.000-08:00

Many people think the news media are biased. In some cases, I’m sure that’s so. Far more widespread is the problem of unexamined assumptions and beliefs, a mindset maintained over time in the face of obvious changes in circumstances. It’s not so much a question of misreporting as of misunderstanding the reality about which the report is made.

Take the recent reporting on the decline in international trade over the past year. A number of stories have presented this as an alarming development and frequently included a gratuitous warning about “growing protectionism.” The Wall Street Journal, for example, ran a story under the headline “Global Trade Posts Sharp Decline.” Comparing different periods in each case, the article reported declines in imports and exports of 27 percent for Japan, 18 percent for the US, and 11.9 percent even for China. The reporter asserted that a decline in trade was an “unusual development even in a recession.”

For starters, that’s a dubious assertion. When as normally happens in a recession a society consumes less, it needs fewer goods -- whether produced at home or abroad. As recessions are corrections for periods of excess consumption, such a decline is not necessarily a bad thing. Painful, yes, for employers and employees. Uncomfortable, yes, for elected officials. But reduced demand can be a normal part of a healthy process of adjustment.

Next, consider what constitutes a “sharp” drop. Compared to the swift and brutal collapse of steel, aluminum and auto production worldwide – just to cite a few industries -- what’s so extraordinary about a 12, 18 or 27 percent drop in overall trade?

Moreover, those numbers obscure some good news. One reason why trade measured in dollars has fallen is that petroleum prices have plummeted from their heights. Remember $140 going on $300 per barrel prices? Does the Journal really want us to consider that an alarming development? Personally, I’m thankful with every tank full of gasoline.

But the basic problem runs deeper. The unstated assumption of the self-proclaimed “pro-trade” camp is that trade, any trade, is per se a good thing and that more trade is always better than less. Cheerleaders for the current globalization model have for years taken pride in the fact that the growth in international trade has outpaced global GDP growth for several decades. Trade must lead growth, you see? Without faster trade growth, the global economic pie couldn’t possibly grow fast enough to satisfy rising expectations, right?

What’s wrong with this view? Two points bear emphasizing:

A major function of international trade is to smooth out imbalances in national economies. When a country needs more than it can produce in a given period, it imports. When it produces a surplus, it naturally tries to sell the excess goods into world markets. Thus, it’s perfectly normal, acceptable and even welcome when trade helps to smooth out excesses and deficiencies in national economic performance.
To succeed, export led growth depends on growing consumer markets abroad. When Sweden or Singapore follows that path, the world market can easily absorb their net exports. When a giant economy such as China pursues this path, however, the strategy will encounter natural limits. As the US case shows, chronic massive trade deficits – the other side of the same coin – are unsustainable. When that point is reached, massive export-led growth becomes unsustainable, too. And when export-led growth strategies come acropper, it’s a correction, not a tragedy.

So, let’s acknowledge the recent drop in international trade for what it is. First, a sign of the fundamental ill health of the world economy, both in the real and financial sectors. Second, the beginning of a long-overdue adjustment to excessive reliance on export-led growth, especially by larger Asian economies. Third, a warning that surplus as well as deficit countries need to get their macroeconomic policies right if either is to prosper over the long run.

Open trade on fair terms is a good thing. It spurs competition and efficiency, expands consumer choice, and keeps prices moderate. It can help poorer countries grow and develop. But, as we commented recently on China’s massive stash of foreign exchange, it’s always possible to have “too much of a good thing.” All those who write, read and think about international trade should take care, especially in these perilous times, to understand the fundamental realities of the present trading system and leave the ghost of 1929 on the scrapheap of history.

Charles Blum

THE WORK OF REMAKING AMERICA

2009-01-20T11:14:00.000-08:00

On the pre-Inaugural weekend, two polls appeared that gave Barack Obama about as high a rating as a mere mortal should be permitted. One showed 52 percent with high hopes for Obama, 80 percent as approving his transition, and 72 percent as confident his economic program will help. Another poll had 79 percent as optimistic about the next four years. After today’s inaugural pageantry, those numbers ought to rise farther.

(A cynic might be tempted to question the credibility of any poll such as the first one in which five percent of the 1,079 respondents thought that the national economy was in excellent shape. Are there really 54 individuals in the entire country who could be so out of touch? Who are these people? Where do they live? How do they make their money?)

Also on the weekend, Parade magazine printed the text of Obama’s loving letter to his two daughters, explaining what he hoped for them and for all children. Two phrases struck me as particularly apt:

-- “… America is great not because it is perfect but because it can always be made better --- and … the unfinished work of perfecting our union falls to each of us.”

-- “… it is only when you hitch your wagon to something larger than yourself that you realize your true potential.”

With different words, these themes were woven into the fabric of his fine inaugural address. After frankly admitting “our collective failure to make hard choices,” he called on all citizens to “begin the work of remaking America” and creating a worthy legacy for future generations. Amen.

Charles Blum

SAY, WHAT?

2009-01-17T10:12:00.000-08:00

I’m perplexed. The powerful president and ceo of the US Chamber of Commerce, Tom Donohue, on January 16 chose Tokyo of all places as the venue to deliver a strong but garbled message on the dollar. Apparently he was upset by the strength of the Japanese yen which has reached a 13-year high against the dollar. According to the Associated Press, Donohue said among other things that:

--A weak dollar won’t help revive the American economy;
--A weak dollar discourages capital inflows; and
--Exchange rates should be determined by markets. “If you start to manage currencies, it creates more difficulties than it creates benefits,” he argued.

Wait just a minute. First, a weak(er) dollar would help American beleaguered exporters by lowering their prices in terms of other currencies. At a time when Americans are having to adjust their overconsumption, recovery must be based at least in part on increased exports and/or reduced imports. A stronger yen helps open the Japanese market to American-made goods. That can help reduce our trade deficit and foreign borrowing. You’d think the Chamber would like that.

Second, a weaker dollar encourages holders of stronger currencies to invest in the US rather than elsewhere. Their stronger currency buys more value for the buck when the buck is cheaper. When America is a more attractive place to invest and produce, foreign investment will increase. In fact, increased investment is crucial to expand our net exports. You’d think the Chamber would like that, all of it.

By contrast, how right Donohue is about currency manipulation! Too bad he doesn’t see it where it exists. The prolonged misalignment of Asian currencies against the dollar is a prime cause of the current global financial, economic and trade mess. Why didn’t Donohue call a spade a spade and urge, as treasury secretary-designate Tim Geithner has done in the past, all Asian trading partners once and for all to stop managing their currencies? Why didn’t he denounce their mercantilist currencies policies as a protectionist burden on the rest of the world? Why didn’t he inform those export-oriented countries that a global recovery will not be sustainable unless they abandon their managed currency policies?

The Asian currencies have long been maintained at well below their market rates, and most of them still are. There still is time for Donohue to get this right. His next stops are in China and Korea, home of two of the world’s most important undervalued currencies.

Charles Blum

TOO MUCH OF A GOOD THING

2009-01-14T18:18:00.000-08:00

In a remarkably off-kilter story in the January 14 Wall Street Journal (“China’s Capital Outflow Forces Country’s Officials to Try to Rebuild Confidence in Yuan”), Andrew Batson reports sympathetically on Chinese officials’ professed concerns over recent capital outflows and their consideration of a depreciation of its undervalued currency. The article is notable in several ways.

First, it lacks any sense of proportion. After noting that China’s official foreign exchange reserves fell by $25.9 billion in the month of October – a large drop to be sure – Batson writes that they recovered by “only” $5.02 billion in November and $61.31 billion in December. If a $25.9 billion decrease is a large number, then how should an increase of more than double that amount be characterized? Whatever the proper term, the December explosion in reserves was enough to bring the net increase for the quarter to a robust $40.45 billion.

China is hardly running short of reserves. In fact, China’s reserves – by far the largest in world history -- are more than ample to cover its import financing requirements and its modest external debt. China’s reserves are not inadequate, but grossly excessive.

Second, Batson himself notes the notorious opacity of official Chinese data. He might have taken a moment to explain that, even if they are entirely accurate, Beijing’s data on official reserves exclude its sovereign wealth fund (the $200 billion China Investment Corporation), China’s social security investment fund, and dollar holdings by Chinese commercial banks. The total size and composition of these holdings are unknown but probably amount to several hundreds of billions of dollars and other hard currencies.

Third and most important, Batson has apparently accepted the proposition that China needs and is entitled to a perpetual increase in its official reserves perpetually. Anyone with a serious interest in the health of the international monetary and financial system should study the language of International Monetary Fund Article IV. Citing as one objective the “continuing development of the underlying conditions that are necessary for financial and economic stability, ” Art. IV sets forth several obligations of all IMF members. China, of course, is a member, one that wants a bigger say in the governance of the world economy.

Specifically, Art. IV obligates members to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members ….” China has ignored this obligation for years, despite advice to the contrary from the IMF, sometimes strident demands from the US Treasury, and entreaties from other trading partners, developing as well as developed.

The treasury secretary-designate, Timothy Geithner, warned in a speech in June 2007 that the buildup of official reserves in Asia might have gone too far. Asian mercantilism (my word) was resulting in “too much of a good thing” when it came to export-led growth and the amassing of hard-currency reserves. Note that when Geithner made this statement, China’s official reserves were “only” 1.2 trillion dollars. Since that summer, they have exploded by an additional $700 billion.

Why then is the Wall Street Journal continuing to make excuses for illegal behavior by China and other mercantilists? Why does the Journal turn a blind eye to one of the root causes of the global financial instability that now threatens the livelihood and retirement funding of millions of Americans and others around the globe?

Charles Blum

WHO AUDITS THE AUDITORS?

2009-01-14T18:16:00.000-08:00

The Wall Street Journal ran a story on January 14 containing more disturbing details of the truth about Satyam, the misnamed Indian company that is being brought down by its own fraudulent behavior. In an article headlined “Satyam Probe Scrutinizes CFO, Audit Committee,” the Journal reported that the company’s audit committee has not been meeting SEC standards.

As a company whose ADRs are traded on US stock exchanges, the company is required to meet both Indian and American governance standards. One of the latter, according to the Journal, is to have qualified experts on its audit committee. Satyam’s has not for some time at least.

Worse, this fact was serious enough for GovernanceMetrics International to warn its clients as far back as December 2006 -- more than two years before the scandal broke – that Satyam’s governance wasn’t up to snuff.

So, how could an accounting firm like PriceWaterhouse miss this crucial, tell-tale detail?

All those who placed their faith in the company’s claims and PriceWterhouse’s stamp of approval must now regret not having got a second opinion. But why should that be necessary? Audit committees and outside auditors should must do their jobs and do them right and be held fully accountable when they fail to do so, or the capital markets will operate under a cloud of suspicion for a long time to come.

Charles Blum

ACTIVISIONARIES

2009-01-14T18:13:00.000-08:00

My recent post on “Slacktivism” struck a responsive chord with some readers. In fact, one called with feigned defensiveness to ask whether he should take the criticism personally. I assured my friend that I had others – many others – in mind, not him.

Ever since, I’ve been pondering what the opposite of a slacktivist might best be called. After all, Eastern philosophies teach that everything has, and is partly defined by, its opposite. I was momentarily triumphant when I thought I had coined the term “activisionary.” An activisionary, I reasoned, was one who had a clear vision of the future and was acting now to realize it.

Unfortunately for my writer’s ego, a brief Web search resulted in a hit on just that made-up term. It’s not someone who works for Activision, Inc., the video game producer. The company recently merged with Vivendi, a French company, so its workers and game addicts might properly be called vivendistes.

No, the word apparently originated with a Filipino group that with the help of Nokia seems to be advocating text messaging as a form of, or at least a means to, joint action. According to the supeme.ph Web site, activisionaries are a “new breed of activists” who have “discovered that change can come from anywhere and everywhere.”

That makes change sound awfully easy. As an American alternative, I’d suggest that activisionaries are those who know the direction they want society to take, believe in Barack Obama’s campaign rhetoric that “change happens from the bottom up,” and are dedicated to working with any and all like-minded allies to effect that change.

So, activisionaries of America, unite!

Charles Blum

THE TRUTH CAN HURT -- OR SET YOU FREE

2009-01-11T11:19:00.000-08:00

Few Americans had ever heard of B. Ramalinga Raju before last week, but most people think they know what to expect of PriceWaterhouse. Raju’s Indian firm, Satyam (from the ancient Sanskrit word for “truth”), built a sterling reputation in providing consulting and outsourcing services to Indians and clients around the world. Ironically, Satyam was no truth-teller. It juiced the value of its shares by inventing assets, including a billion dollars of non-existent cash, and inflating its profits by a factor of nine. As it turns out, Satyam’s fabulous rise was just one more fraud, and Raju, his brother, and the company’s CFO are now under arrest. By contrast, PriceWaterhouse, Satyam’s auditor, insists it’s done nothing wrong.

Thanks to this latest scandal, we can see more clearly than ever that:

--No country has a monopoly on financial fraud. It’s a global problem.

--Even adults need adult supervision, especially when money’s involved. Self-regulation is all too often no regulation at all. When self-regulators fail to adhere to high standards, abuses can go on long enough before being detected that the consequences are dire, widespread and difficult if not impossible to remedy.

--It takes more than one person or a small group of unscrupulous conspirators to perpetrate a fraud such as Raju’s, Madoff’s or the others that keep coming to light. It requires gullible investors in search of the highest possible return, otherwise savvy institutional investors who willingly suspend their disbelief in financial results that sound too good to be true, auditors who don’t audit, and regulators who don’t regulate. These frauds are little more than genteel gangsterism or refined racketeering, not the work of mavericks on the make.
PriceWaterhouse in particular should be ashamed. If it failed to apply the most rigorous accounting standards to Satyam, the culprits within the accounting firm should be prosecuted with the full force of the law. If, as it claims, PriceWaterhouse did it by the book, then the book needs to rewritten – fast.

--In the US and around the world, more than a mere recovery is needed. Our aim must not be to reinflate the bubbles that have been bursting and reward the reckless and irresponsible with an intravenous drip of new capital . Rather, we need simultaneously to restart economic growth, restructure our economies to eliminate the sources of imbalance and excess, and rebuild confidence in our institutions. These goals are interactive and mutually supportive. The bottom line is that a sustainable recovery is probably unattainable unless we get on urgently with the work of restoring confidence in our banks, stock markets, auditors, and governments.

Satyam shows that the truth can hurt. But confronting the truth can set you free, opening up new possibilities for progress and growth with the highest standards of integrity.

Charles Blum

FREE TRADE FANTASIES

2009-01-07T18:58:00.000-08:00

The January 5 Washington Post editorial, “Terms of Trade” Why the U.S. lost manufacturing jobs, and how it can replace them,” illustrates what’s wrong with the establishment’s rote cheerleading for “free trade.” The editorial is a commentary on a recent report by the Congressional Budget Office that had concluded that “much of the relative decline in U.S. manufacturing was due to imports.”

Hardly earth-shaking, but apparently too strong a dose of reality for The Post. The editorial tries to flip the CBO piece on its head by arguing that the “spur of global competition” had made the remaining American producers stronger, and the country as a whole richer by providing cheap imported goods. The editorial concludes darkly: “We hope that the Obama administration helps U.S. firms adapt. But we hope it also understands that no one can abolish economic reality – and that it would be futile to try.”

Haven’t we heard this all before? Of course. Can we settle the argument, of course not.
But we can set a few ground rules for a more informed and productive debate:

First, The Post and every one else should stop talking about “global competition,” “foreign competition,” “trade” and “free trade” as if they were interchangeable. Global competition is a reality; “free trade” exists only in text books. Much of today’s global trade is rigged by price-fixing in the form of undervalued currencies, the targeted development of hot-house industries propped up by subsidies and other benefits conferred by foreign governments, and excessive corporate power over both the marketplace and regulatory agencies. Competition makes one stronger, as The Post argues. Of course it does, provided the competition is fair. But unfair practices destroy competition, distort the free flow of trade, and undermine confidence in the trading system. No less committed a free trader as Ronald Reagan acknowledged these distinctions and based policy on them.
Second, The Post and others should make it a policy not to comment on our disastrous trade performance without calling for fundamental changes in the U.S. tax, energy, and health care policies. Our outmoded policies are not immutable “economic realities” nor are they the product of some grand march of historical forces, as The Post seems to think. They are choices that we, or more precisely our elected representatives, make. Reverse counterproductive policies, and you can expect a quite different set of results. I think I’d know an immutable economic reality if I saw one, but self-inflicted policy wounds simply don’t make the cut.
Third, The Post and others should stop mixing up the long-run productivity gains and concomitant job losses in manufacturing with the artificial advantages given to imports thanks to our own stupid domestic policies and our trading partners’ unfair practices. Productivity gains have been occurring for a long time, of course, and to our great benefit. Even The Post acknowledges that something changed in the current decade when “the loss of manufacturing jobs was especially sharp and sustained.” However, it shows remarkably little curiosity as to what might have caused this devastating destruction of good jobs and fails to deliver on its promise to tell us how to replace them.
Fourth, The post and others should use only real numbers to make their case. The much trumpeted “productivity” numbers of the US Department of Labor, for example, are based on a simple-minded calculation: divide the dollar value of the economy’s reported shipments by the number of hours worked. A moment’s reflection should enable anyone to realize that our so-called productivity gains are a mixture of real improvements in efficiency and off-shoring. The plant that off-shores all its components and now ships the same amount of shipments into the US market with half its former workforce cannot fairly be credited with a doubling of productivity. But that’s what DOL statistics report, and that’s what The Post and others rely to bolster their shaky arguments.
Finally, The Post and others should stop pontificating on the virtues of more “free trade” without discussing our rapidly mounting external debt. Trade deficits drive the debt problem. In fact, more than 35 years of trade deficits have wiped out our status as the world’s leading creditor, morphing us into the biggest debtor in history. The solution to that still worsening problem simply cannot be more of the same trade policy. And if we don’t begin to solve the problem soon, the Great Inflation that will accompany the widespread abandonment of the dollar will do it for us.

Hard-working Americans now and in the future deserve better public policies than we’ve had for decades of decline. Small wonder that so many have soured on international trade agreements and regard our government and our media as out of touch with reality. The next time The Post is tempted to lament the lack of support for the current trading system, it should point the finger of blame squarely into the mirror.

Charles Blum

SLACKTIVISM

2009-01-05T17:56:00.000-08:00

Slacktivism. The term refers to the “feel-good” illusion that many people (the slacktivists) get from lending support to worthy causes in some painless, often costless way involving minimal effort. Signing a petition, wearing a bracelet, sending a contribution are three stand-bys for the slacktivist. Nothing wrong with any of those except the smug sense that one has actually made a difference. India experienced a spate of slacktivism in the weeks -- petitions and street demonstrations -- after the November attack on Mumbai, prompting a scornful critique by Uma Asher in The Times of India (“The e-war on terror,” December 12, 2008).

As I ponder the cloudy prospects for transformative change in America in 2009, this portmanteau (a combination of two words, in this case slacker and activist) haunts me. In my analysis, corporate interests have a vise grip over US trade and tax policy, the government regulatory apparatus, both houses of Congress, and both major political parties. Despite Obama’s astounding success in raising cash from small donors, large donors dominate the money game and thus the political process.

I’ve long believed that the only way to fight such dominance is through grass-roots activism. The keys to effective grass-roots activism seemed to be a) the existence of a crisis atmosphere which opened the door to real change and b) an actionable agenda of solid, well thought-through policy alternatives. Certainly, the present economic conditions qualify as a bona fide crisis and thus a genuine opportunity for fundamental change. Groups like the Coalition for a Prosperous America, the Coalition to Fix America’s Economy, and the China Currency Coalition – all of which I am active in – are getting close to having the necessary sort of action agenda.

What may yet stand in the way of real change is our own slacktivism. Let’s cheer for Obama and watch him deliver “change we can believe in.” Let’s give the Democrats in control of the Congress larger majorities, an ally in the White House, and watch them produce real change. Such slacktivism is delusional and undermines the chances for real progress.

Shalesh Gandhi, a good government crusader in India, was quoted in the Times as saying “Our political class is bad because we do not keep on questioning it.’’ Gandhi added the crucial point that the real work of improving one’s country is not exciting, but dull.

India’s problem is also our own. I’m confident that after the feel-good inaugural ceremony on January 20, the new president and his entourage will parade down Pennsylvania Avenue in front an ebullient crowd. Meanwhile, a horde of lobbyists will descend upon Congressional offices laying the groundwork for killing the Obama program in committee. They know what they want (or don’t want) and back it up with cash, cunning, and ceaseless effort. By contrast, many reformers seem content to feel good about themselves and their beliefs.

Slacktivists of America, unite! You have nothing to lose but your e-mail chains! Now, right now, is the time for all slacktivists to aim higher, to demand and question more of public officials and the media, and especially to do more themselves -- no matter how difficult, daunting or even dull the work may seem.

Charles Blum

GETTING THE RIGHT TOOLS

2008-12-31T08:31:00.000-08:00

On his way out the door, Treasury Secretary Hank Paulson gave a plaintive interview to the Financial Times (See “US lacked the tools to tackle crisis, says Paulson, 12/31/08).

Among other things, the secretary is quoted as saying:

• “… we’ve done all this [in response to the financial meltdown] without all of the authorities that a major nation like the US needs.”
• “We’re dealing with something that is really historic and we haven’t had a playbook. The reason it has been difficult is first of all, these excesses have been building up for many, many years. Secondly, we had a hopelessly outdated global architecture and regulatory authorities …in the US.”
• Future efforts should aim at “better and more effective regulation.”
• “I am sure I am going to look back … and think of all kinds of things I wish I had done differently.”

On a personal level, I feel deep sympathy for the secretary and many of his colleagues who have had to preside over the dismantling of a system that earned them great wealth and sterling reputations. That must be painful and more than a little confusing.

However, I would like to ask Mr. Paulson whether every one of the statements made above might not apply equally to his failed policy to contain mercantilist currency policies. Haven’t the resulting imbalances – trillions of excess currency reserves and other assets in the hands of mercantilist governments – been building for years? Haven’t we lacked the “authorities,” i.e. an effective IMF and WTO as well as national policy tools, to deal with the problem? Don’t we need “better and more effective regulation” to manage the problem?

Paulson’s insistence that he had the tools needed to end monetary misalignment stands in stark contrast to his lamentations regarding financial fraud and failure. He’s wrong on the former for the same reasons as he’s right on the latter. The new administration should scrap this part of Paulson’s playbook and take a fresh approach.

Charles Blum

2008-12-31T08:28:00.000-08:00

THE THREE R’S

2008-12-29T18:54:00.000-08:00

Those of us educated in the dark ages of the last century at least benefited from an unwavering emphasis on the “three R’s.” We learned not only to read, write and do our sums, but also to spell creatively, thereby facilitating modern marketing.

In dealing with the eocnomic crisis, the new administration is not likely to have the same freedom. It’s got to get its own set of three R’s – relief, recovery, and restructuring – right and right from the start. Larry Summers’ op ed piece in yesterday’s Washington Post (“Obama’s Down Payment”) suggested a promising direction. The incoming economic point man touted Obama’s program in the works, the “American Recovery and Reinvestment Plan,” as a way of supporting the “jobs and incomes essential for recovery while also making a down-payment on our nation’s long-term financial health.”

For me, relief is a matter of putting cash and credit in the hands of the many millions of individuals and businesses who desperately need it to avoid calamity. Other sources indicate that the new administration might be considering some form of broad-based immediate tax relief as a way of reinflating disposable income. While they’re at it, the Obamistas might consider relieving employers of FICA payments for the first six months of 2009 to ease labor cost pressures and business cash flow crunches.

Recovery is more a matter of recovery sustained over time with a generous dollop of confidence building. Smart regulation will help in that regard, as we try to convince American creditors with money and those without enough to trust one another again. In his op ed, Summers revised the Obama jobs target again: now it’s 2.4 million private sector jobs and 600,000 government positions. However, as I previously commented, even three million private sector jobs over the next two years wouldn’t come close to qualifying as a real recovery.

Restructuring is what interests me most. That’s partly a matter of investment, of course. Summers makes a good pitch for considering spending on infrastructure, health care, and education as “investments that will work for the American public.” The he adds an argument for “laying the groundwork for recovery and future prosperity … [by] shedding Washington habits.” That implies no Congressional earmarks and other changes in the stupid way we’ve been allocating government resources for a long time now.

I have no problem with Summers’ arguments – as far as they go. However, as I never tire of repeating, long-term success requires fundamentally changing the way we save and invest, produce and consume, export and import. Such a transformation goes way beyond income relief and public investment, no matter how huge the number of dollars injected into the economy. We also need a big increase in private investment in plant and equipment rather than paper assets and estate. That will require, more than anything else, a wholesale revamping of the American tax system. Failing such a fundamental change in the incentive structure, why would a rational investor put money in production facilities in this country when competing nations offer far more attractive terms and conditions?

So, while pursuing relief and recovery, we need to give equal attention to a national strategy to restructure the American economy so that it can be fully competitive in global markets. To get that right, we need a clear, coherent vision of what that economy would look like -- and we need it soon. Otherwise, we’ll end up making a thousand uncoordinated decisions that so muddy the waters as to make subsequent transformative change virtually if not literally impossible. I’m hoping that’s what Summers meant when he concluded: “Far from being an excuse for inaction or delay, the magnitude of the work ahead is all the more reason to begin that work.”

Charles Blum

AIMING LOW

2008-12-27T13:45:00.000-08:00

As the new administration tries to formulate its economic goals, it seems to be consciously aiming low. At first, President-elect Obama hoped to generate 2.5 million jobs in his first two years. Later, he upped the target to 3 million jobs. That would be better, but it’s still a rather paltry number and would hardly constitute a full recovery for
the economy.

Consider the basic numbers:

--In November, according to government statistics, 10 million Americans were unemployed. That’s more than triple the current target for the next two years.

--The American economy has lost 2.6 million jobs since the peak in June 2007 for total private employment. In November 2008 alone, employment levels fell by 533,000. When December numbers are released, we may be close to or even beyond three million jobs lost in a year and a half.

--According to the US Department of Labor, the natural rate of increase in the work force is approximately 100,000 persons. Thus, every 24 months, 2.4 million jobs would be needed just to stand still.

--So, merely to get back to the June 2007 level will require 2.6 million jobs plus 100,000 for each month thereafter. Eighteen months later, we’re already 4.4 million jobs short – and digging deeper.

--By the mid-point of the first next administration the deficit compared to mid-2007 will be 6.8 million jobs.

When facing the worst economic crisis in 80 years, it may be good politics to lowball expectations. Of course, Obama isn’t the first politician to try to lower expectations. Recall that in far less challenging times Bill Clinton pledged to produce ten million jobs by 2000. It sounded bolder than it was (the natural increase in the workforce would have been expected to eat up almost all the 10 million jobs), and he overshot his target: while the civilian workforce grew by 14.5 million in his two terms, the ranks of the employed soared by 18.4 million. Unemployment fell by 3.9 million workers, pushing the unemployment rate to below 4 percent.

This is not an argument of a return to Clintonomics. On the contrary, America needs not just a cyclical recovery, but a genuine economic restructuring. We shouldn’t try to return to the way things were, but to go forward to places we’re never been. We need to become a goods-producing nation again. So much so that we can replace some imports with domestic production and produce in excess of our needs. That’s the only way to pay down our enormous debt to foreigners without a major inflation. My only point is that prudent politics and sound economics can produce two radically different targets. Should the natural caution of politicians triumph, the best chance we may ever get to revamp the economy may be wasted. Please, Obamistas, aim higher!

Charles Blum

PRIMING THE INVESTMENT PUMP

2008-12-22T11:04:00.000-08:00

Gross Domestic Product = C + I + G + (X – M).

We all learned this basic accounting identity in school. C stands for household consumption expenditures. I stands for gross private domestic investment. G stands for government spending whether for consumption or investment . X – M stands for exports minus imports, or net exports.

If you want to increase national production and income – as we all do – you have only four choices: increase C, I, G, and/or X - M.

The Congress and the new administration seem largely focused on expanding consumption, even though excessive reliance on consumption-led growth helped bring about the current calamity in the first place. Until the rest of the economy recovers and credit becomes available again on reasonable terms, there is reason to question the efficacy of measures aimed at expanding household spending. Let’s hope they rethink this before pulling the trigger on the next “recovery” package.

They also seem agreed on a sizable increase in government spending. I’ve got no problem with funding “shovel-ready” infrastructure projects. Many are long overdue. However, realistically even such projects will take years to start and finish. Moreover, we need to do than just repair and rebuild our broken-down roads and bridges if we want to restructure our economy. We need to commit to massive new spending on intercity rail, electricity distribution, and broadband service, among other major public investments.

I’ve written and spoken a lot about expanding net exports without yet hearing any echo from the Congress or the next administration. But let’s face the facts: we owe the rest of the world a huge sum that grows daily by several billion dollars, even in this recessionary period. Replacing imports (especially energy) with domestically produced goods and expanding exports (particularly capital goods) are essential if we are to avoid settling our unbalanced accounts through a massive inflation.

The more “bail-out” money we throw around, the greater the risk of inflation and the sooner the day or reckoning. This is not so much an argument against doing what’s needed to stabilize the financial sector and key industries like the automotive sector (and don’t overlook escalating cuts in state and local government services and employment). Rather, it is a plea to use the recovery to rebuild the productive capacity of the United States.

Like government infrastructure projects, private investment projects produce jobs immediately, even before the new plant and equipment becomes operational. How to prime the private investment pump?

In my last post, I promised to propose a way to do so. Thanks to an op ed piece in this morning’s Financial Times, today I’m not alone in suggesting that the answer lies in the US tax code. Fred Smith,ceo of FedEx, urged that we use the leverage of expensing, that is, allowing private investors to write off their full investment in the tax year in which they incur the expense without any dollar limitation. Quite naturally, he sees spending $150 million on a new Boeing 777 is a “big risk.” “The best way to mitigate that risk,’ he argues, “is to allow the company to get that money back quicker. It reduces risk and encourages investment more quickly in equipment, facilities and jobs.” Smith cites tax experts Ernie Christian and Gary Robbins on the multiplier effect of expensing: for every dollar of tax cuts for expensing, the economy gains nine dollars of GDP growth.

Why not go one or two steps farther? Add bonus depreciation for investments made earlier as a means of accelerating the private sector’s decision-making. Instead of just 100 percent write-off, why not consider an extra 30 or even 50 percent in the first year to be reduced by ten percent in each subsequent year? Then lengthen the period for carrying forward losses so that future profits are sheltered by current losses including the expensing and bonus expensing.

The effects of such a tax approach would stimulate the economy in the short term. They would help restructure the economy in the medium term by expanding our productive capacity with state-of-the-art facilities. They would do so with no up-front government expenditure or borrowing. Government revenues would be reduced in the out-years, but they would grow in the near term and beyond as people returned to work to produce the equipment, components, and materials needed for each new investment. Construction and transportation companies would be revived at the same time. This approach maximizes the reliance on market forces and minimizes the growth of government buy avoiding new subsidy programs.

Finally, such a program would provide an outlet for nervous foreign holders of dollars. Investing in Treasurys that produce a negative real return is obviously only a short-run strategy for those with no other place to run to. Let’s use expensing to give them a reason to invest in America and, by helping us rebuild our productive capacity, to restore value to the dollars they continue to hold.

Charles Blum

DOLLAR DILEMMA

2008-12-18T15:10:00.001-08:00

Currency issues are confusing to Americans. Most of use live and think in dollars, believing that currency fluctuations don’t matter. As this week’s headlines remind us, life’s not that simple. The terminology itself is part of the problem. Subliminally, “strong” registers better than weak.” But does it help or hurt the American economy when the dollar strengthens as it had for several months? Does it help or hurt the American economy when the dollar tumbles as it has in the past few days and weeks, wiping out months of “gains” in value? In both cases, the answer is: both. Mixed blessings are by the same token mixed curses.

A stronger dollar raises the price of US exports in terms of freely traded foreign currencies. Over time, that reduces our access to foreign markets. It also tends to lower the dollar price of imports, adding to our deficit. At the same time, a stronger dollar tends to lower the price of imported oil and gas and is more attractive to foreign suppliers of capital. It reduces inflationary and can spur deflationary pressures.

By contrast, a weaker dollar lowers the price of US exports and raises the price of our imports, reducing our trade deficit and the need to borrow to finance it. At the same time, it tends to raise the price of oil and gas imports and prompts foreign suppliers of capital to park their cash in some other currency.

So, it should be clear that any gains from dollar movements: 1) are accompanied by losses in other parts of our economic life; 2) are temporary and subject to reversal, perhaps even in the short-run; and 3) cannot be relied upon to solve our long-term competitive problems. (Mercantilist currency policies, a pet policy peeve of mine, are simply price-fixing schemes that subvert the working of free markets, thwarting the short-term adjustment function of exchange rates.)

To achieve lasting competitive gains, we need smart policies in all the areas that impact our trade performance. The on-going recovery and rescue packages under consideration are our best opportunity to get some of that right. If we don’t, we’re just wasting trillions of dollars that we’ll be unable to repay – a recipe for massive inflation.

In my next post, I’ll advance one simple idea for getting it right, starting immediately, without any up-front government expenditure, and in a way that maximizes reliance on market forces.

Charles Blum

RISKY BUSINESS

2008-12-16T18:36:00.000-08:00

Bernie Madoff literally made off with billions of unsuspecting people’s cash by promising consistent annual returns that were too good to be true. His $50 billion Ponzi scheme bilked a wide range of rich folks, including a Hollywood mogul, a wealthy US senator and several sports team owners. For some of them, the losses will be significant but not crippling; for others, their entire financial future has gone down the drain. Several charities let the allure of high returns undo the generosity of donors and their ability to perform their mission.

As huge as the scam was, it is not so surprising that personal greed overcame good judgment in a lot of people who might have and should have known better. What’s shocking is the extent to which reputable banks, insurance companies and other financial institutions fell prey to the same instincts.

That list is long and international: Belgium’s floundering Fortis Bank; France’s BNP Paribas which is supposed to rescue Fortis; Spain’s Grupo Santander; the Royal Bank of Scotland; Japan’s Nomura Securities; MassMutual’s Tremont; and more around the world.

Aren’t these the very institutions that are supposed to know all about risk? Don’t they make ordinary borrowers jump through hoops to provide detailed information and pledge collateral before lending sums that by comparison to the eleven figure fraud perpetrated by Madoff are paltry? Aren’t these the very organizations – the financial professionals -- that want to be entrusted with our money because they know best how to manage it?

By the same token, the performance of the Securities and Exchange Commission does little to relieve our fears. The SEC apparently was asked to look into Madoff’s empire in the 1990s and never launched an investigation. Aspiring crooks everywhere may draw the lesson that if the scheme is sufficiently complicated, your reputation impressive enough, and your political contributions well placed, the regulators can’t regulate and might not even try to.

The ongoing meltdown demonstrates that resolving liquidity problems may just be a matter of cash. Restoring confidence is another matter entirely in a financial system that has betrayed the values of honesty and integrity while celebrating “success” that turns out to be based on elaborate fraud and systematic abuse of trust.

Charles Blum