Don't Blame Us

Don't Blame Us
By Ross Kaminsky on 6.20.11 @ 6:08AM



When it comes to the weakness of our current economic "recovery" (a term we must use loosely given unemployment only 1% lower than at its worst), liberals are determined to blame anyone other than the Obama Administration, using arguments both false and reprehensible.

Keynesian-in-Chief Paul Krugman, in his latest conspiracy-under-every-rock article for the New York Times, argues that "rentiers" who own large quantities of U.S. government bonds (which is to say who have done Americans the favor of loaning cheap money to our government) benefit from the low interest rates that usually accompany a weak economy.

Therefore, according to Krugman, this "Pain Caucus" works to "protect the interests of creditors, no matter the cost." One would think that a Nobel Prize-winning economist (though Nobel's shine has lost some luster given its awards to Yasser Arafat, Al Gore, and Barack "maybe I'll earn this one day" Obama) would know better than to offer such claptrap. Or maybe he does know better but assumes -- probably correctly -- that most of his readers don't.

Let's consider whether any among the large holders of our federal debt would actually favor persistently very low interest rates -- and keep in mind that very low long-term rates generally require investor expectations of economic growth too weak to cause inflation, and perhaps weak enough to allow deflation.

• The Federal Reserve, as the largest holder of U.S. debt, has the "dual mandate" of managing inflation and encouraging employment, meaning it must focus on economic growth that would eventually cause a paper "loss" on its bonds, but one that it will probably never realize because it can hold the bonds to maturity rather than selling them.

• China and Japan are the two largest foreign holders of U.S. debt, with oil exporters (in the aggregate) coming in fourth. Exporters to the U.S. care far more about the ability to sell us their stuff, and about the value of the dollar (both for exporting and for the value of their investments) than they care about the nominal prices of the bonds they hold.

• U.S. fixed income investors would be able to invest future cash flows at higher yields if interest rates rose. Furthermore, most investors are diversified in asset classes like stocks, real estate, and commodities that often don't correlate with bond prices.

• Banks profit primarily by lending. Persistently low interest rates signal a low demand for loans. Thus whatever they are "making" on a bond portfolio is being offset by a lack of activity in their real businesses. Most banks would gladly give up very low rates in order to see a return of customers.

Krugman's argument is therefore based on a ridiculous assumption that the levers of power are held, directly or indirectly, by people who own bonds, nothing but bonds, and care about nothing but nominal bond prices. No professional investor or sovereign wealth fund (the investing arm of a government) is that stupid.

Paul Krugman is trying to create another "evil foreigner" or "greedy banker" bogeyman, a financial "man behind the curtain" willing to sacrifice all else for the purposes of boosting a bond portfolio while the world burns around him. It's a pathetic paranoid argument by a man desperate to counter the nation's rational (if overdue) turn against Keynesian economics.

Paul Krugman's article is nonsense, but at least it ascribes a semi-benign motivation to the policy makers themselves: Politicians who don't understand economics very well "assume that what's good for the people you hang out with, the people who seem so impressive in meetings -- hey, they're rich, they're smart, and they have great tailors -- must be good for the economy as a whole." Krugman at least gets this right; most members of Congress have little understanding of economics and can be manipulated, not least by Krugman himself.

It's one thing to say politicians make poor decisions due to being uninformed or manipulated. It's another thing entirely to claim, as Yahoo Finance's Dan Gross does, that Republicans are "trying to do everything they can screw the economy near term so that they can retake the White House and keep their jobs." That at least was the summary of Gross's view by his TV partner, Henry Blodget; Gross called that description "slightly hyperbolic" but then proceeded to say that "the political incentives… for the Republicans are for things to go badly in the economy."

He followed up by arguing that Republicans would prefer the stock market down, economic growth down, and unemployment up to help their electoral chances, concluding "it then stands to reason that if you have the ability to have a role in policy, that you would engineer policy to get that outcome." The helpful crew at Yahoo put a subtitle on the screen during Gross' gross remarks: "Is the GOP trying to sabotage the economy in order to win the White House?"

It's one thing to say that better economic and employment growth would help the prospects of the incumbent party, which happens to be Democrats today. It's another thing entirely, even in these politically cynical times, to say that the out-of-power party would intentionally harm millions of Americans in order to garner extra votes.

The logic behind Gross' remarks is not unlike Krugman's confusion: they both believe that weak economic performance is not due to Democrats' big-spending policies but rather that government simply hasn't taxed and spent enough. The wisdom of "If you find yourself in a deep hole, stop digging" is apparently lost on them.

The blame-anybody-but-us syndrome is also contagious in the left-wing blogosphere. One example suggests, "If you hate the debt, blame Bush." Meanwhile, the Tax Foundation reports that "CBO Figures Dispel Myth that Bush Tax Cuts Caused Today's Deficit." According to the CBO's analysis, the Bush tax cuts were responsible for only 16% of the "swing from surplus to deficit since 2001," with spending growth being responsible for almost three times as much.

Even at 16%, the CBO overestimates revenue loss from the tax cuts by using static modeling, assuming the economy would have grown as much without the tax cuts as it did with them. Scott Hodge, President of the Tax Foundation, offered this data: "While actual individual income tax revenues increased by $369 billion or 46% from 2003 to 2007 -- from $794 billion to $1.16 trillion -- CBO estimates the Bush tax cut 'lost' the Treasury a combined $717 billion during the same period."

You have to go back to 1981 to find a four-year income tax revenue increase as high as we saw from 2003 to 2007. Does any liberal want to blame that on Bush?

From print to TV to the blogosphere, media liberals are desperate to blame Republicans for the slowest economic recovery since the Great Depression. It can't be -- how could it be? -- that the left's textbook theories based on the unshaken faith in our betters in government and the economic equivalent of manna from heaven (aka "stimulus") are not working? It has to be the fault of others (anyone but Obama!), whether bankers or the Chinese or Republicans (evildoers all!), rather than the people who still support Keynesian policies despite evidence of failure all around them.

Americans have woken up to the spectacular failure of Obamanomics. The left's desperation to defend the Administration's economic incompetence is palpable as they sink into the mire of lies and slander.

*****

FOR THE FINANCIALLY INCLINED, here's a more thorough explanation of why Paul Krugman's contention that large bond holders would be pressuring politicians to maintain current policies is utterly mistaken:

The largest holder of U.S. debt is the Federal Reserve, followed by China, the "household sector" of the U.S. (which includes hedge funds), and Japan. The next largest groups hold substantially fewer Treasury obligations, but they include state and local governments, private pension funds, money market and other types of mutual funds, banks, and oil exporters.

The Fed wouldn't aim to lose money on its holdings of bonds if that's all they were thinking about. But the Fed has a "dual mandate" that includes both preventing excess inflation and encouraging employment. Indeed, the Fed's stated reason for embarking on its foolhardy second quantitative easing program ("QE2") was to stimulate economic growth which would ultimately cause long-term rates to rise at least modestly. In other words, if the plan had worked, it would have ensured an eventual loss on their bonds, and they would have been fine with that.

It's true that in the short term the Fed's large buying of bonds was expected to raise prices and lower yields. But markets are forward-looking and rates have been dropping for two months even as we hit the end of QE2, showing that investors do not believe that QE2 or any other current economic policy of this government is likely to encourage -- or even allow -- real economic growth. If the Fed does not lose money on their new acquired bond portfolio, then they have failed in their primary mission. (Even in this case, we're only talking about a mark-to-market loss or an opportunity cost, not a real loss if they hold the paper to maturity.)

The Chinese as well as the Japanese and oil exporters depend on a thriving American economy into which they can sell their products. Worrying about losing a few billion dollars (or perhaps even a hundred billion) in the price of bonds is relatively low on their priority list when China typically exports over $300 billion worth of goods to the U.S. each year; Japan typically exports over $120 billion to us annually and oil imports into the U.S. are struggling to regain their 2003 levels (in terms of barrels, not dollar value).

A bigger worry for non-U.S. investors is the solidity of the U.S. Dollar which, despite the sharp rally last week on European debt fears, is down about 7% versus the Euro this year. It's down about 4.5% versus the British Pound and the Japanese Yen, and a stunning 12% against the Swiss Franc. It's even down 2% against the "manipulated" Chinese Yuan this year and over 5% in the past 12 months. U.S. dollar weakness is also represented in the 10% gain in the price of gold this year. This is what's killing foreign investors in U.S. government debt.

By weakening the dollar, the same policies that are helping the nominal prices of foreigners' bond portfolios are eroding their real values while simultaneously making it more difficult to export to the U.S. The idea that foreign bond holders like what's happening now is simply ridiculous.

("Nominal" means the price as it's quoted on an exchange, in a newspaper, etc. "Real" in this case means the value after the price is adjusted for currency changes. For example, imagine you are a foreigner who buys 100 shares of a $10 stock at a time when one unit of your currency is equal to one U.S. Dollar. Let's say the price per share in the U.S. goes up to $11, so the nominal value of your investment has gone up 10% from $1000 to $1100. But if the value of the U.S. dollar versus your currency dropped so that one unit of your currency is worth US$ 1.15, then you'd actually be down 4.4% in real terms. This also matters to U.S. investors because a weakening dollar erodes our global purchasing power and can be inflationary, though inflation expectations remain low for the moment.)

And what about U.S. investors in bonds? Increasing bond yields might cost them money in terms of the value of their current holdings, but investors from pensions to mutual funds to hedge funds to individuals typically have incoming investable cash flow which could be invested at higher rates of return if yields rise. Furthermore, banks make money borrowing and lending money. Very low interest rates in both short and long durations show that there is no demand for money, suggesting lower profits for the banks than they'd have in a better economy.

Large non-bank investors typically hold diversified investments in stocks, real estate, and other asset classes which don't necessarily correlate with bond prices and often move inversely to bonds, so they also would not be cheering for -- or pressuring politicians for -- persistently low rates caused by persistent economic weakness.

Again, Krugman's conspiracy theory is a flight of leftist paranoid fantasy.