Unlike some, I don’t believe that government spending and investment is necessarily a bad thing. Government spending and investment can create productive jobs and it can create sustainable economic activity. In this sense, I view government as analogous to the private sector: some investments are duds, some are hopelessly inefficient in terms of labor and capital, and some are spectaculor hits.
My biggest concern with government as an economic actor is that our political process often frustrates wise spending and investment.* Since in my opinion the best government spending and investment programs need to be (a) durable, (b) targeted, and (c) large, our political system–with its frequent bureaucrat turnover, partisanship, and need for compromise and back-scratching–generates programs that are (a) temporary, (b) fragmented, and (c) watered down.
That is why I view the current government-generated global growth with skepticism. I have seen no evidence that suggests that this growth has provided a base from which a new economy can flourish. It appears to be a mish-mash of efforts in the form of the prior economic order–an economic order that didn’t appear to be sustainable. Suffice it to say that I have my doubts about the global economy as government efforts slow down in the face of inflationary and fiscal concerns.
*Yes, it is also true that the government is not solely motivated by profit-seeking behavior. But I see this as a good thing: economies are not just about profits, but about fairness and justice. I believe that government can act as a reasonable economic counterbalance to hyper-profit-seeking firms.
In the most recent issue of BusinessWeek, Michael Mandel notes that GDP statistics ignore intangible R&D investments. In the article, entitled “The GDP Mirage“, Mandel argues that companies are cutting these investments in order to boost reported earnings and please Wall Street. The article has a lot of interesting data. For example:
many companies have taken a deep ax to their reported R&D spending, which also doesn’t show up in GDP. Alcoa (AA), in an effort to preserve cash, reduced its third-quarter R&D spending by 36% from the year before. “It’s a matter of focusing on your priorities,” says Alcoa spokesman Kevin Lowery. “We surprised people by announcing a profit [last] quarter.” Texas Instruments (TXN), meanwhile, expects to spend $1.5 billion on R&D in 2009, down 20% from 2008, owing to workforce reductions and cost-control efforts. And Johnson & Johnson (JNJ) has reduced its R&D by 13% over the past year.
As revenues fall, companies including Microsoft and Motorola are boosting profits by laying off thousands of employees.
Good luck with that recovery.
Massive fiscal stimulus and the dollar carry trade, perhaps among other factors, appear to be inflating bubbles in China and elsewhere.
This was buried deep in Michael Pettis’s latest post at China Financial Markets:
I spend a lot of time talking to large hedge funds and institutional investors – with at least three or four one-on-one meetings a week – on China and market conditions. It worries me that recently I have heard investors say many times, generally very sophisticated investors, that we are clearly in a bubble and the best strategy is to ride it out as long as we can. This has almost become one of the mantras of sophisticated investors – the less sophisticated, I guess, assuming that the crisis is safely behind us.
Certainly the dramatic recovery in emerging market equities seems consistent with the new global bubble hypothesis.
Bloomberg is reporting on how the U.S. government and the New York Federal Reserve funneled taxpayer money to Goldman Sachs via the bailout of AIG (“New York Fed’s Secret Choice to Pay for Swaps Hits Taxpayers“, Oct. 27). The article is worth reading in full. In brief, the U.S. government, through the Fed and AIG, bailed out counterparties holding AIG’s credit default swaps (CDSs; essentially insurance policies on financial securities). These bailouts paid the counterparties, including Goldman Sachs, the full par value of the CDSs–that is, the value that the CDSs would have had if the issuer (AIG) had not collapsed. The problem is that the transaction looks suspiciously like a corrupt back-room deal that transferred billions of taxpayer dollars to Goldman and other financial firms. Here’s why:
Before collapsing, AIG had been trying to negotiate with its CDS counterparties to accept reduce payments (less than par value) to terminate the swap agreements.
The U.S. government also began the negotiations under the assumption that the bailout terms would pay the CDS counterparties less than the full par value of the CDSs, as evidenced by the draft term sheet which, according to Bloomberg, contained a blank space for the percent discount to be forced on the counterparties. From the article:
Part of a sentence in the document [the draft term sheet] was crossed out. It contained a blank space that was intended to show the amount of the haircut the banks would take, according to people who saw the term sheet. After less than a week of private negotiations with the banks, the New York Fed instructed AIG to pay them par, or 100 cents on the dollar. The content of its deliberations has never been made public.
So, in secret discussions, the New York Fed agreed to pay the AIG counterparties the full par value, even though these counterparties would have received far less had AIG been allowed to go bankrupt.
To make matters worse, the chairman of the New York Fed personally made millions of dollars from the transaction:
The deal contributed to the more than $14 billion that over 18 months was handed to Goldman Sachs, whose former chairman, Stephen Friedman, was chairman of the board of directors of the New York Fed when the decision was made. Friedman, 71, resigned in May, days after it was disclosed by the Wall Street Journal that he had bought more than 50,000 shares of Goldman Sachs stock following the takeover of AIG. He declined to comment for this article.
Needless to say, Goldman, which has already reserved more than $10 billion for employee bonuses this year and whose business is “bad for America” according to Paul Krugman, is obviously not a deserving recipient of taxpayer aid. Making this suspect decision in secret and under the authority of someone who stood to profit personally from the decision is clearly unacceptable.
I second the call to appoint an independent prosecutor to investigate AIG the bailout.
From Bloomberg:
Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling “huge” bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini. “We have the mother of all carry trades” … “Everybody’s playing the same game and this game is becoming dangerous.”
Yet more reason to be concerned about this trend. Unfortunately, policy makers appear to be behind the curve (as usual), and they don’t even have the data they need to make good decisions. Needless to say, without the data to make good decisions, we should probably expect bad ones.
I’m in Tokyo most of this month working on my Public Interest Capitalism and Computer-Assisted Organizing research. For the first time in all my visits trips to Tokyo since 1998, I’ve been struck by the number of empty storefronts in fashionable areas such as Omotesando and Roppongi. A manager at a serviced apartment company told me that the number of foreign customers has decreased precipitously since the “Lehman Shock” last year. Indeed, there appears to be little cause for optimism here, and the following comments from “Terrie’s Take“, an often insightful newsletter produced by Terrie Lloyd at Japan Inc., add to the gloom.
On advertising:
Our publications have more than 10 sales people visiting a database of around 5,000 different advertisers. What we are finding is that there is a palpable fear in the marketplace that we’re about to enter a second and more severe down leg in the recession. Once the shoe drops in the stock markets that the first-world governments have spent all their current and future cash on stimulus packages, and they’re out of ammunition, panic may spread again as it did last year. This fear is causing all advertisers and their customers to cut back in their marketing spending. Estimates are that overall media ad spend in Japan fell 9.7% in the first half of this year.
9.7% is a large drop. On luxury goods:
As a sign of the Japanese consumers’ move away from luxury brands, in light of the on-going recession, apparel maker Gianni Versace says that it will close down its Japan operations by the end of year. The company shuttered its three company-owned stores in July, and is moving back to a distributor model to sell its products
All that said, it seems to me unlikely that the global economy will go into a tailspin as long as the Fed keeps rates near zero and the dollar keeps falling. Although I’ve been unable to get any figures on the size of the dollar carry trade, my contacts in finance tell me that the dollars are flowing into Chinese real estate and other emerging market asset classes. As long as the dollar carry trade continues, it will create downward pressure on the dollar and upward pressure on emerging market asset prices, making the trades ever more profitable. With unemployment high and rising in the U.S., it’s hard to imagine that the Fed can raise rates anywhere in the near future, so this positive-feedback cycle could run for quite a while, potentially inflating a global bubble even larger than the last one. Of course, we know how the game ends.
It seems the key variable in everybody’s marco forecast is now the dollar. Will it slide steadily down to new lows? Will it strengthen as new waves of deleveraging hit the global banking system? Can we count on an export-led recovery in the U.S.?
It does appear that the Fed and Treasury are continuing in the recent tradition of “benign neglect”: allowing the dollar to weaken as a result of monetary and fiscal policy, all the while jawboning the currency markets about the desire for a “strong dollar”. Of course, they know that a strong dollar will only exacerbate the recent imbalances and require the U.S. system to continue to lever up in order to grow. Thus, the benign neglect and the secret wish that broad dollar depreciation will force surplus countries to appreciate their currencies, providing (perhaps) fuel for a foreign consumption-binge and a domestic export-led recovery.
While a laudable goal, I’m of the opinion that this “beggar-thy-neighbor” policy will face stiff resistance from the export countries, as recently seen by Thursdays foreign currency market intervention by several East Asian countries. Furthermore, Canada is now getting quite concerned and the loonie approaching parity. But, continuing to exchange local currency for dollars will inevitably lead to inflation in economies where additional balance sheet growth is possible. And it is quite unlikely that we will see domestic consumption in foreign countries outstrip foreign production anytime soon (which would turn them into net importers of goods and services).
I have no idea what will happen to the dollar in the medium-term, but its central importance to the course of the global economy makes constant vigilance imperative. Right now, let’s all enjoy the currency-led recovery.