Larry Summers, Bubbles, Fiscal and Monetary Policy, and Financial Regulation; The IMF’s Fourteenth Jacques Polak Annual Research Conference Speech

As I have noted previously, Larry Summers delivered an interesting speech at the IMF’s Fourteenth Jacques Polak Annual Research Conference in November. Some commentators have jumped all over the speech, claiming that Summers is advocating that the Federal Reserve create bubbles in order to stop it from falling into recession or worse. (To find such comments, all you need to do is google “Larry Summers bubbles.”)

I was in the audience when Summers delivered his speech, have watched it again online, and have read a transcript of the speech.* What Summers is saying about bubbles is ambiguous. In fact, the word “bubble” appears only once in the speech. This is what Summers said:

“Let me say a little bit more about why I’m led to think in those terms. If you go back and you study the economy prior to the crisis, there is something a little bit odd. Many people believe that monetary policy was too easy. Everybody agrees that there was a vast amount of imprudent lending going on. Almost everybody believes that wealth, as it was experienced by households, was in excess of its reality: too much easy money, too much borrowing, too much wealth. Was there a great boom? Capacity utilization wasn’t under any great pressure. Unemployment wasn’t at any remarkably low level.  Inflation was entirely quiescent. So, somehow, even a great bubble wasn’t enough to produce any excess in aggregate demand.”  

This, however, is Summers' interpretation of what happened prior to the financial crisis. It is not his policy prescription going forward. In fact, he does not offer policy prescriptions but argues that what we need “to think about” is “how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activity holding our economies below their potential.”

Near the end of his speech is the one statement about asset prices that could be interpreted as Summers’ advocacy of bubble:

“Now, this may all be madness, and I may not have this right at all. But it does seem to me that four years after the successful combating of crisis, since there’s really no evidence of growth that is restoring equilibrium, one has to be concerned about a policy agenda that is doing less with monetary policy than has been done before, doing less with fiscal policy than has been done before, and taking steps whose basic purpose is to cause there to be less lending, borrowing, and inflated asset prices than there were before.”

It is not clear from that how “inflated” asset prices before Summers might want to do something. It is, however, fair to assume that Summers is concerned about a premature cessation of quantitative easing of monetary policy.

With respect to fiscal policy, Summers is pretty clear about what he advocates:

“But imagine a situation where natural and equilibrium interest rates have fallen significantly below zero. Then, conventional macroeconomic thinking leaves us in a very serious problem, because we all seem to agree that whereas you can keep the federal funds rate at a low level forever, it’s much harder to do extraordinary measures beyond that forever; but, the underlying problem may be there forever. It’s much more difficult to say, well, we only needed deficits during the short interval of the crisis if equilibrium interest rates cannot be achieved given the prevailing rate of inflation.”

It is, though, surprising that, even by those inclined to agree with Summers about deficit spending, there has not been much criticism, if any, about another controversial argument Summers made in this speech. Right after the paragraph quoted above, Summers says:

“If this view is correct, most of what might be done under the aegis of preventing a future crisis would be counterproductive, because it would, in one way or another, raise the cost of financial intermediation, and therefore operate to lower the equilibrium interest rate on safe liquid securities.”

It appears that Summers is hinting that, in his view, Dodd-Frank goes too far. Perhaps he is concerned about a Volcker rule that he considers too restraining on banks. The argument that some of what is being done in the regulatory arena could be characterized as closing the barn door after the cows have left or as overkill is not obviously ridiculous even if one is inclined to disagree with it. There were, though, regulatory failures that were clearly an important part of the story of the events leading up to the financial crisis. It is hard to argue against doing something about that, even if one finds fault with particular regulatory initiatives.  

I have criticized Dodd-Frank for not attempting to deal with the regulatory capture issue and not reducing the number of agencies involved in federal regulation. Also, the failure of the regulatory agencies in the years leading up to the financial crisis was more due to a failure to use existing authority rather than due to a lack of authority. For example, it is common to hear the argument that financial derivatives were unregulated prior to Dodd-Frank; however, the bank regulators could have told the banks that certain uses of derivatives constituted an “unsafe and unsound banking practice.”  That they did nothing while major banks were buying credit default swap protection from one source, AIG, was a clear failure. Nevertheless, it is hard to fault the government from trying to rein in excesses in financial markets that pose systemic risks or could result in the taxpayer being on the hook. If Summers made his argument more explicit here, he might find himself in a politically uncomfortable position. Democrats who preferred Janet Yellen over Summers as Fed chair because they felt he might be lax on regulation had a valid concern. (I have previously written about the regulators’ dilemma and regulatory organizational issues.)

Now that Summers is not likely to be appointed to a government position in the near future, I hope he will clarify his thoughts on regulatory issues, as well as resolve the ambiguity of his speech with regard to monetary policy. Even if some of us do not agree with everything he says in this regard, it would certainly be thought provoking. And most of us would probably not disagree with everything.
 

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* The video of the entire panel session during which Larry Summers gave his speech can be found here. It is the last video of the research conference. The video quality is better than what can be found on YouTube.  An unofficial, but it seems to me to be accurate, transcript of the speech can be found here. Summers has posted a “lightly edited” version of the speech on his blog. The major edit is the elimination of his calling “stupid” what “people in Chicago and Minnesota” might write in his hypothetical scenario.  

Observations on Increasing the Fed’s Inflation Target

The U.S. economy is currently growing sluggishly and has too much unemployment. No one thinks this is a good thing. Indeed, at the IMF research conference last month, many economists expressed particular concern about the high youth unemployment rate in the U.S. and elsewhere and the negative implications of this for society.

They are right to be concerned. The question is what should be done.

One answer is given by two economists of different political stripes. They are Paul Krugman and Ken Rogoff. Krugman is clearly a liberal; he even uses that word in the title of his widely read New York Times blog – “The Conscience of a Liberal.” Rogoff’s politics are somewhat less clear; I heard him say at a seminar arranged as part of the program of the World Bank/IMF annual meetings in October that he was not political, just a scholar. However, he was an adviser to the John McCain presidential campaign in 2008.

Even though they have had disagreements, they both advocate that central banks in the current situation target a higher inflation rate than the current two percent. (For example, see here and here.)

The principal argument of some economists advocating a higher inflation target is that it is a way to achieve a negative real rate of interest (the nominal interest rate is lower than the inflation rate), given that the Fed cannot lower nominal interest rates below zero. They believe that a negative real interest rate is necessary to achieve full employment. Another reason, though this seems to be less explicitly argued, is that inflation encourages current consumption (and discourages savings). Consumers have an incentive to buy now before prices increase. The resulting increase in consumption stimulates the economy.

There are a few problems with these arguments. First, in the current period, the Federal Reserve does not seem capable of increasing inflation. It has increased its balance sheet and, hence, the monetary base to an unprecedented degree. This has not, though, translated into rapid growth of the money supply and the current inflation rate, as measured by the CPI, is less than 2 percent. (I have commented on this here, here, and here.) There is, though, concern about possible bubbles in stocks and bonds and in housing prices.

Second, assuming that the Fed could eventually produce four percent or higher inflation, the economists making the case for this seem to assume that there would not be a political reaction reflecting heightened concern among the public about the future value of their savings and their ability to generate earnings that keep up with inflation.¹ In this regard, it is interesting to note that in July 1971, the CPI had risen by 4.4 percent year over year. The next month, President Richard Nixon announced wage and price controls (as well as severing the last remaining link of the dollar to gold).

The public would be right to be concerned about inflation. Monetary policy is a blunt instrument, and it is doubtful that the Fed would be able to achieve a narrow target on the inflation rate for a substantial period of time. Higher inflation also can feed upon itself, as the aftermath of the Nixon’s Administration’s experiment with wage and price controls demonstrates. If this happens, ultimately the Fed would have to slam on the brakes and generate a recession, as Paul Volcker did when he was Fed chairman. Targeting inflation is not the same as targeting a short-term interest rate, such as the fed funds rate (the rate at which banks lend to each other on an unsecured basis). Inflation is only observable with a lag, and it takes some analysis and judgment to discern whether a higher or lower than expected monthly number is due to a temporary aberration or is indicative of something more permanent.

Finally, using fiscal policy is preferable and more likely to be effective than monetary policy to stimulate the economy in a prolonged period of sluggish growth (or worse). When the Fed increases the monetary base, it does not directly add to demand. If the money is lent out by the banks, the borrowers will spend or invest it. But what if the banks sit on a huge amount of excess reserves, as they are doing now? Then nothing much happens to the real economy except for whatever stimulatory effect there is from the increase in the prices of the assets the Fed has bought (Treasury notes and bonds and mortgage backed securities).

On the other hand, if the government spends money, this directly adds to demand. In this regard, there is a strong argument that the federal government should be investing in improving infrastructure, both because infrastructure, such as highways, bridges, public transportation systems, and water and sewer systems, need to be improved and because such projects will put people to work. Krugman and Rogoff agree on this, as does Martin Feldstein, who disagrees with the other two on monetary policy. Also, if the federal government finances this by increased borrowing rather than taxes, it can borrow very cheaply since interest rates are too low. The cost in inflation-adjusted terms may even be negative, if inflation turns out to be higher than the nominal rate at which Treasury borrowed.²

The rejoinder to this argument is that it is not currently politically possible to increase government expenditures in any significant way. That is true, which is why the Fed feels it has no choice but to follow an aggressive monetary policy. Janet Yellen apparently believes that regulatory tools can be used to contain any bubbles that may develop because of this before they cause too many problems. I hope she is right, but I understand why the Fed needs to run this risk when fiscal policy has been contractionary. It is a troubling fact that the current economic distress and uncertainty have given rise to a populism of the right that believes that shrinking government in the current situation will solve economic problems rather than prolong them. It is also troubling that there is a dearth of skilled and knowledgeable politicians who can lead the public to understand the right solutions. Instead, we have a faction of the Republican Party riding the Tea Party wave for opportunistic reasons, though it is doubtful that they will reap the political benefits they hope.

While I think the Fed has no good options other than following its current course, announcing an inflation target of 4 percent would be a mistake. The risks of doing that are, I believe, higher than Krugman and Rogoff appreciate. In any case, it is doubtful that it is politically possible. While the Fed is an independent agency and insulated from the political winds of the moment, it cannot totally ignore political reality.

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1. When I worked at Treasury, I was heavily involved in the discussions about and the development of Treasury inflation-indexed bonds (Treasury Inflation-Protected Securities or “TIPS”). One of the arguments made for Treasury issuing inflation-indexed bonds is that this would facilitate the private sector’s creation of other inflation-indexed products, such as inflation-indexed annuities or mortgages. There has not been much interest in other inflation-indexed products, except for mutual funds that invest in TIPS and, sometimes, physical commodities. Note, though, that, if there were greater use of inflation-indexed products, these instruments could have served to mitigate to a degree people’s fear of inflation, but at the same time they would also have acted to limit inflation’s ability to stimulate the economy.

 

2. Treasury does not match particular security issuances with particular expenditures. Therefore, as a practical matter, it is not possible to determine the borrowing costs for any particular expenditure without making some assumptions.

 

A Brief Note on “Printing Money” and the Monetary Base, M2, and Inflation

When it comes to monetary policy, the media is fixated on the Fed’s “printing money”* and the timing of any tapering of “quantitative easing.” Critics of the Fed assert that the Fed’s quantitative easing policies will lead to inflation. The simple argument is that the Fed’s policies will lead to too much money chasing too few goods, which will result in price increases.

In order to evaluate this argument, it is useful to remind ourselves of some basic facts. It is true that the Fed through its quantitative easing policies – purchasing Treasury notes and bonds and mortgage-backed securities – has been vastly increasing the size of its balance sheet to an unprecedented degree. This has resulted in a large increase in bank reserves and the monetary base (currency in circulation and balances of depository institutions held at Federal Reserve Banks). It has not, though, resulted in an unprecedented increase in the money supply. M2, which is a commonly used measure of the money supply, consists of currency held by the public, transaction deposits at depository institutions, savings deposits, time deposits of less than $100,000, and retail money market fund shares. (See here for the Fed’s description of these aggregates and links to monetary data.) Note that bank reserves, including excess reserves, are not included in M2.

What is important to note is that the relationship of changes in the monetary base, which the Fed controls, and changes in M2 has been completely transformed since the financial crisis. The monetary base also currently has no relationship to inflation as measured by the CPI. This graph shows on a monthly basis beginning in 2000 percentage changes from a year ago of M2, the monetary base, and the CPI.

 

 

Before claiming that Fed policy is leading to inflation, critics need to analyze the change in the relationship between the Fed’s expansion of its balance sheet and the growth rate of M2. They also need to examine the current lack of relationship between the monetary base and inflation.

What seems more plausible is that monetary policy has not been as effective as desired at stimulating the economy. There also is little effect of quantitative easing on increasing the growth rate of the money supply. There is a case to be made, though, that the quantitative easing policies have served to lower long-term interest rates, particularly on Treasuries and mortgage-backed securities, but to an unknown degree. This has perhaps fueled increases in stock market and housing prices, but it has not resulted in an increase in prices of consumer goods. There is reason to be concerned about asset bubbles at the current time, but the danger (or benefit) of inflation seems remote.

Some economists, such as Paul Krugman and Ken Rogoff, advocate Fed policies leading to an increase in inflation as a way to get the economy growing. Higher inflation can produce negative real interest rates, which some view as necessary to get the economy to full employment. At the moment, it would seem that the Fed would have to be much more aggressive than is currently feasible politically or practically to get the inflation rate at some economists’ preferred target of four percent. Of course, it may become possible at a later time, though it is subject to debate whether this would be good policy. At the moment, the greatest risk to the economy from current Fed policy is asset bubbles which inevitably deflate. The Fed’s greatest challenges are deciding how to meet its legislatively mandated goals of “stable prices” and “maximum employment” in a period when fiscal policy is far from helpful in stimulating the economy, when and how to phase out its quantitative easing policies, and how to avoid dangerous asset bubbles.    

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* The phrase “printing money” is misleading shorthand for what the Fed does. I prefer to call it “creating money.” The Treasury Department through its Bureau of Engraving and Printing prints money. The Federal Reserve pays the Treasury for the printing costs. How much the Federal Reserve orders of Federal Reserve notes is largely determined by the public’s demand for physical currency. Coins are minted by the Treasury’s Bureau of the Mint and sold at face value to the Fed. The difference between the face value of the coins and the cost to the Treasury of producing the coin enters into government accounts as a means of financing, i.e., it is not an outlay or a receipt and does not serve to increase or reduce the reported budget deficit. This is called seigniorage. In minting pennies and nickels, this seigniorage is a negative number.

The IMF’s Fourteenth Jacques Polak Annual Research Conference – Some Observations

Last week, the IMF held its annual research conference, which was open to members of the public who registered prior to the conference as guests. I attended the two-day conference and have a few observations.

One of the striking things about this conference was the concern about unemployment, especially long-term unemployment and youth unemployment. The worry is that these factors can cause long-term damage to the economy. One paper by three Federal Reserve Board staffers, including David Wilcox, Director of the Division of Research and Statistics and former Treasury Assistant Secretary for Economic Policy during the Clinton Administration, got particular attention in this regard. The paper – “Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy” – is technical but its conclusions after reporting on model simulations are not reassuring. It argues that the “natural rate of unemployment” has increased and that potential GDP decreased by 7% in the wake of the financial crisis. During the seminar, Wilcox indicated particular concern about unemployment. In his New York Times column, Paul Krugman, who gave the keynote speech at the conference, called this paper the “blockbuster” of the conference.

There was also consideration of what the government should do about an economy mired in a slower than desired recovery. Stanley Fischer (the former head of the Israeli Central Bank, the former deputy head of the IMF, and a renowned economics professor at MIT), who was the honoree of the conference, said that the next revision of his textbook will say that the “zero-bound” does not mean that monetary policy is done, since Bernanke has had some success with quantitative easing. Larry Summers and others indicated that QE has not been enough. The obvious implication is more aggressive fiscal policy, which was more clearly embraced by some speakers than others. I did not hear much deficit hand-wringing, though. Given its history, it is somewhat surprising to hear this at the IMF. It is nice to see people taking to heart the famous statement attributed, perhaps falsely, to Keynes that, when the facts change, he changed his mind.

The last session at the IMF conference included talks by Stanley Fisher and three of his former students – Ben Bernanke, Larry Summers, and Ken Rogoff. Summers' speech was particularly interesting and it was the most entertaining talk I've seen him give. He seemed less constrained in what he said since he is not currently a candidate for any public post. He got a laugh from the IMF staffers in the audience when he suggested that there be a key they could hit when preparing an IMF country report which would insert at the end a statement to the effect that, whatever was being proposed for the near-term, long-term financial prudence in government budgets was, of course, of the utmost importance (or something like that). 

An amusing aspect of the conference was that an author would discuss his or her paper and it would all sound perfectly reasonable. Then, sometimes, the discussant would declare that he or she found the paper very interesting and learned a lot from it. But then sometimes the discussant would next politely but effectively demolish the paper by saying that it was based on too many simplifying assumptions and did not take into consideration x, y, or z. The discussant would conclude by saying that the authors should come up with something akin to a unified field theory (okay, those are my words) on the particular issue they were working on. This would leave the audience on a barren plain, with no guidance about where to go or what to think.

What was missing during the conference was much discussion of the links between economic distress and political developments. I can understand why the Fed and the IMF would want to steer clear of any such discussion, but it remains the case that political developments can affect economic performance and economic performance can affect politics. Severe economic developments can spur groups both on the left and the right. Sometimes this can lead to disastrous consequences; sometimes these movements fizzle out. It depends both on the circumstances and the political culture of a particular country. In the U.S., the rise of the Tea Party is partly due to hard economic times. My guess is that this movement will eventually fizzle out. But how long can countries in the European "periphery" be subject to austerity measures and high unemployment without negative political ramifications? After all, some of these countries were dictatorships not that long ago.

Complicated econometric techniques would not be that useful in looking at the political dimension of hard economic times, and using these techniques, however unrealistic the assumptions sometimes have to be when using them, is what economists are now comfortable doing.

It would be good if economists and political scientists worked together on the feedback effects between economics and politics. Maybe some will, but the institutional separation between economics and political science departments seems to be a high barrier.

Some Recent Articles Criticizing the Affordable Care Act

Critics of the Affordable Care Act are having a field day. Reasons include the well-publicized problems of the federal website for those shopping for health insurance under the ACA, the cancellation of existing insurance plans for some who acquired insurance as individuals, and the President’s false assurances that everybody could keep their existing plans if they “liked” them.. Some of the criticism I have run across comes from well-off, self-employed people; some is purely motivated by politics; and some make come from conservative analysts making valid criticisms and sometimes constructive suggestions.

An example of an unhappy well-off person is Lori Gottlieb, a Los Angeles marriage and family therapist and writer. This past Sunday the print edition of the New York Times published her article on her health insurance travails – “Daring to Complain About Obamacare.” She has two major complaints. First, she thinks the premium increase of $5400 a year over what she had been paying for her canceled plan by for a new plan offered by her insurance company, Anthem Blue Cross, is too much. Her second complaint is the lack of sympathy from her Facebook “friends” when she complained about this on her FB page. The problem with the first complaint is that she apparently has not done any research on what other plans might be available to her. She incidentally would not be dealing with the federal website but the California one, since California has set up its own exchange. Also, she does not mention that her out of pocket costs will be less than any premium increase, since as a self-employed person she can deduct the cost of health insurance as a business expense. The second complaint is pure whining from a person who probably has a relatively high income. Nevertheless, it is true that, if all she knew about the ACA was what the President said, she is right to complain that she was misled. (I would point out that anyone who thought about it had to know that the President’s assurances could not be taken at face value, since insurance companies can always change their plans, cancel policies, raise premiums, and change the membership of its network of providers. More criticism of Gottleib’s article from the progressive left can be found here.)

Today, the Administration bowed to the intense political pressure and announced that it will allow non-compliant plans to continue offering the plans to existing customers throughout 2014. This should please Gottleib.  However, it is not clear how this will work. We will see if private insurance companies and state regulators go along. The new policy does raise an adverse selection issue, which could affect the risk pools on the exchanges. On the other hand, many in the individual insurance market eligible for subsidies may find that to be the cheaper and better option.

Keith Hennessey, who was Director of the National Economic Council in the George W. Bush Administration, has posted on his blog three articles expressing his outrage at the President Obama’s “lies.” He even went so far as to create a flow chart about this. To me, these posts are purely political, but they probably do not accomplish much since most visitors to his blog, except for a few like me, are already convinced that the Obama Administration is terrible at economic policy. His posts are examples of what Ana Marie Cox (founder of and former Wonkette, now serious Guardian columnist) calls “faux outrage.” Unfortunately, Hennessey does not seem interested in making constructive suggestions. (Incidentally, Hennessey’s making unfavorable comparisons between the current Administration and the one he worked for regarding their relative propensities to mislead is a bit rich, even if the major issues in this regard in the Bush Administration did not fall under his bailiwick. In the future, he might want to proceed more cautiously on this topic.)

In the remarkably stupid category of criticism of the ACA is an article by someone who should know better, Edward Lezear, who was Chairman of the Council of Economic Advisers in the George W. Bush Administration – “President Obama, is a 'substandard' health plan really substandard?” In this article, Professor Lezear compares existing insurance plans to the base Ford Focus he chose to buy when he worked for the White House. Even putting aside that cars and health insurance plans are hardly the same thing, would he really want to drive a car that did not meet the minimal safety standards required by the federal government and not be subject to recall if problems develop? Consumers do want government standards when it comes to cars. That is probably enough said about this article, which, as it appears on the Fox News website, is another example of preaching to the choir.

James Capretta, who was an Associate Director of OMB in the first term of the George W. Bush Administration and is clearly no friend of the Obama Administration, recently wrote an article critical of the ACA website issues – “It's Already Too Late to Avoid the Train Wreck.” Capretta uses stronger language than necessary when he writes this at the end of his article that “[t]he Obama administration is in a very dangerous place.” This detracts from the valid point Capretta makes about the website problems. He argues that, even if the website problems are fixed by the end of November, this only gives people about two weeks to sign up for coverage by January 1 (the deadline is December 15.) This may cause problems for both the website and the people having to decide what plan to sign up for and filling out the necessary website forms. That is a genuine concern. The Administration does need to be thinking about contingency plans if the first two weeks of December become a logistical nightmare.

Finally, writing for the Real Clear Politics website, Robert Pollock, who used to be an editor of the opinion pages of the Wall Street Journal makes a suggestion worth considering (“Fixing Obamacare: The Federal Charter Solution”). He suggests that it would greatly simplify the regulatory situation for health insurance plans if there was an option for them to get a federal charter. Health insurance plans that opted for the federal charter would then not be subject to a maze of different regulatory requirements in the 50 states (and, I would add, in the District of Columbia and potentially other places, such as Puerto Rico). This would be similar to the federal charter that is available to commercial banks which choose to be supervised by the Office of the Comptroller of the Currency. It is also similar to the private health insurance plans made available to federal employees and retirees under the Federal Employee Health Benefits Program. These plans are subject to regulations of and overseen by the Office of Personnel Management, a federal government agency, and not by state regulatory authorities. I have not seen any discussion of this issue in the ACA context, but I think Mr. Pollock has made a constructive suggestion, though one that may be politically difficult to implement because of possible strenuous opposition by state governments.  

Republicans Disappoint on Health Care: Excessive Negativity, No Constructive Proposals, and Bad Politics

The reactions to the problems with the website for the health insurance “exchanges” or “marketplaces” set up by the federal government for the majority of states which decided not to set it up for themselves are not surprising. (The websites for the marketplaces set up by states and the District of Columbia are, according to press reports, operating much better than the federal website.) The Democrats are very concerned and worried; some are quite critical of the Administration; and they want this fixed as soon as possible. The Republicans are saying that the problems with the website are evidence for their contention that the Affordable Care Act (“Obamacare,” though I will refer to the law as “ACA,” which is a less politically charged term) is way too complicated, that the Administration is incompetent, and that the law will collapse of its own weight because the financing is based on too rosy assumptions and because the ACA is an inherently flawed restructuring of the U.S. health care system. Some go further and use the website’s problem to rift on the failure of liberalism or, in a remarkably stupid article, “progressive government.”

The Democrats’ reactions are natural and understandable. I will focus in this post on the Republican’s reactions and attacks on the ACA and argue that they are disappointing, demonstrate a bankruptcy in policy ideas and proposals, and, unless most everything goes terribly wrong with the ACA over the coming year, are not helpful to the Republicans politically. Republicans should be offering creative ideas to improve the U.S. health care system while preserving the role of private insurance companies. It is interesting in this regard that the current complexity charge the Republicans throw at the ACA help make the case for a single-payer system (essentially some form of Medicare for everybody), which some Democrats would prefer. In other words, Republicans should be wary of an ACA failure, since this would increase the probability that the U.S. will eventually adopt a single-payer system. What the Republican attack on the ACA fails to take into account is that the health care system in the U.S. prior to the law’s enactment was unsustainable. The U.S. was (and is) paying more per capita on health care than other industrialized countries, while not covering everybody and achieving poorer public health results. In addition, though it has come down recently, health care inflation has been too high and an aging population means more demands on the U.S. health care system. While one can criticize the ACA – it is far from perfect – the status quo ante is not an option, but many Republican are giving the impression that this is what they want. One who does not is Michael Gerson, but the sketchy idea he proposes, health insurance vouchers for everyone, is far from a fully thought-out proposal.

The ACA can be fairly attacked for not doing enough to contain the cost of health care. Republicans who do that use this to make the case that the ACA is too expensive, and, therefore, should be repealed. They do not offer proposals about what to do about the cost of health care and it is far from transparent pricing practices (for example, see Steven Brill’s long March 4, 2013, Time article, “Bitter Pill, Why Medical Bills are Killing Us”).

Perhaps Republicans think that market competition alone will solve this, but it did not under the health care system existing prior to enactment of the ACA. Further, they fail to acknowledge that part of the reason for the excessive cost of health care in the U.S. is the much higher administrative costs here than in other countries. Part of this is due to the overly complex billing system and the need for health care providers to deal with multiple insurance companies and policies with different coverages and allowances. Some standardization among insurance companies and policies might help in reducing administrative costs.

Another blind spot of Republican is that they seem to worry about costs only when it is the government that is footing the bill. However, excessive health care costs are a problem whether it is paid for by private insurance and patients or is paid for partly or completely by the government. Even if one does not believe that affordable basic health care should be something a country as rich as the U.S. should provide all its citizens one way or another, one needs to concede that excessive spending on health care is not conducive to a well-functioning economy. Society as a whole is paying the health care bill, regardless of government involvement. 

Also, it is clear that there is no perfect health care system and that there will always be complaints. For example, after World War II, the government of Clement Attlee set up a health care system in Britain which is probably the most socialist of the major industrial countries. I took the opportunity while traveling in England a few years ago of asking people what they thought of the National Health Service. Though the people I talked to were hardly a representative sample, I received a variety of responses ranging from highly positive to quite critical. (For those with the means, there is option of paying for supplemental private health insurance, which apparently can mean less waiting time to see doctors.) However, that the country as a whole is proud of the NHS was made evident during the opening ceremony of the 2012 London Olympics, in which it was featured.

Now, the NHS is not a model for the U.S.; it is not compatible with our political culture. There are other options. While no option will please everybody, it is necessary for the U.S. health care system to be fixed, both to be true to our values of compassion and fairness and to mitigate a growing burden on the economy.

While today’s Republican Party gives the impression, sometimes explicitly and sometimes implicitly, that they do not consider compassion and fairness as appropriate goals of government, it is somewhat surprising that the party seemingly does want to address the economic implications of increasing health care costs, especially if this means more government involvement. In fact, some in the party are desirous of making Medicare less generous because of its costs, but reducing Medicare expenditures by raising the age of eligibility may not reduce total health care expenditures. In fact, it may increase them because Medicare apparently has been better at keeping the prices in pays health care providers in check than private insurance companies. Republicans should not ignore that excessive spending on health care by society as a whole is excessive spending on health care, no matter who, in the first instance, is doing the spending or how it is financed.

There is a consensus that the House Republicans made a mistake by adopting the strategy of its Tea Party faction in shutting down the government and threatening a government default if they did not get their way in defunding or delaying provisions of the ACA. While there is less of a consensus on the current Republican strategy of attacking the ACA, the persistent negativity is also a political mistake. Michael Gerson is right about that. Now that the Obama Administration and Congress have used ideas, including the individual mandate, originating in conservative think tanks and implemented in Massachusetts with the support of then Governor Mitt Romney, the Republicans are not advancing any proposals to fix the health care system. They are apparently betting on the ACA’s collapse as a way to win back the Presidency and both houses of Congress. Even with the website problems, that is likely to prove to be a bad bet. Some important aspects of the ACA, for example, those involving pre-existing conditions and increasing the age for which young people are eligible to be covered on their parents’ insurances are popular. No doubt the insurance subsidies to those who qualify will also be popular. And, as pointed out in the New Yorker, contrary to Republican claims, the ACA in fact benefits many small businesses by lowering their health insurance costs and promotes entrepreneurship, since leaving a job to start a small business does not mean losing access to affordable health insurance. Republicans should favor that.

When I worked at Treasury, some of the political appointees there would sometimes cryptically say that you can’t beat something with nothing. As a purely political matter, the Republicans should develop sensible health care proposals that they can sell. Being in favor of the status quo ante is both bad policy and bad politics. Perhaps due to their frustrations and their internal problems, that seems to be the Republican position. A political strategy which can only possibly succeed if there is a near-term collapse of the ACA, and maybe not even then, is symptomatic of larger problems the Republicans have in defining themselves in a way palatable to the American electorate.

Debt Limit/Government Shutdown and the Annual Meetings of the World Bank/IMF

Beginning this Friday, October 11 and through the weekend, the World Bank and the IMF will be holding their annual meetings in Washington, DC. This is a very large event, and, in addition to government officials from around the world, a large group of private sector bankers and other individuals employed in the financial sector will be attending various meetings, conferences, and seminars in Washington. The World Bank/IMF will be offering seminars beginning tomorrow, October 8, to participants, press, and guests. Some large banks and other private organizations will hold their own events, including the Institute of International Finance.

It is likely that many of those present will be talking among themselves and some publicly about the government shutdown and the potential for a U.S. government default. While the financial and government types who will be in Washington have many disagreements, including the appropriate response of governments to economies mired in slow growth or recession, the outlook for the euro, the advisability of increased financial regulation, bank capital requirements, etc., almost all of them will agree that a U.S. government default on its debt could well be catastrophic for the world economy. The press will likely take note as this critical mass of well-informed commentators and market participants make their views known. The pressure on Speaker Boehner and the House Republicans will increase.

Larry Summers, Stephen Leacock, and Women

Below is a letter to Mr. Stephen Leacock, a Canadian writer, humorist, and academic, who died in 1944.

Dear Mr. Leacock:

Recently, I had the pleasure of reading your 1922 book, My Discovery of England. As it would no doubt not surprise you, I found it amusing, even though some of it is a bit dated from my vantage point in the early 21st century.

Your book does not strictly limit itself to England but makes room for some of your favorite notions. You might have wanted to constrain yourself on some of these, especially if you cared to appeal to readers some ninety years in the future, about whom, though, you probably did not give much thought. But your passages on the aptitudes and appropriate education of women, which begin as a criticism of Oxford University’s policy of admitting women but quickly become more general, are really over the top.

I should point out in this connection that an American, Mr. Lawrence H. Summers, currently very much alive and a sometimes academic, found himself in a heap of trouble when he made remarks more than eight years ago about the underrepresentation of women in the science and engineering professions. He was at the time President of Harvard University, but found his tenure in that position cut short the following year, owing in part to these remarks. Mr. Summers is an economist and is hoping to become head of the U.S. central bank, but his remarks on women in the sciences are still remembered, especially by those who would prefer someone else for the job.

While you apparently did not harbor ambitions to be head of the Bank of Canada, content with your career as a famous humorist, writer, and professor of Political Economy and Chair of the Department of Economics and Political Science at McGill University, there is some superficial similarity between you and Mr. Summers. I would not want to stretch it too far. Your sense of humor – I think it would not insult Mr. Summers to say – is vastly different and more developed than his. I do believe, though, that you both rightly share a high regard for your own abilities.

Further, I suppose 1922 was a much different time than 2005 when Mr. Summers made his remarks, in particular with respect to what we now call “political correctness.” Still, your remarks about women, which go way beyond anything Mr. Summers said, have the ability to grate.

For his part, Mr. Summers hypothesized that the curve representing the distribution of native abilities in the hard sciences is somewhat fatter at the very high end for men than for women. He did not say that the average women had less ability than the average man. He makes clear that he is “talking about people who are three and a half, four standard deviations above the mean in the one in 5,000, one in 10,000 class. Even small differences in the standard deviation will translate into very large differences in the available pool…” Now whether or not there are such differences in the far-out tails of the distributions of certain intellectual abilities between the populations of men and women is highly debatable, as Mr. Summers was quickly made to realize. He even seemed to have an inkling he was headed for trouble. From the transcript of the event, at the conclusion of Mr. Summers’ remarks, there was this exchange between him and the moderator:

Q: Well, I don't want to take up much time because I know other people have questions, so, first of all I'd like to say thank you for your input. It's very interesting – I noticed it's being recorded so I hope that we'll be able to have a copy of it. That would be nice.

LHS: We'll see. (LAUGHTER)

But Mr. Leacock, in your book, you are talking about averages, not far-out tails. In fact, you dismiss the exceptional woman as irrelevant. Let me quote you:

The fundamental trouble is that men and women are different creatures, with different minds and different aptitudes and different paths in life. There is no need to raise here the question of which is superior and which is inferior (though I think, the Lord help me, I know the answer to that too). The point lies in the fact that they are different.

But the mad passion for equality has masked this obvious fact. When women began to demand, quite rightly, a share in higher education, they took for granted that they wanted the same curriculum as the men. They never stopped to ask whether their aptitudes were not in various directions higher and better than those of the men, and whether it might not be better for their sex to cultivate the things which were best suited to their minds. Let me be more explicit. In all that goes with physical and mathematical science, women, on the average, are far below the standard of men. There are, of course, exceptions. But they prove nothing. It is no use to quote to me the case of some brilliant girl who stood first in physics at Cornell. That's nothing. There is an elephant in the zoo that can count up to ten, yet I refuse to reckon myself his inferior.

And you keep on going, digging a deeper hole for yourself, at least as far as posterity is concerned:

The careers of the men and women who go to college together are necessarily different, and the preparation is all aimed at the man's career. The men are going to be lawyers, doctors, engineers, business men, and politicians. And the women are not.

There is no use pretending about it. It may sound an awful thing to say, but the women are going to be married. That is, and always has been, their career; and, what is more, they know it; and even at college, while they are studying algebra and political economy, they have their eye on it sideways all the time. The plain fact is that, after a girl has spent four years of her time and a great deal of her parents' money in equipping herself for a career that she is never going to have, the wretched creature goes and gets married, and in a few years she has forgotten which is the hypotenuse of a right-angled triangle, and she doesn't care. She has much better things to think of.

Mr. Summers also addressed this issue, but in a somewhat different way, and does not draw your conclusion that there should therefore be a difference in the curriculum offered to men and to women. Here is part of what he said:

…I've had the opportunity to discuss questions like this with chief executive officers at major corporations, the managing partners of large law firms, the directors of prominent teaching hospitals, and with the leaders of other prominent professional service organizations, as well as with colleagues in higher education. In all of those groups, the story is fundamentally the same. Twenty or twenty-five years ago, we started to see very substantial increases in the number of women who were in graduate school in this field. Now the people who went to graduate school when that started are forty, forty-five, fifty years old. If you look at the top cohort in our activity, it is not only nothing like fifty-fifty, it is nothing like what we thought it was when we started having a third of the women, a third of the law school class being female, twenty or twenty-five years ago. And the relatively few women who are in the highest ranking places are disproportionately either unmarried or without children, with the emphasis differing depending on just who you talk to. And that is a reality that is present and that one has exactly the same conversation in almost any high-powered profession. What does one make of that? I think it is hard-and again, I am speaking completely descriptively and non-normatively-to say that there are many professions and many activities, and the most prestigious activities in our society expect of people who are going to rise to leadership positions in their forties near total commitments to their work. They expect a large number of hours in the office, they expect a flexibility of schedules to respond to contingency, they expect a continuity of effort through the life cycle, and they expect – and this is harder to measure – but they expect that the mind is always working on the problems that are in the job, even when the job is not taking place…

Part of the difference, of course, is that Mr. Summers is speaking about the people who get to the top of their professions and you are talking about averages. But you really get into trouble when you discuss what is most appropriate for women. What were you thinking? If you were around today, you would have noticed great changes in the role of women in society. You would not have lasted, much less reached, the pinnacle of the Department of Economics and Political Science at McGill University if you were still writing such things. Fortunately, for this book, the issue of women suffrage for federal elections in Canada had already been settled, though women had to wait until 1940 to vote in Quebec provincial elections. You wisely forgo discussion of this issue, though you are said to have opposed women suffrage.

Nonetheless, I did enjoy your book, filled as it with wry and pointed observations. Your political outlook could probably be characterized as socially and economically conservative, sprinkled with some libertarianism. While I would agree with your attitude towards prohibition, some of the other things you propound as obvious may seem less so to many of us today. Your aversion to government intervention of interference in the economy (“bring back the profiteer”) is a case in point. Perhaps, as you experienced the 1930s, your ideas about the proper role of government in the economy evolved. Not being an expert on the evolution of your ideas, I do not know.

Also, I daresay, you seem to have the notion that societies are fixed. It is this view of a static society that seems to cramp your imagination. Philosophical conservatives have a point when they say that much of human nature is fixed, but this inclines them too much toward a pessimistic and fatalistic view.  Societies are dynamic. We can debate whether the American civil rights leader of the mid twentieth century, Dr. Martin Luther King, Jr., was mostly correct when he said (the statement may not have been original): “The arc of the moral universe is long, but it bends toward justice.” But what is irrefutable is that societies are dynamic, and what seemed impossible at one point in time may become considered normal at some future point. Sometimes it does not even take that long. Look at the evolution of attitudes toward same-sex marriage in many western industrial countries.

It is, though, your views on women which are the most shocking. They marred the otherwise enjoyable experience of reading your book.

                                                                        Sincerely yours,

                                                                        Norman Carleton                                                                                         

CFTC Investigating Goldman’s Aluminum Warehouse Practices

According to news reports, the CFTC is currently investigating allegations that Goldman Sachs has been manipulating the price of aluminum by releasing it too slowly from warehouses it owns through a subsidiary. The CFTC will probably develop a fuller story of what did or did not happen than was contained in the original New York Times article on this subject, which I criticized. This is clearly something the CFTC should investigate.

A Brief Note on Possible Abuses of NSA Information

When I posted some comments on the NSA in July, I was worried about potential abuses of NSA information in the future. I was unaware of any current abuses. On August 7, though, Reuters published an article that reports on possible misuse of NSA information by the Drug Enforcement Administration (“DEA”) and the IRS.  Apparently, there was an IRS manual that was used to train law enforcement agents “to ‘recreate’ the investigative trail to effectively cover up where the information originated [the NSA], a practice that some experts say violates a defendant's Constitutional right to a fair trial.”  According to the article, the origin of the initial information was concealed “not only from defense lawyers but also sometimes from prosecutors and judges.”

Probably any law enforcement agents engaged in this practice justified it to themselves because it helped in their fight against bad guys. But it is not the way law enforcement is supposed to work.

The Senate Banking Subcommittee Hearing on Commodity Activities of Financial Holding Companies (July 23, 2013)

In my previous post, I discussed the problems with a New York Times article on aluminum that seemed timed to precede by a couple of days a hearing held by a subcommittee of the Senate Banking Committee on the permissible activities of financial holding companies. The hearing focused on whether these companies should be permitted to own affiliates involved in such activities as storing physical commodities or generating electricity. The hearing itself did not produce any insights into the aluminum issue but it did usefully shed light on the legal and regulatory developments that resulted in some financial holding companies, notably J.P. Morgan Chase and Goldman Sachs, being in these businesses.

Three witnesses at the hearing argued that financial holding companies involvement in these types of activities should either be prohibited or sharply curtailed: Tim Weiner of MillerCoors, Joshua Rosner of Graham Fisher & Co., and Saule Omarova, an associate law professor at the University of North Carolina at Chapel Hill. Joshua Rosner is the coauthor of Reckless Endangerment, a book I criticized in this blog post. I know Saule Omarova slightly. She was a senior adviser to Randall Quarles when he was Treasury Under Secretary for Domestic Finance in the George W. Bush Administration. I do not know her party affiliation, if any, but many Republicans who follow these issues likely disagree with her forcefully presented and strong opinions on the issues discussed at the hearing.

One witness, Randall D. Guynn, a partner and head of the Financial Institutions Group at the law firm, Davis Polk & Wardwell, argued that no changes needed to be made to curtail financial holding companies activities with respect to physical commodities or electric power generation. Interestingly, both Randall Quarles and Saule Omarova have also worked at Davis Polk. Quarles was at one point the co-head of the Financial Institutions Group.

In his testimony, Mr. Weiner implies that MillerCoors purchases and obtains aluminum through the LME market. However, he does not say that MillerCoors obtains the bulk of the aluminum it uses in this manner. Given the delays he claims, up to 18 months for “aluminum users like MillerCoors,” this is doubtful. There does not appear to be any shortage of beverages in aluminum cans available for purchase by American beverage drinkers. What is most likely is that companies needing aluminum obtain it directly from the companies that produce it. What MillerCoors is apparently upset about, as mentioned in my previous post, is the increase in the “premium” they have to pay. The reason for that remains unclear. Unfortunately, none of the Senators at the hearing questioned Weiner on these issues.

Whether Goldman was deliberately manipulating the aluminum market by its warehouse practices, though, is a separate issue from whether financial holding companies should be in this business at all. Saule Omarova in her testimony and a draft law article she cites in her written statement provides interesting background to the legal development resulting in permitting financial holding companies into the physical commodity business. I also agree with her that financial holding companies should not be permitted to do this. They have conflicts of interest and financial advantages provided by the federal government that argue strongly for limiting what lines of business are permissible for these companies.

“Shuffle of Aluminum” – A Disappointing Investigative Article in the New York Times

On July 20, the New York Times posted an article on its website, “A Shuffle of Aluminum, but to Banks, Pure Gold,” which appeared on the front page of the Sunday edition the next day. The article’s thesis is that Goldman Sachs, through a subsidiary, Metro International, has been keeping the price of aluminum artificially high and collecting unjustified storage fees. The article alleges that they do this by being excessively slow in delivering aluminum out of warehouses designated as good delivery points for aluminum futures trading on the London Metal Exchange (“LME”). Also, the article maintains that Metro shuffles aluminum among around different warehouses in Detroit in order to satisfy LME rule requirement regarding minimum deliveries of aluminum out of approved warehouses.

The article attracted a good deal of attention, especially among those who distrust or have a professional interest in disparaging Wall Street. It was timed to precede by a couple of days a hearing before a subcommittee of the Senate Committee on Banking, Housing, and Urban Affairs focusing on whether financial holding companies, such as Goldman, should be in the physical commodity business at all. There is also now a private lawsuit against Goldman and the LME charging them with antitrust violations by limiting the amount of aluminum available and keeping the price artificially high.

I am not an expert on the aluminum market and do not know whether the allegations against Goldman and the LME have any merit. However, while the Daily Show made fun of those who found the New York Times article confusing, the New York Times article was badly written and, in my view, not ready to print. While the reporter, David Kocieniewski, is on to something, he did not fully explore the issue.

One problem with the article is that the story of a “merry-go-round of metal” appears to be based on interviews with forklift drivers. They are certainly worth talking to, but the reporter did not apparently see or ask for the documentation behind the movements, nor did he obtain an explanation from either Metro or Goldman. In its reply to the article, Goldman states that “it is the owners of the metal who direct warehouse operators to dispose of stored metal or transport metal from LME-approved warehouses to warehouses outside the LME system to meet their own needs or objectives.” Kocieniewski should have explored this issue.  

The article also does not address how the major purchasers of aluminum obtain the metal. It suggests that they buy it on the LME futures markets and stand for delivery. Futures markets, though, are usually used for hedging and speculation, not as marketplaces used to obtain a physical commodity. Some contracts, of course, culminate in delivery, but the amounts are usually not that significant. The reason for a delivery option is that the potential for or threat of delivery ensures that prices in the cash and futures markets converge at the time that the futures contract matures.

Another problem with the article is that it does not discuss the reason aluminum in storage has increased. On this point, Mr. Charles Li, the CEO of HKEx, the Hong Kong firm that now owns the LME, argues that aluminum producers did not cut production and that the global slowdown in the world economy led to reduced demand. The futures markets started pricing aluminum too high relative to the spot price; that is, the cost of aluminum in the cash market plus the cost of carry (storage, interest, and insurance) is lower than the futures market price. This occurred in a situation where the cost of carry had decrease because interest rates had fallen. In such a situation, the obvious arbitrage is to buy the physical aluminum, put it (or keep it) in storage, and sell an equal amount on the futures market. This effectively locks in a profit, though it is not entirely riskless. The risk to this position is that the short position on the futures market may require variation margin payments if the price of aluminum increases (the loss on the short position is offset by a gain in the market value of the physical aluminum, but that does not bring in cash until the position is sold).

Theoretically, this arbitrage should continue until the futures price equals the spot price plus the cost of carry by raising the spot price and lowering the futures price. The arbitrage also has the effect of locking up some aluminum in storage, and it is owned for a time by arbitrageurs who never intend to use the metal for any industrial purpose.

Goldman, in its rebuttal to the Times article claims, however, that “approximately 95 percent of the aluminum that is used in manufacturing is sourced from producers and dealers outside of the LME warehouse system,” and that “aluminum stored in Metro warehouses amounts to approximately 1.5 million tonnes, compared with global aluminum production in 2012 of about 48 million tonnes.” The Times article should have incorporated a discussion of the sources of aluminum to users and addressed the contention that there is no shortage of aluminum to those who want it.

A point on which both Mr. Li and the Times article agree is that there has been an increase in the “premiums” purchasers of physical aluminum have to pay over the spot price due to the warehouse delays. It is not clear why large companies, such as MillerCoors or Coca-Cola, do not have the ability to strike a more favorable deal on premiums with companies such as Alcoa. There is probably an explanation, but the Times article does not provide it.

Another omission from the Times article, particularly significant due to its timing preceding the Congressional hearing on permissible businesses for financial holding companies, is the apparent intent of Goldman and J.P. Morgan Chase to exit the metal warehouse business. The Financial Times reported on July 14, i.e., before the New York Times article appeared, that these two firms “are seeking to sell their metal warehousing units just three years after their controversial entry to the industry, even as a proposed rule change by the London Metal Exchange is likely to reduce the attractiveness of the business.” The New York Times could have usefully mentioned this.

While one can understand that the Times wanted to publish this article before the Congressional hearings, not all the necessary reporting had been done. The news editors should have insisted that the reporter develop more information. Somewhat surprisingly, the editors of the editorial pages wrote an editorial on this subject that was better than the news article. You can read it here.

Some Reactions to Edward Snowden’s NSA Disclosures

Current news stories about the National Security Agency reminded me of a book I read in the early 1980s: James Bamford’s first book on the NSA, The Puzzle Palace: America’s Most Secret Agency (Houghton Mifflin, 1982). At that time, the NSA was not well-known, and, for me, the book revealed capabilities of the U.S. Government and a history about their use of which I had been unaware. My reaction at the time was that the NSA could become a very powerful tool for nefarious purposes if unethical, power-hungry people were to become in charge of the Executive Branch.

Recently, I read an interesting book, Subversives: The FBI’s War on Student Radicals, and Reagan’s Rise toPower (Farrar, Straus and Giroux, 2012), which focuses on the FBI’s relationship with Ronald Reagan while he was in the movie industry as an actor and union leader and then as governor of California unhappy with and fighting developments at the University of California at Berkeley. Amazingly, it took the author, Seth Rosenfeld, a former San Francisco newspaper reporter, decades, beginning in the early 1980’s with multiple lawsuits using the Freedom of Information Act, to pry from the FBI the documents on which the book is based, even though J. Edgar Hoover has been long gone. The book’s title, of course, is ambiguous. Who were the real subversives?

When it comes to the current NSA revelations, defenders and apologists for what the NSA does and the legal framework it operates under can point to Hoover and say what matters are the people, not the technology. After all, Hoover was able to trample on civil liberties and retain power by gathering compromising information on key political players without today’s super computers and near limitless digital storage capacity. In a sense, they have a point; there is no evidence of which I am aware that the NSA has been used to attack domestic political opponents.

It is, though, a limited point. The defenders and apologists miss some reasons for the current concerns, including the innate conservatism of bureaucracies and the temptations of the surveillance apparatus which these bureaucracies will mightily defend. Does anyone doubt that, upon a new Administration entering office, the intelligence community, including the NSA, would be endeavoring to convince their new political masters of the vital role that they play and that their way of doing things, at least for the most part, is essential? They probably make an effective case.

What then are the concerns?

First, it is not difficult to imagine an Administration, faced with some difficult problem, bending the law, maybe just a little, in order to achieve something they believe to be crucial. The problem is that once one goes down that path, it is perhaps easier to justify the next venture going into an area colored by a deeper shade of grey. And, since it is all done in secrecy, there is no need to worry about the media or public comment (as long as leaks do not occur).

Second, the notion of a FISA court approving programs in secret, creating a classified body of law, and doing this without the traditional adversarial procedures that are a key element of our judicial tradition is both laughable and disturbing. Even granting the need to preserve operational secrecy, the development of secret judge-made law is contrary to what most of us thought the American political system stood for.

Third, American history is replete with examples of civil liberties being eroded, if not just completely obliterated, during times of fear. Examples include the Palmer Raids (1919-1920) during the Red Scare of the early 20^th century, the internment of Japanese-Americans on the west coast during World War II, and the excesses of the McCarthy period. Past excesses have eventually been corrected after doing substantial damage to people’s lives, but they have gone quite far before being pulled back. Now we have the rise of the surveillance state, currently justified by the specter of terrorism since 2001.    

Fourth, the collection of information for one purpose easily leads to other uses. Someone will think that information collected for a particular purpose, e.g., protecting against terrorism threats, should be used for some other purpose. Pick your favorite cause: combatting drug trafficking, fighting corporate crime, gathering information on “subversives,” etc.

Finally, it is worrying, not reassuring, that some other governments, such as those of the UK and France, have active surveillance programs. While one might argue, as some have, that French protestations about the NSA are hypocritical, that observation is not dispositive of the concerns.

While intelligence agencies of allies may not always cooperate, since national interests diverge, it seems likely that they also share surveillance information with one another. In some cases, the particular shared information may not be legal according to domestic law for the agency receiving it to collect itself. However, it may not be illegal for the agency to receive it from another government and to use it and store it. In fact, Mr. Bamford in his 1982 book writes about the 1978 FISA law in this regard that the NSA had “skillfully excluded from the coverage of the FISA statute as well as the surveillance court all interceptions received from the British GCHQ or any other non-NSA source. Thus it is possible for GCHQ to monitor the necessary domestic or foreign circuits of interest and pass them on to NSA through the UKUSA Agreement. Once they were received, NSA could process the communications through its own computers and analysts, targeting and watch-listing Americans with impunity, since the action would not be covered under the FIS statute or any other law” (pp. 372-373). (I have not researched any changes to the law since this was written. It may not even be possible to ascertain what the law on this is now, given the secrecy surrounding judicial interpretations.)

At the end of his book, Subversives, Seth Rosenfeld writes:

“On the morning of May 2, 1972, J. Edgar Hoover was found dead on the floor of his bedroom. Helen Gandy, his longtime secretary, quickly executed one of his final orders: to destroy his personal office files.

“Thirty-five file cabinet drawers full of records were removed from his office and shredded. Gandy would later testify that none of them involved bureau business, that they were all private. But some documents survived, having been transferred to other files. They concerned illegal black bag jobs and other highly sensitive matters…”

Of course, the collection of massive computer records cannot be managed nor destroyed by one secretary, nor is it reliant on one official answerable only to himself. Recent polling results suggest that public attitudes concerning the perceived tradeoff between civil liberties and security may be changing. There is both domestic and international pressure for governments to let their publics know more about what they are doing. Preserving civil liberties requires constant vigilance; unchecked, there are great temptations for governments to erode these liberties, even if this does not begin with malicious intent.

What Does John Makin Believe?

I was interested to read recently at the Huffington Post that John Makin, an economist at the American Enterprise Institute (“AEI”), a conservative Washington, DC think tank, had recently written that the U.S. was already on a deficit reduction path and that there should not be more deficit reduction at the current time. Of course, liberals like this message coming from a conservative, but, if one reads Makin’s paper, there is much in it for liberals to dislike. The paper does not appear, though, to be aimed at convincing liberals. It is aimed at a different audience.

Before turning to this recent paper, I note that Paul Krugman once praised John Makin in a post about an article Makin had written in 2010. The title of Krugman’s post was “John Makin’s Hair Is On Fire.”  Krugman wrote that even though Makin is a political conservative at a “right-wing think tank,” he had written “something I or Jan Hatzius (Goldman’s chief economist — never mind the Blankfein stuff, the econ group is very good, and very pessimistic) might have written. Except Makin is even more gloomy, warning that we might enter deflation this year.” 

The article to which Krugman was referring is a July 2010 Economic Outlook piece called “The Rising Threat of Deflation.”  It is worth reading, and it certainly does not toe the line that austerity (“fiscal consolidation”) is a good idea.  At the end of the article, Makin writes:

“The G20's shift toward rapid, global fiscal consolidation--a halving of deficits by 2013--threatens a public sector, Keynesian ‘paradox of thrift’ whereby because all governments are simultaneously tightening fiscal policy, growth is cut so much that revenues collapse and budget deficits actually rise. The underlying hope or expectation that easier money, a weaker currency, and higher exports can somehow compensate for the negative impact on growth from rapid, global fiscal consolidation cannot be realized everywhere at once. The combination of tighter fiscal policy, easy money, and a weaker currency, which can work for a small open economy, cannot work for the global economy.

“The link between volatile financial conditions and the real economy has been powerfully underscored by the events since mid-2007. Growth has suffered and subsequently recovered given powerful monetary and fiscal stimulus. And yet, the damaged financial sector, unable to supply credit; a jump in the precautionary demand for cash; and a persistent overhang of global production capacity have combined to leave deflation pressure intact. The G20's newfound embrace of fiscal stringency only adds to the extant deflation pressure.

“No wonder no country wants a strong currency anymore, as attested to by Europe's easy acceptance of a weaker euro. The acute phase of the financial crisis is over, but the chronic trend toward deflation that has followed it is not.”

One can criticize Makin’s 2010 article for being overly pessimistic; deflation has not happened. It was, though, a solid piece of analysis of the risks. Unfortunately, one cannot say the same about the analysis in his new Economic Outlook piece, “Austerity Undone” or his shorter Guardian article on the same subject.

In “Austerity Undone,” he writes that the now-famous Carmen Reinhart and Kenneth Rogoff article implying that a 90 percent debt-to-GDP ratio represents a danger point “has been shown to be seriously flawed.”  He states that there are now doubts about both “fiscal austerity” and “a resumption of Federal Reserve tightening.” After all, “U.S. inflation is slowing and bond yields are falling…” 

So far, so good. Makin, though, then begins to generate some confusion when he turns his attention to a recent IMF report. He writes:

“Underscoring the widespread confusion about the use of fiscal austerity, the IMF's Fiscal Monitor, after charging the United States with tightening fiscal policy too rapidly, singled it out as among the 10 countries with ‘the most severe fiscal problems,’ suggesting that it still needs to agree on medium-term deficit reduction targets.

“The IMF Fiscal Monitor prescriptions for the United States are badly muddled and ignore significant changes in its fiscal stance. The decried sequester does cut annual spending next year by about $120 billion if it is not rescinded by a nervous and confused-no thanks to the IMF-Congress. Let us hope the sequester is left in place, providing as it does a modest $1.2 trillion worth of spending cuts (only about 2.5 percent of federal spending over the next decade).”

Makin appears to be criticizing the IMF for saying that, while the U.S. has implemented too much austerity in the here and now, it is not doing enough about the deficit in the “medium term.” This view can be criticized, but Makin’s does not make entirely clear his reasons for disagreeing with the IMF. He does say that the IMF ignores the progress that has been made in cutting the budget deficit in the next few years, though Makin just assumes, with no explanation, that this is good policy.  He then turns his attention to the sequester, which he claims to be a “modest” budget cut, but one which he approves. Why? He does not say, but there seems to be an implicit assumption that his audience shares his view that cutting budget spending is usually good idea, even if done in a thoughtless way. Note that he has not prepared the ground for this, because his earlier discussion said there was doubt that austerity is a good idea. He does not give a reason why “modest” austerity is then a good idea; he just assumes it. Perhaps that is a given in the lunchroom at AEI, but it is not elsewhere. And his earlier statements about austerity might not meet with AEI lunchroom approval.

Another Makin opinion that may not sit well in some Republican circles is his statement that “fiscal austerity has been moderate and probably, at the current pace of deficit reduction of about $300 billion per year over the next half decade, has proceeded far enough for now.” In fact, some liberals disagree with this too, believing that the current priority should be growth and that requires increased government spending in a time of lagging private sector demand. In this paper, Makin does not provide a rationale for his position. Why is some austerity called for now, but just the current amount? The reader has no way of knowing what type of economic model Makin is relying on for his judgments.

Makin does take pain, though, to burnish his conservative credibility by criticizing the President’s budget proposal. He claims “it does not advance the fiscal debate.” Really? One may agree or disagree with the Administration’s proposals – and plenty of liberals disagree with some parts of the Administration’s budget – but to say there is no debate to be had here makes no sense. Reading on, it becomes clear what Makin really means. According to his analysis, the Administration’s budget does not reduce the deficit – in his words, advance us on “the road to sustainable fiscal policy.” In other words, the Administration does not advance the fiscal debate because Makin does not agree with what the Administration has proposed. And, he still has not explained why deficit reduction right now is more important than growth-oriented policy. Unlike some fiscal hawks, Makin is not one who argues that deficit reduction is pro-growth. He writes:

“… It is necessary to remember that placing the United States on a sustainable fiscal path after four years of trillion-dollar deficits will have consequences in the short term. Coupled with a ‘tax’ of about $90 billion from higher oil prices, the total of fiscal and oil drag prior to sequester is about $270 billion, and $45 billion in 2013 sequester raised that to $315 billion, or nearly 2 percent of GDP. That drag needs to be contrasted with average fiscal thrust of nearly 3 percentage points of GDP over 2009-12.

“The ‘fiscal swing’ of 5 percentage points of average 2009-12 fiscal thrust of 3 percent of GDP to 2013's 2 percent of GDP drag means that a sharp US slowdown may occur in mid-2013, notwithstanding the heartening signs of growth in the housing sector and a strong push from rising stock prices, all occurring while interest rates remain remarkably low. Still, Congress should not try to reverse deficit reduction progress as the president's budget has in effect suggested. Sequestration will be blamed for any slowdown, but really the cause will be a swing from steady previous stimulus to about $225 billion of fiscal drag along with some bad luck supplied by about $90 billion in higher energy costs.”

This leaves the reader still puzzling why this “fiscal drag” is a good idea, even if factors other than the sequester contribute more to the drag. Why should the government (Congress and the Administration) not pursue in a slowing economy policies generating “fiscal thrust”? Makin assumes we know the answer to that, but readers who do not instinctively share this belief are left puzzled. One wonders how Makin would articulate his position on this if challenged, which I assume is not likely to happen at AEI’s offices in Washington, DC.

Finally, when it comes to deficit reduction, it is clear that Makin prefers spending cuts to tax increases. That is a defensible ideological position, especially if one’s political philosophy leads one to the conclusion that the government’s role is currently too large. But if you are going to contend that one is preferable to the other in terms of the impact on the economy, then one should have an economic argument to back up this assertion. Here is what Makin says:

“Republicans will decry the January 2013 tax increases as crippling the economy and vow to allow no more. Democrats will decry the sequester spending cuts and vow to allow no more spending cuts without tax increases. The president has already proposed rescinding the sequester. The reality the current weak economy is demonstrating is that further tax increases to replace the deficit reduction by the sequester as proposed by the president would weaken the economy even further.”

Makin gives no reason for the contention in the last sentence. Why is that? My guess is that this paper is not really meant as an objective view of the fiscal situation and economic outlook. The evidence is that Makin is perfectly capable of good economic analysis if that is what he wanted to do. Rather, the purpose of this article is to convince Republicans that budget austerity has gone far enough for now. The political reality is that Makin has no hope in convincing them to reverse course, and he knows that. He is worried, though, that additional austerity would be devastating and is trying to convince Republicans in Congress of that while making statements that preserve his conservative credibility. He does not have to justify these statements to his intended target audience.

We are left, though, wondering what Makin actually believes. He may well believe that the current amount of austerity is correct and that increasing taxes and cutting the amount of the sequester by equal amounts is bad policy. Since he gives no reasons, we are left to wonder.

Personal Note:   Early in my career I met John Makin, though I doubt he remembers me. He did some consulting work for the Treasury when I was working on U.S. balance of payment issues. He was trying to use a statistical methodology (Box-Jenkins) to predict the large statistical discrepancy that is put on the capital account side to make the capital and current account balances offset each other exactly, as they must from an accounting perspective. I also ran across him, I believe, in earlier jobs I had in international monetary research at Treasury and at the Federal Reserve Bank of San Francisco.