Rebuttal to Paul Krugman’s “A Permanent Slump” and “Secular
by The Curmudgeon and Victor Sperandeo
In his Monday NY Times Op Ed titled: A Permanent Slump?
Paul Krugman suggests that the past five years of very sluggish economic growth may be the new normal. He asks: "What if depression-like conditions are on track to persist, not for another year or two, but for decades?"
Krugman writes that the case for “secular stagnation” — a persistent state in which a depressed economy is the norm, with episodes of full employment few and far between — was made forcefully at the I.M.F.’s big annual research conference. The very well-known person making that case was Larry Summers who warns that the U.S. and Europe are about to repeat Japan’s ongoing post-1991 episode of secular stagnation.
Mr. Summers states the obvious- that the financial crisis of 2008-2009 is now far behind us. Yet the U.S. economy remains depressed. He then recounted that before the financial crisis we had a huge housing and debt bubble. Yet even with this huge bubble boosting spending, the overall economy was only so-so — the job market was O.K. but not great, and the boom was never powerful enough to produce significant inflationary pressures.
Mr. Summers then said something quite profound: "That we have an economy whose normal condition is one of inadequate demand — of at least mild depression — and which only gets anywhere close to full employment when it is being buoyed by bubbles."
Victor Sperandeo's comment: "This excuse is often used by Keynesian economists to explain a conclusion without a specific cause .... Why then do Apple's products (iPhones, iPads, iPods, MACs, etc.) not have a lack of demand?"
Krugman most definitely agrees with Summers! He writes, "The evidence suggests that we have become an economy whose normal state is one of mild depression, whose brief episodes of prosperity occur only thanks to bubbles and unsustainable borrowing." He cites slowing population growth along with persistent trade deficits as probable causes for the U.S. economic malaise.
But then he drops a bombshell: "Central bankers need to stop talking about “exit strategies.” Easy money should, and probably will, be with us for a very long time. This, in turn, means we can forget all those scare stories about government debt, which run along the lines of 'It may not be a problem now, but just wait until interest rates rise.'"
Author's joint response:
This “easy money" theory implies that monetary policy will always save the day. Well what if the Fed did $500 Billion of QE per month? Would that have much of an impact on the real economy or just boost the price of financial assets? We think that fewer companies would invest in productive assets (or invest less), many would buy stocks rather than spend money on real things. Unemployment would remain high, in our opinion. QE has not worked to stimulate the real economy. See reference to WSJ article below.
In a follow on blog post: Monetary and Fiscal Implications of Secular Stagnation
Krugman amplifies this latter point: "The usual worry about a rising debt level — that it will require that we eventually run big non-interest surpluses to pay down the debt — is all wrong. As long as we run a primary (non-interest) balance, or in fact not too large a deficit, the debt/GDP ratio will tend to erode over time. What’s more, an increase in the primary deficit won’t cause a runaway debt spiral, it will lead to a gradual rise in debt to a higher level, but it will stabilize there."
In other words, Krugman is not at all worried about exponentially increasing U.S. debt or the debt service cost to the federal government if interest rates were to rise (from artificially low levels).
Comment and Analysis:
We find Krugman's view to be quite contentious! Victor and I have previously addressed the problem of a U.S. debt spiral with different interest rate scenarios. Please see: Increasing U.S. Debt, Interest Payments, and Why It Matters Now!
We believe the section of that article sub-titled: Analysis of Normalized U.S. Interest Rates on Debt conclusively refutes Krugman's assertion that increasing U.S. debt levels coupled with rising interest rates won't be a problem. Moreover, Krugman does not explain why the debt level will stabilize after rising to "a higher level." We don't think that will happen without major progress on the U.S. budget deficit, which isn't likely due to political gridlock on Capitol Hill.
Victor asks: "Why are we in the economic state depicted by Krugman?" It's got to be more than just aging population and trade deficits! Why doesn't Krugman clearly state why the U.S. economy is in a semi-permanent mild depression?
Sperandeo thinks one reason is that high taxes, the AMT and excess government regulations kill economic growth! He says that for decades, the average family had one bread winner, but now there are two (or more) in the family and they're still struggling to make ends meet. Let's delve deeper into this problematic issue.
In 1971 the median personal income was $7,896. Today, it is approximately $50,000. [Source: "Median Household Income History in the United States."] But the tax rates now are triple what they were in 1971, which translates into much less discretionary income per person!
Much worse, is that many middle class people (perhaps a majority?) are now paying Alternative Minimum Tax (AMT). Once in the AMT, most state taxes paid and miscellaneous expenses (1040 Schedule A) are disallowed. Yet state tax refunds are fully taxed as income-they are not netted out with state taxes paid (e.g. with holding or estimated tax payments).
The AMT was originally aimed at only the ultra-rich who paid zero tax. When AMT was introduced after 1969, there were only 155 taxpayers making $200,000 or more that paid no income tax (the maximum tax rate was then 70% for "married filing jointly"). The AMT was created to stop tax deductions from the very wealthy, which resulted in them paying zero income tax.
Inflation and tax rates rise, but the adjustment to AMT does not! So more and more middle class people with dividends and/or capital gains get trapped by the AMT each year. In 1969 dollars (see Note below) the AMT threshold today would be $1.24 million adjustable gross income!
Note: Inflation is compounding at 4.14% a year since Nixon went of the gold standard in the summer of 1971.
Add Corporativism/Corporatism to the mix [The organization of a society into industrial and professional corporations serving as organs of political representation and exercising control over persons and activities within their jurisdiction] and one can see how certain industry groups are doing much better economically than individual taxpayers.
Tuesday's WSJ had a gem of an article tucked away on page B6 that may help explain the ongoing U.S. economic malaise: Corporate Results Expose Lack of Confidence-Profits Grew in Third Quarter, but Firms Cut Capital Spending and Kept Adding to Cash Piles
"U.S. companies slashed their spending on factories, equipment and other performance-enhancing investments by 16% from year-earlier levels, according to an analysis by REL Consultancy for The Wall Street Journal. Businesses "are sitting on record cash, capital expenditures are down—that tells you everything you need to know about the mood of executives and boards of directors," said John Mauldin, chairman of investment newsletter publisher Mauldin Economics."
"Almost 90% of the companies that have given financial forecasts for the final quarter of the year have prompted Wall Street analysts to lower their numbers. Only a dozen companies have painted rosier pictures, according to data tracker FactSet."
"Companies are reluctant to raise the bar," said John Butters, senior earnings analyst at FactSet.
An additional factor to consider is that the U.S. Congress has granted favorable tax breaks to corporations in exchange for cash contributions to their election campaigns. [One of those is tax exemption on foreign profits not repatriated back to the U.S.] Why do you think large U.S. corporations pay so little corporate income tax?
Meanwhile, insurance companies get special treatment from the federal government on health care reforms. If they end up losing money due to the ACA they get an effective bailout from the higher taxes collected to pay for ACA.
Instead of the above, why aren't there tax breaks for working or retired people- many of whom are now subject to the draconian AMT? [In 2011, the CURMUDGEON had very little adjusted gross income and owed no federal income tax, but was nonetheless subject to AMT.]
These are the problems Krugman ignores. Victor thinks it's because of his ideology. "Apparently, he likes Statism [a political system in which the state has substantial centralized control over social and economic affairs]."
Victor Sperandeo's Closing Comments:
Austrian Economists refer to "lack of demand" as “Originary Interest." From Ludwig Von Mises:
"Originary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remote periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods."
This simply translates to confidence in the buying of goods today, because one believes things will be better tomorrow. Therefore, savings is not a concern.
Conversely, if one thinks the economic future will be poor, one hoards earnings, boosts savings, and defers purchases. This is what President Obama is causing through his policies and the rhetoric of "class warfare."
Even Maynard Keynes would not suggest a tax increase in a slow economy or recession. The 2013 tax increase is not talked about much anymore, but it's contributing to the current economic stagnation/malaise.
QE is temporary and can be change by whim of the Federal Reserve. But taxes are permanent and can only be changed by a much more difficult and often contentious process--legislation by Congress.
In closing, we say that $500B QE, in a context of bad fiscal and tax policies, is great for stocks, but not for real economic growth or more jobs.
Till next time........................
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1979) to profit in the ever changing and arcane world of markets, economies and government policies. As President and CEO of Alpha Financial Technologies LLC, Sperandeo overseas the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.