Relevant and even prescient commentary on news, politics and the economy.

Kudlow Kontradicts Kash

OK, my apologies for the clownish way of spelling “contradict”, but if we read Larry’s latest, you’ll realize he did not at all challenge Kash:

Three months ago the first government estimate of gross domestic product for the fourth quarter of 2004 came in at 3.1 percent at an annual rate. At the time, the market consensus expected 3.5 percent growth. Immediately, the mainstream media started talking about an economic slowdown. Turns out, that 3.1 percent was finally revised up to 3.8 percent … Well, history is repeating itself – even though, if you look under the GDP hood, you’ll find that the country’s economic engine is humming along … The core U.S. economy – subtracting out trade and government spending and keeping in consumer spending and business capital-goods investment – actually expanded at a 4.3 percent annual rate in the first quarter compared to a 4.8 percent pace in the fourth quarter and a 5.2 percent rate for the last year.

The core economy? Subtracting out net exports and government purchases? But why did Kudlow mention last year and not 2005QI – unless he read Kash’s post noticing that investment growth slowed in this latest quarter, which was Kash’s point. But I’m trying to figure out if Kudlow knows something we don’t, as he seems sure the revised GDP report will show a number greater than 3.1% and not less than 3.1%.

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In Defense of Bush’s Soc. Sec. Proposal

It’s time for “fair and balanced” so we’ll let Donald Luskin tell us why Bush’s proposal makes sense by noting two of his posts today. In one, he noted a couple of privatization principles:

Replace The Empty Promises Being Made to Younger Workers With Real Money. Younger workers should have the option of putting a portion of their payroll taxes into a voluntary personal account which will allow them to build a nest egg that belongs to them. This money will give workers an opportunity to receive a higher rate of return than the current Social Security System can provide.

Voluntary Personal Accounts Should Include The Risk Free Option Of Investing In Treasury Bonds. Voluntary personal accounts should include an investment option that allows workers to invest in U.S. Treasury bonds, which have no risk. Workers who have reservations about investing in the markets will still be able to rely on a Social Security check that is equal to or higher than today’s retirees.

In another, he links to the White House webcite that states:

Today, some opponents of fixing Social Security are suggesting that the President’s proposals would result in “benefit cuts.” This rhetoric recklessly disregards the facts about the President’s proposal:

Fact: Under the President’s proposal, benefits would grow relative to today’s levels. Future generations of seniors would receive benefits that are at least as high as seniors receive today (even after adjusting for inflation.)

Fact: The Pozen proposal referenced by the President would allow for faster overall long-term benefit growth than can be paid by current-law Social Security.

Fact: Under the Pozen proposal referenced by the President, lowest-income Americans would get the fastest benefit growth of all, significantly faster than inflation.

Fact: Under the Pozen proposal referenced by the President, medium-wage workers would also receive faster benefit growth than the current system can pay.

Fact: The current Social Security system can fund only 74% of promised benefits in 2041. The Social Security actuary’s analysis of the Pozen proposal finds that at the same time, each of “Low Earners,” “Medium Earners,” and ‘High Earners” would all receive benefits that are higher than the current system can pay.

Fact: All of the above figures exclude income from personal accounts. Social Security Administration figures show that expected benefit growth will be even greater for those who choose to participate in voluntary personal accounts.

I report, you decide!

Update: The rebuttal is already in – ably provided by Jason Furman (with hat tip to Brad DeLong). For those of you who thought I’d have to comment – outsourcing to CBPP is the way to go!

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Social Security: Soak the Yuppies

As we congratulate Duncan Black for correctly calling that Bush would endorse the Pozen plan, let’s review how George Bush defined the Social Security problem:

Congress also needs to address the challenges facing Social Security. I’ve traveled the country to talk with the American people. They understand that Social Security is headed for serious financial trouble and they expect their leaders in Washington to address the problem … These changes have put Social Security on the path to bankruptcy. When the baby boomers start retiring in three years, Social Security will start heading toward the red. In 2017, the system will start paying out more in benefits than it collects in payroll taxes. Every year after that, the shortfall will get worse, and by 2041 Social Security will be bankrupt … any reform of Social Security must replace the empty promises being made to younger workers with real assets, real money … I know some Americans have reservations about investing in the stock market, so I propose that one investment option consist entirely of treasury bonds, which are backed by the full faith and credit of the United States government … I think if seniors feel like they’re not going to get their check, obviously nothing’s going to happen.

Granny is too smart to think her checks will not be mailed. What makes granny upset is how the White House is flat out lying to her smart granddaughter who is working hard in college. Granny might even be smart enough to know that with no reforms, the kid’s Social Security checks will be only 80% of what is currently promised but that beats the 50% of what is currently promised that would come from the Pozen plan. Let’s also imagine that the kid’s parents are both 45 years sold working hard at jobs paying $45 a hour. The parents have paid a lot into the Trust Fund for 20 years and will continue to pay a lot into it over the next 20 years, but would receive a modest benefit cut relative to what is currently promised if the Pozen plan goes into effect. OK, you conservatives don’t like the term “benefit cut”, so let’s say this plan is a backdoor tax increase on these productive parents but not as large as the backdoor employment tax increase on the kid. Juan Williams this morning on NPR said some conservatives will call this welfare. There are some disincentives to working, but as a liberal – we should not impose the burden of Bush’s fiscal irresponsibility on the poor as much as we should raise taxes on those who Robert Novak call members of the “productive class” – such as Paris Hilton.

Bush also explained why we need privatization:

I feel strongly that there needs to be voluntary personal savings accounts as a part of the Social Security system. I mean, it’s got to be a part of the comprehensive package. And the reason I feel strongly about that is that we got a lot of debt out there, a lot of unfunded liabilities, and our workers need to be able to earn a better rate of return on their money to help deal with that debt. Secondly, I like the idea of giving someone ownership. Why should ownership be confined only to rich people? Why should people, you know, not be allowed to own and manage their own assets, who aren’t the so-called investor class? I think everybody ought to be given that right. Matter of fact, Congress felt so strongly that people ought to be able to own and manage their own accounts, they set one for themselves. And, you know, you’ve heard me say – I like to say this, if it’s good enough for the Congress, it ought to be good enough for the workers to give them that option. The government’s never saying, “You have to set up a personal account.” We’re saying, “You ought to have the right to set a personal savings account so you can earn a better rate of return on your own money than the government can.” And it’s that difference between the rate of return – between what the government gets on your money and what a conservative mix of bonds and stocks can get on your money – that will make an enormous difference in a person being able to build his or her own nest egg that the government cannot spend. Now, it’s very important for our fellow citizens to understand there is not a bank account here in Washington, D.C., where we take your payroll taxes and hold it for you and then give it back to you when you retire. Our system is called pay as you go. You pay into the system through your payroll taxes and the government spends it. It spends the money on the current retirees and with the money left over, it funds other government programs. And all that’s left behind is file cabinets full of IOUs. The reason I believe that this ought to work is not only should a worker get a better rate of return, not only should we encourage ownership, but I want people to have real assets in the system.

So if I own a Treasury bond, that is a real asset but it is not a real asset when a Trust Fund owns a Treasury bond. And suppose I recently purchased a bond paying a 4.8% nominal return. Bush is saying this is somehow a better return than the Trust Fund gets – even though its bond also pays a nominal return equal to 4.8%. That is some kind of fuzzy math akin to Bush’s fuzzy accounting where he claimed that my getting a better return on my 401(K) lowers government liabilities. Incidentally, all individuals currently have the right to open private accounts assuming they have sufficient resources.

But when Bush was suggesting the Trust Fund is pay as you go, David Altig might be surprised to hear that I think Bush had a point with the premise that the Trust Fund surplus funds other government programs. After all, Bush is the one that made sure General Fund revenues were not sufficient to fund all of General Fund expenditures.

Finally Bush explained why we must act now:

Social Security is a big issue, and it’s an issue that we must address now. You see, the longer we wait, the more expensive the solution’s going to be for a younger generation of Americans. The Social Security trustees have estimated that every year we wait to solve the problem, to fix the hole in the safety net for younger Americans, costs about $600 billion.

This canard is bizarre on several fronts as it uses a nominal interest rate applied to cash flow deficits in the future. The Trust Fund is currently earning interest income and the real interest rate is about half the nominal interest rate. Maybe it is true that the real present value of the unfunded liability is rising by about $300 billion a year, but Bush’s proposal insures no additional revenues for the Trust Fund and delays any significant reductions in outlays for another decade. In the meantime, the real interest obligations for the overall Federal debt plus the non-interest deficit for the General Fund are almost $500 billion a year. And the energy part of Bush’s appearance last night promised more pork barrel spending. Maybe my retirement plan should have included buying this stock a few years ago.

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Interest in China’s Exchange Rate

You know that people are a bit on edge regarding China’s exchange rate policy when this story is one of the top news items (at least as of 1pm EDT) on the Financial Times:

China says no change in monetary policy

China’s renminbi currency traded briefly outside its tightly controlled band on Friday, triggering a renewed wave of speculation that the government was set to allow a long-expected revaluation.

…Traders said the renminbi, which has been pegged to the US dollar for a decade, was briefly in the market at a rate of Rmb 8.2700 to the dollar, outside of the usual band of 8.2760 to 8.2800.

For a temporary 0.07% deviation in the Renmimbi exchange rate to make headlines suggests that a lot of people not directly involved in currency trading are very, very interested in what happens in that particular market…


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How Low Can It Go?

Apparently, February’s incredibly low savings rate was not the bottom for the US, because in March it went even lower. Since I’m in a charty kind of mood today, here’s the picture…

(Note: the bump at the end of 2004 is due to Microsoft’s one-time dividend payout in December.)

This incorporates the most recent data on personal income and spending, released this morning by the BEA, which showed that the household savings rate in the US was just 0.4% of household disposable income in March. That’s the lowest monthly savings rate since October 2001, when US consumers embarked on a patriotism-fueled spending spree to make up for a dearth of spending the month before.

This morning’s report also showed a substantial increase in income in March of 0.5% (though the increase was just enough to keep up with inflation), and an even more substantial increase in spending. With luck, strong income growth will continue in coming months and help erase some of the pessimism brought on by yesterday’s GDP report


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Changes in Inventories

So what’s the deal with inventories, anyway? You may have been wondering a bit about that in the wake of yesterday’s GDP report, in which inventory changes played such an important role; one-third of economic growth in the first quarter of 2005 was simply due to firms building up their stocks of inventories.

Studying inventory changes may not be the sexiest topic in the field of macroeconomics… but it turns out to be an extremely important one. That’s because a) inventory changes are notoriously volatile, and thus play a big role in variations in GDP; and b) inventory changes can sometimes give us some information about where the economy is headed. This chart shows the change in inventories in each quarter in recent years:

Clearly the most recent quarter stands out – it was the largest build-up in inventories since the middle of 2000, right before the economic slow-down. But what does it mean?

The subtlety about interpreting inventory changes is that there are different reasons that firms may increase their inventories: they may do it unintentionally, if they are over-optimistic about their sales forecasts and thus produce more than they can sell; but they may do it intentionally, if demand is growing, in order to keep a steady ratio of inventory-to-sales. To make interpretation even a bit more complicated, note that firms’ desired inventory to sales ratio has been steadily declining over time as inventory management gets better:

Looking over a longer time period we can tentatively identify episodes of both types (intentional and unintentional) of inventory accumulation.

Inventory growth in 1994 and 2000 heralded slowdowns in economic growth. But inventory growth in 1997 and 1998 was simply a function of businesses keeping up with rapidly growing demand.

So how should we interpret the inventory numbers from the first quarter of 2005? Were they a sign that firms sense that demand is growing, which might cause them to intentionally keep a larger stock on hand? Or were they an unintentional buildup in inventories that firms will have to undo next quarter by slowing down their production? Looking at other economic data right now gives us no reason to think that firms are expecting a strong surge in demand. Hence (despite the somewhat contradictory inventory to sales ratio, which is still quite low) my guess is that firms will probably try to slow production to reduce their inventories next quarter. And slower production, combined with possibly negative inventory growth, could spell a very low GDP number indeed for the second quarter. But we shall see.


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Bartlett v. Bartlett on Measuring Long-term Deficits

Back in 2003, Bruce Bartlett criticized the Smetters-Gokhale use of present value analysis but now he seems to like such calculations. To be fair, I have used such calculations, while Max Sawicky notes that they look like ginned-up large numbers unless put in the context of the present value of future GDP over the same horizon. And Bruce does close with this:

To make these very large numbers somewhat more concrete, Social Security’s unfunded liability comes to 1.2 percent of GDP in perpetuity … Avoiding such tax increases is the best reason to reform Social Security now.

Actually, my problem with his latest NRO op-ed is that he does not tell us what reforms will avoid the need to raise taxes. Is he talking about benefits cuts or some form of Cato-style free lunch? Of course, President Bush is supposed to inform us tonight what his “reforms” will be.

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Jesus Wants You to Pay Your Taxes?

Are you tired of having the radical right preach to us about what God allegedly wants in the political arena? Tax Analysts reports on this story from Sierra Leone:

Tax officials in Sierra Leone offended the country’s Christian population after launching an advertising campaign on April 25 that claimed that Jesus Christ wanted them to pay their taxes, Agence France-Presse reported on April 25. The half-page newspaper advertisements claimed that “all Christians should follow the teachings and example of Jesus Christ. This week: Pay your taxes!” The ads were aimed at the primarily Muslim nation’s Christians, who make up approximately 30 percent of the country’s population. The ad used a passage from the Bible’s Gospel of Matthew as its source in determining what Jesus’ tax advice would have been. “Pay the emperor what belongs to the emperor and pay to God what belongs to God,” Jesus said on the topic of paying taxes to the Roman Emperor (Matthew 22:17-21). Reaction from Sierra Leonean clergy has ranged from outrage to calls for the “blasphemous” ads to be stopped immediately, according to the report. The tax department defended the ads as an effort to increase compliance among the nation’s taxpayers. The ads were an attempt to encourage people to pay their taxes as soon as possible, a tax department spokesperson was quoted as saying.

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GDP Growth: First Quarter 2005 Advance Estimate

This morning the BEA reported that its advance estimate of GDP growth in the beginning of 2005 came in somewhat below expectations, which were for about 3.5% growth:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 3.1 percent in the first quarter of 2005, according to advance estimates released by the Bureau of Economic Analysis.

…The deceleration in real GDP growth in the first quarter primarily reflected a deceleration in equipment and software, an acceleration in imports, and a deceleration in PCE that were partly offset by accelerations in private inventory investment and in exports.

…The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 3.0 percent in the first quarter, compared with an increase of 2.9 percent in the fourth.

This is not a very good report. In fact, I think it was pretty bad. Much of GDP growth in early 2005 was apparently driven simply by a massive build-up in inventories; over 1.2% of the 3.1% GDP growth rate was due to inventory growth. But obviously, GDP growth can not be sustained by inventory growth. Furthermore, such inventory growth suggests that businesses may need to rein in production a bit.

The time series for GDP growth and inflation over the past four years looks like this:

Much of the growth in GDP over the past couple of years has been driven by investment spending, both by businesses and on housing. But business spending slowed markedly in the beginning of 2005, and residential investment spending has been considerably cooler in the past 3 quarters compared to 2003 and early 2004:

Finally, notice the US’s continuing current account problem: imports, which are much larger than exports in the first place, continue to grow faster than exports. The effect of the weaker dollar on exports has yet to make itself felt:

All in all, a disappointing report. If the apparent slowdown in investment spending continues (and there’s no reason yet to think that businesses have picked up the pace of spending from the levels of early 2005), then GDP growth for the year may be less than 3%. That is not a horrible growth rate, but it is a bit disappointing to those who hoped for another year or two of strong economic growth in the US before this phase of the business cycle was over.


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Calling CalculatedRisk: John Tamny on Interest Rates and Housing Prices

In my view, CalculatedRisk is the blog’s leading authority on the housing market. Having read the latest from John Tamny, James Grant’s Forbes article is something we might all read as well. But Tamny disagrees with Mr. Grant’s assertion that higher interest rates tend to reduce the value of houses:

Though the prime-lending rate rose from the single digits in 1976 all the way to 19 percent in 1979, real estate took off. Gilder noted that by 1979, “the value of individually owned dwellings had reached $1.3 trillion dollars, twice the worth of individually owned corporate stock.” He added that half of the newly minted multimillionaires in 1978 achieved their fortunes in real estate. Grant cites three “brutal property bear markets: 1974-75, 1980 and 1990-92,” but in each case the prime rate was falling during the years mentioned.

I might ask Mr. Tamny to distinguish between changes in nominal v. real housing prices as well as changes in nominal interest rates v. real interest rates, but I suspect CalculatedRisk has already covered these concepts thoroughly.

Two more things: Tamny suggests that the prime interest rate was falling in 1980. One might ask why did he mention the prime interest rate and not mortgage interest rates, which actually rose during 1980. And Tamny bothers to check, it turns out that the prime rate may have been high and volatile, but was not falling over the year. Oh well, I guess understanding the data means one is not qualified to write for the NRO.

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