Category Archives: Economy and Meltdown

Are 'Equity' Vigilantes Keeping The Press Honest On The Fiscal Cliff?


In the past it has been the bond market whose vigilantes had rampaged across the fields to keep policymakers honest – but something has changed with the Fed’s boot on the bond market. As BofAML notes, when the Fed was too soft on inflation or the fiscal deficit was out of control, interest rates spiked higher. In our view, this has changed and today the stock market is the disciplining force for Washington. We have argued this perspective for a while – that nothing will be done until we get a stock market crash – but the press will continue to make molehills out of mountains it seems as BofAML adds, the most obvious lesson of the last week is that when Washington approaches a policy impasse, the financial press tends to signal a resolution of the crisis many times before it happens. Don’t believe it. After elections there is always conciliatory talk: no one wants to be seen as a sore loser or a gloating winner. The risk remains huge and the four hurdles to a grand bargain seem to be getting larger – no matter what the press wants us to think.

 

Via BofAML: Taxing Negotiations

In the past week, Democrats and Republicans have staked their initial negotiating position on the fiscal cliff. The news is not encouraging. As our regular readers know, we expect a complex negotiation process that takes many months and multiple brinkmanship moments before full resolution of the cliff. The news in the last week confirms several of our concerns.

Press fakes
Perhaps the most obvious lesson of the last week is that when Washington approaches a policy impasse, the financial press tends to signal a resolution of the crisis many times before it happens. This was evident in the first few days after the election. In his acceptance speech, the President said: “You elected us to focus on your jobs, not ours. And in the coming weeks and months, I am looking forward to reaching out and working with leaders of both parties to meet the challenges we can only solve together.” On a similar note, House Speaker Boehner said “Republicans have signaled a willingness to accept new revenue if it comes from growth and reform.” These positive statements prompted several days of optimistic headlines.

Don’t believe it. After elections there is always conciliatory talk: no one wants to be seen as a sore loser or a gloating winner. Moreover, surveys show the US public wants politicians to start working together. However, we believe investors should look past reassuring rhetoric and focus on the underlying reality. Recent budget impasses have virtually always gone to the last minute and sometimes beyond. In the latest incarnation, the two sides have dug in their heels on income taxes and have not even started to discuss the rest of the cliff. The disagreements between the two parties run very deep and neither side wants to give ground until it has to. The stakes are particularly high in the first round of negotiations: policy steps today could set the tone for the next several years.

Wile E. Coyote moment

The recent commentary also underscores the risk of going over the cliff before a compromise is reached. As we have noted before, in the run up to the election a wide range of commentators were suggesting that going over the cliff is not such a bad idea. They argue: (1) it won’t hurt the economy if it is temporary, (2) it is a good way to extract concessions from the opponents, (3) it resets the starting point for debate (it is easier to restore tax cuts and rescind spending cuts than to do the opposite), and (4) it allows time to get a better crafted deal. In his first press conference after the election, President Obama hinted that he, too, might be willing to go over the cliff, arguing that that raising taxes on the wealthy must be the first step in any budget deal. Keep in mind that the path of least resistance is down: it is much easier for one party to block legislation, and go over the cliff, than to forge a compromise and avoid the cliff. Some people argue that the weak showing of Republicans in the elections means they will be more inclined to compromise, reducing the risk of going over the cliff.

We are not so sure. After all, the Republicans need to first sort out why they did poorly. Moreover, while the election result may have softened the Republican position, there are plenty of early signs that it has stiffened the backbone of Democrats. For example, President Obama has repeatedly argued that the election is a “very clear mandate” to raise taxes on the wealthy. By contrast, Republican vice presidential candidate Paul Ryan said that there is no such mandate because the public also “reelected the House Republicans.” Are the two sides closer together or farther apart? It is hard to say, but clearly the gap remains very big.

The Grand Distraction

The post-election discussion underscores the futility of trying to get a quick “grand bargain,” putting in place a long-term plan for deficit reduction. Speaker Boehner has emphasized that any increase in tax revenues should come from broad-based reform: “in order to garner Republican support, the President must be willing to reduce spending and shore up the entitlement programs that are the primary drivers of our debt.” While tax and entitlement reform are good long term goals, are they really feasible in a few months?

A near-term grand bargain faces not just one, but four major hurdles:

  1. A low starting point: Neither party has even scratched the surface in presenting a feasible plan for either tax or entitlement reform, in our view. Tax reform requires tough choices around which loopholes to cut, a topic that has been carefully avoided by both parties. Medicare reform also requires tough choices around how care is rationed. Republicans have offered a voucher plan, but haven’t mentioned that it will only reduce costs if patients have large out-of-pocket expenses so they have an incentive to limit their spending. Democrats have offered to cut payments to providers, but without any impact on service. The American public needs to be educated about the true options it faces.
  2. Bi-partisan cooperation: As was clear in the 1986 tax reform, getting complicated and contentious reforms enacted is very hard without true cooperation, particularly with relatively evenly divided government. The leaders of the two parties have to stand together and fight the special interests.
  3. High complexity: The US tax code is extremely complicated and any attempt to change it creates many winners and losers. It has big impacts on the many special interests with tax advantages. It also redistributes income across not just income classes but between states (ironically, high-income people in the “Blue states” that voted for the Obama have the most to lose since those states tend to have high mortgages and high state and local taxes). If anything, Medicare reform is even more difficult since it involves life and death choices and there are fundamental disagreements about the relative role of markets and administration in controlling costs.
  4. A sizable gap in view: The two parties strongly disagree about how tax reform impacts the economy. Republicans argue that most of the revenue from tax reform will come from creating a stronger economy. In the past week, President Obama countered: “What I will not do is to have a process that is vague, that says we’re gonna sorta, kinda raise revenue through dynamic scoring or closing loopholes that have not been identified.”

We agree that it is important to start laying the ground work for tax and entitlement reform, but we also believe it is also important to get the sequencing right. First, dismantle the fiscal cliff, and then start negotiations on the longer term solutions.

Stock market “vigilantes”

Historically the bond market has been a disciplining force for policymakers. When the Fed was too soft on inflation or the fiscal deficit was out of control, interest rates spiked higher. In our view, this has changed and today the stock market is the disciplining force for Washington. Stocks have generally endorsed Fed policy. We estimate that stock prices rose a cumulative 15% in the past three years in response to Fed announcements or actions. While some investors have misgivings about what the Fed is doing, the overall market likes it. By contrast, the stock market is giving a clear no-confidence vote to fiscal policymakers. This was particularly clear when the TARP bailout plan failed to pass and at the end of the debt ceiling debate.

 

Today, the stock market “vigilantes” are gathering again. In early September we argued that “there is a high risk of a risk-off trade in the markets after [the Fed meeting on] September 13.” We argued that market focus would shift from Fed and ECB easing to fiscal policy risks. In the event the Fed meeting did mark a turning point in the markets, and with the election over and the fiscal cliff taking center stage, the downward pressure has accelerated (Chart 1). This weakness has occurred despite better news on the economy and an unremarkable earnings season.

The fiscal cliff is unlikely to be resolved quickly or in a completely benign fashion. Our advice:

“fasten your seatbelts and remain seated until Co-pilots Obama and Boehner turn off the fasten seatbelt sign.”

In particular, we would be leery about a big air pocket in late December, when our political pilots decide whether sharply drop altitude or not.

 

Source: BofAML

How Fiscally FUBAR Will Your State Be?


We all stand ‘fingers-over-eyes and thumbs-in-ears’ awestruck at the immense wreckage that the fiscal cliff titan will wreak upon the country. However, deep inside our socially responsible minds, all we can really think about is – what about my needs? The Pew Center On The States has just released a very broad and detailed look at just how the increased taxation and reduced spending will impact each and every state. Here, in two simple charts, is the answer.

 

TAX HIKES

There is a great deal of uncertainty about whether any or all of the policies in the fiscal cliff will be addressed temporarily or permanently, individually or as a package. Given this, it is useful to look at the different components of the fiscal cliff; examine how federal and state tax codes, revenues, budgets, and spending are linked; and provide a framework for assessing how states could be affected.

For example, almost all states have tax codes linked to the federal code. When certain expiring tax provisions within the fiscal cliff are analyzed independently, they could increase state revenues.

  • For at least 25 states and the District of Columbia, lower federal deductions would mean more income being taxed at the state level, resulting in higher state tax revenues.
  • At least 30 states and the District of Columbia would see revenue increases because they have tax credits based on federal credits that would be reduced.
  • At least 23 states have adopted federal rules for certain deductions related to business expenses. The scheduled expiration of these provisions would mean higher taxable corporate income and hence higher state tax revenues in the near term.
  • Thirty-three states would collect more revenue as a result of scheduled changes in the estate tax.

However, six states allow taxpayers to deduct their federal income taxes on their state tax returns. For these states, higher federal taxes would mean a higher state tax deduction, reducing state tax revenues.

 

SPENDING CUTS

The scheduled spending cuts also would have a significant impact on states. Federal grants to the states constitute about one third of total state revenues, and federal spending affects states’ economic activity and thus their amount of tax revenues.

  • Roughly 18 percent of federal grant dollars flowing to the states would be subject to the fiscal year 2013 across-the-board cuts under the sequester, according to the Federal Funds Information for States, including funding for education programs, nutrition for low-income women and children, public housing, and other programs.
  • Because states differ in the type and amount of federal grants they receive, their exposure to the grant cuts would vary. In all, the federal grants subject to sequester make up more than 10 percent of South Dakota’s revenue, compared with less than 5 percent of Delaware’s revenue.
  • Federal spending on defense accounts for more than 3.5 percent of the total gross domestic product (GDP) of the states, but there is wide variation across the states. Federal defense spending makes up almost 15 percent of Hawaii’s GDP, compared with just 1 percent of state GDP in Oregon.

There is still a lot of uncertainty about how the fiscal cliff would affect states. States might amend their own tax codes in response to the federal tax changes. How across-the-board program cuts under the sequester would actually be implemented is still unclear. In addition, the effect on individuals from the tax increases and spending cuts will vary by state, and states will face difficult choices in addressing these impacts.

 

 

Decisions will be made even amid this uncertainty. The public interest is best served by an enriched policy debate that incorporates implications for all levels of government and leads to long-term fiscal stability for the nation as a whole.

 

Full report here:

 

Pew Fiscal Cliff Report

Meet The New China – Same As The Old China?


Just before the US election, we laid out the details and implications of the ‘other’ major ‘election’ occurring in the world – that of China’s Supreme Leader of Awesomeness. Last night the details were announced of the makeup of the new Politburo Standing Committee. As Bloomberg notes, the panel – the most powerful decision-making body in China – was reduced from nine to seven members and will be led (unsurprisingly) by Xi Jinping. Perhaps, in a lesson for our own politicians, the ‘new’ committee is ‘bipartisan’ with five members from Xi Jinping’s own Jiang Zemin faction and two members from Hu Jintao’s faction (more a balance of reformers and reactionaries). But, in a similar vein to the US, as The Diplomat’s David Cohen notes,”If Xi is to achieve even the economic policy goals that already appear to enjoy consensus support in Beijing, he will need to find ways of overcoming some of the largest entrenched interest groups in contemporary China.  To do so, he may have to set about creating new entrenched interest groups.”

Adjusted from Goldman Sachs: The New Politburo…

 

Via The Diplomat’s David Cohen: Xi Jinping’s Economic Challenge,

For months, China watchers have been vying to predict whether reformers or reactionaries would prevail at this week’s Party Congress – and now that it’s here, analysts have had to begin debating what has actually happened.  Despite the importance of factional politics within the Party, what will determine whether major economic reforms are able to take place in the next year is not a contest of ideologies, but a test of political acumen – specifically, the power of China’s top leaders to control the three vast machines of China’s party, government, and state-owned enterprises (SOEs).  If Xi is to achieve even the economic policy goals that already appear to enjoy consensus support in Beijing, he will need to find ways of overcoming some of the largest entrenched interest groups in contemporary China.  To do so, he may have to set about creating new entrenched interest groups.

 

I’m ready to predict today that Xi’s government will pursue policies intended to reduce corruption, allow more private competitors into sectors monopolized by the state, and rebalance the economy away from its focus on public investment.  This is, I think, a fairly safe projection – these policies have already been announced.  Reforming state-dominated industries to allow private-company market entry was the subject of March’s “New 36 Clauses,” a series of fairly strong demands the State Council that the SOEs produce plans (which have been due for years) soon, and last week SASAC, the body that formally owns and regulates China’s largest state-owned companies, announced plans to strengthen oversight in the interests of competition.  Barry Naughton discusses the rebalancing problem at length in the current issue of China Leadership Monitor and concludes, fairly convincingly, that Prime Minister Wen Jiabao’s policies have widespread support among top leaders, who see them as critical for long-term growth, and, thus, their continued hold on power.

 

Corruption has been a hobbyhorse of the Hu-Wen administration – few major party events go by without President Hu Jintao warning that corruption threatens to undermine the legitimacy of the Communist Party, and the political report at this year’s Party Congress was no exception.  But years of declarations that the Party must reckon with corruption have done nothing to stop local officials from enriching themselves with bribes – nor stopped the families of top leaders from accumulating fortunes measured in hundreds of millions or billions of dollars.

 

There is little question that China’s top leaders see a need for a stronger private sector, and that they are uncomfortable with the extent to which the SOEs have come to dominate huge parts of the economy.  But unless changes reach deep into the structure of government, edicts from the top often have little effect in China.  I spoke a few weeks ago with James McGregor, a Senior Councilor at the public affairs consulting firm APCO Worldwide and author of a new book criticizing the growing dominance of the Chinese state sector, “No Ancient Wisdom, No Followers.”  He said that many in the Chinese government are worried about the shrinking role of private companies in the economy.  But, he said, the power of the SOEs may be enough to frustrate proposed reforms: “It’s a game of power politics now. In China, it’s not unlike the U.S and Europe – this place has a lot of big-money politics, a lot of vested interests that don’t want change.”

 

Economic reform may meet the same fate as the reforms to local government of the Hu-Wen administration, intended to reduce corruption and deal with controversial land seizures: many announcements and little change.  Both Hu and Wen have talked about corruption in public venues for most of their term, and have proposed numerous laws to police officials, while other new laws have created a right to substantial compensation for people whose land is seized.

 

But what has not changed in the last ten years is the fundamental incentives that make corruption and land seizures inevitable.  Land sales made up around 40 percent of the annual funding of local governments in 2010, according to the China Real Estate Information Corp.– and it is therefore no surprise that local officials still participate in land seizures to fund programs of investment and development.  Provincial-level officials still have little reason to look too closely at the affairs of their subordinates – as the Bo Xilai case demonstrates, to do so risks driving them to expose your own hidden affairs.

 

Economic reform will face similar obstacles, and it is whether the new generation of leaders succeeds in overcoming these that will determine the shape of China’s economy for the next ten years.

 

One major obstacle is the power of the state sector, still supercharged from China’s immense stimulus package.  SOEs now serve Chinese officials at all levels as wellsprings of investment to boost local economies, avenues for promotion – a stint running a major SOE has become a common step on the ladder to the Party’s highest ranks – and a source of income for leaders’ families.

 

Their role as the main driver of growth during the past few years has made SOEs heroes, to a certain extent, or at least too important to threaten – and made them a powerful lobby group whose interests are strongly protected by high-level policy-making.  McGregor compared the chiefs of the SOEs to generals and provincial governors: “In a way, they’re like the military – they report only to the Party, not the government.  They outrank the government people who are supposed to keep an eye on them.”

 

Equally strong is the resistance from lower-level officials, who depend heavily on SOE investments to support local economies.  Naughton’s article in CLM has a good account of the problem: while China’s top leaders fret about the collapse of Chinese growth model and the Party’s legitimacy as the manager of the economy, ambitious officials at every other level of government have horizons limited to their district and term – thus, local governments constantly lobby SOEs and private companies to continue to build new factories and real estate developments.

 

Effective reforms will have to take on both of these interest groups – and, most likely, to find or create new ones with incentives to lobby for the private sector.  These challenges are similar to those faced by Deng Xiaoping’s market reforms and the Jiang Zemin effort to streamline and privatize inefficient SOEs – and in order to overcome the resistance of local officials and SOE administrators in those cases both created new ways for them to get rich by reforming.  It was the success of these reforms that created the wealthy, profit-driven central SOEs that are now China’s one of biggest economic headaches.

 

It will certainly be an uphill fight.  But it is one I think Xi may well seek out – to avoid it will be to accept that the President of China and the Politburo Standing Committee are bystanders in the making of China’s economic policy.

Name The Author: "How The Capitalists Are Trying To Scare The People"


Name the author:

No socialist has ever proposed that the “tens of millions”, i.e., the small and middle peasants, should be deprived of their property (“made to abdicate their property rights”). Nothing of the kind! Socialists everywhere have always denied such nonsense. Socialists are out to make only the landowners and capitalists “abdicate”. To deal a decisive blow at those who are defying the people the way the colliery owners are doing when they disrupt and ruin production, it is sufficient to make a few hundred, at the most one or two thousand, millionaires, bank and industrial and commercial bosses, “abdicate” their property rights. This would be quite enough to break the resistance of capital.

Further hint: here is the full speech:

* * *

“How The Capitalists Are Trying To Scare The People”

In an editorial on May 17 Finansovaya Gazeta writes:

The political upheaval, which everyone looked forward to, is assuming the form of a social revolution without precedent anywhere. The ’class struggle’, which is a legitimate and natural thing in a free country, has taken on with us the character of a class war. A financial crash is imminent. An industrial crash is unavoidable.

 

“To effect a political revolution it was enough to make Nicholas II abdicate the throne and to arrest a dozen of his ministers. That was easily done in a single day. To effect a social revolution, however, tens of millions of citizens must be made to abdicate their property rights and all non-socialists must be arrested. This cannot be done in scores of years.”

That is untrue, worthy fellow-citizens. It is a glaring lie! You choose to call control over industry by the workers “social revolution”. In doing so you are committing three monstrous errors.

First, the revolution of February 27 was also a social revolution. Every political upheaval, if it is not a mere change of cliques, is a social revolution. The thing is—what class makes that social revolution. The revolution of February 27, 1917 took the power from the feudal landowners headed by Nicholas II and gave it to the bourgeoisie. It was a social revolution of the bourgeoisie.

By the use of clumsy unscientific terminology which confuses “social” with “socialist” revolution, Finansovaya Gazeta tries to conceal from the people the obvious fact that the workers and peasants cannot content themselves with seizure of power by the bourgeoisie.

By trying to ignore this clear and simple fact the capitalists are deceiving themselves and the people.

Secondly, “without precedent anywhere” is also applicable to the great imperialist war of 1914–17. Such a debacle, such bloody horrors, such a disaster, and such a break-down of our   entire civilisation are “without precedent anywhere”. It is not anybody’s impatience, not anybody’s propaganda, but objective conditions and this unprecedented break-down of civilisation that necessitate this control over production and distribution, over the banks, factories, etc.

Failing this, tens of millions of people can be said without exaggeration to face inevitable ruin and death.

In view of the freedom created by the “political upheaval” of February 27, in view of the existence of the Soviets, such control is impossible unless the workers and peasants unite, unless the minority of the population bows to the majority. Nothing can alter this, protest as you may.

Third, and most important of all—even for the purpose of a socialist revolution there is no need at all for “tens of millions of citizens to abdicate their property rights”. Not even socialism (and control over the banks and factories does not yet mean socialism) requires anything of the kind.

This is an infamous defamation on socialism. No socialist has ever proposed that the “tens of millions”, i.e., the small and middle peasants, should be deprived of their property (“made to abdicate their property rights”).

Nothing of the kind!

Socialists everywhere have always denied such nonsense.

Socialists are out to make only the landowners and capitalists “abdicate”. To deal a decisive blow at those who are defying the people the way the colliery owners are doing when they disrupt and ruin production, it is sufficient to make a few hundred, at the most one or two thousand, millionaires, bank and industrial and commercial bosses, “abdicate” their property rights.

This would be quite enough to break the resistance of capital. Even this tiny group of wealthy people need not have all their property rights taken away from them; they could be allowed to keep many possessions in the way of consumption articles and ownership of a certain modest income.

The question at issue is merely that of breaking down the resistance of a few hundred millionaires. Only in this way can disaster be averted.

* * *

Final hint: all of the above was not said yesterday in Europe, or today somewhere in the US. It was said on May 19, 1917…

* * *

Give up?

The author is Vladimir Ilyich Ulyanov 

* * *

aka V.I. Lenin… who just happened to be a little ahead of his time