Analysis of the global economy
The video below is an in-depth full hour-long segment and well worth watching. Notice that Dalio sees the credit accelerator as a key component adding to aggregate demand and the key component that creates instability in that demand. Unlike traditional econometric models that do not use the debt and credit stock as a consideration for a flow variable like spending, yet again we see that someone who anticipated the crisis does.
According to the Internal Revenue Service, more than 2.7 million people earn $250,000 a year or more — and fewer than one-tenth of them earn a million dollars or more. So more than nine-tenths of the people who would be hit with the higher taxes supposedly aimed at “millionaires and billionaires” are neither. “Bait-and-switch” advertising is exactly what President Obama is doing with his proposed tax increases on “millionaires and billionaires.”
It gets worse when you look at the potential economic consequences of the tax rate increases being proposed. The small proportion of the people targeted for Obama’s higher tax rates who are in fact millionaires and billionaires have the least likelihood of actually paying the higher tax rates. People with annual incomes in the millions or billions of dollars can live pretty high on the hog on a fraction of their income, leaving them with plenty of money to invest. And they can invest it in ways that keep it away from the tax collectors.
via Sowell: Obama uses 'tax the rich' rhetoric to hoodwink voters | The Columbian.
President Francois Hollande recently increased the top income tax rate in France to 75 percent — for incomes in excess of €1 million. This is part of a wider trend with President Obama targeting the wealthy in his election campaign, promising to raise taxes on incomes in excess of $1 million. Shifting the tax burden onto the wealthy might be clever politics, but does it make economic sense? To gauge the effectiveness of this strategy we need to study tax rates and their effect on incomes in the 1920s and 1930s.
By the end of the First World War, Federal government debt had soared to $25.5 billion, from $3 billion in 1915. Income taxes were raised to repay public debt: 60 percent on incomes greater than $100,000 and a top rate of 73 percent on incomes over $1 million. When Andrew Mellon was appointed Treasury Secretary in 1921, he inherited an economy in sharp recession. Falling GDP and declining income tax receipts led Mellon to observe that “73% of nothing is nothing”. He understood that high income taxes discourage entrepreneurs, leading to lower incomes and lower tax receipts — what we now refer to as the Laffer curve. By 1925, under President Coolidge, Mellon had slashed income taxes to a top rate of 25 percent — on incomes greater than $100,000. The economy boomed, tax collections recovered despite lower rates, and Treasury returned budget surpluses throughout the 1920s.
Interestingly, Veronique de Rugy points out that taxes paid by those with incomes over $100,000 more than doubled by the end of the decade.
Andrew Mellon was a wealthy banker and investor: in the mid-1920s he was the third highest taxpayer in the US. His strategy of cutting income tax rates may appear self-interested, but showed an understanding of how taxes can stimulate or impede economic growth, and succeeded in rescuing the economy from prolonged recession in the 1920s.
A decade later, President Herbert Hoover spent liberally on infrastructure programs in an attempt to shock the economy out of recession following the 1929 Wall Street crash. By 1932 Hoover and Mellon raised income taxes to rein in the growing deficit. Tax on incomes greater than $100,000 was increased to 56 percent and the top rate lifted to 63 percent — on incomes over $1 million.
The budget deficit continued to grow. Higher tax rates were maintained throughout the 1930s, under FDR, but failed to achieve their stated aim and may have contributed to the severity of the Great Depression.
GDP rose steeply after 1934. Income tax receipts recovered to pre-crash levels but declined again after 1937, when President Roosevelt introduced payroll taxes. Increased taxes reduced the fiscal deficit but caused a double-dip recession: GDP contracted, income tax receipts fell and the deficit grew.
Comparing the 1920s to the 1930s it is evident that Barack Obama and Francois Hollande threaten to repeat the mistakes of the 1930s. Increasing taxes in the middle of a recession does not reduce the deficit. It merely prolongs the recession.
Sources:
Cato Institute: 1920s Income Tax Cuts Sparked Economic Growth and Raised Federal Revenues by Veronique de Rugy
National Debt History
Wikipedia: Andrew W Mellon
Wikipedia: Laffer Curve
The Politically Incorrect Guide to the Great Depression and the New Deal by Robert Murphy
Harry Dent is always entertaining to listen to, but is he right about the link between demographics and inflation?
There is simply no way the Fed can win the battle it’s currently waging against deflation, because there are 76 million Baby Boomers who increasingly want to save, not spend. Old people don’t buy houses! At the top of the housing boom in recent years, we had the typical upper-‐middle-‐class family living in a 4,000-‐square-‐foot McMansion. About ten years from now, what will they do? They’ll downsize to a 2,000-‐ square-‐foot townhouse. What do they need all those bedrooms for? The kids are gone. They don’t visit anymore. Ten years after that, where are they? They’re in 200-‐square-‐foot nursing home. Ten years later, where are they? They’re in a 20-‐square-‐foot grave plot. That’s the future of real estate. That’s why real estate has not bounced in Japan after 21 years. That’s why it won’t bounce here in the US either. For every young couple that gets married, has babies, and buys a house, there’s an older couple moving into a nursing home or dying.
In my opinion there is a clear link between credit growth and inflation: the faster credit grows, the faster the money supply grows, and the higher the rate of inflation. Demographics are one of the factors that drive credit growth, but they are not the only factor. Interest rates are just as important: when interest rates are low we tend to save less and borrow more. And jobs, as the Fed discovered, are also important: if you haven’t got a job, you can’t borrow from the bank even when interest rates are low.
At present I would guess that jobs are the biggest constraint on credit growth. Later, interest rates will rise when employment recovers — as the Fed attempts to take some of the heat out of the economy. Only then may demographics become the major restriction on credit growth, with older households down-sizing outnumbering younger households up-sizing. But that is by no means definite: solving the jobs crisis alone could take decades!
Harry dent quoted from John Mauldin | A Decade of Volatility: Demographics, Debt, and Deflation (application/pdf Object).
Dean Baker responds to a NYT opinion that “Mr. Clinton is the president who made the sustained case to Democrats that they had to be pro-growth and pro-Wall Street, not just to get elected, but also to build a more modern economy.”
President Clinton’s policies set the country on a course of bubble driven growth. The prosperity of the last four years of his administration was driven by an unsustainable stock bubble. The collapse of the bubble was responsible for the recession of 2001 and the deficits that get the Washington establishment types so excited. It was difficult for the economy to recover from this downturn which led to, at the time, the longest period without job growth since the Great Depression. When the economy finally did recover from this downturn and start to create jobs it was on the back of the housing bubble.
via Pro-Growth and Pro-Wall Street is an Oxymoron | Beat the Press.
By Zarathustra:
How is it that an economy grows at 7.6% yoy is squeezing corporate profitability so hard? How is it that an economy growing at 7.6% yoy feel like there is not enough demand for all the goods and services being produced?…..The answer, to our mind, is quite simply that China has been investing in too much productive capacity…… The return on investments might be good before the financial crisis, yet the collapse of external demand after the financial crisis and more recently in the persistent Euro Crisis have cut external demand significantly. Meanwhile, domestic demand is not growing quite enough to pick up the slack created by collapse of external demand. Worse still, it is rather clear that domestic demand has been sustained by none other than investment itself. Thus, it should come as very little surprise that IMF’s estimate put China’s capacity utilisation at just about 60%.
via China’s overinvestment: the problem of having too much.
Hat tip to Macrobusiness.com.au
The threat of too-big-to-fail banks has not diminished. The combined assets of the 6 largest US banks is bigger now than in 2008. Simon Johnson, Professor of Entrepreneurship at M.I.T. Sloan School of Management, writes:
A growing number of serious-minded politicians are starting to support the point made by Jon Huntsman, the former governor of Utah and a Republican presidential candidate in the recent primaries: global megabanks have become government-sponsored enterprises; their scale does not result from any kind of market process, but is rather the result of a vast state subsidy scheme.
…..Serious people on the right and on the left are reassessing if we really need our largest banks to be so large and so highly leveraged (i.e., with so much debt relative to their equity). The arguments in favor of keeping the global megabanks and allowing them to grow are very weak or nonexistent.
The big banks will vigorously defend any attempt to break them up and they have deep pockets. It would be far more effective and politically achievable to raise reserve requirements, lifting capital ratios and reducing leverage to the point that large and small institutions alike are no longer a threat to the economy. Even if we adopt a two-tier approach, with higher ratios for institutions above a certain size.
We need to remember that a fractional-reserve banking system is not an essential requirement of the capitalist system. All that is needed is an efficient intermediary between investors and borrowers. Equity-funded banks proved effective in funding Germany’s industrialization prior to WW1. Islamic banks today follow similar principles. Over-dependence on deposits is the primary cause of our current instability.
via Simon Johnson: Why Are the Big Banks Suddenly Afraid? – NYTimes.com.
FedEx Corp. FDX -0.10% on Tuesday said a sharp decline in manufacturing activity would harm its profits this year, a sign of how declining Chinese output is ricocheting across economies around the world.
The world’s largest air-cargo shipper by revenue said earnings in the August-ended quarter came in below its already reduced expectations.
via FedEx First-Quarter Earnings View Citing Weak Global Economy – WSJ.com.
Wang Qinghai, chief executive of Shougang, one of China’s biggest state-owned mills, says one reason for slowing steel demand is that China is changing its economic development model. “The investment-led mode of economic development isn’t sustainable, so the government is actively lowering the growth rate . . . in order to create space for economic structural adjustment,” he said at a conference in Beijing on Saturday. That adjustment is a painful process, however, and Mr Wang summarises the outlook for the steel industry as “huge production capacity, a bleak market, and meagre profit”.
Housing credit growth is at its lowest level in over 30 years: lower than the dip of the early 1980s and the crash of 1987. The current rate of growth is barely sufficient to match already depressed construction rates for new homes*. The decline should see a gradual softening of housing prices, accelerating if there are any further falls in housing credit growth.
*Housing finance, for both owner-occupied and investor housing, totaled $59.8 billion for the year ended June 2012 according to the RBA, while residential construction — excluding land — was $44.2 billion according to ABS estimates.
