Economic Reporting Review
By Dean Baker
September
6, 2005
In This Issue:
• Outstanding
Stories of the Week
• Greenspan's
Fed Tenure
• Deflation
• Car
Mileage Standards
• Immigrant
Workers
• Germany
• Social
Security
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Outstanding
Stories
of the Week
Payouts Hinge on the Cause of Damage
Jennifer Bayout
New
York Times, August 31, 2005, Page C5
This article examines the extent to which
victims of the hurricane will be covered by insurance policies. It presents data
on the percent of homeowners who have flood insurance in each of the heavily
affected counties. The average throughout the region is far less than 50
percent, which means that a large portion of the losses from the storm are
likely not to be covered by insurance.
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Good News, Bad News: Your Loan's Approved
Eduardo Porter
New
York Times, August 28, 2005, Section 3, Page 1
This article discusses some of the exotic mortgage
instruments that homebuyers are now using to be able to afford homes. In many
cases, these mortgages allow people to make lower payments initially, but will
require that they make sharply higher payments a few years in the future.
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Greenspan’s
Fed Tenure
Greenspan Cites Economic Risks For Consumers
Nell Henderson
Washington
Post, August 27, 2005, Page A1
Rubin Praises Stance Of Greenspan on Deficits
Nell Henderson
Washington
Post, August 27, 2005, Page D1
Greenspan Chides Investors
Edmund L. Andrews
New
York Times, August 27, 2005, Page B1
These articles report on the Federal Reserve Board's annual meeting Jackson Hole Wyoming. This year's meeting is devoted to an examination of Greenspan's tenure as Chairman of the Federal Reserve Board.
The article on Rubin's talk discusses Greenspan's advocacy of President Bush's tax cut in 2001. The article points out that Greenspan supported the tax cuts based on the large budget surpluses that were projected at the time. Greenspan argued that the budget surpluses were too large and would lead the government to pay off the national debt too quickly.
It is important to note that Greenspan was aware of the stock market bubble. The projections showing large budget surpluses assumed approximately $1 trillion in capital gains tax revenue that depended on the market maintaining bubble inflated values. Since Greenspan recognized the bubble, he must have also recognized that the government would never collect these capital gains taxes, therefore, the rationale he gave for supporting the tax cuts was not true.
This article also asserts that Bush administration officials dispute that the tax cuts have played a major role in the contributing to the budget deficit. This is not really a disputable issue. Income taxes (both personal and corporate) now stand at approximately 8.6 percent of GDP. They averaged more than 10 percent of GDP over the last 40 years. If the revenue from these taxes were 10 percent of GDP at present, the deficit would be $170 billion smaller.
Both articles on Greenspan's speech refer to his decision not to directly attack the stock bubble or the housing bubble. The Times article cites Greenspan's claim that bubbles are extremely difficult to recognize. This is not true. In fact, it is only necessary to use basic arithmetic to detect stock or housing bubble. In the case of the stock market, when the price-to-earnings ratio rose above 20, and eventually above 30, it meant that either:
1) investors were willing to hold stock at an extremely
small premium over totally safe inflation indexed government bonds, or
2) investors had reason to believe that profits were going to grow much faster
than any forecasters (including the Fed) were predicting; or
3) there was an irrational run-up in stock prices.
The first two were highly implausible, which meant that it was virtually certain that the market faced a bubble. Only very basic arithmetic is needed to make this assessment.
The Times article refers to Greenspan's claim that the Fed has limited and blunt tools to deal with a bubble, specifically higher interest rates. Actually, the Fed has much more powerful and direct tools. Fed chairmen in general, and Alan Greenspan in particular, enjoy enormous respect in the financial circles. If Greenspan had explicitly laid out the evidence for there being a stock or housing bubble (clearly presenting the data, with accompanying charts) it would almost certainly have caused the markets to respond.
In fact, clear and continued statements by the Fed about the evidence for a bubble could create potential legal liabilities for fund managers who opted to ignore him. Investment fund managers, who control trillions of dollars, are obligated to act in the best interest of their clients. In the event that the market plunged, and they lost large amounts of money for their clients, because they had ignored Greenspan, they would be pressed to explain how they had decided that Greenspan was wrong and that money was best left in the market, in spite of Greenspan's warnings. Since there was no remotely coherent explanation that these fund managers could have offered, many may have been forced to pay substantial damages to their clients. This risk would lead fund managers to take explicit warnings from the Fed Chairman very seriously.
On this point, the Henderson article wrongly asserts that the markets shrugged off Greenspan's warnings about the stock bubble. This is not true. They fell sharply after his 1996 "irrational exuberance" comment, which he then quickly retracted. Over the next four years, by his own account, he was very careful to avoid saying anything coherent about the stock bubble.
Both the Henderson and Andrews article make reference to the "conundrum" that Greenspan has described, whereby long-term interest rates have remained very low, even as short-term rates have risen by 2.5 percentage points. The Henderson article reports that the conundrum is explained by low inflation. Actually, inflation is not especially low - it currently is close to 3.0 percent. Typically, the interest rate on long-term treasury bonds is 3.0-4.0 percentage points above the inflation rate. This implies a long-term Treasury bond rate between 6.0-7.0 percent. Currently, the 10-year Treasury bond rate is close to 4.2 percent.
The Henderson article also attributes low U.S. interest rates to the fact that overseas investors have been putting money into U.S. financial markets. The more obvious explanation is that overseas central banks (mostly the banks of Japan and China) have been buying up long-term bonds. While Greenspan has been trying to raise long-term interest rates indirectly by raising short-term interest rates, the Japanese and Chinese central banks have worked to keep long-term interest rates in the U.S. low, with the goal of sustaining demand for their exports. They act directly in the long-term market by buying up long-term Treasury bonds. Thus far, the monetary policy of the Japanese and Chinese central banks have been more effective that Greenspan's monetary policy, since the long-term rate has actually fallen over the period that he has been raising short-term interest rates.
The Andrews article also notes Greenspan's warnings against erecting trade barriers to protect U.S. jobs against foreign competition. Actually, the United States already has very rigid barriers to protect jobs against foreign competition, although they primarily benefit workers in higher paying jobs, such as physicians, lawyers, economists, and newspaper reporters. For example, in 1997 Congress imposed a quota on the number of foreign medical residents who could enter the country, with the explicit purpose of maintaining high wages for U.S. doctors. This measure alone costs U.S. consumers close to $80 billion a year, approximately $700 for every household.
While employers freely hire undocumented immigrants for less-skilled jobs like custodians or dishwashers, any newspaper or university that acted the same way toward foreign reporters or university professors (many of whom would be happy to work in the United States at a fraction of the prevailing wage) would quickly be shut down by the Immigration and Naturalization Service.
There is no economic theory that shows that protecting
less-skilled jobs hurts the economy, but protecting high-wage jobs helps the
economy, as Mr. Greenspan seemed to imply with his warning.
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Deflation
Greenspan Confident About Successors
Nell Henderson
Washington
Post, August 28, 2005, Page A11
This article reports on the Fed's annual meetings at Jackson Hole, Wyoming. At one point it refers to the risk of deflation, which it describes as "a dangerous drop in the overall price level." There actually is not any economic theory that supports the assertion that a fall in the price level is necessarily dangerous.
The overall price level is constructed by government statistical agencies. It is an aggregation of the prices of hundreds of thousands of different goods and services. At any point in time, many of these prices are rising and many are falling, especially when the inflation rate is very low - the main goal pursued by Alan Greenspan in his tenure at the Federal Reserve Board.
In fact, a falling overall price level does not even necessarily mean that the prices of goods and services are actually falling. The Commerce Department and Labor Department make quality adjustments in assessing price changes. This means that the price that consumers see for a product can be rising every year, even though the government statistical agencies report the quality-adjusted price as falling. (This is exactly what has happened with new car prices, which have been declining in official data for years, even though the average price of a new car has consistently been rising.)
It is difficult to imagine why the economy would be harmed
if a more rapid rate of quality improvements led the statistical agencies to
record a fall in the overall price level. As a practical matter, economies have
had strong growth during periods of falling prices (e.g. the United States in
the 1890s) and very weak growth during periods of rising prices (e.g. the U.S.
economy during the depression).
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Car
Mileage Standards
Rules to Warm Detroit's Heart
Dan Mitchell
New
York Times, August 27, 2005, Page B5
This article discusses new mileage standards put forward by the Bush administration, which would set specific standards for a wide a variety of care and trucks. The article asserts that the old standards, which set overall averages for all of a manufacturer's vehicles, favored foreign producers because they sold more small cars and fewer SUVs and light trucks.
This assertion ignores the point of the regulations. The
purpose is to reduce the country's consumption of gasoline. There is nothing
gained if everyone switches from inefficient small cars to efficient SUVs, if
the net effect is to raise consumption of gasoline. The Bush administration's
guidelines are contrary to the whole purpose of government-imposed mileage
standards.
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Immigrant
Workers
Bush Pledges Action on Borders
Peter Baker
Washington
Post, August 30, 2005, Page A3
This article discusses President Bush's plans to deal with immigrants entering the United States in search of work. At one point it refers to a bill for a guest worker program that was proposed by Senator John McCain. The article reports that the bill would permit "immigrants to work jobs that citizens do not want."
There are no jobs that citizens do not want. In a market
economy, if there is a shortage of workers, then wages rise until the supply
increases enough to meet the demand. Senator McCain's proposal is intended to
keep the wages for certain jobs at levels so low that few citizens are willing
to taken them. This legislation will have a negative impact on the wages of
workers who might have taken these jobs, just as a guest worker program for
journalists or economists, that allowed professionals from developing countries
to work in the United States at a fraction of the prevailing wage, would have a
negative impact on the wages of workers in these occupations.
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Germany
Europe, With Other Woes, Takes Gas Prices in Stride
Mark Landler and Carter Dougherty
New
York Times, September 1, 2005, Page C4
This article reports on the limited impact of higher gas prices in Europe. At one point it asserts that Germany has "double-digit" unemployment. This is misleading. While Germany's official unemployment rate is 11.5 percent, the German government measure of unemployment is different from the U.S. measure. It counts anyone who works less than 15 hours a week as being unemployed. In the United States such a worker would be counted as employed.
The OECD publishes a measure of unemployment that applies
the U.S. methodology. By this measure, Germany's unemployment rate is 9.5
percent. Since the OECD measure is readily available on its website, there is no
reason to use the official government measure in a news story.
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Social
Security
Bush Renews Drive to Overhaul Social Security
Anne E. Kornblut
New
York Times, August 30, 2005, Page A16
This article reports on a speech by President Bush in California in which he pushed his plan to privatize Social Security. At one point it quotes Bush as saying that listeners had to worry about the survival of Social Security for their grand-children.
It is worth noting that all projections show that Social
Security will always be able to pay a higher benefit to future retirees than it
does to current retires. The only way that the survival of Social Security would
be threatened is if Congress voted to dismantle it.
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Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.