Bernanke As A Deficit Hawk

Craig Torres and Brian Faler writing in "Bernanke Warns Deficits Threaten Financial Stability (Update4)," for Bloomberg on June 3 describe Federal Reserve Chairman Bernanke's most recent comments before the House Budget Committee.  I have bolded several phrases to highlight the Chairman's concern is long term, that deficits, if not dramatically reduced, will affect long term financial stability and economic growth.  Deficit reduction must come from increasing taxes or reducing spending.

Federal Reserve Chairman Ben S. Bernanke said large U.S. budget deficits threaten financial stability and the government can’t continue indefinitely to borrow at the current rate to finance the shortfall.

“Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,” Bernanke said in testimony to lawmakers today. “Maintaining the confidence of the financial markets requires that we, as a nation, begin planning now for the restoration of fiscal balance.”...

...He said the Fed won’t finance government spending over the long term, while warning that the financial industry remains under stress and the credit crunch continues to limit spending...

The budget deficit this year is projected to reach $1.85 trillion, equivalent to 13 percent of the nation’s economy, according to the nonpartisan Congressional Budget Office.

“Either cuts in spending or increases in taxes will be necessary to stabilize the fiscal situation,” Bernanke said in response to a question. “The Federal Reserve will not monetize the debt.”...

Rising government spending, forecasts for a record fiscal deficit and an unprecedented expansion of central bank credit have also fueled investor concerns that inflation will rise. Bernanke said inflation “will remain low” as the economy operates with slack resource use.

I have a modest suggestion for cutting spending now.  Recent improvement in economic conditions is not a result of February's emergency $787 billion stimulus package.  As Russ Robert reports at Cafe Hayek, only $36.7 billion of the stimulus has been spent.  Take President Clinton's budget director Alice Rivlin's advice and divide the stimulus into immediate stimulus measures and long term transformative spending.  Take more time examining the transformative spending.  Most if it can be cut.  Rivlin's advice is not draconian as it would preserve much of the stimulus, but acknowledges weaknesses of fiscal policy: it crowds out private investment lowering long term economic growth, is slow to evolve, and almost always results in wasteful spending.  
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GM and Mixed Public-Private Ownership

Regular readers know that I prefer private ownership to public.  Markets are simply better at providing goods and services.  Unlike many writers, bloggers or otherwise, I do not believe that President Obama is a skulking socialist despite his mounting zealous interventions into markets.  Those who oppose his policy might extend their economic vocabulary of economic systems to better describe its weaknesses.

In a past blog post, I gave a partial defense for temporary nationalization of weak banks, arguing that this would be preferable to public-private ownership.  Briefly, I believe that the partial nationalization of GM is worse than the nationalization of a bank like Citibank because public-private ownership confuses institutional goals, and because the market structure of the auto industry is less competitive than the banking industry, increasing the probability of opportunistic behavior. 

Yesterday, the U.S. (60%) and Canadian (12%) governments, the United Auto Workers (17.5%) and previous bondholders (10%) became the owners of General Motors.  Because the ownership is mixed, the goals that the firm pursues will be unclear.  The government may try to produce environmentally friendly cars they believe are in the public interest.  The union may try to improve wages or other member benefits.  The former bondholders will want profits.  To produce environmentally friendly cars that do not maximize profits, the government may supplement profits with payments from taxpayers, or they may limit foreign competition.  Innumerable opportunities to circumvent market mechanisms exist.

The market structure of the auto industry compared to the banking industry increases the probability of opportunism by any of the owners.  There are simply few competitors making opportunism easier.  In a Wall Street Journal article titled, "Obama Motors Co." dated June 2, 2009, the authors give examples of conflicting goals and opportunistic behavior by the government to achieve its goals by weakening market mechanisms.

The Obama administration continues its campaign against bondholders. 

Every decision the feds have made since December suggests that nonpolitical management will be impossible...Treasury bludgeoned the bond holders in both Chrysler and GM to take pennies on the dollar, which will not make creditors eager to lend to the companies in the future.

Combating global warming and increasing energy security, two stated goals of the Obama administration, take a back seat in a small vehicle to the UAW, part of big labor, and major Obama campaign contributor.

There's also the labor agreement that the UAW approved last week, which goes some way toward reducing costs but probably not enough to make the new, smaller GM competitive. The new agreement simplifies some work rules and job descriptions but makes no reductions in hourly pay, pensions or health care for active workers. The agreement must also be renegotiated in two years by an Obama Administration running for re-election and weighing the need to keep Big Labor happy against the risks to taxpayer-shareholders. Who do you think wins that White House debate?

The Administration's concessions to the UAW also restrict the company's ability to import smaller, more fuel-efficient cars that it already makes overseas. UAW President Ron Gettelfinger boasted on PBS's "NewsHour" last week that "we, quite frankly, put pressure on the White House, the [auto] task force, the corporation" to bar small-car imports from overseas. GM is also selling its Opel operation in Europe as part of this restructuring, and the Washington Post reports that one of Treasury's sale conditions is that Opel's new owners must stay out of the U.S., and even out of China, where GM's business is strong.

  The Obama administration would exempt itself from antitrust rules it claims to value.

This is raw trade protectionism. It is also textbook cartel behavior and would be an antitrust violation if practiced by a business. But the benefits for GM are illusory because the import limits mean the company will have to spend even more to retool its domestic plants to make the little green cars that President Obama and Congress are demanding. No one knows if Americans will buy such cars, even if GM can make them competitively in the U.S.

Congress will also exert ownership control. 

The Administration promises to wield a light ownership hand, but it's only a matter of time before Congress starts to micromanage GM's business judgments. Every decision to close a plant will be second-guessed, much like a military base-closing. And what about buying parts from foreign suppliers? Will those also be banned when Mr. Gettelfinger demands it, even if the costs are lower? GM's managers and directors will have one eye on enhancing shareholder value, but the other on pleasing their political minders in Washington.

The larger corruption will be when government tries to vindicate its ownership by favoring GM over Ford and the other auto makers that aren't wards of the state. The TARP legislation contained one blatant example in the form of a $7,500 tax credit for consumers who buy GM's new electric car, the Chevy Volt. Expect more such favoritism, including huge new subsidies for green cars if consumers prove resistant to their charms.

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Priest on Obama Administration's Antitrust Policy

Christine Varney, the Assistant Attorney General for Antitrust in the Obama administration recently outlined plans for greater enforcement of antitrust laws.  George Priest who teaches antitrust law at Yale University, dissented from her conclusions in a Wall Street Journal opinion article titled, "The Justice Department's Antitrust Bomb." dated June 2, 2009.  As always, the entire article is well worth reading.  I have selected a few quotes that I believe illustrate Priest's reasoning.

Assistant Attorney General for Antitrust Christine Varney claims that the Justice Department can aid economic recovery by prosecuting businesses that have been successful in gaining large market shares. In her announcement last month she argued that "many observers agree" that our current recession reflects "a failure of antitrust" and "inadequate antitrust oversight."

This is news to most economists. The cause of the recession is not easy money by the Fed, or the bursting of the housing bubble, or excessive risk-taking through complicated financial instruments? It's insufficient antitrust prosecution? The claim is hardly plausible. Prosecuting successful businesses will help the recovery? Again, hard to believe.......Her basic proposal is to transform American antitrust law to more closely resemble that of Europe. She states that American antitrust policies have "diverged too frequently" from those of the Europe, and that "[w]e will focus our efforts on working through our previously divergent policies regarding single-firm conduct and pursuing vigorous enforcement on the [monopolization] front."

This is a huge mistake. The principal reasons American and European approaches to antitrust diverge are that the operative legal standards are different and that the Europeans have not adopted a tradition of rigorous economic analysis.

U.S. antitrust laws condemn practices that are "in restraint of trade," which has been interpreted to mean harm to competition. The European Union, in contrast, condemns practices that constitute "abuse of a dominant position."

The European emphasis on "dominance" has consistently led to confusion. A good example is the way the proposed GE-Honeywell merger was treated in 2001. It was uncontested both in the U.S. and in Europe that the proposed merger would create economic efficiencies, lowering product costs to the benefit of consumers. In the U.S. this was reason to approve -- if not applaud -- the merger. But in Europe the expected cost savings would make the merged firms even more dominant. The EU blocked the merger, to the harm of U.S. and European consumers.

Another example is the recent $1.45 billion fine levied by the EU against Intel. Although the EU has not released its full report documenting what violations it found, it appears that the principal concern was Intel's practice of giving "loyalty discounts" to repeat customers, presumably increasing Intel's dominance in the microprocessor business...

[T]he fact that it has been able to maintain roughly an 80% market share for decades provides strong evidence that it is producing a valuable product. The antitrust questions with regard to dominant firms should be: What is the source of dominance and how has it survived over time?

The EU complaint claims that Intel has practiced a variation of predatory pricing. As is well-established in U.S. law, predatory pricing claims are highly questionable in the intellectual property field. Although the EU competition unit has added economists to its staff since GE-Honeywell, its antitrust theories are roughly 30 years behind those in the U.S.

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Overselling Global Warming

Lydia Saad, writes for Gallop in "Increased Number Think Global Warming Is “Exaggerated” (March 11, 2009) that,

PRINCETON, NJ -- Although a majority of Americans believe the seriousness of global warming is either correctly portrayed in the news or underestimated, a record-high 41% now say it is exaggerated. This represents the highest level of public skepticism about mainstream reporting on global warming seen in more than a decade of Gallup polling on the subject.

Perhaps its stories like "Global warming of 7C 'could kill billions this century'," by Louise Gray in the Telegraph create the skepticism. 

Global temperatures could rise by more than 7C this century killing billions of people and leaving the world on the brink of total collapse, according to new research.

The study, carried out in unprecedented detail, projected that without "rapid and massive action" temperatures worldwide will increase by as much as 7.4C (13.3F) by 2100, from levels seen in 2000...

Friends of the Earth climate campaigner Tom Picken said that if the new research by MIT is accurate the results for the planet would be catastrophic.

Or perhaps it is Congress using catastrophic climate change as the pretext for enacting legislation to pass taxpayer dollars to special interests like biofuels producers that create the skepticism.  Ted Gayer explains in "Lose-Lose on Biofuels?," published in The American describes the economic and environmental impact of the legislation.

The Environmental Protection Agency recently released its analysis of the renewable fuel standard enacted by the Energy Independence and Security Act of 2007. The standard requires 11.1 billion gallons of renewable fuel to displace petroleum fuel in 2009, ratcheting up each year until reaching 36.0 billion gallons of renewable fuels by 2022. There are separate volume requirements for advanced biofuels, cellulosic, and biodiesel.

Forcing the market to produce large amounts of renewable fuel will harm consumers in two ways: it will increase prices at the pump, because biofuels are more costly than gasoline, and it will drive up the price of food, because it diverts crops into fuel. The impact of food price inflation will weigh most heavily in developing countries where food purchases comprise larger shares of consumption. Food expenditures account for as much as 70 percent of household consumption among lower income groups in the developing world.

The direct economic impact is bad enough, but the environmental impact is the kicker. 

An article published in Sciencemagazinein 2008 found that “corn-based ethanol nearly doubles greenhouse gas emissions over 30 years and increases greenhouse gases for 167 years.” Another article in Scienceconcluded that crop-based biofuels create a “biofuel carbon debt of 17 to 420 times more carbon dioxide than the greenhouse gas reductions that these biofuels would provide by displacing fossil fuels.”

Gayer provides a little ameliorating information about other biofuels that perform better, but even in a best case scenario, carbon reductions would not occur until the world passes the "tipping point" described in the worst case scenarios. 
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The Obama Administration and GM

The Obama administration has been the de facto owner of GM for some time, firing GM CEO, Richard Wagoner, hiring the new CEO, Fritz Henderson, broadly determining the new marketing plan and restructuring debt.  Through bankruptcy proceedings, the courts are making the federal government the de jure as well as de facto owners.  Peter Whoriskey, Kendra Marr and William Branigin of the Washington Post ("Obama: GM Restructuring Plan 'Full of Promise'," June 1, 2009) report President Obama comments on the bankruptcy filing.  

In a speech at the White House hours after GM filed for Chapter 11 bankruptcy protection in New York, Obama hailed GM's plan to emerge from its current woes as "credible" and "full of promise." But he also sought to reassure Americans skeptical about the plan's provisions to transfer a 60 percent ownership stake in the company to the U.S. government in return for an additional investment of about $30 billion during and after the bankruptcy process. The new infusion of cash will bring the total U.S. commitment to GM to about $50 billion.

"We are acting as reluctant shareholders, because that is the only way to help GM succeed," Obama said. "What we are not doing -- what I have no interest in doing -- is running GM."

Steve Rattner, head of Obama's auto task force also affirmed the government's desire for limited decision making saying that the government would be passive owners (Jim Puzzanghera. "U.S. role at GM to be passive, Obama vows,"  Los Angeles Times, June 2, 2009).  While past performance is no guarantee of future results, it often is illustrative.  I hope but doubt that government funding of GM is at an end as well as its intrusion into management.  The Obama administration should avoid mixed public-private ownership because there is ample evidence that this structure is problematic in the auto industry.  Ion Mihai Pacepa, the highest ranking Soviet bloc official granted political asylum in the U.S., and the author of the memoir "Red Horizons," was Romanian dictator Nicolae Ceausescu's "Car Czar."  He describes several unsuccessful government attempts to product cars, including his own which I quote below.

Ceausescu tasked me to mediate the purchase of a minimum, basic license for a small car from a major Western manufacturer, and then to steal everything else needed to produce the car.

Three Western companies competed for the honor. Ceausescu decided on Renault, because it was owned by the French government (all Soviet bloc rulers distrusted private companies). We ended up with a license for an antiquated and about-to-be-discontinued Renault-12 car, because it was the cheapest. "Good enough for the idiots," Ceausescu decided, showing what he thought of the Romanian people. He baptized the car Dacia, to commemorate Romania's 2,000-year history going back to Dacia Felix, as the ancient Romans called that part of the world. In that government-run economy, symbolism was the most important consideration, especially when it came to things in short supply (such as food).

"Too luxurious for the idiots," Ceausescu decreed when he saw the first Dacia car made in Romania. Immediately, the radio, right side mirror and backseat heating were dropped. Other "unnecessary luxuries" were soon eliminated by the bureaucrats and their workers' union that were running the factory. The car that finally hit the market was a stripped-down version of the old, stripped-down Renault 12. "Perfect for the idiots," Ceausescu approved. Indeed, the Romanian people, who had never before had any car, came to cherish the Dacia.

For the Western market, however, the Dacia was a nightmare. To the best of my knowledge, no Dacia car was ever sold in the U.S.

I hope that we can avoid the fiascos described by Pacepa; taxpayers are already on the hook for tens of billions.  Mitt Romney suggests a plan that would limit taxpayer losses ("Gordon Trowbridge. "Romney balks at government ownership of GM," The Detroit News, May 31, 2009).

The Obama administration and the United Auto Workers should immediately distribute their stock in a restructured GM to American taxpayers, former...presidential candidate Mitt Romney said Sunday.

I would be happy if the the government and the UAW sold their shares in monthly prescheduled blocks of ten percent beginning in January 2010. 
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Red Ink Outlining His Carbon Footprint

(HT Drudge) President Obama kept a promise of a night on the town to his wife this weekend, apparently on the American taxpayers' dime.  Charles Hurt and Stefanie Cohen describe the promise and the date ("Obama Keeps His Big Apple Pledge," New York Post, May 31, 2009).

"I am taking my wife to New York City because I promised her during the campaign that I would take her to a Broadway show after it was all finished," the president said yesterday after touching down at JFK for an intimate night on the town.

By the way, did anybody calculate the Obama's carbon footprint for the night?

Taxpayers footed the bill for the big night on the town, which included a total of at least $24,000 for the three aircraft used to ferry the Obamas, aides and reporters to New York and back. Dinner costs and orchestra seat tickets -- at $96.50 apiece -- were paid by the Obamas.Obama's jet, a Gulfstream 500, served as a more modest Air Force One for the day in place of the customary presidential Boeing 747.

The White House declined to say how much the trip was costing taxpayers.

Is a night on the town worse than a weekend at the Crawford ranch?  Of course not, but a little modesty by a president ready to micro manage our lives would be nice.  A president preparing a cap and trade program to curtail our carbon footprint could easily be tracked from Washington to Broadway by following his.  A president who lectured American consumers and business for their profligacy spending painted the town red using only a drop in an ocean of red ink from his own deficit.  I found the night on Broadway, tone deaf.
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Obama Administration Concerned About Deficit?

Treasury Secretary Timothy Geithner is in China to reassure them that the Obama administration will work hard to close the budget deficit.  Rebecca Christie, "Geithner Tells China U.S. Will Tackle Budget Deficit (Update2)," (Bloomberg, June 1, 2009) describes the trip.

Treasury Secretary Timothy Geithner told China that the U.S. wants to shrink its budget gap as soon as an economic recovery takes hold, reassuring the nation that is the biggest holder of U.S. government debt.

The U.S. goal is a deficit of “roughly 3 percent” of gross domestic product from a projected 12.9 percent this year, Geithner reaffirmed today in a speech in Beijing...

The U.S. will need to phase out the tax cuts and bank rescue programs set up to help the economy recover from a deep recession, Geithner said. Spending cuts also will be needed, along with health care reform and new budget constraints like pay-as-you-go rules.

I have a hard time believing that the Obama administration has come to grips with the size of the deficit or that the deficit is deemed a major problem.  In the third paragraph that I quoted, Geithner refers to health care reform as a method of reducing the deficit.  A good, short Washington Post article, "Health Reform's Savings Myth," May 31, 2009, lists several reasons why it will do just the opposite (HT Mankiw).  I quote just one.

"Health-care reform is entitlement reform" has become a mantra of the Obama administration. The idea is that Congress can add a massive health-care program this year -- covering the uninsured -- and use the same measures that pay for the health reform to fix the broader budget problems. If that sounds too good to be true, there's a reason.

...It's true that Congress doesn't much like all-pain-and-no-gain policies. But the administration's proposal, even before Congress gets to work, is to spend $100 billion more on coverage while finding cost-saving measures worth only about a third as much. Another third would be paid for by tax increases. The last third, so far, isn't paid for at all. That's three times as much sweetener as medicine, in other words -- and Congress will be tempted to jettison some of the savings and all of the tax increases.

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