Notes made for remarks to the Federalist Society on November 13, 2009 

It’s an honor to be on this panel with all these distinguished people. But I’m afraid I was invited because I’m considered soft on bailouts. That’s a terrible reputation to have. What is it they say about poker? “If you look around the table and you can’t tell who the sucker is, it’s you.”

The case for bailouts is usually systemic risk. You do it, not for the bailout-ee, but to limit the collateral damage, damage to the whole “system.” The case against bailouts is that by saving management and owners from the consequences of their excessive risk-taking or bad decisions, you create moral hazard and encourage similar behavior by others.

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The goods and services trade deficit widened in September, reversing recent improvements. It was good news that both imports and exports increased after a shrinkage of trade resulting from the global contraction. The deficit increased because imports increased more than exports.

Exports or goods and services increased by $3.7 billion to $132.0 billion while imports increased by $9.3 billion to $168.4 billion. The deficit for September increased from $30.8 billion to $36.5 billion, an increase of 18 percent.

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As now, the dollar was in general decline against some currencies during September 2007. The Euro was strong against the dollar; the British pound reached $2 per pound and the Canadian dollar reached 1 to 1 parity with the dollar.

I have always kept track of the U.S./Canadian dollars by comparing the two prices inside new book dust covers. I wrote about this here on October 4, 2007 in a post titled McTeer on Dollars and Books.

Chairman Greenspan’s book, The Age of Turbulence, was released on September 17, 2007, priced at U.S. $35.00 and Canada $43.50. That was a 24 percent difference despite the parity in the exchange markets that month. His publisher obviously didn’t think the parity would hold.

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My recent interviews on CNBC cover the FOMC’s decision and discussion of the dollar. To access my CNBC profile click here. The videos below were filmed November 4th, November 3rd, and October 30th, respectively.

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Credits in the U.S. balance of payments give rise to a demand for dollars. Debits reflect the supply of dollars. Together, they determined the exchange rate for the dollar. So far, so good. Everybody knows that.

Then why is it that virtually all the commentary on the dollar on financial TV and in blogs fails to mention the balance of payments when discussing the dollar? The dollar is considered super-important these days while the balance of payments isn’t considered important enough to mention. That’s like saying the price is important, but supply and demand don’t matter.

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(Not All Details are Bad)

The front page of today’s Wall Street Journal features a useful breakdown of the third quarter real GDP statistics. On the negative side, it shows that the strength in consumption spending benefited from various temporary government programs: primarily cash for clunkers and the first time home buyers’ credit. Those will eventually go away.

Showing imports as well as exports is almost a breakthrough since commentators typically focus only on exports as a positive to GDP growth. The chart showed exports as contributing 1.5 percentage points of the total increase of 3.5 percentage points. Fair enough. But it also showed imports subtracting 2.0 percentage points, making net exports (exports minus imports) a net drag of 0.5 percentage points.

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Much hand-wringing is taking place over the reduction or possible loss of the dollar’s reserve currency status. That’s a bit ironic since the whole concept of a reserve currency is no longer valid in a system of floating exchange rates.

Under the dollar-exchange system established at Bretton Woods, New Hampshire after World War II, countries committed to keep their own currencies in a narrow band around a par value expressed in U.S. dollars. No reserves were needed to offset upward pressure on the domestic currency since the monetary authority could sell their own currencies for dollars in theoretically unlimited amounts. But to offset downward pressure on the domestic currency, a reserve currency was needed to purchase and support the domestic currency. A country’s ability to defend its currency from downward pressure was thus limited by the amount of the currency held in reserve. Since the parity was expressed in dollars, it was convenient to use dollars as the reserve currency.

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We continue to discuss the topics above as separate issues, without acknowledging their interdependence. They are mutually determined as in the solving of simultaneous equations. For example, our budget deficit indirectly, and our current account deficit more directly, affect the dollar exchange rate and the size of our trade deficit (and capital inflow). With China’s trade surplus being the main counterpart to our deficit, its inflow of dollars to China depends more on the size of that imbalance than their desire for dollars over other currencies.

Our national saving—made up of personal, business and government saving—is being supplemented by the foreign capital inflow that finances our current account deficit and helps support domestic investment. The floating dollar adjusts to help maintain the necessary relationships.

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Nonfarm payroll employment declined by another 263,000 jobs in September. According the the Labor Department release, over the recent period . . .

“From May through September, job losses averaged 307,000 per month, compared with losses averaging 645,000 per month from November 2008 to April. Since the start of the recession in December 2007, payroll employment has fallen by 7.2 million.”

As usual, most of the TV commentators gave the impression to their viewers that there was no job creation in September and that there were 263,000 job losses. A typical question was “When are we going to see job creation again?”

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“You can’t spend your way out of recession” is a sound bite heard almost every day on financial TV. Recently a guest commentator combined that sound bite with this one: “You can’t borrow your way out of debt.” Perhaps the second one was intended to divert our attention from the first one. Clever. Perhaps too clever by half.

Of course you can spend your way out of recession, almost by definition. A recession can be defined as a shrinkage of spending and income. More spending is needed to generate more income. Therefore, more spending will do the job.

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I try to keep up, but occasionally it dawns on me that I’ve been missing something. The latest example is the importance being placed on G-20 meetings. I wake up to find that there is to be a debate in Pittsburg on such matters as how much the respective governments should restrict banker pay packages. Apparently, we plan to crack down, but not as much as most others. There will be a debate.

What’s going on here? It’s not just that the debate will be over different degrees of government intervention into areas of business not normally under government jurisdiction. More scary is the idea that we might be morally bound, or even influenced, in such matters by the other 19. I didn’t get to vote for those guys. How did they get a vote on my banker’s pay?

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(The Glass is Half Full; not Half Empty)

The good news that employment declined less in August than in previous months is more important than the bad news of the rise in the unemployment rate. As I've noted here previously, the unemployment rate (from the household survey) had not kept up with employment losses and a convergence was over due. It should not be considered new bad news. The unemployment rate will rise further, even if employment losses continue to decline. One reason is that discouraged workers will come into the labor force as their perceived prospects improve. Keep your eye on employment rather than unemployment as a measure of how the economy is doing.

(I'm Hopeful, but not Convinced)

A Technical Answer

The Business Cycle Dating Committee (BCDC) of the National Bureau of Economic Analysis determined that the current recession began when payroll employment started declining in January 2008. I doubt that they well declare the recession over while payrolls continue to decline, even if we get positive GDP growth in the current quarter, especially if the growth results primarily from an inventory rebound and one-time clunker rebates.

My assessment differs from many talking heads who have gotten used to the idea of a "jobless recovery" based on experience of the last two recessions. Many of them have declared the recession over already, expecting a positive third quarter GDP number, even though they expect employment to decline for several more months. However, I think they've misread recent history.

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A Mixed Blessing

Productivity  surged in the second quarter–up 6.3 percent in the business sector and 6.4 percent in the nonfarm business sector. These were the largest increases since the third quarter of 2003. Rising productivity is a blessing. It's a mixed blessing during periods of high unemployment, however, since the alternative is higher employment.

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The decline in payroll jobs of 247, 000 was a pleasant surprise to most observers, including me. It continues the "less bad is the new good" paradigm, but I'll take it. The negative must get smaller before it becomes positive.

More surprising to me was the decline in the unemployment rate from 9.5 percent to 9.4 percent. Since the unemployment rate-measured by the household survey-had risen only a tenth in June with a fairly large decline in payroll employment, I thought it had some catching up to do.

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My local newspaper this morning showed a picture of a guy standing in a line of job seekers at a Career Expo. He had his cap on backwards.

If, in the unlikely event, he were contacted for the household survey of employment, they would ask him if he had a job. He would say no. Then, they would ask if he had looked for a job in the last six weeks. He could truthfully say yes. He would be classified as in the labor force but unemployed.

Perhaps they should add another question to the survey: "Did you wear your cap backwards when you applied for a job?" If so, he would be classified as not in the labor force, and the number of unemployed would go down by one.

Gross Domestic Product (GDP) and real GDP are generated by total U.S. spending on final goods and services. The U.S. national income accounts use the spending categories of Consumption (C) plus Investment (I) plus Government spending (G) plus Exports minus Imports (X-M). GDP = C + I +G + X – M.

(These categories roughly correspond to the categories Keynes outlined in his General Theory of Employment, Interest and Money.)

The net change in second quarter real  U.S. GDP was a decline of 1 percent at an annual rate. This is down from the 6.4 percent rate of decline (revised) in the first quarter of 2009. The percentage contributions of the main categories of spending to the 1 percent decline in the second quarter real GDP are listed below:
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Some Reminders from Econ 101:

GDP is an estimate of the total value of all final goods and services produced during a year (or in a quarter expressed at an annual rate).

It's the broadest most comprehensive estimate of the value of the total output (and income) produced in the economy.

Estimate. Yes, it's an estimate and would look much like making sausage, but don't worry about that. It's as good as smart people can make it, but, perhaps more important, it's reasonably consistent over time. The consistency makes it useful in the same way that my bathroom scales are, or the calorie count on my exercise equipment. You can measure relative performance without perfection on the level of performance.  

Value. Price is the way we add up diverse elements-the common denominator. A three dollar broom adds half as much to GDP as a $6 hamburger.

(Breakdown of GDP Numbers after the Fold)

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The talks by our Secretary of State and Secretary of the Treasury with the Chinese about U.S. borrowing have once again created some mushy commentary by the talking heads. They speak in terms of how much U.S. debt China will be willing to buy in the short-term and in the long-term.

No one has thought to mention that those amounts depend almost entirely on the volume and balance of trade between the two countries. If the U.S. trade deficit (and Chinese surplus) grows, it will be necessary to borrow more to finance it. If trade shrinks, less borrowing will take place.

If the willingness to borrow changes independently of the financing needs of trade, then the trade will have to adjust. Either way, the two are linked, and it is foolish to talk about them as if there is no relationship at all.

The stimulus plan was designed to fail- not deliberately, probably, but in effect. It reflected priorities other than job creation or preservation, as had been advertized. It was not timely- we're still waiting for most of it to be implemented- and it was not focused. It was scattershot. At the time I likened it to "Shooting Wild Hogs with a Shotgun."

But, let's be fair. The fact that employment has continued to fall and unemployment has continued to rise is not sufficient evidence of its failure. That was already baked into the cake, and I expect those trends to continue for some time even if the stimulus package is working. Unemployment will peak above 10 percent, if not 11 percent.

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