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.

In most of the so-called bailouts during the Panic of 2008—bunched together in September 2008—the decision-makers were not saved or rescued. Top management, directors and stockholders generally lost their jobs and much of their wealth, and were maligned in Congress and by the press.

They didn’t benefit from a “heads I win, tails you lose” proposition. They had won for a while; then they lost.

Future decision makers under similar circumstances will remember both sides of that coin and not want to go there. Public humiliation is not something you want to emulate.

Mr. Paulson, in fact, seemed eager to fire people at the top who had done no wrong specifically so that he could not be accused of creating moral hazard. The CEOs of Fannie and Freddie were following policies mandated by Congress and were not the same CEOs in place during the earlier accounting scandals. I believe the fired CEO of AIG had been on the job only a few months. And Ken Lewis of Bank of America has learned that no good deeds go unpunished.

Moral hazard did get us into this mess. The making and securitizing of subprime mortgage loans and selling those mortgage bonds all over the world was the mother of moral hazards, since mostly independent unregulated mortgage brokers made the credit decisions and unsuspecting owners of the bonds—misled by their AAA ratings—bore the risk.

Many pundits who were saying “let ‘em fail,” “let ‘em fail” later said letting Lehman Brothers fail was the biggest mistake of the crisis. I tend to agree.

There were a lot of tall dominoes, standing close together. I’m not sure the system could have survived many other failures like Lehman’s, which cost me about 40 percent of my little portfolio.

Given time, I’m sure the Treasury’s TARP program could have been better designed and executed, but under the circumstances I think it’s working pretty well for almost 700 banks caught holding mortgage-backed securities and other assets no longer trading. We only hear of the top nine or the top 19.

I won’t try to defend TARP’s use outside the financial system or the way Congress has used it to fan and pander to our worst populist instincts, to demonize bankers, and as a pretext to expand government power, violate contracts and private property rights. It has been shameful.

The public, egged on by politicians, regards TARP as the Government spending their money to support “evil doers.” Most people have no idea that the Treasury will be able to sell its preferred stock and warrants received from banks, likely at a profit.

There will be losses here and there, on individual transactions and banks, but, overall, I won’t be surprised if taxpayers come out ahead net. The Treasury has earned about 18 percent on the banks that left the program early.

The Federal Reserve’s extraordinary lending last year and security purchases this year are even more likely to earn a net profit for taxpayers. The Fed generally turns over about 90 percent of its earnings to the Treasury’s general fund. Those earnings are rising significantly with the expansion of the Fed’s balance sheet, and those earnings will benefit taxpayers. Even the individual losses here and there, to the extent there will be any, would not be a loss of existing money, but only a loss of the new money created by the transaction—an opportunity cost loss.

Skeptics make much of the Fed’s expansion of bank reserves and money and take it for granted that it will be highly inflationary. Possibly, but I doubt it.

New money must be spent before it can cause inflation. Banks are holding most of their new reserves idle as excess reserves because they are scared to death. And the public has similarly reduced the velocity, or turnover, of money sharply. With the velocity of money collapsing, and credit shrinking, rapid money expansion has not been inflationary. So far, rapid money growth has been needed to forestall deflation.

Despite some pick-up lately, both the Consumer Price Index and the Producer Price Index remain below year-ago levels. Prices for the year are down, not up.

The trick for the Fed will be to adjust money growth as velocity returns toward normal—the exit strategy.

Chairman Bernanke’s study of the Depression has convinced him that tightening monetary policy prematurely is a greater danger than tightening too late. Most pundits on financial TV seem to assume the opposite.

During the Depression the Federal Reserve increased reserve requirements on banks to “mop up” banks’ excess reserves. The banks reacted by contracting credit further. It turned out that the reserves were not considered excess by the banks themselves. They wanted an extra cushion against uncertainty.

Today, the pundits are urging the Fed to make the same mistake—to “mop up’ excess bank reserves before they are used for loans and investments that might create inflation. But the banks are holding those excess reserves voluntarily—for the same reasons they did during the depression, as precautionary balances. Just because they may be excess reserves in a regulatory sense doesn’t make them excess in a more real sense.

While I give passing marks to the Treasury’s capital injections into banks and to the Fed’s direct and indirect lending, I put the massive stimulus program on the other end of the spectrum. It reminds me of hunting wild hogs with a shotgun rather than a rifle. There is a lot of firepower, but it’s diffused–not focused enough. It has probably prevented some layoffs at the state and local levels, but at a huge cost in money, deficits, and debt.

The Fed made loans and the Treasury made investments. The stimulus program, however, was old-fashioned spending. Money spent, money gone.

The deficit as a percent of GDP has tripled and outstanding debt is headed above its recent level of about 40 percent of GDP.

Instead of targeted marginal tax-rate cuts to stimulate the private sector, we face the prospects of repeating a huge mistake made during the depression—raising taxes in a weak economy. Not only the expiration of the Bush tax-rate cuts, but also additional taxes to finance new government programs.

In the 1937-38 period during the depression, the government raised taxes to finance new government programs already put in place. They wanted to balance the budget. We face the prospect of new taxes for existing programs and new programs yet to come.

Another negative feature of the Depression that we seem to be copying is class warfare against business leaders. How that is supposed to help anything is a mystery to me. But, to my knowledge, even Roosevelt didn’t think to have a pay czar.

Another depression-era mistake we’re in danger of repeating is protectionism. We haven’t gone as far as the Smoot-Hawley tariff increase yet, but we are on a slippery slope in that direction, with the violation of the NAFTA agreement on Mexican trucks, tariffs on Chinese tires, and buy-American policies spread all over the stimulus bill.

Will we ever learn?

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.

The cause of the deterioration is not obvious. Normally faster growing imports than exports would reflect faster U.S. growth than our trading partners. That isn’t the case with our Asian trading partners, especially China. They have been growing faster.

The answer may lie in capital flows that mirror trade flows and can be the driving force rather than just the passive financing of trade. In other words, the trade deficit may be “financing” an increase in net capital inflows rather than the other way around.

This explanation is consistent with what I’ve suggested before–that more net capital inflows (and thus larger trade deficits) may be necessary to make up for the shortfall of domestic saving in financing domestic investment. With huge increases in government dissaving in the form of larger and larger budget deficits, national saving is shrinking. That means either domestic investment has to fall to match lower saving, or more foreign saving will be necessary to supplement domestic saving.

This explanation is plausible, but nonintuitive. Among  other things, it suggests that we have to have a larger external deficit because of our larger budget deficit. The positive side of that is that a shrinkage of the budget deficit would help on two fronts: it would help finance and sustain domestic investment and would also help reduce the external deficit and accumulation of U.S. debt by our trading partners.

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.

The Prince of Darkness by Robert Novak had come in with a little earlier with a 27 percent difference. Other books I bought around that time had a similar premium on the dollar, the lowest being 21 percent.

With dollar weakness again in the news, I’ve done a bit of empirical research on my recent purchases. A Colossal Failure of Common Sense, The Inside Story of the Collapse of Lehman Brothers by Lawrence G. McDonald and Patrick Robinson is priced at $27.00 U.S. and $33.00 Canadian. That’s a 22 percent premium for the U.S. dollar, in line with two years ago.

In Fed we Trust by David Wessel is priced at $26.99 U.S. and $33.99 Canadian. That’s a 26 percent premium, still in the middle of the range of two years ago. So was Glenn Beck’s, Arguing With Idiots, (a gift) at 23 percent–$29.99 U.S. and $36.99 Canadian.

This Time is Different, Eight Centuries of Financial Folly, by Carmen M. Reinhart & Kenneth S. Rogoff was a gift from my son who was vastly overestimating my scholarship and patience. Speaking of patience, Ken Rogoff and I once spent a week in London one afternoon visiting financial firms there. He was a delightful guy and great company for a professor at a school that doesn’t have a good football team. Anyway the publisher of Ken’s book apparently punted on the exchange rate question. The price was $35.00 U.S. with no Canadian price listed. I’d better not speculate, so that’s all I have to say about that.

Hold on. Stop the presses. I just bought Charles Gasparino’s The Sellout. Same thing: A USA price of $27.99 with no Canadian price.

Do I have to have a conclusion?  What about “The dollar hasn’t really lost any value in the last two years in terms of books, but some publishers are backing away.”

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.

Instead, a strong dollar is treated as both the evidence of U.S. economic strength and a major cause of it. A weak dollar reflects and causes economic weakness. This relationship is either taken as self evident or is based on historical periods when the economy and the dollar were strong together or weak together. Unfortunately, these conclusions are the opposite of what economy theory teaches.

Other things equal, a primary result of an exogenous weakening of the dollar is an increase in foreign demand for U.S. exports, since they are now cheaper in terms of foreign currencies. A weaker dollar also makes foreign exports (U.S. imports) more expensive in dollar terms. Therefore, the weaker dollar will stimulate U.S. exports and depress U.S. imports. This increase in net exports (U.S. exports minus imports) adds to total spending as measured by GDP. If GDP is at recession levels, a weaker dollar helps pull us out of recession.

I don’t deny that many other economic variables have an influence on these relationships. However, the relative price change brought about by changes in the exchange rate are considered dominant among economists who study the matter.

The positive jolt to domestic GDP caused by a depreciating home currency is well known all over the world. That is why during a global slump such as we are in today we have to guard against competitive devaluations where each country tries to boost its economy through depreciation or devaluation which has the opposite effect on its trading partners. The term of art is “beggar thy neighbor” policies, sometimes called “beggar my neighbor” policies.

While the competitive advantages of currency depreciation are widely understood around the world, most of the talking heads on financial TV seem to believe that the opposite is true for the United States. They imply that a stronger dollar will lead to a stronger economy and a stronger economy will lead to a stronger dollar.

Apparently forgotten is the pressure U.S. officials put on China in the not-too-distant past to let the yuan appreciate, which would effectively depreciate the dollar against the yuan. I wasn’t in favor of pressuring China on that point, but at least those who did understood that a more expensive yuan and less expensive dollar would help restore more balance to trade between those countries. Today’s proponents of dollar appreciation are pulling in the opposite direction. It is amazing to me that China has completely turned the tables on us by arguing that it is us with the weak currency while touting their own artificially weak currency (roughly pegged to the dollar and protected also by exchange controls) as a potential reserve currency.

I’m changing focus now. Pay attention.

While a weaker currency helps a country pull out of a recession, a strong currency is beneficial if there is no recession, or shortage of aggregate demand. A strong currency relative to those of your trading partners helps consumers by making imported goods and services cheaper in the domestic currency. The added competition from imports also lowers the price of many domestically produced goods and services. A strong currency puts pressure on producers, exporters, and potential exporters to remain competitive, which isn’t always possible. Businesses may fail and jobs may be lost.

A strong currency generally harms producers and exporters. To repeat: a strong currency generally helps consumers and harms producers.

So, how do you choose which group to help?

The answer is you don’t. Under our system of market-determined exchange rates, the rules-of- the-game call for hands off. Keep the float clean, not dirty. Government tinkering with a floating currency opens it up to intense lobbying by pressure groups that is best avoided.

In the quandary of whether to favor consumers or producers, importers or exporters, a couple of points should help. One is no matter what we do for a living, we are all consumers. Even those harmed as producers will be helped as consumers. Another question to ponder is this: Who is an economy for, consumers or producers? I think the answer is consumers. This is similar to the question, do we work to eat or eat to work? Or, do we import to export or do we export to import. I think the unstated consensus in a democracy is we work to eat and we export to import. Consumption is the end; production is the means. A more totalitarian government, like China, is usually tempted toward mercantilism, which includes a higher priority on exports than imports.

So, my conclusion is there is a strong argument to be made for a strong currency. It just doesn’t apply in the midst of a deep recession when the main problem is inadequate aggregate demand. Many people who don’t acknowledge that are, in my opinion, trying to avoid sounding “Keynesian.”

I’ve said this many times before. My position on a strong dollar is similar to St.Augustine’s position on chastity in his famous prayer: “Lord, make me chaste, but not just yet.” My prayer is, “Lord give us a strong dollar, but not just yet.”

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.

It’s important to remember that imports are a subtraction from U.S. GDP numbers because the various categories of spending listed have import components that generate income abroad rather than at home. Imports are subtracted to prevent over counting in those other categories.

A very positive detail is the contribution of inventory investments. Inventories have been drawn down in recent quarters, and I was expecting a boost from some rebuilding of inventories in the third quarter. Instead, the boost came from a slower liquidation of inventories than in the previous quarter rather than a rebuilding. (A smaller minus has the effect of a plus.) The reason this is so positive, in my opinion, is that the rebuilding of inventories and its boost to GDP is still in our future. It will likely boost the fourth quarter GDP number; if not, the first quarter. It’s an ace in the hole.

I find it disconcerting that everyone seems to equate an increase in the GDP number as an end to the recession even though everyone expects employment to continue falling for some time. Falling employment is hardly consistent with a recovery in my book.

One might think me a killjoy for raining on the recovery parade, but I do believe too much positive spin on current numbers sets us up for disappointment in the near future. The stock market, in particular, swings up and down on exaggerated news spin. More realistic interpretation of incoming economic data might help the stock market have a slower, but more sustainable, increase.

But just to be clear: a 3.5 percent increase in the third quarter is a good thing.

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.

The U.S. commitment was to peg the dollar to gold at a rate of $35 per troy ounce by standing ready to buy or sell gold at that rate with foreign central banks or Treasuries. (That official rate was later changed to $42.22 when we devalued the dollar.) Other currencies were pegged to the dollar by exchange-market intervention while the dollar was pegged to gold the same way. Therefore, all currencies were indirectly tied to gold.

Under the “rules of the game,” a country’s policymakers were supposed to follow policies similar to what would happen automatically under a pure gold standard. If their currencies came under upward pressure, they should permit domestic economic expansion and/or inflation to correct the imbalance. Downward pressure on the domestic currency should prompt a policy tightening to correct the underlying imbalance while dollar reserves were used in the meantime to defend the peg.

Theoretically, the Bretton Woods arrangement was supposed to simulate a real gold standard where inflows or outflows of gold were allowed to raise or contract the domestic money supply. That was easier to do when domestic expansion was called for. Expansion is fun. It was less easy when contraction was called for. It was common for countries to “sterilize” the gold outflows and counteract their impact on the domestic economy.

In the early postwar period, and the early years of the Bretton Woods system, the world was starved for dollars and most countries gladly accumulated dollars in their reserves. This was a sweet deal for the United States because it meant we could buy real goods and services on world markets and pay with money unlikely to be redeemed in gold.

Over the years, however, the world accumulated as many dollar reserves as it needed and increasingly wanted to exchange some of them for gold, which they had the right to do. The United States, however, was not eager to lose gold; so it pressured its trading partners to continue holding dollars without demanding gold. “You don’t really want gold, do you?”

The dollars had been supplied to the world through deficits in the U.S. balance of payments and comparable surpluses by our trading partners. From our viewpoint, having the dollar used as the reserve currency was like playing poker with IOUs that the other players were willing to accept during the game and did not present for “redemption” after the game was over. (“There’s time enough for counting with the dealing’s done.” Kenny Rogers)

Eventually, the accumulated U.S. deficits had supplied more dollars than our trading partners wanted to hold. At the same time, U.S. policymakers did not want to follow the rules of the gold standard game and tighten policy to improve the balance of payments. So, President Nixon broke the last link between the dollar and gold in 1971 and we went on a system of floating exchange rates.

Under floating exchange rates, the exchange rate itself is supposed to trigger the internal economic adjustments necessary to restore and maintain equilibrium rather than changes in domestic policy. The rule of floating exchange rates is to let the market determine the exchange rate without policy interference. Let the float be clean. Policies to influence the exchange rate would dirty the float and would be considered inappropriate.

With no pegged exchange rate to defend, and with sporadic intervention considered inappropriate, there is no need for a reserve currency. Reserve currencies are a feature of fixed exchange rates, not floating rates.

Part of the angst over the potential loss of the reserve currency status of the dollar is really over the use of the dollar as a transactions currency in much of the world and in certain markets, particularly the oil market. There is now a long-standing tradition of pricing oil in dollars even if the United States is not a party to the trade. That means that a decline in the exchange value of the dollar makes oil effectively cheaper—good for buyers, bad for sellers. Of course, what has been happening is that oil sellers raise the nominal price of oil to offset the decline in the value cause by dollar depreciation. This peculiar relationship does not apply to most other commodities.

Pricing goods in dollars is a separate issue from the use of the dollar as a reserve currency.

Our reserve-currency equivalent is gold, which to my knowledge is setting in Ft Knox, on the books at $42.22 per ounce, the last official pegged price before the link was cut. And you thought all the gold was in a bank in the middle of Beverly Hills in somebody else’s name!

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.

China has absorbed fewer dollars lately because our trade deficit has shrunk as reduced domestic demand has reduced our demand for imports more than reduced foreign demand has reduced the demand for our exports. China’s dollar holdings are influenced by everything that affects our trade deficit and capital inflow, including our budget deficit, along with personal and business saving.  Those holdings aren’t independent of these complex relationships.

If any category of our national saving increased, other things equal, our current account deficit would tend to shrink. An appreciating dollar would likely be part of that adjustment process. So, more personal saving, more business saving, or more government saving (a smaller deficit) would all tend to strengthen the dollar. Conversely, a reduction in those categories by our trading partners would have a similar effect.

One caution: if the government increases its deficit to increase transfer payments, which get saved by the recipients, there is no increase in national saving. The greater government dissaving offsets the greater personal saving.

Everyone would be happier campers if we saved more domestically and China and other trading partners would consume more and save less domestically. This would indirectly reduce the trade imbalances and the comparable capital flows and ease the downward pressure on the dollar.

Of course, government saving is tax revenue minus government expenditure; so more government saving could occur either through less spending or more tax revenue. Note that I said tax revenue, not tax rates.

Under those circumstances the dollar would be strengthened by the fundamentals. Attempts to support the dollar without the underlying support of the fundamentals would be like moving the dial on a thermometer without changing the temperature.

“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?”

The truth is that there were many jobs created in September and in recent months. It’s just that there were more jobs lost. The numbers we get are the net differences between significant numbers of gross job gains and gross job losses. These gross gains and losses are many times the net difference. This detail is worth keeping in mind lest we get the false impression that our dynamic ever-changing and evolving economy is stagnant.

The Bureau of Labor Statistics, in addition to the net changes in jobs, publishes a data series called Business Employment Dynamics. It shows the gross changes that make up the net changes. Unfortunately, the gross changes are published with a lengthy lag.

When I checked on this a couple of years ago before the dramatic declines began, I found that the monthly gross job gains and gross job losses were very roughly 2,400,000 each per month. On average, and very roughly speaking, the net gains would be about that much above 2,400,000 and the net losses would be about that much below 2,400,000.

I adopted the 2,400,000 number as my approximation because it was also convenient to think of it as the length of a 24 inch, or 2 foot, ruler, with each of the 24 inches representing 100,000 jobs. As a guest host on Squawk Box on CNBC once I actually brought two colored 24 inch sticks to demonstrate visually that what makes the news is whether the green job gain stick was an inch or two above or below the red job lose stick. I think I made the point adequately, but the regulars on the set looked a little pale when I brought out my sticks.

The latest published numbers from gross private job gains and losses are for the 4th quarter of 2008 when unemployment was rising rapidly. The gross job gain that quarter came to 6,712,000 while gross job losses totaled 8,467,000, for a net quarterly loss of 1,755,000 private jobs. Dividing these numbers by 3 to convert quarters to months, gross monthly gains were 2,237,333, gross monthly losses were  2,822,333, and net monthly private job losses were 585,000 per month. That last number is the only one emphasized in the media and what most people see or hear. I think most will agree that, while correct, that practice greatly understates the underlying dynamics of the economy.

In terms of my corny sticks with 1 inch equal to 100,000 jobs, gross monthly job gains are just over 22 inches while job losses are just over 28 inches–a six inch difference. Job gains are down two inches while losses are up four inches. They need me and my sticks back on Squawk Box.

This is a corrected version of the original

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.

I think the problem is that spending your way out of a recession is the message of Keynes’s “General Theory of Employment Interest and Money, and people don’t want to be labeled a “Keynesian.” But surely one can cling to his classical economic principles while acknowledging that Keynes had a point, especially during recessions.

In a recession, income declines because spending declines, and spending declines because income declines. It’s a vicious circle that needs to be broken. One option might be tax cuts to increase business spending. Another might be lower interest rates to stimulate spending. Another is to have government spending make up the slack. That will work if it has monetary policy support, i.e. if the government spends newly created money so it doesn’t crowd out private spending.

I don’t necessarily want to be labeled a Keynesian either, but I see no reason to fear acknowledging that he had a point. To say that we can’t spend our way out of a  recession may make a good sound bite, but it has no credibility.