Re: The Politics of Recession

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Sven R Larson wrote:

> Henry,
>
> The problem with the pending recession will not be private debt as such,
> but payments on that debt.

The negative wealth effect impacts debt in two ways: 1) it creates a cash
flow shortfall in servicing the debt with interesst payment and 2) it erodes
the value of the collateral behind the loans, causing margin calls and
rolloever difficulties.  Both impact generate selling pressure to generate
cash which in turn exacerbate further negative wealth effect.  This downward
slide can come in great force quickly.

> I disagree with you on the timing of tax cuts: given that cuts are
> discussed early in 2001, announced before the US fiscal year of 2002
> starts next fall, and effected during that year, households will have good
> reason to expect little impact on their purchasing power.

We have no disagreement on this point.  I merely think that Bush will use
the "Clinton recession" as an argument to sell his tax cut proposal next
year.

> It will, in other words, keep them from making overly pessimistic changes
> to their spending patterns. In other words: so long as households can be
> given good reason to believe that they will still be able to pay
> principals and interest on their debt even two years from now, they will
> not turn whatever they have in assets into debt reduction. (If they did,
> considering the strong wealth growth during the
> Clinton years that could trigger an ugly acceleration of the recession)
> The critical point of a downturn is precisely to keep expectations healthy
> - so long as the downturn doesn't threaten to ruin the bulk of consumer
> expectations it will stay mild.

Here we have a difference of view. My take is that we have exhausted the
"expectation" or "confidence" effect.  There is no more additional credit
available unless Greenspan is prepared to inject massive creddit into the
system and accept high inflation.  The falling consumer spending is now
slowed by a real cash flow crunch: no new credit, no additional disposable
income, therefore lower sales and lower coroporate profits.  Two year from
now, when the tax cut kicks in, many personal loans and credit card loans
would have defaulted long before.

>
> Bush is better prepared than Gore to help households land softly in a
> recession, as tax cuts are high on his agenda (even higher than budget
> balancing was on Gore's...). His problem is to tune them towards the
> middle class enough to get the right macroeconomic boost.

Congress may push Bush in the mre progressive direction, although on the tax
issue, so far Bush is coming on strong as a matter of ideology rather than
economics.  He may weel get his tax package and compromise on other issues,
such as social security and drugs.

>
> What America needs now is not more government spending, but lower taxes to
> preserve household cash flow margins.
>

We are only talking about lower tax rates.  Tax payment will be lowered
regardless because income will drop.  From many unemployed households, what
Rogers said about the Soviet Union may apply to them: "there is no income
tax when there is no income."  Most Americans will have so much tax loss
from the market that the tax rate will have reduced impact, unless the Bush
tax package further plugs deduction loopholes.  The ability of the private
sector to create job is non-existent in the next two, perhaps five years,
regardless of tax cut or no tax cut.  The only way to keep unemployment
below 10% would be be public works and defense spendings.  Everyday there
are announcements of thousands of jobs being eliminated by major firms.
Notice that all the profit warnings and announcement are for quarter when no
analyst described with the R word.  The 4th quarter 2000 and 1st quarter
2001 reports will be shocking.
Notice the new Treasury Secretary is from industry, not Wall Street.

Henry

>
> "Henry C.K. Liu" wrote:
> >
> > I have suggested that Bush and his team have every incentive to
> > pin the inevitable recession solidly on Clinton.  The Fed
> > decision today, which I have predicted in an earlier post: "My
> > take is that the Fed in December will hold ff rate unchange and
> > remove that inflation bias (balance of risk)", confirms that
> > strategy.  If Gore were elected, Greenspan would have surely
> > lowered ffr today, perhaps even by a full 100 basis points.
> > Greenspan's record shows that he has been 6 mongths late in
> > responding to recession signals and Fed data are generally 2
> > months late.  Thus a reversal of Fed policy only after January
> > 20 can be expected  with the perfect excuse of lag time.   At
> > any rate, even if Greenspan cuts ffr to 2%, by next June, it may
> > not help because of the dollar exchange rate problem.   Bush can
> > use a mild recession to push through his tax cut anyway, except
> > this one won't be mild by a long stretch.  Some very astute
> > economists (easy, Allan, I have names) think that the surplus is
> > the problem and that what the US economy needs at this moment is
> > a healthy deficit, not from tax cuts, but from government
> > spending.  I think these economists are on target, but even then
> > it may be too late, because private sector debt is too
> > overwhelming.  And the IMF is still going around the global with
> > blindly demanding government surpluses.  Its going to get bad
> > before it can get better.  The Japanese dceade-long drought
> > looks likely to repeat in the US, unless the Fed is prepared to
> > sacrifice the US banks, something the Fed has been telling the
> > Japanese to do for years.
> >
> > Henry C.K. Liu
> >
> > confirm
>
> --
> Sven R Larson
> PhD; Assistant professor of economics
> Department of Social Sciences, Bldg. 22.2
> Roskilde University
> Pb 260
> DK-4000 Roskilde, Denmark
> Phone: (+45) 4674 2910