Archives: February, 2009

Week in Review: Deficit Spending, Troop Increases and More Auto Bailouts

With a Stroke of a Pen, Future Generations a Trillion More in the Red

Now that President Obama’s $787 billion spending measure has become law, will the plan work? Senior Fellow Richard Rahn takes a look back to see if history can offer guidance on whether this massive intervention of federal money will pull us out of the recession, or make things worse.

When President Obama signed the bill this week, many of the 1996 welfare reform provisions were chipped away, says Cato Senior Fellow Michael D. Tanner. In an op-ed for The New York Post, and in a Cato daily podcast, Tanner explains how parts of the new law actually offer states incentives to add people to their welfare rolls.

Both Presidents Obama and Bush have used fear-mongering rhetoric to radically expand the size of government. But wasn’t it Naomi Klein, who asserted in her book The Shock Doctrine:The Rise of Disaster Capitalism, that free-market advocates are the ones spending their careers waiting for a crisis that could be used as a springboard for implementing free-market ideas? In an article for The Guardian Online, Cato Executive Vice President David Boaz points out that Klein has it backward: When crisis strikes, government usually gets larger, not smaller.

In a Cato daily podcast, Boaz exposes Obama’s Shock Doctrine:

We had a financial crisis and what happened? Did the incumbent Republican administration say, now’s our chance to implement Milton Friedman’s program and privatize and deregulate? No, they did what governments always do: they expanded their own powers at the expense of civil society, and so in that sense, Obama’s just doing the same thing that Bush did. We could call this the Bush-Obama era.

Obama to Send 17,000 More Troops to Afghanistan

Time Magazine reports, “Afghanistan became President Obama’s war on Tuesday, when he ordered two more U.S. combat brigades into the fight. He will send 17,000 combat troops to join the 36,000-strong U.S. force already in the theater. The fact that the units now ordered to Afghanistan had originally been slated for Iraq underscores the new Administration’s shift in priorities.”

Blogging the day after the president’s announcement, Benjamin H. Friedman, research fellow in Defense and Homeland Security Studies, comments on the country’s new approach toward Afghanistan:

A stable Afghanistan is neither necessary to US security nor obviously possible at reasonable cost, as I have periodically written. It is not evident that Al Qaeda types would again find haven in Afghanistan should we go. But assuming that they would, there remains an alternative to trying to overcome Afghanistan’s anarchic history. We could attack only the remaining jihadists, their allies, and insurgents who will not settle for local power. That would require only a small U.S. ground presence, airstrikes and local allies.

The Bush Administration may no longer be in power, but don’t expect defense spending to drop substantially, says Friedman. In an article for World Politics Review, Friedman discusses the future of foreign policy under the new administration and why it’s unlikely Obama will rein in spending.

They’re Baaaack! Automakers Seek Billions More in U.S. Aid

After receiving billions of dollars from President Bush to rescue their companies, U.S. automakers are asking for billions more from the new administration. CNN.com reports that when the final dollar is received, the auto bailout tab could top $130 billion.

Daniel J. Ikenson, Cato’s associate director for trade policy studies, says this was to be expected:

Bush’s decision to defy Congress and provide “loans” to GM ($9.4 billion) and Chrysler ($4 billion) back in December wasn’t even intended as a cure all. It was designed to buy time for the producers to come up with detailed viability plans for their next bite at the apple. And as expected, central to both viability plans, which were unveiled yesterday, is more taxpayer money. At the moment, a combined $22 billion is being requested, which would bring the total doled out to just under $40 billion.

Not to say we told you so, but during the auto bailout debate, Ikenson warned time and time again about the pitfalls of bailing out these failing companies.

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Inflation and the Fed

In a National Review post on the recent Producer Price Index numbers, I argued that inflation worries are overwrought — for now. If inflation does become a problem, though, the Fed could have trouble controlling it. Here’s why.

According to a recent AP story, “Federal Reserve Chairman Ben Bernanke told an audience at the National Press Club on Wednesday that … once the economy begins to rebound and financial markets stabilize, the Fed will be able to quickly reverse the actions it has taken before inflation becomes a problem.”

That’s the trillion dollar question.

Federal Reserve bank credit rose from $890.4 billion on September 10 to $1.83 trillion by February 11, mainly because the Fed purchased a lot of semi-toxic securities (e.g., from Bear Stearns) and made huge loans against other dodgy assets. That allowed a similar doubling of the monetary base (bank reserves and currency). Even before that happened, the Fed was selling off Treasuries to make room for lesser investments. The Fed’s holding of government securities has fallen from $790.5 billion in September 2007 to $470.7 billion on February 11 (not counting some second-rate IOUs from Fannie Mae and Freddie Mac).

To assume, as Bernanke does, that inflation cannot possibly accelerate until “the economy begins to rebound and financial markets stabilize” is to assume stagflation is impossible, though 1973-75 and 1979-82 proved otherwise. If inflation catches the Fed by surprise, are they really “able to quickly reverse the actions,” as Bernanke says? How could they do that?

The Fed could certainly raise the interest rates on bank reserves — the fed funds and discount rate — which is how it makes money and credit tighter in normal times. But that rationing device would not prove so effective in times like these, because banks are already sitting on a mountain of untapped reserves. Besides, once expected inflation has begun to rise, the Fed has usually moved rates up in tiny 25-basis point steps — increases so small that perceived real interest rates can continue to fall even as nominal rates rise.

To literally reverse the actions that doubled its assets since last September, the Fed would have to sell nearly a trillion dollars worth of IOUs. Unfortunately, they don’t have nearly that many Treasury securities to sell. And even if the Fed were willing sell off all of its Treasury bills and bonds, the remaining backing for Federal Reserve notes would be little better than junk bonds. Meanwhile, private and agency securities acquired since last September must be very hard to sell — or else the Fed would not have felt obliged to buy them.

The Fed’s System Open Market Account at the Federal Reserve Bank of New York holds $39.4 billion in inflation-protected Treasury bonds — more than twice its $18.4 billion stash of short-term Treasury bills. Are they trying to tell us something?

China in Africa

Tom Ricks used to cover the Pentagon for the Wall Street Journal and the Washington Post. He wrote terrific books about the Marines and the war in Iraq. Now among other gigs, he is a blogger for Foreign Policy. It’s great when top-notch reporters write for blogs, even when they are overly enthusiastic about counterinsurgency warfare. That is an issue we will take up with Ricks when he visits Cato on March 13 for a forum on military reform.

I have a smaller bone to pick now. Ricks, like many Pentagon types, is worried about Chinese activities in Africa. He links to a story about a bridge-building project in Mali and suggests that the Chinese are doing something clever that we will someday realize has harmed us.

I hear variants of this all the time — China is doing stuff in Africa, so we must imitate them. It doesn’t make sense. Even if you think the United States has a zero-sum relationship with China where their gain is our loss (I don’t), you should worry about something else. There is little that China can do in Africa to make it stronger or to damage U.S. interests.

There are basically three things Americans worry about China doing in Africa: gaining influence from aid and diplomacy that it will use against us, gaining wealth from investments that it will use against us, or somehow screwing up our access to oil.

On the first concern, you have to ask what influence in Africa gets you, other than a happy feeling. Traditionally, as in World War II or the start of the Cold War, we worried about hostile states gaining industrial might by conquest that they could harness against us in a war. Whether or not that was a valid concern is open to academic debate, but there was never much reason to worry about Soviet efforts to buy support in poor countries during the Cold War. There was little to gain there in a geopolitical sense, outside of raw materials rare enough that they might be blocked from the market in a war. It makes even less sense to worry about China gaining influence in Africa now. If Mali likes China because it builds bridges there, so what? We are not poorer or less safe for it.

What about investments? Chinese investments in Mali are more useful to Mali and China than government aid, assuming the investments are sensible ones. If they are wise investments, however, U.S. companies won’t be far behind, and our national income will rise as a result. If they are not economically sensible, they will not enhance Chinese power, and we should not imitate them.

The biggest worry is that China is locking up energy supply in Africa. This concern is born of a failure to understand that oil is a global commodity. If the Chinese tap more of it, American consumers pay less too. If they own production facilities, that matters not at all if the oil is going to market. If the Chinese have a mercantilist energy policy, that is their problem. For more on energy alarmism, see here, here and here.

There is nothing sinister or clever about Chinese activity in Africa. Americans shouldn’t worry about it.

While we’re talking about Foreign Policy bloggers and developing countries, be sure to check Stephen Walt’s attack on his employers’ vacuous cover story: “The Axis of Upheaval.” Great stuff.

Criminals Caught on Tape?

It’s not surveillance film from a bank or gas station hold-up — it’s guys in lab coats who seem to be helping the police and prosecutors by making evidence “fit” a murder charge

This particular case is not for the faint of heart. The film shows an autopsy of a young girl whose parent claims she drowned in the bath tub. Prosecutors say it was murder. The forensic “experts” appear to be putting bite marks on the child’s dead body using a plaster mold of the defendant’s teeth. 

Assuming that’s right, how perverse is that? The government’s scientists put the marks on the child, snap some photos of the marks, and then show those pictures to the jury and declare, “The bite marks match the defendant.” 

You might think that once the film is brought to the attention of the District Attorney, he’d disavow the case against the parent and have the “scientist” arrested for tampering with evidence. Sadly, it doesn’t work like that. The authorities are probably hiding under their desks, hoping this story will just go away. Because if this is not an isolated incident and someone takes a serious look at all the cases these ”experts” have been involved in, lawsuits will be filed, careers will end, and grand juries may be convened. Super-sleuth Radley Balko has been on the trail of these junk scientists for the past year or two. 

60 Minutes should investigate this thing further.

State Budget Exaggerations

Here we go again with the state budget “crisis” narrative. Today on the front page, the Washington Post highlights meaningless “budget gap” data from an interest group that always makes modest government restraint sound like fiscal armageddon.

[N]early all states are feeling pressure from falling revenue and rising costs as tax collections decline and demand for services increases. At least 46 states are facing shortfalls this year or next, and the combined budget gaps are estimated to total more than $350 billion, according to the Center on Budget and Policy Priorities.

There is a lot wrong with that statement. First, the $350 billion figure from CBPP is over three years, not the two implied by the story. Second, overall state/local tax revenues are essentially flat, not “falling” or “declining.” Third, of course the “demand” for state services is increasing — you give people something for free and they want more and more. That’s just Economics 101.

More importantly, budget gap data from the CBPP and the National Conference of State Legislatures are mainly fiction. The data have as much to do with errors in economic forecasting as with the economy. Suppose state general fund revenues and spending are $700 billion this year, and states had planned for these totals to rise to $750 billion next year. But now it looks like revenues will only be $710 billion next year — the “budget gap” is then said to be $40 billion and scaremongers would complain about $40 billion in “cuts.” But you can see that the real problem is an error in forecasting combined with the assumption that spending should always rise. If spending is restrained, no actually gap appears.

Data from the National Governors Association show that state general fund spending has been flat, on average. Spending in FY2008 was exactly the same as it was in FY2009 at $689 billion. See pages 33 and 36 here.

More authoritative data for combined state and local governments comes from the Bureau of Economic Analysis (Table 3.3). Data for 2008 is now available. The figure shows that total spending has risen strongly and continuously in recent years, with a large rise of 6.1 percent in 2008.

With the recession, state/local revenues are growing slowly, even as spending keeps rising. The table shows state/local tax receipts and overall state/local receipts, which includes federal grants and other items. (I have estimated corporate tax receipts for 2008).

It appears that if the states and cities, on average, hold their spending growth to about 2 percent to match revenue growth, the budget gap problem is solved. When families and businesses across America are having to freeze or cut their budgets, it’s surely no tragedy to expect such modest restraint from government.

Oil Price Collapse — Bad News?

In the Washington Post today, staff writer Steven Mufson gets space on the front page to tell us about how the oil price collapse is playing out for oil producers, rival energy generators, and, ultimately, for consumers. Much of what follows is obvious — prices are declining because the economic collapse is hammering demand — but other aspects of the narrative offered by Mufson are on shakier ground.

Ed Morse — managing director and chief economist of LCM Research and a favorite “go-to” guy for print reporters — says, “The last five years saw the rebirth of the use of oil as a critical instrument of foreign policy by key resource countries, Iran, Russia, and Venezuela in particular. With oil and natural gas prices having collapsed, the power of their weapons has been waning rapidly…” Really? When, exactly, have oil-producing states used oil as a weapon in foreign policy over the course of the 2004-2008 price spiral? Have there been embargoes I’ve missed? Strategic production cutbacks tied to the Israeli occupation of the West Bank? Or substantive threats about the same that have been used as an effective lever in international relations? Not that I know of.

The only example I am aware of that Morse might cite to back up his claim is Russia’s ongoing dispute with Ukraine over natural gas prices. But gas producers have leverage in markets that oil producers don’t have, given the much higher transaction costs associated with changing buyer-seller relationships.

In short, Morse’s first claim — that oil producers have been using oil as an effective foreign policy weapon during the boom — is utterly without foundation. His second claim conflates natural gas with oil markets in a manner that muddies the issue. Belief in the “oil weapon” is like belief in UFOs; lots of people claim to have seen such things — and some continue to fear such things — but every attempt at verifying existence has come up empty. The reality is that embargoes can’t deny oil to consuming states given the fungible nature of the international oil market and severe production cutbacks will do far more harm to producers than consumers — which is why we never see those sustained production cutbacks play out.

Next, Mufson implies that energy secretary Steven Chu made some sort of gaffe when he told reporters on Tuesday that OPEC was “not in my domain.” Now, it may be correct that, politically speaking, OPEC is in his “domain,” but the reality is that American pressure on OPEC never has and probably never will have an effect on decisions made by the cartel. OPEC’s aim, after all, is to maximize revenue. Can the U.S. talk OPEC into decisions that will cost OPEC money? Chu’s right to suggest that no mere U.S. energy secretary is capable of such a thing and probably shouldn’t waste much time laboring for such an unlikely end. Bully for Chu — for a few moments at least, he had the courage to say what almost no energy secretary before him has ever dared to say.

Unfortunately, Chu quickly spends his intellectual capital with me in the very next paragraph when he warns that oil prices will likely rise over time. Well, they may, but there is no statistically significant trend toward higher oil prices if we examine quarterly data from 1970 forward. Oil prices move around a lot, but they have always migrated back toward an equilibrium price in the inflation-adjusted mid-$20 range. The belief that oil prices march ever higher over time is widely shared, but has no historical basis.

Chu’s worries about higher prices dovetail with the related warning (this time, from OPEC president Chakib Khelil) that the price respite is only temporary. Soon enough (two years, Khelil says), demand will pick up again and then where will we be? Low oil prices mean cuts in upstream investment which means that, down the road, we’ll get even higher prices than we would have had, had the price collapse never occurred.

Now, it is true that the oil market always has and probably always will move in boom and bust cycles with price spirals and price collapses feeding off one another. But historically, those cycles take a lot longer to play out than a couple of years. We heard the same warning against complacency in 1986 when oil prices went through their last bust cycle — but it wasn’t until 18 years later (2004) that prices recovered and moved into boom cycle once again. And that experience is fairly typical. The time between peaks and valleys in global oil prices run about 20 years apart and have been doing so for over 100 years.

Producers love to warn against low oil prices because, well, they hate them. But the idea that low prices are bad for consumers is one of those things that is so obviously at odds with the reality that one should take such warnings with a heavy block of salt. Domestically, those warnings have been used to justify producer subsidies that fail to pass any reasonable economic test.

Do low oil prices “make it harder for more expensive wind and solar projects to compete,” as Mufson asserts? No. Wind and solar energy does not compete with oil because only a tiny amount of electricity is generated by oil in the United States. Low coal and natural gas prices make it hard for wind and solar to compete. True, fossil fuel prices tend to move roughly in tandem over time, but precision is everything here. Low oil prices do not “cause” natural gas and coal prices to fall and thus do not directly undercut wind and solar.

Finally, what about the dog that’s not barking — that is, what about the claim heard ad infinitum from people like Thomas Friedman and James Woolsey that oil profits are military steroids for Islamic terrorists and that eliminating the same would cut Islamic terrorism off at the knees? So far, we find little evidence that al Qaeda or related groups have been particularly harmed by low oil prices. That shouldn’t surprise — there is no historical correlation between oil prices and Islamic terrorism — whether we’re looking at number of terrorist attacks or fatalities from the same.

[Cross-posted at NRO’s The Corner]