Topic: Finance, Banking & Monetary Policy

U.S. Military Spending: A Lot? Or a Lot More?

In 2015, U.S. defense spending will be about $600 billion, or about 3.24 percent of GDP. The former figure would strike many Americans as sufficient, and a few would find it excessive. Robert Gates once said, “If the Department of Defense can’t figure out a way to defend the United States on a budget of more than half a trillion dollars a year, then our problems are much bigger than anything that can be cured by buying a few more ships and planes.”

But hawks want you to focus on the latter figure, 3.24: they believe that an arbitrary fixed percentage of national output should be dedicated to defense spending every year. For example, Mitt Romney and Bobby Jindal would peg defense spending at 4 percent of GDP. Wall Street Journal columnist Bret Stephens would see that, and raise them. In his new book, America in Retreat, Stephens calls for sharply increasing “military spending to upwards of 5 percent of GDP.”

It’s unclear whether these gentlemen fully appreciate what their proposals would equate to in real dollar terms. (Take a look at the chart below, prepared by my colleague Travis Evans). The bipartisan Budget Control Act (BCA) capped discretionary Pentagon spending at $3.9 trillion between 2015 and 2021, an average of 2.6 percent of GDP per year. That means Americans would need to spend $2.1 trillion above the current caps to meet the 4 percent threshold, and $3.6 trillion more to reach 5 percent. For added perspective, then-House Budget Committee Chairman Paul Ryan’s FY15 alternative projected $4.2 trillion for defense, or 2.8 percent of GDP. In other words, Romney proposed to spend $1.8 trillion more than his running mate, and Stephens’ plan is even more disconnected from fiscal reality – $3.3 trillion more than the de facto GOP budget.

Conflicted on 529s

If you like feeling conflicted, you’ll love being a libertarian thinking about President Obama’s recent proposal – and even more recent rescinding of that proposal – to essentially end 529 college savings plans. The President proposed killing the ability to use funds saved under a 529 plan tax free to pay for college, which would have gutted the program’s real value.

On one side, a libertarian should be aggravated by such a proposal. The goal certainly seemed to be income redistribution, generating new revenues from relatively well-to-do Americans and giving it to (presumably) less well-to-do Americans with free community college and expanded “refundable” tax credits. It also seemed intended to support a divisive, rhetorical war of the “middle class” vs. “the rich” (though certainly many people who use 529s consider themselves middle class). And unlike federal grants, loans, and those refundable credits that are often essentially grants for people who don’t owe much in taxes, 529s are about people saving their own money to pay for college, not taking it from taxpayers.

On the other side, libertarians – heck, everyone – should want a simple tax code that isn’t riven with special breaks, loopholes, and encouragements to do things politicians decide are worthy but which have massive negative, unintended consequences. And when it comes to higher education, those consequences are huge, including rampant tuition inflation, awful completion rates, major underemployment, serious credential inflation, and a burgeoning academic water park industry. And where does the federal government get the authority to incentivize saving for college in the first place? Not in the Constitution.

So how should libertarians feel about the demise of the President’s 529 plan? I guess a little sad, because the Feds simply shouldn’t be in the business of encouraging college consumption. Even more, though, they should feel angry, because we are so deep in a federally driven, college-funding quagmire.

Banks Are ‘Under Assault’

J.P. Morgan Chase’s CEO Jamie Dimon has it right when he asserts that banks are “under assault.

This has put a damper on the source of 80 percent of the U.S. money supply, broadly measured. The CFS Divisia M4 is growing at an anemic 2.2 percent on a year-over-year basis.

Since the course of nominal national income is determined by the money supply, it’s not surprising that U.S. growth is also anemic. Final Sales to Domestic Purchasers, the best proxy for U.S. aggregate demand, has still not reached its trend rate of growth. In the face of these facts,

I don’t anticipate that the Fed will (or should), “tighten” at its Federal Open Market Committee meetings on January 27–28. Nor do I think the Fed will tighten as soon as most people think. 

The Fed Should Quit Making Interest-Rate Promises

If there’s anything we ought to have learned from the recent boom and bust, it’s that a Fed commitment to keep interest rates low for any considerable length of time, like the one Greenspan’s Fed made in 2003, is extremely unwise. 

The problem isn’t simply that interest rates should be higher, or that the Fed should have a different plan for how it will adjust them in the future.  It’s that the Fed shouldn’t be making promises about future interest rates at all, because it can’t predict whether a rate chosen today will be consistent with stability in six months, or in one month, or even in a week.

Instead of making promises about future interest rates, the Fed should promise to change its interest rate target whenever doing so will serve to maintain a reasonable level of nominal spending or nominal gross domestic product, which is the best way to avoid causing either a boom or a bust.

The World Misery Index: 108 Countries

Every country aims to lower inflation, unemployment, and lending rates, while increasing gross domestic product (GDP) per capita. Through a simple sum of the former three rates, minus year-on-year per capita GDP growth, I constructed a misery index that comprehensively ranks 108 countries based on “misery.”

Below the jump are the index scores for 2014. Countries not included in the table did not report satisfactory data for 2014.

The five most miserable countries in the world at the end of 2014 are, in order: Venezuela, Argentina, Syria, Ukraine, and Iran. In 2014, Argentina and Ukraine moved into the top five, displacing Sudan and Sao Tome and Principe.

The five least miserable are Brunei, Switzerland, China, Taiwan, and Japan. The United States ranks 95th, which makes it the 14th least miserable nation of the 108 countries on the table.

The Fed Policy Statement

Here is the statement I would like to see the Federal Open Market Committee issue on January 28 on conclusion of its first meeting of 2015:

Information received since the FOMC met in December confirms that economic activity is expanding at a moderate pace. Inflation has continued to run below the Committee’s longer-run objective, primarily reflecting a decline in energy prices. That decline appears to be principally a consequence of improving technology in oil and natural gas production and is, thus, a change in relative prices that has no long-term implications for the aggregate rate of inflation.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. To support continued progress toward these goals, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.

To minimize uncertainty over the course of policy, the Committee judges that the process of normalizing interest rates should begin in June. However, the exact timing is data dependent and might be adjusted as necessary.

The Committee also judges that it is now appropriate to begin the process of normalizing its open market portfolio. Effective immediately, the Federal Reserve will cease to reinvest interest on the portfolio and maturing principal.

Several FOMC members have suggested that midyear will be the appropriate time to begin to raise policy rates. The FOMC itself has been vague. No member of the leadership team–which I would define as Chair Janet Yellen, Vice Chair Stanley Fischer, and William Dudley, President Federal Reserve Bank of New York–has ruled out the midyear timing. In general, it is not good practice to announce a future date for a policy change, but such an approach makes sense at this time given that policy rates have been near zero since December 2008. Announcing a June date will not be a shock to the market, as market commentary widely suggests that June is the time the FOMC will act. It is, of course, always possible that economic conditions will change dramatically before June, requiring a change of plan. Nonetheless, it is time for the FOMC to clear the air by stating a plan.

Recollections on Fannie Mae’s Housing Goals

With the release of Peter Wallison’s new book, Hidden in Plain Sight, I suspect the debates over the role of Fannie Mae and Freddie Mac in the financial crisis may heat up again (I suspect Joe Nocera is working up a nasty review).  Anyone interested in the financial crisis should read this book.  It is extensively documented and well-written.  While the narrative is similar to other of Wallison’s writings, he musters far more evidence for his case here. The amount of contemporaneous material from advocates, HUD and the GSEs (Fannie and Freddie) is impressive.

I’ve generally been on the fence about the housing goals, as I have felt that GSE leverage was a far greater issue.  The book leaves me more sympathetic to Wallison’s argument.  For the best counter-argument regarding the goals, see John Weicher’s paper on the issue (unlike Nocera, Weicher includes facts and analysis).