Tuesday, February 10, 2009

Market to Obama: you're not helping us

The market is telling Obama and Geithner to go back to the drawing board. Stocks are down, and Treasury yields are down, good signs that today's two big events, the Senate passage of the so-called stimulus bill and Geithner's unveiling of his grand plans for fixing the financial markets, are not going to be helpful.

I'm somewhat encouraged that key risk measures, such as the Vix Index, the TED spread, and swap spreads, have not deteriorated materially. This suggests that the two measures won't increase risk or uncertainty, but they will fail to produce any meaningful improvement and could actually slow down an eventual recovery.

How about trying some very simple but potentially incredibly powerful ideas? Why not slash or eliminate completely the corporate income tax? That would be far less expensive that the stimulus bill, and it would take effect immediately rather than over the course of years. Plus, corporations have this thing about spending their money on projects that make sense, whereas politicians such as Nancy Pelosi love to spend other people's money with wild abandon.

How about relaxing the mark-to-market rules? This would go a long way to relieving the burden of toxic assets on bank balance sheets.

How about cutting the capital gains tax? That, combined with a big reduction in the corporate income tax would immediately give a huge boost to equity values, and that in turn would go a long way to offsetting the wealth destruction of declining home prices. Both measures would also instantly increase the after-tax rewards to creating new ventures, which in turn would result in new jobs.


Unknown said...

How about Scott Grannis for Treasury Secretary?

Scott Grannis said...

No way could I leave the beach for Washington. Besides, I think I might have trouble getting along with Obama.

Mark Gerber said...

Maybe Obama is already listening to you Scott. After all, what we got today was nothing. No new programs are in place, no new funds have been allocated, no proposals for government-private partnerships to buy assets announced – not even a plan for anything. Seriously, isn't the market dropping today because for the past few weeks we were all built up for some new Financial Stabilization plan to be announced today and what we got was … nothing! We already knew the $800B Safety Net Plan aka "Stimulus Plan" would pass the Senate and is likely to pass the House and be signed by Obama. The market is not reacting to that. The market is reacting to our great big nothing. The biggest nothing I can remember ever hearing from a president.
Nope, what we now have is nothing, while every leading economic indicator is dropping. Indeed, the second derivative has gone from negative to zero on a few of them, which is better than a sharp stick in the eye, but we are still falling at a rapid pace. The only sign of life is China. After the Olympics, they stopped buying overinflated commodities, and now they are using their war chest of reserves to start stocking up again on firesale priced basic materials to stock up again to implement a true stimulus package in their country. (Isn’t that why the Baltic Dry Index is up?) In the meantime, what we have is nothing , except a new website from the Treasury, that is. I would short the heck out of this market if it wasn’t already at a new low when priced in gold.

Speaking of the Baltic Dry Index, how do you justify using a log axis on one economic indicator (dry index) and linear on the other (S&P) to overlay them to demonstrate correlation?

Scott Grannis said...

Mark: I don't share all of your pessimism, but it would be great if the government actually did do nothing!

As for the charts, I use log scales when the price changes are huge in percentage terms. I should probably have used a log scale for the S&P but I doubt it would have made much difference.

Cabodog said...

What I'm wondering is just why they won't budge on mark-to-market rules? That, and just why they won't reinstate the uptick short rule...

chaim said...


Again, your succinct objective data and analysis are absolutely refreshing.

You concentrate mainly on U.S. data.

However, it appears that the global/ overseas economic universe is more concerning.

What do you make of the statistics in the following article?


Some of the salient quotes:

“The US Treasury alone needs to raise $2 trillion in 2009.
“Where is the money to come from? China, the Pacific tigers and the commodity powers are no longer amassing foreign reserves ($7.6 trillion). Their exports have collapsed. Instead of buying a trillion dollars of extra bonds each year, they have become net sellers. In aggregate, they dumped $190bn over the last fifteen weeks.

…”Events in Japan have turned deeply alarming. Exports fell 35pc in December. Industrial output fell 9.6pc. The economy is contracting at an annual rate of 12pc.

"Falling exports are triggering a downward spiral of production, incomes and spending…

“…The European Central Bank's refusal to follow the lead of the US, Japan, Britain, Canada, Switzerland and Sweden in slashing rates shows how destructive Europe's monetary union has become. German orders fells 25pc year-on-year in December. French house prices collapsed 9.9pc in the fourth quarter, the steepest since data began in 1936….”

“…Spain's unemployment has jumped to 3.3m – or 14.4pc – and will hit 19pc next year, on Brussels data…”

“…Ireland lost 36,500 jobs in January – equal to a monthly loss of 2.3m in the US. As the budget deficit surges to 12pc of GDP, Dublin is cutting wages, disguised as a pension levy. It has announced "Rooseveltian measures" to rescue the foundering companies….”

“….Meanwhile, Eastern Europe is imploding. Industrial output fell 27pc in Ukraine and 10pc in Russia in December. Latvia's GDP contracted at a 29pc annual rate in the fourth quarter. Polish homeowners have had the shock from Hell. Some 60pc of mortgages are in Swiss francs. The zloty has halved against the franc since July...”

Mark A. Sadowski said...

I just wanted to drop my two cents worth on the tax policy proposals you posted here.

First, there is a limit to tax-rate reduction. Cutting the top marginal personal income tax rate on unearned income from 70% to 50%, as was done in 1981, provided a huge increase in the after-tax rate of return. The after tax rate of return on interest or dividend income increased by 66.7% as a result. But dropping the top marginal capital gains rate from 20% to 15%, as we did in 2003, only increased the after-tax return by 6.3%. That's more than nothing of course, but one can hardly expect the same kind of economic gain from reducing the top rate a little from an already low level as one would get from reducing a very high rate a lot. As a result I don’t think there’s going to be much benefit from a capital gains tax reduction.

As for a corporate tax rate reduction, the economics literature on the strong long term benefits of investment to economic growth is quite convincing. Unfortunately the literature on the effect of tax incentives to spur investment shows that firms are very insensitive to the cost of physical capital.

And as a policy to spur the economy in the short run, the fiscal multipliers imply that neither policy would be very effective. Mark Zandi's research for example assigned a value of 0.30 for an across the board corporate tax cut and 0.37 for making the dividends and capital gains tax cut permanent. Those multipliers are just about the worst of any discretionary fiscal policy. I think there's probably very little "bang for the buck" in the short run with either policy proposal.

The countries with the lowest marginal tax rates have been among those hardest hit in this global crisis. As already noted, Ireland, the Ukraine, and Latvia seem to be imploding economically. Other countries with the lowest marginal tax rates that have been especially hard hit have been Estonia, Lithuania, Hungary, Hong Kong and Singapore. Low marginal tax rates failed to insulate these countries from plunging aggregate demand in the short run.

On the other hand (it’s a good job I have two hands), as a policy proposal that might improve long run growth, corporate tax reform is long overdue in the United States. A flat corporate tax rate without any deductions or credits could raise the same revenue as the current one with a rate of perhaps 27%. And I would not be opposed to allowing corporate dividends to be deductible (it’s double taxation after all) as long as dividends were treated as regular personal income. Theoretically at least, this could have long term growth benefits.

Scott Grannis said...

chaim: the author you cite is a member of the doomsayers club. I laugh when I see comments like this:
"there is no hope at all of stabilizing the world economy on current policies." That's the sort of thing you always find at bottoms. I've addressed most of what he talks about in earlier posts (i.e., big decline in Japanese industrial production). Plus, the Baltic indices suggest the global economy is starting to rev up.

Scott Grannis said...

Mark: how about eliminating the capgains tax? That would be huge in my opinion, and not very expensive compared to the $800 billion stimulus bill. I've already mentioned my low regard for Mark Zandi's work. Why is he all of a sudden the genius everyone cites?

Desribe to me the logic behind the assertion that the fiscal multiplier is more significant that the tax multiplier. I utterly fail to see it.

The countries you cite have all been booming until recently, with Hong Kong a perennial favorite for "world's most dynamic economy" thanks to its 15% tax rate. You should also note that trade plays a much bigger role in those same country's economies. They can therefore bounce back much faster than we can.

Finally, why would you want to double tax dividends by retaining the corporate tax and then taxing the profits at individual rates? It's extremely inefficient and punishes investment, the worst possible thing we should be doing now.

Public Library said...

The Fed and Treasury have been bungling this entire process since 2007. I won't even start on the decade prior.

This is not about Obama so much as it is about a complete LACK of leadership in this country starting at the top and trickling all the way down to consumers.

There is no magic wand to wisp away 2 decades of gluttony, greed and criminal behavior and the Fed has rendered itself useless.

Oh the glory days when everyone looked fro Greeny and the Fed to bailout our sniffles...

Scott Grannis said...

Bernard: if that's the way you feel (and I share your concerns), then you will love this:


Mark A. Sadowski said...

I think you missunderstood me. I'm in favor of eliminating double taxation (it's already been done in other countries). And taxing dividends once at 35% would be less than taxing them twice at 39% (or 27%) and 15% for example. Individuals would of course pay a higher rate than they do now but I think it's fairer than taxing earned income at a higher rate than dividends.

Eliminating capital gains would only increase after tax earnings by 17.6%. And the deadweight losses that accrue from such a low rate of taxation are miniscule, so eliminating the capital gains tax would not provide very much of an economic benefit relative to the loss in revenue. Furthermore I genuinely believe it will not provide much of a short run fiscal stimulus, compared to other policy proposals.

You're right of course that many of the countries I mentioned have small export driven economies. And I truly believe that low corporate tax rates are an excellent strategy for developing countries with well educated populations and good infrastructure to pursue. It seems to be a primary factor behind the high rates of long run growth such countries experience. But my point was that low marginal rates are not an effective strategy for countering a decline in aggregate demand in the short run.

The logic of why spending provides more fiscal stimulus than tax cuts is a serious question deserving a serious answer. Let me just say for the moment that foremost, in order to have an effect, a fiscal stimulus must be spent. Government spending, by definition, is spent. Tax cuts on the other hand are not always spent by individuals or businesses in the short run. And in a severe recessions especially, most individuals save a tax cut rather than spend it because they are worried about lower income and wealth in the near future. Similarly businesses have little interest in expanding capacity when demand is falling. This all relates to the Keynesian concept of the Paradox of Thrift.

Steve Grannis said...

Some excellent ideas, Scott. Too bad they're not marketable i.e. politicians can't buy any votes with them. Another idea, and one that would work well in concert with yours, would be the implementation of some variation of the FairTax. I know it has problems of its own -- exempting food and necessities, for example -- but capturing the underground economy would pay for an awful lot of reductions in other taxes.

Trouble is, politicians can't buy votes with the FairTax either.

Scott Grannis said...

Mark: eliminating capgains tax would be huge. It represents a triple taxation on capital, to begin with. Plus, it applies to all gains that come with inflation, which means the effective capgains tax can be much higher than the stated rate.

You are proposing a corporate income tax and taxing dividends at the individual level; that's double taxation and that's bad. Or perhaps I am still not understanding you, in which case I apologize.

The best tax scheme to minimize economic roller coasters is a low, flat tax with a very broad base.

And you always revert to Keynesian thinking. Downturns are not necessarily caused by a downturn in demand. The weak demand we observe today is really just people scared of counterparty risk.

I'm a supply sider because I believe supply is the key driver of an economy. And that only gets disrupted by bad policies or external shocks. Low tax rates keep the supply side of an economy strong.

Scott Grannis said...

Steve: Politicians are the biggest problem we have these days. They have too much power, they are easily corruptible, and they all think they are brilliant economists, when in fact they know next to nothing about the subject.

Mark A. Sadowski said...

I fear we're not communicating very effectively. Let me try and be more clear.

Allow corporations to deduct dividends. That would eliminate double taxation.

Capital gains should be adjusted for inflation. That only makes common sense.

On the other hand, I'm a Keynesian because I believe that they are two sides to this equation: aggregate demand and supply. Each needs to be given their credence. Paying attention to only one or the other will only lead to huge macroeconomic mistakes.

P.S. I've enjoyed arguing on your blog since I've discovered it. Otherwise I wouldn't have spent so much time here.

mmf said...


Martin Wolf in FT - normally a sober commentator - takes a negative view on Giethner - perhaps you could argue he has fallen under the spell on the gloomsters, but there does seem to be a major issue with bank solvency - and Geithner doesnt seem to have a plan and in the absence of, the markets could move down sharply,

Public Library said...

Now that we know our future tax burdens are going to be much much higher, is it better to use a Roth IRA versus a traditional IRA. Lol

Scott, the video clip of Schumer just about sums up politics in this country.

Dan said...

The problem with those ideas is that do nothing for the general population, i.e the average American. Those actions would be viewed as corporate centric by the common man who is looking for their piece of the bail out. Are there any actions the government take that will directly affect the average American who may not immediately benefit from a removal of cap gain tax or other rule changes in the way businesses lend money to each other?

Donny Baseball said...

The first two comments on this post illuminate why we have such a dearth of good policy. Nobody with talent and good sense would go to Washington to serve in the morass that is our current federal government.

Scott Grannis said...

Mark: Ok, I think we're in agreement finally, except for the keynesian stuff.

Scott Grannis said...

mmf: I have two sources of hope: that Geithner eventually stumbles on a solution (he's trying hard to find one, and that's good), and that the market is already braced for the worst.

Scott Grannis said...

Bernard: Roth IRAs are always a good idea, especially if taxes are going to rise. Unfortunately not everyone can take advantage of them.

Scott Grannis said...

Dan: I'm willing to bet that the average person out there understands that what is good for business is good for the average person. Our leaders don't share that understanding however, since they believe they know so much more than the average person. The only way for government policies to really stimulate an economy is by changing people's incentives to work, save, and take risk. In the end that boils down to reducing tax rates. No other magic bullets that I'm aware of.

Mark A. Sadowski said...

I have no doubt that we can agree on supply side policies. My goal is to get you to recognize there is another half to the equation. I think if I have enough time and energy I can convince you of a more balanced path that considers the aggregate demand side of the matter. Balance is the key to prosperity (at least from the macroeconomic perspective).

Scott Grannis said...

Mark: I've spent 28 years considering the relative merits of supply-side vs. demand-side economics. Before you try to convince me I've missed something, I'd recommend you spend more time with supply-side ideas. George Gilder's "Wealth and Poverty" and Jude Wanniski's "The Way the World Works" would be good places to start. Jude also has a whole library of his writings available here, and I believe I've read every thing he's written:


Mark A. Sadowski said...

That's my whole point Scott,
I read George Gilder's book when it first came out (I can see it on my bookshelf from here). But I've read a lot of books since then. Supply side economics is fantastic. But it's absolutely worthless without the demand side.

Scott Grannis said...

So try Jude's stuff. He was the most prolific writer of supply-side stuff (and the inventor of the term) of anyone I know. We had disagreements towards the end, but I learned a lot from him.

Mark A. Sadowski said...

I don't want to be cryptic. I think that I was always interested in economics. I was 17 when my father gave a copy of "Wealth and Poverty" to me as a birthday gift (he knew I wanted it, and I'm looking at it as I write). At the time I thought Reaganomics was a great antidote to the excesses that we had experienced the past few decades. But the pendulum has gone too far. It is time to push it back. It is the fundamental reason for our current economic predicament. We need to restore some sense of balance.

Mark A. Sadowski said...

What were your disagreements with Jude? (I know he coined the term.) Could it be that he thought that supply side economics had reached its logical limit?

Mark A. Sadowski said...

That's alright. I did my own research. He didn't abandon his views on taxation. He failed to support the Iraq war and he supported John Kerry in 2004. But this has nothing to do with economics. And in which case, he was economicaly extreme to the end. Balance is the key.

Scott Grannis said...

No, my disagreements with him concerned monetary policy among a few other minor things. He came up with a theory in 1994 which he called the "Treadmill." As I recall, he argued that the Fed could never bring inflation down by raising interest rates, because higher rates would destroy the demand for money and that would only cause more inflation.

Mark A. Sadowski said...

If I understand you correctly, Jude's ideas didn't make any sense at all. But this leaves me all the more perplexed. I'm sure we can find more common ground.

Scott Grannis said...

I'm about as likely to embrace Keynesian ideas as Obama is to welcome bipartisan input to his economic policies.

Mark A. Sadowski said...

I had to laugh out loud because I made a similar comment on Pollster today! (Check it out!)

ThatDeborahGirl said...

LOL. You've got to be kidding me. Those are the same Bush/Cheney/Rove failed ideas that got us into this mess in the first place.

Even a market uneducated peasant like me has heard the "Hotel Mark-to-Market" parody that underscored the entire Enron scandal (and all the corporations who followed right in their footsteps.

Geesh. I was looking for evidence that Obama is not on the right track and trying to get a feel for the buzz on his policies, but damn your post has really given me some food for thought. Anything that Obama is doing to get away from those failed strategies is definitely the right thing.