Wednesday, January 27, 2010

Misery Index update

On the eve of Obama's first State of the Union address, it's appropriate to update this chart that was first made popular by Jimmy Carter while running for the presidency in 1976. While emphasizing the economic mess that was the legacy of the Nixon and Ford administrations (rising unemployment and rising inflation) likely helped Carter win the '76 election, the Misery Index came back to haunt him by soaring to 22 during the summer of election year 1980. Though not an exact parallel, Obama now faces the wrath of voters as the Misery Index stands at 12.8 (10% unemployment plus 2.8% inflation), its highest level since 1983. This looks especially bad since he promised a year ago that spending $1 trillion in stimulus funds would keep the unemployment rate from rising above 8%.

To make matters worse, today the CBO said that the unemployment rate will likely exceed 10% for the first half of this year and average 10% in the fourth quarter of this year. Meanwhile, by my estimates, the year over year change in the CPI could reach 3.5% by mid-year, and that would combine to push the Misery Index up to almost 14. Not a pretty picture at all.

I'm reminded of Reagan's prescription for taming the miserable Misery Index he inherited: significant marginal tax cuts to boost the economy, and very tight monetary policy to bring inflation down. Obama seems quite unlikely to adopt either of those policy prescriptions, unfortunately. He's promising to freeze non-defense discretionary spending, but that's a mere drop in the almost $4 trillion federal budget bucket. He will probably suggest some tax credits, but those are ineffective at stimulating growth since they aren't permanent and they don't reward increased work and risk-taking. He may offer some tax cuts to small businesses, but how effective they will be remains to be seen. He'll want to spend more money on jobs programs, but that reflects a woeful ignorance of how jobs are created—real jobs are created by the private sector, not by government bureaucrats or spending programs. And with the budget deficit likely to exceed 10% of GDP for the foreseeable future, government borrowing demands can gobble up enormous amounts of credit that could otherwise be used by the private sector for more productive causes.

As for monetary policy, the Fed is sailing in uncharted waters that have the potential to be quite inflationary, but only a handful of folks in Washington are calling for Bernanke to step on the monetary brakes, and not a single Democrat is included in that count.

And thus the year starts with very high stakes at play. I'm counting on the sea-change in the electorate, to judge by the recent Massachusetts vote, to block counterproductive Keynesian spending programs. I'm counting on the economy's inherent dynamism to overcome the adverse headwinds of unproductive government spending programs, as it has done all year long. And I'm counting on all the green shoots and V-signs that I have seen over the past year—signs that the economic fundamentals have improved dramatically and with no help from monetary or fiscal stimulus—to keep economic growth alive, even though unemployment is unlikely to come down meaningfully anytime soon.

One big tailwind I'm counting on is that I think the market is still so worried about a whole host of concerns—another wave of real estate defaults and foreclosures, a dearth of new jobs, another wave of housing defaults, Chinese monetary tightening, a lack of bank lending, huge economic slack (which supposedly threatens deflation), the Fed's inability to reverse its quantitative easing in time—or an unexpected Fed tightening, trillion dollar deficits, the very weak dollar, Obama's increasingly evident inexperience—that any morsel of good news will be a big plus. And despite the constant drumbeat of concerns, we've had a steady diet of good news for many months.

So while there is no shortage of things to worry about, I do see a very significant shift in the political winds. If Obama is going to make any changes to his strategy, they will likely be of the type that is less anti-business and less anti-growth. Even if he doesn't have Bill Clinton's ability to triangulate, Obama today has much less freedom to maneuver on the left. He may feel miserable, but all is not lost from the market's perspective.


alstry said...

If Oregon's vote yesterday is any indication on the trend to punish business at the state level is a trend......right not the trend is not our friend.

Let's hope this is not an indication of things to come as our cities, counties, and states are running out of money.

Benjamin Cole said...

I am sure everyone knows monetary policy is not the ken of the President. So blaming Bush or Obama for monetary policy--or crediting Reagan--is misplaced.

You might want to praise Volcker.

All in all, I think Bernanke is doing a great job, under tough circumstances.

On fiscal policy, Obama is spending a lot of money, on top of the built-in waste of the ossified federal government.

I would rather see tax cuts, targeting people who will spend the money, meaning the lower two-thirds.

Yes, the Oregon vote was interesting, as was the Mass. vote. People will vote for anything, is my conclusion.

Scott Grannis said...

Reagan gave Volcker complete support even though tight money helped cause a recession. That's very important. Would anyone in Washington do the same today? How about Dodd being proud that he extracted concessions from Bernanke, who promised to make sure money was freely available?

Benjamin Cole said...


Good points.

While I liked much about Reagan, I regret that he also ushered in the era of red-ink Republicans.

Since and including Reagan (and maybe since Nixon, I now can't remember), no Republican President has even proposed a balanced budget.

Cut a DC Republican and he bleeds red ink.

Obama may top them all, I agree.

But I will always regret that Reagan or Bush Two did not seize opportunities to say, "Things have changed. We are cutting taxes, but cutting outlays even more. No department, including Defense or Agriculture or Energy or Education or Labor, is exempt. We are balancing the budget first, as a long-term priority, and then cutting taxes."

I thought Bush Two missed a real chance after 9/11, when so much of the public supported him.

I would wholeheartedly vote the R-ticket if I thought they would balance the budget.

I regret to note that during the Clinton years, outlays as a fraction of GDP declined, and we ran federal surpluses, as proposed by Clinton and Treasury Secy Rubin. If you wish, give the R-Party Congress of thew 1990s credit, although my view of Congress--any Congress--is that they favor spending in their districts, and will log-roll to get it. Meaning deficits.

I would happily vote for Scott Grannis for President, if he would only run!

W.E. Heasley said...

Mr. Grannis:

“He will probably suggest some tax credits, but those are ineffective at stimulating growth since they aren't permanent and they don't reward increased work and risk-taking.”

You make an excellent point that never gets much attention. Within supply side economics a theory exists that one time tax rebates and/or short term tax changes do nothing to stimulate investment or consumption. That a tax reduction requires a long time horizon where investors and/or consumer know that the playing field is set for a long period, then investment and consumption decisions can be made with certainty.

Further, the reduction in tax needs to be applied to all members associated with a particular tax. For example, marginal tax rates reduced for all tax brackets for all tax payers. That in fact, all taxpayers in all brackets make decisions on investment and consumption hence tax cuts need to apply to the entire group. Also, the class warfare ideology associated with taxes made by many self appointed intellectuals is bypassed when all member of the group receive the reduction in tax.

Scott Grannis said...

Benjamin: I'm not going to make excuses for Bush, nor do I want to minimize how upset I was with his inability to veto anything. But I would make one point about the reduction in spending as a % of GDP under Clinton: most of that reduction came because defense spending was cut way back. It's arguable whether that was a good thing or not.