How the current economy affects the enrollment of colleges, especially the private liberal arts colleges. (source: NYT)

Larry Meyer, former Fed governor, founder of Macroeconomic Advisers, which provides the only monthly US GDP series, talks about the outlook of the economy.

Roubini’s recent interview on FT:

Despite the nation’s reputation as a rootless society, only about one in 10 Americans moved in the last year — roughly half the proportion that changed residences as recently as four decades ago, census data show.

The monthly Current Population Survey found that fewer than 12 percent of Americans moved since 2007, a decline of nearly a full percentage point compared with the year before. In the 1950s and ’60s, the number of movers hovered near 20 percent.

The number has been declining steadily, and 12 percent is the lowest rate since the Census Bureau began counting people who move in 1940.

Read more here

Part 2, The 30-year China and US trade partnership all worked, until it didn't.  The US now will learn to how to save more.  Meanwhile, China should rethink its development strategies.  Thomas Friedman tells an anecdotal story to illustrate this point. (Source: NYT)

I had no idea that many of those oil paintings that hang in hotel rooms and starter homes across America are actually produced by just one Chinese village, Dafen, north of Hong Kong. And I had no idea that Dafen’s artist colony — the world’s leading center for mass-produced artwork and knockoffs of masterpieces — had been devastated by the bursting of the U.S. housing bubble. I should have, though.

“American property owners and hotels were usually the biggest consumers of Dafen’s works,” Zhou Xiaohong, deputy head of the Art Industry Association of Dafen, told Hong Kong’s Sunday Morning Post. “The more houses built in the United States, the more walls that needed our paintings. Now our business has frozen following the crash of the Western property market.”

Dafen is just one of a million Chinese and American enterprises that constitute the most important economic engine in the world today — what historian Niall Ferguson calls “Chimerica,” the de facto partnership between Chinese savers and producers and U.S. spenders and borrowers. That 30-year-old partnership is about to undergo a radical restructuring as a result of the current economic crisis, and the global economy will be highly impacted by the outcome.

After all, it was China’s willingness to hold the dollars and Treasury bills it had earned from exporting to America that helped keep U.S. interest rates low, giving Americans the money they needed to keep buying shoes, flat-screen TVs and paintings from China, as well as homes in America. Americans then borrowed against those homes to consume even more — one reason we enjoyed rising wealth without rising incomes.

This division of labor not only nourished our respective economies, but also shaped our politics. It enabled China’s ruling Communist Party to say to its people: “We will guarantee you ever-higher standards of living and in return you will stay out of politics and let us rule.” So China’s leaders could enjoy double-digit growth without political reform. And it enabled successive U.S. administrations, particularly the current one, to tell Americans: “You can have guns and butter — subprime mortgages with nothing down and nothing to pay for two years, ever-higher consumption and two wars, without tax increases!”

It all worked — until it didn’t.

With unemployment now soaring across the U.S., said Stephen Roach, the chairman of Morgan Stanley Asia, Americans — “the most over-extended consumer in world history” — can no longer buy so many Chinese exports. We need to save more, invest more, consume less and throw out most of our credit cards to bail ourselves out of this crisis.

But as that happens, we need China to take our discarded credit cards and distribute them to its own people so they can buy more of what China produces and more imports from the rest of the world. That’s the only way Beijing can sustain the minimum 8 percent growth it needs to maintain the political bargain between China’s leaders and led — not to mention pick up some of the slack in the global economy from America’s slowdown.

However, if I’ve learned one thing here, it’s just how hard doing that will be. China’s whole system and culture nourish saving, not spending, and changing that will require a huge “cultural and structural” shift, said Fred Hu, chairman for Greater China for Goldman Sachs.

In China, for instance, to buy a home you have to put at least 20 percent down, and the average is 40 percent. If you try to walk away from the mortgage, the bank will come after your personal assets. Moreover, China can’t just shift production from the U.S. market to its own consumers. Not many Chinese villagers want to buy $400 tennis shoes or Christmas tree ornaments.

Also, China has no real Social Security, health insurance or unemployment insurance. Without that social safety net, it’s hard to see how Chinese don’t end up saving most of their stimulus. “You open up the newspaper every day and you hear about this factory shutting down or that supplier going belly up,” said Willie Fung, whose company, Top Form International, is the world’s leading bra maker. “You can never be too careful in this financial climate.”

As such, “the world should not have a false hope that China can cushion the global downturn,” by stimulating its domestic demand in a big way, said Frank Gong, head of China research for JPMorgan Chase. “The best thing China can do is keep its own economy stable.”

It’s good advice. China is not going to rescue us or the world economy. We’re going to have to get out of this crisis the old-fashioned way: by digging inside ourselves and getting back to basics — improving U.S. productivity, saving more, studying harder and inventing more stuff to export. The days of phony prosperity — I borrow cheap money from China to build a house and then borrow on that house to buy cheap paintings from China to decorate my walls and everybody is a winner — are over.

Quantitative Easing is not panacea.  Japan's QE popped up a bond bubble and killed money market.  These are hard lessons the Fed should keep in mind (source: FT).

By John Richards

As the recession deepens, policy rates around the world are rapidly approaching zero and they cannot go any lower. Does that mean that central bankers have run out of ammunition? Not necessarily.

With policy rates approaching zero, central banks can still impact the economy by buying government securities across the yield curve, bringing down longer term interest rates, thereby boosting the economy.

The US Federal Reserve adopted this strategy at Tuesday’s federal open market committee meeting. Now, the asset (securities) and the liability sides (deposits) of the Fed’s balance sheets will expand rapidly.

Support will be provided indirectly to leading sectors of the economy, such as housing, as the Fed purchases mortgage-backed securities and the debt of government sponsored enterprises such as Fannie Mae and Freddie Mac.

Because the Fed’s balance sheet is set to expand almost without limit and without regard to the level of the policy rate, this policy is called quantitative easing.

But does quantitative easing work? Does it have unforeseen consequences? Japan is the only economy in recent times to have tried a full-scale version of quantitative easing for a significant period.

The Bank of Japan lowered the policy rate to zero in February 2001 and then went to quantitative easing the next month. It ended both quantitative easing and its zero interest rate policy only in 2006.

In Japan’s case, the mechanics were simple. The BoJ added reserves to the banking system through open market operations and by directly purchasing government securities from the secondary market.

The size of the bond-buying operation (Rinban) became the policy tool to target the level of reserves rather than the policy rate, which was fixed at virtually zero.

The BoJ’s monetary policy committee voted on the desirable level of reserves and the size of the Rinban, much as it had previously voted on the level of the policy rate.

And, when the economy deteriorated further, the BoJ increased the Rinban, pumping up reserves. At its peak, reserves reached around Y35,000bn of which only around Y8,000bn were required.

It is a matter of debate whether or not quantitative easing had much impact on the Japanese economy, even though it coincided with the longest expansion in Japan’s post world war two history (2002-2007). But, I think not.

Quantitative easing was nearly irrelevant to the expansion of real economic activity that began in 2002. The expansion was largely self-financed by corporations’ free cash flow and therefore not constrained by an absence of banks’ lending.

Neither were there big liquidity problems in Japan to be solved by quantitative easing. Capital injections and guarantees to the banks had largely cured them well before the process began.

Money market rates were already low and their spreads were tight to the policy rate. High oil and other input prices ended headline consumer price index deflation, but the CPI less food and energy continue to be nearly flat even now.

This makes it hard to argue that quantitative easing ended deflation; high oil prices did that. Meanwhile, the economy cured on its own most of the structural problems such as excess capacity and too much debt associated with the deflationary environment.

However, the bond market during quantitative easing was anything but smooth. The process ignited a bond bubble, whose eventual collapse destabilised financial markets, even threatening Japan’s hard-earned economic recovery. Long- term interest rates began to plummet in the spring 2002, with 10s reaching 0.48 per cent in June 2003, down 120 basis points over the year.

The yield curve experienced a rolling flattening in which successively longer maturities tightened down on the zero policy rate.

When the bond-bubble burst in June 2003, rates soared and the curve steepened sharply. This created what in Japan is still known as the Var-shock because of the sudden rise in yields and the accompanying jump in volatility triggered when banks, which were using similar risk management models, tried to dump Japanese government bonds at the same time.

The effects on banks’ earnings were so severe that it raised concerns that the economy would be plunged back into another 1990s-style period of economic stagnation.

About all quantitative easing did on the positive side for Japan was to help the BoJ keep its independence from the politicians by giving the appearance of action.

The costs were the shutting down of the money market, although it revived fairly quickly when QE ended, and a dangerous bond-bubble, whose popping threatened the recovery and destabilised the financial system.

One of the lessons of this episode for policymakers is that while quantitative easing may help to solve the short-run liquidity problems that arise in times of extreme financial duress, it is not a substitute for some of the harder choices governments must make.

These include underwriting of systemic financial risks, e.g. by guaranteeing bank deposits, the re-capitalisation (forced or voluntary) of the banks, regulatory pressure on banks to disclose and write down the bad assets, or the pressures on businesses directly via their banks to restructure and deleverage or shut down.

A worst-case current scenario is that policymakers rushing to quantitative easing fail to understand this, giving us a bond-bubble but no permanent fixes of the underlying structural problems.

In that case, when the bond-bubble bursts, paradoxically, quantitative easing will have increased systemic financial risks instead of decreasing them.

John Richards is head of Research, Royal Bank of Scotland, Asia Pacific

How Bill Miller at Legg Mason consistently beat the market for over 15 years and then lost all his reputation in this crisis. (source: WSJ)

Why Permanent Tax Cuts Are the Best Stimulus

Short-term fiscal policies fail to promote long-term growth

The incoming Obama administration and congressional Democrats are now considering a second fiscal stimulus package, estimated at more than $500 billion, to follow the Economic Stimulus Act of 2008. As they do, much can be learned by examining the first.

The major part of the first stimulus package was the $115 billion, temporary rebate payment program targeted to individuals and families that phased out as incomes rose. Most of the rebate checks were mailed or directly deposited during May, June and July.

The argument in favor of these temporary rebate payments was that they would increase consumption, stimulate aggregate demand, and thereby get the economy growing again. What were the results? The chart nearby reveals the answer.

The upper line shows disposable personal income through September. Disposable personal income is what households have left after paying taxes and receiving transfers from the government. The big blip is due to the rebate payments in May through July.

The lower line shows personal consumption expenditures by households. Observe that consumption shows no noticeable increase at the time of the rebate. Hence, by this simple measure, the rebate did little or nothing to stimulate consumption, overall aggregate demand, or the economy.

These results may seem surprising, but they are not. They correspond very closely to what basic economic theory tells us. According to the permanent-income theory of Milton Friedman, or the life-cycle theory of Franco Modigliani, temporary increases in income will not lead to significant increases in consumption. However, if increases are longer-term, as in the case of permanent tax cut, then consumption is increased, and by a significant amount.

After years of study and debate, theories based on the permanent-income model led many economists to conclude that discretionary fiscal policy actions, such as temporary rebates, are not a good policy tool. Rather, fiscal policy should focus on the "automatic stabilizers" (the tendency for tax revenues to decline in a recession and transfer payments such as unemployment compensation to increase in a recession), which are built into the tax-and-transfer system, and on more permanent fiscal changes that will positively affect the long-term growth of the economy.

Why did that consensus seem to break down during the public debates about the fiscal stimulus early this year? One reason may have been the apparent success of the rebate payments in 2001. However, those rebate payments were the first installment of more permanent, multiyear tax cuts passed that same year. Hence, they were not temporary.

What are the implications for a second stimulus early next year? The mantra often heard during debates about the first stimulus was that it should be temporary, targeted and timely. Clearly, that mantra must be replaced. In testimony before the Senate Budget Committee on Nov. 19, I recommended alternative principles: permanent, pervasive and predictable.

– Permanent. The most obvious lesson learned from the first stimulus is that temporary is not a principle to follow if you want to get the economy moving again. Rather than one- or two-year packages, we should be looking for permanent fiscal changes that turn the economy around in a lasting way.

– Pervasive. One argument in favor of "targeting" the first stimulus package was that, by focusing on people who might consume more, the impact would be larger. But the stimulus was ineffective with such targeting. Moreover, targeting implied that increased tax rates, as currently scheduled, will not be a drag on the economy as long as increased payments to the targeted groups are larger than the higher taxes paid by others. But increasing tax rates on businesses or on investments in the current weak economy would increase unemployment and further weaken the economy. Better to seek an across-the-board approach where both employers and employees benefit.

– Predictable. While timeliness is an admirable attribute, it is only one property of good fiscal policy. More important is that policy should be clear and understandable — that is, predictable — so that individuals and firms know what to expect.

Many complain that government interventions in the current crisis have been too erratic. Economic policy — from monetary policy to regulatory policy, international policy and fiscal policy — works best if it is as predictable as possible.

Many good fiscal packages are consistent with these principles. But what can Congress and the incoming Obama administration do to give the economy a real boost on Jan. 20? Here are a few fairly bipartisan measures worth considering:

First, make a commitment, passed into law, to keep all income-tax rates were they are now, effectively making current tax rates permanent. This would be a significant stimulus to the economy, because tax-rate increases are now expected on a majority of small business income, capital gains income, and dividend income.

Second, enact a worker's tax credit equal to 6.2% of wages up to $8,000 as Mr. Obama proposed during the campaign — but make it permanent rather than a one-time check.

Third, recognize explicitly that the "automatic stabilizers" are likely to be as large as 2.5% of GDP this fiscal year, that they will help stabilize the economy, and that they should be viewed as part of the overall fiscal package even if they do not require legislation.

Fourth, construct a government spending plan that meets long-term objectives, puts the economy on a path to budget balance, and is expedited to the degree possible without causing waste and inefficiency.

Some who promoted the first stimulus package have reacted to its failure by saying that we must now switch to large increases in government spending to stimulate demand. But government spending does not address the causes of the weak economy, which has been pulled down by a housing slump, a financial crisis and a bout of high energy prices, and where expectations of future income and employment growth are low.

The theory that a short-run government spending stimulus will jump-start the economy is based on old-fashioned, largely static Keynesian theories. These approaches do not adequately account for the complex dynamics of a modern international economy, or for expectations of the future that are now built into decisions in virtually every market.

Mr. Taylor, undersecretary of Treasury for international affairs 2001-2005, is a senior fellow at the Hoover Institution and a professor of economics at Stanford University.