Peter Schiff on Fox Business Channel 03 July, 2010 Barry Horowitz,

03 July, 2010.

Excellent panel, great content. As always Peter Schiff stole the show, Barry Harrowitz is excellent also.

How to fix US deficit: Stick to the law

I haven’t had a chance to digest CBO’s long-term outlook yet (released earlier today), but luckily I did see Ezra Klein’s post on it, which featured two charts which highlight the difference between CBO’s current-law baseline, and their “alternative fiscal scenario” which is more of a “policy-extended” baseline–similar to the one the Obama Administration uses as the baseline relative to which they measure the costs (or savings) of their budget proposals.

In theory, CBO’s deficit assumptions project the effects of settled law. And if you do that, revenues pretty much pay for spending over the next few decades.

Note that the chart shows that under CBO’s “extended baseline” scenario, reflecting current law, “primary balance” is achieved, where there is no “fiscal gap” between non-interest spending and revenues. That doesn’t mean the federal budget is perfectly balanced, because interest costs take total federal spending above revenues, but it does mean that the deficit is pretty small–as a matter of fact, less than 3 percent of GDP by 2015, which means it’s economically sustainable (because at 3 percent, the stock of federal debt is growing at about the same pace as the economy).

Coincidentally, this picture above could also be labeled “2015 Goal of President Obama’s Fiscal Commission”–because the commission’s goal is also to achieve “primary balance” and a “sustainable” level of deficits by 2015.

So CBO is showing us we don’t have to do anything to achieve fiscally-responsible policy over the next 25 years. It’s already set by laws we’ve already passed. Congress can go home. They don’t need to pass any deficit-reducing legislation, and President Obama doesn’t have to sign it.

Well, unfortunately life is not so simple. As Ezra warns:

But current law is not likely to advance unmolested. You’ll notice, for instance, that there’s a big jump in current-law revenues next year. That’s because the Bush tax cuts are slated to expire totally. But few expect Congress to allow them to expire totally. They’re likely to preserve the bulk of the cuts, rejecting only some of the cuts that helped out the rich.

Ah, but here’s where the President’s fiscal commission can help us stick to the “simple” solution of holding onto current law. They can make it simpler to hold onto this fiscally-responsible, current-law policy over the longer run by giving their blessing to letting go of current law (only) temporarily–letting Congress and President Obama enact a (popular) tax cut to help the recovering-but-still-weak economy: an only temporary extension of the bulk of the Bush tax cuts. In exchange, the commission could require that the federal government get back on track in a couple years, recommitting to the picture above by getting back to the current-law baseline level of revenues. That doesn’t have to mean sticking to current tax law, but it does mean that any deviations from that “script” will have to be revenue-neutral. And that sounds a lot like an exercise in fundamental tax reform, which could boost the strength and sustainability of our federal revenue system even beyond the next 25 years.

In fact, this was a strategy that Bob Bixby, the Concord Coalition’s executive director (and my boss), recommended to the President’s commission today. From his written testimony:

That leaves us with tax policy. Sticking to the CBO current-law baseline on taxes, 19.7 percent of GDP, gets the budget deficit to the commission’s target. Legislatively, that represents the easiest option, as policymakers simply need to do nothing and let current law play out.

However, that does not mean current law represents the most desirable policy path to achieve the baseline level of revenues. If reverting to the pre-2001 era tax policy (with its higher marginal tax rates) at the beginning of 2011 is deemed undesirable for political reasons, or out of economic concern for raising marginal tax rates during the early stages of economic recovery, tax policy could be reformed to achieve the same revenue levels without raising marginal tax rates.

The commission might find fertile common ground on steps to improve the tax code in ways that would increase efficiency and thus increase revenues. A thorough scrubbing of the system to identify preferences that serve no compelling use or that could be altered in a resetting of priorities is long overdue.

The fact that the commission’s short-term goal is to achieve a lower deficit by 2015 and not sooner suggests a tax policy strategy that could acknowledge the concern of many economists about the dangers of “unwinding” our currently stimulative fiscal stance too quickly. The 2001 and 2003 tax cuts that President Obama has proposed to permanently extend could instead be extended only temporarily. If done for one or two years, this would be long enough not just to allow for a more solid economic recovery, but also long enough to develop a more fundamental reform of the federal tax system that could more efficiently achieve current-law revenue levels by 2015.

This would provide an opportunity to enact a tax policy that meets the commission’s 2015 goal, while earning bipartisan support, while also building a tax system capable of remaining adequate and economically efficient over the longer term — boosting our chances for economic growth and a more sustainable fiscal future.

And so, Ezra’s take-away lesson from the CBO report is (emphasis added):

Either Congress can pass and implement policies that will bring the long-term deficit under control or it can’t. Those are the only two choices here. But there’s no real mechanism for getting the deficit under control aside from Congress passing laws and then sticking to them.

I’ll have some of my own analysis of the CBO long-term outlook report later this week. There have been some changes to the two baselines CBO defines, some of those changes a bit puzzling and even intriguing.

(My Concord colleague, Josh Gordon, blogged more comprehensively about the CBO report and Bob’s testimony on Concord’s Tabulation blog today. As he emphasizes, our recommendations for achieving longer-term fiscal sustainability are not just “stick with current tax law” or the “stick with the current-law revenue baseline.” The largest longer-term challenge remains health care spending. But the biggest and most reliable “2015 lever” is clearly tax policy, and no matter how great the health-reform lever eventually works decades from now, we’ll still need the tax system to support that not-so-outrageous-but-still-expensive health care system over the longer run.)

A look at global economic developments Economic Theory

A look at economic developments and activity in major stock markets around the world Thursday:

SHANGHAI — Slowing global demand and a retreat from stimulus policies led to a weakening in China's manufacturing in June for a third month.

Reports from Market Economics also indicated that manufacturing sector growth in India, South Korea, Australia and Taiwan was slowing.

In Asian markets, Japan's benchmark Nikkei 225 stock index closed down 2 percent, South Korea's Kospi index shed 0.7 percent, Australia's S&P/ASX 200 tumbled 1.5 percent and markets in Singapore, Malaysia and Taiwan also fell.

BERLIN — The European Central Bank said it is lending 111.2 billion euros ($136.7 billion) to banks in a six-day tender, completing an effort to smooth over the expiry of a record batch of loans.

The ECB said 78 banks subscribed to the operation, conducted as 442 billion euros in credit granted a year ago to support banks during the financial crisis expired.

That came after the central bank said Wednesday it would lend a lower-than-expected 131.9 billion euros to banks for three months. Neither the banks nor their nationalities were identified.

The outcome of the longer-term auction suggested that banks' cash needs are easing despite lingering worries about the impact of the eurozone debt crisis. More than 1,100 banks subscribed to last June's unusual 12-month operation.

LONDON — The industrial sector's growth cooled slightly in the 16 countries using the euro and the United Kingdom, according to manufacturing surveys.

European stocks fell. The FTSE 100 index of leading British shares closed down 2.3 percent, Germany's DAX dropped 1.8 percent and France's CAC-40 fell 3.

TOKYO — Major Japanese manufacturers, riding high from a booming Asia, haven't felt this good for a long time. Business confidence improved for a fifth straight quarter and was in positive territory for the first time in two years.

LONDON — The Bank of England says the amount of secured credit available to households increased slightly in the second quarter, but lenders say it might be more scarce in the July-September quarter.

BERLIN — A small rise in retail sales offered a hopeful sign for Germany's long-sluggish domestic demand, even as the country's economy minister mounted a robust defense of its export-heavy recipe for success.

MADRID — Spain successfully raised 3.5 billion euros ($4.3 billion) in an oversubscribed bond sale, a reassuring sign for markets a day after ratings agency Moody's warned it may join others in downgrading the country's debt.

BEIJING — A Chinese company canceled a $2.5 billion project to develop a bauxite mine in Australia, blaming difficult conditions in the global industry.

TIANJIN, China — Workers at a Japanese-owned electronics factory in the northern Chinese city of Tianjin were on strike over pay and benefits for a third day, the latest in a spate of labor disputes as an increasingly restive work force demands better conditions.

STOCKHOLM — The Swedish central bank raised its key interest rate for the first time in two years, saying the economy is recovering strongly from last year's global downturn.

The Riksbank raised the key repo rate by a quarter percentage point to 0.5 percent.

ATHENS, Greece — Prices of consumer goods and services have risen overnight in Greece, as a new sales tax hike takes effect in an effort to boost government finances.

SINGAPORE — Singapore real estate prices jumped to a record high in the second quarter as the city-state's economic recovery broadened.

NAIROBI, Kenya — Five nations in East Africa implemented new economic rules to boost cross-border employment and trade.

The new steps push forward a larger plan to integrate the economies of Burundi, Kenya, Rwanda, Tanzania and Uganda, which together form the East African Community.

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China's Secret Recipe - Economics Theory

BEIJING -- China’s GDP growth this year may approach 10%. While some countries are still dealing with economic crisis or its aftermath, China’s challenge is, once again, how to manage a boom.

Thanks to decisive policy moves to preempt a housing bubble, the real-estate market has stabilized, and further corrections are expected soon. This is good news for China’s economy, but disappointing, perhaps, to those who assumed that the government would allow the bubble to grow bigger and bigger, eventually precipitating a crash.

Whether or not the housing correction will hit overall growth depends on how one defines "hit." Lower asset prices may slow total investment growth and GDP, but if the slowdown is (supposedly) from 11% to 9%, China will avoid economic over-heating yet still enjoy sustainable high growth. Indeed, for China, the current annualized growth rate of 37% in housing investment is very negative. Ideally, it would slow to, say, 27% this year!

China has sustained rapid economic growth for 30 years without significant fluctuations or interruption -- so far. Excluding the 1989-1990 slowdown that followed the Tiananmen crisis, average annual growth over this period was 9.45%, with a peak of 14.2% in 1994 and 2007, and a nadir of 7.6% in 1999.

While most major economies in their early stages of growth suffered crises, China’s story seems abnormal (or accidental), and has elicited periodic predictions of an "upcoming crash." All such predictions have proved wrong, but the longer the story lasts, the more people forecast a bad end.

For me, there is nothing more abnormal about China’s unbroken pattern of growth than effective macroeconomic intervention in boom times.

To be sure, both economic development and institutional reforms may cause instability. Indeed, the type of central government inherited from the old planned economy, with its overstretched growth plans, causes fluctuations, and contributed significantly to instability in the early 1980s.

But the central government must be responsible for inflation in times of overheating, lest a bursting bubble fuel unemployment. Local governments and state-owned enterprises do not necessarily have those concerns. They want high GDP growth, without worrying much about the macroeconomic consequences. They want to borrow as much as possible to finance ambitious investment projects, without worrying much about either repayment or inflation.

Indeed, the main cause of overheating in the early 1990s was over-borrowing by local governments. Inflation soared to 21% in 1994 -- its highest level over the past 30 years -- and a great deal of local debt ended up as non-performing loans, which amounted to 40% of total credits in the state banking sector in the mid-1990s. This source of vulnerability has become less important, owing to tight restrictions imposed since the 1990s on local governments’ borrowing capacity.

Now, however, the so-called "animal spirits" of China’s first generation of entrepreneurs have become another source of overheating risk. The economy has been booming, income has been rising, and markets have been expanding: all this creates high potential for enterprises to grow; all want to seize new opportunities, and every investor want to get rich fast. They have been successful and, so far, have not experienced bad times. So they invest and speculate fiercely without much consideration of risk.

The relatively high inflation of the early 1990s was a warning to central government policymakers about the macroeconomic risks posed by fast growth. The bubble bursts in Japan’s economy in the early 1990s, and the Southeast Asian economies later in the decade, provided a neighborly lesson to stop believing that bubbles never burst.

Since then, the central government’s policy stance has been to put brakes on the economy whenever there is a tendency toward over-heating. Stringent measures were implemented in the early 1990s to reduce the money supply and stop over-investment, thereby heading off hyperinflation.

In the recent cycle, the authorities began cooling down the economy as early as 2004, when China had just emerged from the downturn caused by the SARS scare in 2003. In late 2007, when GDP growth hit 13%, the government adopted more restrictive anti-bubble policies in industries (steel, for example) and asset markets (real estate), which set the stage for an early correction.

Economic theory holds that all crises are caused by bubbles or overheating, so if you can manage to prevent bubbles, you can prevent crises. The most important thing for "ironing out cycles" is not the stimulus policy implemented after a crash has already occurred, but to be proactive in boom times and stop bubbles in their early stages.

I am not quite sure whether all Chinese policymakers are good students of modern economics. But it seems that what they have been doing in practice happened to be better than what their counterparts in some other countries were doing -- a lot on "de-regulation," but too little on cooling things down when the economy was booming and bubbles were forming.

The problem for the world economy is that everybody remembered Keynes’s lesson about the need for countercyclical policies only when the crisis erupted, after demanding to be left alone -- with no symmetric policy intervention -- during the preceding boom. But managing the boom is more important, because it addresses what causes crises in the first place.

In a sense, what China has been doing seems to me to be the creation of a true "Keynesian world": more private business and freer price competition at the micro level, and active countercyclical policy intervention at the macro level.

There may be other factors that could slow down or interrupt China’s growth. I only hope that policymakers’ vigilance will prevail (and be improved upon), enabling China’s high-growth story to continue for another 10, 20, or 30 years.

Fan Gang is professor of Economics at Beijing University and the Chinese Academy of Social Sciences, director of China’s National Economic Research Institute, secretary-general of the China Reform Foundation, and a member of the Monetary Policy Committee of the People’s Bank of China.

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