Obama's Economic Team Flees

I start off todays blog with some speculation as to why Larry Summers is the third senior official to leave Obama’s economic team. I touch on the gloomy assessment in the Fed’s statement following its meeting yesterday, and go on to discuss the idea that the US’s persistent trade deficit is leaking vital capital overseas, and is a primary cause of our current economic malaise.


* Yesterday Larry Summers announced that he will leave Obama’s economic team.  As I said when Christine Romer announced that she left to go back to teaching at Berkeley, it is smart for her to get out of Dodge before the next Tsunami hits, and the same applies to Summers. Does Romer and Summers understand that the economy is going to sink no matter what the government’s policies are, or did they just get tired of working in the White House? Or is there underlying dissent about how to fit Obama’s socialistic agenda into a budget and an economy which supports that agenda? 


If these departures were expected, then I would have thought that Obama would have had replacements lined up, but he doesn’t. That tells me Obama is in a bit of a quandary as to how to proceed forward. Clearly, his economic team has failed him and the country. Obama says that without his policies, that the economic situation will have been worse. He is correct in that assessment. My contention is that there is a day of reckoning ahead for the US, and that Obama’s policies are only delaying that from happening. As one reader responded to yesterday’s readers comment/analogy to “Batman”:


“Maybe you and the others all watched a different Batman show. In the ones I watched, Batman and Robin always got away and got the bad guys!”


We all watched the same show, except the current situation is not made up by clever writers, although I must admit that today’s politicians have most of us convinced that the recession is over, and all is well. Let’s consider the first paragraph in the Federal Reserve’s statement which was released yesterday:


“Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months. The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term.”


Does this sound like an economy you want to start a business in? Or work in the Obama administration when you realize the ship is going to go down? Exit Summers, stage, left…. is a smart move in my opinion.


Back to the implications of the Fed’s statement: At the risk of being redundant, my contention is that our trade deficit is an important contributor of the economy’s malaise. Simply put, over the past 5 years, the US has been running a $600 billion trade deficit, which represents a tax on our economy, but not a tax in the conventional context, but more so as a governor on our economies ability to grow. Up to 2006, equity extraction from the great housing machine served to counter-balance this tax. Now housing is in retreat, and debt de-leveraging will continue to contribute to a drain on the economy. Meanwhile the fact that over half a trillion dollars goes overseas is being used to fuel overseas economies, and so long as our trading partners are content to hold our currency and invest in US treasuries, there is no mechanism for these funds to return to the US. In short, the normal trade balancing mechanisms such as the selling of the surplus dollars, and a declining value of the dollar, which would serve to make imports to the US more expensive, would reduce US demand for imports, while making US exports less expensive, with increased demand. The stock-piling of dollars in overseas accounts is preventing this stabilization mechanism from occurring.


While everyone (including myself) is busy trying to figure out what government budget policies should be, the real solution probably resides with our policies towards the trade surplus countries. What if the US placed a limit on the amount of externally held treasury debt they paid interest on? And when the number goes above a certain amount, then the US just haircuts the interest paid to all external holders? Of course, the Fed must agree to step in an purchase any treasuries the external holders want to sell, to keep that market stable. This is probably a stupid idea, but nonetheless, there is something like that, which is totally outside the traditional tool box, will need to be implemented to solve our trade deficit problem. 


I will give Obama credit for taking on the Chinese in the town hall meeting he participated in on Monday. I will conclude today’s blog with the idea that there must be some method to balance out the US’s trade deficits, because the money which is leaking out, via the trade deficit, needs to be recycled into our economy. If these monies were somehow kept in the US, then I would bet that you would see a recovery in our economy. Of course there are other implications of a declining US trade deficit, including declining wages in order to bring the US more in line with foreign competitors, but with average US wages over ten times the average wage in China, Thailand, etc, there are other issues which will need to be addressed. These discussions will be fodder for future blogs.