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Debunking Policy and Economic Myths

 

The Spin: Unemployment is rising and the level is very high
 
Reality:
That’s backward looking. Yes, unemployment is high and it will remain high for a while, but what matters for recovery is whether it is rising or falling. The recovery won’t really be underway until unemployment starts to fall. The change is what matters for getting a recovery underway. The level is what matters to politicians.
 
The Spin
Mortgage defaults are high. Short sales are still high. Banks own lots of repossessed homes.
 
Reality
Yes, there is plenty of bad news (still) in the        housing market. Again, it is the level of housing that’s bad, not the direction of change. In fact, virtually every single measure of housing health shows improvement, typically significant improvement: home prices, inventories of new and existing homes, new home starts (the latest report notwithstanding), pending home sales, and even default rates are slowing. You name it in housing and it shows gains. The turnaround is already well underway.
 
The Spin:
Excess liquidity will produce high inflation.
 
Reality
This could happen. If the Fed screws up completely and fails to withdraw the excess liquidity at the appropriate time, then high inflation could happen. But before it can happen, other conditions must be met, notably capital and labor must become scarce, enough to create bottlenecks somewhere—anywhere-- in the economy. That’s not even on the radar screen, yet.
 
The Spin:
The Fed needs an exit strategy.
 
Reality:
Yes, but it does, but isn’t that somewhat premature before the economy has even reported its first rise in payroll employment? Even then, shouldn’t we wait until it seems likely that the expansion is embedded in the economy? Why take the risk of aborting the recovery? See point above.
 
The Spin:
Credit problems could create deflation.
 
Reality:
This is also a possibility. But credit market conditions have already improved dramatically and conditions continue to get better. Also, we can’t have both inflation and deflation simultaneously.
Both criticisms can’t be correct.
 
The Spin:
Credit problems, especially for small business, will stunt the recovery.
 
Reality:
Lack of credit availability is behind most forecasts of a slow or moderate economic recovery. This is a legitimate concern, which is one reason why the Fed’s current accommodative policy stance is appropriate and you can be sure Fed policy won’t change until this problem is gone.  Time should heal this problem.
 
The Spin:
We are dependent on the “kindness of strangers” and will suffer if they reduce their purchases of Treasury securities.
 
Reality:
Does anyone think that the Chinese are buying Treasuries to be nice to us? Aren’t they buying to prevent the yuan from appreciating, so they will be able to continue to export? If so, then they are buying Treasuries to help themselves and will continue to do so. (Don’t forget it wasn’t long ago we were pressuring them to allow their currency to rise.)
 
The Spin:
The dollar is collapsing.
 
Reality:
Using a “loaded” word doesn’t make it so, even if it helps in marketing. The dollar has been weak over the past several months, reflecting a weak U.S. economy and a trade deficit. An economic recovery will provide support for the dollar. In the meantime, dollar weakness will strengthen exports, which is helpful for recovery.
 
The Spin:
The collapse in commercial real estate still lies ahead.
 
Reality:
In fact, public REITs have all been huge issuers of equity to pay down debt and selling new bonds to roll over maturing issues with great ease. Problems are much greater for privately owned companies, which were more leveraged. Most importantly, real estate markets appear to be stabilizing. Even the CMBS market is reopening. There will be more defaults, but the worst is already over.
 
The Spin:
Cash for Clunkers created a false illusion of economic growth and consumer spending that cannot be sustained.
 
Reality:
Yes, auto sales surged due to Cash for Clunkers and sales declined to pre-Clunker levels in September. But that sales rate was below the rate cars are being junked, so the September sales were unsustainably low and the false illusion argument can’t be reconciled at all with the latest rise in auto sales in October. Cash for clunkers got rid of excess inventory quickly and the recovery in auto sales is underway. Expect auto sales to rise significantly in 2010.
 
The Spin:
The government’s stimulus isn’t working. 
 
Reality:
No one ever claimed we were turning on a light switch. It does take time. Moreover, the turn round does appear to be underway. It is surely odd for critics to argue it isn’t working and also the pickup in consumer spending and housing aren’t sustainable.  It’s unnecessary to argue it’s unsustainable, if it isn’t happening.
 
The Spin:
The deficit is a killer.
 
Reality:
This argument really ought to be just about timing. You would flunk any economic 101 course if you failed to argue for spending increases or tax cuts to combat recession. Recall that Hoover was criticized (deservedly) for raising tax rates during the Depression. Is that the model to be followed? You would also fail if you don’t argue for reducing spending or raising taxes once the economy is recovering.
 
The Spin:
The 50% rise in stock prices is excessive
 
Reality:
Really? If so, was the decline of more than 50% off the peak normal? Stocks were pricing in a worst case scenario in which the meltdown might cause depression. That worst case outcome was averted, so stocks should no longer be priced for that possibility. Moreover, the rebound in 2009 hasn’t even brought us back to pre-Lehman levels. Historically, stocks always anticipate recovery and bounce very strongly in that early stage before recovery becomes unmistakable and stock prices rise further as the expansion unfolds over time.
 
The Spin:
Interest rates close to zero are too low and this will create another bubble.
 
Reality:
It is correct that interest rates are unsustainably low, but it is premature to think this will create another bubble when we haven’t even had our first positive employment number yet. Last time, interest rates were held low for quite a while after the economy started to recover. Besides, the housing crash was more a result of poor mortgage underwriting or even fraud, rather than just low interest rates.
 
The Spin:
Consumer deleveraging will continue for many years as households pay down debt and rebuild the savings rate.
 
Reality:

This is a forecast and like many forecasts, especially more extreme forecasts, may prove untrue. Households proved more than ready to buy a lot of cars when the Cash for Clunkers deal was available. It is easy to forecast that savings rates will rise towards 10%, as was the case decades ago, but this isn’t assured. It might even be unlikely because there have been many structural changes in the economy.