Excerpts from John’s letter, dated December 1, 2003 (John’s questions/comments are underlined)
See Nov 8 Economist for a discussion of the Bush Financial Strategy - or lack thereof. They were heavily critical of the mess it will create…Much less complacent than your letter.
Let's see, since November 8th, the Real GDP has been revised upward, we have the lowest number of new jobless claims since January 2001, most all of the positive indicators are on the rise, and the negatives on the wane. No doubt they (The Economist) point to concerns over deficits and trade balance issues - well, the truth of the matter is that we can and will grow out of our short-term deficits and the trade deficit is already showing signs of diminishing. More to the point, with the expanding economy, healthy, nominal GDP growth will bring in more tax dollars. Trade balance issues are complex in that there are numerous reasons why they continue: protecting our national interest (China, G7…now G8 with Russia), the still robust dollar (it is depreciating), and wholesale intervention by other nations who use our imports/their exports as a means to conduct domestic policy.
The unemployment situation is very serious here. It is not turning around. I hope that it will but there are people leaving for jobs elsewhere. Two of my kids are unemployed (Seattle and Boston) and say there are pretty limited opportunities. Our raises are going to be on the order of 2% for most people this year. I do not see this as a rosy economy yet.
Raises first - why should raises be any more than 2% if inflation is basically zero (it is generally accepted that the CPI overstates inflation by between 1 and 2 percent)? Besides, increased compensation translates into higher product costs - the consumer won't pay for it because there are substitutes (competition - the heart and soul of the New Paradigm). Besides, a 2% increase goes much further when it is basically a REAL 2%.
Unemployment: Again, The New Paradigm speaks to structural unemployment, that is unemployment not cyclical in nature - jobs go away period, and new jobs have to be created...this last part takes time, much more than in the past. For the months of September and October the economy grew 250k jobs. This may not seem like much, but it is better than had taken place for the two years previous. The numbers have been less than encouraging, but there is improvement, as I noted above.
Nationally we have an increasing debt to service, increased cost of war, increased farm subsidies, the baby boomers getting ready to retire, and increased medical costs born by the government. In addition, a lot of people have borrowed heavily during the low inflation/interest. Who is going to pay for all this and when?
Who do you think pays for this stuff, John? Those that pay taxes pay for all of this stuff. Sorry, don't mean to sound trite, but it is true.
As indicated in the graph below, the debt service is not as big a problem as you might think (bear in mind that lower interest rates also reduce cash flow and debt service concerns, allowing the public to again retain more for their money). Also, debt service ratios have actually eased a bit since 4th Quarter 2001.
The cost of caring for the Baby boomers will be borne by subsequent generations, as has been the case for previous generations. The real issue that will arise and will continue to be raised is transfer of wealth to the next and subsequent generations.
One of the major issues the editors of this newsletter have been discussing is what is the best course of action the government should take, in a fiscal sense to address the concerns of a burgeoning deficit. The biggest problem we noted from the nineties was that fiscal policy was basically geared to tax increases to run surpluses. The problem with that was that excessive taxes depress, making it increasingly difficult for the economy to maintain substantial growth. Instead, it is our assertion that it is far better to allow the economy to expand at a faster rate with lower tax rates and allow the tax base to increase more quickly (no matter how you look at it, taxes depress - whether in the Keynesian Model or in this New Paradigm).
Your newsletter should offer options for solutions, not just discourse.
Interesting comment, John. We are very confident that we have in fact done just that, by defining what the issues are and going from there. We certainly have discussed and to that end make no apology, but so far as offering solutions, we have laid out options and paths that we believe should be followed.
It is apparent from your comment that we have much work to do toward that end.
After reading an article by Alan Framm of the Associated Press, Analysts: Future Budget Outlook Gloomy, I couldn’t help but feel a measure of discomfort at the prospect of ballooning and persistent budget deficits. How are we going to cope with these seemingly problematic deficits?
Thanks for the article. Yes, running significant and consistent deficits is not a good way to go in the long run. The point is that when an economy is on the way to recovery, it is not uncommon to run budget deficits, especially in light of the added cost in the war on Terrorism. The major point to bear in mind is that while we are certainly running deficits, the economy is expanding at a rate much higher than government expenditures are actually expanding…at least this has been the case for the 3rd Quarter 2003:
Think of a typical situation in business: you are incurring higher levels of debt in order to expand your business, increase your cash flow. The short-term risk of running deficits can, if managed properly, afford long term gains in the form of increased sales/expanding business. There is not much difference at the government level. So long as government expenditures maintain a long run growth level below GDP, we should avoid any long-term problems. Additionally, as government receipts grow, in spite of lower tax rates, we should start seeing a turn around in the deficit picture within about 3-4 years. In fact, within 10 years, we will likely begin to see surpluses. All of this is dependent upon a lot of factors, including sound fiscal and monetary policy...and, most importantly, continued economic growth.
George in Rancho Bernardo, CA…
In an article by Justin Lahart, CNN, “Bill Gross has added his voice to the growing throng of market observers who see inflation on the rise. In his latest monthly missive, the bond manager, who oversees $350 billion in assets for Pimco, said the stage has been set for higher prices and recommended that investors act accordingly. A fed funds rate at 1 percent, massive current account and budget deficits, high levels of household debt, lower tax rates, a falling dollar, rising commodity prices, costly Medicare reform are all pointing the way to a revival of inflation.”
What’s up with all of this literature of impending doom? The one thing that I’ve learned in my reading is that those portending bad things to come outnumber the good by at least two to one. While I am not a pessimistic person by nature, I am concerned. In the spirit of your New Paradigm, would you care to debunk (address) the possibility of the upcoming 'inflationary' period forecasted by Gross?
A few things to remember:
· Henry Ford: 'History is BUNK!'
· In 1997, many smart people said DOW 20K in Y2K.
· The BCS system ensures an unambiguous NCAA Division 1 Football National Champ!
The curious thing with Mr. Gross is that if you were to present the current scenario to him: that is the economy growing at an 8% clip; the Fed Funds Rate at 1%; deficits running at around $500 Billion; Current Account Deficit (Trade Balance + Unilateral Transfers) at around the same rate $500 Billion; and a depreciating dollar, this fellow would no doubt tell you that inflation is well into the teens. Guess what, George? We're running in the 1-2% range, with the most recent data indicating deflation in the CPI. Mr. Gross is suffering from what the Fed has been wringing their hands about for the past several years - where in the hell is inflation? It has become the dog that didn’t bark.
Burned by their last adventure into economy killing rate hikes, the Fed is loathe to raise rates without substantial proof that inflation is rearing its head. The point is that Gross and probably the Fed have a bias toward inflation driven via the money supply (Monetarism), or by fear of an expanding inflationary gap (Keynesian). Remember this comment on inflation, George: firms raising prices cause inflation. The presence of heavy market competition, productivity gains, etc., has precluded any significant increase in prices in the economy to date. In the nineties, Robert Ruben took credit for keeping inflation at bay, citing that high taxes kept consumer spending under control. What was really going on was that competition was becoming more pervasive, keeping inflation at relatively insignificant levels in spite of sustained economic growth...
Yes, he (Gross) indicates that commodities have and will continue to rise as the dollar depreciates - but the flip side to this is that as the dollar depreciates it becomes more advantageous for domestic producers to crank up their volumes (oil, copper, steel, etc.). His assertion that consumer debt is flat out wrong. As indicated in the newsletter, Volume 2003: Issue 3 and in the graph found in the response to John’s letter, consumer debt is not running out of control.
The question for Gross and others who doubt the realities of this recovery is when will this uptick in inflation occur, and how much inflation are they speaking of?
One last thought...yes, the Fed was speaking of deflation a few months back, primarily because their monetary policy (influencing/coaxing the Fed Funds to the 1% level) was basically irrelevant and impotent. The amusing thing is that what completely befuddles the Fed is that inflation has not already reared its head - again, citing the incredible growth...this is what Gross is banking on. Let's see how it plays out in the months ahead, shall we.
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