Wednesday, November 26, 2008

Robert Mundell’s New Wisdom

New economic stats on consumer spending and business durable goods investment show an economy that’s sinking fast across-the-board. Wall Street economist John Ryding expects a 4 percent drop in fourth quarter real GDP.

Of course, the Fed is pouring in new cash hand-over-fist. And plunging retail gas prices to about $1.85 per gallon nationally amounts to a huge consumer tax cut of perhaps $320 billion, according to Mark Perry of the University of Michigan. So we’ve moved from tight money and an energy tax hike a year ago, to easy money and an energy tax cut today. The former mix has generated a nasty credit crunch and a recession. But the new monetary/energy mix will generate recovery next year. I hope.

At a wonderful dinner last night I had a chance to talk to Nobel Prize winning economist Robert Mundell about all things economic. What is to be done? I asked him.

Mundell, you may remember, was a leading supply-sider in the Reagan revolution. He argued for low marginal tax rates to spur the economy and a stable dollar to eliminate inflation. Bob Mundell also is the father of the euro. He is plainly an incredibly brilliant and distinguished

The dinner was put together by the indefatigable hard-money analyst Judy Shelton, a pretty smart gal herself. Our spouses were there along with some friends.

So here’s Mundell’s latest take on a pro-recovery, fiscal-monetary, growth mix. First, he’d like to see a complete corporate tax holiday for one year. He then favors corporate tax reform that would drop the current top rate from 35 percent to 15 or 20 percent. He believes this would generate badly needed business investment and job-creation to fight recession.

Incidentally, in today’s durable-goods business-investment report for October, capital-goods shipments are falling at a 12 percent annual rate versus their third-quarter average. Orders are down 35 percent. (By the way, that third-quarter average was a negative number.)

So Mundell is clearly on to something. Business needs help. Without healthy business, there will be no significant new job creation or consumer spending power.

On money, Mundell had two interesting thoughts: First, the U.S. dollar and the Chinese yuan should basically be re-linked at roughly today’s exchange rate (about 6.8 yuan to the dollar). There should be no more Chinese currency appreciation. Incidentally, Mundell thinks the Chinese economy is actually in some trouble. And he’d know. Mundell travels to China about once every other month as a key advisor to the Bank of China.

Also on the currency front, Mundell would prefer a floor under the euro at roughly $1.25. That’s about where it is today. It’s also roughly the same as the original $1.18 euro initial public offering in 2000. So Mundell is pressing for dollar stability relative to Europe and China. And he believes
that would be consistent with domestic price stability here at home.

Unfortunately, Fed head Ben Bernanke simply doesn’t think in these global currency terms. Mundell has no real problem with the Fed’s huge balance-sheet expansion to push new cash into the credit-crunched recessionary economy. He believes there is a huge demand for dollars at
home and overseas, and that the Fed should be accommodating this.

But Mundell frets that Bernanke is too much of a Phillips-curve unemployment-rate targeter, and that he doesn’t understand the powerful influence of a sound currency policy.

Putting it all together, Mundell’s anti-recession program is a reduction of the high marginal tax rate on business to reignite growth along with a stable dollar to contain inflation.

We also got around to talking about Paul Volcker, who is a friend of Mundell’s. He’s also my former boss from 1975, back when I was a young staffer at the New York Fed and Paul Volcker was the bank’s new president. Volcker, of course, has been counseling Barack Obama during the financial crunch. And today, the president-elect appointed Volcker, the former Fed chair, to be the head of a new White House advisory board on the economy. This advisory board takes a page from Ronald Reagan, who set up PEPAB, the President’s Economic Policy Advisory Board, back in 1981. Members of that group included Milton Friedman, Art Laffer, Alan Greenspan, Arthur Burns, Herb Stein, and others. George Schultz was the first chairman. This group helped sustain Reagan’s supply-side policies during some difficult times in 1981-82.

Now, no one really knows what Paul Volcker really thinks about the myriad TARP financial-rescue packages being run by the Treasury, the Fed, and the FDIC. Nor do we know what Volcker thinks about the Fed’s ballooning balance sheet, or U.S. dollar policy for that matter. A lifelong Democrat, Volcker is properly credited with slaying inflation in the 1980s. But he is no supply-sider.

Presumably, however, the conservative-Keynesian Volcker, along with Tim Geithner, Larry Summers, and Christina Romer, will advise Obama not to hike taxes in the next two years.

But that’s a presumption. We don’t know who else will be on this Obama economic advisory board. Might they consider a stable dollar and a big corporate tax cut? Well, if Volcker listens to his friend Mundell, he’ll gain some important advice to be passed along to the new president-elect.


Intrade said...

dr461 said :

    Same old conservative mantra--CUT CORPORATE TAXES? They rear-ended the American public, by underwriting bad mortgages with greedy CDOs, and expect us to want them to be rewarded for this? How pathetic that this hack (Kudlow) still has an audience. TRICKLE DOWN does NOT work, you idiot. If we don't invest in the middle and working classes in the United States, there won't be any consumers left. Don't you greedy Republicans get it?

Intrade said...

jc said :

I wish I had the E-mail addresses of Bernake, Volker and Geithner to present my idea for getting our banking system performing as it should. I propose the following two types of commercial banks.

One group of banks can continue under the current Fed regulations, the board and executives make the decisions, BUT THEY ARE TOLD THEY CAN RUN IT THEIR WAY BUT THERE WILL BE NO MORE HAND OUTS.

The other group of banks who opt to abide by the alternative Fed regulations for banks are told the Feb will provide adequate capitalization to be held by the Fed but they must agree to be subject to these regulations. Compensation packages will be set by the Fed and will be based upon the size of the bank. The Fed will provide mandatory guide lines for making loans. Loans may be sold but are identified as 100% from this group of banks and may not be packaged with loans from the other group of banks. Equity holders will continue to own the banks. Depositors may be solicited. Equity may be sold and be available for the banks business and not siphoned off to cover capitalization requirements. The original group of banks may not purchase this new group of banks unless they convert to the same rules. They must be kept separate.

This plan frees up the banks from having to hold cash to cover anticipated capital requirements. The Fed is providing this capitalization and these banks are then free to provide the services intended. This eliminates the cash taxpayers are handing out and the Fed merely stands behind this group of banks operating under these changed regulations.

The first group would have to make changes to their business plan to survive, join this newly regulated group or fail. If I am right this would start money moving in our economy and banks could return to the original business plan intended.


This is not socialization, the bank is not forced to opt for these new regulations but is free to pursue which business plan they prefer.

John Caldwell
127 Queen Christina Court
North Hutchison Island, FL 34949

Intrade said...

nemisis said :

    Kudlow continued to preach "goldilocks economy" for the past year and is the poster boy for why economists are the worst predictors of the stock market..anyone who listens to him deserves to lose...

Intrade said...

bailey said :

    Did Mundell consider putting the middle class to work with a livable wage and re-build our decaying Infrasture. The middle class would then spend and that money would trickle up to business and then create new jobs, If we give business tax breaks the they will just indulge themselves and their shareholders more. Corporate malfeasance should not be rewarded.
new monies just go to higher Executive wages

Intrade said...

At Least He's Not Jim Cramer said :

    For shame, Larry Kudlow! This pessimism does not become you. Goldilocks is alive and well! It's the greatest story never told!

Intrade said...

jc said :

    A friend of mine explained the actual theory behind trickle down economics to me.
John; I had trickle down economics explained to me by a 88 year old black man in narainger, fl. just south of miami in 1992. He said it was the rich upperclass white fat cat ,standin on the roof ,pissin off the edge, and low and behold it is tricklein down on him!!! So far no one has explained it any better than that...
Reagan started this trickle down economics and the result has been eliminating the middle class and sending the aged into poverty. Let's try the trickle up economics. Give em jobs and wages. They will spend their wages and that money will move up the chain till it reaches the producers and even the fat cats will get their honest share. Trickle down is starting at the top, but instead of the money moving down the chain, the greedy invest it trying to increase their wealth. My theory is certain to work. We have seen what trickle down has done to our country.