No reason to hit the panic button
Local economist Bill Watkins discusses America’s credit rating and economic future
By Michael Sullivan 08/11/2011
When Chicken Little was hit on the head by a piece of fruit, he spread fear to his whole farm community by mistakenly telling them, “The sky is falling!” The problem with Chicken Little is that he didn’t wait to see if another piece of “sky” would hit him on the head before causing a major panic.
According to local economist Bill Watkins, the downgrading of America’s credit rating isn’t a reason to panic. The 600-point drop in the Dow Jones on Monday is also not a reason to get upset. But for some reason, investors panicked at the new credit rating, then more major worry with the disturbance in the stock market. Watkins says that what we need is more time to see what is going to happen. (The Dow Jones rebounded Tuesday by 439 points.)
Watkins, executive director of Cal Lutheran Center for Economic Research and Forecasting, talked with the Reporter this week about America’s overarching economic situation and why not to panic. Well, not just yet, at least.
VCReporter: We have heard a lot about the consequences of delaying the raising of the debt ceiling. Though we did raise it, our AAA score went down.
Bill Watkins: I am not sure why the rating changed and had the impact it has. Everything is the same, there isn’t real news there.
We see events change behaviors in big ways. Sept. 2008 — the world just panicked, asset values went way down. We have also seen panics before — Y2K, Black Friday, stocks collapsed — nothing happened.
In 1987, there was a stock market crash, and in those days 500 points was different than today — that was 22 percent of value, a pretty big drop. The point is that nothing happened after that — people panicked and then went back to business as usual.
The mantra for the last few years is to create more jobs. Yet we are hearing more about the disparity in income, and few mid- to high-paying jobs are being created. Why is this happening? Why aren’t owners investing in their employees?
The job thing is sort of complicated. One problem is that business owners own a lot more real estate than most people. About 65 percent of Americans own the home they live in, but business owners, 98 percent. Over half own more than one property, so the collapse in real estate values has hit those people’s balance sheets far harder than most of us.
This is their personal balance sheets?
The problem is that people use real estate to finance growth in their business — it’s their equity, but their equity went away, and so small-business people, and that combined with the need to borrow — they are not in a position to hire, they just can’t do it.
The stock market — people investing money into other people’s businesses. Is there any way to trickle it down to smaller companies, or is there just not enough reward?
What we’ve seen in this recovery has been that what is good for Wall Street isn’t necessarily good for Main Street. And so we have seen Wall Street and the stock market pick up quite nicely, and very little for small businesses.
So how do we fix that?
I think you begin by recognizing that this recession was not typical. You need different policies to deal with it. I think there should be some ways to help businesses, even though the real estate equity is gone. You know, there used to be a thing that was very popular — base lending — and I’ve heard this on the radio recently, but we need different types of borrowing that doesn’t need to be [based] on real estate.
The fact is that a financial recession caused by financial panic means you’re going to have a longer recovery. That’s just the way it works
The European Union — what’s going on there?
The European Union was put together in spite of the best advice of economists — something like 70 percent of economists (which is as close as you’re ever going to get to a majority) concurred that it’s a bad idea and it’s too big, with too many countries, to be a common currency. It really comes down to the fact that Greece and Germany shouldn’t have the same monetary policy — most of us had expected [for it to dismantle] eventually. The Union came together in 1997 or 1998. Milton Freedman’s forecast was that it would last 15 years.
One of the things you need for a common currency is labor mobility. It works for the U.S. because people are relatively mobile. Everyone speaks the same language and has a similar culture. Whereas in Europe, you have all these different countries speaking different languages, and less labor mobility. It’s harder for someone in Greece to move to Finland than someone to move to Southern California from Maine. But even in the U.S., California would like a different market policy than Texas right now. In a place like Europe, it is causing real serious pain, and ultimately it will come apart. What we see is that democracy has a terrible time with that, becoming smaller. It’s everywhere and we’ve seen it recently in the whole debate about extending the debt. Democracy dealing with a long-term financial crisis is just extremely difficult. They took a long time to put the European Union together. … What it looks like they’re going to do is subsidize the outliers, subsidize, subsidize and someday they’ll give up, and then there will be a financial crisis.
Can the U.S. still get the credit it needs to pay off its debts?
By trading rules, it could lower the cost, and this is really perverse, things that are supposed to maintain an average quality, things like Fannie Mae and Freddie Mac, carry the rating they carry because they are backed by the Treasury and everyone expects them to pay them off, and they’ll get bailed out. If the government rating goes down, Fannie and Freddie have to go down.
Here’s the deal: if you’re trying to maintain your portfolio average, what you may have to do is sell Fannie and Freddie and buy Treasury to improve the average. The Treasury is still the safest thing you can buy. It could have the perverse effect of causing the buying cost of Freddie and Fannie to go up, and the Treasury to go down
And this will affect people trying to get home loans and student loans?
Why is it so bad to add an extra tax to a person who is a billionaire? What’s the problem?
The problem is that the billionaire can change his behavior. If you raise tax on me, I’m still going to go to work everyday because I’m paid a salary. If you’re a billionaire, you may decide, “I don’t want to invest in this, because I don’t want to pay the tax. It’s not worth my trouble, and instead I’ll just go on vacation.” Billionaires can move to France to get out of paying taxes. Rich people can change their behavior easier than we can. One problem is that in California especially, when you have a huge percentage of tax dependent on a small percentage of the population, the tax revenues are very volatile; the way to keep it from being volatile is to have it broad-based.
How are we going to solve it?
At some point, entitlement programs need to get cut back, in my opinion. We would need to do a needs test for Medicare and Medicaid to see if they can afford to pay themselves. Right now, anyone who turns a certain age gets it. It doesn’t matter how rich you are. I would raise the retiring age on Social Security. You have to do that; to me it is unavoidable. I would broaden the tax base, making it less reliant on the success of a relatively small portion of the population — we could do that with value-added tax, with a national sales tax, making a sort of minimum tax for people, making taxes less progressive.
But We’re OK right now?
Six hundred points in one day is not a big deal, if we fall 600 the next three days, then no. Eighteen hundred in a day is a big deal; 1,800 total in three days is a big deal. We need to watch the market in the next few days.