Thomas Palley

Bernie's no radical: he's an American constitutionalist

Fear is the enemy of change and the friend of hate. That is why both sides of the political establishment, Democrats and Republicans alike, are now running a full-blown campaign of fear-mongering against Bernie Sanders.

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The stock market boom hides a toxic reality

The US is currently enjoying another stock market boom which, if history is any guide, also stands to end in a bust. In the meantime, the boom is having a politically toxic effect by lending support to Donald Trump and obscuring the case for reversing the neoliberal economic paradigm.

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Trumponomics: Neocon Neoliberalism Camouflaged With Anti-Globalization Circus

A key element of Trump’s political success has been his masquerade of being pro-worker, which includes posturing as anti-globalization. However, his true economic interest is the exact opposite. That creates conflict between Trump’s political and economic interests. Understanding the calculus of that conflict is critical for understanding and predicting Trump’s economic policy, especially his international economic policy.

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Bush Gives Big Iron a Steely Grip on a Key Sector of the Economy

Iron ore prices have recently been in the headlines, having jumped eighty-five percent. This news is troubling as such price increases threaten to raise steel prices, which will add to cost inflation and further undermine economic activity.

Behind these price increases lies the unusual structure of the iron ore market which is best characterized as bi-lateral oligopoly. That structure makes enormously troubling the Bush administration's decision to give regulatory clearance to a combination of the number two (Rio Tinto) and number three (BHP Billiton) ore producers.

Unlike other commodity markets, iron ore prices are set through annual negotiations between the ore producers (Big Iron) and the ore users (Big Steel). Recent contractual negotiations have resulted in huge price increases that reflect the ore market's structure.

On one side is Big Steel, consisting of an increasingly few large steel producers. On the other side is Big Iron, made up of an even fewer number of ore producers. Thus, the top three producers -- Vale do Rio Doce, Rio Tinto, and BHP Billiton -- account for seventy-five percent of total global production. Moreover, the oligopolistic power of the producers is reinforced by geography. Vale do Rio Doce is Brazilian and located in the western hemisphere, while Rio Tinto's and BHP Billiton's operations are in Australia. That creates a geographic split that helps Big Iron's profits.

In recent years steel production has been marked by significant mergers and right-sizing of capacity, combined with growth of state-directed steel capacity in China. The result has been a huge boom in steel profits that is reflected in steel company stock prices. For instance, consider U.S. Steel that traded at twelve dollars a share five years ago, and in June 2008 peaked at one hundred and ninety-six dollars a share.

Big Steel's earnings rolled in first, being at the end of the production chain. Now, Big Iron is trying to muscle in on the action and grab a share of those profits for itself. It is able to do so because of its bargaining power, and it would be no surprise if there also were some informal collusion among ore producers given their small world.

With limited alternatives, Steel has been forced to cough up some of its oligopoly profits, turning them into Iron's mining rents. That is a bad switch. Higher earnings in iron ore mining will have negligible impact on their economic plans as the industry was already earning large excessive profits. However, higher ore prices will raise steel prices, undermining manufacturing and causing inflation. Meanwhile, lower steel profits will reduce steel investment.

Lastly, speculation may also have contributed to the jump in ore prices, albeit not the speculation associated with other commodity markets in which speculative trading is rampant. Since iron ore is not traded on global commodity markets, financial speculators cannot be responsible for higher prices.

Instead, iron ore speculation is best characterized as 'joint speculation' by the ore producers and users about the continuation of steel profits and the ability of steel companies to pass on higher costs. In this light, the jump in ore contract prices can be viewed as a combination of profit capture by the ore producers plus a big bet on future macroeconomic conditions.

Such user-producer speculation is hard to argue against, but one can argue against an oligopolistic market structure that amplifies speculation's destructive effects. That makes the Bush administration's decision to approve a Rio Tinto-BHP Billiton combination another terrible public policy decision.

The approval of combination reveals the worst proclivities of the Bush administration, which is peppered with extractive industry boosters, particularly oil. The quest for combination shows that the much maligned Karl Marx was right about capital's proclivity to combine.

Beating the Oil Barrons

Over the past eighteen months, oil prices have more than doubled, inflicting huge costs on the global economy. Strong global demand, owing to emerging economies like China, has undoubtedly fueled some of the price increase. But the scale of the price spike exceeds normal demand and supply factors, pointing to the role of speculation -- and underscoring the need for policy action to clean up the oil market.

Reflecting their faith in markets, most economists dismiss the idea that speculation is responsible for the price rise. If speculation were really the cause, they argue, there should be an increase in oil inventories, because higher prices would reduce consumption, forcing speculators to accumulate oil. The fact that inventories have not risen supposedly exonerates oil speculators.

But the picture is far more complicated, because oil demand is extremely price insensitive. In the short run, it is technically difficult to adjust consumption. For instance, the fuel efficiency of every automobile and truck is fixed, and most travel is non-discretionary. Though higher airline ticket prices may reduce purchases, airlines reduce oil consumption only when they cancel flights.

This illustrates a fundamental point: in the short run, reduced economic activity is the principle way of lowering oil demand. Thus, absent a recession, demand has remained largely unchanged over the past year.

Moreover, it is relatively easy to postpone lowering oil consumption. Consumers can reduce spending on other discretionary items and use the savings to pay higher gasoline prices. Credit can also temporarily fill consumer budget gaps. Although the housing boom in the United States -- which helped in this regard -- ended in 2006, consumer debt continues to grow, and America's Federal Reserve has been doing everything it can to encourage this. Consequently, for the time being the US economy has been able to pay the oil tax imposed by speculators.

Unfortunately, proving that speculation is responsible for rising prices is difficult, because speculation tends to occur during booms, so that price increases easily masquerade as a reflection of economic fundamentals. But, contrary to economists' claims, oil inventories do reveal a footprint of speculation. Inventories are actually at historically normal levels and 10% higher than five years ago. Furthermore, with oil prices up so much, inventories should have fallen, owing to strong incentives to reduce holdings. Meanwhile, The Wall Street Journal has reported that financial firms are increasingly involved in leasing oil storage capacity.

The root problem is that financial markets can now mobilize tens of billions of dollars for speculative purposes. This has enabled traders collectively to hit upon a strategy of buying oil and quickly re-selling it when end users accommodate higher prices -- a situation that has been aggravated by the Bush administration, which has persistently added oil supplies to the US strategic reserve, further inflating demand and providing additional storage capacity.

Absent a change in trader beliefs, the current oil price spike will be broken only by a recession that exhausts consumers' capacity to buffer higher prices, or when the slow process of substitution away from oil kicks in. Thus, economic fundamentals will eventually trump speculation, but in the meantime society will have paid a high price.

Whereas oil speculators have gained, both the US and global economies have suffered and been pushed closer to recession. In the case of the US, heavy dependence on imported oil has worsened the trade deficit and further weakened the dollar.

This sobering picture calls for new licensing regulations limiting oil-market participation, limits on permissible trading positions, and high margin requirements where feasible. Sadly, given the conventional economic wisdom, implementing such measures will be an uphill struggle.

But some unilateral populist action is possible. A major form of gasoline storage is the tanks in cars. If people would stop filling up and instead make do with half a tank, they would immediately lower gasoline demand. Given lack of storage capacity, this could quickly lower prices and burn speculators.

Copyright: Project Syndicate, 2008.

Taxes and the Cult of Home Ownership

The bursting of the recent house price bubble has focused attention on the failures of monetary and regulatory policy. However, tax policy also likely played a role in our current mess by providing tax subsidies that contributed to a cult of home ownership. This policy is flawed. However, it is politically difficult to change because households see the benefits of tax subsidies and higher house prices but do not recognize the accompanying costs. By showing the downside of high prices, the housing bust provides an opportunity to escape this political trap.

Current tax law exempts capital gains on private homes up to $500,000 and treats mortgage interest as a deduction. Both measures are intended to help middle-class families, yet the reality is they distort the economy, are costly, and likely do little to make working families better off. That speaks for changing housing's tax treatment.

The mortgage interest deduction is extremely expensive, costing the Treasury approximately eighty billion dollars in 2007. Moreover, it is highly regressive because high-income taxpayers get to deduct their interest payments at top marginal tax rates, whereas others deduct at lower tax rates. That means high-income taxpayers get a higher subsidy rate, and their subsidy is further increased because they also tend to have larger mortgages. Meanwhile, many poor workers get no housing assistance because they rent and rental expenses are non-deductible.

Both the mortgage interest deduction and housing capital gains exemption encourage home ownership. Mortgage interest deductibility encourages switching from renting to owning, while the capital gains exemption encourages owning housing instead of other forms of wealth.

This tax treatment has increased demand for houses, raising prices. However, higher house prices entail larger mortgages so that households end up with larger gross interest payments that offset much of the interest deduction. Additionally, larger mortgages make households more vulnerable to losses if they have to sell under unfavorable conditions - as is now happening.

Since most households lack capital, higher house prices also make it difficult to come up with down-payments. That has encouraged risky non-traditional mortgages such as zero-down products, and these products are a significant factor in the current housing crisis. Furthermore, these mortgages carry higher interest rates that further offset the benefit of mortgage interest deductibility.

At the social level, higher house prices mean both spouses have to work, which undermines family structure. It also puts downward pressure on wages by increasing labor supply. However, the system gives every family an incentive to buy a house to lock-in ownership, even though the system may make them collectively worse off.

Higher home prices are also very unfair from an inter-generational standpoint. Increasingly, younger workers cannot afford houses, and that promises to undermine the market with those buying last losing most.

Finally, excessive home ownership may increase unemployment. This is because workers become tied down to their homes by attached financial obligations, reducing responsiveness to changing job market conditions.

The tax system has helped create a cult of home ownership, and that cult appears to have been an ingredient in the recent house price bubble. Rather than creating wealth, the tax treatment of housing redistributes wealth inter-generationally and makes households financially vulnerable. That means tax policy should change. Here are some suggestions.

First, the capital gains exemption should be abolished for all new home purchases. Instead, the base cost of houses should be indexed to inflation so that homeowners are not taxed on inflation gains. Existing homeowners should be grand-fathered under current law to discourage selling to protect unrealized gains, which would destabilize the housing market.

Second, the ceiling (currently $500,000 per taxpayer) on mortgages qualifying for interest deductibility should be gradually lowered to zero over a ten-year period. Such a gradual phase-out can actually help existing middle-class homeowners because it will make top-end homes relatively less affordable compared to mid-market homes that retain the tax subsidy. That will shift demand toward the mid-market segment, helping maintain mid-market prices and thereby mitigating the housing slump.

Third, since everyone needs housing, the Federal government should phase in a refundable housing cost tax credit available to all, regardless of whether they own or rent. That credit can be financed with revenues generated by phasing out the mortgage interest deduction. During the transition every taxpayer should have the choice between taking either the available mortgage interest deduction or receiving the housing tax credit.

Current tax treatment of housing is intended to benefit working families, but it actually creates bad outcomes. The reality is current tax law distorts the economy, promotes house price speculation, renders households over-indebted and financially vulnerable, and undermines wages and family structure. There is a better way to help working families afford decent housing, and now is a good time for policy to transition in that direction.

The Curse of the Clintons

Speaking the truth is discouraged in Washington DC. For journalists there is the fear that truth telling will mean not being invited back for the next press conference or another exclusive interview. For political insiders the fear is that speaking up will injure their careers by costing them political appointment. This dynamic has helped keep the lid on the curse of the Clintons.

From the start of the 2008 primary campaign many political experts have believed Hillary Clinton would have difficulty winning the general election even if she sailed through the primaries. This is because polls have consistently shown she has exceptionally high negative ratings, which matters enormously as it is very difficult to win-over people holding negative views. The best that can be done is persuading them not to vote. If winning were difficult before, current conditions make a Clinton general election win even less likely. Her slick assist in letting the race genie out of the bottle has alienated African-Americans, and without their turnout a Democratic win is almost impossible.

Equally importantly, should Senator Clinton manage to wrest the nomination from Senator Obama by insider dealings, she stands to alienate the young and independent voters that he has attracted. These voters will probably not vote for John McCain, but their enthusiastic support is also critical for a Democratic victory.

That begs the question of why Senator Clinton persists in running. One reason is hubris prevents her from acknowledging the political facts, so that she really believes she can win. A second more cynical reason is that Senator Clinton's political ambition is best served by having a bruised and battered Senator Obama run in November, thereby facilitating a McCain victory. That would allow her to run again in 2012 on an "I told you so" platform.

For Democrats this is a terrible curse. If Clinton persists with her campaign, Obama is weakened in November. And if Clinton actually gets the nomination, Democrats stand to lose the election and also forfeit Senator Obama's extraordinary political bequest.

In political science one of the best established facts is that the way a person votes the first time is a strong predictor of how they will vote the rest of their lives. Senator Obama has attracted droves of first time voters, setting up the prospect of a generation of Democratic political dominance. Depriving him of the nomination risks so disenchanting these new voters that they may return to political apathy. That would cheat Democrats of a bright future, which is something super-delegates with political futures of their own should ponder.

In the 1990s, when Bill Clinton turned his back on progressive politics, many speculated Hillary was the real progressive among the two. The reality is both are cut from the same cloth, which is marked by unbridled ambition and desire for power for power's sake.

Bill Clinton lied under oath during the Lewinsky investigation. Senator Clinton lied about being under fire in Bosnia. Bill Clinton abandoned unions and working families with his promotion of NAFTA, free trade with China, and the elimination of the right to welfare assistance in hard times. Senator Clinton initially endorsed this policy legacy, and only changed her tune when John Edwards' call for real change started gaining traction. Bill Clinton's middle name is "triangulation". Senator Clinton shamelessly sought to profit from Barack Obama's casual observations about the link between economic disenfranchisement and "guns and bible" politics. In doing so, she showed a willingness to keep alive right-wing conservatives' major wedge issue just to damage her rival.

The cruelest irony concerns women and women's rights. Many women champion Senator Clinton as a defender of women's rights, including the right to an abortion. However, her ambition is increasingly jeopardizing that right. Mrs. Clinton cannot win in November, and her refusal to bow out has done damage to Senator Obama's prospects. That sets up the conditions for a McCain victory, the price of which will be the Supreme Court.

Truth telling is difficult in Washington, and the truth is also often stranger than fiction. When it comes to the Clintons, the truth is they have become a curse for Democrats and not an asset.

AlterNet is a non profit organization and does not make political endorsements. The opinions expressed by our writers are their own.

The Fed and Crony Capitalism

The Federal Reserve's recent decision to grant Wall Street access to special borrowing facilities smells of special dealing for special interests. The decision subsidizes the biggest most powerful investment banks, thereby distorting financial markets in their favor. Behind the decision lies the problem of excessive representation of Wall Street interests within the Fed.

The Fed's response to the crisis, combined with its earlier massive policy failure to address asset price bubbles, raise grave questions about its independence and judgment. At this stage, Congress should launch formal hearings into the governance of the Fed, which has remained largely unchanged since the 1930s.

The Fed's new Primary Dealer Credit Facility (PDCF) effectively gives Wall Street's primary government securities dealers, which includes all the large investment banks, access to discount window borrowing. That means access to funding at the bargain basement interest rate of 2.5 percent, and all that is asked is borrowers post some form of investment grade collateral.

This arrangement constitutes a massive subsidy, which would be large in normal times. However, it is especially large at a time of market uncertainty and liquidity shortage. While other market participants are being forced to de-lever at fire-sale prices, the Fed's friends are being given near-free government money to snap up assets.

Wall Street has been quick to embrace the facility, and within four days borrowing reached $29 billion. Erin Callan, Chief Financial Officer of Lehman Brothers, enthusiastically declared the facility to be "incredibly attractive... Our ability to access that form of financing to do more business for clients is incredibly interesting."

Morgan Stanley Chief Financial Officer Colm Kelleher described the facility as being "there for normal business. It's not meant to be there as a last-recourse thing." A Goldman Sachs spokesman declared "we think the Fed window provides a good alternative to the secured funding markets and we welcome the initiative."

The new facility represents a complete break with the past. Previously, discount window borrowing was restricted to regulated depository institutions, and access was always described as "a privilege and not a right." That meant banks could only get access to cover seasonal shortfalls of funds or dire emergency needs, and any borrowing was subject to regulatory disapproval - so-called Federal Reserve "frown" costs. Now, the Fed has apparently made the discount window available to Wall Street as a source of ordinary business finance.

This means the Fed is providing risk capital to the likes of Goldman Sachs at paltry interest rates that confer a significant subsidy. Moreover, the mere right of access enables them to borrow more cheaply from other lenders because of the back-stop reassurance provided by discount window access. It also establishes incentives for future excessive risk-taking.

These subsidies are a travesty. Goldman Sachs, Lehman Brothers, and Morgan Stanley are extraordinarily profitable companies. They have also been the drivers of the worst trends in the American economy over the past generation, pushing excessive CEO pay that has spread like a cancer throughout corporate America, even reaching into universities and non-profits. Additionally, they have pedaled the shareholder value paradigm, that has pushed companies to emphasize short-term gain over long-term investment, and contributed to ripping up America's social contract. Meanwhile, their business model has promoted speculation that is behind repeated asset and commodity price bubbles.

Subsidizing these firms is an insult to Main Street. Many families are losing their homes as part of the mortgage crisis. If they had access to 2.5 percent financing that would not be happening. Likewise, manufacturing firms are being forced to close because of lack of affordable capital, which is destroying jobs and the economic foundation of communities.

The Fed will claim it had to institute these measures to calm Wall Street. That is nonsense. The fair and economically efficient way to deliver emergency liquidity to Wall Street is through an auction facility that is open to all financial firms, and in which participants supply good collateral. Those who need the funds most will bid the highest. That way, taxpayers get properly paid for their support, and the funds go to those who need them most.

Geologists say they learn the most from extreme events like earthquakes that reveal the reality of the earth's crust. For the past twenty-five years, critics of the Fed have been dismissed, and the Fed's high standing has blinded the reality of its revolving door with Wall Street and its class-based conduct of policy. Now, the Fed's response to Wall Street's panic has revealed the reality of its crony capitalist world. That provides an opening for long-needed reform.

How Obama or Clinton Can Win the Edwards Vote

John Edwards' exit from the presidential race puts his supporters up for grabs. Both Senators Clinton and Obama want those votes. Here's how to win them.

The central plank of the Edwards' campaign was restoring a prosperous and secure middle class, which requires ending wage stagnation and having wages again grow with productivity. This must be the central economic policy goal of any candidate wanting the Edwards vote.

The generation long rupture of the wage - productivity link reflects deep structural failings in the economy that must be corrected. Helping hand social policies, such as trade adjustment assistance and the earned income tax credit, are welcome but they are not adequate to the scale of the problem.

Having government try to remedy wage stagnation through after-tax income redistribution does not address the core problem of unfair before-tax incomes. A progressive tax system is critical for fairness, but it cannot ensure a prosperous middle class. That requires decent wages paid in return for a decent day's work.

The starting point for shared prosperity must be full employment, since only then do workers everywhere have the power to bargain increased wages that equal productivity growth. Monetary, fiscal, and exchange rate policy must work in coordinated fashion to this end. The best measure of full employment is when wages steadily rise with productivity.

Restoring the balance of power in labor markets is critical for wage bargaining. This requires labor law reform that ends employer intimidation preventing workers from joining unions and bargaining fair contracts, and government must vigorously enforce the law. The minimum wage must be reformed and tied to average wages so that it provides a true floor that rises as the economy grows. Unemployment insurance must also be reformed so that its duration is extended and coverage broadened.

Modernizing financial regulation is another needed measure. The housing bubble and sub-prime mortgage crisis show the financial system is broken. Today, the only instrument of control is the blunderbuss of Federal Reserve interest rate changes that inflict unemployment or inflation. New ideas exist and should be given space through a national financial markets reform commission that airs all views, and not just those of Wall Street.

The debate over fiscal responsibility must be redefined. That debate should be about containing healthcare inflation that threatens to bust the budget and funding needed public investment. It is time to break with conservatives' definition of fiscal responsibility that attacks government and seeks to cut essential programs like Social Security.

Public investment is critical. The economy sits on the edge of a recession and fiscal stimulus is needed to combat that danger. But beyond that, the country must invest in its future and fill the enormous investment gap resulting from a generation of neglect of public onfrastructure. Public investment in schools, hospitals, roads, bridges, and public transportation is enormously productive. It creates jobs and raises private sector productivity, the key to growth and an essential condition for a prosperous middle class.

Global warming presents new challenges that also call for public sector investment. Those challenges are an opportunity to create a 21st century green economy. To that end there is need for an Apollo-scale commitment promoting energy efficiency through new technologies, incentives for energy saving investments, and improved and subsidized public transportation.

Globalization means international economic policy is more important than ever. The trade deficit has hollowed manufacturing and must be reduced. Policy must put a stop to unfair international competition based on undervalued exchange rates, export subsidies, and unfair trade restrictions. America must also lead in the creation of a new international financial architecture that promotes fair and balanced trade, and only countries that truly join in this endeavor can be allowed full access to the America's markets.

Finally, there is need to tackle the problem of corporate governance and regulation. Corporations have been the major force rupturing the link between wages and productivity growth, and they have also been the major force driving globalization. That calls for a corporate reform agenda that addresses excessive CEO pay, restores shareholder control, and realigns business incentives so that corporations again serve the national interest as well their private interests.

John Edwards' campaign recognized the imminent challenge of recession and advocated fiscal stimulus. Both the Obama and Clinton campaigns have done likewise. However, it is not enough to just change the economic policy dial settings. The Edwards campaign also spoke to the need to change the long-term direction of the economy by restoring full employment, leveling the playing field between workers and corporations, and fixing unfair competition unleashed by globalization.

That's the message that will win the Edwards vote.


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