PIMCO's Bill Gross: Government must take a leading role in job creation

I was pleased to read this week that Bill Gross, co-founder and managing director of the investment giant PIMCO, believes the US federal government should be doing more to address the unemployment problem. According to Gross, "deficits are important, but their immediate reduction can wait for a stronger economy and lower unemployment. Jobs are today’s and tomorrow’s immediate problem."

Gross's brief also contains some valuable commentary reminiscent of the past insights of the now-retired PIMCO partner Paul McCulley (now with the Global Interdependence Center). Gross's dismissal of the Ricardian equivalence proposition (the notion that budget deficits dampen consumer and investor confidence) and his reference to the ideas of economist Hy Minsky reminded me of this excellent commentary by McCulley.

Also, it's interesting to see Gross giving clear support for more activist fiscal policy measures. In the past, some of Gross's views could have been interpreted as being somewhat dismissive of the effectiveness of Keynesian-type remedies (for instance, see here, p.4).

That being said, if Gross is serious about his plea for more government action, perhaps he should warn the current author of PIMCO's Global Central Bank Focus column, Tony Crescenzi, to ease-off on the anti-inflation rhetoric (see here). First of all, much of what Crescenzi writes in regard to the effects of inflation is not supported by the facts. Secondly, Crescenzi's views on inflation are exactly the type of commentary that opponents of government intervention would use to attack the very proposals now being recommended by Gross.

Increase in household debt slows

Canada's 2011 Q1 National Balance Sheet Accounts were released yesterday. Here are some of the highlights:

• the growth in household net worth as a percentage of income is slowing
• the growth in debt to personal disposable income and household debt to GDP is slowing
• household debt to net worth rises for a second quarter in row after having fallen in mid-2010

The good news is that the household sector is now definitely up to reducing its level of debt. The bad news is that improving household balance sheets will probably take time.

The picture is different with respect to the corporate sector, as the total debt to equity of private non-financial corporations continues to fall to record lows.

On a final point, I've been hearing commentators say that the household sector's position isn't so bad given that the household debt service ratio is still at a reasonable level. That, in my view, is a very simplistic way of looking at things. For instance, the chart below (double click to enlarge) shows that Canada's moderate debt service ratio is essentially being sustained by the low interest rates.* If you look at indicators such as total liabilities or the ratio of debt to net worth, you see that the situation isn't as acceptable as some make it out to be.

To be sure, higher levels of household debt may sustain higher levels of household assets. Also, the fact that debt is greater than income isn't a problem unless household income isn't sufficient to cover for debt payments and living expenses. However, the situation could turn ugly if the value of household assets falls, as this would undermine the basis on which the debt was issued. Therefore, in a context in which some economists are predicting a significant decline in home prices (up to 30 percent in some areas) within the next few years, it would be wise for Canada's monetary and fiscal authorities to tread carefully during this period when households are seeking to reduce their level of debt. Rising interest rates or a decline in household income could trigger financial problems moving forward.

* The chart is based on Statistics Canada data and my own calculations. Data in chart is for persons and unincorporated businesses.

Slowdown in consumer services

Here's a stock paragraph from Statistics Canada's web link to monthly data about the country's services sector:

Our mining, oil and natural gas industries may get all the headlines, but they will not displace service industries any time soon. The services sector dominates the economy. Canadian businesses and consumers rely heavily on the services sector for a wide range of activities.

So what does it mean when the rate of change in consumer services goes negative?

While it's too early to make predictions based solely on this statistic, I think it's important to keep in mind that the federal government has made it clear that it too is in the process of reducing its contribution to the services sector in order to eliminate its budget deficit. Also, if you consider the fact that consumer borrowing is slowing down and export potential isn't what it used to be due to the strong Canadian dollar, it's clear that all there is left to keep GDP growing is business investment, an area that is actually doing well these days.

Perhaps the fall in demand for consumer services is simply a one-off event.* That being said, it should be emphasized that a negative rate of change in consumer services has only occurred once before in the last decade. And that was in 2008 at the start of the last recession.

* Statistics Canada defines consumer service as follows:

Services consumed by households, such as rent (including the rent imputed on owner-occupied housing), transportation, education, medical care, child care, food and accommodation services as well as travel expenditures of Canadians abroad, less travel expenditures of foreigners in Canada. Also includes the current (operating) expenses of associations of individuals and unincorporated businesses.

Corporate vs. government debt: putting things in perspective

From Sally Kohn:

The United States generates approximately $14.5 trillion in GDP each year and carries, currently, $14.3 trillion in debt. That represents a debt-to-income ratio of roughly 1-to-1.

By comparison, here are the debt-to-income ratios of some of the leading corporations in America:

•IBM — 2-1

•Dupont — 3-1

•United Technologies — 3-1

•Boeing — 4-1

•Caterpillar — 14-1

•JP Morgan Chase — 50-1

In other words, IBM borrows twice as much money as it earns annually. Boeing borrows four times more than it earns. And JP Morgan Chase, clearly not too big to borrow, borrows 50 times more than it earns — getting $50 from lenders for every $1 it makes.

I've always thought that reminding people of these facts was a pretty good way of demonstrating how the notion of eliminating public sector deficits is misguided.

And in case you're wondering: no, the analogy isn't faulty. In fact, Bill Vickrey, the late economist and Bank of Sweden Nobel laureate, made a similar case in favor of government budget deficits a decade ago:

If General Motors, AT&T, and individual households had been required to balance their budgets in the manner being applied to the Federal government, there would be no corporate bonds, no mortgages, no bank loans, and many fewer automobiles, telephones, and houses. (p. 2)

Still, some disagree with comparing private and public debt on the grounds that government spending, unlike the product of private industry, is unproductive. If you happen to adhere to this view, I suggest you take a look at "Is Public Expenditure Productive?" by David Aschauer, a former economist of the Federal Reserve Bank of Chicago. According to Aschauer (and contrary to what most people believe), additions to the net capital stock of public infrastructure have a positive impact on overall productivity growth.

Aschauer, D., "Is Public Expenditure Productive?", Journal of Monetary Economics 23, 1989, pp. 177-200.

Vickrey, B., "Fifteen fatal fallacies of financial fundamentalism: A disquisition on demand side economics", Working Paper No.1, January 2000. A copy of the paper is available on the website of the Center for Full Employment and Price Stability, http://www.cfeps.org/pubs/