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Goolsbee: We Need More Investment

Ben Johnson, CFA

Ben Johnson: Hi. I’m Ben Johnson, director of passive funds research with Morningstar. I’m here on the sidelines of our ETF Invest 2013 Conference. Today, I’m joined by Austan Goolsbee. Austan was the former chair of President Obama's Council of Economic Advisers, and he's currently a professor of economics just down the street here at the University of Chicago.

Austan, thank you so much for joining.

Austan Goolsbee: Thanks for having me.

Johnson: Now, you really had a front-row seat to the very worst of the financial crisis, being in the position you were in.

Goolsbee: It was one of those front-row seats you don't want, where the guy is spitting on you from the stage, but that was a crazy moment. For all the struggles and troubles to get the growth rate up in the country, it certainly feels better in markets and in the economy than it was back then.

Johnson: But given your broad role and, I mean, you were even on the Detroit automotive industry task force, what about what you saw then and what you were planning for then has panned out sort of as expected, and what now a few years removed has panned out in ways you could have never imagined?

Goolsbee: That's an important and deep question. There’s several different areas. I would say, on the financial side, we've learned that if you get into a crisis, precommitting to recapitalize the banks doing a full-blown stress test, where you open the books and show the market here's where the holes are and here's where they're going to be filled, I think most analysts agree that's how you should do it; have the government take warrants. At the time, everybody was nervous that it wouldn't work. That hadn't really been fully tried before.

So that one was a surprise to the upside; not that it worked at all, but that at least on the bank side the Troubled Asset Relief Program ended up getting paid back in full. Back at that time there were a lot of people saying $700 billion, it might be $1 trillion or more. If you look at the international evidence of big financial crises, they end up costing the governments somewhere between 5% and 10% of GDP on average. So that the banks paid back the money was great. I'm extremely happy they did that.

I think the other surprise to the upside was in the discussions about the rescue of the auto industry, nobody knew whether demand was going to come back strong enough that we would be able to keep these companies afloat long enough that the rising tide will lift them up. That proved the demand came back stronger than people even anticipated. So, you've seen with the announcements at GM, at Chrysler that they've kind of matched back to fore that the auto industry is coming back. So, both of those were positive.

I'd say on the negative side, we did not know at the time when trying to come up with the stimulus, what the nature of the downturn was. Is it a long-lived, extended, slow growth kind of a recovery, or will it be more traditional? We had a very sharp downturn, therefore we'll have a very sharp upswing. That debate took place in the government and the stimulus itself and many of the government actions were on both sides or every side of that. Unfortunately, it's proved in both the U.S. and the rest of the world to be the long, extended painful type of recovery. So we're still living with those issues.

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Johnson: Here we are, it’s five years now removed from the Lehman Brothers bankruptcy. It has been that long, slow slog, and in recent days, in Washington in particular, things have actually come to a grinding halt. Where do we head from here? I mean, there is still lot uncertainty, albeit maybe in different form and centered around really our nation’s capital in precisely this moment.

Goolsbee: That’s a big mess, obviously, and for anybody who has gotten out of Washington, they look back and say, "Oh, phew, thank God, I’m not there." I was there the last time we had the debt-ceiling fight, and it just seemed pretty awful then, too. I think the reality is that the United States' growth rate of, let's call it, 2.0%, 2.5% that we've had for several years is OK. It's not adequate to really pull the unemployment rate down or generate big jobs numbers. It's going to come down at this modest rate as long as we're growing that modestly.

Now, I then go look around the world and, unfortunately, see the U.S.’s 2% growth rate is about the fastest of all the advanced world. In Europe, they are dancing a jig that they raised growth forecast to 0.2%. This is not a great time for the world economy, by any means, really in any part. I think the only way out of this, Washington has got to sort out its own pathologies. Hopefully, if there is some upside of a government shutdown and this kind of dysfunction, maybe it's that it forces the minds of the American voters to decide what do they actually want Washington to do; maybe this shutdown precipitates the kind of crisis that allows them to make a decision and move on.

The good news is, the overwhelming majority of what has happened and needs to happen for economic growth doesn't have anything to do with Washington. It's taking place in the private sector and the private sector was scarred rather badly from the financial crisis, and there is still a lot of both uncertainty and trepidation about--"We have cash on our balance sheet, so do we want to spend the money? Well, we just went through a period where anybody who didn't have liquid assets died, so do we really want to get rid of our liquid assets?"

We still got to get past that fear, and slowly we are doing that. I think you are seeing credit markets slowly improving back to something similar to what they were before. You are seeing some turnaround in the housing market, though I caution people I don't think it's going back to the go-go days, but it is turning around. And I think that's the only way out. It's not going to be a rapid way out.

Johnson: What will ultimately sort of bring some of this cash back to where it belongs, which is investment in growth and investment in infrastructure. Corporations are flush with cash right now, and I would tend to think that a lot of that is because of a lot of this uncertainty around health care, taxation, so on and so forth. What brings that cash back into the economy?

Goolsbee: I would say, thus far I know people talk about policy uncertainty in Washington being a source of the cash sitting on the balance sheet. The reason I don't think that's the predominant factor is you see that exact same pattern taking place throughout the advanced economies of the world. There has been return to profitability and a high reluctance to spend the money on capital investment because we've got overbuilt in a lot of investment-good areas, and it's still far from clear that we've crossed a hurdle that the world economy is really strongly growing again.

I think the main thing is we've got to just keep working our way out. As economic growth starts, that's when people start using their money and start investing. When they anticipate growth is about to begin, we've got to have capacity on the scene to satisfy that. I think that's been made more complicated by credit markets still fundamentally not healed for all. If you are an investment-grade company, the credit crunch is over. If you are not an investment-grade company, and particularly if you are trying to get credit in different international markets, there have been ups and downs, and they haven't been small. There have been some tough periods for small business and some of the normal channels of job creation and investment in the country.

I think we’ve got to just count on continuing to slog our way out, and slowly you will see that translating into investment. The cost of capital is extremely low. Normally, as you come out of recession, there is not an obvious source of money to fuel an investment boom; this time there is. I think those are positives. There is still some pent-up demand that's sitting under there after we clear out these kinds of financial problems and structural changes that we need to make. I think there is still a fair amount of potential demand, and the basic engine of U.S. economic prosperity has been the innovative capacity of the economy. And that really has not changed. Nothing negative happened with that in the last four or five years, and so you see there are a number of fast-growing sectors; you see in energy, you see in high-tech. They are booming like crazy; they are investing a lot and we just got to keep expanding the set of what industries are doing it.

Johnson: It seems like, more than anything, it's really just a matter of we’ve been very badly bitten and how do we conjure up those so-called animal spirits again to get people excited about investing?

Goolsbee: I don't think it's just psychological, I guess is the way I’d put it. So when you say "animal spirits," it connotes that it's just about psychology and that if people just felt better, then they would invest. I think the slow growth has been rooted in the fundamentals. I mean, as I say, all around the world they aren’t growing very fast, so exports from the U.S. have had a hard slog. Even though they have increased a lot, that in itself has been a tough slog. It's always hard if you got to shift the main focus of what the economy is doing. In the 2000s the two big drivers as we know were consumer spending growing faster than income was growing and residential construction, and both of those were fueled by bubbles that we can't go back to. We need more investment, we need more exports, we need to shift the focus of the economy, and that takes a bit of time. So it's partly some animal spirits, but it’s also just partly the grubby day-to-day work of economic transformation.

Johnson: Thank you so much for being here and sharing your insights with us.

Goolsbee: It's my pleasure to be here. It's a great conference.