Sunday, March 30, 2008
The current argument is that over-the-top leveraging is the consequence of a regulatory breakdown, and there is certainly truth to the extent that the failure of oversight has enabled investment banks and hedge funds to do whatever they want — but why did they want to extend themselves so far?
Here is one possibility: the new math-intensive strategies are chasing tiny margins. The trading programs are designed to perceive opportunities for arbitrage a nanosecond before anyone else, taking advantage of the slightest misalignment of related prices. We have also witnessed ever more elaborate strategies involving complex tradeoffs between risk and return to create composite positions whose alpha is perceived to be a shade higher in relation to its beta.
The profit margins on these strategies are minuscule, but if everything goes as programmed, predictable. This means that they can be turned into respectable earnings only through intense leverage. By investing in positions at the rate of 3000% of capital, you turn 1% annualized margins (which correspond to much smaller margins on any given trade) into 30%. And the geniuses who devise these opaque instruments tell you that the risk is small relative to the return.
What the risk jockeys always seem to miss is that estimates of portfolio risk depend on covariances among the individual elements, and these in turn are determined by the structural properties of the system in question. And no one can know what they are, because the system is too complex, there are too few data points, and the structure keeps changing. So the models work, trade after trade, until there is an unforeseen systemic event, after which all hell breaks loose.
Then the high degree of leverage, which was necessary to make the strategy pay sufficient dividends, magnifies the risk instead of the return.
If this analysis is correct, it suggests that putting a ceiling on leverage may also slow down the drive toward unfathomable financial complexity. That would be a good thing, and not just for us dummies.
Friday, March 28, 2008
Juan Cole claims it is that ragamuffin madman Cheney again, whispering in al-Maliki's ear that since the Iraqis have agreed to have serious provincial eletions this fall so that the Sunnis of violent Diyala Province can get rid of their Shi'i government, al-Maliki should take the Sadrists down in Basra so that they do not take over the government there, Iraq's second largest city, and its main export point for oil. Control of oil revenues are clearly a key in this. Of course the part of this that is a big lie has been the claim that the Sadrists are allies of Iran rather than al-Maliki and his ally, al-Hakim. In fact, it is al-Hakim, leader of Iraq's largest party, whose Badr Corps militia has reputedly been the largest recipient of Iranian military aid, and who spent most of the Saddam years in Tehran, whereas al-Sadr, the nationalist, never was in Tehran ever. But, he opposes US troops being in Iraq. So, the US must have lots of troops in Iraq so that we can help defeat those who do not want us to have troops in Iraq, and so that the truly close allies of Iran can remain in control, especially of all the oil revenues from the exports out of Basra.
Thursday, March 27, 2008
If anybody wants to contribute to my new career, please send me your checks ASAP. Get in on the ground floor.
Wednesday, March 26, 2008
1) Saddam would no longer violate anybody's human rights (I did not foresee that US troops would be engaging in torture subsequently).
2) US troops in Saudi Arabia to oversee the no-fly zones could be removed, thereby removing one of Osama bin Laden's leading propaganda tools (more than offset by the length and severity of our occupation of Iraq).
3) That whatever regime would come to power in Iraq, the ending of economic sanctions would be a positive (more than offset by the negative impact of the insurgency on the Iraqi economy).
1) Women's rights would be reduced (Laura Bush likes to say they are enhanced, but women must wear veils and stay at home in a majority of Iraq, although not in the Kurdish-ruled areas; there they may be better off, my only possible mistake here).
2) Christians would be persecuted (about half the Christian population of Iraq, some of which has been there for nearly 2000 years, has left the country).
3) The invasion would serve as a recruiting tool for al Qaeda, in my mind the most important and overwhelming of all these. Indeed, the fact that there was no al Qaeda in Iraq before the invasion but it is now the US's worst enemy there proves this. Indeed, the only reason they have for existing is our presence there. If we pulled our troops out, they would be reduced to near zero very soon thereafter, another forecast from me!
Tuesday, March 25, 2008
The inimitable and careful Bruce Webb has pointed out to me personally that even though they are still projecting by their intermediate projections program exhaustion in 2041, the consequences and longer run gaps are now reduced. So, the projected 75-year deficit is now to be 1.70 percent of taxable payroll rather than 1.95%, a decline of 0.25% and total actuarial deficit over 75 years is now supposed to be $4.3 trillion rather than $4.7 trillion, down $400 billion. Also, if the system were to go "bankrupt" in 2041, the payments would be cut to 78% of then existing receipts rather than 75% (this number was 71% back when Bush gave his doom scenario in his SOTU speech in 2005 when he made his push to "reform" SS). So, bit by bit, the reality that social security is really not in such bad shape is creeping in.
Monday, March 24, 2008
The most recent estimate for last year’s current account deficit is around $740B. To make things simple, assume it remains the same this year. (Recession at home will push it down; recession abroad, if it begins to happen, and oil prices, if they remain higher, will push it up.) If the January rate of official finance continues, it would stand at more than $1200B for the year. The difference, $460B would represent net private capital outflows from the US. If this isn’t capital flight, it’s at least a pretty substantial exodus. My instincts tell me that a full-bore capital flight is the big risk lurking in the shadows. What is the cutoff point between where we are today and a dollar crisis? The answer is, a rate of private outflow that central banks are unable or unwilling to offset. And how much is that?
We are conducting a global experiment right now to find out.
Sunday, March 23, 2008
Nothing restores a sandwichman's optimism like a pep talk from "economists" about how they've arranged things so there can't be "another depression like the 1930s"!
Case in point: an article by Charles Duhigg in the New York Times today assures readers that economists say "the odds of a full-blown depression are almost nonexistent."
Why? "incomes are more stable. Many more Americans hold jobs in service sectors, like medicine or education. And more Americans work for the government, which is less inclined to fire people just because the economy turns gloomy."
"Moreover, there are safety nets that can be traced to the Great Depression, like Social Security, unemployment benefits, food stamp programs..."
"Today, we have a lot more flexibility and we can prop up banks and the economy to give us enough time to let things stabilize..."
"... whatever name economists give the current downturn, we are unlikely to see the bread lines, shantytowns and dust bowl of the Great Depression. More likely, these economists say, would be a sudden increase in the number of people selling belongings on eBay."
For sure there won't be another depression like the 1930s. There also will not be another war like World War I or even World War II. But there already is the Iraq War and there already is homelessness, "foodbanks" and social economic exclusion. No breadlines? What about the ones that have been there throughout the boom years? Are they going to abolish those? How long those folks "selling their belongings on eBay" will have to wait for a free terminal at the public library is another question.
The public policy priority of the last 35 years has been to whittle away at the "safety nets", both regulatory and personal security. I see nothing in the NYT article about recent enthusiasm for "reforming" Social Security. Is that because those reform proposals relied on perpetually rising financial markets? Let me get this straight: Social Security, which a few years ago was headed for "bankruptcy", is the safety net that will spare the economy from the consequences of the credit crunch. Could you explain the logic again S L O W L Y, please, Mr. Duhigg?
In a word, ladies and gentlemen, BULLSHIT! Another thing that has changed since the 1930s is the carefully-orchestrated refusal to entertain progressive policy responses to emerging economic
difficulties. And economists have been at the forefront of the neoliberal gatekeeping. Policy ideas have to pass through the wringer of the market-friendly test. The result: wasteful bloat-is-growth policies that enrich the wealthiest and leave the rest to stagnate.
On cue, all the hacks and charlatans who have been clapping and chanting, "FREE MARKETS! FREE MARKETS!" will continue clapping and but begin chanting, "GOVERNMENT SAFETY NETS! GOVERNMENT REGULATIONS!" And all will be well, children.
Friday, March 21, 2008
As for Hillary, the key will not be how she does in upcoming primaries (although losing in PA would really shut her down immediately), but how she stacks up against Obama in the head-to-head polls of each against McCain. As of last weekend, for the first time ever, she was doing better than Obama against McCain. If that develops to be a consistent pattern, then those superdelegates, most of them Dem officeholders worrying about reelection, might well surge to Hillary, her only chance. However, as of yesterday, the most recent Rasmusen tracking poll had McCain slaughtering both of them, but Hillary a bit worse: McCain 51% Hillary 41%, McCain 49% Obama 42%. Ugh.
It is not just the occasional repos that have had negative nominal interest rates. Barrons in 2006 has reported on a curious financial instrument issued by Berkshire-Hathaway known as "squarz." These have had negative nominal rates on them. Also, in 1998 for a brief period very short term government securities in Japan had negative nominal interest rates, during the pit of their deflation, as reported in the Monetary Trends column of Daniel Thornton from the St. Louis Fed in January, 1999. And, finally, although this has never been reported in print, I was personally told by the individual who handled dealings between the Fed and Freddie Mac that on Dec. 31, 1986, the last day of the old tax code before the Reagan simplification, when many were trying to close a lot of deals, the federal funds rate itself briefly went into negative territory down to about - 1/2 percent, although it also soared as high as about 18% on that rather wild ride of a day. In any case, things are getting weirder and weirder in the current frenzy of the financial markets.
Tuesday, March 18, 2008
however a substantial block of these are "reformist" or "pragmatic" conservatives who are critical of Ahmadinejad on economic policy.
Most of the little commentary in the West has been scary, that Ahmadinejad has been backed. But the real subtext is the domination by Supreme Jurisprudent Ali Khamene'i, who encouraged the pragmatic conservatives while blocking the Khatami group, with the somewhat moderate former nuclear negotiator, Ali Larijani winning big in Qom, and poised to become Speaker of the Assembly. The key point is that Khamene'i has been very clear in supporting a civilian nuclear power program while opposing a military one, just what the US NIE reported this past fall. Thus, while many in the US do not like these guys, there is every reason to believe that they are not pursuing nuclear weapons, the underpinning of the Bush approach to Iran (and apparently that of McCain as well, who has just bizarrely announced that Iran has been training and supporting al Qaeda in Iraq, on which point Joe Lieberman had to correct him by whispering in his ear).
So, I shall only not two things. One is that in the last ten years the economy has outperformed the low cost projection, and the low cost projection has a deficit never appearing, no 2017 at all. The second is that medicare is already running a deficit, which is rapidly rising, and the earth has not stood still (or, maybe that is why Bear Stearns failed?). The fiscal problem the US faces is medicare, and medical care more broadly, not social security.
Monday, March 17, 2008
I cannot help but feel some satisfaction in watching recent event confirm the diagnosis found in my Confiscation of American Prosperity: From Right Wing Extremism and Economic Ideology to the Next Great Depression (Palgrave). The toxic combination of speculative excesses, financial deregulation, and unequal incomes, which make demand dependent on credit.
All the while, Panglossian economics insisted that this was the best of all possible worlds, except for some residues of the New Deal.
The book begins with the historical perspective that the earlier massive waves of inequality and free market dogmatism all led to disaster. This one may not become a renewal of the Great Depression. The Fed may succeed in reflating the bubble, but sooner or later the purge will occur.
Forget about Bear Stearns. It's the long term fallout from the credit crisis that people should be worried about. In a word: unemployment. Somebody has to pay to clean up the mess the financial oligarchy has made.
You know who.
Ultimately, the only way to underwrite the Fed's bailout activity is through wage cuts for ordinary working people. Massive wage cuts. For structural and historical reasons, such cuts can't occur smoothly and easily. So the first round of real wage cuts takes the form of inflation combined with a freeze of nominal wages. We've already seen the beginning of steep increases in food and energy costs. The credit crisis will supply the motivation for capping employment earnings.
There's just one problem (or several): the erosion of dispoable income, combined with an end to easy credit will work its way through the system to depress effective demand for commodities. And don't look to Keynes for a solution. For one thing, it's the long run -- he's dead. For another, Keynes never offered a magic solution for indefinitely continuing to stimulate demand in an already credit and inflation bloated system.
Keynes's answer -- applicable long before we would have gotten to this point -- was essentially the same as Marx's: limit the hours of work.
In a letter to the poet, T.S. Eliot, dated April 5, 1945, Keynes identified shorter hours of work as one of three “ingredients of a cure” for unemployment. The other two ingredients were investment and more consumption. Keynes regarded investment as "first aid," while he called working less the "ultimate solution." A more thorough and formal presentation of his view appeared in a note Keynes prepared in May 1943 on "The Long-Term Problem of Full Employment." In that note, Keynes projected three phases of post-war economic performance. During the third phase, estimated to commence some ten to fifteen years after the end of the war, "It becomes necessary to encourage wise consumption and discourage saving, –and to absorb some part of the unwanted surplus by increased leisure, more holidays (which are a wonderfully good way of getting rid of money) and shorter hours."
Sunday, March 16, 2008
Of course, the other question has got be, who's next? The Fed has now made two major innovative efforts to stabilize the markets in the last two weeks, but the TED spread has barely budged, and both Carlyle and Citigroup have been in trouble as well as BS. Major financial entities are hurting, and the dollar continues to fall while oil has now gone above $110 per barrel. The Fed is running out of arrows in its quiver.
This graphic shows that health care accounts for nearly half the increase in private sector jobs from March 01 to December 07. Questions: Does this increase translate into better health care or more bureaucratic bloat? Is wasteful health care the new jobs program?
I wish Mankiw all the best in his courtship of McCain, but the guy really doesn’t get it about trade. This is not a matter of free trade versus protectionism. OK, that archaic duality comes up periodically in a small way (like the recent spat over the Pentagon’s spurning of Boeing tankers), but it is not the main issue. There are two big facts that menace the US economy like twin Voldemorts, the long-term erosion of wages for most of the population and the buildup of massive current account deficits. These are almost surely related, though not in any simple way. Intensifying competition among the world’s workers has been great for investors, bad for wages, and poison for the US international position.
The question is not whether there should be trade or not, but under what rules it should take place. NAFTA was not a one-page flyer announcing free trade in North America. Renegotiating it to promote more equity and sustainability is not flat-earth economics. But above all, thinking that a trade deficit of 5+% of GDP, year after year, is rendered benign by the writings Smith, Ricardo, or for that matter Samuelson is to live in a world of magic, not reality. The Muggles are right.
In Thailand, the health ministry is recommending that the government ignore patents.
Zamiska, Nicholas. 2008. "Thai Ministry to Recommend Ignoring Patents on Cancer Drugs." Wall Street Journal (11 March): p. A 16.
"Thailand's new health minister announced that he would urge the Thai government to continue to ignore patents on several cancer drugs, disappointing big pharmaceutical companies that had hoped Bangkok might roll back a policy of overriding patents in the name of public health."
"Ever since a bloodless military coup in Thailand in September 2006, the military-installed government had been battling big pharmaceutical companies, threatening to sidestep their patents on drugs for AIDS and other diseases if they didn't drop the price of their medications. The Thai government argued that since the country's poor population couldn't afford the lifesaving drugs, and the government didn't have sufficient funds to cover their cost, drug companies should put public health before profit and cut the cost of the medications."
Pollack, Andrew. 2008. "Cutting Dosage of Costly Drug Spurs a Debate." New York Times (16 March).
"Cerezyme, used to treat a rare inherited enzyme deficiency called Gaucher disease, costs $300,000 a year. Sales of Cerezyme totaled $1.1 billion last year, making it a blockbuster by industry standards."
"Shauna Mangum, of Farmington, N.M., began treatment in 2000, at a cost of more than $400,000 a year. The next year, the premiums for everyone in her insurance pool went up by $180 a month."
Doctors are considering cutting the dosage to save money, setting off a strong debate about the practice.
Friday, March 14, 2008
A header describes the role of the multinationals as "exporting jobs, not goods."
Mandel, Michael. 2008. "Multinationals: Are They Good for America?" Business Week (28 February): pp. 41-51.
41: "the top 150 U.S.-based nonfinancial multinationals, which include the likes of Hewlett-Packard, Pfizer, eBay, and Sara Lee, had more than $500 billion in cash and short-term investments at the end of 2007."
41: "Figures collected by the Bureau of Economic Analysis suggest the multinational sector has in some ways been a drag on the U.S. economy since 2000. From 2000 to 2005, the last year for which full data are available, U.S. multinationals cut more than 2 million jobs at home, even as employment in the rest of the private sector grew -- and there's no sign the trend has significantly reversed."
I note a similarity between The Great World Food Crisis of then and now, besides the role of rising energy prices. That is a surge of demand for meat, which is wasteful in terms of grain use. In 1972 it was Russia, with Nixon quietly approving a stealth major purchase of massive amounts of US grain by the Soviets as part of his early detente. The Soviets were interested in increasing the amount of meat in their diet and were also facing some grain shortage problems due to bad weather. Today, China in particular is buying more grain to feed a rising demand for meat, and we also have bad drought in Australia pinching supply, quite aside from all the assinine shifting of corn production to ethanol in Iowa driven by subsidies, and propped up by the presidential politics of having Iowa go first in the selection process.
My point here is not to glorify it all, far from it. That war was a horror, if not as deadly as its successor, WW II. The literature inspired by it is one of horror and alienation: A Farewell to Arms, All Quiet on the Western Front, and even the more depressing war scenes from The Lord of the Rings (Tolkien served in the trenches of France then). My point is that we should fear that the consciousness of how horrible war is and has become should not fade, even as those who experience it die off.
Assume that a gold bubble has started, i.e., that recent price upsurges do not just represent a short-term blip. If anyone wants to wants to buy and hold gold for long periods as a hedge against inflation, it's then too late, since prices are too high.
The exception to this outrageous assertion would be if the end of the "long period" is (by coincidence) either at the peak of the bubble or some time after the bubble pops when gold prices start rising again. (Gold prices should be measured in real terms, corrected for the ability of gold to buy actual goods & services, by the way. It's only when real gold prices rise that they're a successful investment.) As the bubble grows, the "too late" verdict will become more and more true.
On the other hand, if anyone wants to speculate by buying now (when prices are low compared to the future peak) and selling right before or at the peak price, that actually encourages the bubble, by increasing demand.
We can tell if a bubble is actually happening if we start hearing about how "gold is a perfect hedge" or "you can't lose by investing in gold" or "gold prices have nowhere to go but up." These kinds of statements reflect the hopes of the aforementioned speculators -- and their later efforts to ensure that their speculation pays off by driving up gold prices further.
Of course, it's a big gambling game. The gold-bugs who win at the peak (buying low and then selling high) have to find others who are willing to buy at the high price. (These are called the "greater fools.") Note that the winners' loot corresponds to the losses of those left holding the bag: as the bubble pops, the sellers drive prices down, imposing capital losses on the late buyers.
(In addition, the "house" wins to the extent that there are brokerage fees in the gold market.)
Of course, gold pays no interest or dividends. That makes the popping worse, since the only way to win in a bubble is to grab for all the capital gains one can.
J.M. Keynes's "betting on a beauty contest" theory of bubbles doesn't add anything to this discussion (because, unlike corporate stocks & bonds, gold is a well-known asset). But his "snap" analogy does say something. It's more familiar to U.S. residents as the "musical chairs" analogy.
As people begin to think that the bubble is reaching its peak size, their fear that the music will stop heightens. However, because everyone wants to avoid sitting down until a second before the music stops, they hold on to their gold. Then, for some reason -- the scary sight of an advertisment for beer projected on the Moon? -- some people start sitting down. This causes a panicked rush to the chairs. In other words, everyone tries to sell, driving gold prices down steeply.
On an unrelated topic, I'm waiting to see if Krugman is playing by Obama rules. Several times in past columns he has raked Obama over the proverbial coals for using Republican-sounding talking points in criticizing Clinton's health-care proposals and in calling for a fix for social security. Of course, Obama has never implied that any Republican candidate had a health-care plan that was preferable to Clinton's. Clinton, on the other hand, has said that she and McCain (and presumably Sinbad and Cheryl Crowe) have, while Obama has not, crossed the "commander-in-chief threshold." This is really inexcusable. Don't you think, Paul?
Thursday, March 13, 2008
The increasing bureaucratization of education has now reached the tipping point where faculty represent less than half the full-time professional staff at Title IV institutions. I have not seen any data to be able to project when more than half of faculty time will be devoted to unproductive administrative duties, but what I noticed here is that that point will not be too far off in the future.
U.S. Department of Education. 2008. Employees in Postsecondary Institutions, Fall 2006, and Salaries of Full-Time Instructional Faculty, 2006-07, NCES 2008-172 (Institute of Education Sciences National Center for Education Statistics).Only 48.6 percent of full-time professional staff at Title IV institutions are faculty, indicating a surge in administrators. In public institutions, 51.1 percent, while the figure for private institutions is 44%.
Wednesday, March 12, 2008
Update: Make that 1.56 to the Euro....and counting.
The nice thing about the Fed exchanging treasuries for MBS is that it is not expansionary monetary policy and need not be seen as inflationary. The not so nice thing is that $400B, the amount said to be in play, is tiny compared to the $10T or so in anticipated losses stemming from the collapse of the housing bubble. If fiddling with its portfolio is not enough and Plan B is for the Fed to flood the markets with money, expectations of inflation could be reignited, with further risks to the dollar.
So there are two abysses facing the US economy and not much policy space between them.
Tuesday, March 11, 2008
So what’s his theory? In a nutshell, he says that the US is now in the hands of its FIRE brigade — finance, insurance and real estate. They own the politicians and control economic policy. Bubbles are their stock in trade. These guys get rich and leave the rest of us with the tab. To save our economy from certain ruin in the wake of one bubble, we have to pump up the next one. This is how the housing bubble inflated after tech bubble popped. And where do we turn after housing goes bust? Janszen predicts alternative energy (including nuclear) as the new new new thing.
I like anyone who builds a worldview around bubblesome finance. Nevertheless, putting on my skeptical academic hat, I think he has slipped into the dangerous waters of functionalism, believing that social or economic events happen because they are needed to happen. There is a longstanding critique of such reasoning, but I’ll spare you. The point is that functionalist explanations don’t really explain. For instance, Janszen’s article doesn’t explain why some economies are more bubble-prone than others, nor does it offer a reason why efforts of insiders to inflate a new sector will necessarily succeed.
As my loyal legions know, I think there is a structural factor behind US asset price inflations during the last 15 years or so, capital account recycling. I’m hoping to get a few hours in the coming weeks to put this into its proper algebraic form. This is how we become convincing in my business. As Groucho almost said, “Who are you going to believe, my model or your own eyes?”
Speaking of quotes, I like this one by Janszen: “Since the early 1980s, the free-market orthodoxy of the Chicago School has driven policy on the upward slope of an economic boom, but we’re all Keynesians on the way down: rate cuts by the Federal Reserve, tax cuts by Congress, deficit spending, and dollar depreciation are deployed in heroic proportions.” Amen brother.
Monday, March 10, 2008
In very broad outlines, here is how Round 1 looks: Over the course the 1990s the US began to run increasingly large current account deficits, which then further swelled during the Bush years, peaking at nearly 7% of GDP in 2006 before falling back a percent or so.
Financing the deficit was not difficult during the go-go years of the ‘90s bull market, as private investment poured in from around the world. In the wake of the dot.com collapse of 2000-01, however, it became increasingly difficult to recycle dollars through private channels. Central banks, and to a lesser extent sovereign wealth funds, stepped forward to do the job. These entities now finance essentially the entire payments gap, largely by using their dollar accumulations to purchase US treasury bills. Acquisition of other assets, as when China tries to acquire an oil company or Dubai goes in for a money center bank, attracts headlines but as yet account for a small fraction of this recycling.
The willingness of these public entities (it may be a stretch to call funds under the control of Gulf monarchies “public”, but economic language is not especially nuanced) to hold dollar assets prevents the dollar from falling even faster, and more broadly, than it has and serves to keep US interest rates far lower than they would be otherwise. The growth in foreign dollar reserves alone last year was approximately $900B, in excess of the entire US financing requirement. It would be going too far to claim that this extraordinary level of support is motivated by a desire to sustain the US economy; certainly other interests are at play, but the effect has been to enable US consumption to exceed production by a substantial margin, year after year. Given the scale of the enterprise, you might call this not a bailout but an international payments sump pump.
Now we face a new crisis: because of large developing writedowns in the housing market and the opacity of investment instruments that bundled low-value mortgages in ostensibly high-value securities, a credit crunch is enveloping US markets. Banks and equity funds, desperate to safeguard what remains of their capital base, are pulling out of markets for a variety of loans: for business investment, for certain forms of municipal investment finance, for college students borrowing to pay tuition. This credit retrenchment, according to Larry Summers, constitutes “the most serious....economic and financial stresses that the US has faced in at least a generation, and possibly much longer.” (Thanks to Brad Setser for this.)
The Federal Reserve has created a term auction facility (TAF) which will extend up to $200B to banks, while accepting mortgage-backed securities as collateral. Effectively, this represents an infusion of $200B in demand for the most troubled assets. Dean Baker thinks this simply socializes the losses of the rich after years in which their profits were hoarded by an elite few. Even so, the biggest fear has been that the Fed intervention will prove to be too small relative to the size of the markets to make a difference. This is precisely Paul Krugman’s point, seconded by Setser. So does this mean that there is no defense against a financial meltdown?
Think again about where the financial clout now lies. After years of accumulating treasuries, foreign central banks now have a far larger stash of securities than the Fed. (The Fed’s holdings of treasuries stand at about $800B, less than a year’s accumulation abroad.) The Fed can play with its portfolio, selling some treasuries and effectively buying mortgages, but between them the dollar-soaked central banks of China, Japan, the Gulf states, Brazil et al. have an even larger portfolio to deal from. Hence the potential for these entities to step into the market and buy assets at risk.
Will this be Round 2? If it is true that the Fed is no longer big enough for the job, it’s hard to see an alternative. The US, even in financial tatters, is too big to fail, and it is not difficult to imagine that rescue discussions are already under way. It’s not a sure thing, but a coordinated global move could restore enough demand to keep mortgage and other bubbly assets afloat yet a few more quarters or even years into the future. This would buy more time for the adjustments needed to address the true underlying problem, massive ongoing US current account deficits. I could even imagine a quid pro quo in which support for US markets is tied to a set of policies to rebalance the US position, although it would not likely take a public or transparent form. (Whether those policies would actually do the job is another matter, of course.)
We are in highly speculative territory here, and I could be way off the mark. But maybe not, and if the second phase of the global bailout begins to take form in the next few weeks, tell everyone you heard it here first.
My favorite howler from this article was the following Stein quote: “there’s just a lot of people who don’t believe that big science and Darwinism should have a stranglehold on academic life....” Yes, big science is the problem. We need small, innovative start-up sciences that aren’t tied down by, you know, peer-reviewed journals and experimental protocols. Biology, geology, they’re just cruising on their legacy market share. With a good business plan and access to the right angels, a neo-biblical venture could be really competitive.
So, anybody got any explanations for this curiosum?
Saturday, March 8, 2008
For superb background reading, take a look at this paper by Greenlaw, Hatzius, Kashyap and Shin. It’s low tech; in fact much of it reads like a macro principles text of the future, after the flow of funds and balance sheet analysis will have been integrated into the core model. Some readers will note that the authors make a structural case for Minsky cycles, one that does not depend directly on psychological postulates. All of this, plus an informed (but probably conservative) estimate of the contribution the credit crunch (“deleveraging”) will make to an overall economic slowdown.
Friday, March 7, 2008
Silva, Lauren and Martin Hutchinson. 2008. "Pension Guarantor's Bad Bet." Wall Street Journal (21 February): p. C 14. http://online.wsj.com/article/SB120356297487082117.html?mod=todays_us_money_and_investing
"The U.S. Pension Benefit Guaranty Corp.'s decision to boost its investment in equities and alternative assets looks like poor risk management. The liabilities of this government guarantor of corporate pensions increase sharply in economic downturns, when companies file for bankruptcy and offload their under-funded pension plans onto it. So equities, which tend to fall in downturns, and alternative investments, which can become illiquid, may represent a doubling of risk for the pension agency, rather than a hedge. Pension Benefit Guaranty, established in 1974, has been funded primarily by corporate premiums. It had built up a surplus of $9.7 billion by 2000, but two factors caused it to run a deficit since 2002. First, several large bankruptcies, particularly in the airline sector, burdened it with large, unfunded pension liabilities. Second, bond yields dropped. That lowered the discount rate used to calculate the present value of its future pension obligations, meaning that from an accounting perspective, they increased rapidly."
"The agency's new investment plan -- to increase its allocation to equities to about 45% from about 25%, and allocating 10% to alternative investments -- also looks poorly timed. Making such a move after a lengthy bull market and a period of low interest rates and high speculative activity can lead to low returns, even over 20 or 30 years."
Thursday, March 6, 2008
Supposedly, the most efficient businesses are supposed to survive, but that works only if there is adequate infrastructure.
Aeppel, Timothy. 2008. "U.S. Shoe Factory Finds Supplies Are Achilles' Heel." Wall Street Journal (2 March). http://online.wsj.com/article/SB120450124543206313.html
Howard Shaffer's factory for making high-end custom shoes, relied on computer imaging to fit customers from around the U.S. and Canada remotely, turning out shoes for $450 or more a pop.
"Having spent the previous decade setting up plants in China to manufacture shoes for big U.S. brands, he thought he knew how to revive the moribund U.S. footwear industry: use heavy automation run by a handful of skilled workers instead of relying on large numbers of low-paid Chinese laborers."
A trade magazine catering to the factory-automation industry pronounced him "Progressive Manufacturer of the Year" in 2005, picking tiny Otabo for an award that usually goes to a large multinational.
"But now, he is throwing in the towel on that venture, too. He closed his factory over the weekend, and is shifting the bulk of his operations to China."
"What killed his U.S. factory isn't just competition from Asia's cheap labor, he says. It is the lack of infrastructure needed to make a factory tick, a problem that has bedeviled the few remaining independent shoemakers in the U.S. Finding technicians to fly in on short notice to fix shoe machines was a constant and growing challenge, Mr. Shaffer says, because the number of U.S. companies that make and service machines has dwindled. The suppliers of shoelaces, leather, and other basic materials insisted that he buy in batches far larger than made sense for a small-scale producer."
"Consider what happened with his supplier of outsoles, which form the bottom part of the shoe. Mr. Shaffer initially found a domestic supplier to provide what he needed at a reasonable price. But a glitch developed about a year ago. One Otabo style required an outsole with two types of polyurethane sandwiched together -- a tough bottom layer that resists wear and a spongy inner layer that makes the shoes more comfortable. It is a more complex process, Mr. Shaffer says, "and so after three years of supplying us, they said they just can't do it that way anymore"."
"David Murphy, chief executive of closely held Red Wing Shoe Co. in Red Wing, Minn., an iconic American boot maker that has kept a large manufacturing operation in the U.S., says even a larger-scale company like his, with annual sales of more than $400 million, has to worry about the shoe industry's withering infrastructure."
"Almost 99% of the 2.4 billion shoes purchased in the U.S. every year are imported, 86% of them from China. The problem of obtaining components is especially acute when it comes to materials uniquely designed for shoes, as opposed to generic items such as cardboard boxes that are used by a wide array of manufacturers. This is one reason why Red Wing prepares its own shoe leather, says Mr. Murphy. Mr. Murphy notes he just got a call from a small custom shoe producer in northern Minnesota who often turns to Red Wing for supplies. "They were having trouble getting shoe laces," he says."
The Bank of Japan ran an excessively accommodative monetary policy for most of the 1980s. In the United States, the Federal Reserve did the same thing beginning in the late 1990s. In both cases, loose money fueled liquidity booms that led to major bubbles.
But why is it excessively "accommodative monetary policy"?
Without this kind of monetary policy in the late 1990s, the US economy would likely have stalled in 1996 or 1997 or thereabouts. The short period of close-to-full employment at the end of the decade would not have happened. Without this kind of monetary policy, the recession in 2001 would likely have been deeper and longer, with even more negative impact on workers. It seems like the US economy cannot have half-decent growth of demand without "excessively accommodative monetary policy"!
What's the problem? To my mind, it's the way that the distribution of income and wealth have steadilyly tilted to the right (since 1980 or so), with the rich getting richer (and richer and richer...) and the rest of us facing stagnant or even falling incomes. This has led to a stagnation of mass consumption (absent expansion of credit) or what I've termed the "underconsumption undertow."
Just as a strong swimmer can beat an undertow, an economy can enjoy demand growth, roughly in step with its potential growth, despite an underconsumption undertow. (For the mathematical condition that must be met for this to happen, see my 1994 RESEARCH IN POLITICAL ECONOMY article.) This can happen due to private nonresidential fixed investment, as happened in the late 1990s. It can happen due to investment in housing and credit-based expansion of consumer spending, as has happened in the post-2001 period until recently. It can also happen due to increased luxury spending, as has happened since about 1980 or so, accelerating in recent years. With stagnant underlying consumer spending (sans credit expansion) in place, all of these props but perhaps the last (i.e., increasingly luxury spending) require what Roach calls "excessively accommodative monetary policy."
The problem is that relying on any of these props makes the economy increasingly unstable, i.e., prone to collapse. Fixed nonresidential investment is notoriously less stable than consumer spending. So is luxury spending -- since, after all, it's not really needed. Housing investment is also unstable, fluctuating more than most. And credit-based consumption spending leads to the accumulation of debt, which is hard to sustain. In a time when the Federal government's purchases (G) were shrinking as a percentage of GDP, these private-sector sources of instability become increasingly important.
(Federal G shrank relative to GDP from 1991 to the present, with an up-tick about 2001 to 2004 which did not cancel out the over-all trend. The up-tick partly reflects the increase in military spending. State & Local purchases are ignored because those governments behave more like consumers, varying purchases with tax revenues.)
So the general growth story that the US has followed as a way to deal with the underconsumption undertow has been to use "excessive monetary accommodation" to pump up bubbles, not just financial but real ones (based in spending on goods and services). This has lead to what the late Hyman Minsky called "financial fragility" -- plus real fragility. The fragility has led to recessions.
As Roach notes, the 2001 recession and the current one (if it ends up being classified using that term) both involved bubbles popping: underlying instability came to the top. He then suggests that infrastructural investment (and if the US is lucky, export growth) can fill the gap. Hopefully, it will be "green" investment. My friend Julio adds the Clintonesque point that the government could invest in "human capital" (i.e. education). That's fine, but I would add in basic research, public health, reconstruction after disasters (think New Orleans), and the like. Then, the government should not try to fund these investments out of a balanced budget but instead by using credit. After all, corporations don't run balanced capital budgets.
The increased role of government sure fits with the normal tendency of capitalism that results from what Engels calls the contradiction between socialized production and private appropriation (of profits). That is, all else constant, this contradiction drives the capitalist state to play a bigger and bigger role (at least until things have settled down, the way they did in (say) the 1950s). It socializes private losses.
But what about raising (after tax) wages, to strike a direct blow at the underconsumption undertow? In theory, this could make bubbles unnecessary to stable growth. This kind of solution seems totally forgotten. That's likely because it involves reversing the ongoing one-sided class war.
Wednesday, March 5, 2008
This matters a lot. Leaving Japan aside for another day, we should note that the broad relationship between US bubbles – stocks, mortgages, creative credit packages, and the currency itself – are ultimately derived from the recycling of dollars exiting the country through the current account deficit. These returning capital inflows purchase assets that support, directly or indirectly, the ability of US consumers to enjoy consumption in excess of production. The moral of the story: the US economy, steadily drawing down its privileges from decades of producing the world’s key currency, is able to maintain otherwise impossible external deficits, and these in turn impose low or even negative savings rates. (For details, read this.)
So Roach has it backwards when he says
Like their counterparts in Japan in the 1990s, American authorities may be deluding themselves into believing they can forestall the endgame of post-bubble adjustments. Government aid is being aimed, mistakenly, at maintaining unsustainably high rates of personal consumption. Yet that’s precisely what got the United States into this mess in the first place — pushing down the savings rate, fostering a huge trade deficit and stretching consumers to take on an untenable amount of debt.
Trying to solve the underlying cause of the current account/bubble dependency problem by allowing consumption to collapse is killing the patient to cure the disease. He then partially contradicts himself and gets it right when he immediately adds
A more effective strategy would be to try to tilt the economy away from consumption and toward exports and long-needed investments in infrastructure.
Investments in infrastructure, need we point out, also support consumption, especially if they are financed by an enlargement of public debt, but they do it the right way.
His other suggestion, a weaker dollar, is reasonable as far as it goes, but it would be an exaggeration to call it a policy. There is no magic wand anyone in the US can wave to make the dollar go down: it requires accommodation from those whose currencies have to rise. Moreover, the problem at the moment is that exchange rate flexibility is grossly uneven and doesn’t correspond to trade flows. Nearly all the burden of adjustment is being placed on the dollar-euro exchange rate. This is a big problem for Europe, particularly since the RMB is tied to the dollar. So the EU racks up an ever-bigger deficit with China: how does this help the US? A dollar initiative has to be multilateral, like the Plaza Accord of old. Failing that, or as an inducement to cooperation, the US can begin to explore unilateral options to manage its current and capital accounts.
Sectoral strategies can also play a big role. Emergency action to reduce oil consumption, and therefore imports, should be high on the agenda. We can dust off perfectly reasonable ideas that were shelved at the end of the 1970's, beginning of course with much more aggressive fuel economy standards and support for residential insulation. For more particulars see organizations like ACEEE. The general point is that expenditure-switching is ultimately an investment program.
Incidentally, one of the paradoxes of this election season is the vast gulf that separates the economic pronouncements of the candidates from the actual condition of the country. No one is talking in a coherent way at the moment about the toxic stew of external deficits, bubble finance, and sputtering demand. Creative strategies that could link economic solutions to progress on climate change and other social goals are completely out of the picture. Do we expect sensible policies to just descend on us, like spores from outer space, in 2009?
Monday, March 3, 2008
I'd forgotten the thing I'd most hated about canvassing: the snarling dog held back by its owner at the front door, ready to pounce. Someone tells me she's from Chicago and thinks Ohio's too green to vote for. So you're a global warming skeptic?, I respond. Not even a smile. Next house. Yes, we can!
Saturday, March 1, 2008
The article seems to suggest a type of learning suggestive of the ideology of Mao’s China, where the best had the responsibility of helping the others.
“15-year-old Fanny Salo at Norssi gives a glimpse of the no-frills curriculum. Fanny is a bubbly ninth-grader who loves "Gossip Girl" books, the TV show "Desperate Housewives" and digging through the clothing racks at H&M stores with her friends. Fanny earns straight A's, and with no gifted classes she sometimes doodles in her journal while waiting for others to catch up. She often helps lagging classmates. "It's fun to have time to relax a little in the middle of class," Fanny says. Finnish educators believe they get better overall results by concentrating on weaker students rather than by pushing gifted students ahead of everyone else. The idea is that bright students can help average ones without harming their own progress.”
The article also suggests the value of a welfare state without a heavy hand, unlike the US where we get the heavy hand without the welfare -- at least in education.
The article also mentions the obvious fact that there are fewer disparities in education and income levels among Finns. Also
“Each school year, the U.S. spends an average of $8,700 per student, while the Finns spend $7,500. Finland's high-tax government provides roughly equal per-pupil funding, unlike the disparities between Beverly Hills public schools, for example, and schools in poorer districts. The gap between Finland's best- and worst-performing schools was the smallest of any country in the PISA testing. The U.S. ranks about average.”