Balance of Payments, Balance of Power

Against the backdrop of chaos on Wall Street, I’ve been reading Brad Setser’s latest take on global political economy. It shows him at his most cogent and most misguided.



1. The presentation of the key data on global imbalances is superb. Setser has followed this issue closely for years and knows the dark side of the data as well as the published numbers. He explains the situation clearly and gives us telling diagrams. For those of you who want a quick refresher on global capital flows, this is an excellent place to begin.

2. He does a superb job of puncturing the pollyannaish notion that America’s creditors would never allow a dollar crash. Here is an argument from the standpoint of elementary economic rationality:

...it is in China’s financial interest to stop buying dollars sooner rather than later. Buying dollars today allows China to avoid registering a fall in the value of its portfolio today, but it only adds to the size of China’s dollar portfolio and thus to China’s expected future loss. U.S. financial stability relies on China’s ongoing preference to take larger losses in the future rather than a smaller loss today.

And here is another from the standpoint of political economy:

...democratic change in countries with a large stock of U.S. assets could be a threat to U.S. financial stability. A more democratic Gulf region almost certainly would be far less willing to hold U.S. assets—whether because of concerns about the risk of financial losses, concerns about financing American foreign policy in the Middle East, or a desire to spend more at home. A more democratic China would face similar pressures.

3. On the other hand, he misses the connection between sovereign capital inflows (unbidden by market returns) and asset bubbles, a point I have pushed in the past. Caballero et al. pick up on this, although their model makes the bizarre assumption that flows on the capital account are driven by private investors.

4. On still another hand (Vishnu?), Setser underestimates the trigger potential of private capital. Specifically, he doesn’t consider the possibility that a further rise in default risk in US financial markets could initiate a burst of capital flight beyond the capacity or willingness of sovereign creditors to absorb.

5. When he gets to remedies, Setser rightly points to the crushing burden of oil imports, but he also falls back on the discredited notion that current account deficits are driven by net savings. He offers soothing words about how he only wants to reduce fiscal deficits over the business cycle and not in the downturn, but squeezing domestic demand is the only possible channel by which his medicine could work. (If you are thinking “but what about interest rates and the dollar?”, recall that a central motive behind sovereign dollar reserve accumulation is to manipulate its value, and if that isn’t enough, look at what happened during the 1990s.) The false diagnosis of a savings shortfall is the mother of bad macropolicy.

6. Finally for the point most readers of this blog have been waiting for: this is a Council on Foreign Relations report, and it is framed by fears of what global imbalances imply for American power. The unstated assumption is that this power is benign, and that the world will be a worse place if Washington, DC is no longer its political-economic capital.

What can I say? Without harboring any illusions about the motives of our mega-creditors—China, Saudi Arabia, Russia—I would venture to suggest that no small amount of brutality and misery is purveyed by ours truly. Setser makes a big point of the financial clout of authoritarian regimes, but he gives no scrutiny to those he credits with “democratic values”. Maybe this is what it takes to get published by CFR, but readers should bear in mind that political values and practices are located on a spectrum, and the US is some distance from the democratic end. It is also a good idea to reread Thucydides, who understood that how a state respects its own citizens is one thing and how it exploits foreigners is another—although the differences have admittedly been shrinking in contemporary America, and in all the wrong ways.

Greenspan On McCain’s Tax Cuts – Again Pretending Spending Cuts Will Be There

Scott Lanman of Bloomberg reports:

Former Federal Reserve Chairman Alan Greenspan said the country can't afford $3.3 trillion of tax cuts proposed by Republican presidential nominee John McCain without corresponding spending reductions. Greenspan, a lifelong Republican and longtime friend of McCain, said today on Bloomberg Television's ``Political Capital With Al Hunt’' that ``I'm not in favor of financing tax cuts with borrowed money.'' McCain has said he would balance the cost of most of his tax cuts with budget reductions, while providing few details beyond eliminating earmarks and other pork-barrel spending

EconomistMom received an email from Jason Furman who is advising Barck Obama. You see – EconomistMom is a deficit hawk type along the lines of the Concord Coalition. Is Greenspan agreeing with us deficit hawks – even though he supported the 2001 tax cuts? Well, EconomistMom reads further into this Bloomberg story citing Greenspan’s excuse for supporting the 2001 tax cut:

“I always have tied tax cuts to spending,'' Greenspan said. In 2001 testimony before Congress, Greenspan was widely interpreted to have endorsed Bush's proposal to cut taxes by $1.6 trillion over 10 years. In the book, Greenspan characterized his testimony as politically careless and said his words were misinterpreted.

Of course – no one in 2001 seriously thought George W. Bush was going to slash Federal spending. No one today should have any illusions that a McCain administration has some magical way of reducing Federal spending while increasing defense spending. I thought Greenspan was a smart fellow – he cannot believe that significant spending cuts will pay for these proposed tax cuts.

And it seems that Douglas Holtz-Eakin - a McCain economic advisor - argues that it is likely that a President McCain will have to increase taxes unless he succeeds at slashing entitlement benefits.

The Political Economy of the Redistribution of Risk

One of the themes of my book Manufacturing Discontent was the redistribution of risk in the neoliberal era. There are two dimensions to this redistribution of risk. The first, which was most obvious, was shifting risk downward for those who are least able to defend themselves. In this downward shift, both government and business walked away from their respective roles in helping to shield people from risk.

In addition, the financial system was supposed to be able to engineer the elimination of risk for those who would be willing to pay a price. The subprime mortgage system was a perfect example. Lenders could take advantage of the opportunity to profit from what would otherwise be very risky loans by sharing some of their profits with those who were willing to shoulder the risk.


Of course, we know that many of those who assume the risk had no idea about what they were doing because, in part, the ratings agencies, which were supposed to inform the public about risk chose to increase their profits by producing disinformation.

I wonder what the economy would’ve looked like since the second half of 1990s if the public had a better idea of risk. Presumably, the dot.com bubble and the housing bubble would never have happened. But, even more interesting to me, is the question of what would be what would have sustained the economy.

Other questions present themselves. What would the distribution of income look like today? Would the government search even bigger wars to distract the public and build up demand?

The End of the Universe as We Know It

This is too good to keep to myself. For all those who are waiting for Armageddon in Geneva.....

Is capitalism dead?

Capitalism has been understood to be an economic system whereby the main forces of production are: (i) owned and controlled by an enterprising minority who (ii) produce and sell in competition with one another, (ii) on the basis of the exploitation of those who live by the sale of their labour power.

In other words, in capitalism, the market is understood to operate to fulfil certain crucial public functions that in other systems such as socialism are fulfilled by governmental institutions. The functions of the market may include the allocation and distribution of resources, the development of needed goods and services and the setting of social priorities. However, as far back as the early 1970s Richard Barnet and Ronald Muller presented compelling evidence in their book 'Global Reach' that "the intersecting and cumululative effect of mounting concentration and globalisation of the US economy [had] negated the market as a social institution in significant ways." [1]



Critical problems are being experienced now in the realm of government policy because the market assumptions upon which they are based on are no longer realistic. The arms-length transactions between buyer and seller are rare. Multinational conglomerates currently negotiate directly with governments for vital resources such as forests, agricultural land and water. Or they cooperate and/or share ownership between themselves. Oligopoly concentration and other forms of stranglehold over whole industries and regional economies means (among other things) that higher interest rate costs to business doesn't translate to the curtailment of output. Inflation is also likely to arise as any increase in costs are passed on to captive consumers. Conversely, tax credits don't result in increases in production at anticipated rates.

Prices, generally, cannot be relied on as signals for allocating resources and market imperfections are no longer occasional nor correctable.

Moreover, labour doesn't so much 'sell' it labour-power to employers. It would be more accurate to say that wages are far more a function of social expectations largely set by those that have levers in dominant media and influential institutions.

Though the 'market' never was the perfect allocator of resources nor a good adjudicator of social priorities the current paradigm is an illegitimate and far more dangerous form of global sovereignty.

"Those who guide the nation-states are fearful that if the world economy is made more efficient and national borders are not allowed to impede the most efficient use of land, capital, labor, ideas, then the nation-state will have no reason to exist."
Conclusion of the 'Chief Executive Officers Roundtable', Business International gathering in Jamaica on 6th January 1971.

[1] 'Global Reach', Richard Barnet and Ronald Muller. Simon and Schuster, 1974. SBN 671-22104-3 Paperback. Page 268

Some Thoughts on Carbon “Neutrality”

My institution, beloved Evergreen with its moss-covered halls, is eager to be greener than green. Like many of its ilk, it especially wants to be able to say that its operations are carbon neutral. Since there is no way that its footprint (either production or consumption based) can go to zero, this means offsets. In preparation for a meeting on this topic, I’ve been thinking about what it means for an enterprise to achieve neutrality, and I’d like to float some of these ruminations.



1. Evergreen is different from most other colleges or companies in that it maintains a large forest. Each year our trees get bigger and more organic matter gets built into the soil, so that represents a big plus in the carbon ledger. From a simple accounting standpoint there can be no dispute. Nevertheless, what does it mean for an entity (like Evergreen) to operate two divisions, so to speak, a working college and an intact forest? Does this mean that we have a license to spew more carbon in our educational operations than we would if we deeded the forest to a land trust? Perhaps the problem lies in the rather arbitrary goal of carbon neutrality. If you will be fixing a certain amount of carbon in one branch of your operations, it may mean that your proper goal overall is a corresponding degree of carbon negativity.

2. And even in the absence of a forest, what is the magic of neutrality? From an economic point of view, the goal should be to maximize the value added (broadly defined) per unit of carbon. This involves reducing the footprint for a given level of services, maybe more services for a given footprint, maybe a better mix of services from a carbon standpoint that will do both. But looking only at the footprint side misses the point. (1) Some services are worth having even if they are relatively, and unavoidably, carbon-intensive. (2) In an ideal world, some institutions would end up having higher footprints than others, with the goal of equalizing net social benefits per ton of carbon. Specifically, it may be (and as an academic I am dogmatically convinced that) a college does more good than almost any other type of organization in society. In that case, it may well be wrong for a college to crimp its services in the pursuit of carbon savings; other savings elsewhere (like hedge funds) are more crimpable. Even more specifically (and with even more self-interest on my part), what about faculty travel to conferences? Very bad, carbonically, but think of the immense social benefit that comes from the networks we geniuses establish among ourselves. Better that, oh, sales reps for academic software companies stay at home and do their pitching via remote teleconferencing.

3. Then there is vexing issue of buying carbon offsets. I’m on record as saying that, in a voluntary environment like the one we have now, offsets are OK, but once we have a mandatory carbon cap they should be seen as a hole in the bucket. I will stand by that, but what happens when you adopt the goal of carbon neutrality? The fact is, if an organization takes neutrality as its mission, it really does trade off its own emission reductions against the purchase of offsets. Since offsets are unreliable (additivity problems, principle-agent problems), how should they be discounted in carbon calculations? I still think that, all else equal, it is peachy to purchase an offset, but if the price includes not taking some other beneficial action that was available, all else is not equal and all bets are off. So, if you can reduce air travel but you don’t because you’ve bought some offsets instead, if the offsets don’t do what they promise you don’t meet your goals. Once again, I think the root problem is the assumption that neutrality is a magic point on the carbon meter, and that reductions above or below that level (as opposed to getting to it) are of second-order significance. If you drop that and view all reductions as intrinsically good (leaving aside costs), the notion of a tradeoff between reducing your own emissions and buying offsets vanishes. And that’s how it should be. The goal should be calibrated to what an institution can accomplish. If you have the possibility to significantly cut your carbon footprint you should try to do that. If you have a good financial mechanism for purchasing offsets, do that too. Good is good.

4. We are (or maybe only I am) getting tied into knots over nothing. At the moment we are in a strange situation: most of the public recognizes the necessity of combating climate change and there is near-consensus at institutions like Evergreen that we have to begin taking action now. Meanwhile, the federal government is in the hands of what can only be described as a hydrocarbon cult, determined to thwart any threat to their beloved industry. This can’t continue much longer, and I’m convinced it won’t. Not only do both major presidential candidates back a mandatory carbon cap, the corporate sector seems to be on board too. (They will do whatever it takes to minimize their own financial exposure, but that’s a different story.) Chances are, in a year we will have legislation that puts a limit on greenhouse gas emissions and drives the price of carbon fuels way up. Then the big challenge facing everyone will be how to cope with it. Places like Evergreen won’t need a carbon neutrality task force; they will be forced to dramatically curtail their footprint just like everyone else. Students who now commute by car won’t be able to afford it any more, so you have to find other commuting and housing options for them or you lose your students. Heating bills will explode, so you have to find ways to use less fuel for heating. And yes, faculty travel to distant conferences will become a lot more expensive, so solutions will have to be found there too. Repeat: instead of wracking our brains about how to calculate our carbon footprint, we will be struggling to control costs. This will lead us to reduce our footprint whether we want to or not, which is the point of the legislation. Maybe, just maybe the institutions that take action today to reduce carbon emissions will be better positioned to survive the coming cap, but that will be because they have taken action on their own operations, not because they bought a thick portfolio of offsets.

So the bottom line is that, in voluntary carbon policy, as in most other aspects of this issue, we are losing valuable time by asking the wrong questions. There are ultimately only two questions that make sense for us individually and collectively: how can we get a fair, effective, rational climate policy pronto, and how can we cope with it once we have it? If Evergreen has a few grand to invest in offsets, I’d rather see it put the money into political action for better policy. And rather than pulling me into a task force to measure our carbon footprint operation by operation, I’d like them to enlist me and anyone else they can corral into an effort to forecast the impact that national policy will have on us so we can start preparing today.

The Economics of Kapital and the Capital of Economics

I am preparing a talk to give in China in a few months. I have an initial draft & would very much appreciate feedback. Warning: it is a first draft.

The Economics of Kapital and the Capital of Economics (doc)

Do Econospeakers Speak Science Journalese?

Palgrave's Econolog (http://www.econolog.net/stats.php?area=blogs) has just issued a ranking of econ blogs, on which Econospeak is 46, some sort of weird method based on links coming in to them plus their "econolog sauce," as we are 75 on Aaron Schiff, based on Technorati links and 63 on Brian Gongol based on visits. When Econospeak started about a year ago we were in the 90s on those last two, but got as high as the 40s briefly before drifting down to about where we are now (our predecessor, Maxspeak, was at about 12 on Schiff when Max pulled the plug). Of course there is a steadily increasing number of these blogs all the time.

Perhaps a more curious item is that they have done an analysis of "readability" of the blogs based on the Gunning-Fog index, which is supposed to measure the number of years of education one needs to read the blog intelligently (only 50 were measured). The bottom tier is 6-10, labeled "Dan Brown," with few known blogs there, the Big Picture being probably the most prominent. Next is 10-14 "Thomas Pynchon," where one finds Marginal Revolution, Brad Delong, and Econbrowser, among others. Next is 14-17, "Science Journal," where Econospeak is with a 15 along with Krugman, Economists View, Dani Rodrik, Meagan McArdle, and some others. Finally ther 17-20, "Manual for a Taiwanese DVD," which had only one I had ever heard of, Economic Principals. Anyway, this is near the first birthday of this blog, although I do not remember the precise date, so happy birthday everybody, and I do not know if it is good to be a 15 or lower on this scale.

THAT'S NOT LIPSTICK WE CAN BELIEVE IN...

by the Sandwichman

John McCain on Sarah Palin's foreign policy credentials: "She knows more about energy than probably anyone else in the United States of America."

It would unduly dignify the above statement to call it a lie. Think about it. Telling a lie implies an intention to deceive the listener. But the point of McClain's claim is not to persuade people that Palin has credentials she doesn't have. The claim is too utterly outlandish.

Its purpose is to mock the presumably communicative function of language. It's function is as a metacommentary about the meaninglessness of credentials ('badges') and democratic discourse in a spectacle of succession whose outcome has been already been determined. That is to say:

Reporter: 'If you're the police where are your badges?'

McCain: 'Badges? We ain't got no badges. We don't need no badges! I don't have to show you any stinkin' badges!'

Has Barack Obama formally been advised of the outcome of the election, its inevitability and of the campaign ground rules from here on out to insure that "nobody gets hurt"?

Bubbles Begetting Bubbles

As is widely understood, the process of cutting interest rates to recover from bursting bubbles creates a sequence of bubbles. Other methods of coping with the consequences of bursting bubbles can also help to generate new bubbles.

Here is a suggestion that the Savings and Loan crisis helped set the stage for the recent real estate collapse:

Adams, Johnathan. 1996. "CMBS Structures and Relative Value Analysis." In Anand K. Bhattacharya and Frank J. Fabozz, eds. Asset-Backed Securities (New York: John Wiley and Sons): pp. 207-26.

208: "The first substantial surge in commercial mortgage securitization may be traced to the Resolution Trust Corporation (RTC) and its decision to use the CMBS [Commercial Mortgage-Backed Securities] market to liquidate the assets of insolvent thrifts. Between 1991 and 1993, the RTC issued an extraordinary $13.8 billion of CMBS."

Inspired from a hint from
"Rescue Risks Setting Stage For New Woes" by Mark Gongloff

Anti-trust a la Bush

The second paragraph is the killer. I wonder what made the West Virginia case so egregious that the government had to step in.

Lichtblau, Eric. 2008. “Antitrust Document Exposes Rift.” New York Times (8 September): p. C 1.

The Justice Department laid out a broad policy on antitrust enforcement on Monday that drew an unusually sharp rebuke from three federal trade commissioners, who said it would protect monopolies from prosecution.

A 215-page report from the Justice Department, coming after nearly a year of public hearings, was originally meant to lay out a governmentwide approach to combating anticompetitive business practices. Instead, it exposed a rift between the Justice Department and the Federal Trade Commission over whether the government was protecting consumers or big businesses.

In nearly eight years under the Bush administration, the Justice Department has brought one case against a business on anticompetitive grounds, seeking to block the purchase of a West Virginia newspaper by a competitor.

Lawrence Summers on Fiscal Policy During This Recession & McCain v. Obama

On Saturday, I speculated on what Lawrence Summers might say in light of the dismal employment news:

Summers strikes me as a long-term deficit hawk for the same pro-growth reasons that I am. Something to do with increasing national savings – which of course the Reagan-Bush43-McCain wing of the Republican Party seems to think has it all backwards. We deficit hawks tend to favor countercyclical monetary policy that lowers interest rates to encourage investment (and yes net exports via dollar devaluation) when aggregate demand is weak. But the Federal Reserve has played that lever and some of us are concerned that it alone will not be enough. So as the politicians want to pander to the public with promises of both more spending and tax cuts too, let’s try to figure out which set of fiscal policies can do the best job of giving timely, targeted, and effective short-term fiscal stimulus and at the same time tell Wall Street that we are serious about long-term fiscal responsibility. This policy prescription used to be called Rubinomics and I submit that it worked well for the Clinton Administration. But then Summers was one of his excellent economic advisors – to which President Clinton did listen to carefully.

Well – when Larry speaks, I often just listen:

Former U.S. Treasury Secretary Lawrence Summers Tuesday said a second fiscal stimulus program is “the right response” to the current turmoil facing the U.S. economy but the plan shouldn’t raise projected deficits beyond a year or two. “Beyond this horizon it is essential that any new spending or tax cutting be offset by measures that reduce projected deficits,” said Summers, a Harvard University professor who has advised Democratic presidential candidate Barack Obama. Testifying before the House Budget Committee at an afternoon hearing, Summers said that any new stimulus plan should be temporary and targeted and also matched by actions that make the program budget-neutral over a five- or 10-year horizon. “I believe the balance of risks suggest a compelling case for a significant fiscal stimulus program that increases the deficit in the short run” but not over the medium to longer term, he said. The program may be most beneficial if it includes new measures for food stamps, unemployment insurance and other policies aimed at supporting low-income families, said Summers. He also argued in favor of new infrastructure investment as well as changes in Medicaid reimbursement rules and new funding to help low-income residents pay their heating bills.

Like I said! But let’s see if any of the Presidential candidates are listening:

McCain wants tax cuts – lots of them. Some of them are temporary tax cuts (gasoline tax rebates) which a lot of economists would argue have little bang for the back. But McCain is also advocating making George W. Bush’s tax cuts permanent. Whoops – that’s the complete opposite of what Rubinomics would call for. It would reduce national savings and long-term economic growth and could even hurt forward looking investors types such as those folks on Wall Street. The McCain recipe is a lot like the Reagan and Bush43 recipes and the evidence is that these recipes work poorly. Obama is calling for an acceleration of public investment projects, which could give a large bang for the buck and perhaps more timely bang for the buck. But I’m not ready to say President Obama would be a repeat of what President Clinton did back in 1993. Candidate Obama wants to tell all but the very rich they get a tax cut. Then again candidate Clinton made that promise back in 1992. But at least candidate Obama is proposing less fiscal irresponsibility than candidate McCain and is willing to say some folks will have to pay more in taxes. Candidate Obama is also surrounding himself with economic advisors who are actual economists. McCain’s idea for economic advisors include Carly Fiorina and Phil Gramm.

Talk about lipstick on a pig!

D. H. Lawrence with Penelope Cruz Thrown In

My apologies for going middlebrow, but that's my take on the new Woody Allen movie, “Vicky Christina Barcelona”. PC almost pulls it out. Since this is an economics blog, I’d like to ask, has anyone else noticed that the money just seems to be there in Woodyland? People have jobs mainly as a source of identity, but in fact they just pass Go every now and then, and their bank accounts are recharged so they can enjoy the comfortable life without worrying about how much it costs. Only in this magical world would a woman’s choice between a young Wall St. go-getter and a “bohemian” artist have no financial implications.

The Fed and Fear of Becoming Japan

I just got around to reading the Aug. 23 The Economists with its Economics Focus article on "The Lost Decade" (more than that now), comparing the US and Japanese housing bubbles. Turns out our bubble has been a lot worse than theirs. Between 1985 and 1991, housing prices nationally in Japan rose only 50%, whereas in the US between 2000 and 2006 they rose 90%. Furthermore, even after the recent declines in the US market, national housing prices are still above the peak level reached in early 1991 in Japan in terms of percent above the starting point, which does not bode well for the future. While housing prices stabilized in major Japanese cities a few years ago, they continue to gradually decline nationally, as they have since 1991, providing a major downward drag on the Japanese economy.

So, the Fed is afraid of this, and Bernanke has encouraged the Fannie/Freddie bailout, partly with "advice" from both the Chinese and Japanese, who just happen to hold a lot of paper from those Agencies. But, in fact, this fear has been influencing the Fed for quite some time. In the period of 2002-2004 the stimulative policies of the Fed, which cynics might say were designed to help Bush get reelected, were justified on the basis of avoiding getting into a Japanese style deflation, which fear was what triggered Bernanke to make his famous public remarks about dropping money out of helicopters (an image taken originally from Milton Friedman, who did not approve of such an approach). Indeed, Alan Greenspan noted the problem of the threat of a possible deflation in his discussion of monetary policy during that period in his AER paper (Alan Greenspan, "Risk and Uncertainty in Monetary Policy," American Economic Review, Papers and Proceedings, May 2004, pp. 33-40). Of course the ultimate irony here is that this stimulative policy almost certainly further goosed the US housing bubble, whose unraveling is now causing such havoc in the financial markets, so that a policy to avoid a crisis has brought about a crisis.

LIPSTICK ON PIG

by the Sandwichman

So what's the fuss? Senator Obama called a spade a spade.