McCain and The Financial System: TWO LITTLE WORDS

KEATING FIVE! Are you listening, Barack? The iron is red hot. Strike!

Altering Incentives to Combat Police Repression

Reports out of Minneapolis, combined with memories of New York during the 2004 Republican convention, make it clear that police across the country are adopting a new tactic to suppress demonstrations: they conduct mass arrests of as many demonstrators as they can, remove them from the action, then drop the charges. No doubt they are acting on studies that show that this is a cost-effective way of limiting protest activity, but it is also a clear violation of civil rights. A quick and dirty economic analysis suggests a possible solution.



False arrest has always been a problem, but an important countervailing factor has been the sheer cost of imprisonment and trial. The individual cop does not bear this cost, but the political jurisdiction does, and this gives them at least some incentive to reign in the most egregious miscreants on the police force. It would be far too optimistic to say that this incentive is strong enough to enforce a respect for civil liberties all on its own, but it probably leads to less infringement than we would otherwise have. The great Wobbly free speech fights of the pre-WWI era, in which an army of activists would descend on a town in order to get themselves arrested for the horrible crime of speaking freely in public places, were based on this cost. A town would find that granting freedom of speech, compared to the cost of confining and trying dozens or hundreds of IWW activists, was the “lesser evil”.

No such incentive operates against the tactic of mass arrest, followed by dismissal of charges. For the hundreds, including several journalists, herded onto a bridge in Minneapolis by riot police, handcuffed, led away, held and then released (too late for them to participate in the planned demonstration timed to coincide with McCain’s acceptance speech), the only incremental cost to the city was the plastic hand-ties. Next time they could go green and make them out of potato starch so they can be composted.

The point is that there needs to be a real cost. And in human terms, of course, there is a cost, the inconvenience and denial of rights experienced by those who are rounded up. Hence my proposal: those who care about this issue should promote a policy of financial compensation for any citizen who is arrested and then released without charges being filed. It is government’s way of saying, sorry for hassle—we made a mistake and will reimburse you for it. Suppose the amount were $100. This would have an insignificant effect on local budgets as long as the false arrests were occasional, honest mistakes. But if the police deliberately detain 500 citizens without cause they are exposing the taxpayers to an extra $50,000 payout. This might be enough to nip this tactic in the bud; if not there is always the possibility of giving the compensation an upward nudge.

This is an entirely feasible reform, as far as I can see. It has an obvious fairness value in situations where individuals are unfairly detained. And it would have minimal effect on local finances unless the tactic of mass false arrest is being contemplated.

Why AIG Must Be Bailed Out

Suppose somebody wants to make a bet with me that the San Francisco 49ers will win the next two Super Bowls. He gives me $100 today, and I have to give him $100 million in case he's right. The chances of this happening are very small, but just in case the impossible happens I want some backup. I buy insurance from my next-door neighbor. I offer to give him a nickel every week in return for his promise to cover my bet.

My neighbor sees that he has a good thing going -- getting money for nothing. After a while he takes on more and more bets until others follow in his footsteps. Soon, a market develops. In effect, people can bet on bets. Eventually, the total potential amount of money builds up into the billions and trillions of dollars.

Unexpectedly, the San Francisco 49ers win two Super Bowls in a row. My neighbor does not have $100 million on hand to cover my loss. The nickels I have been giving him have been wasted. I don't have $100 million either.

Suddenly everybody in the market is worried about people's ability to back up their bets. The Federal Reserve steps in and takes over the market. The free world is saved.

McCain’s Fiscal Fiasco: Brad DeLong is Not Happy with Martin Feldstein and John Taylor

A couple of weeks ago - Feldstein and Taylor claimed that McCain’s fiscal policy proposals would increase national savings and investment. Brad DeLong has finally read their WSJ op-ed and finds it really embarrassing:

Their willingness to roll over and tell spinmaster-generated lies is the principal reason why their successors as Republican economic policymakers will be scorned and ignored whenever the Republicans hold power--just as their predecessors' willigness to roll over and tell lies is the principal reason why they were scorned and ignored when they served in government.

The Feldstein-Taylor claim that likely set Brad off was the oft heard and never delivered proposition that a Republican Administration would pay for its promised tax cuts by drastically reducing the size of the government. Tax cuts financed by deficit spending, on the other hand, tend to reduce national savings and investment as noted here:

The McCain fiscal proposals amount to continued fiscal irresponsibility which will lower national savings leading to less investment and long-term growth. I’m shocked that these two gentlemen would lend their name to such free lunch supply-side silliness.

Since McCain nominated Sarah Palin to be his vice presidential running mate, the press has become more alert to their recent lies. I just wish that the press would spend more time on those supply-side lies that date back to the 1980 campaign by someone named Ronald Reagan.

Green Finance?

Two of the recent corporate disasters (AIG and Bear Stearns) were recently run by Greenbergs, following a bubble inflated by Greenspan?????

Historical Notes on Fictitious Capital

Here is a follow-up of my suggestion yesterday about the relevance of Marx’s theory of fictitious capital for the present day crisis. It begins with a historical overview of the expression, “fictitious capital,” before it gets into the crisis material. The material comes from a book of mine, Marx’s Crises Theory: Scarcity, Labor, and Finance.

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Lying to a Son Going Off to War

I am sorry, but I simply cannot hold back commenting on how Sarah Palin lied to her son and his comrades in the Alaska National Guard, whom she addressed on 9/11 prior to their deployment to Iraq. I should probably not criticize a mother in such a situation, who might be doing it to make him feel good or feel motivated, although the same lie was told to US troops for a long time who were deployed to Iraq, that they were fighting the people who carried out 9/11. Of course, it may not be that Palin was lying consciously. She may well be one of the many people in the US who apparently still believe that Saddam Hussein was involved in 9/11. She is reported to have said that our war in Iraq is a "mission from God."

It is true that some Sunni insurgents with some foreigners were calling themselves "al Qaeda in Iraq," but three points need to be understood. 1) They have not done so since al-Zarqawi was killed a couple of years ago, 2) they have been effectively defeated in their stronghold in al-Anbar province since they ticked off the local tribal sheiks by some of their conduct (although their renamed remnants continue to be active around Mosul reportedly), and 3) they only came into existence because we had invaded Iraq. Some mission from God. In any case, we are left with that old question that has often been asked about President Bush: is she a liar or just ignorant?

Terrible News for the Novel

David Foster Wallace is dead:

Timothy Williams: "Postmodern Writer Is Found Dead at Home"

Infinite Jest was one of the best novels I have ever read. This is a great loss.

A Tale of Two Cities – Something Donald Luskin Must Not Have Read

So why does Brad DeLong think Donald Luskin is the Stupidest Man Alive? Maybe because Luskin cites Charles Dickens without even understanding what The Tale of Two Cities was all about:

I imagine that's what Charles Dickens would conclude about the current condition of the U.S. economy, based on the relentless drumbeat of pessimism in the media and on the campaign trail … unemployment figures are up a bit, too. None of this, however, is cause for depression -- or exaggerated Depression comparisons. Overall, the pessimists are up against an insurmountable reality: In the last reported quarter, the U.S. economy grew at an annual rate of 3.3 percent, adjusted for inflation. That's virtually the same as the 3.4 percent average growth rate since -- yes -- the Great Depression.

In case Luskin failed to grasp the theme of social injustice in my favorite Dickens novel – might I suggest he read John H. Hagan, Jr even if this was about a different Dickens novel. So why does Luskin focus on the aggregate macroeconomic picture failing to acknowledge that income inequality has risen over the past several years?

Even on the aggregates, comparing what real GDP growth for one quarter to the historical average is silly. Luskin fails to mention the fact that real GDP growth for 2007 was only 2.0 percent and that the annualized growth rate for the first quarter of 2008 was less than 1 percent. Finally, he fails to note that the average growth rate for the 2001 to 2006 was also anemic compared to the average growth rate for the second half of last century. Maybe that is why the employment-population ratio was only 63.4 percent in December 2006 as compared to 64.4 percent as of December 2000. Of course, it dropped even further to 62.1 percent as of August 2008 but Luskin says unemployment rose only a bit.

On the political side, is the following something we should praise John McCain for or ridicule him for?

Obama is flat-out wrong when he frets on his campaign Web site that "the personal savings rate is now the lowest it's been since the Great Depression." The latest rate, for the second quarter of 2008, is 2.6 percent -- higher than the 1.9 percent rate that prevailed in the last quarter of Bill Clinton's presidency. Full disclosure: I'm an adviser to John McCain's campaign, though as far as I know, the senator has never taken one word of my advice.

While having Luskin as an advisor strikes me as insane, at least McCain is smart enough not to take any of us his advice. After all, comparing personal savings rates during a period of government budget surpluses to personal savings rates during a period of government deficits misses the point that it is national savings that drives long-term growth in a standard Solow model.

Update: Cunning Realist takes a look at the type of investment advice provided by Donald Luskin during the subprime crash. Let’s just hope you did not heed his advice.

Thoughts on Fictitious Capital

Karl Marx’s concept of fictitious capital is very useful in understanding modern crises. I have explored this in an earlier book, entitled Marx’s Crises Theory: Scarcity, Labor, and Finance.

For Marx, capitalism uses markets to distribute labor into productive activities, but it does so very imperfectly. Part of the problem is that lack of knowledge about the future causes imperfect investments. These imperfections magnify as the economy seems to prosper making people become giddy about their chances of success.

Crises are a way of eliminating unproductive investments, which eventually makes the economy stronger, unless the crisis becomes so severe that it shatters the foundation of capitalism.

The crises will become more violent if the distribution of income becomes too lopsided, leaving investors flush with money, while consumers are relatively strapped. Massive amounts of money will flow into speculative ventures, creating bubbles. In effect, a market which is supposed to be a wonderful feedback system to inform capitalists about the needs of society, takes on logic of its own.

Eventually, the bubble pops and there is hell to pay. The question today is our how extreme shock will be. Capitalism has shown quite a bit of resilience in the past. What is happening now could turn out to be relatively mild or could be severe.

I use San Francisco as an analogy for my students. There will eventually be a serious earthquake that will do enormous damage. Nobody can predict what will happen. Even when the earth begins to tremble, the severity of the event may be in doubt.

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