Fun with U

by the Sandwichman

Alan Clarke, economist from the bank BNP Paribas, said the number of those claiming unemployment benefit was due to break the one million mark by the end of next month at the latest, with up to two million looking for work by December: he is forecasting unemployment to hit 7 per cent by the middle of next year and carry on rising until 2010.

Reading the above paragraph, from the Guardian, leaves the false impression that unemployment in the UK will double between next month and Christmas. Hogwash. "Those claiming unemployment benefit" and those "looking for work" are two different categories. The August figure for benefit claimants in the UK is 904,000. For ILO-defined unemployment ("those looking for work"), the number was 1.72 million.

The Ultimate Risk: Capital Flight from the Dollar

The analysis by Floyd Norris in the New York Times is so wrongheaded it is difficult to know where to begin. I could complain about his focus only on banks rather than the shadow banking system, or his conflation of liquidity and solvency threats, or his comparing apples and oranges in measurements of leverage across countries. But the most important error is his claim that the US, by virtue of issuing the world’s reserve currency, has unlimited resources to throw at its financial system:

As the banking system quaked this week in many countries, and various governments took steps to bail out their banks or at least guarantee deposits, one question was asked quietly: Can the governments afford it?

That is not a question for the United States, which can print dollars and has a banking system that is the largest in the world but is small in relation to the national economy.

The last part of that sentence is about the confusion between banks and financial intermediaries (how could a Times columnist make this mistake after all that has happened during the past year?), but it is the first half I want to discuss.



Something like a trillion dollars (give or most likely take a couple of hundred billion) has been spent thus far in the pursuit of a bailout. How is it being financed? Not with money creation. The Fed can, if it wishes, treat its purchase of troubled assets (and institutions) like ordinary open market operations, simply crediting the accounts of sellers held as Fed liabilities. Indeed, it has done some of that in recent weeks, as the following chart shows.

M1 and M2 growth, 3rd quarter 2008 (index, July 7 = 1.00)


Indeed, an expansion of over 10% in M1 within the space of two weeks might be considered extravagant, except that during this same period M2 was up only about a tenth of that. In other words, the Fed is largely offsetting the contractive effects of the credit crunch, slightly erring on the side of greater liquidity. In absolute terms, the Fed’s additional injection comes to about $150B. The remainder of its bailout finance comes from a variety of sources, but essential is the global demand for treasuries, which has jumped by over $2T on an annualized basis in the first two quarters of this year compared to pre-crisis levels. It is difficult to disentangle the official from the private flows, but the latter by all accounts has been dramatic, as the herd rushes to “quality”.

The constraint faced by the Fed is the willingness of wealth holders to continue to skew their portfolios so strongly toward dollars. In an earlier post (“reverse tsunami”), I simplified by assuming that rebalancing will occur only after the crisis is over. Actually, it is entirely possible that this rebalancing (aka “capital flight”) could occur at any time. If it happens it will be triggered by a change in perceptions, that the dollar is not the rock in a raging sea that it previously seemed to be. Some of the factors that could cause this are beyond the control of Bernanke’s crew (such as one or more high profile nonfinancial defaults), but the perception that the US intends to inflate its way out of the crisis would have a similar effect and is clearly related to the “print dollars” option that Norris takes for granted. In other words, open market-style purchases of bad assets is effectively limited by private sector credit contraction. The bad assets are a stock (size unknown) and the contraction a flow, hence no match can be assumed.

A closing word of paranoia: it is difficult to overstate the significance of the financing constraint on bailout strategies. The lesson here is not 1929, but 1931-32, when a series of national currency runs whiplashed the global system and prevented any individual country from taking effective action. A change in sentiment on the dollar, if it occurs, will be sudden, unexpected and massive. An outflow of funds would stop the Fed/Treasury strategy in its tracks and mark the end of any meaningful program to restore financial markets. No one knows what the tipping point could be, or even whether the most enlightened policy can avert it. (In that respect our financial imbroglio resembles the risk of catastrophic climate change.) But its shadow looms over the entire operation, and this is constraint that policy-makers should keep firmly in mind, assuming they are not as clueless about the existential risks we face as current journalistic coverage.

Peak Toil

by the Sandwichman

In 1936, M. King Hubbert, the prophet of "Peak Oil" (Hubbert's Peak) and at that time a leader in the Technocracy organization, wrote a pamphlet on Man-Hours and Distribution.

The period since 1929 has been one of the most unique and one of the most disturbing in the history of North America. The events that have occurred since the stock market crash of that year have provoked more competent social thinking on the part of the American people, and have demolished more fixed tenets of our American social and economic faith than those of any preceding half century.

Up until the year 1929 the American public had been brought up in the belief that any child with ambition and a willingness to work would automatically be rewarded with material gain in direct proportion to the effort and ingenuity displayed; that any office boy might become the president of his corporation in due time provided he displayed the proper virtues of industriousness, honesty, respectfulness and thrift; that every boy had an equal chance of becoming President some day; that the pathway to success was to be found in part through proper education, and that educational facilities were equally available to all; that work could be had by all who were willing; and, conversely, that unemployment and lack of material success were themselves indicative of the lack of those cardinal virtues of industriousness, thrift, honesty, and the like.

In 1929 and the years that have followed, these tenets of our American folk-lore have been rudely shattered, for during that time one-quarter to one-third of all those willing and able to work have found it impossible to obtain employment and have consequently been forced to depend upon their relatives and friends for support, or else upon public governmental relief. During those years as many as one-quarter of the entire population have been dependent upon the funds of the federal government for food and clothing. Even the most independent and rugged of our remaining individualists, the American farmer, has found it increasingly necessary to rely upon the funds of the federal government. Corporate business has likewise had to be bolstered up.

The Risk of a Positive Feedback Loop

The current financial crisis is the result of very large declines in asset prices, whose epicenter is the housing market. We had a bubble, trillions of dollars in bets were made on the assumption it would continue, and it didn’t. The ultimate cost of a bailout (and therefore its feasibility given limited resources) is, at this point, determined by the volume of net asset deflation minus pre-existing equity of financial intermediaries (which, due to their extreme leverage, was minimal). So far so bad.

But it could get much worse. The world has almost certainly entered into a recession. The current decline in US consumer spending, the first since the sharp V-slump of the early 1990s, is a bad sign. As the downturn picks up speed, it will add to the quantity of distressed assets: new corporate paper gone bad, further declines in equities, even greater distress in housing. This could increase the amount of implicit writeoffs and expose even more counterparties to default risk. The price tag of a bailout would lurch further out of reach.

Consider, for instance, the effect of an announcement by General Motors that it is filing for bankruptcy. For some time the markets have told us this is a 50-50 possibility; with car sales plunging and the apparent desperation of GM management in its merger maneuvers, it has to be an even greater possibility today. This would be taken as a sign by almost everyone that a positive feedback loop from the real sector to the financial sector is beginning to take form, and the consequences would not be pretty.

Of course, no one knows what the future holds in store. We may yet waltz out of this with only a trillion or two in losses to show for our fears of impending doom. That looks like the best-case scenario. As for me, I’m worried about positive feedback and the risk that even the best-designed bailout (better than what is now on the table) will not be enough. This is why I think that what I originally called Plan B, and now stands as Plan C or D—public banking—ought to be given immediate consideration. Why should we pin all our hopes on a bailout that may fail to catch up with its moving target?

The Second Shoe, part III

by the Sandwichman

In earlier installments I discussed the non-parliamentary, non-democratic and accounting error dimensions of the current crisis. I indicated that in the next posting I would address "accounting for labor power." Before doing so, I would like to comment on the crackpot title of a feature in this week's Newsweek, "How to save capitalism." What an absurd way to frame the question! The point is not "saving" or "abolishing" capitalism. The point is getting on somehow with life and livelihood. If there are indeed elements of capitalism that we might want to retain, they must withstand some reasonable tests of usefulness and durability.

Having previously cited Engels and Lenin on book-keeping, I now will cite Marx, himself:

After the abolition of the capitalist mode of production, but still retaining social production, the determination of value continues to prevail in the sense that the regulation of labour-time and the distribution of social labour among the various production groups, ultimately the book-keeping encompassing all this, become more essential than ever.

Thus, for Marx, the key to determining value is the regulation of labor time and the distribution of social labor. This is regardless of whether one is intent on saving or abolishing capitalism. But how does capitalist book-keeping encompass the regulation of labor time? By compiling a payroll that records wage rates and hour worked by employees.

Is that how post-capitalist book-keeping with regard to labor time would also work? No. According to Moishe Postone, Marx analyzes four distinct elements of labor time. Necessary and surplus labor time from the perspective of the individual worker, socially necessary labor time from the global perspective and superfluous time, a fourth category that arises as labor time itself ceases to be the primary source of material wealth. Although this labor time is superfluous to the production of material wealth, under capitalism it remains a prerequisite for the performance of necessary labor time to the extent that labor time remains the source and measure of value. The material wealth that results from this fourth kind of labor time needs to be destroyed. War is the accustomed method for destroying this superfluous material wealth. But anything that promotes conspicuously wasteful consumption helps. After capitalism, this superfluous labor time (in theory!) could be converted to time free from labor.

I like Postone's interpretation but the categories may be a bit too abstract for book-keeping purposes. That's because he starts out from marxist theory rather than accounting practice. My own approach is to begin from an instance of accounting practice that is uniquely relevant to the analysis of labor time: the costing of collective bargaining proposals by unions and employers.

It so happens that unions and employers evaluate working time differently in their costing models. Unions typically use "paid hours" as the divisor for evaluating hourly labor rates. Employers use "hours actually worked". Neither side explicitly recognizes the productivity effects of different working time arrangements although the union approach does implicitly and very imprecisely. It's not difficult to build a spreadsheet model that reconciles the union and employer perspective while incorporating an explicit productivity factor. I've done it. What has proven difficult is convincing unions, employers or governments of the urgency of doing a more responsive costing of labor time.

Necessity, nonnecessity, freedom

"...according to Marx, historical necessity cannot, in and of itself, give rise to freedom. The nature of capitalist development, however, is such that it can and does give rise to its immediate opposite -- historical nonnecessity -- which, in turn, allows for the determinate historical negation of capitalism." -- Moishe Postone, Time, Labor and Social Domination

The Last Hurrah

by the Sandwichman

In 1995, following several years of "jobless recovery", Jeremy Rifkin's The End of Work was published and became a short-lived sensation. There was nothing new in Rifkin's central thesis of intractable technological unemployment. But the timing of his book seemed impeccable. For a while. Then a funny thing happened. The fantastic American job-creating machine fired up and talk about the end of work receded.

That "job-creating machine" was a centralized policy response to stagnation, not some inherent dynamic feature of free-market capitalism. The following graph by Paul Krugman shows the timing and effect of the Greenspan bubble machine.


Absent a new bubble, the collapse of the house price bubble brings us back to the question of technological unemployment or "the end of work" as Rifkin put it. Apologists for capitalism will be rooting for a new bubble. But is a new bubble even feasible? I say no, at least not for a considerable period of time. Bubbles are a confidence game. That is, they rely on widespread confidence that they are not bubbles. Too much learning has occurred over the past year for a new bubble to be able to take hold. Maybe after several years of forgetting...

Economic and Social Importance of the Eight-Hour Movement

"The end and object of produc­tion is consumption. Nothing but the de­sire for a commodity and a willingness to give an equivalent for it will cause it to be produced."

Update: For a contemporary survey with a great deal of relevance to the matters being raised here, please see: Fear of fallowing: the specter of a no-growth world published in the March 2008 Haper's magazine.

The employer represents capital, and capital represents the means of production; hence, the employing class represents pro­duction.The end and object of produc­tion is consumption. Nothing but the de­sire for a commodity and a willingness to give an equivalent for it will cause it to be produced. Production is universally the economic response to, and consequence of consumption. No one will continuously produce a commodity unless he can find consumers for it. To the extent that he ignores this fact, he pays the penalty in loss and bankruptcy. The market is the basis of the workshop and the warehouse, and the habitual daily consumption of wealth by the community is the basis of the mar­ket. Thus, economic production abso­lutely depends upon social consumption, and the success of the employing class de­pends upon the extent of the consuming class.

Sorting Through the Bubbles and the Crashes

Now that we have seen a full bore, global panic and crash, it might be worth sorting out how many bubbles there have been, and which of the three patterns identified by Minsky and Kindleberger (and first formally modeled by me, dating back to 1991) each has followed.

So, the first and most fundamental has been the housing bubble. This seems to have followed the pattern of gradually up and then gradually down, with no crash. The peak was end of 2005, and if one believes the various Shiller indexes, it still has a good 10-40% to go or so. Of course real estate bubbles rarely crash, unless they are for vacant land as in Florida in the 1920s, as people will generally not dump their own homes in a panic.

The next was the derivatives bubble. Whereas the housing bubble fairly clearly started around 2000 or 2001 after the tech stock crash, the beginning of the derivatives bubble is shrouded in mist, still much about it is not well known. However, it looks to have followed the peak followed by a period of financial distress and then a crash pattern, the most common pattern for major bubbles. The peak would appear to have been August, 2007, and the crash was the outright financial market panic on Sept. 17, 2008, after Lehman Brothers was allowed to fail and AIG nearly went under, with Treasury yields dropping to 0.06% at one point. This crash ended with the announcement of the bailout of AIG and that there would be a broader bailout, although clearly the credit and derivative markets have not really recovered from that crash.

Then there was the oil bubble, which looks more like the theoretically preferred one that goes up, peaks, and then pretty much crashes, which happened in July, although it has continued to sink since, and very rapidly in recent days.

Finally there is the behavior of the stock markets. While there was a bubble in US stocks in the 1990s, the more recent behavior has not been particularly bubbly. The sharp crash of the last few days has been a negative bubble, an epiphenomenon emanating from the crashes of the derivatives and credit markets, collateral damage, although quite serious, and threatening to take down the real economy as well (bankruptcy for General Motors anybody?).

Looking Ahead: A Reverse Tsunami

This afternoon I co-led a forum on the financial crisis with my Evergreen colleague Peter Bohmer. I had a flash as I was preparing: at some future point we could be in for a reverse tsunami.

Here’s the idea: A real tsunami begins with an outward flow of water. If you’re standing on the beach and suddenly the water line retreats 10 or 20 meters, it’s time to race for higher ground. Now consider the opposite phenomenon. The massive Fed/Treasury spending spree to hold the crisis at bay, thus far unsuccessful, is being financed by a massive capital inflow. Some of this comes from foreign CB’s eager to do their part, but a big part is the result of global capital flight to the supposedly least risky currency. Suppose we get out of this alive and calm returns to the markets. Most of those people are going to want to bring their money back—that’s the reverse tsunami. How do we finance that? The Fed’s balance sheet will be wall-to-wall junk.

OK, just getting to that moment will be a big victory.

"Revulsion" and the Minsky Moment

The two hour drop of the Dow leading to the second largest decline in percentage terms in a single day ever looks like we have finally come to the end of the period of financial distress described by Minsky and Kindleberger that we have been in since August, 2007, the move to panic and crash, the drop off the cliff. Which brings to mind another old fashioned term (like "fictitious capital," brought up here recently by michael perelman). This would be "revulsion," also a term liked by Minsky (for his "moment") and Kindleberger, which happens at the worst point of the panic and crash stage.

How to Think about the Crisis

My piece on How to Think About the Crisis was just published in Radical Notes
http://radicalnotes.com/content/view/73/39/

The Corrosive Qualities of Inequality: The Roots of the Current Meltdown.

My article was just published in Challenge Magazine.

"The Corrosive Qualities of Inequality: The Roots of the Current Meltdown." Challenge, Vol. 51, No. 5 (September-October, 2008): pp. 40-64.

McCain’s Mortgage Subsidy: Incidence to Homeowners or to Bankers?

Mike Allen reports:

Sen. John McCain (R-Ariz.) made an overnight change in the homeowner bailout he proposed at Tuesday’s presidential debate, making it more generous to financial institutions and more costly for taxpayers. McCain's staff says it was always meant that way. When McCain sprung his surprise idea at the start of the debate in Nashville, his campaign posted details online of his American Homeownership Resurgence Plan, which would direct the government to buy up bad home mortgages, allowing strapped people to keep their property. The document posted and e-mailed by the McCain campaign on Tuesday night says at the end of its first full paragraph: “Lenders in these cases must recognize the loss that they’ve already suffered.” So the government would buy the mortgages at a discounted rate, reflecting the declining value of the mortgage paper. But when McCain reissued the document on Wednesday, that sentence was missing, to the dismay of many conservatives. That would mean the U.S. would pay face value for the troubled documents, which was the main reason Sen. Barack Obama (D-Ill.) gave for opposing the plan. A McCain campaign official explained the change: “That language was mistakenly included in the initial draft and it’s been corrected. It doesn’t reflect the intentions of the initiative, which necessitated the correction and the removal of the sentence. A simple mistake.” Obama Campaign Economic Policy Director Jason Furman said in the campaign statement opposing McCain's plan: "John McCain wants the government to massively overpay for mortgages in a plan that would guarantee taxpayers lose money, and put them at risk of losing even more if home values don’t recover. The biggest beneficiaries of this plan will be the same financial institutions that got us into this mess, some of whom even committed fraud."

When I posted this, Barkley suggested that the McCain proposal wasn’t quite so bad. He – like me – was assuming that most of the incidence of this subsidy would go to homeowners. Brad DeLong, however, seems to be saying that most of this subsidy would go “to the shareholders and managers of banks with troubled assets”. If that’s the case, I agree that this is a really bad proposal.

Voluntary Debt for Government Equity: the Mankiw-Paulson Bank Bailout Plan

Greg Mankiw wrote yesterday:

Some economists have proposed forcing these firms to go raise more capital from private sources. But how exactly can the government do that? It is not entirely clear how, as a legal matter, that can be accomplished. Perhaps regulators can twist the arms of the financial institutions. Call it the Tony Soprano approach. “Nice bank you have here. I wouldn’t want anything bad to happen to it.” Other economists have suggested that the government inject capital itself. That raises several questions. First, which firms? The government does not want to put taxpayer money into “zombie” firms that are in fact deeply insolvent but have not yet recognized it. Second, at what price should the government buy in? Third, isn’t this, kind of, like socialism? That is, do we really want the government to start playing a large, continuing role running Wall Street and allocating capital resources? I certainly don't. Here is an idea that might deal with these problems: The government can stand ready to be a silent partner to future Warren Buffetts. It could work as follows. Whenever any financial institution attracts new private capital in an arms-length transaction, it can access an equal amount of public capital. The taxpayer would get the same terms as the private investor. The only difference is that government’s shares would be nonvoting until the government sold the shares at a later date. This plan would solve the three problems. The private sector rather than the government would weed out the zombie firms. The private sector rather than the government would set the price. And the private sector rather than the government would exercise corporate control. Why would an undercapitalized financial firm take advantage of this offer? Because it would need to raise only half as much capital from private sources, that financing should be easier to come by. With Warren Buffetts in scarce supply, the government can in effect replicate them, by pigging backing on what they do.

Today, we learn:

The Bush administration is considering taking ownership stakes in certain U.S. banks as an option for dealing with a severe global credit crisis ... A decision to inject capital directly into financial institutions in return for ownership stakes would be similar to a plan announced Wednesday by Britain ... Treasury Secretary Henry Paulson told reporters that Treasury was moving quickly to implement the $700 billion rescue effort and he specifically mentioned reviewing ways to bolster the capital of banks.

My concern with Mankiw’s idea starts with the Akerlof demand for lemons problem where insiders may have information about the health of their company that the public or the government does not have (the asymmetric information problem). When this information is positive, they would be less likely to accept new equity infusion. Those willing to accept equity infusion may possess negative inside information about the health of their companies. The case against forced debt for equity swaps is not quite as air tight as Greg Mankiw suggests.