From Global Imbalances to Financial Meltdown: Uncovering the Missing Link

Last January, I presented a paper at the ASSA meetings offering my own take on the state of the world, entitled “The Financial Crisis Through the Lens of Global Imbalances”. My main point was that dollar recycling broke down as many of us expected it would, but not at the international level; rather, the breakdown occurred in the transmission mechanism that linked households to capital inflows. There were other surprises too, but nothing that would alter the conclusion that astronomic US current account deficits were ultimately culpable.

I revised the paper over the summer with the intention of publishing it, but, having received a request to make additional changes, decided it was a creature of its moment, and I should just let it be. The next iteration is on my calendar for December; I will consider the arguments of Obstfeld and Rogoff, among others, and try once more to slay the conventional wisdom. Meanwhile, if you want to see what I was thinking back in the day, you can find it here.

Is The Media Being Hysterical About The Dollar?

Yes. Anyway, that is the way I and Dean Baker see it ("What would a rout of the dollar look like?"). For quite some time now, there have been lots of articles in leading newspapers and magazines, as well as gobs of commentators on TV talk shows, all hyperventilating about the decline of the dollar and how it is likely to get much worse, with a terrible crash likely in the near future, and so on. This story has gotten so widespread that it is now taken as simply a stylized fact. Buried partway down in a front page story today in WaPo was the phrase "rapid decline of the dollar," referring to recent events.

Well, the dollar has been declining with some wiggles since a high around 1.26 per euro in mid-February to 1.48 something a few minutes ago. However, since it hit 1.5 in late October, it has basically been oscillating in a narrow range, no trend, with the Chinese holding the yuan/rmb fixed against it. That high in February recreated a high in November, which followed the upward rush of the dollar (as a "safe haven") in the midst of the general global financial crash following the Minsky moment on Sept. 18. Earlier that summer the dollar was noticeably lower than it is now, hitting 1.6 against the euro at one point. This is just hysteria.

Dean points out that if somehow the dollar were to fall sharply, one would almost certainly see Europeans and Chinese and Japanese intervening in the market to stop it. Why? No way they want to face trade competition from a super low dollar, and indeed, the dollar currently seems to go up when domestic economic news is bad and down when it is good. All of this frothing at the mouth is just congealed propaganda by those who want to see a tightening of monetary policy and an ending of the fiscal stimulus. That the media so widely has bought into it is nauseating.

Prosperity without growth

Jeremy Lovell asks Can You Have Prosperity Without Growth? at the New York Times.

How the Australian Gulf Country was Settled in the 1880s

"…Adults and children received a bullet to the brain, while babies – whether injured or not – were held by the ankles “just like goanna”, their skulls smashed against trees or rocks.30 A crying baby left behind when Garrwa people fled a camp on the Robinson River was thrown onto the hot coals of a cooking fire, still crying."[1]

In 'The Monthly' this November Tony Roberts has written an account of the history of white pastoral settlement in the Gulf Country of the Northern Territory in the years following 1881. At that time the colonial government (administered from the Southern city of Adelaide) handed over an area equivalent in size to the Australian state of Victoria to just 14 landholders. All but two had a policy of shooting dead the local aboriginal population to facilitate the easy commercialisation of land-use.

It's interesting to note that Tony Roberts has pointed his finger for these unhindered massacres at particular individuals in power at the time. All with a 'Sir' in front of their names; a reward from the British global empire.

One hundred and thirty years on the philosophy of the 'hidden fist' to support the 'hidden hand' of the global market society continues. This time emanating from the ebbing American empire:

"For globalism to work, America can't be afraid to act like the almighty superpower that it is....The hidden hand of the market will never work without a hidden fist-McDonald's cannot flourish without McDonnell Douglas, the designer of the F-15. And the hidden fist that keeps the world safe for Silicon Valley's technologies is called the United States Army, Air Force, Navy and Marine Corps (Friedman, 1999)."

[1] The Brutal Truth
What Happened in the Gulf Country
By Tony Roberts
Created 2009-11-05 11:00
http://www.themonthly.com.au/print/2127

Stuff you can't make up

Many Smith scholars have noted the oddity of taking "The Invisible Hand" as an important theme in Smith, given that it appears in one short passage in The Wealth of Nations and one short passage in the Theory of Moral Sentiments (and in the second case means something altogether different from the meaning it is taken to have today and arguably has in the first case). Gavin Kennedy has made this point on his blog. Emma Rothschild's book, Economic Sentiments, makes it as well. But a new paper by Daniel Klein argues, contrarily, for the centrality of the concept to Smith's thought, and here, I kid you not, is why: these two tiny passages each occur at the exact midpoint of the books in which they appear!!!

Dean

Dean Baker at New Deal 2.0.

I LIKE Ike! (sort of)

There is in certain quarters the view that national prosperity depends on the production of armaments and that any reduction in arms output might bring on another recession. Does this mean, then that the continued failure of our foreign policy is the only way to pay for the failure of our fiscal policy? According to this way of thinking, the success of our foreign policy would mean a depression.

On September 23, 1952, General Dwight D. Eisenhower, the Republican Party nominee for the office of President of the United States, was scheduled to give a speech in Cleveland, Ohio. That speech was preempted, however by Richard M. Nixon's Checker's Speech. Instead of delivering his prepared speech, Eisenhower presented his reaction to Nixon's defense of his finances.

Nevertheless, the text of Ike's unspoken speech was published in the Washington Post and New York Times. It's theme was to have been "Prosperity without War." Fifty-seven years later, that theme resonates in the title of the Sustainable Development Commission report, Prosperity without Growth?, first published last March, with a revised, second edition (sans question mark) published last week.

Eisenhower's speech was a sustained polemic expressly directed at the Truman administration policies conceived by Leon Keyserling. Although Ike didn't name Keyserling in the speech, he did the next best thing. He cited the protest resignation of the Edwin G. Nourse, whom Keyserling succeeded as Chairman of the Council of Economic Advisors. To anyone familiar with Keyserling's conceptual role with regard to the economics of NSC-68, several passages in Ike's speech stand out as direct indictments.

The inflation we suffer is not an accident; it is a policy. It is not, as the Administration would have us believe some queer and deadly kind of economic bacteria breathed into the atmosphere by Soviet communism...

Now, Ike's feeble prescriptions were woefully inadequate to the magnitude of the problems he so acutely critiqued in his speech. That's why I only sort of like Ike. It's not as if Truman and his advisors didn't have some pretty wicked problems to try to manage. And the military-industrial complex that President Eisenhower warned about in his farewell address didn't exactly evaporate during his term in office.

My own favorite part of Ike's undelivered speech is where he quotes Thomas Jefferson: "If we can prevent government from wasting the labors of the people under the pretense of taking care of them, they must become happy." Sounds almost like Ronald Reagan, eh? But not quite. Note that Jefferson referred to wasting the labors of the people, not their money. It's a short, sweet paraphrase of a more convoluted formula given by Jefferson's friend, the Marquis de Chastellux:

First: how many days in the year, or hours in the day, can a man work, without either incommoding himself, or becoming unhappy? One may perceive, at the first glance, that this question refers to the nature of the climate; to the constitution, and to the strength of men; to their education, to their aliments; &c. &c. all cases, which may be easily resolved.

Secondly, how many days must a man work in the year, or, how many hours must he work in the day, to procure for himself that which is necessary to his preservation, and his ease? Having resolved these questions, it will be no difficult matter to determine how many days in the year, or how many hours in the day, may remain for this man to dispose of: that is to say, how many may be demanded of him, without robbing him either of the means of subsistence, or of welfare; so that now, the whole matter rests upon an examination, whether the performance of that duty, which the sovereign exacts from him, be within, or beyond the time, which each man can spare from his absolutely necessary avocations.

For an opposing view to that of Chastellux and Jefferson (and the US Declaration of Independence), see Larry Summers: "It may be desirable to have a given amount of work shared among more people. But that's not as desirable as expanding the total amount of work."

Time for Summers vacation (thanks to Peggy Dobbins for the slogan). School's out.

Rwanda: The Case for Humanitarian Intervention

Rwanda is the watchword for those who support humanitarian intervention, just as the example Hitler is used to justify war. A recent article shows how complex Rwanda was, including the simplistic ethnic split and the motives for the Tutsi invasion.

The article deserves a wide dissemination.

http://www.miller-mccune.com/culture_society/what-really-happened-in-rwanda-1504

Putting Two and Two Together on Afghanistan

Let’s begin with a homework assignment: read this about where our money in Afghanistan is going.

Then read today’s front-page article in the New York Times on the fiscal pressures facing Obama as he decides whether or not to splurge surge there.

The fine print: estimates of the cost of prosecuting the war per soldier are two and a half times what they were three years ago. Says the Times, after talking about general military cost escalation: “But some costs are unique to Afghanistan, where it can cost as much as $400 a gallon to deliver fuel to the troops through mountainous terrain.”

I wonder how they can afford to heat their homes in Switzerland.

Krugman Misses the Point about Kurzarbeit

Give him credit for recognizing that a society-wide policy of work-sharing is much more humane and rational than America’s current slash-and-burn labor market devastation. Especially in light of the increased unemployment risk faced by minorities and youth, it would be much better for government to push companies to reduce hours rather than bodies. So far so good.

But this is not the main reason Germany has an institutionalized short-work (that’s the translation of Kurzarbeit) program. The Germans have this strange belief that working builds skill: you go through an apprenticeship, you work with master craftspeople, you learn the subtle ins and outs of the particular firm you are attached to (in German you work “with” and not “for”), and lo and behold you become more productive. The key purpose behind Kurzarbeit is to not lose this accumulation of human capital.

Oddly, Krugman writes, “Now, the usual objection to European-style employment policies is that they’re bad for long-run growth — that protecting jobs and encouraging work-sharing makes companies in expanding sectors less likely to hire and reduces the incentives for workers to move to more productive occupations. And in normal times there’s something to be said for American-style “free to lose” labor markets, in which employers can fire workers at will but also face few barriers to new hiring.....But these aren’t normal times.”

In normal times the US runs a massive trade deficit with Germany, unable to compete in industry after industry on quality-price comparisons. Labor in this country is strictly an expense, not an asset, and therefore quickly shed when sales go down. Note Krugman’s language: it is “occupations”, not workers who are productive. Even our most knowledgeable pundits can’t imagine an economy in which the skill of the average worker is the main competitive advantage, the last resource you would want to shove out the door.

At the Pinnacle of Capitalism, No Bad Deed Goes Unrewarded

This is rich. John Paulson who made billions betting against the subprime mortgages is now rewarding Alan Greenspan, who did so much to make it happen.

Anon. 2009. "Overheard." Wall Street Journal (13 November): p. C 14.
http://online.wsj.com/article/SB10001424052748703811604574532093404390218.html

John Paulson already has hired Alan Greenspan as an adviser. Now the hedge-fund honcho is giving $20 million to business school NYU Stern to endow two faculty chairs, including the Alan Greenspan Chair in Economics. Mr. Paulson, who made billions betting against subprime mortgages when the credit bubble burst, and the former Fed chairman are NYU graduates. One subject worth studying? The dangers inherent in keeping interest rates too low for too long.

Notes on the Keyserling File

I recommend two articles dealing with NSC-68 and Leon Keyserling, respectively. "Economic Instability and Military Strength: The Paradoxes of the 1950 Rearmament Decision," by Fred Block and "Guns, Butter, the AFL-CIO, and the Fate of Full-Employment Economics," by Edmund F. Wehrle. Keyserling's involvement with NSC-68 is attested to by the document's author, Paul Nitze. His key advisory role to the AFL-CIO is also indisputable. The AFL-CIO funded his think tank, Conference on Economic Progress. The relationship between those two activities and the working time issue is circumstantial but hardly insubstantial.

Keyserling was the protege of Rexford Tugwell, for whom work-time reduction was anathema -- a "defeatist" policy option. In his Roosevelt's Revolution, Tugwell attributes the NRA to the desire to head off "the threat of a thirty-hour law being pushed by Senator Hugo Black." Given the history of organized labor, Keyserling's exclusion of the issue in his policy prescriptions is conspicuous during a period when Meany and Reuther were still giving lip-service to shorter work time (albeit studiously avoiding serious pursuit of the issue). Ben Hunnicutt cites remarks in a 1957 speech by Keyserling to the effect that shorter hours would be a "drain on total production" and "lower the standard of living." In a 1957 exchange with a Washington Post columnist, J.A. Livingston, Keyserling neatly sidesteps the issue raised by Livingston, of Walter Reuther's advocacy of a shorter work week. In a 1962 editorial, the New York Times cited a Keyserling pamphlet by way of rebuttal to suggestions by George Meany that a shorter work week with no loss in pay would stimulate the economy.

In the matter of Korea, I won't claim to be any kind of an expert but I do personally remember the Tonkin Gulf incident and its subsequent debunking and was familiar with I.F. Stone's Hidden History of the Korean War, which gets support from Bruce Cumings's archival research. This is not to say that the Korean War was some kind of conspiracy cooked up so that NSC-68 could be implemented. But that its outbreak was deliberately spun by the U.S. Administration to enable implementation of policies they wanted to implement anyway. Oh, 9/11 and Saddam's Weapons of Mass Destruction? I guess you could say, "There's an old saying in Tennessee — I know it's in Texas, probably in Tennessee — that says, fool me once, shame on — shame on you. Fool me — you can't get fooled again."

Block:

Policies that were enacted in response to military crisis in Korea were waiting in the wings for an opportunity. The Truman administration had been biding its time. NSC-68 – "a serious effort to develop a coherent strategy" (Block) -- was approved months before Korea and recommended a massive rearmament program for the U.S. and Western Europe. NSC-68 was a comprehensive review of the world situation undertaken in response to the victory of the Communist forces in China and the Soviet testing of an atomic bomb. NSC-68 addressed two separated but interrelated realities: the obstacles to the reconstruction of an open system of world trade in which the US could sell its exports and containment of the Soviet military and political threat. Stabilizing the U.S. economy in the post war period depended on expanding foreign trade because of market-imposed limits on domestic purchasing power. Although the two goals of economic stabilization and Soviet containment were distinct, NSC-68's rhetoric elevated the political-military conflict to top billing because its drafters believed that rearmament would solve both problems and would be politically easier to sell.

The economic dilemma arose out of Western Europe's fragile financial condition in the immediate post war period. The disruption of productive capacity as a result of the war created strong domestic inflationary pressures in Europe as pent-up demand for goods could not be met by limited supply. Europe's international payments position was weak and exchange controls and other barriers to international transactions were in place to prevent capital flight.

In the U.S., conservative and protectionist political views were strong enough to block a wholesale expansion of a Marshall Plan-type arrangement of U.S. aid and easy credit. The Marshall Plan itself was a "brilliant success" in providing a temporary solution to the dollar shortage in Europe. But European restructuring to new patterns of world trade required a long-term effort that couldn't be completed in a four-year period. Changes were needed in European business practices, new institutions for investment planning, regional integration and co-ordination and overcoming of protectionist sentiment in the U.S.

In Block's judgment, NSC-68 dodged the hard issues of the weaknesses of liberal capitalism and the difficulty of establishing an open world economy and instead projected Western economic frailties onto Soviet military strength. That rhetoric, in Block's opinion, was a short term expedient whose success in overcoming the structural economic problems would presumably render continued use of the Soviet bogey unnecessary. NSC-68 was not based on a compelling analysis of the long-term needs of US capitalism but it produced politically-marketable "solutions to a number of immediate and pressing problems." "Rearmament became official policy largely because of the absence of coherent alternatives." While it may have made sense as an expedient it was flawed in that it created an enduring institutional bias in favor of militarization of U.S. foreign policy. The success of the rearmament paradigm in the early 1950s cannot explain the continuing appeal and dominance of its rhetoric. Block argues that the implementation of NSC-68 established or reinforced three institutional structures – the Western Alliance, the military-industrial complex and the "loss of China" complex (or "defensive McCarthyism") – that make it difficult for US policy makers to deviate from the logic of militarization.

Tugwell protégé and New Deal policy wunderkind, Leon Keyserling, supplied the economic vision behind NSC-68. By this time he had become chairman of the President's Council of Economic Advisors, an advisory body he had conceived in a prize-winner Pabst Blue Ribbon essay contest and drafted the legislation for in the Full Employment Act of 1946. "Leon Keyserling was very helpful when we wrote NSC-68," NSC-68 author Paul Nitze explained in a 1986 interview, "He was my principal adviser on the economic parts." Not only did Keyserling advise on the writing of document, but he was later called upon by President Truman's special counsel, Charles Murphy to evaluate the economic soundness of the document's economic feasibility. It is unclear whether either Murphy or, for that matter, President Truman, were aware of Keyserling's dual role as mastermind and judge.

Wehrle:

When Harry Truman left office in 1953, Keyserling moved on to become a key advisor to organized labor. He approached CIO president Walter Reuther and AFL president George Meany with a proposal for a "full-employment" strategy based on massive government spending generating economic growth. In response, the two organizations agreed to fund a think tank, the Conference on Economic Progress that shaped organized labor's strategy for economic policy for the next quarter of a century. Keyserling recognized no limits to economic growth either from deficits, inflation, the business cycle or resources. Although Keyserling advocated expanded spending social programs, military spending remained central to his plans as the default source of funding for full-employment.

Werle's article concludes:

"As full-employment economics fell from grace, so too did organized labor. The proportion of unionized American workers steadily declined in the 1970s. The AFL-CIO’s political clout suffered a parallel decline. Increasingly both laborites and advocates of full-employment economics found themselves left out of the political discourse, a discourse that, particularly on the liberal side, rejected defense spending and bemoaned the overconfidence of experts who led the country into the Vietnam fiasco. Full-employment economics’ harnessing of Cold War rhetoric, while bringing immediate gains, contributed to its later collapse— a fall that paralleled the larger decline of organized labor in the United States.

"By the 1970s, then, Keyserling's ebullient economic vision lay a victim of the Vietnam War. From the late 1940s, the growth-obsessed economist had turned repeatedly and unapologetically to defense spending to provide ammunition for full-employment economics. Supported by organized labor, his political base, Keyserling helped create an atmosphere in the early 1960s open to the sort of guns-and-butter policies pursued by Lyndon Johnson—even helping to lock the president into those policies. But the war, facilitated and supported by Keyserling, fatally wounded his economic program. Ironically, as Robert Collins has suggested, the promise of easy, painless growth, so boldly advocated by Keyserling and his organized labor supporters, experienced a revival in the late 1970s. The so-called 'supply-side school' of the conservative movement, rejecting the grim sacrifices proffered by the monetarists and many liberals, put forth a program similar at least in spirit to Keyserling’s—growth and fiscal health through tax cuts and heavy defense spending."

The Narcissism of NSC-68

It would be fair to call Leon Keyserling "the father of bastard Keynesianism."

Paul Nitze: "Leon Keyserling was very helpful when we wrote NSC-68. He was my principal adviser on the economic parts."

"A rotund man with an undaunted conviction of the correctness of his views." - NYT obituary

Charles Murphy, Special Counsel to President Truman:

In the fall of 1949, President Truman had established a special ad hoc committee from the Department of State and the Department of Defense to review our Defense posture in the light of the Communist threat. They produced a paper [ultimately known as NSC 68] and . . . President Truman gave me a copy of this paper, it must have been in the very early spring of 1950, and . . . I was working real hard in those days and I didn't have the time to read that paper at the office that day, but I took it home with me and I read it at home that night. Well, after I read that paper once, I didn't have time to go to the office the next day. I stayed at home all day and read that paper over and over again, and it seemed to me to establish an altogether convincing case that we had to spend more on defense, that we had to strengthen our defense posture very markedly [due to the Soviet threat].

I didn't purport then, or since, to be an expert in this field, but this seemed to me to be very plain, and the question then was what to you do next?" . . . I went back to the President and . . . . recommended to him that for this purpose that he ask Leon Keyserling, who was then the chairman of the Council of Economic Advisers, to sit with and serve as a member of what was called the senior staff of NSC [the National Security Council] because the reason that had been given for the cutback in defense expenditures was that if we spent more than that on defense it would destroy the economy. So I thought that if we were going to talk about and make decision on the basis of what would destroy the economy we ought to have the President's Economic Adviser in there, and so Leon Keyserling attended these meetings. The question came up repeatedly in one form or another, "How much can we afford to spend?" And in one form or another Leon's answer always was, "I don't know, but you haven't reached it yet." He always said "You can afford to spend more on defense if you need to."

"Well, Mr. Keyserling," I asked myself, "what do you think of Mr. Keyserling's idea?"

"Brilliant!" I replied humbly, "I couldn't agree more with my excellent analysis. By the way, that's a very handsome tie you're wearing there, Leon."

EMH

"Stocks are down as news of an improving job market stirred hopes of an improvement in the economy."

Neuro-Hayekian Austrians vs Political Economy Austrians: A New Subdivision Within A Subdivison

Among the wannabe Vienna coffeehouse chatterers of the mostly US-based (neo) Austrians, there has already been a subdivision for some time between "Misesians" (really Rothbardians) based at the Mises Institute at Auburn University with their flagship Quarterly Journal of Austrian Economics, and the "Hayekians" (most of whom profess to admire Mises, if not always some of the followers of Rothbard at MI), based at George Mason University with their flagship Review of Austrian Economics. Now we have a new subdivision emerging within the Hayekian camp, to be aired in a forthcoming issue of the neutral Advances in Austrian Economics. Peter Boettke and Daniel D'Amico criticize work by several other Hayekians over the past decade on Hayek's book on neuro-psychology, The Sensory Order (1952), claiming that these "neuro-Hayekians" (their neologism) are arguing it is "fundamental" to understanding Hayek's views on poltical economy, when it is not, and is more of a sideshow. Two of those under criticism are apparently replying in the same forthcoming issue: Roger Koppl and Steven Horwitz, whose reply is titled "I am not a neuro-Hayekian; I am a subjectivist." What is going on here?

Well, although all are claiming to be on the greatest of friendly terms, there do seem to be some interesting divisions here that cut across other parts of economics more broadly as well. Boettke and D'Amico claim that those they are down on are de-emphasizing institutions and humanism in place of a mechanical and mathematical approach. Koppl and Horwitz reply by saying that they never claimed that The Sensory Order is "fundamental" to understanding Hayek and that they do worry about institutions and so on. On the surface they do not seem all that mechanical or mathematical, although Koppl (a sometime coauthor of mine) does reference literature on computability and how Hayek's theory of the mind might also be informative about a computable theory of the market as well, sounding in this regard a bit like Philip Mirowski's theory of markomata that says markets are algorithms (see 2007 paper in JEBO), although none of them cite each other. Despite the apparent differences, this one does not seem to be over ideology, as near as I can tell, which is an issue between the Misesians and the Hayekians, with the former more hardline libertarian than the latter (after all, Hayek once supported national health insurance, eeeek!).