What Is Public Capital?

Floyd Norris really missed the boat this morning in his column on the European Banking Authority’s latest round of stress tests. There are big issues with the stresses EBA elected to test, but that’s a story for another day. For now, focus on Norris’ criticism of Helaba, the state bank (landesbank) for Hesse and Thuringia:

Helaba is outraged that the E.B.A. will not count “hardened silent participations” as core capital. And what is that? As near as I can tell, it amounts to promises by the two states that own the bank that the states will put up more money if needed....

The fact that these arguments are going on does provide some evidence that the stress tests are more credible than previous ones. They also remind us that one of the games that banks have played in the past — often with support from bank regulators — has been to count some pretty dubious things as capital. When the crisis hit, a lot of that “capital” turned out to not be of much use.

This makes it sound as though Helaba is a band of sharp operators trying to hide how overleveraged they are—like some of the Wall Street players that blew up in 2008. There is a lot you could say about the landesbanken, but sharp is not what comes to mind.

The first thing you need to know is what the state banks like Helaba are. They are publicly owned entities that rest on top of a pyramid of thousands of municipally owned savings banks. If you add in the specialized publicly owned real estate lenders, about half the total assets of the German banking system are in the public sector. (Another substantial chunk is in cooperative savings banks.) They are key tools of German industrial policy, specializing in loans to the Mittelstand, the small-to-medium size businesses that are at the core of that country’s export engine. Because of the landesbanken, small firms in Germany have as much access to capital as large firms; there are no economies of scale in finance. This also means that workers in the small business sector earn the same wages as those in big corporations, have the same skills and training, and are just as productive.

But the EU doesn’t like the landesbanken. They denounce the explicit and implicit public subsidies that state ownership entails, saying they violate the rules of competition policy. For over a decade they have fought to have the system privatized. In the end, the dispute is simply ideological: if you think that public ownership should only be an exception, narrowly crafted to address specific market failures, you want to see the landesbanken put on the auction block. If you think an economy should be organized to meet socially defined needs, you would want a large part of capital allocation to be responsive to public input, and you’d fight to keep the landesbanken the way they are. (There is a movement afoot in the US to promote public banking.)

One result of the EU attack has been pressure on the landesbanken to demonstrate competitive rates of return. The folks who move money in these banks are public servants, very good with forms and checklists in hallowed German tradition, but not very savvy in nouveau finance. Sadly, some of these naive beamters loaded up on the mortgage-based securities that collapsed in the financial crisis, since the returns were what Brussels was demanding, and, well, they were AAA.

But on to the topic at hand. What constitutes equity for the landesbanken? For a privately owned bank, capital is raised by drawing on private funds, for instance through a share offering. For a public bank, capital is the financial commitment authorized by the public institutions that guarantee the bank’s liabilities. It’s pretty obvious when you think about it, and that’s the position taken by Helaba and the other landesbanken.

According to the EBA, however, public commitments don’t count. They don’t think there should be public banks in the first place, and they don’t want to legitimize the financial structure of the German public banking system. In other words, their opposition isn’t about whether the landesbanken can cover their liabilities, but is pure ideology.

My guess is that Norris is unaware of the battle lines that have formed around the landesbanken and has adopted the EU position by reflex, out of distrust for all financial institutions. The cynicism that serves so well in the US, however, has to be translated into the European context before you can understand why Helaba is so stressed about its stress test.

Sex, Lies, and Economics: please help

I have just finished my introduction to the book, which is shaping up. I would very much appreciate any comments.

http://michaelperelman.files.wordpress.com/2011/07/intro.doc

Consciousness Lost. Looking back at 1972

I experienced 1972 as another letdown year of revived 'business as usual'. The shutdown of the alternative press and progressive environmental and social thought was pretty obvious in the mass media at the time and it has continued to this present day. It is so hard to imagine, for those born in latter decades, that open discussion and heated debate on our most important and vital issues did occur for a short and glorious few years in the 1960s. Then blackout.

1972 – The World3 'reference run' projected that the industrial output per capita (IOPC) would reach its all-time peak in 2013 and then would steeply decline through 2100. Moreover, the duration of Industrial Civilization (as measured by the leading and lagging IOPC 30% points) came out to be about 105 years. [Industrial Civilization, defined herein, began in 1930 and is predicted to end on or before the year 2030.] [1]


1972 Conference on the Human Environment. The Stockholm deliberations were confused by the fact that the luckier nations which happened to achieve industrial prodigality before the earth's savings became depleted had already infected the other nations with an insatiable desire to emulate that prodigality. The infection preceded recognition of the depletion. The result of this sad historical sequence was the pathetic quarrel over whether the luxury we cannot afford is economic growth or environmental preservation. Neither was a luxury; worse, neither was possible on a global scale. [2]

1972 – 1981 – The price of oil increased nine-fold. This fueled stagflation. Important changes occurred within the World Bank as a result of the energy crisis. It moved from supporting protection for infant industries and state planning and lending for state-owned enterprises to a commitment to trade liberalization and abandoned its support for public enterprises.[3]

1972 – December. John Kenneth Galbraith restates that the neglect of power in economics serves conservative political and social functions. The state is the only social entity that could exercise countervailing power to the corporate oligarchy but this situation is problematic given the state’s ‘consanguinity’ to the very corporate oligarchy that must be challenged. [4]

REFERENCES:
[1] THE PEAK OF WORLD OIL PRODUCTION AND THE ROAD TO THE OLDUVAI GORGE
Richard C. Duncan, Ph.D.1
Pardee Keynote Symposia
Geological Society of America
Summit 2000
Reno, Nevada
November 13, 2000
http://dieoff.org/page224.htm

[2] Industrialization: Prelude to Collapse
by William Catton
(Excerpt from Overshoot: The Ecological Basis of Revolutionary Change)
Unrecognized Preview
http://dieoff.org/page15.htm

[3] jkissing on April 23, 2006 - 7:24pm
http://www.theoildrum.com/story/2006/4/22/23169/4783

[4] Galbraith and Robinson's second crisis of economic theory.
Publication: Journal of Economic Issues
Publication Date: 01-MAR-08
Author: Wrenn, Mary ; Stanfield, James Ronald ; Carroll, Michael
http://www.accessmylibrary.com/coms2/summary_0286-34227679_ITM
COPYRIGHT 2008 Association for Evolutionary Economics

Ambient Stupidity Alert: Opinion Polling about the Federal Budget Deficit

There is crazy-making economic noise all around us, and one way to grope our way back to sanity is to recognize it, bottle it, and stuff it into an Ambient Stupidity Alert.

My contribution today is to make yesterday’s Five Thirty Eight column in the New York Times disappear, cognitively at least.

Nate Silver, who really knows his polling numbers, processes a recent Gallup poll on policies to reduce the federal budget deficit. Here’s the question Gallup asked:

Now let’s try to cut through the noise. Why should a rational person have a preference for how to cut the budget deficit before deciding whether to cut the deficit? As the most recent employment and job vacancies numbers make clear, the economy is treading water at best, and, as the last remaining stimulus funds are spent, budget policy at both state and federal levels is dangerously procyclical. On top of that, our trade deficit just bumped up to an annualized rate of $600B, and that means that, between them, households, firms and the federal government will have to borrow more if that trend continues. The external deficit is identically and simultaneously a flow of borrowing, and the only question is who goes into hock. How about a poll question about that?

But it gets worse. Gallup asks abstractly about “spending cuts” and “tax increases”, as if it were rational to have monolithic preferences about these wildly heterogeneous categories. If I wanted to cut the budget deficit, the very first thing I would do is put a quick end to counterproductive wars and provocative military spending projects. The last thing I would do is cut the social safety net when un- and underemployment are wreaking havoc. I would certainly favor increased taxes on above-median earners (which includes me incidentally), but I would be against raising them for those in the bottom slice. So how am I supposed to answer Gallup’s brain-dead questions?

Here’s a hypothesis: When the Gallup interviewer asks what people think about “tax increases”, most of them translate that into “tax increases on me”, and they don’t like them. What if you asked them about tax increases only on those at the top of the heap, whose income is well above most of the respondents? I’m not saying that soak-the-rich would push aside all the other choices, but it would fare better than soak-yourself.

And another: What if, instead of asking about “spending cuts”, Gallup gave people a short list of spending categories, how much is in each of them, and ask, how much would you want to cut from them? Don’t ask if people want to cut “foreign aid” with no clue about how much money is at stake—show them the money, alongside the amounts in the other categories, and let them make at least a potentially reasoned choice.

Reading this column was like getting sucked into an alternate universe, where pod people with blank expressions mumble strange things about economics. Wake up, before you become one of them.

Obama, Social Security, My Totalled Car

A young student side-swiped our car a few days ago totaling it. We need a new one. I can do everything on a bike, but Blanche cannot.

I had read that Hyundai was making good low cost cars. We went to see them yesterday. I was appalled how much of the car was made of cheap plastic that was very vulnerable and sure not to last. It seemed like a disposable vehicle.

The article about the quality of the GM cheap car struck home.

http://www.nytimes.com/2011/07/13/business/with-chevrolet-sonic-gm-and-uaw-reinvent-automaking.html?src=me&ref=business

The car made me think about the CPI. I am sure that such quality deterioration will not show up in the cost of living, speeding up Obama's plan for undermining Social Security via the Consumer Price Index.

My Latest Book Published!

Over a decade in the writing, my latest book has just been published by Springer, Complex Evolutionary Dynamics in Urban-Regional and Ecologic-Economic Systems: From Catastrophe to Chaos and Beyond. It is an unpleasant $119.00 from the publisher, but "only" $98.49 at Amazon, where it is apparently selling well for a book of this sort.

An oddity is that they left the "Jr." off my name on both the cover and the copyright page, which means that some people may think the book is by my late father. However, ironically, a recent reprint of his most famous book, Logic [for Mathematicians], is being advertised by eBay on the internet as being by "J. Barkley Rosser, Jr." and somebody has put into my father's Wikipedia entry that the book is by "John B. Rosser," ugh, with neither he nor I ever using our first name(s) in any of our publications of any sort ever. Oh well, darned computer software and who knows what all.

For a Stochastic Jubiliee

Modern economies depend on credit: a credit system moves economic resources from where they are acquired to where they are needed. In most times financial systems do a tolerably good job of this—not as good as they could do (since incentives and prices are often misaligned with needs), but good enough that we allow the system to operate.

But credit systems are inherently unstable. Without going into Minskyan detail, it is enough to say that loans sometimes fail to work out as intended, and that systemic overleveraging and herd dynamics can lead to massive, rogue waves of default. This “can” is actually a “will”: you can be certain that, from time to time, major credit disruptions will occur.

The financial crisis of 2007-8 was such an event. It is not over, as the Eurozone credit overhang builds to a potentially disorderly default. Large scale defaults are dangerous, posing enormous technical management challenges and even greater political-economic ones. The one we are in has been very bad and is sure to get worse. Everything we know about credit systems tells us that it won’t be the last.

What to do?

There is an ancient idea that is almost right. The Book of Leviticus calls for the freeing of all slaves and the annulling of debts every 50 years. Today we would not wait so long to restore freedom, but the idea of a periodic debt annulment is attractive. The big problem is that the biblical solution to annulment risk is not practical. God, at this early stage of economic analysis, thought that it would be possible to price in the risk, so that implicit interest rates would rise as the jubilee year approached. Clearly this is wrong. With a fixed date for wiping out debt obligations, the economy would come to a standstill many years in advance.

The solution is obvious: rather than fixing a date for the jubilee, it should be a random draw with a 2% chance in any given year. This would necessitate an additional 2% risk premium on all contracts—a burden to be sure, but one that is bearable, especially since monetary authorities could compensate in part by targeting lower policy rates than they do at present. (This expedient falls short in a liquidity trap, but such a trap would be far less likely if debt overhangs were periodically drained via jubilees.)

It would be an interesting empirical project to simulate a global stochastic jubilee using data from, say, 1950 from the present. Suppose the 2% draw were introduced at the beginning of this period, and suppose, for the sake of simplicity, that monetary authorities were able to fully offset its interest rate effect so as to neutralize its impact on the real economy. Do a Monte Carlo to see the impact of different jubilee dates on the debt accumulation profiles of the runs compared to that which actually occurred. How would these differences have altered the consequences of crunch points like 1982, 1997 and 2007?

One way to think about the agonizing negotiations taking place in Europe today is that they are attempting to work out the dimensions and modalities of a partial jubilee in real time under crisis conditions. Wouldn’t it be a lot easier to work out a preventive system that operates routinely and, except for its timing, predictably?

Sex, Lies, and Economics Video

I was invited to give a lecture to the Annual Summer Institute of the History of Economic Thought. The people there mostly tend to be followers of Hayek or James Buchanan, who was the keynote speaker. Although the people there are very conservative, every one of them was open to constructive dialogue, making the eperience very constructive and very enjoyable.

Here is the video of my lecture.

www.youtube.com/watch?v=iwPROPfSDU4

A Partial Cure for the “Is Consistent With” Syndrome

As I’ve argued in the past, economists often pretend to test their theories by identifying an outcome their model predicts, and analyzing a real-world dataset to see if the outcome occurs. If it does, they crow about how the result “is consistent with” their theoretical musings. Of course, they use the latest and greatest econometric techniques, scrupulously avoiding Type I error (false positives) in that aspect of their work. This way they can claim that there is absolutely no chance the result they found was due to unobserved endogeneity, an inappropriate parametric assumption or some other glitch.

Fine: but nothing in this approach addresses the far larger problem of how likely it is that this result could occur even if the theory is wrong. That’s the real issue for Type I error minimization. While there is no formal test for this problem, there is a procedure which can address it and even turn it to some advantage.

A researcher has a theory, call it X1, that can be expressed as a model of how some portion of the world works. Among other things, this theory predicts an outcome Y1 under a specified set of circumstances. There is a dataset that enables you to ascertain that these circumstances apply and to identify whether or not Y1 has arisen. How should this test be interpreted?

My proposal is simply this: the researcher should be expected to consider how many other plausible theories, X2, X3 and so on, also predict Y1. This should take the form of a section in the writeup: “How Unique Is this Prediction?” or something like that. If X1 is the only plausible theory that predicts, or better permits, Y1—if Y1 is inconsistent with all X except X1—the empirical test is critical: it decisively scrutinizes whether X1 is correct. If, however, there are other X’s that also yield Y1, the test is much weaker. It will accurately determine if X1 is false only if all the other X’s are false as well.

The first point, then, is that this additional part of the writeup will indicate to the reader how much weight to place on the demonstration that X1 has passed the Y1 test.

The second point is perhaps even more valuable. By giving some thought to the alternative theories that also explain Y1, the researcher may notice other predictions that enable her to discriminate between them. It may be that X2 predicts Y1, but only X1 predicts both Y1 and Y2. This moves the test closer to criticality, depending on how many other X’s there are in the game. Getting into the habit of testing theories not in a vacuum, but in relation to other, competing theories would be a huge advance. As a further bonus, it would push researchers in the direction of expanding their knowledge of competing theoretical traditions.

I’m going to begin making this suggestion in all theory-plus-empirical-test articles I review from now on.

Korean Interview with Michael Perelman

I did an interview on a Korean FM program 1013 Main Street regarding Manufacturing Discontent: The Trap of Individualism in Corporate Society, which is available in Korean. The interviewer has a remarkable command of language as well as the understanding of the book

http://www.archive.org/download/Michael.perelmansKoreanInterview/MPerelman110708_3.mp3

Prepare To Declare The Debt Ceiling Unconstitutional

On April 19 I called here for an abolition of the debt ceiling, http://econospeak.blogspot.com/2011/04/abolish-debt-ceiling.html , a call noted on May 23 on a NY Times blog, with my arguments since repeated by former Reagan-Bush Treasury official, Bruce Bartelett (although without citing me), http://www.stlbeacon.org/voices/in-the-news/11523-what-happens-if-we-dont-raise-the-debt-ceiling . The furor has been intensified by major public discussions of the possible unconstitutionality of the debt ceiling based on part d of the 14th Amendment, with even such heavies as Harvard Law Professor Laurence Tribe weighing in that it is unconstitutional. On Wednesday, President Obama was asked about this, but declined to comment. Yesterday, George Madison, Chief Counsel of the Treasury Department wrote to the NY Times saying that it is a legal limit, but that Congress must raise it. However, some are noting that the constitutionality issue has not been directly addressed and that Obama and Geither may be leaving the door open just a crack for a declaration of its unconstitutionaity if it comes down to it, but avoiding doing so now out of fear of weakening the negotiations with Congress, http://m.gawker.com581953/obama-nixes-the-lets-just-call-the-debt-ceiling-unconstitutional .

Well, the rumors of what they are willing to give (cuts in social security?), along with the prospect that this game will be played again in the future (talk about moral hazard), suggests to me that the administration had better be prepared to play the game fully now. Indeed, the debt ceiling has been ignored since its imposition in 1917 precisely because it has always been nearly routinely raised (including ten times since 2001, most recently in Feb. 2010). It is completely incoherent to have budgets passed mandating spending and taxes that breach the debt ceiling and then demand that it be enforced by somebody other than Congress that did the mandating. The administraion should prepare to declare the debt ceiling unconstitutional and do so in order to save the world economy, not to mention Obama's own reelection.

How does a fiscal stimulus work these days?

It seems logical in this time of high unemployment and increasing poverty to be talking about stimulating the economy; for the federal government to throw money into the general economy and let businesses and consumers take up the slack.

In my hometown in the 1950s a bit of extra money received by families would have improved the lives of many people. There were - at this time - plenty of resources from which to draw to expand the production of food and other commodities and services. (An energy shortage was a concept we didn't give a moments thought to.)

In the middle of the 20th century a large range of economic activity was locally based. The milkman three miles down the road (and the father of a family friend) delivered his product to the back door as did the local baker (my aunty and uncle). The wheat was grown in the paddocks surrounding the town and bread was baked in a small central shop in the main street and so were the pies and cakes we gobbled up for school lunch. The local butcher obtained his meat from grazing farmers just outside of the town boundary. Cuts of meat were prepared onsite, usually only few hours before the townsfolk purchased their weekly supply. My mother preserved many jars of fruit for the winter from fresh supplies of pears and peaches obtained from orchards in a nearby town. As I walked home from school I passed the local cordial factory and the enterprising neighbourhood bottle recycler. At the local picture theatre my sisters and I spent money in the intermission between the two movies at the owner-operated fish and chip shop.

At home, eggs were often purchased from a neighbour across the street.

Today, all but one of those small local businesses have disappeared. The bakery remains. The milkman, butcher, many farming graziers and local orchards have been replaced by the provision of pre-packaged food in a supermarket owned by investors that probably live in a different country. The products we buy are not made locally and their origin and quality is often impossible to trace. A fish and chip shop was replaced a few years ago by a McDonalds restaurant and the last picture show in the Sanger Street 'flicks' happened sometime in the late 1960s.

More money spent at one of Australia's oligopoly supermarket chains and at McDonalds would mostly flow straight out of the town and go to absentee investors somewhere else.

So how does a stimulus work these days?

What More to Say?

I feel guilty in not upholding my turf here at EconoSpeak; I should be issuing thunderbolts about the debt ceiling negotiations, the sagging economy, the slo-mo Eurozone meltdown, and similar perils. But I can’t seem to do it. The whole bloody mess is just too stupid.

The US economy is clearly floundering, and elementary macroeconomics says we need fiscal stimulus, yet both Obama and the Republicans are debating how to strangle the public sector in order to raise a debt limit that makes no sense in the first place. Eurozone politicians crow over their success in imposing yet another austerity-cum-bailout package on Greece, one that no independent economic observer, much less the financial markets, have the slightest faith in. (As if rounding up the rating agencies and sending them to some Euro-Guantanamo will keep peripheral sovereign rates from marching ever upward.)

There are lots of interesting, complex issues in political economy. None of that matters now: the world is in the hands of politicians governed by expediency calculations whose time horizon can be measured in weeks. As far as I can tell, the gross illogic of their policies is simply beside the point.

Happiness and miscellaneous

Richard Easterlin et. al. have a new working paper, "The Happiness-Income Paradox Revisited." Note first the rare scholarly modesty here: it is of course "The Easterlin paradox" that we are talking about : the paradox that consists in the fact that happiness increases with income in the cross-section while it is unaffected by income over the long run (see below) in the time series. It presents new support for the paradox as well as a response to some of the recent self-styled refutations from the likes especially of Stevenson and Wolpers. Some of the criticism, they claim, presents the cross-sectional positive association (across countries) as a refutation, which it is nothing of the sort, since that relationship is one plank of the paradox itself! Wolpers and Stevenson, they claim, are looking at short time series and picking up - what has been known for some time - the short run positive association over the business cycle between the two. I liked the paper and found it pretty convincing.

There is no theory in the piece, but they pithily sum up the most plausible explanations of the paradox: " the escalation of material aspirations with economic growth, reflecting the impact of social comparison and hedonic adaptation."

Readers of The Theory of Moral Sentiments will know that Adam Smith would not have been at all surprised by the paradox. On the contrary - remember his description of the poor man striving all his life to become rich who, when he finally succeeds, finds he is no happier than he began? But for Smith - and I agree - the paradox is in itself no critique of economic growth, as it has been wielded in contemporary debate: Smith thinks it a good thing (I'm paraphrasing, my TMS is in the office 20 miles down the road) that we Nature (I think it's capital N Nature, or it may be capital P Providence) deludes us in to thinking that more income will make us happier, because all this striving under this delusion has produced, well, Civilization! "Turned mighty ocean into a broad highway" and such - you know the passage. The larger point, though is this: why should happiness or utility be the desideratum of economic growth? Just as they had an objective, rather than a subjective, theory of value, The Classical economists generally, I suggest, had an objective rather than a subjective theory of well-being. In Senian terms, economic growth increases our capabilities. What we do with them is another thing.

By the way, in this last point I am echoing to some extent Deirdre McCloskey, whose latest book, Bourgeois Dignity, may well be her best. I was not a fan of its predecessor, Bourgeois Virtue, but any economist concerned with explaining the explosive nature of modern growth ( the famous hockey-stick) need to read this book. It is mostly an attack on all the explanations that have been offered so far. Later work will make her positive case that it was a change in ideology, not in itself explicable by material conditions, to wit, the change in the valuation of innovation and the bourgeoisie generally, the giving of dignity to such activity that occurs in the Netherlands and England 1650-1800 that explains the industrial revolution and the break-out form the Malthusian trap. The take-down of Gregory Clark's "eugenic materialism" is alone worth the price of the book. If you've read any of her work, you know that she is a wonderful and astonishingly erudite writer - even when you disagree with her. Highly Recommended!


Finally, along with all of you I am sure, I am confident that the medicine The Republicans and - say it isn't so - Obama, are preparing for the sick Economy, LEECHES, will work as it always has. Sad beyond words -


.

My former student on the front page of the New York Times

I have been virtually incommunicado for a while, giving papers at conferences, having my electronics from my suitcase after I checked it in at the South Bend airport, and now trying to catch up with the backlog of deadlines.

I briefly awoke from my slumber with today's New York Times article regarding Congressman Mike Thompson, who was a outstanding student of mine. He also used to keep my tractor repaired and his wife would sometimes babysit for us. Both were very, very nice people.

Mike earned an internship with a powerful representative in the state legislature, who taught him the ropes. Later, he ran for state Sen. in our district against the Republican who should have been a shoe-in. Republican, however, got caught up in a scandal and Mike won the office. He later switched districts in order to be closer to his home in the Napa Valley. The congressional seat had switched back and forth between parties, ever since a long standing representative, Don Claussen, was defeated. Mike won and has held the office ever since.

He only contacted me a couple times many years ago and I have not heard from him since. He and Darrell Issa were the two representatives, who met with Saddam Hussein prior to the war, to see if hostilities could be prevented. I should have mentioned that he was also a Vietnam veteran.

I can't tell if the article is attacking him for being overly supportive of the wine industry or if he is self interested as a small wine grower. In reality, he was interested in the wine industry as a student. Consequently, nothing he says seems particularly scandalous.

I understand that Mike is a favorite of Nancy Pelosi. I recall that he identified himself as a blue dog. Our politics are obviously far apart, but I do remember him fondly as an excellent student and a friend, even though I'm not aware of any courageous stands he has taken, with the exception of the trip to Iraq.