Barack Hoover?

CNNMoney reports:

President Obama on Monday called for a two-year freeze in the wages of federal employees. The freeze, which would need congressional approval and save $60 billion over 10 years, would make a small dent in the nation's debt problem. The accumulated deficits are currently forecast to exceed $9 trillion over the next decade.

This strikes me as short-term fiscal restraint but not a really serious attempt to getting the long-term fiscal house in order. In other words precisely the opposite of what we should be doing while in a very depressed economy. So why would this President make such a recommendation:

On Capitol Hill, Obama's proposal is likely to pick up support on the other side of the aisle. Republicans have argued in favor of a freeze in recent weeks, and the co-chairmen of Obama's bipartisan deficit commission made a similar recommendation earlier this month. "It's a great start. I'll applaud when he [Obama] does the right thing, and he did in this case," said Rep. Jason Chaffetz, a Utah Republican and the presumptive chairman of the House subcommittee on federal workers. "I'd like to see things go further. Personally, I would like to see the overall payroll cut by 10%."

The President has decided to go with what Republicans want to do. Fortunately, congressional Democrats are already speaking out against this proposal.

Update: Larry Mishel gets it right:

In the context of the deficit, Obama will get chump change from freezing federal pay, and will only enlarge the degree to which federal pay lags that of the private sector ... This is another example of the administration’s tendency to bargain with itself rather than Republicans, and in the process reinforces conservative myths, in this case the myth that federal workers are overpaid. Such a policy also ignores the fact that deficit reduction and loss of pay at a time when the unemployment rate remains above 9% will only weaken a too-weak recovery.

The Impoverished, and Impoverishing, Debate about Fiscal Deficits

It is like living in a dream—a very bad dream. Everything seems at once real and imaginary, serious and deliriously impossible. The language is familiar and incomprehensible. And it seems there is no waking up, ever.

I’m talking about the “debate” over America’s fiscal deficits, which is what I stumbled into after a night of much happier visions. Now, according to this morning’s New York Times, the left has weighed in with its own plans to achieve deficit stability. Of course, it is more reasonable than the pronunciamenti of the Simpson-Bowles cabal, with a wiser assortment of cuts and more progressive tax adjustments. Still, it is part of the same bizarre trance, disconnected from the basic laws of income accounting.

All you need to know is the fundamental identity. In its financial balance form, it appears as

Private Deficits + Public Deficits ≡ Current Account Balance

If the US runs, say, a 4% CA deficit, the sum of its net public and private deficits must equal 4%. You can’t alter this no matter how you juggle budgets.

Add to this one more piece of wisdom, which we should have learned from the past three years, even if we were blind to everything else: private debts matter as much as public ones. The indebtedness of households, corporations and financial entities can bring down the economy as readily as the profligacy of the public sector. In fact, in the grip of a crisis (which we have not yet escaped), private deficits are far harder to finance because of their greater default risk. That’s why governments slathered themselves with red ink: they borrowed to assume the debts that private parties could no longer bear.

So what does this mean for US fiscal deficits? Isn’t it obvious? Public deficits can be brought down only to the extent that the private willingness and capacity to borrow increases and current account (mostly trade) deficits shrink. There is still an important discussion to be had over the size and composition of revenues and expenditures, of course, but this is only about how, not how much. To put it differently, if private deficits and the external position of the US economy remain as they are, planned deficit reduction by the government cannot be realized. Revenues will fall along with spending, the economy will take a dive, and actual fiscal deficits will be unmoved. This is guaranteed by the laws of arithmetic, and you can see such a process happening in real time in the peripheral Eurozone countries.

What can break this fall? The current account constraint can be relaxed as falling incomes drive falling imports, but this entails an economic catastrophe unless devaluation can do the job instead. Or the borrowing capacity of the private sector can rise, but this is inconceivable in a collapsing economy. Or, facing the abyss, those who run the show can dispense with all the nonsense about fiscal prudence in isolation from surrounding economic conditions, and open the spigots once again.

My prediction: if there is deficit-cutting in the US of any sort before the private sector is prepared to take on more debt and, especially, approximate trade balance is restored, we will see exactly this third scenario. The economy will take a dive, political leaders (whether of the latté or tea persuasion) will spend like crazy, and fiscal deficits will be larger than ever. The deficit-cutting debate is delusional.

The Irrelevance Of Krauthammer and WaPo On START

Yesterday's Washington Post contained a column by ardently neoconner Charles Krauthammer on "The Irrelevance of START" (Strategic Arms Reduction Treaty), which follows similar columns by the main editorial writer (usually Fred Hiatt) and Jacskon Diehl. Krauthammer whined that Obama should be focusing on tax and jobs policies rather than the long-negotiated renewal of the START, which expired last December and was first put in place under George H.W. Bush in the aftermath of the breakup of the Soviet Union, even though he does not support any of Obama's proposals on taxes or jobs, along with nearly all Republicans in the lame duck Congress.

He and WaPo and Diehl effectively support the opposition by Senator Kyl (AZ-R) who wants more funding for nuclear weapons in the face of pressure for cutting deficits, with Obama offering $84 billion, but this was not enough for him, and if it does not pass in the lame duck, it will almost surely not pass in the next Congress. This treaty is supported by virtually all of the military, including 7 of the last 8 commanders of US Strategic Nuclear Forces and nearly all past Republican Secretaries of State, Defense, and National Security Advisers, including such figures as Henry Kissinger and Brent Scowcroft, with none of these figures expressing any public opposition. Most say that this is a no-brainer that should be beyond partisan politics, with the absence of US observers in Russian nuclear facilities since the old treaty expired last December supposedly making it so (and certainly making it look so to me).

Besides the economy, Krauthammer says we should focus on Iran and North Korea instead, not on such an irrelevant place as Russia. Of course, official US intel reports say Iran is not actively pursuing nuclear weapons, although presumably Krauthammer would like the US to do the bidding of Israel and bomb a few nuclear facilities in Iran, just to keep them in line. North Korea certainly has some nukes and is acting very dangerously right now, with it leading to those 3 AM phone calls for Obama. But it is unclear that anything the lame duck Congress could do would do anything to help about that situation, which got out of hand back when GW Bush was in and dumped the older agreement on pressure from Cheney and Rumsfeld early in his administration, leading the North Koreans to withdraw from the NNPT and to restart their plutonium bomb production plants that had been shut in 1994, leading to the production and testing of actual nuclear weapons now in their possession.

Quite aside from all that, there are at least three other reasons why Obama is right to push START ratification and why it is massively irresponsible of all these commentators and politicians to play politics and make stupid comments about this.

1) If one is really worried about Iran and North Korea, Russia is an important player in dealing with both of them, and having cooperation from Russia will help, which ratifying START will help in getting (and rejecting ratification will damage).

2) Unmentioned by all these supposedly sage commentators is that the greatest nuclear danger to the US is none of the above, but rather terrorists getting their hands on loose nukes. The major possible source of those is the still huge stockpile in Russia. Having US inspectors on the ground there should help in the securing of those stockpiles against terrorists or rogue Russian generals messing with them. Saying that Russia is not going to attack is silly in light of the real threat from these weapons.

3) And beyond that,leadership in Russia might change or a rogue general might get at them, and even these glb commentators realize that the only really serious danger from a nuclear confrontation in terms of major world destruction would be an exchange betweeen the US and Russia, which could happen even by accident with no ill intentions. So, reducing those stockpiles somewhat further from their ridiculously overly large levels would improve world security against the damage that might arise from a US-Russian nuclear exchange, however unlikely that may seem.

Ratifying this treaty really is a no-brainer and Obama is completely correct to make it a top priority for passage by the lame duck Congress, far ahead of pretty much anything else. The decline of intelligent public discourse on such matters is one of the most disturbing trends I can think of going on right now.

Why is homeland security enforcing the nation against music downloads?

"In what appears to be the latest phase of a far-reaching federal crackdown on online piracy of music and movies, a number of sites that facilitate illegal file-sharing were shut down this week by Immigration and Customs Enforcement, a division of the Department of Homeland Security."

Sisario, Ben. 2010. "U.S. Shuts Down Web Sites in Piracy Crackdown." New York Times (27 November).
http://www.nytimes.com/2010/11/27/technology/27torrent.html?hp

Ecological Headstand -- Sandwichman's web log

Sandwichman has his own web log. It's called Ecological Headstand because it stands William Rees's "Ecological Footprint" metaphor on its head. Currently, the focus is more on bibliography than commentary. For example, yesterday the Sandwichman posted a set of key references for a discussion of the politics of social accounting.

Social accounting is what statistics agencies do when they compile the Gross Domestic Product. It's also what employers and unions do, at least implicitly, in collective bargaining. The controversy over "growth" is not new. In fact, it began with the first release of GNP estimates by the U.S. Commerce Department back in 1947 and that first salvo is documented in an exchange between Simon Kuznets and the team from Commerce. What grows? That depends on the objectives of the people who have designed the measurement of national product. Sandwichman will soon be posting a brief summary of the main issues to Ecological Headstand but in the meanwhile,  here's a brain teaser.

The Eichengreen Paradox

This does not refer to an observation about international political economy but Barry Eichengreen himself. He seems like a very nice guy and also very smart. He is well-read and has an unusually broad understanding of history and politics. His views on any topic other than economics are insightful and valuable. But when the subject turns to economics proper, he displays a hidebound, and perplexing, orthodoxy.

This paradox is on full view in a short interview with him posted on Five Books. He really understands the politics of the euro, how it is rooted in the reaction to two world wars and the shaped by the national cultures of its leading players. He recognizes that countries like France and Germany have institutions that are superior in many ways to those in the US. I can’t think of anyone I would trust more to take the pulse of decision-makers in the Eurozone. And his economic advice is woefully insufficient.

Read the interview for its many virtues, but, in the meantime, consider where Eichengreen ends up. He makes three proposals going forward: less populist national fiscal policy institutions (quasi-autonomy for fiscal policy the way autonomous central banks are supposed to do monetary policy), stronger euro-wide financial regulation, and a permanent resolution authority along the lines advocated by Germany. Numbers two and three on this list are OK, number one is misguided, and package as a whole is not remotely up to the job.

Without getting into an argument over Keynesian versus deficit hawk fiscal priorities, it should be clear that national budget profligacy was not a factor in most of the countries now facing financial distress. Ireland and Spain in particular had the most orthodox of fiscal policies, but here they are, sinking into the morass of fiscal insolvency. Nor is the failure of financial regulation the factor that separates the objects and subjects of bailouts. Germany too has had its share of banker rule-bending and incompetence (Hypo anyone?), but it has been spared the pity of its neighbors.

The truth is, the countries facing disaster are those that ran large, persistent current account deficits during the past decade. They accumulated enormous private debt, and fiscal freefall is the response to the souring and freezing of this debt: the public sector is leveraging so that the private sector can deleverage. Because of the euro, currency adjustment is unavailable.

Why, you might ask, doesn’t the US face the same dilemmas at the state level? As Paul Krugman has asked, what’s the difference between Ireland and Texas (other than about 30 inches of rain)? There are two answers. First, if a region within the US has a significant trade deficit with other regions—if its industries languish while others forge ahead—its incomes fall and people and jobs relocate. This is difficult in Europe because of linguistic and cultural differences. Second, we have a common fiscal authority which, as a matter of routine, transfers income between regions with domestic surpluses and deficits. The absence of this in Europe, the fact that there is a single central bank but no common Treasury, has crippled its response to the crisis.

With other avenues closed—large-scale migration, fiscal integration, exchange rate adjustment—there is only one remaining degree of freedom. Deficit countries within the Eurozone must either rebalance through austerity or sustain their growth through public and private borrowing. But restoring balance, much less paying down past debts, is nearly impossible through austerity alone. The arithmetic, which tells us that the amount by which national income must fall equals the deficit reduction target divided by the marginal propensity to import, is frightening. But that’s where peripheral Europe is headed unless there is a much more aggressive program than Eichengreen is willing to contemplate.

invisible handcuffs to finally appear

Amazon is listing the cost for a pre-order at $12.78.

Embarrassed by the Left

That’s all I can say after reading this dreadful critique of Krugman’s writings on Japan that appeared on Common Dreams, along with almost 100 responses, the vast majority utterly clueless.

The original article said, in a nutshell, that Krugman shows his economist’s blinders by criticizing Japan’s fiscal and monetary policies when they enjoy low unemployment, universal health care and other good things. Japan and Germany show us the way: economic growth is unimportant, what counts is having a healthy society. Growth is a chimera in the age of sustainability, anyway. We should listen to Germany’s criticism of profligate American borrowing, rather than lecturing other countries to become dissolute in our image.

The responses, except for just a few, praised this argument to the skies.

Allow one more indoctrinated economist to make these points:

1. Japanese and German living standards depend on the debt-financed consumption of the US and other net importing countries. That doesn’t mean their social achievements are worthless—far from it—but it indicates that the sustainability problem is not all ours.

2. The Japanese have kept going through the accumulation of a massive public debt. This has been possible only because they are a surplus country, so the debt can be domestically financed without cutting into finance for private investment. In other words, the economic policies Krugman criticized have not led to a Japanese meltdown only because of global imbalances, from which they benefit.

3. Economic growth is essential. If you divide up the world’s output equally among the world’s people, it falls well short of how we want to live. We need redistribution and growth. Greening the economy will also entail tons of investment, which we will have to afford somehow. On top of this, enviro-austerians confuse the growth of value (economic growth) with the growth of stuff (physical throughput). In the economy, better is more, but not necessarily the other way around (if the costs of stuff exceed their benefits).

I hate to say this, but reading the broad swath of opinion on websites like Common Dreams convinces me that the US left is nowhere near ready for prime time. There is a flippancy and anti-intellectualism that is as immature as anything you’ll find among the Tea Partiers. Did I mention that they have a conception of economics (slash the GDP!) that will relegate them to fringe political status in perpetuity?

The Political Economy of the Inflation Hawks

Brad DeLong asks an interesting and very pertinent question: what are the motives behind those who are screaming that the Fed is stoking the fires of inflation?

Brad’s comparison of olden times, before WWII, and today is worth quoting. Then:

There was then a hard-money lobby: a substantial number of very rich, socially influential, and politically powerful people whose investments were overwhelmingly in bonds. They had little--personally--at stake in a high level of capacity utilization and a low level of unemployment. They had a great deal at stake in stable prices. They wanted hard money above everything.

Now:

Today we have next to no hard-money lobby, for nearly everybody has a substantially diversified portfolio and suffers mightily when unemployment is high and capacity utilization and spending are low.

Why then does there appear to be such a powerful, well-healed constituency for restrictive monetary policy in the face of persistent high unemployment? I don’t claim to know the answer, but here is my speculation:

1. Bonds continue to play a very important role in the portfolios of the well-to-do. Hard money remains a significant desideratum for them, although it might be offset in other respects.

2. There is little systematic relationship between equity prices, much less more sophisticated derivatives, and macroeconomic conditions, certainly nothing approaching the strong relationship between bond prices and monetary policy. (This is net of sovereign default risk, of course.)

3. To the extent there remains a relationship between macroeconomic performance and non-credit assets, it is obscured by the tremendous variation across individual portfolios. Investors can tell themselves their profits in good times are due to smart trading strategies, and their losses the result of inevitable mistakes.

Above all of this, I think it is too simple to reduce ideology to immediate self-interest. The ideas people are inclined to believe in are those which appear correct from the social position of the believer, or which foreground the problems that people in this position commonly face. For instance, there is nothing illogical about the fear of wealthy individuals that the governments which borrow from them may resort to inflating away their debts or at least give insufficient consideration to that possibility. They are right to worry about this as a potential conflict of interest: government as borrower and as controller of monetary policy. At the moment, I agree that the risk of excessive inflation pales beside that of insufficient inflation, but in part this is because I am not as fearful that central banks will fail to respond to signals of a recovery if one actually materializes. I recognize the potential conflict of interests that hard money people fret about, but I do not foreground it as they do. This difference between me and them could be called ideological in the social-science definition of that term.

On top of this, ideas have to fit together. The hard money view is an extensive belief system, incorporating distrust of discretionary monetary policy, ethical judgments of the virtue of savers and the sins of borrowers, and the conviction that only the discipline of tough, unshielded consequences can provide a sound foundation for the functioning of a market economy. This frame of mind may be so enveloping that those who subscribe to it may oppose bailouts that are in their immediate personal interest. (But human creativity can also be directed at the search for exceptions and loopholes....)

To put it simply: the ideology of hard money, as opposed to the immediate interests it generates, is not calibrated to the direct costs and benefits of economic policies. It reflects instead an intellectual orientation that is reinforced by the experiences and interests of the wealth-holding class as they have accumulated over time and can sometime lead to policies that may harm their portfolios in the short run, as opposition to the current round of quantitative easing may do. The natural selection of beliefs, like that of species, operates in the context of structural factors—the interrelationship between concepts/traits—and does not necessarily optimize over each individual element.

Are Republicans Arguing for Less Net Exports?

Reuters reports on why some Republicans oppose QE2:

The Fed's $600 billion quantitative easing program "introduces significant uncertainty regarding the future strength of the dollar and could result both in hard-to-control, long-term inflation and potentially generate artificial asset bubbles that could cause further economic disruptions," the Republican leaders of the House of Representatives and Senate wrote.

If this new round of monetary policy does lead to a weaker dollar – then it would tend to increase net exports. Given the twin facts that we have a current account deficit and insufficient aggregate demand – this would be a good thing.

Gavin Jones and Mark Felsenthal report on the FED’s chairman reply to the critics of QE2.

Two Inside Jobs

One is the great animated film about the sort-of dentist who pulls off a jaw-dropping heist while musing on “The Secret of the Sierra Madre”.

The other is the near-great documentary about the financial crisis now showing in small-capacity art houses in scattered American cities. Economists have fixated on the section near the end that lampoons Fred Mishkin, John Campbell and Glenn Hubbard, the latter somewhat too aggressively for my comfort. (Even the evildoers deserve to have their responses to attacks by interviewers not edited out.)

Overall, I think the film does a fine job explaining the profound malfeasance of the financial sector, finance’s lock on government, and government’s enabling of the whole thing. What’s missing from its purview, however, is economics—not the profession but the dimension.

This shows up in the way economists are criticized: they are denounced for their venality and policy recommendations, but not for the intellectual constructs they have promulgated that have made it almost impossible to think clearly about finance and macroeconomic risk. Just to take one example, it is remarkable that the filmmakers could devote an entire segment to the sins of economists and never mention the efficient market hypothesis. OK, maybe I am asking for the sort of treatment that would appeal to a handful of dissident economists and would be of no interest at all to the millions Ferguson and his colleagues are hoping to reach.

Nevertheless, the lack of economic perspective (which is reinforced by the list of individuals thanked in the closing credits) shows up in two particularly important ways. First, while income inequality is recognized as a cause of the rapid increase in household debt, no mention is made of current account deficits (global imbalances). This topic does not have to be presented scholastically; on the contrary, it lends itself to catchy animations, ominous music (of which there is already a lot), and expressions of outrage.

Second, the critique of the 2008 bailouts offered by the film is entirely moralistic: bad people were rescued at our expense and allowed to profit handsomely for their crimes. Yes, but there is another point of increasing importance: the decision of governments to assume the full burden of private financial losses has stretched public treasuries to the breaking point. This is already visible in Ireland and beginning to emerge in Portugal and Spain. The process of writing off bad debt is still at an early stage in the US, but it is possible we will experience similar tensions. At the least, the attempt to postpone or sidestep writedowns will prolong deleveraging and lead to many years of anemic economic performance.

On a positive note, and despite the cheesiness of the final shot of ol’ Lady Liberty, I welcome the closing message, which echoes the point I’ve tried to make as well: this disaster was the result of the political hegemony of the financial sector, and until those bums are thrown out no meaningful public action is possible.

The Finance Perspective

I’ve been ruminating for a few days on this post by Brad DeLong defending Larry Summers. Here is Brad’s version: Summers (and Brad himself) welcomed the massive leverage taken on by the trading houses, since this would serve to shift money from the hands of risk averse small savers to large risk-accepting institutions. Since returns to the first group are historically much lower than to the second, this should lead to faster economic growth. The unforeseen flaw proved to be the inability of the Fed, this time around, to clean up the mess when some of the risky bets soured. This was understandable, says Brad, because the Fed had been able to do the job repeatedly in the past. If the Fed had been able to tidy things up properly in 2007-08, we would have been able to return to a higher-risk, higher-growth trajectory, and all would have been well.

In order to understand the deeper assumptions on which Brad’s argument depends, and to see why it should be called a “finance perspective”, we need to deconstruct this crucial word, risk.

Risk, as Brad and Larry see it, is about the variability of returns, the building block of modern financial models. With more variability comes an increased likelihood of episodes in which losses are bunched, so it is necessary to have a player, like the Fed, who can steer us through them. Otherwise, there is little social cost (as opposed to the private costs of the liquidity-constrained) to shifting the allocation of investable funds from the those with a low tolerance for beta to those with a high tolerance.

This would be a reasonable assessment, if the risk Brad refers to is the risk that brought down the global economy, but it wasn’t. The financial crisis that triggered the crash was not the result of a random stochastic swing, or not primarily. It was due to the accumulation of multiple risks that are real and visible, although not present in financial models. What were they?

In no particular order, here are a few:

1. Global systemic risk (aka global imbalances). Huge, persistent current account deficits were financed by unsustainable accumulations of debt, not only in the US but also in the peripheral European countries that are now under the gun. Since the debts are denominated in reserve currencies (dollars and euros), they did not trigger forex crises, which might have relieved them, if in a disorderly way. Instead, the process continued until the borrowers were simply unable to service, once the bubble dynamics (refinance through asset appreciation) came to a sudden stop.

2. Bubble dynamics. Housing bubbles inflated in the deficit countries in broad daylight. It should have been obvious that when the bubbles popped, a large amount of paper would have to be repriced, and this in turn posed risks for financial institutions. What we didn’t realize until too late was that a mountain of derivatives had been built on top of the original bubble-prone assets, and that they had infiltrated portfolios everywhere.

3. Institutional failure. The current crisis has exposed shoddy behavior in all corners of the system. Mortgage originators threw out all standards and saddled vulnerable borrowers, disproportionately minority, with unserviceable debts. They misrepresented the assets they transferred to the banks, and the banks didn’t care, because they were packaging them to sell. Rating agencies didn’t care. Regulators didn’t care. Cynicism was universal. One of the eternal lessons of markets—all markets—is that the unraveling of behavioral standards is a significant risk whenever the financial returns to deception are large and the institutions of monitoring and control are weak.

4. Distributional effects. During the era of de facto deregulation, the US financial sector metastasized and raked in half of all corporate profits. On the eve of the crash, the average compensation for workers—all of them—in this sector had reached $100,000, and this does not include bonuses, which were estimated to average $200,000 each (although not all employees received them). In other words, the financial sector alone accounted for a noticeable portion of the overall increase in income inequality, which in turn caused many hard-pressed households to substitute credit for income in order to maintain living standards. The gross inequalities of the last few decades—megaprofits for a few and stagnation for the many—have been risky.

These risks, in conjunction with excessive leverage in the financial sector, crashed the economy. Most of them, however, play no role in the category of “risk” as it appears in financial models. What’s going on here?

In my opinion, this leads us to a deeper, cultural level. Risk in its narrow financial sense is abstract and disembodied. It pertains to no specific industry, practice or moment in history. It has no particular context; it applies to every activity in general and none in particular. In other words, it is a typical product of the information revolution of the twentieth century, the intellectual shift that gave us digital communications, genetic sequencing, and, of course, the computer. It is based on the notion that standardized bits of information can be extracted from any actual entity or event, and that the manipulation of these bits can achieve almost any goal for the system from which they were extracted. A useful metaphor is the container revolution in shipping. The container is abstract and universal, the same unit no matter what or how much it holds. Container logistics is essentially unrelated to the specifics of who is shipping what. Financial flows are the containers of economics; it is the function of finance, as the sector that controls these containers, to regulate the entire system algorithmically.

This view of the world as being reducible to disembodied information is widespread among the highly educated, especially if they are conversant with digital technology. Actually, Brad puts it better than he realizes: “....the most powerful lobe of my brain is the one that is always running an instantiation of the Larry Summers thought emulation module on top of its native wetware code.” Exactly.

It is possible to be an adherent of the disembodied-information-school-of-almost-reality without being a believer in finance as the rational control center of a modern economy, but in practice the first eases the way toward the second. Why should we worry about whether a mortgage monger in Cleveland has fudged the paperwork on a house that’s been flipped to a laid-off machinist, when the whole system can be optimized by tweaking the way “risk” is priced and allocated by financial markets?

And that, of course, leads to the question about self-interest, which has also been part of the Summers story. What difference does it make that economists who touted the wonders of deregulated finance were also handsomely rewarded by the financiers? Surely they don’t tailor their economic views to their bank accounts, do they?

My guess is that Summers, like the others who cashed in during the boom (and may be re-cashing today), really, truly believes that the people who have made him rich are doing the Lord’s work. Finance, for him, remains the command center of economic life, and it is necessary that smart people operate these controls and are given the latitude to get the job done. As is usually the case with ideology, it isn’t possible to disentangle the intellectual sources of belief from those of expediency.

As for the rest of us, I hope we realize that a principal goal of economic reform should be to shrink finance. There should be a much smaller financial sector, and it should make a lot less money. Its size and wealth are out of all proportion to its actual contribution to the actual economies we inhabit. This is not a “luddite” call to eliminate sophisticated methods of pricing assets and moving money. A dynamic economy depends, as it always has, on the ability to move resources from where they are earned to where they are needed. But return once again to the container revolution: it has vastly improved shipping, but shipping (fortunately) remains a small part of overall economic life. Most of the employment and earnings belong to those who make or sell stuff, if not in the most equitable way, and the folks who move it from point A to point B are a small part of the story.

Laffer’s Wedge Model of Falling Employment

Having read the latest supply-side silliness from Art Laffer, I think we should ask Stanford University how they ever gave a Ph.D. in economics to him. Consider in turn three portions of this atrocious writing:

Since its cyclical zenith in December 2007, U.S. economic production has been on its worst trajectory since the Great Depression. Massive stimulus spending and unprecedented monetary easing haven't helped, and yet the Obama administration and the Federal Reserve still cling to the book of Keynes. It's an approach ill-suited to solving the growth problem that the United States has today.

We are in the midst of the Great Recession and Mr. Laffer thinks we have too much fiscal and monetary stimulus? I guess we are witnessing hyperinflation and high interest rates in his little Alice-in-Wonderland Economy (I had to give a hat tip to Jay Bookman somewhere). And there is:

The solution can be found in the price theory section of any economics textbook. It's basic supply and demand. Employment is low because the incentives for workers to work are too small, and the incentives not to work too high. Workers' net wages are down, so the supply of labor is limited. Meanwhile, demand for labor is also down since employers consider the costs of employing new workers—wages, health care and more—to be greater today than the benefits.

The reduction in employment is because folks are voluntarily leaving their jobs? There isn’t much of an unemployment problem? If Laffer really believes this – he might write that there was a movement along the supply curve rather than say “the supply is limited”. After all, the distinction between movement along a curve versus shift of a curve is found in almost every beginning textbook given to college freshman. Or was this a shift of the demand for labor schedule? Laffer’s writing is incredibly confused.

Actually what Mr. Laffer is suggesting is that there has been an increase in the wedge often modeled as the tax rate on employment:

Firms choose whether to hire based on the total cost of employing workers, including all federal, state and local income taxes; all payroll, sales and property taxes; regulatory costs; record-keeping costs; the costs of maintaining health and safety standards; and the costs of insurance for health care, class action lawsuits, and workers compensation … The problem is that the government has driven a massive wedge between the wages paid by firms and the wages received by workers.

Fine but this wedge has not been increased dramatically. Laffer does not even try to suggest that it has increased. All he is claiming is that a wedge exists. But it existed back in 2006 when the labor market was healthy. I guess his Stanford professors did not require this student to understand the concept of comparative statics!

If Laffer’s wedge model were the driving force behind firms reducing employment, one might seen this in terms of a dramatic increase in the Employment Cost Index but it seems the goods folks over at the Bureau of Labor Statistics provide little evidence to buttress Mr. Laffer’s absurd rant.

Have I Been Wrong About The Price And Role Of Gold?

The short answer is yes regarding the price of gold, although I think I avoided making my most incorrect predictions public on this or other blogs. I continue to think that gold is experiencing a bubble (more below on that), while having to admit that at least some of my private forecasts incorrectly put too low a ceiling on the possible price of gold. I privately said it could go to $1300 an ounce, but was skeptical of much above that, and have said to several folks that it could not hit $2000. While I still think it is a bubble, and that a return to a gold standard would be a disaster (even if "watching gold" while not taking it too seriously may not be completely stupid for policymakers as Robert Zoellick appears to be calling for), the bubble can go higher, especially with the Chinese and Indian central banks buying it, as they are reportedly doing. Evidence here is that in the last gold bubble 30 years ago, it hit a current real price of about $2387 an ounce according to some sources before it crashed hard and stayed down for over two decades.

But is it a bubble? Well, some of the evidence is in the publicity, all those people yelling that it cannot go down, which is generally one of the surest signs of something being a bubble. There is also the problem that gold is usually best bought as an inflation hedge, as it was in the 1970s, but that despite some people shrieking loudly about possible hyperinflation, the market evidence is that inflation expectations have only risen modestly with the QEII. On this, and on the matter of the gold standard and commodity prices in general, see the last three posts by Jim Hamilton and Menzie Chinn at Econbrowser, http://www.econbrowser.com. Chinn notes that the five year TIPS spread has moved a whopping 0.4% upwards, from 1.2% to about 1.6%, hardly an outbreak of hyperinflation, even if I do not buy into rational expectations (thus granting that the TIPS market can be more than stochastically wrong, or may even be being manipulated, as reportedly the Fed holds something like 10% of the TIPS bonds out there, although have not heard of any changes in that proportion recently).

Regarding the broader path of commodity prices, Hamilton worries about this, focusing not on gold but on his old fave, oil, arguing that we may be in trouble if it goes noticeably above $90 per barrel, which we are unpleasantly near. He also notes a sharp increase in the correlation between various commodity prices recently, particularly starting in 2009. However, I must note that a non-trivial portion of the runup in the price of gold occurred prior to then, so that even if quite a few commodities have risen more sharply since then, supposed evidence against the bubble hypothesis put forward by some commentators, it is still much higher relative to most of them than was the case if one goes back somewhat further in years. So, yes, Virginia, there is a bubble in gold, but it could still go some ways up further before we see it crash.

How’s That Audacity Thing Working Out for Ya?

Now that Obama has initiated Phase II of his presidency with yet another craven retreat—this time on the Bush tax cuts—perhaps we should take a look at this remarkable aspect of his personality. Normally I am a knee-jerk structuralist, assigning nearly all effectivity to economic, political and social conditions and virtually none to the individual traits of leaders, but in this case I think personality rises in significance. On every issue that has marked Phase I, including health care, stimulus, financial reform and climate change, Obama has given ground without a fight. The issues left off his agenda, such as labor law reform and global public finance (like financial transaction taxes), echo loudly in their silence.

To put it bluntly, Obama may be the most risk-averse president we have had in decades. He is pathologically risk averse. His fear of losing a congressional vote has utterly paralyzed his agenda, just as his fear of being surprised by some detail of an appointee’s background has caused unprecedented delays in staffing his administration. He has kept silent during congressional debates in which vital interests were at stake, for fear of being rebuffed even by a few words in the language of a bill.

Like most Obama-watchers, I was not surprised by his centrist politics; he advertised them honestly during his primary and general election campaigns. What has baffled me, however, is how someone whose political career seemed to be painted in bold, even audacious, strokes could, on reaching his promised land, turn so timid.

Over the next two years there is absolutely no chance that legislation to the left of John Boehner’s right pinkie will get through congress. Unless Obama is willing to fight for a losing cause, he will have no causes at all. What then?