"There was no credit crisis. What was happening was much more arcane: A few big institutions that had made bad bets were at risk of going bust, and that’s it. And if they had gone bankrupt, it wouldn’t have been the end of the world. In fact, there is huge excess capacity in financial services and there’s a need to focus on the healthy ones and let others fail. Meanwhile, business lending and consumer lending were still strong in September and October, and it’s still okay." [1]
"Maybe Bernanke and Paulson had information that they were not making public, but the available data simply did not support what they were saying....This was a lot like the run-up to the Iraq invasion in 2003. You had people in government saying: `We’re smart guys, trust us.’ But they were either wrong or they were lying." [2]
"Normally, when you’re going to spend a lot of money, you present the data and the economic theory to support it, yet here’s the biggest non-military government intervention in history since the Great Depression, and there was no evidence presented to support it, and no detailed economic argument made about what market failures this $700 billion was going to fix.....“If what we’re experiencing is a generic recession, all that money spent investing in the banks would be wasted, and that may be what this is: a generic recession.”" [3]
"With all the money that’s already been committed, it is going to be hard to get the stimulus money that is needed now,” she says. “Deficits are already so massive that at some point interest rates on long bonds are going to jump from 3% to 5%, and that will be good-bye mortgage markets." [4]
[1] Octavio Marenzi, founder of financial technology research and consulting firm Celent. As quoted in 'Follow the Money'
From the 2/1/2009 Issue of Treasury and Risk
By * Dave Lindorff
http://www.treasuryandrisk.com/Issues/2009/February%202009/Pages/Follow-the-Money.aspx
[2] V.V. Charri, an economist at the Minneapolis Fed. As quoted in 'Follow the Money'
From the 2/1/2009 Issue of Treasury and Risk
By * Dave Lindorff
http://www.treasuryandrisk.com/Issues/2009/February%202009/Pages/Follow-the-Money.aspx
[3] Patrick Kehoe, co-author of an article entitled: 'Facts and Myths About the Financial Crisis of 2008'. As quoted in 'Follow the Money'
From the 2/1/2009 Issue of Treasury and Risk
By * Dave Lindorff
http://www.treasuryandrisk.com/Issues/2009/February%202009/Pages/Follow-the-Money.aspx
[4] Yves Smith from the Naked Capitalism blog. As quoted in 'Follow the Money'
From the 2/1/2009 Issue of Treasury and Risk
By * Dave Lindorff
http://www.treasuryandrisk.com/Issues/2009/February%202009/Pages/Follow-the-Money.aspx
Thursday, February 5, 2009
CBO Does Not Agree With Brian Riedl
I normally do not cite the Washington Times as a good source for economics but in this case it does seem they are getting what the CBO has to say correct in the following sense:
It is true that the Washington Times also talked a lot about long-term crowding-out. Douglas Elmendorf writing for the CBO also notes long-term crowding-out:
This admission that a long-term fiscal stimulus that concentrated on government consumption rather than government investment would lead to long-term crowding-out follows what Elmendorf writes about the short-term effects:
As we noted, Brian Riedl tried to argue short-term crowding-out, which the CBO quite clearly says will not be the case. Even the most ardent Keynesian would concede that long-term fiscal stimulus leads to long-term crowding-out. Only those pseudo-economists who were apologists for the Bush43 fiscal stimulus would try to deny this. In my view, the ideal fiscal stance would be short-term stimulus followed by long-term fiscal restraint once the economy approached full employment. This was the policy of the Clinton Administration as I understand it – it is what is being recommended to President Obama by his economic advisors.
I guess we should thank the author of this Angrybear post for bringing to our attention the Washington Times somewhat misleading account of what CBO said – even if Sammy refuses to recognize the critical distinction between short-term Keynesian effects versus long-term classical effects.
CBO, the official scorekeepers for legislation, said the House and Senate bills will help in the short term ... CBO said there is no crowding out in the short term, so the plan would succeed in boosting growth in 2009 and 2010.
It is true that the Washington Times also talked a lot about long-term crowding-out. Douglas Elmendorf writing for the CBO also notes long-term crowding-out:
Even if the fiscal stimulus persisted, however, the short-run effects on output that operate by increasing demand for goods and services would eventually fade away. In the long run, the economy produces close to its potential output on average, and that potential level is determined by the stock of productive capital, the supply of labor, and productivity … In contrast to its positive near-term macroeconomic effects, the Senate legislation would reduce output slightly in the long run, CBO estimates, as would other similar proposals. The principal channel for this effect is that the legislation would result in an increase in government debt. To the extent that people hold their wealth in the form of government bonds rather than in a form that can be used to finance private investment, the increased government debt would tend to “crowd out” private investment—thus reducing the stock of private capital and the long-term potential output of the economy. The negative effect of crowding out could be offset somewhat by a positive long-term effect on the economy of some provsions—such as funding for infrastructure spending, education programs, and investment incentives, which might increase economic output in the long run. CBO estimated that such provisions account for roughly one-quarter of the legislation’s budgetary cost. Including the effects of both crowding out of private investment (which would reduce output in the long run) and possibly productive government investment (which could increase output), CBO estimates that by 2019 the Senate legislation would reduce GDP by 0.1 percent to 0.3 percent on net.
This admission that a long-term fiscal stimulus that concentrated on government consumption rather than government investment would lead to long-term crowding-out follows what Elmendorf writes about the short-term effects:
CBO estimates that the Senate legislation would raise output by between 1.4 percent and 4.1 percent by the fourth quarter of 2009; by between 1.2 percent and 3.6 percent by the fourth quarter of 2010; and by between 0.4 percent and 1.2 percent by the fourth quarter of 2011. CBO estimates that the legislation would raise employment by 0.9 million to 2.5 million at the end of 2009; 1.3 million to 3.9 million at the end of 2010; and 0.6 million to 1.9 million at the end of 2011.
As we noted, Brian Riedl tried to argue short-term crowding-out, which the CBO quite clearly says will not be the case. Even the most ardent Keynesian would concede that long-term fiscal stimulus leads to long-term crowding-out. Only those pseudo-economists who were apologists for the Bush43 fiscal stimulus would try to deny this. In my view, the ideal fiscal stance would be short-term stimulus followed by long-term fiscal restraint once the economy approached full employment. This was the policy of the Clinton Administration as I understand it – it is what is being recommended to President Obama by his economic advisors.
I guess we should thank the author of this Angrybear post for bringing to our attention the Washington Times somewhat misleading account of what CBO said – even if Sammy refuses to recognize the critical distinction between short-term Keynesian effects versus long-term classical effects.
Wednesday, February 4, 2009
Revoke Krugman's Nobel Prize!
Yes, I know, not only has no Nobel Prize ever been revoked for anything, but they certainly do not do so for idiotic statements made by winners after they have won. However, as the first winner of the prize for international trade in 31 years, I find it appalling that Paul Krugman has come out for the "buy American" provision in the fiscal stimulus package now under consideration in the US Senate, a provision not supported by President Obama, and roundly denounced by pretty much everybody outside the US, a provision that would violate promises made in November in Washington not to engage in protectionist actions for "at least a year," with at its worst the nightmare possibility of a rerun of the trade war of the 1930s following the US Smoot-Hawley tariff that exacerbated the Great Depression. While some may dismiss such a possibility now, the standing of the US in the world on economic policy may have never been worse, given the role of the collapse of our sub-prime market in the current troubles, and with world merchandise trade dropping at an annualized rate of nearly 45% in November. This is not the time to be playing with such irresponsible fire.
I did agree that Krugman was deserving of the prize as the person who applied an innovative idea to both trade and to regional economics (aka "economic geography"), as the last winner for trade did also, Bertil Ohlin. However, I was unhappy that it was not shared, and this unhappiness appears to be spreading, with a recent posting at voxeu by Jota Ishikawa on the matter. He named a number of others, but had the two I think most deserved to share it upfront. One is Avinash Dixit, given that the model that Krugman applied is the Dixit-Stiglitz model of industrial organization. The other is Masahisa Fujita, who was the first to apply the Dixit-Stiglitz model to urban and regional economics in a not widely read journal, Regional Science and Urban Economics in 1988, three years before Krugman's paper in 1991 in the Journal of Political Economy the Nobel committee recognized (and in which Krugman failed to cite Fujita). Frankly, in this area Fujita's work has been far more innovative and of far higher intellectual quality than that of Krugman, and I also note that nobody east of India has ever received the prize.
I close by also whining again that Krugman has long gotten away with seriously misrepresenting the state of affairs in economic geography and urban and regional economics, claiming that until he came along the discussion of agglomeration was all verbal and non-rigorous. He has to this day never admitted the existence of or cited the work of such individuals as Peter Allen, Roger White, Gunter Haag, or Wolfgang Weidlich, who were doing mathematically rigorous such models, some of them with close resemblance to later work of Krugman's, thoughout the 1980s, even before Fujita's work, who is an economist. These people were even easier to ignore as they are mostly physicists with an occasional geographer thrown in (White) and published their work in such places as Environment and Planning A, Geographical Analysis, and the Journal of Regional Science, easy to ignore for a publicity hound like Krugman, and easy for a sloppy Nobel Committee to miss that clearly did not do its homework very well.
I did agree that Krugman was deserving of the prize as the person who applied an innovative idea to both trade and to regional economics (aka "economic geography"), as the last winner for trade did also, Bertil Ohlin. However, I was unhappy that it was not shared, and this unhappiness appears to be spreading, with a recent posting at voxeu by Jota Ishikawa on the matter. He named a number of others, but had the two I think most deserved to share it upfront. One is Avinash Dixit, given that the model that Krugman applied is the Dixit-Stiglitz model of industrial organization. The other is Masahisa Fujita, who was the first to apply the Dixit-Stiglitz model to urban and regional economics in a not widely read journal, Regional Science and Urban Economics in 1988, three years before Krugman's paper in 1991 in the Journal of Political Economy the Nobel committee recognized (and in which Krugman failed to cite Fujita). Frankly, in this area Fujita's work has been far more innovative and of far higher intellectual quality than that of Krugman, and I also note that nobody east of India has ever received the prize.
I close by also whining again that Krugman has long gotten away with seriously misrepresenting the state of affairs in economic geography and urban and regional economics, claiming that until he came along the discussion of agglomeration was all verbal and non-rigorous. He has to this day never admitted the existence of or cited the work of such individuals as Peter Allen, Roger White, Gunter Haag, or Wolfgang Weidlich, who were doing mathematically rigorous such models, some of them with close resemblance to later work of Krugman's, thoughout the 1980s, even before Fujita's work, who is an economist. These people were even easier to ignore as they are mostly physicists with an occasional geographer thrown in (White) and published their work in such places as Environment and Planning A, Geographical Analysis, and the Journal of Regional Science, easy to ignore for a publicity hound like Krugman, and easy for a sloppy Nobel Committee to miss that clearly did not do its homework very well.
Gun Nuts Roll the Virginia Senate
As I predicted, Democrats are now kowtowing in fear to the jackboots of the National Rifle Association. While Democrats control the Virginia Senate, 21-19, yesterday that body passed a bill, 23-17. to allow people to carry concealed weapons into restaurants serving alcohol, although its backers say it is reasonable because they are not allowed to consume alcohol themselves and must inform somebody in the restaurant that they are packing heat. Goody. There is a bill still alive to close the "gun show loophole" that made it out of a committee, but everybody is forecasting it will not pass the whole Senate. As it is, this new bill will easily pass the GOP-controlled Assembly, although I do not know what Governor Kaine will do with it. In any case, all the hysterical gun rights advocates freaking out that everybody is out to take away their rights are way off base here in Virginia, as I forecast in an earlier posting on this subject. The gun nuts have won another one.
Defense Spending in 2010: Rightwingers Portray Increase as a Cut
Josh Rogin has an irony for us:
I’ll concede that a 2.7 percent nominal increase is not a large increase. Whether this represents a real increase greater than 2.7 percent or less than 2.7 percent depends on whether we have deflation or inflation over the year. But what the Joint Chiefs of Staff had requested represented a 13.6 percent nominal increase.
Robert Kagan tried to argue:
The rest of Kagan’s op-ed claimed that President Obama wants to cut defense spending. I hear my boss wants to increase my pay by only 3 percent this year so maybe I should go into his office and request a 13 percent increase. That way – I can tell everyone he wants to cut my pay by 10 percent (as compared to my wish list).
If this had been a domestic spending program that got a 3 percent increase rather than a 13 percent increase and some liberal screamed “spending cuts”, one would think Tony Blankley would mock the liberal:
Tony trusts his Pentagon sources? I guess he did not read Spencer Ackerman who first wrote:
Spencer added:
Note that Spencer wrote this two days ago – and yet Kagan misrepresented the story yesterday, while Blankley misrepresented it today.
The Obama administration has given the Pentagon a $527 billion limit, excluding war costs, for its fiscal 2010 Defense budget, an Office of Management and Budget official said Monday. If enacted, that would be about $14 billion more than the $513 billion allocated for fiscal 2009 (PL 110-329), including military construction funds, and it would match what the Bush administration estimated last year for the Pentagon in fiscal 2010. But it sets up a potential conflict between the new administration and the Defense Department’s entrenched bureaucracy, which has remained largely intact through the presidential transition. Some Pentagon officials and congressional conservatives are already trying to portray the OMB number as a cut by comparing it with a $584 billion draft budget request compiled last fall by the Joint Chiefs of Staff for fiscal 2010.
I’ll concede that a 2.7 percent nominal increase is not a large increase. Whether this represents a real increase greater than 2.7 percent or less than 2.7 percent depends on whether we have deflation or inflation over the year. But what the Joint Chiefs of Staff had requested represented a 13.6 percent nominal increase.
Robert Kagan tried to argue:
Pentagon officials have leaked word that the Office of Management and Budget has ordered a 10 percent cut in defense spending for the coming fiscal year, giving Defense Secretary Robert Gates a substantially smaller budget than he requested.
The rest of Kagan’s op-ed claimed that President Obama wants to cut defense spending. I hear my boss wants to increase my pay by only 3 percent this year so maybe I should go into his office and request a 13 percent increase. That way – I can tell everyone he wants to cut my pay by 10 percent (as compared to my wish list).
If this had been a domestic spending program that got a 3 percent increase rather than a 13 percent increase and some liberal screamed “spending cuts”, one would think Tony Blankley would mock the liberal:
I have been told by sources at the Pentagon that they have been told to not expect full funding of all existing programs. And there is evidence that Obama has apparently been planning to force cuts on our military for some time.
Tony trusts his Pentagon sources? I guess he did not read Spencer Ackerman who first wrote:
Late last week, the White House Office of Management and Budget told the Pentagon to “substantial[ly]” restrain its planned fiscal 2010 budget, which the Bush administration beefed up by $60 billion over the 2009 budget before leaving office.
Spencer added:
Here’s where it helps to have Defense Secretary Bob Gates impose some discipline. Getting eight percent more, outside the costs of the wars (!), during a time of global economic distress is, you know, really generous. An OMB official told Rogin that the Bush-drafted request was a “wish list” for conceivable defense spending — a classy little sayonara to the incoming Obama team — not a realistic budget. Gates has been telling anyone who will listen that the budget is coming down, hard choices are going to have to be made, and people are going to have to stop whining and reconcile themselves to this new reality. So it’ll be interesting to see if he starts with this budgetary gem. But! I hear that he may send OMB a letter objecting to the $527 billion (outside of the wars!) ceiling.
Note that Spencer wrote this two days ago – and yet Kagan misrepresented the story yesterday, while Blankley misrepresented it today.
Heritage and the National Review Adopt the Treasury View
David Freddoso of the National Review interviews Brian Riedl of Heritage (not Cato - my apologies) in the The Case for No Stimulus:
Hang on a second – Riedl notes that Keynesian insufficiency of aggregate demand may have existed in the 1930’s so that an increase in national savings does not automatically become investment demand but he argues for complete crowding-out ala the classical full employment model is the only relevant view for today’s economy. Has he been asleep for the past couple of years? Does he not know how far the employment-population ratio has declined or how low Treasury bill interest rates are? I know we should expect incredible stupidity from the National Review but this one really takes the cake!
Footnote: Thanks for Tom Bozzo for noting that Riedl is with Heritage and not Cato (I do get these two confused at time). It also seems that Tom's Angrybear colleague Sammy recognized Riedl's appropriate association even if Sammy did not realize (at first) that Riedl's argument was the discredited Treasury view.
Update: While I should thank Tom Bozzo for linking to this over at Angrybear, I am appalled by the critical comments from folks who have not been following this discussion of how Eugene Fama stumbled in his revival of the Treasury view. Apparently, my former colleagues at Angrybear do not read Brad DeLong who has even written a paper on this.
The grand Keynesian myth is that you can spend money and thereby increase demand. And it’s a myth because Congress does not have a vault of money to distribute in the economy. Every dollar Congress injects into the economy must first be taxed or borrowed out of the economy. You’re not creating new demand, you’re just transferring it from one group of people to another. If Washington borrows the money from domestic lenders, then investment spending falls, dollar for dollar. If they borrow the money from foreigners, say from China, then net exports drop dollar for dollar, because the balance of payments must adjust. Therefore, again, there is no net increase in aggregate demand ... There is this notion that the redistribution of money from savers to spenders creates new spending. But that assumes that people store their savings in their mattresses. That may have been true in the 1930s, but today, people use their savings to pay down debts or invest. Or they put it into the bank, who in turn lends it to others to spend. Therefore, savings circulate through the investment side of the economy, which counts just as much in the GDP as the consumption side of the economy ... The government is going to have to raise interest rates in order to convince people to lend them the full amount they need. We’re already facing a deficit of $1.2 trillion this year, and 700 billion next year. We borrowed $700 billion for TARP, and now we’re going to borrow $800 billion for this stimulus package.
Hang on a second – Riedl notes that Keynesian insufficiency of aggregate demand may have existed in the 1930’s so that an increase in national savings does not automatically become investment demand but he argues for complete crowding-out ala the classical full employment model is the only relevant view for today’s economy. Has he been asleep for the past couple of years? Does he not know how far the employment-population ratio has declined or how low Treasury bill interest rates are? I know we should expect incredible stupidity from the National Review but this one really takes the cake!
Footnote: Thanks for Tom Bozzo for noting that Riedl is with Heritage and not Cato (I do get these two confused at time). It also seems that Tom's Angrybear colleague Sammy recognized Riedl's appropriate association even if Sammy did not realize (at first) that Riedl's argument was the discredited Treasury view.
Update: While I should thank Tom Bozzo for linking to this over at Angrybear, I am appalled by the critical comments from folks who have not been following this discussion of how Eugene Fama stumbled in his revival of the Treasury view. Apparently, my former colleagues at Angrybear do not read Brad DeLong who has even written a paper on this.
Tuesday, February 3, 2009
Iraq Update
Now that W. is out and a moderately calm set of provincial elections have been held in Iraq (although none in Kurdistan) that apparently will strengthen the hand of the current, pro-central-authority government, with declining, if not gone, violence more generally, it may well be that there will be little need to post much in the future on Iraq, and hopefully President Obama will be able to proceed with his plans to withdraw US troops over the next 16 months without a major catastrophe happening. While there continue to be loose ends, especially regarding the relationship between Kurdistan and the rest of Iraq and the matter of the distribution and control of oil revenues (see on this the ever informative Ben Lando at http://www.iraqioilreport.com), in many ways the situation may be finally reverting to what it looked like it might be when I wrote a column on the war on the day that Tikrit fell in April 2003, which was before all the unforeseeable screwups by the US from disbanding the Iraqi military to torturing prisoners at Abu Ghraib had happened to make truly royal mess of things. So, in this update at this time of transition, I shall go back to that moment when the war looked at its best to see how things stand. I forecasted three likely positives and three likely negatives of the war, with the latter outweighing the former in my view then and now, all of them having come true.
Positives:
1. The most important was to end the massive human rights violations by Saddam Hussein. This was followed by serious violations by others, although hopefully this is now subsiding, and this positive may finally be more seriously in place. on net after a lot of horrors.
2. Reduction of US military presence in Saudi Arabia, which had been sore point for al Qaeda. This was relatively trivial, but was achieved a long time ago.
2. Ending of international economic sanctions against Iraq. Also achieved a long time ago, but this was for a long time overshadowed by the general economic catastrophe that has engulfed Iraq since, now easing, although the recent fall in oil prices is not helping.
Negatives:
1. I forecast that the Christian population of Iraq would suffer discrimination and persecution by governments dominated by sectarian Shi'a. This happened, and today the Christian population of Iraq is about half what it was before 2003. Keep in mind that this has been one of the oldest Christian populations in the world, many of them speaking Aramaic, the language of Jesus himself, although one never hears about this from the Christian Right wingnut crowd.
2. I forecast that for the same reason the Christians would suffer, so would women generally. This does not seem to have occurred in Kurdistan, but there have been many problems in the rest of the country, with most observers saying that the status of women is generally worse off than before the war. Two sources are an older more detailed one, a report by the US ABA accessible at http://www.abanet.org/rol/publications/Iraq_status_of_women_update.2006.pdf, and a more recent but less detailed on by Women for Women International issued last year on International Womens' Day describing the status of women in Iraq as a "national crisis." A comment on that report is at http://www.womensmedia.cener.com/ex/030608.html.
3. And the worst was that I forecast that the US would lose support around the world and especially among Muslims as we would get bogged down and do bad things. I do not think I need to detail how accurate that forecast became.
Before ending this I want to address the matter of the "surge," which so many commentators have claimed was a "success" and how Obama and others should give credit to Bush for pushing it. I am sorry, but I do not buy it. The alternative was the in-place DOD plan to start drawing down troops back in 2006 that Bush turned around to increase troops there. As near as I can tell there were three bases for the claim of the surge bringing success.
The first was the turn of tribal sheikhs in al Anbar province against Al Qaeda in Iraq. However, this happened before the surge and was independent of it, other than the US giving the sheikhs arms. But this could have been done without the surge.
The second was the increase in rule by the central government in Basra in the South. The US role in this mostly involved bombing and little in the way of troops. Again, this could have been done without the surge.
Finally, there is the decline in violence in Baghdad. However, this was due to the ending of the neighborhood ethnic cleansing that had gone on for a long time, with the Shi'a-Sunni population ratio going from 2 to 1 to 3 to 1. The one area the surge might have helped slightly here was that to enforce this walls have been built between the neighborhoods, which damage the economy, but do help keep violence down. Apparently US troops helped with that, so maybe there we have one minor positive to be credited to the surge.
Positives:
1. The most important was to end the massive human rights violations by Saddam Hussein. This was followed by serious violations by others, although hopefully this is now subsiding, and this positive may finally be more seriously in place. on net after a lot of horrors.
2. Reduction of US military presence in Saudi Arabia, which had been sore point for al Qaeda. This was relatively trivial, but was achieved a long time ago.
2. Ending of international economic sanctions against Iraq. Also achieved a long time ago, but this was for a long time overshadowed by the general economic catastrophe that has engulfed Iraq since, now easing, although the recent fall in oil prices is not helping.
Negatives:
1. I forecast that the Christian population of Iraq would suffer discrimination and persecution by governments dominated by sectarian Shi'a. This happened, and today the Christian population of Iraq is about half what it was before 2003. Keep in mind that this has been one of the oldest Christian populations in the world, many of them speaking Aramaic, the language of Jesus himself, although one never hears about this from the Christian Right wingnut crowd.
2. I forecast that for the same reason the Christians would suffer, so would women generally. This does not seem to have occurred in Kurdistan, but there have been many problems in the rest of the country, with most observers saying that the status of women is generally worse off than before the war. Two sources are an older more detailed one, a report by the US ABA accessible at http://www.abanet.org/rol/publications/Iraq_status_of_women_update.2006.pdf, and a more recent but less detailed on by Women for Women International issued last year on International Womens' Day describing the status of women in Iraq as a "national crisis." A comment on that report is at http://www.womensmedia.cener.com/ex/030608.html.
3. And the worst was that I forecast that the US would lose support around the world and especially among Muslims as we would get bogged down and do bad things. I do not think I need to detail how accurate that forecast became.
Before ending this I want to address the matter of the "surge," which so many commentators have claimed was a "success" and how Obama and others should give credit to Bush for pushing it. I am sorry, but I do not buy it. The alternative was the in-place DOD plan to start drawing down troops back in 2006 that Bush turned around to increase troops there. As near as I can tell there were three bases for the claim of the surge bringing success.
The first was the turn of tribal sheikhs in al Anbar province against Al Qaeda in Iraq. However, this happened before the surge and was independent of it, other than the US giving the sheikhs arms. But this could have been done without the surge.
The second was the increase in rule by the central government in Basra in the South. The US role in this mostly involved bombing and little in the way of troops. Again, this could have been done without the surge.
Finally, there is the decline in violence in Baghdad. However, this was due to the ending of the neighborhood ethnic cleansing that had gone on for a long time, with the Shi'a-Sunni population ratio going from 2 to 1 to 3 to 1. The one area the surge might have helped slightly here was that to enforce this walls have been built between the neighborhoods, which damage the economy, but do help keep violence down. Apparently US troops helped with that, so maybe there we have one minor positive to be credited to the surge.
Retaliation – the Problem with Expenditure-Switching Policies
As I tried to present the discussion so far as to the Buy American provisions floating around Congress in their hotly debate ideas as to how to stimulate U.S. aggregate demand, Barkley reminds us that foreign governments might retaliate with their own expenditure-switching policies:
To be fair, Paul Krugman is hoping for more expenditure-adjusting policies:
Whether or not such a global scale movement towards autarky would induce more global fiscal stimulus is an issue I’ll leave to those smarter about these things than me, but I thought it was interesting that even Mitch McConnell understands what Barkley is saying:
While we are experiencing some improvement in our net exports, the reason has more to do with our falling demand for imports than it does with rising exports. Real exports fell during 2008QIV and it is not surprising to see why if one reviews the information in table 1.1 of the IMF’s World Economic Outlook. World output slowed in 2008 – particularly among the advanced economies. This slowdown is projected to continue during 2009. The growth in world imports/exports also slowed – particularly among the advanced economies.
Any attempt by the U.S. to increase its aggregate demand via expenditure-switching policies will reduce the net exports of our trading partners. Given that our trading partners are also likely to face insufficient aggregate demand during 2009, Senator McConnell’s concern about setting off a trade war appears to be a legitimate one.
In 1930, the US passed the Smoot-Hawley tariff in order to preserve US jobs. This was a fixed exchange rate world under the gold standard. There was full bore reaction by other countries, most significantly the British Commonwealth ones, but others as well, and world trade declined sharply, certainly exacerbating the plunge into the Great Depression, although the degree of its role remains a matter of debate. However, I am unaware of any economist anywhere who argues that American jobs were saved by this catastrophic policy. Now there is a hard international political economic reality here that is being ignored. The just-ended Davos conference included fiercesome denunciations of the US for having triggered what is now the most widespread global recession ever. Merchandise trade declined in November at an annualized rate of 45%, while the big conference in Washington supposedly agreed on avoiding protectionism for at least a year, and in mid-January the US put a bunch of trade sanctions on the EU (no more Roquefort cheese to be had in the US anytime soon). Without doubt, such a stupid move by the US would this time also trigger massive reactions and the very serious danger of a full-blown trade war. No way this is going to help the world economy, much less the US one, although certain sectors might do better in the short run (Krugman's argument).
To be fair, Paul Krugman is hoping for more expenditure-adjusting policies:
Now ask, how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise.
Whether or not such a global scale movement towards autarky would induce more global fiscal stimulus is an issue I’ll leave to those smarter about these things than me, but I thought it was interesting that even Mitch McConnell understands what Barkley is saying:
I don't think we ought to use a measure that is supposed to be timely, temporary, and targeted to set off trade wars when the entire world is experiencing a downturn in the economy
While we are experiencing some improvement in our net exports, the reason has more to do with our falling demand for imports than it does with rising exports. Real exports fell during 2008QIV and it is not surprising to see why if one reviews the information in table 1.1 of the IMF’s World Economic Outlook. World output slowed in 2008 – particularly among the advanced economies. This slowdown is projected to continue during 2009. The growth in world imports/exports also slowed – particularly among the advanced economies.
Any attempt by the U.S. to increase its aggregate demand via expenditure-switching policies will reduce the net exports of our trading partners. Given that our trading partners are also likely to face insufficient aggregate demand during 2009, Senator McConnell’s concern about setting off a trade war appears to be a legitimate one.
Harding’s Alleged Small Government Economic Miracle
Jim Powell wants us to believe that reducing the size of the Federal government is the key to getting the economy back to full employment:
Which U.S. president ranks as America’s greatest depression fighter? Not the fabled Franklin Delano Roosevelt … America’s greatest depression fighter was Warren Gamaliel Harding. An Ohio senator when he was elected president in 1920, he followed the much praised Woodrow Wilson — who had brought America into World War I, built up huge federal bureaucracies, imprisoned dissenters, and incurred $25 billion of debt. Harding inherited Wilson’s mess — in particular, a post–World War I depression that was almost as severe, from peak to trough, as the Great Contraction from 1929 to 1933 that FDR would later inherit. The estimated gross national product plunged 24 percent from $91.5 billion in 1920 to $69.6 billion in 1921. The number of unemployed people jumped from 2.1 million to 4.9 million ... Federal spending was cut from $6.3 billion in 1920 to $5 billion in 1921 and $3.2 billion in 1922. Federal taxes fell from $6.6 billion in 1920 to $5.5 billion in 1921 and $4 billion in 1922.
Spencer spots a flaw in Powell’s reporting of GDP:
First, the 24% plunge in GDP he cites is nominal GDP, not real GDP. The drop in real GDP was about 5%, as compared to the 26% drop in 1929-33.
So with prices falling during this period, the decline in any real variable is less than the decline in the reported nominal variable, which should hold for those reported declines in government spending and tax figures. Alas, Spencer only tells us the qualitative direction of the general price level, which of course is a lot more informative than the disinformation from Mr. Powell. This source, however, lets us know that the CPI fell by 10.85% in 1921 and 6.1% in 1922. In real terms, Federal spending and taxes were still lower in 1922 than they were in 1920, but Powell’s abuse of nominal figures greatly exaggerates not only the size of the post World War I recession but also the size of the decline in Federal spending and taxes.
Then again, it is not unusual to see Federal spending and taxes fall after a major war. Our chart was created using information from this source and shows total government revenue in real terms (2000$) from 1902 to 1940. The size of the government during the years preceding World War I appears to be a lot smaller than the size of the government in 1922. And we should note that real Federal revenues rose for the rest of the 1920’s eclipsing real Federal revenues in 1920.
Spencer is right – Jim Powell has put forward a lot of disinformation in his National Review column. But that is nothing new for those who write for the National Review!
How the Five-Day-Week Prolonged the Depression!
by the Sandwichman
Hooray for Harold L. Cole and Lee E. Ohanian! They have raised, in an admittedly inept and backward manner, an issue that many Keynesians and New Deal apologists seem to have trouble acknowledging. (See also Brad DeLong and Eric Rauchway).
But we do know that one part of what did happen was that the hours of work were reduced. They weren't reduced as much as William Green's AFL wanted them to be or as much as the Black-Connery bill would have mandated -- to 30 hours a week. The reduction in hours was permanent -- a permanent withdrawal of superfluous labor power from the market. Wartime mobilization withdrew labor power from the market in another way, by putting 12 million men in uniform and sending them overseas.
But here's the point: recovery from the Depression was not just about public works and fiscal policy. It was also about enforcing a reduction of working time. Cole and Ohanian are on to something, even if their interpretation of it is ass backwards.
To put Cole and Ohanian's free market mindset into perspective, I've posted, below the jump, the introduction to the October 1926 issue of the Pocket Bulletin, Official Publication of the National Association of Manufacturers, which announced its theme on the cover as "Will the Five-Day-Week Become Universal? IT WILL NOT!"
Hooray for Harold L. Cole and Lee E. Ohanian! They have raised, in an admittedly inept and backward manner, an issue that many Keynesians and New Deal apologists seem to have trouble acknowledging. (See also Brad DeLong and Eric Rauchway).
The goal of the New Deal was to get Americans back to work. But the New Deal didn't restore employment. In fact, there was even less work on average during the New Deal than before FDR took office. Total hours worked per adult, including government employees, were 18% below their 1929 level between 1930-32, but were 23% lower on average during the New Deal (1933-39). Private hours worked were even lower after FDR took office, averaging 27% below their 1929 level, compared to 18% lower between in 1930-32.The hours of work decreased during the New Deal! Think of that! People worked fewer hours at the end of the 1930s than they did when Roosevelt took office. Of course, Cole and Ohanian think that was a bad thing, just like they think high wages were a bad thing. They also seem to believe that the Depression would have ended sooner if the market had been left alone to work out its kinks. Yeah, right. I don't want to live through that experiment.
Even comparing hours worked at the end of 1930s to those at the beginning of FDR's presidency doesn't paint a picture of recovery. Total hours worked per adult in 1939 remained about 21% below their 1929 level, compared to a decline of 27% in 1933. And it wasn't just work that remained scarce during the New Deal. Per capita consumption did not recover at all, remaining 25% below its trend level throughout the New Deal, and per-capita nonresidential investment averaged about 60% below trend. The Great Depression clearly continued long after FDR took office.
But we do know that one part of what did happen was that the hours of work were reduced. They weren't reduced as much as William Green's AFL wanted them to be or as much as the Black-Connery bill would have mandated -- to 30 hours a week. The reduction in hours was permanent -- a permanent withdrawal of superfluous labor power from the market. Wartime mobilization withdrew labor power from the market in another way, by putting 12 million men in uniform and sending them overseas.
But here's the point: recovery from the Depression was not just about public works and fiscal policy. It was also about enforcing a reduction of working time. Cole and Ohanian are on to something, even if their interpretation of it is ass backwards.
To put Cole and Ohanian's free market mindset into perspective, I've posted, below the jump, the introduction to the October 1926 issue of the Pocket Bulletin, Official Publication of the National Association of Manufacturers, which announced its theme on the cover as "Will the Five-Day-Week Become Universal? IT WILL NOT!"
The Five-Day-Work Week; Can It Become Universal?
Presidents of Numerous Large Establishments Employing Hundreds of Thousands of Men in Various Lines of Manufacture, Declare Tendency to Less Work and More Pay Will Leave Us Wide Open for European Onslaught
Will Henry Ford's five-day week, just put into operation in his plants, and now urged as ideal by labor leaders, be adopted generally by the industries of the country?
It will not!
For the following chief reasons:
1. It would greatly increase the cost of living.
2. It would increase wages generally by more than 15 per cent and decrease production.
3. It would be impracticable for all industries.
4. It would create a craving for additional luxuries to occupy the additional time.
5. It would mean a trend toward the Arena, Rome did that and Rome died.
6. It would be against the best interests of the men who want to work and advance.
7. It would be all right to meet a sales emergency but would not work out as a permanent thing.
8. It would make us more vulnerable to the economic onslaughts of Europe, now working as hard as she can to overcome our lead.
These are some of the conclusions drawn by the presidents of some of the largest industrial concerns in the country, members of the National Association of Manufacturers and employing thousands of workers in various phases of industry.
Mankind does not thrive on holidays. Idle hours breed mischief. The days are too short for the worthwhile men of the world to accomplish the tasks which they set themselves. No man has ever attained success in industry, in science, or in any other worthwhile activity of life by limiting his hours of labor.
Monday, February 2, 2009
Buy American: Is There a Trade-off Between Free Trade and Full Employment?
Paul Krugman gets partial credit for expounding on an argument made by Dani Rodrik (here and here):
As we noted, Dani was assuming a fixed exchange rate model. I suspect Paul is also assuming a fixed exchange rate model:
We also noted that Nick Rowe considered the implications of floating exchange rates:
Let’s expound on this in three ways. First of all – the choice between floating v. fixed exchange rates plus protection (as we noted earlier) comes down to whether one wants the benefits of fiscal stimulus to accrue partly to the export sector v. whether one wants a lot of the benefits to accrue to sectors such as the steel industry. A lot of economists who argue against the Buy American provisions on the grounds of efficiency are implicitly favoring the export sector over the import competing sectors.
Secondly, some rightwing pundits fear that a dollar devaluation will prove inflationary. I think most economists would argue that the kind of real devaluation that Nick is referring to will have only a modest impact on the overall price index. Besides, the Federal Reserve seems to be more afraid of deflation that a little inflation.
The third point comes from several of the comments surrounding Nick’s contribution – that being that we may be in a Bretton Woods II era if the Chinese government maintains a fixed exchange rate. In other words, the lessons learned from Dani’s and Paul’s fixed exchange rate model are not as easily dismissed as applying to the current situation. Paul noted that if we had better international coordination of macroeconomic and exchange rate policies, we might not need protectionism. Alas, such coordination does not seem to be on the horizon.
Update: Nick Rowe adds more to this debate.
The economic case against protectionism is that it distorts incentives: each country produces goods in which it has a comparative disadvantage, and consumes too little of imported goods. And under normal conditions that’s the end of the story. But these are not normal conditions. We’re in the midst of a global slump, with governments everywhere having trouble coming up with an effective response ... how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise. Yes, trade would be more distorted, which is a cost; but the distortion caused by a severely underemployed world economy would be reduced. And as the late James Tobin liked to say, it takes a lot of Harberger triangles to fill an Okun gap.
As we noted, Dani was assuming a fixed exchange rate model. I suspect Paul is also assuming a fixed exchange rate model:
And one part of the problem facing the world is that there are major policy externalities. My fiscal stimulus helps your economy, by increasing your exports — but you don’t share in my addition to government debt.
We also noted that Nick Rowe considered the implications of floating exchange rates:
Nick’s floating exchange rate version of the model, however, has the exchange rate automatically adjust such that the ultimate change in net exports is zero. In this case, the multiplier for fiscal policy is 5 and the multiplier for mercantilist policy is zero. In other words, a $200 increase in government purchases still achieves the goal of increasing real GDP by $1000. Lesson learned – floating exchange rates can achieve the same goal as Dani’s mercantilism. There is one difference, however, between the two approaches. Mercantilism often works by protecting the import competing sector. Under floating exchange rates, we are more likely to see increased employment in the export sector.
Let’s expound on this in three ways. First of all – the choice between floating v. fixed exchange rates plus protection (as we noted earlier) comes down to whether one wants the benefits of fiscal stimulus to accrue partly to the export sector v. whether one wants a lot of the benefits to accrue to sectors such as the steel industry. A lot of economists who argue against the Buy American provisions on the grounds of efficiency are implicitly favoring the export sector over the import competing sectors.
Secondly, some rightwing pundits fear that a dollar devaluation will prove inflationary. I think most economists would argue that the kind of real devaluation that Nick is referring to will have only a modest impact on the overall price index. Besides, the Federal Reserve seems to be more afraid of deflation that a little inflation.
The third point comes from several of the comments surrounding Nick’s contribution – that being that we may be in a Bretton Woods II era if the Chinese government maintains a fixed exchange rate. In other words, the lessons learned from Dani’s and Paul’s fixed exchange rate model are not as easily dismissed as applying to the current situation. Paul noted that if we had better international coordination of macroeconomic and exchange rate policies, we might not need protectionism. Alas, such coordination does not seem to be on the horizon.
Update: Nick Rowe adds more to this debate.
Sunday, February 1, 2009
The Source and Remedy of the National Difficulties
by the Sandwichman
How is it that notwithstanding the unbounded extent of our capital, the progressive improvement and wonderful perfection of our machinery, our canals, roads, and of all other things that can, either facilitate labour, or increase its produce; our labourer, instead of having his labours abridged, toils infinitely more, more hours, more laboriously...?At the request of Michael Perelman, the Sandwichman is posting, below the jump, the 1821 pamphlet, The Source and Remedy of the National Difficulties, Deduced from Principles of Political Economy in a Letter to Lord John Russell. I've toyed with the idea of doing a point-by-point serialization so that people could digest and discuss the extraordinary logic and rhetoric of the piece. By my count, there's around 44 discrete "points" so such a serialization would be a vast undertaking. I think I'll wait and see how much popular clamor there is for such a serialization...
Published anonymously in 1821, The Source and Remedy was, according to Frederick Engels, "saved from falling into oblivion," by Karl Marx, who, in published writings up to the time of Engel’s remark, had scarcely mentioned the pamphlet in a cryptic footnote in Volume I of Capital. Engels acclaimed the pamphlet as “but the farthest outpost of an entire literature which in the twenties turned the Ricardian theory of value and surplus value against capitalist production in the interest of the proletariat.”
For his part, Marx declared in his unpublished notebooks that the pamphlet was an advance beyond Adam Smith and David Ricardo in its conscious and consistent distinction between the general form of surplus value or surplus labour and its particular manifestations in the form of land rent, interest of money or profit of enterprise. In commenting on the pamphlet, Marx returned several times to what he upheld as the "fine statement": "a nation is really rich if no interest is paid for the use of capital, if the working day is only 6 hours rather than 12. WEALTH IS DISPOSABLE TIME, AND NOTHING MORE."
Marx noted that Ricardo had also identified disposable time as the true wealth with the difference for Ricardo, however, that it was disposable time for the capitalist that constituted such wealth, thus the ideal should be to maximize surplus value relative to total output.
One of those citations occurs in Marx's Grundrisse, immediately after the following characteristically revolutionary proposition: "Forces of production and social relations -- two different sides of the development of the social individual -- appear to capital as mere means for it to produce on its limited foundation. In fact, however, they are the material condition to blow this foundation sky-high."
Indeed, in his reinterpretation of Marx's critical theory, Time, Labor and Social Domination, Moishe Postone placed the issue of disposable time at the "essential core" of Marx's analysis in Capital. Although Postone didn't emphasize the pamphlet itself, he highlighted a passage from the same paragraph in the Grundrisse that concludes with the pamphlet's "fine statement."
Just how successful Marx was in saving the 1821 pamphlet from oblivion remains to be seen. Obviously, the pamphlet was spared from total oblivion or I wouldn't be writing this. A copy of it was included in the microfilm Goldsmiths-Kress Library of Economic Literature. Routledge republished it in 2005 as part of a ten-volume collection of Owenite Socialism : Pamphlets and Correspondence edited by Gregory Claeys (price?: 3891.66 Euros -- socialism ain't cheap y'know).
Aside from the few references by Marx and Engels, there have been scattered mentions of the pamphlet but, to my knowledge, no sustained consideration, which seems odd considering the importance that Engels -- and in his manuscripts, Marx -- assigned to it.
Perhaps one of the difficulties has been the anonymity of its authorship. That problem would appear to have been resolved by a disclosure in the biography of the 19th century editor and literary critic, Charles Wentworth Dilke, Papers of a Critic, written by his grandson, Sir Charles Wentworth Dilke. The younger Dilke reported having found an annotated copy of the pamphlet, acknowledging authorship, among his grandfather's papers. Subsequent authorities on Dilke and on the literary journal he edited for [30?] years, The Athaeneum, appear satisfied with the plausibility of this attribution, given Dilke's writing style, his proclivity for anonymous and pseudonymous publication, his political inclinations and his subsequent career. There doesn't appear to have been any concerted effort to either definitively establish or to refute Dilke's authorship. So Dilke qualifies as the leading and, so far, only candidate for authorship.
If Dilke was indeed the author, this presents at least two rather significant bits of context to the pamphlet as well as several minor but intriguing ones. First, Dilke was an ardent disciple of William Godwin. The poet, John Keats, who was a close friend and next-door neighbor referred to him as a "Godwin perfectability man". He was said to have retained this political inclination throughout his life. Second, in his career as editor of the Athaeneum, Dilke campaigned famously against journalistic "puffery" -- the practice of publishers placing in literary journals, for a fee, promotional material for their books under the guise of independent reviews.
Both of these contextual items could be significant for an interpretation of The Source and Remedy precisely because the pamphlet lends itself comfortably to a reading as a Godwinist tract (rather than a pre-Marxist one) but also to a reading as a polemic against yet another brand of puffery -- political economic puffery. As for "turning the Ricardian theory of value against capitalist production," such an intention would hardly seem to fit an essay that on its closing page counts among the great advantages of the measures proposed therein that "their adoption would leave the country at liberty to pursue such a wise and politic system of financial legislation as would leave trade and commerce unrestricted."
The Source and Remedy of the National Difficulties appears to have had something to say somewhat distinct from the message Marx took away from it. In his various notes on the pamphlet, Marx seems to have paid closest attention to the first six pages of the 40-page pamphlet and to have glossed over the rest somewhat disparagingly or with an eye to the arresting quote.
In his discussion of the pamphlet in Theories of Surplus Value, for example, the reader may wonder if Marx is actually still talking about the pamphlet after a few pages or has gone off on a tangent inspired by the pamphleteer having overlooked the impact of unemployment on wages. It has to be cautioned, though, that Marx's extended comments on the pamphlet appeared in manuscript notes that were published posthumously. They are not polished, fully thought out positions directly intended for publication.
Although the first six pages are indeed interesting, in the context of the pamphlet as a whole their function is to set the stage for the crucial pair of questions that appear on page seven. That is, after deducing from principles of political economy that capital, left to its natural course, would soon do away with further accumulation, the author asks why that seemingly inevitable result has never happened and how it is that with all the presumably labor-saving wonders of modern industry, workers work longer hours and more laboriously than ever before.
Dilke's answer was that government and legislation act ceaselessly to destroy the produce of labor and interfere with the natural development of capital. They do this indirectly by, on the one hand, maintaining "unproductive classes" at a constant proportion to productive laborers and on the other by enabling the immense expansion of "fictitious capital," based ultimately on protectionism and government finance. Government does these things so that it may raise an enormous level of revenues that it couldn't through direct taxation of the laboring population, because "it would have been gross, open, shameless, and consequently impossible."
Instead, it makes the holders of this fictitious capital "particeps criminis" in a stratagem to exact a much-enlarged revenue. As partner in crime, the capitalist lays claim to a generous portion of the booty. Not surprisingly, war is a "powerful cooperator" in this relentless process of destroying the produce of labor and expanding the claims of fictitious capital.
As for the "natural" claims of surplus value exacted by the capitalist, Dilke viewed it as causing the laborer "no real grievance to complain of," a position at least apparently at odds with Marx's views of exploitation and almost certainly incompatible with Engels' assertion that the pamphlet turned Ricardian theory "against capitalist production."
Not only was Dilke not opposed to capitalist production, he described it as leading to a Utopian condition of freedom if only it was left to unfold according to its nature. In his note, Marx objected that the pamphleteer had overlooked two things in coming to such a sanguine conclusion about the trajectory of capitalist accumulation. One was unemployment; the other Marx never got around to specifying.
Dilke's reasoning, although thought provoking, is far from airtight. He confesses in his closing pages that his argument "is not so consecutive, that the proofs do not follow the principles laid down so immediately as I could have wished. The reasoning is too desultory, too loose in its texture." Whether such regrets are heartfelt or simply an obligatory rhetorical gesture of modesty is hard to say. The subject matter itself is elusive and no treatment of it could be exempt some flaws.
But, nevertheless, the case he presents is an original and important one that has as far as I know been overlooked by Marx and his intellectual heirs.
The part of the argument that Marx appropriated to his own analysis -- the author's consistent reference to surplus value as the general form underlying profit, rent and interest was ultimately incidental to Dilke's main points that nature places a limit on accumulation and that the surpassing of those natural limits occurs only as a result of government intervention, which, in effect mandates excess exploitation of labor.
There is a problem that arises from Marx appropriating the (for Marx) correct premise of the pamphlet without first having systematically refuted the author's own deductions from it. What if Dilke's deductions were either equally or more plausible than Marx's? Rather than being a focal point of class struggle, might not surplus value then be "no real grievance to complain of?" Rather than underpinning a contradiction fated to blow the foundation of capital sky-high, might not the tension between "things superfluous" and disposable time have the potential to be adjusted like wing flaps to help bring capital in for a soft landing?
By things superfluous, I refer, first, to the unholy trinity of fictitious capital, unproductive labor and inconvertible paper money and second, to their commodified expression as luxury goods. What I am suggesting is that for Dilke it seems that the primary contradictions of capitalism (to use Marx's expression) lay not so much between capital and labor as between real and fictitious capital, productive and unproductive labor, convertible and inconvertible money, necessities and luxury goods.
This internalizing of the contradictions recalls Solzhenitsyn's observation in the Gulag Archipelago that, "the line separating good and evil passes not through states, nor between classes, nor between political parties either, but right through every human heart, and through all human hearts." Might we not ask if it's not only the line between good and evil that passes through every human heart but also the line between labor and capital, proletariat and bourgeoisie?
From the standpoint of the arguments presented in The Source and Remedy, a proletarian revolution would be entirely unnecessary. Ironically, the non-necessity of the revolution would arrive precisely at the moment in which such a revolution would have become possible.
Keeping Score
Your anonymous, absentee administrator is pleased to see site traffic here breach the daily thousand level. I thought it must be due to the recent Krugman link, but in fact there have been spikes in the past as well. If you check the Sitemeter link (bottom, right column), you can see a new plateau of 16,000 visitors a month was hit on September of 2008. This past month it was 26,000. In general the blog is doing pretty well for a group of deep thinkers. Of course, there is really nothing like it on the left. Among economics blogs of all political stripes, this was ranked 19th, ahead of 'Freakonomics' and other illustrious characters.
We should give a special shout-out to Diane Warth of Karmalised for help on the site management front.
Congratulations to all, and remember folks, the more you post the more readers you will get.
We should give a special shout-out to Diane Warth of Karmalised for help on the site management front.
Congratulations to all, and remember folks, the more you post the more readers you will get.
Milton Friedman and Paul Krugman on the Current Fiscal Policy Debate
Paul Krugman was gracious enough to say our discussion of Ricardian Equivalence exposed a higher-level fallacy with respect to some recent fiscal policy skeptics. Paul also extends the argument in a way that I suspect even Milton Friedman would approve:
This is also a very nice statement of the Barro-Ricardo equivalence proposition, which of course, is an extension of Friedman’s permanent income hypothesis.
suppose that the government introduces a new program that will cause it to spend $100 billion a year every year from now on. To pay for this, it will have to raise taxes by $100 billion a year, permanently — and if consumers take this into account, they might well cut their spending enough to offset the increase in government purchases. But suppose the government introduces a one-time, $100 billion program to repair bridges over the next year. The government will have to issue debt to pay for this, and will have to service that debt, requiring higher taxes — say, $5 billion a year. That’s a much smaller impact on consumers’ future after-tax income than the permanent program. So much less of the spending rise will be offset by a fall in consumer demand. (I’m not considering the effect of the spending in raising income, which would probably cause consumer demand to rise rather than fall.) So economic theory — Milton Friedman’s theory! — says that spending is a more effective form of stimulus than tax cuts.
This is also a very nice statement of the Barro-Ricardo equivalence proposition, which of course, is an extension of Friedman’s permanent income hypothesis.
Saturday, January 31, 2009
"From 2002 to 2008, the five biggest Wall Street securities firms [Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley] paid an estimated $190 billion in bonuses. Those companies churned out $76 billion in combined profits during the same period. Last year, the companies had a combined net loss of $25.3 billion, yet paid bonuses of roughly $26 billion."
Lucchetti, Aaron and Matthew Karnitschnig. 2009. "On Street, New Reality on Pay Sets In: Financial Firms Race to Reset Compensation Policies as U.S. Government Aims to Set Some Limits." Wall Street Journal (31 January): p. B 1.
http://online.wsj.com/article/SB123336341862935387.html?mod=todays_us_money_and_investing
Lucchetti, Aaron and Matthew Karnitschnig. 2009. "On Street, New Reality on Pay Sets In: Financial Firms Race to Reset Compensation Policies as U.S. Government Aims to Set Some Limits." Wall Street Journal (31 January): p. B 1.
http://online.wsj.com/article/SB123336341862935387.html?mod=todays_us_money_and_investing
Marx before Minsky
Previously, I made the case that the financial meltdown was basically a delayed response to the severe neglect of investment in plant, equipment, and infrastructure. I also explained the cause of this neglect.
http://radicalnotes.com/content/view/73/39/
Here, I'm going to discuss the financial side of the crisis, which, while secondary, is still important.
This crisis has been nicely described as a Minsky moment, but it may just as well be described as a Marx moment. Marx's term fictitious capital and the more conventional discounted present value are not entirely different, but Marx's expression emphasizes the fact that the future is both unknown and unknowable.
As Keynes explained very well, the future takes on an appearance of being known, but this knowledge is not knowledge at all. It is merely an extrapolation of the past.
There was a time when the returns from holding General Motors stock would have seemed very predictable, almost as much as an investment with Bernie Madoff.
Anticipating Hyman Minsky, Marx realized that over time people would become less risk averse and the risk-corrected discounted present values would start to rise. Extrapolating, this trend would be expected to continue.
What I did, many years ago, in Karl Marx's Crises Theory: Labor, Scarcity and Fictitious Capital (New York: Praeger, 1987) was to explain that this psychological phenomenon would tend to delink prices from underlying values. Expensive corporate headquarters would be built into the overhead costs of business. At the same time, as such capital values accumulate, measures of invested capital will increase, pulling down the rate of profit. Hunting for yields to maintain profit rates will set off bubbles, further promoting an even more speculative environment. Over time, this speculative psychology will eliminate the limited coordinating powers of the market and set the stage for a future crisis.
When the crisis comes, much of the fictitious capital will disappear, bringing prices more in line with underlying values.
In a sense, this part of Marx's crisis theory is not that far from Hayek's, but I think that Hayek may have taken this from Marx without attribution.
All this sounds very Minskyian. Of course, Minsky knew his Marx, just as he knew his Keynes. And Keynes, though never really studied Marx by his own confession, was surrounded by people who did.
http://radicalnotes.com/content/view/73/39/
Here, I'm going to discuss the financial side of the crisis, which, while secondary, is still important.
This crisis has been nicely described as a Minsky moment, but it may just as well be described as a Marx moment. Marx's term fictitious capital and the more conventional discounted present value are not entirely different, but Marx's expression emphasizes the fact that the future is both unknown and unknowable.
As Keynes explained very well, the future takes on an appearance of being known, but this knowledge is not knowledge at all. It is merely an extrapolation of the past.
There was a time when the returns from holding General Motors stock would have seemed very predictable, almost as much as an investment with Bernie Madoff.
Anticipating Hyman Minsky, Marx realized that over time people would become less risk averse and the risk-corrected discounted present values would start to rise. Extrapolating, this trend would be expected to continue.
What I did, many years ago, in Karl Marx's Crises Theory: Labor, Scarcity and Fictitious Capital (New York: Praeger, 1987) was to explain that this psychological phenomenon would tend to delink prices from underlying values. Expensive corporate headquarters would be built into the overhead costs of business. At the same time, as such capital values accumulate, measures of invested capital will increase, pulling down the rate of profit. Hunting for yields to maintain profit rates will set off bubbles, further promoting an even more speculative environment. Over time, this speculative psychology will eliminate the limited coordinating powers of the market and set the stage for a future crisis.
When the crisis comes, much of the fictitious capital will disappear, bringing prices more in line with underlying values.
In a sense, this part of Marx's crisis theory is not that far from Hayek's, but I think that Hayek may have taken this from Marx without attribution.
All this sounds very Minskyian. Of course, Minsky knew his Marx, just as he knew his Keynes. And Keynes, though never really studied Marx by his own confession, was surrounded by people who did.
Does Protection Have No Impact on Aggregate Demand?
Nick Rowe makes an argument against the “Buy American” provisions that I have made in the past:
Nick then admits that if we are in a liquidity trap, the interest rate to capital account channel is cut off so a fiscal stimulus does not necessarily crowd-out net exports but then he writes:
Dani Rodrik, however, takes another view:
Dani also notes:
I guess Nick can come back and say Dani was assuming fixed exchange rates. So how is this all supposed to work out under fixed interest rates but floating exchange rates?
Our model is essentially:
Y = D(Y) + X(Y, e)
where Y = real GDP, D = domestic demand, X = net exports, and e is the real exchange rate. Let’s consider a hypothetical economy known as Obamia that has a domestic marginal propensity to spend = 0.8 and a marginal propensity to import = 0.2 and wants to increase real GDP by $1000 (think of America as one billion times the size of Obamia). Under fixed exchange rates and no trade protection, the multiplier is 2.5 so government purchases would have to be raised by $400 if no other policy tool was used. As real GDP rose increased by $1000, imports would increase by $200.
But suppose that the conservative part of Obamia balks at a large fiscal stimulus and its leaders reach some bipartisan compromise of having government purchases rise by only $200. Dani’s point is that if we adopt a mercantilist policy to increase the net export schedule by $200, then we can still achieve the real GDP goal.
Nick’s floating exchange rate version of the model, however, has the exchange rate automatically adjust such that the ultimate change in net exports is zero. In this case, the multiplier for fiscal policy is 5 and the multiplier for mercantilist policy is zero. In other words, a $200 increase in government purchases still achieves the goal of increasing real GDP by $1000. Lesson learned – floating exchange rates can achieve the same goal as Dani’s mercantilism. There is one difference, however, between the two approaches. Mercantilism often works by protecting the import competing sector. Under floating exchange rates, we are more likely to see increased employment in the export sector.
Most (all?) economists agree that in a global recession, when each country wants to boost demand for the goods it produces, policies which steer demand to domestically-produced goods are individually rational (provided other countries don't retaliate), but collectively irrational when all countries do the same. I think most economists are wrong. It's not just collectively irrational, but individually irrational as well, at least for countries with flexible exchange rates ... In normal times, outside of a liquidity trap, an expansionary fiscal policy will put upward pressure on interest rates as the demand for money increases with higher income. Or the central bank raises interest rates to offset the increased demand to keep inflation on target. An increase in domestic interest rates will cause a capital account inflow, which causes the exchange rate to appreciate. The exchange rate appreciation will cause net exports to fall. The fall in net exports offsets the expansionary fiscal policy. Under imperfect capital mobility the offset will be partial. Under perfect capital mobility there will be full offset, for a small open economy. So in normal times, part or all of the increased demand from an expansionary fiscal policy will be lost due to a decline in net exports. Some or all of the extra demand just leaks out to foreign countries.
Nick then admits that if we are in a liquidity trap, the interest rate to capital account channel is cut off so a fiscal stimulus does not necessarily crowd-out net exports but then he writes:
A "buy domestic" policy will not shift demand towards domestic goods. If it did, so that imports fell and net exports increased, the current account surplus would merely cause the exchange rate to appreciate so that net exports fell to their original level. The current account must stay the same, because the capital account stays the same, because the interest rate differential stays the same, because interest rates stay the same.
Dani Rodrik, however, takes another view:
Yes it does. And not just in theory, but also in practice. The evidence comes from the 1930s, and from the work of Ben Bernanke himself (along with other scholars like Barry Eichengreen). The important finding is that countries that devalued their currencies by getting off the gold standard were able to recover more quickly, thanks in part to an increase in their net exports relative to countries that stayed on gold. Note that a currency depreciation amounts to a policy of combining import tariffs with export subsidies--hence the mercantilist intent and effect.
Dani also notes:
How much of a boost to economic activity will a fiscal stimulus provide? For those who believe that we have entered a Keynesian world of shortage of aggregate demand--me included--the answer depends on the Keynesian multiplier. The size of this multiplier depends in turn on three things in particular, the marginal propensity to consume (c), the marginal tax rate (t), and the marginal propensity to import (m). If c = 0.8, t = 0.2, and m = 0.2, the Keynesian multiplier is 1.8 (=1/(1-c(1-t)+m)). A $1 trillion fiscal stimulus would increase GDP by $1.8 trillion. Now suppose that we had a way to raise the multiplier by more than half, from 1.8 to 2.8. The same fiscal stimulus would now produce an increase in GDP of $2.8 trillion--quite a difference. Nice deal if you can get it. In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do--but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care?
I guess Nick can come back and say Dani was assuming fixed exchange rates. So how is this all supposed to work out under fixed interest rates but floating exchange rates?
Our model is essentially:
Y = D(Y) + X(Y, e)
where Y = real GDP, D = domestic demand, X = net exports, and e is the real exchange rate. Let’s consider a hypothetical economy known as Obamia that has a domestic marginal propensity to spend = 0.8 and a marginal propensity to import = 0.2 and wants to increase real GDP by $1000 (think of America as one billion times the size of Obamia). Under fixed exchange rates and no trade protection, the multiplier is 2.5 so government purchases would have to be raised by $400 if no other policy tool was used. As real GDP rose increased by $1000, imports would increase by $200.
But suppose that the conservative part of Obamia balks at a large fiscal stimulus and its leaders reach some bipartisan compromise of having government purchases rise by only $200. Dani’s point is that if we adopt a mercantilist policy to increase the net export schedule by $200, then we can still achieve the real GDP goal.
Nick’s floating exchange rate version of the model, however, has the exchange rate automatically adjust such that the ultimate change in net exports is zero. In this case, the multiplier for fiscal policy is 5 and the multiplier for mercantilist policy is zero. In other words, a $200 increase in government purchases still achieves the goal of increasing real GDP by $1000. Lesson learned – floating exchange rates can achieve the same goal as Dani’s mercantilism. There is one difference, however, between the two approaches. Mercantilism often works by protecting the import competing sector. Under floating exchange rates, we are more likely to see increased employment in the export sector.
The House's Modern-Day Hoovers
Time to turn the microphone over to Colbert I. King:
The pain of this recession was apparently lost on Boehner and his House Republicans. Their public fretting over the future impact of deficits on today's children and grandchildren is disingenuous. In truth, what really gets them hot and bothered is the thought of government taking on more responsibility to fight this deepening recession, and the huge amount of public spending it will take to pull the economy out of the doldrums. It so happened that the Republican standard-bearer in the 1920s, Herbert Hoover, felt that way, too. Hoover's distaste for government, and his belief that business was the answer to the country's economic tailspin, got Democrat Franklin Delano Roosevelt elected president in 1932. In their slavish devotion to Hooverism, today's Republicans are repeating the mistakes that banished their party to the political wilderness in the '30s.
Friday, January 30, 2009
The Disastrous Toll of Fictitious Value
The world of fictitious value mesmerizes itself by using a strange language. Financial operations refer to their "shop," as if they were standing over a workbench shaping metal or wood. Then they talk about "value creation."
What does that mean? Suppose I start a private equity company. People give me money to create value. I can create this value by taking over a company with very little of my own money. I need a banking accomplice to give me a bridge loan and a compliant company management. Then I can "unlock" the firm's value.
Once source of untapped value is a pension fund. Workers can be granted stock in the company as compensation. I can take over the firm, then use the pension fund to pay for some of the money I own. I can load the firm up with debt and charge it exorbitant fees. Now I have begun to "unlock" value.
Next, I can fire lots of workers, including those whose pension fund financed my takeover. By doing so, I can show that I am creating efficiencies. Once I cook the books to make the firm look profitable and sell it to a unsuspecting public.
Should anyone be surprised that many of these companies have been going bankrupt? And the workers whose pensions were central to the process? Well, they have some pretty paper.
Ain't capital wonderful?
What does that mean? Suppose I start a private equity company. People give me money to create value. I can create this value by taking over a company with very little of my own money. I need a banking accomplice to give me a bridge loan and a compliant company management. Then I can "unlock" the firm's value.
Once source of untapped value is a pension fund. Workers can be granted stock in the company as compensation. I can take over the firm, then use the pension fund to pay for some of the money I own. I can load the firm up with debt and charge it exorbitant fees. Now I have begun to "unlock" value.
Next, I can fire lots of workers, including those whose pension fund financed my takeover. By doing so, I can show that I am creating efficiencies. Once I cook the books to make the firm look profitable and sell it to a unsuspecting public.
Should anyone be surprised that many of these companies have been going bankrupt? And the workers whose pensions were central to the process? Well, they have some pretty paper.
Ain't capital wonderful?
(Harrisonburg, Pay Attention) The Wonders of City Bike Systems
There is now a nice, green policy that is being followed in as many as 21 European cities that is not yet being followed in a single US one that I am aware of, having just googled a bunch on the matter. It is a city bike system, also sometimes generically called a "Velib" system after the very popular and famous one in Paris that began in 2007. However, while it is doing very well (see the Wikipedia entry for "Velib" about it), it has some oddities that may make it less desirable for cities in the US thinking of adopting such a system, it being run by a private company for the city.
Probably the oldest running, since the 1970s, and the best run is the one in Copenhagen, where nearly 40% of trips are now done by city bike. The city (actually through a non-profit organization) owns bikes that are kept in parking stands. In Paris they make you pay a subscription, and then you can access the bikes, which are locked up in their stands. In both the stands are all over the city, but in Copenhagen they are free. You just pull one out and ride it to another stand. Reduces traffic, improves health, reduces pollution, and any city in the US would look very cool and progressive and innovative if it were the first one in the country to do it. The bikes tend to be three speed and pretty tough with a good-sized basket in front. The biggest problems have been with car traffic, and in Copenhagen, with cars turning right and not paying attention to bikes coming up. Anyway, a nice link about the Copenhagen system.
Probably the oldest running, since the 1970s, and the best run is the one in Copenhagen, where nearly 40% of trips are now done by city bike. The city (actually through a non-profit organization) owns bikes that are kept in parking stands. In Paris they make you pay a subscription, and then you can access the bikes, which are locked up in their stands. In both the stands are all over the city, but in Copenhagen they are free. You just pull one out and ride it to another stand. Reduces traffic, improves health, reduces pollution, and any city in the US would look very cool and progressive and innovative if it were the first one in the country to do it. The bikes tend to be three speed and pretty tough with a good-sized basket in front. The biggest problems have been with car traffic, and in Copenhagen, with cars turning right and not paying attention to bikes coming up. Anyway, a nice link about the Copenhagen system.
Draft Submission to the White House Task Force on Working Families
by the Sandwichman
White House press release:
· ensuring that the benefits of economic growth reach middle-class, working families;
· improving work and family balance;
· restoring labor standards;
· focusing on "green jobs" that "use renewable energy resources, reduce pollution, conserve energy and natural resources and reconstitute waste."
The underlying argument of this submission is that it is time to reconsider and rehabilitate the "surprisingly apposite" founding philosophy of the American labor movement. "Sharing the work and sparing the planet" comprehensively addresses the issues of green jobs, labor standards, work and family balance and fairness in the distribution of the benefits of economic growth.
White House press release:
President Barack Obama today announced the creation of a White House Task Force on Middle Class Working Families to be chaired by Vice President Joe Biden. The Task Force is a major initiative targeted at raising the living standards of middle-class, working families in America. It is comprised of top-level administration policy makers, and in addition to regular meetings, it will conduct outreach sessions with representatives of labor, business, and the advocacy communities.In response to the White House announcement, the Sandwichman is posting his Draft Submission to the White House Task Force on Working Families on EconoSpeak. This submission specifically addresses four of the major objectives for the Task Force, as elaborated in statements by President Obama and Vice President Biden, and in the theme for the first meeting of the Task Force on February 27, 2009 in Philadelphia, Pennsylvania:
· ensuring that the benefits of economic growth reach middle-class, working families;
· improving work and family balance;
· restoring labor standards;
· focusing on "green jobs" that "use renewable energy resources, reduce pollution, conserve energy and natural resources and reconstitute waste."
The underlying argument of this submission is that it is time to reconsider and rehabilitate the "surprisingly apposite" founding philosophy of the American labor movement. "Sharing the work and sparing the planet" comprehensively addresses the issues of green jobs, labor standards, work and family balance and fairness in the distribution of the benefits of economic growth.
Real GDP and Its Components: 2008QIV versus 2007QIII
BEA released its advanced estimate for the last quarter of 2008 and the news was awful:
While real GDP rose somewhat during the first two quarters of 2008, real GDP fell a bit during the last quarter of 2007. Real GDP was running at an annualized clip of $11,625.7 billion as of 2007QIII but real GDP for 2008QIV was reported to be only $11,599.4 billion.
I guess the silver lining was that both government purchases and net exports continued to improve. The improvement in real exports was tiny but imports fell – likely as a result of a weaker economy. Consumption demand fell by more than $90 billion – while investment demand fell by more than $190 billion. Maybe this will wake up a few Republicans in the Senate that we have indeed entered into a deep recession.
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 3.8 percent in the fourth quarter of 2008, (that is, from the third quarter to the fourth quarter), according to advance estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP decreased 0.5 percent.
While real GDP rose somewhat during the first two quarters of 2008, real GDP fell a bit during the last quarter of 2007. Real GDP was running at an annualized clip of $11,625.7 billion as of 2007QIII but real GDP for 2008QIV was reported to be only $11,599.4 billion.
I guess the silver lining was that both government purchases and net exports continued to improve. The improvement in real exports was tiny but imports fell – likely as a result of a weaker economy. Consumption demand fell by more than $90 billion – while investment demand fell by more than $190 billion. Maybe this will wake up a few Republicans in the Senate that we have indeed entered into a deep recession.
About Hedge Funds
· ‘Survivorship bias’
Hedge funds that die are not included in the index, and since the mortality rate among hedge funds is higher than among mutual funds, it produces a greater gap between the returns reported in the indices versus those earned by a typical investor. There are about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.
· Distortion of returns reported to hedge funds versus the typical investor
– associated with the higher mortality rate of hedge funds. Also the reporting for hedge funds is voluntary and they tend not to report bad results.
· Lack of auditing.
They represent a relatively small share of total financial assets but their relative share has increased significantly.
· Substantial leverage
Hedge funds have the ability to take on substantial leverage.
· Large potential impact on financial market conditions
The substantial leverage of hedge funds magnifies the potential impact on financial market conditions.
· Hedge funds play a large (inappropriate) role as an insurer for regulated institutions
"Hedge funds have become an important source of protection to regulated institutions by being large sellers of credit insurance in the rapidly growing market for credit default swaps . But highly-leveraged and unregulated hedge funds are not the ideal type of insurer!"
· Hedge funds are receiving money from Australian superannuation funds.
Because of the current great doubt experienced by the two major political parties about the virtues of the fiduciary habits of ordinary workers, they feel compelled to take their savings away. The money is placed in pension funds for their old age. Workers are not allowed to withdraw this money and especially they are not permitted any control over the way in which these dollars are invested. (Meanwhile we'll continue to tout the virtues of a 'free market' system).
..Superannuation fund trustees have traditionally not invested in hedge funds both because of the infancy of the hedge fund market in Australia and because of the legal obligations described above. Rather,superannuation trustees have tended to prefer to invest in fixed interest investments, cash, government bonds and property investment trusts.
Hedge funds have not been favoured areas of investment principally because of perceptions concerning:
• the volatility of returns;
• level of regulation;
• the perceived lack of transparency of hedge funds ;
• levels of management fees; and
• additional risks associated with the use of derivatives by hedge fund managers.
In order to make such investments, superannuation trustees need to give careful consideration to the legal restrictions imposed in the form of general trustee duties and the investment parameters imposed by their trust deed, investment plan and the SIS Act.
However, despite this traditional reluctance to invest in hedge funds, superannuation trustees in Australia are now starting to use hedge funds to diversify their investments. Hedge fund investment is providing superannuation trustees with a way of counter-balancing the decline in returns on investments in traditional products. Those trustees are also attracted by the relative low correlation between the performance of some hedge funds and that of the equity markets more generally. There is also a considerable degree of liquidity with hedge funds, something that real estate or other structured assets may not offer. Finally, the introduction of hedge funds for retail investors has made the product apparently more mainstream and therefore, for trustees, possibly less likely to result in fund member concern..."
Australia: Some Legal Issues relating to Superannuation Trustees as Hedge Fund Investors
By Tessa Hoser and Katherine Henzell, Blake Dawson Waldron
1 December 2002.
· One third of hedge fund capital comes from pension funds
One third of hedge fund capital comes from pension funds. “Pension funds reusing hedge fund investment to diversify their own risks, but a situation where almost one-third of the capital for institutions on the cutting edge of financial risks comes from institutions whose first priority is safe investments certainly bears watching”.
Rodrigo Rato, IMF Managing Director
· The insurance provided by hedge funds lacks integrity.
1. How can you collect on an insurance contract when no-one can agree on the amount of the losses??
2. Both the buyer and seller of CDS may trade their obligation in the OTC market. There is nothing to prevent the insurer from offloading his obligation to an unqualified or unreliable party, in the process irreparably damaging the value of the insurance originally purchased.
I would be interested to learn if anyone can shed light on a potential problem in financial markets larger by at least an order of magnitude greater than subprime + CDO s sold to the SIV s and other institutions that hold them. Dr. Roubini has put numbers on subprime and alt-A plus CDO s, of about 1.5 trillion, and we don't have good estimates yet for auto loan and credit card securitized debt. Dwarfing these numbers is the 30 to 40 trillion dollar (or more) value of credit default swaps (CDS) outstanding. These swaps are essentially insurance policies between 2 parties. The FIRST buyer, presumably, is one with an asset (bond or securitized debt) to hedge. The FIRST seller, presumably, is a party known to the buyer who is financially able to provide the contracted protection in the event being insured (default) in return for the fee collected. But if both sides of this equation may TRADE their obligation in the OTC market, what is to prevent the INSURER from offloading his obligation to an UNQUALIFIED party, damaging irreparably the value of insurance originally purchased. If the insured has no control over the assignment to a third party of the obligation, of what value is the insurance. You may recall that in the DELPHI automotive bankruptcy, with 2 billion in bonds outstanding, there were over 20 billion in CDS outstanding. If the presumed solvency of unregulated insurance providers has enabled careless debt instrument purchases, watch out.
Written by RHK on 2007-11-06 08:01:26
3. The Over the Counter (OTC) trade is opaque and allows for the creation of fictionalised capital.
· There’s been a dramatic acceleration in number and type of derivative instruments.
(But current accounting and regulatory practice – as of December 2007 - allow for the creation of huge amounts of imaginary capital that is opaque and not subject to appropriate credit ratings. With the possibility of firms upping their trade in derivatives to hide the day of reckoning that comes with insolvency. See the linked article on credit default swaps.)
Hedge funds (holding Russian corporate bonds with ‘put options’) are demanding either full payment of debt or much higher interest rates; up to 16% during 2008.
· The total number of hedge funds has grown dramatically.
In 2007 there existed about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.
· Hedge funds are ‘Program Trading outfits’. They make money by buying large baskets of stocks.
A hedge fund, like investment banks, are referred to as ‘Program Trading outfits’. They make money by buying large baskets of stocks and then will blow out of those positions when their computers are programmed to sell.
· The range of hedge fund returns is large and unprecedented.
· Hedge fund managers’ earnings are astronomical. are determined by the gains of their own capital in their funds and their share of their firm’s management and performance fees. Most funds charge a 5% management fee and a 44% performance fee)
Of the 200-plus funds that Permal invests in, the poorest performer in the year to date – from January through to November 15 – had reported a loss of 7 per cent, and the top performer had returned 70 per cent. [unsourced]
“…Combined, the top 50 hedge fund managers last year earned $29 billion. That figure represents the managers’ own pay and excludes the compensation of their employees. Five of the top 10, including Mr. Simons and Mr. Soros, were also at the top of the list for 2006….”
Wall Street Winners Get Billion-Dollar Paydays
By JENNY ANDERSON
Published: April 16, 2008
+
“Hedge fund managers, those masters of a secretive, sometimes volatile financial universe, are making money on a scale that once seemed unimaginable, even in Wall Street's rarefied realms. One manager, John Paulson, made $3.7 billion last year. He reaped that bounty, probably the richest in Wall Street history, by betting against certain mortgages and complex financial products that held them. Paulson, the founder of Paulson & Company, was not the only big winner. The hedge fund managers James Simons and George Soros each earned almost $3 billion last year, according to an annual ranking of top hedge fund earners by Institutional Investor's Alpha magazine, which comes out Wednesday. Hedge fund managers have redefined notions of wealth in recent years. And the richest among them are redefining those notions once again. Their unprecedented and growing affluence underscores the gaping inequality between the millions of Americans facing stagnating wages and rising home foreclosures and an agile financial elite that seems to thrive in good times and bad. Such profits may also prompt more calls for regulation of the industry…”
Hedge fund managers get billion-dollar paydays
By Jenny Anderson
Wednesday, April 16, 2008
· G8 finance ministers meet on the issues relating to hedge funds but fail to address the issues.
G8 finance ministers met on the issue of the lack of supervision of hedge funds but they failed to address the issue. (When?, Source?)
Hedge funds that die are not included in the index, and since the mortality rate among hedge funds is higher than among mutual funds, it produces a greater gap between the returns reported in the indices versus those earned by a typical investor. There are about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.
· Distortion of returns reported to hedge funds versus the typical investor
– associated with the higher mortality rate of hedge funds. Also the reporting for hedge funds is voluntary and they tend not to report bad results.
· Lack of auditing.
They represent a relatively small share of total financial assets but their relative share has increased significantly.
· Substantial leverage
Hedge funds have the ability to take on substantial leverage.
· Large potential impact on financial market conditions
The substantial leverage of hedge funds magnifies the potential impact on financial market conditions.
· Hedge funds play a large (inappropriate) role as an insurer for regulated institutions
"Hedge funds have become an important source of protection to regulated institutions by being large sellers of credit insurance in the rapidly growing market for credit default swaps . But highly-leveraged and unregulated hedge funds are not the ideal type of insurer!"
· Hedge funds are receiving money from Australian superannuation funds.
Because of the current great doubt experienced by the two major political parties about the virtues of the fiduciary habits of ordinary workers, they feel compelled to take their savings away. The money is placed in pension funds for their old age. Workers are not allowed to withdraw this money and especially they are not permitted any control over the way in which these dollars are invested. (Meanwhile we'll continue to tout the virtues of a 'free market' system).
..Superannuation fund trustees have traditionally not invested in hedge funds both because of the infancy of the hedge fund market in Australia and because of the legal obligations described above. Rather,superannuation trustees have tended to prefer to invest in fixed interest investments, cash, government bonds and property investment trusts.
Hedge funds have not been favoured areas of investment principally because of perceptions concerning:
• the volatility of returns;
• level of regulation;
• the perceived lack of transparency of hedge funds ;
• levels of management fees; and
• additional risks associated with the use of derivatives by hedge fund managers.
In order to make such investments, superannuation trustees need to give careful consideration to the legal restrictions imposed in the form of general trustee duties and the investment parameters imposed by their trust deed, investment plan and the SIS Act.
However, despite this traditional reluctance to invest in hedge funds, superannuation trustees in Australia are now starting to use hedge funds to diversify their investments. Hedge fund investment is providing superannuation trustees with a way of counter-balancing the decline in returns on investments in traditional products. Those trustees are also attracted by the relative low correlation between the performance of some hedge funds and that of the equity markets more generally. There is also a considerable degree of liquidity with hedge funds, something that real estate or other structured assets may not offer. Finally, the introduction of hedge funds for retail investors has made the product apparently more mainstream and therefore, for trustees, possibly less likely to result in fund member concern..."
Australia: Some Legal Issues relating to Superannuation Trustees as Hedge Fund Investors
By Tessa Hoser and Katherine Henzell, Blake Dawson Waldron
1 December 2002.
· One third of hedge fund capital comes from pension funds
One third of hedge fund capital comes from pension funds. “Pension funds reusing hedge fund investment to diversify their own risks, but a situation where almost one-third of the capital for institutions on the cutting edge of financial risks comes from institutions whose first priority is safe investments certainly bears watching”.
Rodrigo Rato, IMF Managing Director
· The insurance provided by hedge funds lacks integrity.
1. How can you collect on an insurance contract when no-one can agree on the amount of the losses??
2. Both the buyer and seller of CDS may trade their obligation in the OTC market. There is nothing to prevent the insurer from offloading his obligation to an unqualified or unreliable party, in the process irreparably damaging the value of the insurance originally purchased.
I would be interested to learn if anyone can shed light on a potential problem in financial markets larger by at least an order of magnitude greater than subprime + CDO s sold to the SIV s and other institutions that hold them. Dr. Roubini has put numbers on subprime and alt-A plus CDO s, of about 1.5 trillion, and we don't have good estimates yet for auto loan and credit card securitized debt. Dwarfing these numbers is the 30 to 40 trillion dollar (or more) value of credit default swaps (CDS) outstanding. These swaps are essentially insurance policies between 2 parties. The FIRST buyer, presumably, is one with an asset (bond or securitized debt) to hedge. The FIRST seller, presumably, is a party known to the buyer who is financially able to provide the contracted protection in the event being insured (default) in return for the fee collected. But if both sides of this equation may TRADE their obligation in the OTC market, what is to prevent the INSURER from offloading his obligation to an UNQUALIFIED party, damaging irreparably the value of insurance originally purchased. If the insured has no control over the assignment to a third party of the obligation, of what value is the insurance. You may recall that in the DELPHI automotive bankruptcy, with 2 billion in bonds outstanding, there were over 20 billion in CDS outstanding. If the presumed solvency of unregulated insurance providers has enabled careless debt instrument purchases, watch out.
Written by RHK on 2007-11-06 08:01:26
3. The Over the Counter (OTC) trade is opaque and allows for the creation of fictionalised capital.
· There’s been a dramatic acceleration in number and type of derivative instruments.
(But current accounting and regulatory practice – as of December 2007 - allow for the creation of huge amounts of imaginary capital that is opaque and not subject to appropriate credit ratings. With the possibility of firms upping their trade in derivatives to hide the day of reckoning that comes with insolvency. See the linked article on credit default swaps.)
Hedge funds (holding Russian corporate bonds with ‘put options’) are demanding either full payment of debt or much higher interest rates; up to 16% during 2008.
· The total number of hedge funds has grown dramatically.
In 2007 there existed about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.
· Hedge funds are ‘Program Trading outfits’. They make money by buying large baskets of stocks.
A hedge fund, like investment banks, are referred to as ‘Program Trading outfits’. They make money by buying large baskets of stocks and then will blow out of those positions when their computers are programmed to sell.
· The range of hedge fund returns is large and unprecedented.
· Hedge fund managers’ earnings are astronomical. are determined by the gains of their own capital in their funds and their share of their firm’s management and performance fees. Most funds charge a 5% management fee and a 44% performance fee)
Of the 200-plus funds that Permal invests in, the poorest performer in the year to date – from January through to November 15 – had reported a loss of 7 per cent, and the top performer had returned 70 per cent. [unsourced]
“…Combined, the top 50 hedge fund managers last year earned $29 billion. That figure represents the managers’ own pay and excludes the compensation of their employees. Five of the top 10, including Mr. Simons and Mr. Soros, were also at the top of the list for 2006….”
Wall Street Winners Get Billion-Dollar Paydays
By JENNY ANDERSON
Published: April 16, 2008
+
“Hedge fund managers, those masters of a secretive, sometimes volatile financial universe, are making money on a scale that once seemed unimaginable, even in Wall Street's rarefied realms. One manager, John Paulson, made $3.7 billion last year. He reaped that bounty, probably the richest in Wall Street history, by betting against certain mortgages and complex financial products that held them. Paulson, the founder of Paulson & Company, was not the only big winner. The hedge fund managers James Simons and George Soros each earned almost $3 billion last year, according to an annual ranking of top hedge fund earners by Institutional Investor's Alpha magazine, which comes out Wednesday. Hedge fund managers have redefined notions of wealth in recent years. And the richest among them are redefining those notions once again. Their unprecedented and growing affluence underscores the gaping inequality between the millions of Americans facing stagnating wages and rising home foreclosures and an agile financial elite that seems to thrive in good times and bad. Such profits may also prompt more calls for regulation of the industry…”
Hedge fund managers get billion-dollar paydays
By Jenny Anderson
Wednesday, April 16, 2008
· G8 finance ministers meet on the issues relating to hedge funds but fail to address the issues.
G8 finance ministers met on the issue of the lack of supervision of hedge funds but they failed to address the issue. (When?, Source?)
Wall Street Bonuses in 2008 – Disappointing or Shameful?
When I first heard that bonuses paid to Wall Street types dropped from around $33 billion in 2007 to only $18.4 billion, the Manhattan resident in me thought – “ouch, that’s going to hurt the already sagging aggregate demand around here”. Call me a Keynesian. The President had a different thought:
OK – we don’t reward incompetence and we don’t give income assistance during hard times to the very wealthy. I’m with you Mr. President!
Update: Rudy Guiliani goes Keynesian on this story too:
Memo to self – in the future, check out what Josh Marshall has to say before blogging on these types of issues:
President Obama branded Wall Street bankers “shameful” on Thursday for giving themselves nearly $20 billion in bonuses as the economy was deteriorating and the government was spending billions to bail out some of the nation’s most prominent financial institutions. “There will be time for them to make profits, and there will be time for them to get bonuses”
OK – we don’t reward incompetence and we don’t give income assistance during hard times to the very wealthy. I’m with you Mr. President!
Update: Rudy Guiliani goes Keynesian on this story too:
Bonuses for Wall Street fat cats are easy political fodder in uncertain economic times, but former New York Mayor Rudy Giuliani said Friday cutting corporate bonuses means slashing jobs in the Big Apple. "If you somehow take that bonus out of the economy, it really will create unemployment," he said on CNN's "American Morning." "It means less spending in restaurants, less spending in department stores, so everything has an impact."
Memo to self – in the future, check out what Josh Marshall has to say before blogging on these types of issues:
As a resident of New York City, I think it's probably true that those dollars do do a decent amount for New York City economy, in the form of tax dollars and supporting local businesses -- though I would question its relative efficiency in stimulus terms. (And that's in large part because it's a lot of money in a fairly restricted geographic area.) But the government support that keeps these firms afloat doesn't just come from New York City, does it? This is the definition of trickle down -- give huge amounts of money to a small number of individuals, most of which will be socked away but a relatively small percentage of which will be spent on luxury goods. Amazing that this goof was once the GOP frontrunner for president.
Thursday, January 29, 2009
Stimulus Pork
Senator Max Baucus got $26 billion for private equity companies -- the vultures that buy companies, load them up with debt, collect exorbitant fees, and then try to sell them to the unsuspecting public.
Senator Robert Byrd is getting $4.6 billion for clean coal. "Clean, carbon-neutral coal can be a 'green' energy," Byrd said.
What the hell other crap is out there?
http://www.commondreams.org/headline/2009/01/28-2
Drucker, Jesse and Peter Lattman. 2009. "Senate Provision Would Let Buyout Firms Defer Taxes on Canceled Debt." Wall Street Journal (28 January).
http://online.wsj.com/article/SB123310671578422199.html?mod=todays_us_page_one
"Senate Finance Committee Chairman Max Baucus included language in the tax portion of the proposed stimulus package that would allow companies to defer income taxes triggered when they repurchase their own troubled debt at a discount. That would benefit a wide array of companies and industries, but would be a particular windfall to private-equity firms, which acquire companies using piles of debt in hopes of producing large profits for their investors. Amid the economic downturn, many of these deals have run into trouble and the firms are seeking to refinance them."
"The Joint Committee on Taxation estimates the proposal would cost the government roughly $26 billion over the next three years."
"A study by Boston Consulting Group found that, of 328 private-equity portfolio companies, roughly 60% had debt trading at levels considered "distressed"."
"To stave off default, private-equity executives have made reduction of their companies' debt a top priority. The companies are asking investors to swap their bonds for ones with lower values and longer maturities and also seeking to settle debt with cash. However, reducing debt levels can result in a big tax bill. For example, if a company issues $1 billion in debt, but later runs into trouble and exchanges it for new debt worth $600 million -- or buys it back for $600 million -- the remaining $400 million in cash is taxable income."
Senator Robert Byrd is getting $4.6 billion for clean coal. "Clean, carbon-neutral coal can be a 'green' energy," Byrd said.
What the hell other crap is out there?
http://www.commondreams.org/headline/2009/01/28-2
Drucker, Jesse and Peter Lattman. 2009. "Senate Provision Would Let Buyout Firms Defer Taxes on Canceled Debt." Wall Street Journal (28 January).
http://online.wsj.com/article/SB123310671578422199.html?mod=todays_us_page_one
"Senate Finance Committee Chairman Max Baucus included language in the tax portion of the proposed stimulus package that would allow companies to defer income taxes triggered when they repurchase their own troubled debt at a discount. That would benefit a wide array of companies and industries, but would be a particular windfall to private-equity firms, which acquire companies using piles of debt in hopes of producing large profits for their investors. Amid the economic downturn, many of these deals have run into trouble and the firms are seeking to refinance them."
"The Joint Committee on Taxation estimates the proposal would cost the government roughly $26 billion over the next three years."
"A study by Boston Consulting Group found that, of 328 private-equity portfolio companies, roughly 60% had debt trading at levels considered "distressed"."
"To stave off default, private-equity executives have made reduction of their companies' debt a top priority. The companies are asking investors to swap their bonds for ones with lower values and longer maturities and also seeking to settle debt with cash. However, reducing debt levels can result in a big tax bill. For example, if a company issues $1 billion in debt, but later runs into trouble and exchanges it for new debt worth $600 million -- or buys it back for $600 million -- the remaining $400 million in cash is taxable income."
Stimulus Debate: Flakey Economics
Jeff Flake had a novel argument against increasing at least one form of additional government spending as Josh Marshall notes and rebuts:
Net income for both Ford and GM has recently been negative so does Congressman Flake think that if the American automobile manufacturers are somehow encouraged to hire more workers that this fails to constitute stimulus? In fact, a lot of companies currently have negative net income. According to Flake’s “logic”, the prospect for a recovery is really dismal!
Now he's explaining how capital spending on AMTRAK is also not stimulus because AMTRAK doesn't run a profit. Again, total non-sequitur. I think rail is something we should be spending a lot more on. But you can certainly disagree with that on policy terms. But you can't claim that that capital spending on rail stock and rail upgrades doesn't provide jobs. Of course it provides jobs. And whether Amtrak is profitable or not is completely beside the point.
Net income for both Ford and GM has recently been negative so does Congressman Flake think that if the American automobile manufacturers are somehow encouraged to hire more workers that this fails to constitute stimulus? In fact, a lot of companies currently have negative net income. According to Flake’s “logic”, the prospect for a recovery is really dismal!
Wednesday, January 28, 2009
Do House Republicans Understand Tax Policy and Consumption Demand?
I submit that Congressman Jeff Flake does not:
While I have been noting that Ricardian Equivalence would argue for the proposition that tax cuts do not increase aggregate demand while increases in government purchases would stimulate aggregate demand, we should recognize the role of borrowing constraints:
Flake seems to be arguing that households that do not face borrowing constraints would be more likely to consume a tax “cut” than those that do face borrowing constraints. This proposition is precisely the opposite of what economic theory would tell us. Then again – economic theory tells us that increases in tax cuts (especially tax cuts for rich households) have less bang for the buck than increases in government purchases. Are these House Republicans hoping for the lowest bang for the buck or are they really this stupid?
Rep. Flake (R) was just on CSPAN moments ago talking about tax cuts in the Stimulus Bill. And he just made the argument that a lot of tax cuts in the bill go to 'people who don't pay income taxes', i.e., they're tax rebates … There's a decent case that one-off tax rebates aren't as potent as spending in terms of pumping money back into the economy. The one from last year didn't seem to have much of a punch. But whether the money goes into the hands of people who do or do not pay income taxes is a completely irrelevant point in itself. It's only relevant to whether you can focus tax breaks on wealthier people -- a political point. What's more, since people who 'don't pay income taxes' are overwhelmingly people with low incomes, those people by definition spend more than those with higher incomes, if only because they have no choice. It's just a straight-up nonsensical statement.
While I have been noting that Ricardian Equivalence would argue for the proposition that tax cuts do not increase aggregate demand while increases in government purchases would stimulate aggregate demand, we should recognize the role of borrowing constraints:
If “strapped consumers” means those facing borrowing constraints, it is precisely these households that are more likely to consume rather than save a tax cut.
Flake seems to be arguing that households that do not face borrowing constraints would be more likely to consume a tax “cut” than those that do face borrowing constraints. This proposition is precisely the opposite of what economic theory would tell us. Then again – economic theory tells us that increases in tax cuts (especially tax cuts for rich households) have less bang for the buck than increases in government purchases. Are these House Republicans hoping for the lowest bang for the buck or are they really this stupid?
World Growth Collapses
Econbrowser provides a link to a just-released IMF survey that reports that in November, 2008, world industrial production went from growing at a positive amount to an annual rate of -15%, and world merchandise trade went from growing at a positive rate to nearly a -45% rate, a total collapse probably more dramatic than even during the Great Depression. The IMF has lowered its projection for aggregate world economic growth in 2009 from 2.4% to 0.5%, which if it comes to pass would be the lowest rate of world GDP growth since WW II. We are indeed in a massive world economic crisis of the first order.
More Less
Pass the stimulus - then help shorten the work week
New York Daily News
By Dean Baker
Wednesday, January 28th 2009, 4:00 AM
As job losses hemorrhage, the American economy is in desperate need of a stimulus. It is becoming increasingly clear that Congress must work rapidly to approve some version of President Obama's plan.
Then, Obama and the Congress should very quickly turn to taking a second, temporary step to create more jobs: creating incentives for companies to reduce the workweek and work year for many Americans.
The idea is not as radical as it sounds - and could prove very productive indeed for the American worker....
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