Paul Krugman: Lest We Forget

Financial reform and regulation of the shadow banking system cannot wait:

Lest We Forget, by Paul Krugman, Commentary, NY Times: A few months ago I found myself at a meeting of economists and finance officials, discussing — what else? — the crisis. There was a lot of soul-searching going on. One senior policy maker asked, “Why didn’t we see this coming?”

There was, of course, only one thing to say...: “What do you mean ‘we,’ white man?”

Seriously, though, the official had a point. Some people say that the current crisis is unprecedented, but ... there were plenty of precedents... Yet these precedents were ignored. And the story of how “we” failed to see this coming has a clear policy implication — namely, that financial market reform ... shouldn’t wait until the crisis is resolved. ...

Why did so many observers dismiss the obvious signs of a housing bubble, even though the 1990s dot-com bubble was fresh in our memories?

Why did so many people insist that our financial system was “resilient,” as Alan Greenspan put it, when in 1998 the collapse of a single hedge fund, Long-Term Capital Management, temporarily paralyzed credit markets around the world?

Why did almost everyone believe in the omnipotence of the Federal Reserve when its counterpart, the Bank of Japan, spent a decade trying and failing to jump-start a stalled economy?

One answer ... is that nobody likes a party pooper. While the housing bubble was still inflating, lenders[, investment banks, and money managers] were making lots of money... Who wanted to hear from dismal economists warning that the whole thing was, in effect, a giant Ponzi scheme?

There’s also another reason the economic policy establishment failed to see the current crisis coming. ... [T]he crisis of 1997-98... showed that the modern financial system, with its deregulated markets, highly leveraged players and global capital flows, was becoming dangerously fragile. But when the crisis abated, the order of the day was triumphalism, not soul-searching.

Time magazine famously named Mr. Greenspan, Robert Rubin and Lawrence Summers “The Committee to Save the World”... who “prevented a global meltdown.” In effect, everyone declared ... victory..., while forgetting to ask how we got so close to the brink in the first place.

In fact, both the crisis of 1997-98 and the bursting of the dot-com bubble probably had the perverse effect of making both investors and public officials more, not less, complacent. Because neither crisis quite lived up to our worst fears,... investors came to believe that Mr. Greenspan had the magical power to solve all problems — and so, one suspects, did Mr. Greenspan himself, who opposed ... prudential regulation of the financial system.

Now we’re in the midst of another crisis, the worst since the 1930s. For the moment, all eyes are on the immediate response to that crisis. ...

And because we’re all so worried about the current crisis, it’s hard to focus on the longer-term issues — on reining in our out-of-control financial system, so as to prevent or at least limit the next crisis. Yet the experience of the last decade suggests that we should be ... regulating the “shadow banking system” at the heart of the current mess, sooner rather than later.

For once the economy is on the road to recovery, the wheeler-dealers will be making easy money again — and will lobby hard against anyone who tries to limit their bottom lines. Moreover, the success of recovery efforts will come to seem preordained, even though it wasn’t, and the urgency of action will be lost.

So here’s my plea: even though the incoming administration’s agenda is already very full, it should not put off financial reform. The time to start preventing the next crisis is now.

Comments

[a]

"And because we’re all so worried about the current crisis, it’s hard to focus on the longer-term issues — on reining in our out-of-control ..."

And the fill-in-the-blank should be:
a/ consumption
b/ financial system
c/ Fed Reserve
d/ all of the above

[M Quinlan]

The penultimate paragraph is key. As long as the financial "industry", and there wealthy clients, are patrons of the political process, regulation will be subverted.
Unfortunately Obama's selection of advisers and major campaign contributors doesn't bode well.
Ruben and Summers were instrumental in demolishing existing regulation and (Rubin at least) personally profited greatly from doing so.

[gordon]

I surmise that there are a lot of well-informed Americans getting out of America about now, as the US version of the Weimar Republic pursues what looks like its inevitable course towards a foreseeable denouement. It would perhaps be of interest to discuss preferred destinations. Europe? Canada? South America? New Zealand?

[calmo]

One senior policy maker, dressed in his best business suit, asked, “Why didn’t we see this coming?”
But Paul had inside information and was ready with his moccasins and tomahawk...: “What do you mean ‘we,’ white man?”

Only on Thanksgiving Day does this have the bite it does.

Krugman speaks directly to me, you? I hesitate to waste any more electrons here:One answer ... is that nobody likes a party pooper. Especially the party at the top...and needless to say, dismantling the "shadow banking system" is easier said than done.

[mmckinl]

Generally I agree with Krugman. Not this time. In fact in the video on CR Krugman said the RE bubble was there for all to see ...

All I see is professional economists making excuses for each other again when the real reasons the bubble was not called was much more nefarious.
Economists know who butters their bead and they dance to their tune.

Sorry Paul, you got this one wrong, your fellow economists are not the pure and innocent fellows that you would portray. He who pays the piper calls the tune. Corporate jobs, slots at Think Tanks and tenured positions are in short supply and the tenure and audition for same would likely cause Pavarotti to sing off key.

[Massimo GIANNINI]

Summary of unconvenient truths of this crisis

[ken melvin]

Be there a senator or congrescritter that wouldn't sell us down the drain? OK, there's a few. But damned few.

The pressures to play it again are going to be tremendous. As a half assed's guess: The great one was brought on by as excess capacity to produce goods for which there wasn't a market which lead to some hella creative financing. Equilibrium of a sort was found, but it wasn't so good. Government spending got some of the some of out there to create a little more demand and businesses answered, followed the war, etc. Times were when most didn't have cars, electricity, refrigerators, washing machines, indoor toilets, running water, ..., i.e., lots of room for expansion. Throw in obsolescence and voila, happy days are here again. In fact, happier days than ever before. Business boomed, people working making good money, …

Long ago, England’s, France’s , and – heck even ours, upper crust lived off slavery. Today, there are those who think that the US’s and China’s can live off China’s cheap labor (and the coolies thought they had it bad).

This time, Japanese cars last twenty years, one-forth the number of people can produce twice as much, everyone has more than one of everything, and we’re running out of everything. So, what’ll it be? My guess is that we’ll try a couple more booms with predictably disastrous results, settle for some sort of equilibrium and, then, figure out a system of distribution sited the reality.

[Noni Mausa]

mmckinl: ...your fellow economists are not the pure and innocent fellows that you would portray .... Corporate jobs, slots at Think Tanks and tenured positions are in short supply and the tenure and audition for same would likely cause Pavarotti to sing off key.

That's exactly what Paul was saying when he said, "Nobody likes a party pooper". That's a gentler way of saying that most people, most of the time, will go with convenient, conventional wisdom, especially when it's wrong. If changing the conventional wisdom is easy, then people will do so fairly quickly. But once it has become a tidal wave, it takes a strong (or tenured) voice to speak against it.

Suppose half the economists had spoken out against the Ponzi scheme, how long do you think it would take them to realize it was them who were getting laid off and ignored for consulting gigs?

Being the Lone Ranger sounds noble, but did you ever notice the Lone Ranger has one companion but no home or family, and his earthly wealth consists of one horse, a mask and a belt of silver bullets? I bet his retirement plan would not lure many to join him.

Noni

[Bubble Trouble]

"...housing bubble...the whole thing was, in effect, a giant Ponzi scheme?"

Yes it is, and its not over yet. Policy is still attempting to figure out how to shoehorn the lower half into expensive McMansions. Policy is still limiting supply (zoning) to drive up prices to unaffordable levels. Policy is trying to re-inflate the housing bubble as the solution to the financial crises. Policy is still trying to continuously expand credit (debt), despite it already being at unsustainable levels.

It didn't work in the past, and it won't work now.

says...

http://www.nytimes.com/2008/11/28/opinion/28krugman.html?ref=opinion&pagewatned=print

November 28, 2008

Lest We Forget
By PAUL KRUGMAN

Why did so many people insist that our financial system was “resilient,” as Alan Greenspan put it, when in 1998 the collapse of a single hedge fund, Long-Term Capital Management, temporarily paralyzed credit markets around the world?

[What was puzzling at the time and after, was that the Long-Term Capital Management crisis which was serious enough to have threatened to prevent trading in bonds or proper pricing of bonds was both so severe seemingly stemming from the speculation of a single company and taken so lightly. How the positions taken by a single company could threaten a market larger than the stock market has never been made clear but led to several specialist bond investors changing management practices in openly becoming more conservative even as investment houses were selling and buying increasingly risky bond derivatives.]

says...

http://www.nytimes.com/2008/11/28/opinion/28krugman.html?ref=opinion&pagewatned=print

Why did almost everyone believe in the omnipotence of the Federal Reserve when its counterpart, the Bank of Japan, spent a decade trying and failing to jump-start a stalled economy?

[Paul Krugman was trying to make clear in the 1990s that the Japanese deflation experience was not necessarily isolated or to be blamed entirely on Japanese domestic policy as was done by almost all American and British analysts. Nor was the Japanese fiscal response to the deflation, which well protected employment, a mistaken response as was evident to the Japanese then and should be evident to international analysts now. Japan may have grown slowly through the later 1990s, but Japan grew and employment protections were successful though repeatedly condemned by British and American analysts other than Krugman.]

The above comment was by me, but my computer did not notice.

[anne]

Darn, again my computer failed to notice me. I suppose the problem is morning.

[bakho]

Even for people who knew the party was headed over a cliff, the temptation of short term profits was too great.

How to diminish short term temptation? Require more capitalization. That limits the leverage.

[anne]

http://www.nytimes.com/2008/11/28/opinion/28krugman.html?ref=opinion&pagewatned=print

Why did so many observers dismiss the obvious signs of a housing bubble, even though the 1990s dot-com bubble was fresh in our memories?

[What is more puzzling, and what is being privately asked by several economists, is why given low and lowered taxes, low interest rates, rapidly growing military spending along with non-military spending that more or less paced economic growth, a vibrant international economy, a relatively weak dollar, along with a housing boom, why was the economy so relatively weak through the Bush Presidency before 2008?

Why was the Bush expansion so relatively weak?]

[anne]

The Bush Presidency through June 2008, marked GDP growth at 2.3% or significantly lower than any Democratic Presidency since Kennedy and significantly lower than Reagan or Nixon. Employment growth through July 2008, was lower than any President since Eisenhower in 1953 and will of course be even more markedly lower when the final months are counted. But, why?

Why was employment growth even during the finest 52 months of the Bush Presidency so much lower than during the Clinton Presidency? Here was a profoundly business oriented Presidency that was profoundly unsuccessful beyond a notable quickening of corporate profit growth, but why?

[kharris]

Sorry this is so wandering and long. Don't have time to rewrite.

Noni's explication of Krugman is a good starting point for seeking an institutional solution to this problem of dwelling on good news.

Why can we not tell the difference between good and bad advice? Often, we don't want to. Good advice often comes in the form of "a penney saved is a penney earned" and "eat you peas" and "early to bed and early to rise". OK, we are smart people and we now have Nobel Prize winners who know enough about the interaction between human thought patterns and decision making to produce some basic rules to help us eat our peas. Maybe formalizing that knowledge and putting it in the first chapter of the regulatory handbook would be a help.

We might also want to try to get past this policy as partisan battleground business. When one party can fall under the guidance of people who harbor the undemocratic notion of a permanent majority for their own party, we probably need more powerful, wiser bureaucrats, in the model of Europe.

What's the role of government? Under the label "fostering growth" we have adopted policies and allowed practices which increase economic risk. This is true at the household level and on a systemic basis in the financial sector. But the traditional role of government has been to mitigate risk and to take necessary action that the private market is unlikely to pursue. This description includes defense of the borders, law enforcement and regulation. The argument that markets will regulate themselves is essentially an argument that the private sector can and will provide adequate protection for one group from the risks willingly taken by another. However, the argument in favor of "letting markets work" as a means of self-regulation misses the innocent bystander problem altogether.

But I digress. A big part of government's role has been to mitigate risk. Why, then, should we accept governance which shirks that traditional role? Why foster the primary private sector goal of getting rich by exploiting communal resources for private gain? Don't we tell ourselves, in our entrepreneur-as-hero versions of the market economy story, that the entrepreneur can handle that part of the job? Isn't "fostering" just a nice word for the very sort of meddling that our story says produces inefficiency?

This is the long way of saying that government has no business making society riskier, or in allowing society to become risky in ideosyncratic ways. We all knew that insurance was regulated. Credit default swaps are insurance. Why selectively allow them to go unregulated? The real answer is money, but the answer we surely would have gotten from Greenspan, Rubin and the rest, is that innovation is good and regulation inhibits innovation. The record is otherwise. Financial innovation nearly always proves problematic in the early days. We know that, so why do we not have a risk-management system which takes that into account? We know that it is the job of profit seeking private interest to take risks in the quest for reward. What we need is a system which keeps those risks within a set of bounds, bounds which prevent the risk from spilling over to those who cannot hope to profit directly from the risk.

[Barkley Rosser]

Krugman is right here. I think the issue is the party pooper one. This is the more difficult problem in battling any bubble, as I publicly called for at the Galbraith conference in New York on Nov. 14: as long as people are making money they seriously do not like being told to stop or have somebody forcibly act to make them stop, even when they know it is not sustainable and at some point the music will stop and they may not be sitting in a chair. They think they will be, and it will be somebody else left standing with the hot potato in their hands.

For those who keep saying no economists foresaw this, lots of us did, but nobody paid attention to us. Me me me! Heck, I shall be so churlish as to point out that I was even more accurate than the now-much-praised Dean Baker and Nouriel Roubini, who failed to figure out that the fall of the dollar would stimulate exports and called for the recessin to start at the beginning of 2007. Some of us (me me me!) said the housing bubble would crash the derivatives market into a big mess, but not at the beginning of 2007. I argued with Dean about this over on Maxspeak, all in the archives. (Me me me! I am wonderful, no matter what anne says, :-))

[hari]

I think, like Paul, there are other's (here) who are also hiding behind their socalled *nationalism* - it's un-American to criticise *free market or laissez faire capitalism*.

Bush called it *Democratic Capitalism* during (14-15 Nov) G-20 meeting; and, with help of Japan, avoided any mention of
what People's Daily (Beijing) called the hegemonic role of dollar in world finance....

I was just now listening to Dr Doom on Bloomberg (speaking from Moscow) and they asked him the same q' - *Why didn't other's see what MR saw in the faltering US economy?* His answer was very honest and simple (unlike Paul's) *they're all in the bubble....*

US-Centric culture of seeing everything thru American colored binoculars is the price *Democratic capitalism* pays for its excuberance.

It's time to wake up and change those stupid mind-set and become a bit Un-American and criticize your own indogenous policy makers and think-tanks for digging the ditch....for collapse of the hegemon.

[im1dc]

I truly hope Our Professor Krugman writes more forcefully in the days, weeks and months to come about anything he sees lacking in the Obama Presidency's response to this current economic crisis.

If he is not to be around the table of Obama's advisors then at least let the blogosphere know what those Advisors ought to be telling Obama so that we can echo it to our Elected.

[Steven Earl Salmony]

Behold a chimera on the far horizon, a paint horse upon which imperious and ignoble GREED rides. This horse and its pin-striped rider are an unexpected front runner, a Fifth Horseman of the Apocalypse. The "Four Horsemen" in tandem are following close behind.

Steven Earl Salmony
AWAREness Campaign on the Human Population,
established 2001
http://sustainabilityscience.org/content.html?contentid=1176

[Julio]

And the typo of the day award goes to:
kharris

"a penney saved is a penney earned"

Excellent advice for our incoming administration.

[Julio]

From kharris' comment:

"This is the long way of saying that government has no business making society riskier, or in allowing society to become risky in ideosyncratic ways.
...
We know that it is the job of profit seeking private interest to take risks in the quest for reward. What we need is a system which keeps those risks within a set of bounds, bounds which prevent the risk from spilling over to those who cannot hope to profit directly from the risk."

I made the point in another thread that capitalism is like a machine, useful and powerful but with no moral compass. I think "profit seeking private interest" here refers to the same machine.

Put another way, there is only some correlation between social needs and the maximization of the machine's output. In particular when talking about systemic risk: would the current crisis, and earlier crises with their attendant suffering, be OK if we determined that GDP 10 years after the crisis would be lower if we had managed risk more forcefully?

The "system" we need is outside, and may be at odds with, "the job of profit seeking private interest".

Government's role cannot just be to make the machine run faster. It cannot just oil the machine, it has to also steer, based on goals external to the machine.

Rereading this comment before posting, I think I may have just stated the obvious. Having lived most of my adult life under Reagansim, I'm not so sure...

[mountainaires]

"...once the economy is on the road to recovery, the wheeler-dealers will be making easy money again — and will lobby hard against anyone who tries to limit their bottom lines. Moreover, the success of recovery efforts will come to seem preordained, even though it wasn’t, and the urgency of action will be lost."

That may be a bit optimistic.

Nasseem Nicholas Taleb has a different perspective. He says we may be entering the "most serious situation we've been in since the American Revolution":

http://www.youtube.com:80/watch?v=H3zZ6qNWeGw&NR=1

Experts Warn of Food Shortages

George Washington’s Blog
Thursday, Nov 27, 2008

The headline of an article on Bloomberg warns “Food Prices Will Rise, Causing Export Bans, Riots“.

Leading economist Nouriel Roubini warns of possible food riots.

The Financial Times points out that farmers rely on credit, and credit is drying up.

One of the top experts on derivatives, economist Nassim Nicholas Taleb, warns that supermarkets may not be able to borrow against their inventory, and will thus be forced to shut down.

Live links at:

http://www.prisonplanet.com/experts-warn-of-food-shortages.html

[kharris]

im1dc,

I suspect that Krugman can be at the table, with the advisors, if not the president, more or less at will. He knows them. They know him. They are willing to recognize his abilities in a way that nobody under Bush was allowed to do. One big difference between the coming administration - heck, any administration bakc to Daddy Bush - and the Baby Bush administration is a willingness to listen before deciding.

[a]

I don't think the "party pooper" explanation is quite right.

Let's take an economist at random - Brad deLong. He would have loved to have criticized the Bush Administration's economic policy - and he often did. So he had all the incentive in the world to say, Things are going to end badly. He didn't. Neither did most other Democrat-leaning economists. They had enough of an incentive to be "party poopers", but they weren't.

It's more that economists of all stripes believed in economics - they thought economics had progressed and economists knew more about preventing recessions - and to say, "Things are going to end badly" implied that economics wasn't really as successful as they had come to believe. Criticism would be cutting out the floor under their own feet, removing their own legitimacy. So when Dean Baker said, "Things will end badly," it reflects on him personally (just as there were many non-economists who said the same thing), and not on his profession.

[JIMB]

Next crisis is baked in the cake: a run on (i.e. out of) all currencies. After the deflation, a giant inflation.

[Lee A. Arnold]

Crises? Wildlife ecosystems are half gone, and the rest are headed to simplification and extinction. Two more degrees on the thermometer and Greenland's melt will inundate all coastal populations. Path-dependence in oil energy has locked us onto collision courses: in environment, foreign policy, social amenities. The enormous and growing disparities in wealth and income are mostly based on positional luck, not skill. In the United States, tens of millions of people are without basic healthcare. The response of most of the economics profession? Rational choice in free markets! At the center of the crises, an intellectual disaster.

[anne]

What was characteristic about the bond market shock in 1998 or the stock market shock in 1987, was the speed with which the problems were dealt with and the minimally lasting effects of the shocks which gave every reason to suspect, as Alan Greenspan often suggested, that the economy had become increasingly more resilient since 1980. I never heard Greenspan argued with on the issue, since growth was generally sustained from 1982 on through a set of important economic problems or shocks of varying severity.

There were bear markets caused by the shocks of 1987 and 1998, but the bear markets lasted mere weeks while economic growth continued. Even the lasting bear market shock from 2000 to 2002, the result of a deflating bubble, resulted in only a minimal recession.

That the financial system was becoming increasingly unstable, and the economy less resilient, say from 1998, was not necessarily evident. Then too, as Lawrence Summers noted, the years immediately before 2008 marked the most sustained and quickest economic growth we have record of internationally. The growth of developing countries was profound, from 2001 and before this year.

What was puzzling to Joseph Stiglitz especially was the limited American growth from 2001.

[Lee A. Arnold]

Since 1980 it's been running more and more on debt, and on the "wealth effects" from the series of asset bubbles. Rentier wannabes. At the same time, you know the litany, wages have been almost stagnant and the cost of some necessities such as healthcare have spiralled, etc. Plenty of "common" people were ready to argue with Greenspan -- just none of them heard, none from the power structures of the United States, nor more than a very few from the economics profession.

There's been an intellectual abdication, caused essentially by a methodological inability. We need synthesis. But their mathematics models forbid them from being comprehensive, except at the airiest levels of the macro accounts.

[Bruce Wilder]

PK: "One senior policy maker asked, 'Why didn’t we see this coming?' "

PK: ". . . the wheeler-dealers will be making easy money again — and will lobby hard against anyone who tries to limit their bottom lines. Moreover, the success of recovery efforts will come to seem preordained, even though it wasn’t, and the urgency of action will be lost."

BR: "as long as people are making money they seriously do not like being told to stop or have somebody forcibly act to make them stop, even when they know it is not sustainable and at some point the music will stop and they may not be sitting in a chair."

A number of commenters have made the point that the corrupt plutocracy will oppose effective regulatory reform, and that will certainly be an obstacle, although there are limits. After all, even a thief wants the money he steals to be worth something; all thieves dream of using their ill-gotten gains to build a life in the legitimate world where one is able to invest and buy things with money.

Every society has an elite. A moderately healthy society finds ways to draw its elites into piety and responsible behavior, and away from the vampirism, which has come to characterize the asshole culture of the typical arrogant, angry, corporate Republican, the culture of Hank Paulson or Carly Fiorina, or John Templeton, Jr. And, a healthy society creates bases of countervailing power, as Galbraith put it, to oppose and judge and divide the elite -- the professions, academia, the clergy, the Media, labor unions, competing political parties, minority religions, dissenting subcultures. In this diversity, varying talents, views and ideas can gain legitimacy, economic resources and incubate and persist; a critique can be elaborated, an alternative can gain a full trial.

(It's a bit of a digression, but for some reason, on my way to my point, I can't help reflecting on the extent to which the emergence of the modern world in the Enlightenment, and Scientific and Industrial Revolutions depended on, first, the decimation the English hereditary aristocracy in the Wars of the Roses, and then the fracturing of British society in the English Civil War; it was the dissenters, the Scots, the untitled landed gentry and those gone to America, who made the modern happen.)

I don't mean to pick on Barkley, but I do think that the systematic ignorance of economists on the subject of regulation is at least as great an obstacle to reform, as the self-interested parochialism of elite bankers. Academic economics ought to be an island of intelligent analysis and deliberate thought, an independent base of deep expertise and historical if not institutional memory. But, instead, we get "hoocoodenode?" and essays both elementary and superficial.

To take up Barkley's point, does regulation rest on the ability of regulators to be wiser and smarter, in real time, than the bankers they regulate? The regulations put in place at the end of the 1930's didn't rest on such a basis. They rested, instead on maintaining the integrity of banking process, and a diversity of banking institutions. Both integrity of process and diversity have been under sustained assault by the forces championing deregulation for 35 years. And, already in the present crisis there are plenty, who call for a further consolidation of "competing" regulatory authorities, or who assure us that the bankers have learned their lesson (markets are naturally self-regulating, don't ya no?). "We wouldn't want to hobble bankers with a lot of regulations aimed at preventing a peculiar problem, which will never arise again, would we?" That's going to be proposed as conventional wisdom in the days ahead; that the crisis was a terrible accident, with peculiar causes. And regulatory capture limits what can be done, so we should facilitate regulatory capture. And, besides, greed has been causing financial crises since the ancient Greeks, it's like the weather (or climate change), you can talk about it, but there's nothing to be done.

It would be really nice if academia could offer something other than the corrupt hackery of Glenn Hubbard or the whimsical hackery of Greg Mankiw. The best the present administration seems to be able to manage is Larry Summers and Christina Romer, who, from my distant perspective, seem to have grown remarkably pale and wan, during the long Reagan night.

I sense that America is bit tired of teh Stupid; even David Broder wrote the other day that he's glad the President is a smart guy, even though he's spent his whole forty year career touting the advantages of having stupid Presidents. We breached the racial barrier, to make a President out of a former community activist, who, in turn, has found for a Treasury Secretary, the one smart guy, who knows what he's doing, and who is not either an arrogant academic (Larry Summers) or, himself, a greedy zillionaire banker (Robert Rubin). So, maybe there's hope.

[calmo]

So many excellent comments...where to poke?...I have not pressed wunderkind bakho in a bit:Even for people who knew the party was headed over a cliff, the temptation of short term profits was too great. [excellente, no? a visit to the comment section at CR's illustrates the practice...the point of understanding anything is not merely to avoid trouble, but to profit...as if HF managers were not demonstrating this...as if the WSJ was not aggrandizing this HF practice...as if the (mostly Christian) moral codes in this country don't condemn the notion of profiting from your neighbor.]

How to diminish short term temptation? Require more capitalization. That limits the leverage. [ so practical B bakho...but this needs a longer, larger response, yes? There are so many sharks, the minnows have become little sharklets (not calmo's view of the financial arena where the Goliaths have been felled by peewees, zillions of peewees)...it is tied to the wealth gradient and we need to flatten it...get a respectable Gini Coef and mo.]

[Switcharoo]

The domestic economy has been running more on debt, but there is no domestic saving. Yet savings must equal borrowing. Some goods/services have been borrowed from overseas, but this does not explain the magnitude of the debt. The missing savings is forced savings regressively extracted from the ordinary consumer.

This explains the necessity for ever more overtime to make ends meet, and declining standard of living for those unable to work more overtime.

[im1dc]

kharris says...I suspect that Krugman can be at the table, with the advisors, if not the president, more or less at will.

I do hope you are right. I pray you are right. I want you to be right.

[anne]

http://krugman.blogs.nytimes.com/2008/11/28/too-much-of-a-good-thing/

November 28, 2008

Too Much Of a Good Thing …
By Paul Krugman

Is only prudent. As far as I know, nobody has written up the case for a fiscal expansion larger than our best estimate of what’s needed to close the looming output gap. So I thought it might be useful to write the obvious down.

In the figure below, I’ve drawn a series of “IS curves” — each showing how the level of real GDP depends on the Fed’s target interest rate. Currently, the economy looks like IS1: even at a zero interest rate, output will be far short of full employment. Fiscal expansion should shift the curve right — but it might either be too little (IS2) or too much (IS3).

The key point is this: if fiscal expansion is too little, that’s the end of the story. If it’s too much, the Fed can head off inflation by raising rates. So there’s an asymmetry.

In reality, we can’t be sure how much bang we’ll get for the buck. What the asymmetry means is that we should err on the side of too much.

[[Figure] Go big!

[anne]

http://krugman.blogs.nytimes.com/2008/11/10/stimulus-math-wonkish/

November 10, 2008

Stimulus Math (Wonkish)
By Paul Krugman

I wrote this morning's column * partly because I had a hunch that the Obama people might be thinking too small on stimulus. Now I have more than a hunch – I've heard an unreliable rumor! So let's talk about stimulus math, as I see it.

Actually, before I get to the math, some concepts. Nearly every forecast now says that, in the absence of strong policy action, real GDP will fall far below potential output in the near future. In normal times, that would be a reason to cut interest rates. But interest rates can't be cut in any meaningful sense. ** Fiscal policy is the only game in town.

Wait, there's more. Ben Bernanke can't push on a string – but he can pull, if necessary. Suppose fiscal policy ends up being too expansionary, so that real GDP "wants" to come in 2 percent above potential. In that case the Fed can tighten a bit, and no harm is done. But if fiscal policy is too contractionary, and real GDP comes in below potential, there's no potential monetary offset. That means that fiscal policy should take risks in the direction of boldness.

So what kinds of numbers are we talking about? GDP next year will be about $15 trillion, so 1% of GDP is $150 billion. The natural rate of unemployment is, say, 5% — maybe lower. Given Okun's law, every excess point of unemployment above 5 means a 2% output gap.

Right now, we're at 6.5% unemployment and a 3% output gap – but those numbers are heading higher fast. Goldman predicts 8.5% unemployment, *** meaning a 7% output gap. That sounds reasonable to me.

So we need a fiscal stimulus big enough to close a 7% output gap. Remember, if the stimulus is too big, it does much less harm than if it's too small. What's the multiplier? Better, we hope, than on the early-2008 package. But you'd be hard pressed to argue for an overall multiplier as high as 2.

When I put all this together, I conclude that the stimulus package should be at least 4% of GDP, or $600 billion.

That's twice what the unreliable rumor says. So if there's any truth to the rumor, my advice to the powers that be (or more accurately will be in a couple of months) is to think hard – you really, really don't want to lowball this.

* http://www.nytimes.com/2008/11/10/opinion/10krugman.html

** http://www.econbrowser.com/archives/2008/11/the_new_improve.html

*** http://www.marketwatch.com/news/story/Goldman-forecasting-biggest-rise-joblessness/story.aspx?guid=%7BC174CCA5%2D803B%2D4656%2D9340%2D5591106B08D8%7D&dist=hplatest

[anne]

http://krugman.blogs.nytimes.com/2008/11/27/touchy-touchy/

November 27, 2008

Touchy, Touchy
By Paul Krugman

Dear Greg: *

I was actually thinking mainly about Tim Geithner versus John Snow, not about you. **

* http://gregmankiw.blogspot.com/2008/11/redefining-grownup-and-hack.html

** http://krugman.blogs.nytimes.com/2008/11/22/the-grownups-are-coming/

[anne]

http://krugman.blogs.nytimes.com/2008/11/22/the-grownups-are-coming/

November 22, 2008

The Grownups are Coming
By Paul Krugman

So, it appears that a sinister cabal * is taking control of economic policy, not only in the United States, but in much of the world.

Seriously, isn't it amazing just how impressive the people being named to key positions in the Obama administration seem? Bye-bye hacks and cronies, hello people who actually know what they're doing. For a bunch of people who were written off as a permanent minority four years ago, the Democrats look remarkably like the natural governing party these days, with a deep bench of talent.

That doesn't mean they'll succeed — this might be a good time to reread "The Best and the Brightest." But what an improvement!

* http://www.group30.org/members.htm

[anne]

http://krugman.blogs.nytimes.com/2008/11/28/was-the-great-depression-a-monetary-phenomenon/

November 28, 2008

Was the Great Depression a Monetary Phenomenon?
By Paul Krugman

[Chart] Sins of omission?

Has anyone else noticed that the current crisis sheds light on one of the great controversies of economic history?

A central theme of Keynes’s General Theory was the impotence of monetary policy in depression-type conditions. But Milton Friedman and Anna Schwartz, in their magisterial monetary history of the United States, claimed that the Fed could have prevented the Great Depression — a claim that in later, popular writings, including those of Friedman himself, was transmuted into the claim that the Fed caused the Depression.

Now, what the Fed really controlled was the monetary base — currency plus bank reserves. As the figure shows, the base actually rose during the great slump, which is why it’s hard to make the case that the Fed caused the Depression. But arguably the Depression could have been prevented if the Fed had done more — if it had expanded the monetary base faster and done more to rescue banks in trouble.

So here we are, facing a new crisis reminiscent of the 1930s. And this time the Fed has been spectacularly aggressive about expanding the monetary base:

[Chart] Ben goes for broke

And guess what — it doesn’t seem to be workiing.

I think the thesis of the Monetary History has just taken a hit.

[anne]

The interest rate for the 3 month Treasury is at a comical or scary 0.03%, the 2 year at 0.99% and the 10 year is 2.93%. The Federal Funds rate is 1%. Essentially short term loans to the Treasury are being made for free, as during the Depression or through the Japanese general deflation. This is a liquidity trap, and the experiences we have with such traps is that they are long-lasting, even beyond a return to inflation during the Depression or in Japan.

The problem is that interest rates on commercial loans are far higher than on Treasury loans, and commercial credit is difficult to come by.

Comical or scary, whichever we wish.

[anne]

http://www.usinflationcalculator.com/inflation/historical-inflation-rates/

2008

Inflation Rate, 1923-2007
(Consumer Price Index)

1923 1.8 Coolidge
1924 0.0

1925 2.3
1926 1.1
1927 - 1.7
1928 - 1.7
1929 0.0 Hoover era, contraction begins, August

1930 - 2.3
1931 - 9.0
1932 - 9.9
1933 - 5.1 Roosevelt era, contraction ends, March
1934 3.1

1935 2.2
1936 1.5
1937 3.6 Recession begins, May
1938 - 2.1 Recession ends, June
1939 - 1.4

1940 0.7
1941 5.0
1942 10.9
1943 6.1
1944 1.7

1945 2.3 Truman

[Hank Roberts]

http://yamaguchy.netfirms.com/7897401/lafollette/lf08mar17.html

Congressional Record — Senate, page 3434, 1908 March 17
Senate bill 3023, AMENDMENT OF NATIONAL BANKING LAWS.

... The Senator from Wisconsin [Mr. La Follette]:

-----excerpt follows------

In an article on the “Concentration of banking interests in the United States,” written in 1905, Charles J. Bullock, professor of economics, Williams College, says :

Unlike the central banks of other countries, our largest institutions are closely connected with various industrial interests, so that they do not occupy an independent position. Their policy is not controlled with sole regard for the general welfare of our banking system ; but they have been drawn into vast enterprises, into promotion or reorganization, often of a speculative character, and have displayed less, not more, than ordinary conservatism. ... to illustrate the dangers of the association of banks with industrial promotion and speculative enterprises.

Continuing, Professor Bullock says :

It is to be feared that our financiers have not yet learned the difference between banking and the promotion of companies—

In reading this, I need not suggest to Senators that Professor Bullock, being at the head of the economics department of an old renowned Massachusetts college, would certainly be very conservative in all that he might write—

It is to be feared that our financiers have not yet learned the difference between banking and the promotion of companies ; but until this distinction is better understood, New York City will not rival London as an international financial center. * * *

The concentration of banking power has now proceeded so far that discussion has inevitably arisen concerning the length to which it will be carried, and the possible dangers of the movement. ...

Mark you, Mr. President, I am quoting from recognized authority, not upon present conditions, but upon the situation as it presented itself to students of government finance three or four or five years ago.

[anne]

http://krugman.blogs.nytimes.com/2008/11/22/depression-analogies/

November 22, 2008

Depression Analogies
By Paul Krugman

[Charting 3 month Treasury bill interest rates:
Zero bound worries.]

Daniel Gross pushes back * against analogies with the Great Depression:

"Instead of workers with 5 o'clock shadows asking, 'Brother, can you spare a dime?' we have clean-shaven financial-services executives asking congressmen if they can spare $100 billion."

But I think he misses the point. The reason we're making analogies with the Great Depression — and the reason I've come out with a new edition of "The Return of Depression Economics" — is the collapse of policy certainties. In particular, the Fed's sudden impotence — its inability to cut rates any more, because they're essentially zero — is a very real parallel with the Depression, and necessitates drastic responses.

Now, if all goes well the Obama stimulus plan will head off the worst. But that will be precisely because we understood that the current crisis is, indeed, like the Great Depression in important ways. Only those who learn from history can hope to avoid repeating it.

* http://www.slate.com/id/2205186/?from=rss

[Notice how long the 3 month Treasury remained at about 0%, beyond deflation and to the 1940s.]

[Lafayette]

Article: One senior policy maker asked, “Why didn’t we see this coming?”

This is the fifth or sixth, depending upon how you count them, financial mess to have come down around our ears. Have we already forgot the dot.com boom 'n bust? The S&L scandal?

Maybe we didn't see it coming because we did not go looking for it?

Old Chinese dictum: There is nothing so obvious to a man as something he does not want to see.

[Barkley Rosser]

a,

You are right that Brad Delong did not call it and has since admitted (as has Arnold Kling) that he did not realize how bad the housing bubble was. This is ironic in that he was a coauthor of those famous papers back in the early 90s with Summers, Shleifer, and Waldmann about speculative bubbles. So, maybe they thought this was just all theory, and they would know a bubble when they saw it, but they (or at least Brad and Larry) didn't.

Regarding how many of us there were, well, Jamie Galbraith said in the New York Times recently that there were about ten to twelve of us, including him and me and Dean Baker. So, yes, that is not all that great a number, I must agree. Roubini and Shiller must be included in there as well, although I am not sure Shiller saw the linkages with the out of control derivatives market or how big a mess the collapse of the housing bubble would lead to.

BTW, the reason that I doubt that "JK Galbraith" who commented here recently is Jamie Galbraith himself is that Jamie generally signs himself as "James K. Galbraith" or "James Galbraith," not the ambiguous "JK Galbraith," which conjurs up his dad.

[anne]

http://www.economagic.com/em-cgi/data.exe/fedbog/tbaa3m
http://www.economagic.com/em-cgi/data.exe/fedbog/tbsm3m

2008

Interest Rates on 3-month Treasury Bills, 1931-1950 *

1931 0.95 January
1931 0.48 July

1932 2.68
1932 0.42

1933 0.21
1933 0.37

1934 0.72
1934 0.15

1935 0.20
1935 0.15

1936 0.20
1936 0.15

1937 0.17
1937 0.28

1938 0.10
1938 0.07

1939 0.03
1939 0.04

1940 0.01
1940 0.05

1941 0.02
1941 0.12

1942 0.27
1942 0.38

1943 0.38
1943 0.38

1944 0.38
1944 0.38

1945 0.38
1945 0.38

1946 0.38
1946 0.38

1947 0.38
1947 0.66

1948 0.97
1948 1.00

1949 1.17
1949 1.02

1950 1.07
1950 1.16

* http://krugman.blogs.nytimes.com/2008/11/22/depression-analogies/

[anne]

What is especially bothersome in looking to Krugman's discussions of the liquidity trap is the length of time the near zero government rate existed following deflation during the Depression and the Japanese deflation. The problem then becomes the spread between government and commercial interest rates, making commercial investment a problem unless there is direct investment stimulus as during the New Deal and the World War or during the Japanese deflation and beyond.

Stiglitz has been worried about commercial domestic investment since 2002, when it became increasing evident such investment was relatively lagging through an economic recovery and expansion. The Japanese have spurred investment through New Deal-style stimulus plans, as well as selected government corporate pressure.

[anne]

http://krugman.blogs.nytimes.com/2008/11/19/corporate-cost-of-borrowing/

November 19, 2008

Corporate Cost of Borrowing
By Paul Krugman

Aaa 4.8%
Baa 7.2%

It's the real thing.

The figure above shows the real interest rates on corporate bonds, with the expected rate of inflation from the spread between 20-year TIPS and 20-year Treasury rates. All data monthly, from St. Louis Fed. *

The surge in real borrowing costs reflects the combination of rising risk spreads — even for AAA borrowers — and falling expectations of inflation. This is why deflation is a problem.

And the high cost of capital is going to be one more reason for enormous downward pressure on the economy.

This just keeps looking uglier.

* http://research.stlouisfed.org/fred2/

[anne]

http://www.cbpp.org/8-9-05bud.htm

August 29, 2008

How Robust Was the 2001-2007 Economic Expansion?
By Aviva Aron-Dine, Chad Stone, and Richard Kogan

Annual Growth Rates Measured from Trough *

Non-Residential Fixed Investment
Corporate Profits

Current Expansion

3.9%
10.8%

Post-War Average

6.0%
7.4%

1990s

7.6%
8.0%

* Average growth rate in 23 quarters after trough.

[anne]

http://www.cbpp.org/8-9-05bud.htm

August 29, 2008

How Robust Was the 2001-2007 Economic Expansion?
By Aviva Aron-Dine, Chad Stone, and Richard Kogan

Annual Growth Rates Measured from Peak **

Non-Residential Fixed Investment
Corporate Profits

Current Expansion

2.0%
9.5%

Post-War Average

3.7%
3.8%

1990s

6.4%
8.1%

** Average growth rate in 26 quarters after peak.

[Considering how tepid domestic non-residential commercial investment was through the Bush expansion, there is no reason to expect significant investment from here unless there are specific stimulus measures taken to generate such investment. The experience we have of liquidity traps suggests there will be an important, long lasting limiting of commercial investment if policy is not designed to counter this limiting.]

[a]

Barkley,

Did those economists who "saw" it, see it because they were looking at the "right" economic theory? Or were they looking at the same theory as everyone else, but for some reason (temperament, perspicacity, ...) drawing different conclusions than the main, and if so what was the reason? These are honest questions; I'm not trying to pre-suppose the answer (even though in the last paragraph, I explain my own views).

Let's leave you out of it (although by all means you can bring yourself in, if you want...), and let me bring up Dean Baker, who I think by and large did say, "It's all going to end in tears." If we say that he was looking at the right theory, then one would hope that he's still looking at it, and proposing the right solution. Yet - and this I admit is "yet" for me and not for almost everyone else - he is proposing stimulus as the or a solution to the mess. And stimulus seems to me the wrong way to go. I'm not saying I'm right, only, *if* I'm right (about the stimulus), then that implies it wasn't the right theory that was guiding him, but something else, such as temperament (or maybe even "luck", in the same way that *some* fund manager has to outperform the market). On the other hand, if it was theory, then what was the theory (that others didn't have)? And why (again, this is from my perspective, which most seem to be against) is it wrong about the stimulus?

I guess my question comes down to this. Is the problem with economics - it's trying to be a predictive science about things which are too complex to predict? Or is the problem sociological? The "party pooper" explanation accepts that the problem is sociological. And I'm afraid it's just not clear to me that the problem is not just with economics - that it's trying to do something, which can't be done.

This is not to say that I don't think that economics has value; it's just not a science and cannot always make predictions, and it should stop pretending that it can.

[Barkley Rosser]

a,

Fair question. I would say that most of us who "saw it" were not big followers of orthodox economic theory, with a number of us having at least some degree of Post Keynesian orientation with a willingness to take Minsky and Kindleberger seriously, as well as Robert Shiller's numbers on housing, which were the key evidence that indeed we were in a massive housing bubble of historic proportions, screamingly evident by the time the second edition of his Irrational Exuberance came out in 2005. The connections with the financial derivatives markets took a bit harder looking, but were there to see especially as 2006 wore on.

So, yes, it is partly a matter of economic theory, which generally rules out bubbles. You will not find them discussed in very many textbooks, and only fleetingly when they are. They are a violation of rational expectations and all that, so out damned bubble.

However, that is a matter of economic theorists. There were quite a few commentators, such as Steven Perlstein at WaPo, as well as such sage folks as Warren Buffett and Paul Volcker, who were calling it rather publicly. But they were ignored as well, along with the more heterodox and thus more easily dismissed of the economists who were calling it. That is the arena where the party pooper aspect becomes more important, although I think this also probably affected some of the more serious economists who should have known better, such as Brad DeLong and Larry Summers.

Krugman is more conventional in his theoretical orientation, but perhaps his position as a columnist made him more open to thinking about what was going on. He called it earlier than most, although not as early as some of the rest of us.

As for policy, I think it is a matter not of "stimulus is bad," but what kind of stimulus. So, focusing on trying to prop up housing prices is not the way to go. Broader stimulus is needed. We are facing a massive collapse of aggregate demand, and a fiscal stimulus is really all there is, but let it be infrastructure investment, preferably green, and revenue sharing and extending unemployment insurance, and such things. The other thing needed is to restructure and reorder the regulation of the financial system.

[a]

Correct me if I'm wrong, but what I take away from your comment is that those who saw it, had the advantage because they believed that bubbles were possible; and that most economists didn't believe bubbles were possible because it went against rational-expectation theory. I guess I must misunderstand something here, or making it out to be too simple, because the Nasdaq was clearly a bubble; so clearly there would be a problem (and an important problem) with rational-expectations theory which should have been evident almost a good decade ago - or at least the part with bubbles.

Here's a case which maybe you can comment on. Krugman (sort of) saw a bubble in housing. But with oil prices four or so months ago, he belittled the idea that there was a bubble, and tried to prove so with economic arguments. Yet here we are, a few months later, and it sure looks like there was one. So those who were right, were able to see a bubble in housing; but at least some weren't also able to see one in oil. What was the difference? Was it data (such as the existence of ratios such as (housing buying cost)/rent for housing), which made the call in housing easier? Or is there something with theory somewhere that explains it?

[im1dc]

anne your posts today following your train of thought are truly outstanding. Thank you.

[im1dc]

anne your posts today following your train of thought are truly outstanding. Thank you.

[im1dc]

To a and Barkley Rosser

I don't pretend to know all or any that you two know of Economics but it is clear at least to me that Economics is a budding science that has not evolved to the point of making predictions -- except with 20/20 hindsight. Not any different imo from sociology or psychology in that regard.

The problem with the social sciences is the inherently unstable and uncontrollable variable that is intimately involved in every transaction and analysis they attempt: humans.

People are just too complex and changeable to be predicted with great certainty,

And people lie with alacrity too.

That said Economics, Sociology and Psychology are all valuable sciences adding to our knowledge base even with their short comings.

[im1dc]

anne

Observation on the commercial side of things.

Reading CalculatedRisk and looking around my secondary MSA it appears obvious that commercial activity is now showing all the signs of slowing to a stop.

Although I read in a paper that VW continued its site work with earth moving equipment in Chattanooga and said they are going forward with its $Billion dollar VW assembly plant in TN slated to come online in 2011.

In the article I read today VW added they will go forward with plant expansion to add to that plant to increase production from the initial 150K cars a year to 500K cars a year.

Seems almost counterintuitive but then production in the Southern USA is cheaper than producing VW's in Germany.

[bakho]

There was a financial bubble. Way more money was loaned than could possibly be paid back, especially with misallocation of money to failed investments. The debt must either be forgiven or paid off in inflated currency (which is about the same thing). The current strategy of financial system bailout is one form of debt forgiveness, but will it be enough?

There are a lot of wealthy people who are going to lose a lot of money. There response is to try to squeeze blood out of the turnips at the bottom of the economy. They owe so much money that they have no more to lend to those at the bottom. However, no money at the bottom of the economy means recession and potentially depression. Not only does debt need to be forgiven at the top, but money needs to be extended at the bottom. Since debt load is too high on the lower wage earners as it is, redistribution of money to the bottom also needs to take place.

We need to raise the EITC or the minimum wage or both.,

[john c. halasz]

What hasn't been mentioned in this thread, which many of those of us who "saw it coming", (without being sure of the timing, though probably it would go on for far longer than we could rationally expect), is those mounting CA deficits, of unprecedented proportions, which IMHO were directly linked to the formation of the housing/credit bubbles, and rooted in long-standing policies and trends promoting growing income inequality and suppressing the power/role of labor through MNC directed trade and deregulation policies. At any rate, when the Fed dropped to 1%, I, for one, was shocked, and immediately inferred that they were in a serious panic over possible deflation. Add to that the utter lack of any Bushevik responsive fiscal policy, and a disinflationary environment, leaving little pricing power and hence incentivizing cost-cutting/wage-suppressive strategies, and the investment dearth and housing bubble, combined with factitiously high corporate profits, due to the lack of investment costs and cheap easy credit, make a sort of "inevitable" sense. And the point about the housing bubble was that housing was the main repository of net worth for the broadest swathe of U.S. households, so its bursting and the deflation in housing prices would leave many of them in a condition of debt-peonage, just like is traditional in those third world countries that are the beloved targets of MNC "platforming", which is why the blowing of the housing bubble, which IMHO was deliberate policy de facto, if not de jure, was especially pernicious compared to other asset bubbles, which would tend to hit the investor class first and more, before spilling over into the broader economy, rather than directly collapsing the position of wage-dependent households. Since this would so obviously all end in severe grief and since none of these interconnections was mysterious, but rather all too apparent to laymen, such as myself, the "mystery" is why so few professional economists drew those connections.

I'll just hazard some rough guesses. Perhaps it goes to the tendency of economists to focus on aggregates and the statistical analysis of large aggregates, combined with an assumption that the economy will tend to general equilibrium, as a condition of maximal efficiency/full resource utilization, as if that were always and everywhere the case by definition, without attending to the specific sources, pathways, and differential mechanisms of flows going into the composition of those aggregates. And, of course "economic growth" is attributed to investment, with labor a mere "factor of production", a commodity like any other, whose returns are determined by market prices at the margin. Hence, economics as a profession/discipline is already constituted as pro-capitalist, (which is not quite the same as pro-capitalism), and policy orientations tend to be concerned with maintaining the nominal rate of profit as the key to ever increasing efficiency. The neo-Ricardoan point made by Sraffa et alia, that the distribution of income, as an inverse proportion between profits and wages, is a crucial parameter determining both the level and composition of real effective demand, seems lost to most economists, focusing on aggregate output through the equilibriation of nominal prices, which, by definition, should always be the case. But there is little differentiation between short-run equilibrium mechanisms and long-run equilibrium dynamics, since the one is supposed to lead to the other through the postulation of a general equilibrium level, (without any consideration of the blockages that might render the notion of a general equilibrium, as necessarily optimal, fictional). Since flows in terms of nominal prices not only guarantee the tendency toward equilibrium, but are the only truly "empirical" data, it doesn't seem to occur to them that inter-temporal transitions and substitutions in the re-production of intersectoral balances might alter and perhaps even destabilize what might count as equilibrium conditions, not to mention changes in underlying technical coefficients of production, which determine differing rates of productivity increases, which might not be reflected simply in terms of chained-indexes correcting for nominal prices. In short, that there might be a paradox of productivity, as well as one of thrift. And there is a need to distinguish between increases in the real distributable surplus product, actual economic growth, from nominal price effects that might be due to shifts in the underlying ratio of distributions between wages and profits, which mainstream economists are loathe to distinguish, since it implies "undue" interference with market equilibriating processes. And, of course, the idea that an economy must reproduce in an intersectorally balanced way to grow in real and sustainable terms has become obscure, not just because the terms of intersectoral balances are constantly technically changing, but because globalization of both finance and production supply chains has rendered the idea of "an economy", let alone its intersectoral balances, so complex as to be obscure and even outmoded. In sum, the focus on grand macro aggregates, together with undifferentiated assumptions about equilibrium,- (and economics, since its inception, has always been a "classical" discipline, questing after a grand overview by means of theory, with an Olympian detachment),- tends to induce in economists a desire to view any given set of conditions as tending to optimality, thereby rationalizing underlying instabilities and imbalances, which may well be visible in the data, but can't be integrated into the theory, as themselves effects of equilibrium.

All of which fore-going brings me to my pet peeve here. About a year ago, it came to my attention that the official measure of the U.S. external debt, the NIIP, stood at just south of $2.6 trillion, which surprised me, since that meant it had actually shrunk from $3 trillion earlier, inspite of ongoing CA deficits. In fact, it was less than the sum of the CA deficits from the last 4 years! And, if one adds up the sum of annual U.S. CA deficits since 1990, there is some $2.9 trillion missing from the official U.S. external debt. I tried looking up the U.S. external debt/NIIP on google, but found precious little. Inquiring in comments at Brad Setser's blog, I was referred to the work of an economist, who inferred that some $600 billion of bond debt was missing from the NIIP account, which still would leave $2.3 trillion missing. The main explanation is that U.S. MNCs and wealthy investors have been effectively borrowing cheaply from abroad and investing in equity abroad, which foreign equity markets, (ex Japan), have been booming, compared to the relatively laggard performance of U.S. equities, so that U.S. $ had been magically vaporized into the divine ether. Hence there is little wonder that economists, if focused solely on nominal aggregates and sufficiently incurious, might overlook the burgeoning issue of those CA deficits. (There was that ridiculous paper on "dark matter", which amounts to a parody on the tendency at issue). But, of course, foreign equity markets have now crashed in the Great Unwind of dodgy, over-leveraged $ assets and a sudden "shortage" of U.S.$, temporarily driving up its exchange "value", so I'd expect all those vapor bucks to come raining back down from the divine ether, and the NIIP to start to suddenly and rapidly expand. As yet, I've seen no mention of the issue on econ/finance blogs,- (and I tend to travel the pessimistic/skeptical circuit),- but it seems to me, even if I tend to have a U.S.-centric perspective, since that's the rough data I've followed in real time, that the issue deserves much more urgent attention, in deliberating what to do in the face of the current debacle.

Some years ago, I commented to a correspondent at an obscure blog, who had just won his M.S. degree in economics, that I was amazed/aghast at the complacency of mainstream economics commentary, and that, though the probability of a global depression was small, it was still larger than it should be. IIRC, the occasion was the Rogoff/Oberfeld paper on trade imbalances and required currency adjustments, to try and pin down the date. The correspondent agreed. Well, I don't know the exact probability of a global depression, but it's now even larger than it should be.

[cm]

Of course there is the matter of the careers of mainstream administrators and subject matter experts being invested in and "aligned" with the status quo. But even for those in a position to raise the issue, the problem is timing, especially if with enough "management" and manipulation events can be pushed out or patched over for a long while. How many (mostly outside the power structures) have spoken out, and have been ridiculed for the better part of a decade (and when TSHTF, even blamed for it)? That's a powerful disincentive - pissing off the people who count, and "being wrong" too. Being right a few years too late, when your position has already been tarnished, will often repair neither credibility nor relationships.

[Blissex]

«That is the arena where the party pooper aspect becomes more important,»

But not just for housing -- there have been several bubbles since 1995 (when apparently fractional reserve requirements were effectively abolished, and the BoJ created the yen carry trade by cutting interest rates to less then 1%).

Serious Economists always found ways to state authoritatively that there was no bubble. It is all part of market worship, which justifies the distribution of income as righteous. And making apologies for the distribution of income is more or less the job description of Serious Economists.

«although I think this also probably affected some of the more serious economists who should have known better, such as Brad DeLong and Larry Summers.»

But they probably knew better. Serious Economists know very well that going against the consensus cannot happen in public.

[Blissex]

«those mounting CA deficits, of unprecedented proportions, which IMHO were directly linked to the formation of the housing/credit bubbles, and rooted in long-standing policies and trends promoting growing income inequality and suppressing the power/role of labor through MNC directed trade and deregulation policies. At any rate, when the Fed dropped to 1%,»

But that was very late, in 2001. The real start of the current policy environment was the nugatory interest rate policy of the Bank of Japan:

http://www.icasinc.org/1999/1999w/1999wakh.html
«After a series of interest rate reductions, the Bank of Japan cut the discount rate again in September 1995 to a half percent, making this the lowest discount rate in the history of central banking in the world.»

as well as the effective abolition of reserve requirements for USA banks.

«I, for one, was shocked, and immediately inferred that they were in a serious panic over possible deflation.»

Perhaps, but thinking in these terms is nearly always wrong. Talking generically about "deflation", as well as "the economy", "inflation", "average income" usually obscures the very important fact that generic aggregates don't matter to policy makers; it is the effects on particular constituencies that matter.

In 2001 there was a risk of deflation for some specific constituencies, and perhaps :-) the Greenspan Put 1% rate was aimed at aimed at making sure that the deflation of those constituencies was countered, and damn the rest...

[Blissex]

«Since debt load is too high on the lower wage earners as it is, redistribution of money to the bottom also needs to take place.»

That sounds like wishful thinking. The thinking of Serious Economists is that the bottom (80% of workers) is composed of unproductive, parasitical exploiters, and that any increase in their income reduces economic efficiency, and redistributing income from them to the more productive, deserving wealth creators in the top 1% improves economic efficiency, as well as being ethically righteous.

The goal is not to make life easier for *everybody*, but only for those who deserve it. Ands the latter can live well off the work of Chinese labour, and who then needs USA labour?

We need to raise the EITC or the minimum wage or both.,

[Blissex]

«But, of course, foreign equity markets have now crashed in the Great Unwind of dodgy, over-leveraged $ assets and a sudden "shortage" of U.S.$, temporarily driving up its exchange "value", so I'd expect all those vapor bucks to come raining back down from the divine ether, and the NIIP to start to suddenly and rapidly expand. As yet, I've seen no mention of the issue on econ/finance blogs,- (and I tend to travel the pessimistic/skeptical circuit),»

I have recently discovered a very, very good blog about these issues:

http://emsnews.wordpress.com/
http://elainemeinelsupkis.typepad.com/

Don't be put off by the writing style (a bit too allegorical and folksy with funky cartoons) the content is very lucid and direct with lots of interesting data.

[ken melvin]

Being five-ten-fifteen years ahead be the dreaded curse of intelligence.

[bakho]

Fiscal spending can be counterproductive if it is misallocated. The FSU building unsustainable cities in the middle of Siberia comes to mind.

Improving the electrical grid, moves toward electrification of transportation, close the gaps in health care coverage and fixing the disparity in our education system are all "can't miss". That is pretty much the entire $1 Trillion right there.

Cutting ten billion for missile defense to annoy Russia would be an easy cut.

A 10% surtax on all executive compensation over $1 million dollars would be redistributive.

The recession rules are usually misstated to be "Don't raise taxes during a recession". The correct formulation is "Increase the downward redistribution of wealth during a recession".

[Steven Earl Salmony]

See the "Horsemen of the Apocalypse" ride during "blitz" of Wal Mart in Valley Stream, NY.

"Blitz" lines are a sign of the times. These 'lines' are designed to evince rampaging greed. How many other ploys can you think of that surreptitiously exploit human avarice?

Here and now we behold the chimera, the "paint horse and its pin-striped-suited rider, named GREED" being followed closely by a pale horse ridden by Death.

Steven Earl Salmony
AWAREness Campaign on The Human Population,
established 2001

[Barkley Rosser]

a,

Well, I called the oil price surge in mid-summer a bubble on a local TV station here. Once the price got beyond $110 per barrel it was clear from looking at details of how buying was occurring that it was probably a bubble, although it is much harder to call a bubble in commodities than in things like real estate or financial assets where there are income flows (or are supposed to be). But production increased in both Iraq and Saudi Arabia, although the latter took a huge effort as output from al Ghawar is falling, and with the cutback in Chinese buying, especially after the Olympics, there were fundamentals moving the other way.

A lot of people denied there was a bubble in the NASDAQ until it collapsed, a lot of people. Also, even though pretty much everybody knows that not everybody has ratex, there are these old theorems that say the price will reflect the behavior of those who know the most, even though DeLong et al showed that noise traders can dominate a market and end up making the most money out of it (they, or some of them, are the ones who buy lowest and sell highest in a bubble).

Anyway, yes, you are right. The existence of all those nice price-to-rent and price-to-income ratios in the housing market make it a lot easier than in the oil market, where one ends up trying to track all sorts of forms of buying as well as these shifts in supply and non-speculative demand globally, a hairy business indeed.

Oh, and for the record, while I have been touting my own record, I did not call how bad the recession would be. I said the housing/derivatives mess would cause one, but I have never said how bad it would be. Never knew and still don't. We are in Keynesian uncertainty land here, with all those nonlinear complex dynamics plus an unforecastable new regime changing itself every other day in policymaking.

[Barkley Rosser]

Not to mention not knowing the full depths of the entanglements in the derivatives and credit markets and the scale of the toxic waste out there still not revealed or still not turned into toxic waste, given that housing prices still have a ways to fall. That was "Geithner's Nightmare" as I started calling it in public addresses after his Sept. 2006 speech when he said that the Fed would not know what to do if (when) the derivatives markets would blow up because they did not know this stuff. That followed the first half of 2006 when the scale of derivatives globally increased by 50%. That was clearly unsustainable and a waking nigthmare stalking the globe just waiting to hit.

[ken melvin]

A Bubbles like oil price was to be expected when you have some goofy saber rattling bastard like bush on stage. Different reason(s) for housing.