The mid-size broker-dealer MF Global filed for Chapter 11 bankruptcy this morning. In the big picture, this isn't huge news. MF Global had a $42.5 billion balance sheet-- not tiny, but about 1/15th the size of Lehman Brothers' when they filed three years ago. Clearly, the financial system isn't going over a cliff because of this one. But what's interesting about this is what it means for the Titans of Wall Street, whose biggest names are seeing their reputations continue to take a hit in the aftermath of the global economic meltdown.
MF Global is probably most famous for the guy in charge-- Jon Corzine. In his last life, he was governor of New Jersey. Before that, he was the senator from New Jersey. And before that, he was a senior partner at Goldman Sachs, succeeding Steve Friedman before Hank Paulson pushed him out in 1999. It's a bit of a stunning fall from grace for Corzine-- he goes from being run out of Goldman to losing a re-election campaign to Chris Christie to presiding over MF Global for 18 months before it collapsed. Corzine took over the sleepy broker-dealer and hoped to turn it into another Goldman Sachs-- a bold risk-taking firm that could make big returns on equity by placing bets with its own money. The perception was that he was succeeding-- in August, MF Global floated bonds whose yield would jump 1% (they'd have to pay more interest) if Corzine left the firm to serve in the Obama Administration before 2013. Instead, Corzine's strategy imploded. The firm found itself with about $185 million in losses last quarter (compared to just under $1.5 billion in equity) after taking an over $6 billion position in distressed European debt. As if that wasn't bad enough, it looks like almost $700 million in customer funds is unaccounted for after the bankruptcy filing. While it's unlikely that it was stolen, it does look like MF Global was mingling its customers' funds with its own capital, which is a big regulatory no-no.
But the big story, to me, is how Corzine's fall from grace continues a proud line of big names from Goldman who just haven't done particularly well in other places. First, it was Bob Rubin, who left with a glittering reputation to join the Clinton Administration, was hailed as a great Treasury secretary... and then left to become Chairman of the Executive Committee at Citigroup. There, he pushed Citi to take bigger risks, Goldman-style, saw his deregulatory policies as Treasury Secretary fall into heavy disfavor, then watched Citi drive itself to the brink of collapse after taking his advice. But Rubin and Corzine aren't the only ones who have fallen out of favor: Chris Flowers, who left Goldman to open his own private equity shop, lost almost $50 million betting on MF Global, and keeps appearing at the scene of financial disaster after financial disaster.
So it seems like Goldman execs don't exactly have a great track record of replicating Goldman's success after leaving the firm. But it's not just leaving Goldman that seems to be a recipe for disaster-- Goldman itself isn't exactly flying high right about now either. Last quarter, they posted their second quarterly loss since going public in 1999 (the first was in 2008). Their stock price is off by about 60% from its 2007 peak, and it had to cut 1000 more employees recently (in addition to the typical performance-related layoffs). What this looks like to me is that it's not Goldman's traders that turned it into the best-performing big investment bank of the last two decades-- it was their risk management people, who kept them afloat through rough market conditions even as other firms teetered on the brink. Take the risk takers like Corzine and Rubin away from the risk managers, and they're no better than anyone else in the industry.
Now, I might be wrong in my diagnosis, but, at least perception-wise, the old superstars of Goldman's past have pretty much all lost their luster over the last few years. Corzine wasn't the first, and I kind of doubt he'll be the last...
Monday, October 31, 2011
Monday, October 17, 2011
The case for voting Republican
Sometimes, I remember that next year's an election year. Which means the Republicans are going to run a candidate to rival Obama. Now, with unemployment above 9%, the only issue that really matters is the economy. Since the general public doesn't understand the first thing about economic policymaking, chances are if the economy is still in the tanker next Fall, a Republican could win. The Republican debate on the economy was, as I figured it would be, a complete sham. They stood on stage and tried to outdo each other by saying dumber and dumber things. And some of them actually believed it. Which is why there's no way in hell I'd ever vote for Herman Cain, whose bank teller economic adviser managed to create a tax plan that reduces revenue AND raises taxes for the poor and the middle class, while cutting them massively for buyout barons and hedge fund managers. So he's out. Rick Perry has a "super secret" plan he won't disclose, but he's campaigning on the "competitively lower wages against yourself" platform, which shows he doesn't understand accounting identities, so he's out too. Jon Huntsman is running as white Obama, so the chances of him getting nominated are zero. Rick Santorum is a fool and Michele Bachmann's nuts. So that leaves Mitt Romney.
Right now, Romney's the front-runner, and, if things go according to plan, will probably be the nominee. And if he is, I'd be tempted to vote for him. Here's why. While he's been playing an idiot on TV for the last two months to appeal to his base, Romney's no fool. His economic team is headed by Greg Mankiw, who, while definitely a Republican, is a very good economist. And Mankiw and Romney realize that wrecking the economy isn't good for Romney's re-election prospects. So the results... will likely be economic policies that look an awful lot like Obama's, only more aggressive. The rhetoric about lynching Bernanke will go out the window. And lip service will be paid to "repealing regulations" so that, in the end, if the economy does recover, Romney can claim that it was the vague platitudes that are the cause. But in reality, while promising less aggressive policies, he'll likely be able to deliver more. Why? Because, while Republicans in Congress have spent the last 3 years decrying everything Obama's proposed as the death knell of capitalism, they won't want to see a Romney presidency fail. So the apocalyptic rhetoric will die down, and we'll get better policy, simply because of the political party of the person in the White House.
Now, my main reservation about voting for Romney is that it would reward Republicans for their bad behavior. Frankly, the last few years have been completely disgusting in that regard. Obama hasn't been able to get even extremely competent appointees past Congress... three years into his term (Richard Shelby's claim that Nobel laureate Peter Diamond was "unqualified" for the Fed board was an embarrassment). Any effort to relieve the economic problems has been stonewalled. And the Republicans risked allowing the nation to default just to wring concessions out of Obama. I can definitively say nothing like that would happen with President Romney in power. In essence, we'd likely get more aggressive policies than we got under Obama (though not as aggressive as might be ideal) because Republicans won't line up to oppose a Romney presidency the way they did to Obama.
But the real issue with casting that vote is that it essentially sends the signal to the Republican Party that they can stonewall everything for political gain, and it will benefit them politically in the end. So I'm really not inclined to cast my vote that way just for that reason. But I think it's very likely that we'll be better off under a President Romney just for that reason, and it is something I've thought about.
Goldman joins the 99%
All of the big Wall Street banks keep economists on their payroll to forecast trends and assist their traders in establishing positions. Goldman Sachs happens to have one of the best in the industry in Jan Hatzius. Now, Hatzius is calling on the Fed to set an explicit nominal GDP target which, combined with more quantitative easing, would bolster economic growth. Hatzius's baseline scenario (no action on the Fed's part) has unemployment at over 7% at the end of 2015 (a truly scary proposition), he forecasts that a nominal GDP target combined with more QE could get unemployment under 7% before 2013 rolls around.
A rising tide (in terms of GDP) certainly lifts all ships-- a thriving economy wouldn't just be beneficial to Goldman; it would also be welcome relief for the millions of unemployed who have suffered through this crisis. And the biggest roadblock to Fed action right now is... Republican politicians. While Democratic (Krugman, Stiglitz, Roubini) and Republican (Mankiw, Rogoff) economists alike have called on the Fed to be more aggressive, Republican presidential candidates have all decided that Ben Bernanke should be replaced as Fed chairman... because he's done too much to help support the economy. Which is kind of an absurd position, given that, without his support, we would be looking at catastrophic unemployment worse than we had during the Great Depression.
But the real message to take out of this is that, when it comes to fixing the economy, Wall Street and Main Street are on the same page-- both would benefit from aggressive action by both the Fed and the government to tackle the unemployment problem. But it's politicians that are blocking the road path to fixing that problem.
A rising tide (in terms of GDP) certainly lifts all ships-- a thriving economy wouldn't just be beneficial to Goldman; it would also be welcome relief for the millions of unemployed who have suffered through this crisis. And the biggest roadblock to Fed action right now is... Republican politicians. While Democratic (Krugman, Stiglitz, Roubini) and Republican (Mankiw, Rogoff) economists alike have called on the Fed to be more aggressive, Republican presidential candidates have all decided that Ben Bernanke should be replaced as Fed chairman... because he's done too much to help support the economy. Which is kind of an absurd position, given that, without his support, we would be looking at catastrophic unemployment worse than we had during the Great Depression.
But the real message to take out of this is that, when it comes to fixing the economy, Wall Street and Main Street are on the same page-- both would benefit from aggressive action by both the Fed and the government to tackle the unemployment problem. But it's politicians that are blocking the road path to fixing that problem.
Friday, October 14, 2011
Republicans on the economy
When it comes to job creation, the Obama Administration has a pretty poor record-- that's no secret. It pitched an initial stimulus that was much too small, came back for a second round of stimulus that was also much too small, and really hasn't done anything about the debt overhang in housing that's continuing to drag economic growth. But, unfortunately, politics being what it is, the question isn't whether the Obama Administration is doing well-- it's whether the Republicans have a better alternative. And, after reading the transcript of the primary debate, the clear answer is that, at least from what they say, the answer is very clearly "no." So first, I'll go through some general thoughts, and then some specifics about what's wrong with each candidate.
What the Republicans don't seem to understand, across the board, is simple accounting identities. To be fair, Britain's Prime Minister, David Cameron, doesn't understand them either. It's very clear that a major drag on growth in the US is that consumers built up unsustainable debt burdens by borrowing against their houses. The big banks did the same thing. And, with tax revenues depressed, government has been running deficits (rightly, but ignore my commentary for a second). So, in essence, consumers and businesses have both been savings to pay down their debts. Government spending hasn't done nearly enough to fill that hole. But the Republican candidates, to a man, seem to think that government should be cutting spending, and that those spending cuts will somehow spur job creation. To understand how wrong that is, all you need to understand is simple arithmetic. The first truism is that debt is a zero-sum game: there's no such thing as "too much debt in the system"-- individuals can be overindebted, businesses can be overindebted, and governments can be overindebted. But every dollar of debt is offset by a dollar of lending-- you can't run up debt unless you find someone else to lend to you. Demand (and the size of the economy and job growth by extension), however, is not a zero-sum game. If, as the Republican candidates insist, government should be reducing the deficit (and paying down debt), and consumers should be paying down debt (which they obviously should be), and businesses should be paying down debt (which certainly happened over the last few years), then there's no place for demand to come from. To pay down debt, you need income. And to earn income, someone has to demand your labor (meaning spend money). And that means that someone has to be borrowing. Now, consumers are already overindebted, so consumer borrowing is a terrible idea. And it's hard to induce businesses to spend when demand is weak without creating expected inflation (go find a Republican presidential candidate to advocate higher inflation), so the only remaining candidate is the government. By putting people to work, they can pay down their debts, which allows them to spend more in the future once they have paid off their debts. This economic growth eventually bolsters government finances and allows the government to draw down its spending and pay down its debts. Unfortunately, none of the Republican candidates seem to understand this accounting identity. So instead we've got a bunch of candidates who insist that everyone needs to save more simultaneously and get out of debt at the same time. Which is a nice recipe for disaster.
Now, even though all of the candidates are a mess, the specifics are pretty bad too. To start with, we've got the Hermanator hawking his "9-9-9" tax plan, which sounds an awful lot like Domino's 5-5-5 pizza deal from back in the day. When the moderator pointed out that 9-9-9 wouldn't raise enough revenue to run the government, the Hermanator said everyone was using the wrong baseline. But, since he hasn't pointed out that baseline, I guess we're supposed to take him at his word. Good luck with that. It also doesn't help that the "expert" who came up with this idea isn't an economist at all-- it's a Wells Fargo wealth manager with an accounting degree. And not a high-level wealth manager, but the guy you go to if you want to plan your retirement. Which is a respectable profession and all, but most definitely doesn't qualify you to advise a presidential candidate on federal tax policy. It's the equivalent of a Starcraft junkie coming up with military strategy.
Then you've got Rick Perry. Somehow, he's gonna create 1.2 million jobs in the energy industry by "making America energy independent." But no one knows what the plan is, and no one's suggested they can make anything of it, so there's no there there. Then you've got Michelle Bachmann, who whined about Barney Frank a lot, but didn't offer anything in the way of ideas. Ron Paul gave a ramped-down version o his usual schpiel about the Fed-- just as silly and nonsensical as always. Jon Huntsman didn't offer much specific, but, reading between the lines, I think he's running as Obama with an R next to his name-- not stupid enough to actively harm the economy like most of the rest of the field, but not aggressive enough to make an active difference.
The last candidate worth mentioning is Romney. On issues, he brought up the usual Republican platitudes about regulation and not raising taxes, but I seriously doubt he'll actually end up following through. More likely, you can learn a lot about what he thinks by looking at his advisers, Glenn Hubbard and Greg Mankiw. Hubbard is the dean of Columbia Business School, so he's not a dumb guy. His policy views are pretty wrongheaded, but he certainly understands business. Mankiw is a Harvard economist who chaired George W. Bush's Council of Economic Advisers for awhile. On policy grounds, he's a somewhat tax-obsessed New Keynesian. In other words, he thinks tax rates matter more than most New Keynesians do, but in terms of the models he's using, he's starting from the same place as Paul Krugman and Joe Stiglitz. And he's recently advocated a higher inflation target to stimulate growth. This is a good idea not just to stimulate consumption, but also because it reduces the real value of debt, which in turn is kind of a good thing when we have a private debt problem. But, again, Mankiw is an academic and Romney is a Republican politician-- throwing out that platform will get him burned at the stake. But I do have far more confidence in Romney than in any of the other Republican contenders solely because he has real advisers who aren't inept.
The one thing that all the Republican contenders seemed to agree on was the need to get rid of Ben Bernanke. Ignore for a second the fact that Bernanke is probably the single biggest reason we didn't have a second Great Depression-- he's also a Republican who was appointed by George W. Bush, and a pupil of Milton Friedman's. The public lynching of Bernanke shows just how far the Republican Party's gone off the rails in the last 3 years. And that's scary.
What the Republicans don't seem to understand, across the board, is simple accounting identities. To be fair, Britain's Prime Minister, David Cameron, doesn't understand them either. It's very clear that a major drag on growth in the US is that consumers built up unsustainable debt burdens by borrowing against their houses. The big banks did the same thing. And, with tax revenues depressed, government has been running deficits (rightly, but ignore my commentary for a second). So, in essence, consumers and businesses have both been savings to pay down their debts. Government spending hasn't done nearly enough to fill that hole. But the Republican candidates, to a man, seem to think that government should be cutting spending, and that those spending cuts will somehow spur job creation. To understand how wrong that is, all you need to understand is simple arithmetic. The first truism is that debt is a zero-sum game: there's no such thing as "too much debt in the system"-- individuals can be overindebted, businesses can be overindebted, and governments can be overindebted. But every dollar of debt is offset by a dollar of lending-- you can't run up debt unless you find someone else to lend to you. Demand (and the size of the economy and job growth by extension), however, is not a zero-sum game. If, as the Republican candidates insist, government should be reducing the deficit (and paying down debt), and consumers should be paying down debt (which they obviously should be), and businesses should be paying down debt (which certainly happened over the last few years), then there's no place for demand to come from. To pay down debt, you need income. And to earn income, someone has to demand your labor (meaning spend money). And that means that someone has to be borrowing. Now, consumers are already overindebted, so consumer borrowing is a terrible idea. And it's hard to induce businesses to spend when demand is weak without creating expected inflation (go find a Republican presidential candidate to advocate higher inflation), so the only remaining candidate is the government. By putting people to work, they can pay down their debts, which allows them to spend more in the future once they have paid off their debts. This economic growth eventually bolsters government finances and allows the government to draw down its spending and pay down its debts. Unfortunately, none of the Republican candidates seem to understand this accounting identity. So instead we've got a bunch of candidates who insist that everyone needs to save more simultaneously and get out of debt at the same time. Which is a nice recipe for disaster.
Now, even though all of the candidates are a mess, the specifics are pretty bad too. To start with, we've got the Hermanator hawking his "9-9-9" tax plan, which sounds an awful lot like Domino's 5-5-5 pizza deal from back in the day. When the moderator pointed out that 9-9-9 wouldn't raise enough revenue to run the government, the Hermanator said everyone was using the wrong baseline. But, since he hasn't pointed out that baseline, I guess we're supposed to take him at his word. Good luck with that. It also doesn't help that the "expert" who came up with this idea isn't an economist at all-- it's a Wells Fargo wealth manager with an accounting degree. And not a high-level wealth manager, but the guy you go to if you want to plan your retirement. Which is a respectable profession and all, but most definitely doesn't qualify you to advise a presidential candidate on federal tax policy. It's the equivalent of a Starcraft junkie coming up with military strategy.
Then you've got Rick Perry. Somehow, he's gonna create 1.2 million jobs in the energy industry by "making America energy independent." But no one knows what the plan is, and no one's suggested they can make anything of it, so there's no there there. Then you've got Michelle Bachmann, who whined about Barney Frank a lot, but didn't offer anything in the way of ideas. Ron Paul gave a ramped-down version o his usual schpiel about the Fed-- just as silly and nonsensical as always. Jon Huntsman didn't offer much specific, but, reading between the lines, I think he's running as Obama with an R next to his name-- not stupid enough to actively harm the economy like most of the rest of the field, but not aggressive enough to make an active difference.
The last candidate worth mentioning is Romney. On issues, he brought up the usual Republican platitudes about regulation and not raising taxes, but I seriously doubt he'll actually end up following through. More likely, you can learn a lot about what he thinks by looking at his advisers, Glenn Hubbard and Greg Mankiw. Hubbard is the dean of Columbia Business School, so he's not a dumb guy. His policy views are pretty wrongheaded, but he certainly understands business. Mankiw is a Harvard economist who chaired George W. Bush's Council of Economic Advisers for awhile. On policy grounds, he's a somewhat tax-obsessed New Keynesian. In other words, he thinks tax rates matter more than most New Keynesians do, but in terms of the models he's using, he's starting from the same place as Paul Krugman and Joe Stiglitz. And he's recently advocated a higher inflation target to stimulate growth. This is a good idea not just to stimulate consumption, but also because it reduces the real value of debt, which in turn is kind of a good thing when we have a private debt problem. But, again, Mankiw is an academic and Romney is a Republican politician-- throwing out that platform will get him burned at the stake. But I do have far more confidence in Romney than in any of the other Republican contenders solely because he has real advisers who aren't inept.
The one thing that all the Republican contenders seemed to agree on was the need to get rid of Ben Bernanke. Ignore for a second the fact that Bernanke is probably the single biggest reason we didn't have a second Great Depression-- he's also a Republican who was appointed by George W. Bush, and a pupil of Milton Friedman's. The public lynching of Bernanke shows just how far the Republican Party's gone off the rails in the last 3 years. And that's scary.
Thursday, October 13, 2011
Wall Street Is Struggling: Should we care?
Bloomberg had an article a couple of days ago talking about the struggles on Wall Street. Essentially, the article points out that Wall Street banks aren't actually doing as well as the Occupy Wall Street people seem to think. And that's certainly true-- Goldman is set to announce its second quarterly loss since going public in 1999 this month, and Morgan Stanley, Citigroup, and especially Bank of America aren't doing so hot either, especially compared to the heights they reached in 2007. All of them have laid off employees, and pay is down. What struck me in particular was this passage from the end of the article:
The implication seems to be that the trader is demoralized because he's working hard and his pay is down. But his discontent shows just how far off the rails our financial system was in the boom years leading up to 2007, when these kinds of pay packages were common. Short of a brilliant entrepreneur starting his own company, no 27-year-old employee creates a half-million worth of value in a year. Pay packages on Wall Street were certainly huge, but they were huge for a reason: banks could make directional bets with their capital, and use extreme leverage to magnify their returns. The result was huge profits... but also huge risks that were borne not just by the banks, but by the entire economy. Think of it this way. If a 27-year-old trader makes a huge trading profit, he takes a significant chunk of the upside. If he loses that much, his bonus may be cut, but he'll still get a salary. And if the trade is complex enough that it doesn't go sour for 5 years, well, he'll pocket big gains, then leave his firm holding the bag. But with financial firms as big as they were, it wasn't really the firms holding the bag-- it was taxpayers. Because banks do provide valuable services to businesses that can't be replaced on a whim. But it's not those activities that were earning traders monster bonuses in the good years.
What we've seen over the last couple of years is a realization that the outsize pay in the banking sector didn't in any way reflect social value-- banks certainly play a valuable role in helping companies streamline operations, go public, merge, make acquisitions, go public, and hedge their risks and exposures. Heck, Goldman Sachs has done an aggressive ad campaign over the last few years emphasizing its role in financing public projects. And those services are truly valuable. But what they don't mention is that those services made up something like 10% of their profits during the boom years (I may be remembering the exact number wrong, but it was certainly at most 25%). But in boom times, it was proprietary trading and investments that were driving monster profits, as well as securitization fees from their disastrous mortgage operations. The Dodd-Frank bill cut back on a lot of those extremely profitable but not particularly socially useful activities... and a lot of monster paychecks went by the wayside (though finance still pays a LOT more than just about any other industry). So what we're seeing, I think, is these 27 year olds who think they're entitled to monster paychecks because they "work hard", who don't realize that those monster paychecks came about in large part because of a system that was rife with moral hazard (government picking up the tab for losses while banks took all the gains). If reduced paychecks in finance meant companies had a harder time raising capital, or made going public more difficult, it would be a cause for concern. But there's no evidence of that: I hope that what we're seeing instead is a useful readjustment of Wall Street's proper role in helping businesses raise capital.
Good thing... if it leads to more financial stability. These people are colorblind to the fact that their risk-taking in "good times" helped wreck the economy. But it also says that the solution isn't more railing on Wall Street-- Wall Street's been reined in to some extent already. The solutions need to be macro in scope.
Bankers aren’t optimistic about those gains. Options Group’s Karp said he met last month over tea at the Gramercy Park Hotel in New York with a trader who made $500,000 last year at one of the six largest U.S. banks.
The trader, a 27-year-old Ivy League graduate, complained that he has worked harder this year and will be paid less. The headhunter told him to stay put and collect his bonus.
“This is very demoralizing to people,” Karp said. “Especially young guys who have gone to college and wanted to come onto the Street, having dreams of becoming millionaires.”
The implication seems to be that the trader is demoralized because he's working hard and his pay is down. But his discontent shows just how far off the rails our financial system was in the boom years leading up to 2007, when these kinds of pay packages were common. Short of a brilliant entrepreneur starting his own company, no 27-year-old employee creates a half-million worth of value in a year. Pay packages on Wall Street were certainly huge, but they were huge for a reason: banks could make directional bets with their capital, and use extreme leverage to magnify their returns. The result was huge profits... but also huge risks that were borne not just by the banks, but by the entire economy. Think of it this way. If a 27-year-old trader makes a huge trading profit, he takes a significant chunk of the upside. If he loses that much, his bonus may be cut, but he'll still get a salary. And if the trade is complex enough that it doesn't go sour for 5 years, well, he'll pocket big gains, then leave his firm holding the bag. But with financial firms as big as they were, it wasn't really the firms holding the bag-- it was taxpayers. Because banks do provide valuable services to businesses that can't be replaced on a whim. But it's not those activities that were earning traders monster bonuses in the good years.
What we've seen over the last couple of years is a realization that the outsize pay in the banking sector didn't in any way reflect social value-- banks certainly play a valuable role in helping companies streamline operations, go public, merge, make acquisitions, go public, and hedge their risks and exposures. Heck, Goldman Sachs has done an aggressive ad campaign over the last few years emphasizing its role in financing public projects. And those services are truly valuable. But what they don't mention is that those services made up something like 10% of their profits during the boom years (I may be remembering the exact number wrong, but it was certainly at most 25%). But in boom times, it was proprietary trading and investments that were driving monster profits, as well as securitization fees from their disastrous mortgage operations. The Dodd-Frank bill cut back on a lot of those extremely profitable but not particularly socially useful activities... and a lot of monster paychecks went by the wayside (though finance still pays a LOT more than just about any other industry). So what we're seeing, I think, is these 27 year olds who think they're entitled to monster paychecks because they "work hard", who don't realize that those monster paychecks came about in large part because of a system that was rife with moral hazard (government picking up the tab for losses while banks took all the gains). If reduced paychecks in finance meant companies had a harder time raising capital, or made going public more difficult, it would be a cause for concern. But there's no evidence of that: I hope that what we're seeing instead is a useful readjustment of Wall Street's proper role in helping businesses raise capital.
Good thing... if it leads to more financial stability. These people are colorblind to the fact that their risk-taking in "good times" helped wreck the economy. But it also says that the solution isn't more railing on Wall Street-- Wall Street's been reined in to some extent already. The solutions need to be macro in scope.
Wednesday, October 12, 2011
"We are the 53%" is really really stupid
So, in response to the Occupy Wall Street folks, Erick Erickson from RedState.com decided to start a competing "movement" called "We are the 53%." The idea behind the tag is that 53% of Americans pay income taxes and 47% don't, and the 47% should work harder and stop complaining. This is without a doubt one of the dumbest ideas of all time. To start with, the statistic it's based on is a common right-wing talking point that's also laughably misleading. Yes, a lot of people don't pay federal income taxes. Why? Well, first, a lot of those lucky duckies are poor. The idea seems to be that if you're lucky enough to be poor, you won't have to pay taxes! That's like being jealous of your neighbor whose friends chipped in to buy him a wheelchair after his legs were blown off. It's easy to join the 47%, Erick-- just stop working. Then go out and tell all those poor folks all about how awesome it is to be poor in America. Of course, the Heritage Foundation released a nice little survey recently pointing out that, if you're poor in America, odds are pretty good that you've got a refrigerator and a microwave. Great. Maybe Heritage can start a movement. Tag: "Being poor in America: Way better than being poor in Somalia." The second reason the tag is stupid (and probably the more relevant one) is that the implication is that 47% of the country doesn't pay taxes on their income. That's baloney. The federal income tax is a specific tax on income across the board. But for most Americans, federal income tax isn't the biggest tax they pay-- instead, it's the payroll tax. Which... is also levied on income. So they cherry-pick a tax and decide that, because a lot of people are too poor to pay it, they must be freeloading. Clever (except not).
Then there's the second reason that "movement" is stupid-- it's the implication that if only people wanted to get jobs, they could get them. It's a rehash of the absurd idea the Real Business Cycle folks like to float-- that downturns happen because people suddenly decide that they value leisure time more than working. Their explanation for the Great Depression boils down to a quarter of the population dropping everything and deciding that they all simultaneously wanted to go on a long vacation. And also stand in bread lines. Yes, the idea is as dumb as it sounds. So, implicit in the "53%ers" demands is the idea that the reason a lot of people are out of work is they're not working hard enough to find jobs that are out there. Which is a patently ridiculous idea-- if taken to its logical conclusion, it suggests that, in the last 3 years, twice as many people have become lazy and stopped looking for jobs that are out there. The reality, of course, is that jobs aren't hiding in the woods waiting to be found-- if businesses are selling a lot of their product, they'll expand and hire workers. And they won't keep those jobs secret from the unemployed so that they'll have to finish a scavenger hunt to get hired.
But the problem is that those businesses ARE seeing weak sales. And the result is 9% unemployment and frustrated people protesting all over the country (whether they're protesting at the right places is a different question).
Two reasons: 1) Misleading statistic, 2) Economy is cyclical-- implication is that 10% of the population suddenly became super lazy in 2008.
Then there's the second reason that "movement" is stupid-- it's the implication that if only people wanted to get jobs, they could get them. It's a rehash of the absurd idea the Real Business Cycle folks like to float-- that downturns happen because people suddenly decide that they value leisure time more than working. Their explanation for the Great Depression boils down to a quarter of the population dropping everything and deciding that they all simultaneously wanted to go on a long vacation. And also stand in bread lines. Yes, the idea is as dumb as it sounds. So, implicit in the "53%ers" demands is the idea that the reason a lot of people are out of work is they're not working hard enough to find jobs that are out there. Which is a patently ridiculous idea-- if taken to its logical conclusion, it suggests that, in the last 3 years, twice as many people have become lazy and stopped looking for jobs that are out there. The reality, of course, is that jobs aren't hiding in the woods waiting to be found-- if businesses are selling a lot of their product, they'll expand and hire workers. And they won't keep those jobs secret from the unemployed so that they'll have to finish a scavenger hunt to get hired.
But the problem is that those businesses ARE seeing weak sales. And the result is 9% unemployment and frustrated people protesting all over the country (whether they're protesting at the right places is a different question).
Two reasons: 1) Misleading statistic, 2) Economy is cyclical-- implication is that 10% of the population suddenly became super lazy in 2008.
Monday, October 10, 2011
Don't Listen to Ron Paul: Part 129
Paul Krugman has a good blog post explaining in three paragraphs why the Austrians' obsession with banning banking is inane. I don't have much to add, but it's worth reading, if nothing else to understand why listening to Ron Paul is a good way to make yourself dumber.
Occupy Wall Street and its Discontents
Paul Krugman has a defense of the Occupy Wall Street people in his Times column. As usual, it's well-written and persuasive, but I don't think it gets at the whole of the issue. Krugman's central argument is that the movement is essentially right to vilify Wall Street and the wealthy, and that it's those positions that are dangerous and extreme rather than, as the Right would tell you, Occupy Wall Street's.
Now, I think Krugman's main mistake is that he projects onto Occupy Wall Street what he wants to see in it: essentially an army of center-left folks who believe that we need government to tame the excesses of the market and regulate industries that are habitually destabilizing when left to their own devices. And while Krugman's position is cogent, powerful, and essentially correct, I think much of Occupy Wall Street has a different agenda. There are segments that are essentially protesting for the sake of protesting (and flying a Marxist flag to feel important). Those folks can be dismissed out of hand. There's another chunk that is taking up traditional far-left positions that are either entirely economically indefensible (like rejecting free trade), or more nuanced than those people like to think they are (like minimum wage hikes).
But the segment that I think Krugman is correct in sympathizing with, and which is the portion with whom I am most sympathetic, are those who are protesting out of an unspecified frustration with the American economy. They know something is wrong. They know that the economy is in a hole, and ordinary people are struggling while Congresspeople are sitting around and worrying about government solvency at a time when investors are lending to the US government at incredibly low rates and 9% of the workforce is out of work. And they know that super-wealthy people are doing exceptionally well and paying very little in taxes to top it off while ordinary people struggle. But those people don't know exactly what to do about it, while people like Krugman do.
But where I think the movement goes off the rails (and Krugman with it) is in the tenor of the protests. To put it in simple terms, to me, this doesn't look like a "what about us" protest-- it looks like a "let's cut the rich down to size" protest. And the two are very different. Yes, rich people broadly and Wall Street in particular are doing better than the average American. The question, then, is what we can do about it. Cutting CEO pay isn't going to put millions of people back to work. Nor will abolishing Wall Street help the country move forward-- more likely it'll hurt.
The real changes have to come at the policy level, in ways that make the "99%" better off rather than the "1%" worse off (though there's at least some inevitable sacrifice that "1%" will have to make to get that result). Simply put, the economy's problem is massive private debt overhang that is keeping consumers from spending and stifling demand. Wall Street people are smart enough to support such provisions. Goldman, Morgan Stanley, Citigroup, and every other big bank have economists on staff who forecast the economic impact of government stimulus. And those economists, across the board, acknowledge that stimulus will improve the economy. So what's blocking policies that will resolve those issues? My feeling is it's two things. First, this is still a country whose people are widely suspicious of government. Tea Party folks might not like Wall Street any more than the "Occupy Wall Street" folks, but talk to them about stimulus, and they'll wave their pitchforks in the air and mutiny. They've convinced themselves that if government just gets out of the way, business will magically start hiring (for some reason neither they nor their leaders can articulate in any minimally coherent way) and the economy will start booming. These people might not like Wall Street, but they and their leaders refuse to acknowledge that the solution is more rather than less government investment. Second, and this point is more directly related to Wall Street, is the fact that relief for debtors (which is probably the single most significant step government could take to speed up the recovery) would force banks to take write-downs, which in turn would cut into their revenues and damage their balance sheets. And, at a time when Citigroup and Bank of America are especially vulnerable, forced write-downs may not be wise policy. And, at the end of the day, with much of the country still opposed to debt relief for ordinary people (remember, the Tea Party started with Rick Santelli's nonsensical rant about bailing out "losers"; and those "losers" weren't the illiquid banks-- they were homeowners who were underwater on their mortgages), there's no political will to override the creditors' position on that issue.
One solution might be targeted stimulus directed at household balance sheets-- in essence, paying off mortgages for those who are underwater, or combining forced write-downs on the principal of underwater mortgages with subsidies for the banks holding those mortgages. Would this be another bailout? Sure. But economics isn't a morality play. While debtors were certainly irresponsible for taking out loans they couldn't afford, creditors were equally irresponsible for making loans to creditors without doing their due diligence. And such a solution would provide equal relief for both guilty parties. Would this reward the "guilty" (dumb borrowers and lenders) at the expense of the "innocent" (those who borrowed and lent prudently)? Sure again. But it's not like it's only those who are underwater on their mortgages who are struggling. The overhang of debt is having a huge effect on aggregate demand, which in turn affects even the prudent. So a factory worker who is laid off because her company's sales dropped 30% because households started saving to pay down debts instead of spending may have done everything right, but that's no relief to her. And debt relief for underwater homeowners and banks, by shoring up household balance sheets and freeing up funds to spend, would indirectly help her as well.
But I think such nuanced solutions aren't what OWS is fundamentally about-- I kind of get the sense it's more about dragging down "the rich" and "Wall Street" than it is about promoting policies that will actually improve the lives of ordinary people. And I think that's my biggest problem with the nature of the protests.
Now, I think Krugman's main mistake is that he projects onto Occupy Wall Street what he wants to see in it: essentially an army of center-left folks who believe that we need government to tame the excesses of the market and regulate industries that are habitually destabilizing when left to their own devices. And while Krugman's position is cogent, powerful, and essentially correct, I think much of Occupy Wall Street has a different agenda. There are segments that are essentially protesting for the sake of protesting (and flying a Marxist flag to feel important). Those folks can be dismissed out of hand. There's another chunk that is taking up traditional far-left positions that are either entirely economically indefensible (like rejecting free trade), or more nuanced than those people like to think they are (like minimum wage hikes).
But the segment that I think Krugman is correct in sympathizing with, and which is the portion with whom I am most sympathetic, are those who are protesting out of an unspecified frustration with the American economy. They know something is wrong. They know that the economy is in a hole, and ordinary people are struggling while Congresspeople are sitting around and worrying about government solvency at a time when investors are lending to the US government at incredibly low rates and 9% of the workforce is out of work. And they know that super-wealthy people are doing exceptionally well and paying very little in taxes to top it off while ordinary people struggle. But those people don't know exactly what to do about it, while people like Krugman do.
But where I think the movement goes off the rails (and Krugman with it) is in the tenor of the protests. To put it in simple terms, to me, this doesn't look like a "what about us" protest-- it looks like a "let's cut the rich down to size" protest. And the two are very different. Yes, rich people broadly and Wall Street in particular are doing better than the average American. The question, then, is what we can do about it. Cutting CEO pay isn't going to put millions of people back to work. Nor will abolishing Wall Street help the country move forward-- more likely it'll hurt.
The real changes have to come at the policy level, in ways that make the "99%" better off rather than the "1%" worse off (though there's at least some inevitable sacrifice that "1%" will have to make to get that result). Simply put, the economy's problem is massive private debt overhang that is keeping consumers from spending and stifling demand. Wall Street people are smart enough to support such provisions. Goldman, Morgan Stanley, Citigroup, and every other big bank have economists on staff who forecast the economic impact of government stimulus. And those economists, across the board, acknowledge that stimulus will improve the economy. So what's blocking policies that will resolve those issues? My feeling is it's two things. First, this is still a country whose people are widely suspicious of government. Tea Party folks might not like Wall Street any more than the "Occupy Wall Street" folks, but talk to them about stimulus, and they'll wave their pitchforks in the air and mutiny. They've convinced themselves that if government just gets out of the way, business will magically start hiring (for some reason neither they nor their leaders can articulate in any minimally coherent way) and the economy will start booming. These people might not like Wall Street, but they and their leaders refuse to acknowledge that the solution is more rather than less government investment. Second, and this point is more directly related to Wall Street, is the fact that relief for debtors (which is probably the single most significant step government could take to speed up the recovery) would force banks to take write-downs, which in turn would cut into their revenues and damage their balance sheets. And, at a time when Citigroup and Bank of America are especially vulnerable, forced write-downs may not be wise policy. And, at the end of the day, with much of the country still opposed to debt relief for ordinary people (remember, the Tea Party started with Rick Santelli's nonsensical rant about bailing out "losers"; and those "losers" weren't the illiquid banks-- they were homeowners who were underwater on their mortgages), there's no political will to override the creditors' position on that issue.
One solution might be targeted stimulus directed at household balance sheets-- in essence, paying off mortgages for those who are underwater, or combining forced write-downs on the principal of underwater mortgages with subsidies for the banks holding those mortgages. Would this be another bailout? Sure. But economics isn't a morality play. While debtors were certainly irresponsible for taking out loans they couldn't afford, creditors were equally irresponsible for making loans to creditors without doing their due diligence. And such a solution would provide equal relief for both guilty parties. Would this reward the "guilty" (dumb borrowers and lenders) at the expense of the "innocent" (those who borrowed and lent prudently)? Sure again. But it's not like it's only those who are underwater on their mortgages who are struggling. The overhang of debt is having a huge effect on aggregate demand, which in turn affects even the prudent. So a factory worker who is laid off because her company's sales dropped 30% because households started saving to pay down debts instead of spending may have done everything right, but that's no relief to her. And debt relief for underwater homeowners and banks, by shoring up household balance sheets and freeing up funds to spend, would indirectly help her as well.
But I think such nuanced solutions aren't what OWS is fundamentally about-- I kind of get the sense it's more about dragging down "the rich" and "Wall Street" than it is about promoting policies that will actually improve the lives of ordinary people. And I think that's my biggest problem with the nature of the protests.
Wednesday, October 5, 2011
Why does the Left love George Soros but hate Goldman Sachs?
An inevitable response when anyone on the left mentions that Koch Industries is run more or less as a criminal enterprise is, "Well, George Soros is worse." Never mind that it's nowhere near true, but the left still goes to great lengths to defend Soros from accusations that he's the same kind of "immoral corporate goon" as all the others. On the other hand, the populists left's favorite target is Wall Street, and probably the biggest symbol they hold up of Wall Street's immorality during the financial crisis is Goldman realizing massive profits betting on the collapse of the housing market, while the economy crumbled around them. Now, the first thing to mention is that the argument puts Goldman in an absurd catch-22-- had they gone along with the herd and bet on housing, they would have been blamed for making dumb bets in the same way the rest of Wall Street was. By betting against housing, they were "betting against America" while ordinary people suffered. Either way, they couldn't win. Instead, let's focus on the parallels between Goldman's "big short" against housing and the defining act of Soros's career: his short of the British pound in 1992.
Without getting into the economic details, the essence of Soros's trade was pretty simple: at the time, Britain was in the Exchange Rate Mechanism (the precursor to the Euro), which committed them to maintaining the pound at a certain level relative to other European currencies (not a specific price, but a band). To do that, the Bank of England had to maintain certain levels of foreign exchange reserves and commit to exchange them for foreign currencies on demand. Then, in 1992, Germany and England's economies diverged rapidly. Reunification produced a boom in Germany as the East was built up to restore parity with the West, and inflation started running higher than they wanted, leading the Bundesbank to raise interest rates (which has the side effect of strengthening the currency relative to others). At the same time, Britain was in a nasty recession, so it needed lower interest rates, and a relatively lower value for the pound relative to the deutschmark to make its exports competitive. But staying in the ERM would have required the Bank of England to raise rates, and it did so, exacerbating the Depression. Soros recognized this weakness, and started shorting the pound-- he borrowed pounds and started selling them to the Treasury at the par rate, draining the British Treasury of its foreign exchange reserves. Eventually, he (along with a bunch of other traders doing the same thing) forced Britain out of the ERM, and Soros realized a gain of over $1 billion. It was a brilliant opportunity for Soros-- an ordinary short position is extremely risky because it has unlimited downside-- by borrowing and then selling an asset, you run the risk of that asset rising to infinity in the meantime. This trade, however, was almost risk-free: the pound was never going to RISE relative to other currencies so, at worst, if the British Treasury had somehow managed to defend the pound from the speculative attack, Soros would have lost only the interest rate he paid for borrowing the pounds that he then sold short.
The ultimate loser, however, was the British taxpayer, as the Treasury sold its reserves of foreign currencies for far less than they were worth after it had to devalue the pound. So, in a simple sense, Soros made over $1 billion at the expense of British taxpayers. But the story doesn't end there, of course. Leaving the ERM was ultimately absolutely the right step for England-- it allowed the economy to escape the nasty recession it was in, and kept it out of the trap that was the Euro (today, Britain isn't necessarily doing much better in terms of its budget picture than Spain or Italy, but its borrowing costs are MUCH MUCH lower, the sole reason being that it has its own currency. If David Cameron hadn't stupidly decided to pursue austerity in the middle of a recession, they might actually be recovering nicely now.
Now compare that to Goldman's trade during the crisis. In essence, in 2006, while the rest of Wall Street was knee-deep in housing exposures, Goldman's mortgage desk realized the market was headed for a crash and made a big short bet. In essence, once the market tanked (as it was bound to do anyway), Goldman would profit. The losers, ultimately, were their counterparties (those on the other side of their short positions). The only differences between Goldman's short and Soros's are 1) the asset that was being shorted, and 2) the fact that the entire financial system didn't need to be bailed out after Soros's bet. Another difference is that, while Soros was a hedge fund manager (meaning that his sole business was finding and exploiting market inefficiencies), Goldman is also involved in raising capital for businesses and advising clients on mergers and acquisitions (each of which serves a much more straightforward social purpose, though the latter probably less than the former).
This isn't to say that Goldman necessarily didn't do anything wrong: they did pay a settlement to the SEC for fleecing clients on one of their Abacus deals in 2007. But the ones they might have fleeced on that deal weren't taxpayers; they were German banks who probably should have known better. So, while they did make plenty of money during the crisis, the right response isn't to pick up your pitchfork: it's to ask what you expected them to do.
But I suspect that what the difference might come down to is the fact that Soros has been bankrolling left-leaning causes for the better part of two decades. He funded the Center for American Progress, raised lots of money to defeat George Bush, and is one of the left's highest-profile donors. A dirty little secret, though, is that Goldman is a pretty liberal operation itself. Though ex-Goldman CEO and Treasur Secretary Hank Paulson is nominally a Republican, and former senior partner Steve Friedman also leans to the right, as a whole, Goldman is a pretty left-leaning organization. Their current CEO, Lloyd Blankfein, was a pretty prominent Hillary Clinton supporter in 2008. Clinton's Treasury Secretary (and former senior partner) Robert Rubin is a centrist, but certainly a Democrat. And the company as a whole has historically donated more to Democrats than to Republicans. While which political party an organization supports shouldn't necessarily matter, the fact of the matter is, I'm pretty sure liberals would be up in arms over George Soros if it were the Heritage Foundation that he was funding rather than CAP.
But my point isn't that liberals should hate George Soros, or that conservatives should hate Goldman. It's that there's no real reason to hate either Soros or Goldman-- both play by the rules of the system. The problem is the system has long had flawed rules. Fixing those rules is something Soros publicly welcomes, but it's something that is the responsibility of politicians rather than participants in that system. So instead of complaining about how terrible Goldman Sachs is, liberals should think about electing better politicians who will work to fix the rules of the system in which Goldman plays. Regardless of the environment, firms like Goldman will keep making money, and that is, at bottom, a good thing. But the environment should be one in which regulations prevent firms playing by those rules from endangering the global economy.
Without getting into the economic details, the essence of Soros's trade was pretty simple: at the time, Britain was in the Exchange Rate Mechanism (the precursor to the Euro), which committed them to maintaining the pound at a certain level relative to other European currencies (not a specific price, but a band). To do that, the Bank of England had to maintain certain levels of foreign exchange reserves and commit to exchange them for foreign currencies on demand. Then, in 1992, Germany and England's economies diverged rapidly. Reunification produced a boom in Germany as the East was built up to restore parity with the West, and inflation started running higher than they wanted, leading the Bundesbank to raise interest rates (which has the side effect of strengthening the currency relative to others). At the same time, Britain was in a nasty recession, so it needed lower interest rates, and a relatively lower value for the pound relative to the deutschmark to make its exports competitive. But staying in the ERM would have required the Bank of England to raise rates, and it did so, exacerbating the Depression. Soros recognized this weakness, and started shorting the pound-- he borrowed pounds and started selling them to the Treasury at the par rate, draining the British Treasury of its foreign exchange reserves. Eventually, he (along with a bunch of other traders doing the same thing) forced Britain out of the ERM, and Soros realized a gain of over $1 billion. It was a brilliant opportunity for Soros-- an ordinary short position is extremely risky because it has unlimited downside-- by borrowing and then selling an asset, you run the risk of that asset rising to infinity in the meantime. This trade, however, was almost risk-free: the pound was never going to RISE relative to other currencies so, at worst, if the British Treasury had somehow managed to defend the pound from the speculative attack, Soros would have lost only the interest rate he paid for borrowing the pounds that he then sold short.
The ultimate loser, however, was the British taxpayer, as the Treasury sold its reserves of foreign currencies for far less than they were worth after it had to devalue the pound. So, in a simple sense, Soros made over $1 billion at the expense of British taxpayers. But the story doesn't end there, of course. Leaving the ERM was ultimately absolutely the right step for England-- it allowed the economy to escape the nasty recession it was in, and kept it out of the trap that was the Euro (today, Britain isn't necessarily doing much better in terms of its budget picture than Spain or Italy, but its borrowing costs are MUCH MUCH lower, the sole reason being that it has its own currency. If David Cameron hadn't stupidly decided to pursue austerity in the middle of a recession, they might actually be recovering nicely now.
Now compare that to Goldman's trade during the crisis. In essence, in 2006, while the rest of Wall Street was knee-deep in housing exposures, Goldman's mortgage desk realized the market was headed for a crash and made a big short bet. In essence, once the market tanked (as it was bound to do anyway), Goldman would profit. The losers, ultimately, were their counterparties (those on the other side of their short positions). The only differences between Goldman's short and Soros's are 1) the asset that was being shorted, and 2) the fact that the entire financial system didn't need to be bailed out after Soros's bet. Another difference is that, while Soros was a hedge fund manager (meaning that his sole business was finding and exploiting market inefficiencies), Goldman is also involved in raising capital for businesses and advising clients on mergers and acquisitions (each of which serves a much more straightforward social purpose, though the latter probably less than the former).
This isn't to say that Goldman necessarily didn't do anything wrong: they did pay a settlement to the SEC for fleecing clients on one of their Abacus deals in 2007. But the ones they might have fleeced on that deal weren't taxpayers; they were German banks who probably should have known better. So, while they did make plenty of money during the crisis, the right response isn't to pick up your pitchfork: it's to ask what you expected them to do.
But I suspect that what the difference might come down to is the fact that Soros has been bankrolling left-leaning causes for the better part of two decades. He funded the Center for American Progress, raised lots of money to defeat George Bush, and is one of the left's highest-profile donors. A dirty little secret, though, is that Goldman is a pretty liberal operation itself. Though ex-Goldman CEO and Treasur Secretary Hank Paulson is nominally a Republican, and former senior partner Steve Friedman also leans to the right, as a whole, Goldman is a pretty left-leaning organization. Their current CEO, Lloyd Blankfein, was a pretty prominent Hillary Clinton supporter in 2008. Clinton's Treasury Secretary (and former senior partner) Robert Rubin is a centrist, but certainly a Democrat. And the company as a whole has historically donated more to Democrats than to Republicans. While which political party an organization supports shouldn't necessarily matter, the fact of the matter is, I'm pretty sure liberals would be up in arms over George Soros if it were the Heritage Foundation that he was funding rather than CAP.
But my point isn't that liberals should hate George Soros, or that conservatives should hate Goldman. It's that there's no real reason to hate either Soros or Goldman-- both play by the rules of the system. The problem is the system has long had flawed rules. Fixing those rules is something Soros publicly welcomes, but it's something that is the responsibility of politicians rather than participants in that system. So instead of complaining about how terrible Goldman Sachs is, liberals should think about electing better politicians who will work to fix the rules of the system in which Goldman plays. Regardless of the environment, firms like Goldman will keep making money, and that is, at bottom, a good thing. But the environment should be one in which regulations prevent firms playing by those rules from endangering the global economy.
Monday, October 3, 2011
Expectations and the Fed
Apparently, Obama's jobs bill is dead. At least Eric Cantor says so. Honestly, I'm pretty apathetic at this point. It certainly would have helped, but not nearly enough to make a huge debt in unemployment ($500 billion into a $14 trillion+ economy isn't much). So the last place we can realistically do something about jobs is through monetary policy. And this is where it's worth going into a semi-technical discussion about what the Fed can do to support employment in a liquidity trap.
So right now, the economy is in a textbook liquidity trap-- we're nowhere near full employment, the federal funds rate is as low as it can get, and there's an excess of desired savings over desired investment. As a result, everyone's rushing to hold Treasuries (10-years ended today at 1.79%), businesses are sitting on cash, and investment is depressed along with GDP. Theoretically, this means more monetary policy is just a dead end, right? Well, no, not quite. See, the Fed has a dual mandate-- stable prices and full employment. And while inflation continues to run steady and low (though there was a blip as a commodity blip made its way through the economy), unemployment is unacceptably high. So what can the Fed do about that unemployment problem? Well, step one is to signal its intent. The federal funds rate is already at zero, and we've had two rounds of quantitative easing (buying longer-dated securities), and now we've got Operation Twist (driving down long-term rates to encourage investment). And the impact has been positive, but very muted (on the QE; economists seem to agree that Operation Twist is unlikely to do much).
But Brad DeLong points out an interesting thought experiment by Larry Summers. Summers asks: if the Swiss National Bank wanted to lower the value of the Swiss franc, which step would require it to print more money: announcing that it would print whatever it takes to get the value to where it needs to be, or announcing that it would print X number of francs, then reassess the situation. The answer is, obviously, the latter. It signals an action, while the prior scenario signals a goal. Scott Sumner applies the lesson to the US. He argues that the Fed has plenty of credibility... but it's using that credibility to convince consumers and businesses that inflation will remain low. But why low inflation and a strong dollar are always a good thing is baffling to me. The inevitable response will be, "WEIMAR GERMANY OH NO!". Which would be compelling if it weren't intensely wrong-- yelling about hyperinflation in today's US is like yelling about the risk of hypothermia in Abu Dhabi. But there's no research indicating that, say, 4 or even 5 percent inflation is any worse for the economy than 2 percent inflation. And the Fed committing itself to an explicit inflation target of 4 percent would be a very good thing. Why? Well, it's pretty simple.
Imagine the Fed announced its new inflation target tomorrow and immediately started printing money. Assuming investors and businesses consider the Fed to be credible, they will react rationally. And those investors and businesses are sitting on huge stacks of cash right now. If they expect the real value of that cash to decline by 4 percent in the next year, you'd better bet they're not going to sit on that cash-- they'll deploy it somewhere where they'll get returns. That might mean moving up investment (if you need to replace your factory within the next 5 years, but you expect doing so to be 25% more expensive in 5 years, you're going to do it as soon as possible), or it might mean reinvesting the cash in higher-yielding assets, but either way it discourages holding cash. The same incentives apply to consumers. The important thing to note about consumers is that they are, by and large, still very indebted. But if they expect their wages to rise 4% in the next year, that debt will stop looking as daunting (wages can rise, but debts stay the same size), and their cash will be less encumbered. More importantly, they'll look to spend or invest their savings, which will drive up demand further and get money circulating through the economy.
Of course, avoiding a wage-price spiral is important, but if the Fed has credibility, it can target, say, a 3 year program of 4% annualized inflation, after which it will cut back. With any luck, in that stretch, the economy will grow substantially and we will be in much better shape than we are today. Of course, this is all speculation. My argument really isn't anything unique-- Ben Bernanke made it persuasively in his analysis of the Great Depression and Japan's Lost Decade, and I think if he were the only person in charge at the Fed, it's something he would consider. Unfortunately, there are others at the Fed who fear doing anything, so it's not likely to happen. But the point is that there ARE tools available that the Fed could use to get unemployment down... if only the will to use them existed.
So right now, the economy is in a textbook liquidity trap-- we're nowhere near full employment, the federal funds rate is as low as it can get, and there's an excess of desired savings over desired investment. As a result, everyone's rushing to hold Treasuries (10-years ended today at 1.79%), businesses are sitting on cash, and investment is depressed along with GDP. Theoretically, this means more monetary policy is just a dead end, right? Well, no, not quite. See, the Fed has a dual mandate-- stable prices and full employment. And while inflation continues to run steady and low (though there was a blip as a commodity blip made its way through the economy), unemployment is unacceptably high. So what can the Fed do about that unemployment problem? Well, step one is to signal its intent. The federal funds rate is already at zero, and we've had two rounds of quantitative easing (buying longer-dated securities), and now we've got Operation Twist (driving down long-term rates to encourage investment). And the impact has been positive, but very muted (on the QE; economists seem to agree that Operation Twist is unlikely to do much).
But Brad DeLong points out an interesting thought experiment by Larry Summers. Summers asks: if the Swiss National Bank wanted to lower the value of the Swiss franc, which step would require it to print more money: announcing that it would print whatever it takes to get the value to where it needs to be, or announcing that it would print X number of francs, then reassess the situation. The answer is, obviously, the latter. It signals an action, while the prior scenario signals a goal. Scott Sumner applies the lesson to the US. He argues that the Fed has plenty of credibility... but it's using that credibility to convince consumers and businesses that inflation will remain low. But why low inflation and a strong dollar are always a good thing is baffling to me. The inevitable response will be, "WEIMAR GERMANY OH NO!". Which would be compelling if it weren't intensely wrong-- yelling about hyperinflation in today's US is like yelling about the risk of hypothermia in Abu Dhabi. But there's no research indicating that, say, 4 or even 5 percent inflation is any worse for the economy than 2 percent inflation. And the Fed committing itself to an explicit inflation target of 4 percent would be a very good thing. Why? Well, it's pretty simple.
Imagine the Fed announced its new inflation target tomorrow and immediately started printing money. Assuming investors and businesses consider the Fed to be credible, they will react rationally. And those investors and businesses are sitting on huge stacks of cash right now. If they expect the real value of that cash to decline by 4 percent in the next year, you'd better bet they're not going to sit on that cash-- they'll deploy it somewhere where they'll get returns. That might mean moving up investment (if you need to replace your factory within the next 5 years, but you expect doing so to be 25% more expensive in 5 years, you're going to do it as soon as possible), or it might mean reinvesting the cash in higher-yielding assets, but either way it discourages holding cash. The same incentives apply to consumers. The important thing to note about consumers is that they are, by and large, still very indebted. But if they expect their wages to rise 4% in the next year, that debt will stop looking as daunting (wages can rise, but debts stay the same size), and their cash will be less encumbered. More importantly, they'll look to spend or invest their savings, which will drive up demand further and get money circulating through the economy.
Of course, avoiding a wage-price spiral is important, but if the Fed has credibility, it can target, say, a 3 year program of 4% annualized inflation, after which it will cut back. With any luck, in that stretch, the economy will grow substantially and we will be in much better shape than we are today. Of course, this is all speculation. My argument really isn't anything unique-- Ben Bernanke made it persuasively in his analysis of the Great Depression and Japan's Lost Decade, and I think if he were the only person in charge at the Fed, it's something he would consider. Unfortunately, there are others at the Fed who fear doing anything, so it's not likely to happen. But the point is that there ARE tools available that the Fed could use to get unemployment down... if only the will to use them existed.
Sunday, October 2, 2011
Uncertainty and Taxes are NOT the cause of our economic problems
A pretty popular meme among the usual suspects about why we're not adding jobs nearly fast enough to lower the unemployment rate is that they're "uncertain about taxes and regulation." Basically, the idea is that our economic problems must be government's fault, and lowering taxes and deregulating will somehow fix everything. Of course, that claim is complete baloney. Those who are intellectually honest about it (Robert Lucas) say that they "suspect" that it's the cause and admit that they have no evidence. Others just assert it without bothering to provide evidence.
The Economic Policy Institute's Lawrence Mishel has a very good piece debunking that nonsense claim. Mishel doesn't even have to mention that, as a share of GDP, taxes have been lower in 2009 and 2010 as a share of GDP than they have been in any two-year stretch since 1949 and 1950 (and that's doubly significant considering that GDP has been depressed for those two years). He just compares addition of private sector jobs in the recovery from this recession to their addition in previous recessions (they're actually stronger this time than they were from the 1990-1991 recession under Bush Sr. and the early 2000s recession under Bush Jr.). He also points out that recovery from recessions following financial crises is almost always weaker than from typical cyclical recoveries (Ken Rogoff and Carmen Reinhardt's work makes that case pretty definitively). But most telling is the chart he puts up showing surveys of small business confidence going back to the 70s. The survey asks what the biggest problems facing small business are. And that's where the results are telling. Taxes are cited by about 21% of respondents: marginally more than under Bush Jr. (they look to have averaged between 19 and 20%), but less than during the Clinton era, when private sector job growth was very strong. Similarly, regulations are listed by about 14% of respondents: again, marginally more than under Bush Jr., but less than at any point before him going back to Reagan's second term. So what's the biggest problem cited? Unsurprisingly, POOR SALES (meaning lack of demand), by almost 30% of respondents. What's most remarkable is that this is the highest level at which "poor sales" has been cited since surveying started. By a very broad margin. By comparison, the last peak for "poor sales" was under Bush Jr.'s first term... when a full 15% of respondents cited it. In other words, the numbers are incredibly clear: the problem is lack of demand, NOT the regulatory uncertainty/tax nonsense being peddled by the Wall Street Journal and company.
So, of course, the American Enterprise Institute's James Pethokoukis decided to issue a rebuttal to Mishel's study... which makes it crystal clear that Mishel is spot-on. The response is, in a word, pathetic. It essentially amounts to two claims. First, that businesses still cite taxes and regulations more than they cite poor sales as a cause of their lack of hiring. Ummmm, OK. He kind of ignores the point. Which is that taxes and regulation have ALWAYS been cited more than poor sales as a cause of the lack of hiring. But we've added jobs reasonably well for long stretches of the last 40 years, and poor sales has NEVER been cited close to as much. So what that's telling you is that taxes and regulation aren't any more of a problem now than they were under Clinton, when the private sector added jobs at a better clip than it did pretty much at any point since the 60's (the recovery from the Volcker-induced early 1980s recession possibly excepted; jobs will ALWAYS be added rapidly when interest rates are at 19 percent and the Fed cuts them rapidly). Second, AEI claims that, well, the economy recovered more quickly under Reagan in the early 1980s. The simple answer is, "No kidding." Paul Volcker hiked interest rates to 20% in 1981 to fight inflation. Then he lowered them to 8.5% by the end of 1982. Of course job growth was spurred. By contrast, the federal funds rate was... 0 when Obama took office. And is still zero. That is called a liquidity trap. And it explains why Mr. Pethokoukis's comparison is complete nonsense.
So, when you hear a meme presented without evidence, assume it's wrong. This is a pretty good example of the standard operating procedure of those who just KNOW too much government is the problem and don't bother looking at evidence.
The Economic Policy Institute's Lawrence Mishel has a very good piece debunking that nonsense claim. Mishel doesn't even have to mention that, as a share of GDP, taxes have been lower in 2009 and 2010 as a share of GDP than they have been in any two-year stretch since 1949 and 1950 (and that's doubly significant considering that GDP has been depressed for those two years). He just compares addition of private sector jobs in the recovery from this recession to their addition in previous recessions (they're actually stronger this time than they were from the 1990-1991 recession under Bush Sr. and the early 2000s recession under Bush Jr.). He also points out that recovery from recessions following financial crises is almost always weaker than from typical cyclical recoveries (Ken Rogoff and Carmen Reinhardt's work makes that case pretty definitively). But most telling is the chart he puts up showing surveys of small business confidence going back to the 70s. The survey asks what the biggest problems facing small business are. And that's where the results are telling. Taxes are cited by about 21% of respondents: marginally more than under Bush Jr. (they look to have averaged between 19 and 20%), but less than during the Clinton era, when private sector job growth was very strong. Similarly, regulations are listed by about 14% of respondents: again, marginally more than under Bush Jr., but less than at any point before him going back to Reagan's second term. So what's the biggest problem cited? Unsurprisingly, POOR SALES (meaning lack of demand), by almost 30% of respondents. What's most remarkable is that this is the highest level at which "poor sales" has been cited since surveying started. By a very broad margin. By comparison, the last peak for "poor sales" was under Bush Jr.'s first term... when a full 15% of respondents cited it. In other words, the numbers are incredibly clear: the problem is lack of demand, NOT the regulatory uncertainty/tax nonsense being peddled by the Wall Street Journal and company.
So, of course, the American Enterprise Institute's James Pethokoukis decided to issue a rebuttal to Mishel's study... which makes it crystal clear that Mishel is spot-on. The response is, in a word, pathetic. It essentially amounts to two claims. First, that businesses still cite taxes and regulations more than they cite poor sales as a cause of their lack of hiring. Ummmm, OK. He kind of ignores the point. Which is that taxes and regulation have ALWAYS been cited more than poor sales as a cause of the lack of hiring. But we've added jobs reasonably well for long stretches of the last 40 years, and poor sales has NEVER been cited close to as much. So what that's telling you is that taxes and regulation aren't any more of a problem now than they were under Clinton, when the private sector added jobs at a better clip than it did pretty much at any point since the 60's (the recovery from the Volcker-induced early 1980s recession possibly excepted; jobs will ALWAYS be added rapidly when interest rates are at 19 percent and the Fed cuts them rapidly). Second, AEI claims that, well, the economy recovered more quickly under Reagan in the early 1980s. The simple answer is, "No kidding." Paul Volcker hiked interest rates to 20% in 1981 to fight inflation. Then he lowered them to 8.5% by the end of 1982. Of course job growth was spurred. By contrast, the federal funds rate was... 0 when Obama took office. And is still zero. That is called a liquidity trap. And it explains why Mr. Pethokoukis's comparison is complete nonsense.
So, when you hear a meme presented without evidence, assume it's wrong. This is a pretty good example of the standard operating procedure of those who just KNOW too much government is the problem and don't bother looking at evidence.
WSJ is full of crap
About a week ago, the Wall Street Journal put up this op-ed claiming to prove that boosting aggregate demand (i.e. fiscal stimulus) didn't play a role in ending the Great Depression. Needless to say, their narrative is based on an embarrassing misreading of the facts. Uneasy Money pokes holes in their methodology here. In essence, they either flat out lie about or badly misrepresent the facts to get to their desired conclusion. The relevant garbage collection:
the version of events offered by Cole and Ohanian is still a shocking distortion of what happened before FDR took office in March 1933. In particular, although Cole and Ohanian are correct that the trough of the Great Depression was reached in July 1932, when the Industrial Production Index stood at 3.67, rising to 4.15 in October, an increase of about 13%, they conveniently leave out the fact that there was a double dip; industrial production was flat in November and started falling in December, the Industrial Production Index dropping to 3.78 in March 1933, barely above its level the previous July. And their assertion that deflation continued during the recovery is even farther from the truth than their description of what happened to industrial production. When industrial production started to rise, the Producer Price Index (PPI) increased almost 1% three months in a row, July to September, the only monthly increases since July 1929. The PPI resumed its downward trend in October, falling about 9% from September 1932 t0 February 1933, at the same time that industrial production peaked and started falling again.
That is why most observers date the trough of the Great Depression in the US not in July 1932, but in March 1933 when FDR took office in the midst of a banking crisis that threatened to drive the US economy even deeper into deflation and depression than it had been in July 1932. So when Cole and Ohanian assert that recovery from the Great Depression started in July 1932, and go on to say that the recovery took place during a period of significant deflation, it is hard to avoid the conclusion that they are twisting the facts to suit their own ideological predilection.
The misrepresentation perpetrated by Cole and Ohanian only gets worse when they describe what happened during the period of true recovery, April through July 1933. Contrary to their assertion, deflation stopped in February 1933, the PPI hitting its low point of 10.3. Prices began to rise as soon as FDR suspended the gold standard shortly after taking office in March (not June as Cole and Ohanian mistakenly assert) 1933, the PPI rising to 11.9 in July (an increase of about 14% over February) when industrial production hit a peak of 5.95, 57% above the March low point.
Cole and Ohanian reply to this call-out by suggesting... that they didn't mean what any reasonable reader would conclude they meant. Then Brad DeLong points out that this is complete BS. The relevant part of DeLong's argument.
Cole and Ohanian say:
Cole and Ohanian Reply: Paul Krugman claims our economic history is in "incredibly bad faith" by showing that industrial output is positively correlated with the wholesale price index. The main point of our op-ed, as well as our earlier work, is that most of the increase in per-capita output that occurred after 1933 was due to higher productivity – not higher labor input…
The first three paragraphs of Cole and Ohanian:
HStimulus and the Depression—The Untold Story: About one-half of President Obama's proposed $447 billion American Jobs Act consists of payroll tax holidays designed to boost spending and increase hiring. But these temporary policies will do little to jump-start the economy, much as earlier temporary economic Band-Aids, such as the 2009 stimulus, did little to improve the economy.Proponents justify stimulus spending in part based on the widely held view that government-fueled increases in "aggregate demand" during FDR's New Deal ended the Great Depression and brought recovery. Christina Romer, former chairwoman of Obama's Council of Economic Advisers, has argued in op-eds that government should continue to spend for this reason. And in a 2002 speech as a Federal Reserve governor, current Fed Chairman Ben Bernanke claimed that monetary expansion and the turnaround from the deflation of 1932 to inflation in 1934 was a key reason that output expanded.But boosting aggregate demand did not end the Great Depression. After the initial stock market crash of 1929 and subsequent economic plunge, a recovery began in the summer of 1932, well before the New Deal. The Federal Reserve Board's Index of Industrial production rose nearly 50% between the Depression's trough of July 1932 and June 1933. This was a period of significant deflation. Inflation began after June 1933, following the demise of the gold standard. Despite higher aggregate demand, industrial production was roughly flat over the following year...
I defy anybody to read the first three paragraphs of Cole and Ohanian and not believe that Cole and Ohanian's "main point" is that the level of production is unrelated to aggregate demand--that Romer and Bernanke are wrong in claiming a link. We are told that production "rose nearly 50%… [in] a period of significant deflation". We are told that "despite higher aggregate demand, industrial production was roughly flat…"
If Cole and Ohanian want to delete the first three paragraphs from their op-ed, that would be good.
The proper lesson to be learned here is that the WSJ op-ed authors knowingly mislead their audience.
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