Month: February 2009

Our deflationary recovery from the Great Depression?

Frank Steindl reports:

During the
depression, both output and prices fell, as was their usual behavior in
depressions. The bottom of the depression was May 1938, one year after it
began. Thereafter, output began growing quite robustly, rising 58 percent by
August 1940. Prices, however, continued to fall, for over two years. Figure 8
shows the depression and revival experience from May 1937 through August 1940,
the month in which prices last fell. The two shaded areas are the year-long
depression and the price "spike" in September 1939. Of interest is that the shock
of the war that spurred the price jump did not induce expectations of further
price rises. Prices continued to fall for another year, through August 1940.

Here are some graphs (see Figure 8) and more.  Steindl concludes:

The economic phenomenon that was driving the recovery was probably increasing

In his view that also explains why it was a "jobless recovery" in the 1938-1940 period, namely that the demand for labor did not need to rise so much.  It also has been argued that the technological innovations of the Great Depression were labor-saving ones and that 1930s unemployment cannot be understood apart from this fact.

I do not mean to present these opinions as definitive (by the way here is more by Steindl); I hope to read more in the area and report back to you.  Most generally, I would like to stress how poorly we understand the economics of the 1930s and 40s.

Free Market Bank Nationalization

I believe that bank nationalization is now very likely.  It may even be desirable.  The term nationalization, however, clouds judgment on both sides of the debate.  It's better to think of what we want to do as bankruptcy.  Many of the major banks are insolvent.  When the liabilities of an ordinary firm exceed its assets the firm enters one of a variety of types of bankruptcy procedure during which management is often removed, the firm is sold or reorganized and liability holders take ownership or are paid off at a discount.  Notice that we do not call a bankruptcy procedure, nationalization, even though it typically occurs under the auspices of a government employed judge. 

When it comes to the banks the issue is more complicated than with an ordinary firm because the major liability holders are depositors whom the government has guaranteed.  As a result, the ultimate liability holder is the government.  But now, as a thought experiment, imagine that we had private deposit insurance.  What would a private insurance firm do in this situation?  Would it pander to the current bank management and carry the zombie banks on its books, hoping and waiting for a miracle?  Or would it step in, remove current management, pay off the depositors, reorganize and then sell the banks to recoup its losses?  I believe a private insurer would follow the second path, the fact that the government is not yet ready to do this indicates how powerful bankers are in Washington.  Thus, given deposit insurance the procedure most consistent with free market principles is bankruptcy, preferably a speed bankruptcy procedure under the auspices of the FDIC which has significant expertise in this field.

A speed bankruptcy;  1) punishes current management reducing moral hazard, 2) will be less politicized if done under the auspices of the FDIC than if done piecemeal with congressional involvement and 3) will get the banks working again as soon as possible.

Notice how the term nationalization confuses the issue.  First, it suggests government ownership of the banks which would indeed be a disaster.  People in favor of free markets will rightly want to avoid any such outcome but ironically it's the current situation of "wait and see," and "protect the banker," which is likely to lead to an anemic recovery and eventual government ownership.  Second, it confuses people on the left who think that nationalization is a way to insure that taxpayers get something on the upside.  That idea is a joke – there is no upside.  Taxpayers are going to have to pay through the nose but the critical point is that the taxpayers must pay the depositors whom they have guaranteed not the banks.

The debate so far has been framed between a "bailout" and "nationalization." But the public rightly sees the bailout as a way to protect bankers and thus we get pressure for government ownership, which has already happened in part through government control over banker wages.  Bankruptcy in contrast is a normal free market procedure, it emphasizes that the firm has failed and current management should be removed.  Framing the issue in this way, for example, makes it clear that only the depositors should be protected and under reorganization there should be no control over wages on future management (wages are going to have to be high to get anyone to take on the task).  Finally the idea of bankruptcy makes it clear that the goal is to get banks solvent, under new management, and back under private control as quickly as possible.

Addendum: Garett Jones nicely lays out the case for doing the normal thing.

Mexico fact of the day

This is what happens when your country doesn't have a sufficiently well-developed middle class:

The country’s Federal Competition Commission is looking into Mr. [Carlos] Slim’s
companies. But the agency is outspent and outmanned by Mr. Slim. His
companies “spend more on a single case than our entire annual budget,”
said an official at the commission, who insisted on anonymity because
he was not authorized to speak publicly about agency matters.

Here is the full story.

What if all the smart people are in one party?

Ross Douthat thinks through liberaltarianism and the new spatial equilibrium has him worried:

What could happen, instead, is a bigger-tent liberalism – somewhat
chastened, perhaps, by some big-government failures in the Obama era –
that makes libertarian intellectuals feel welcome, engages them in
conversations about smarter regulations and more efficient tax policy,
and generally woos them away from their culturally-dissonant alliance
with people who attend megachurches and Sarah Palin rallies. This would
make for a smarter left-of-center in the short run, but I think in the
long run it would be pernicious. It would further the Democratic
Party's transformation into a closed circle of brainy meritocrats, and
push the Republican Party in a yet more anti-intellectual direction.
And it would produce an elite consensus more impervious to structural
critiques, and a right-wing populism more incapable of providing them.
The Democratic Party would hold power more often, and become more
sclerotic as a result; the GOP would take office less often, and behave
more recklessly on those rare occasions when it did manage to seize the
reins of state.

Put aside your views on the R, D, and L people and think in terms of an abstract argument.  There is an optimal distribution of smart people across political parties and it need not be all in the same party.  For one thing, the marginal product of a smart person in a stupid party might be very high.  For another, being in power all the time may corrupt the thinking processes of smart people and we want to have some smart people insulated from this corruption.

So should a smart person attempt to move the world toward an optimal distribution of smart people across parties?  Or should a smart person join the party he or she most wishes to belong to?  Should a smart person advise others according to the same standard she uses to regulate herself?  In general does the world "cluster" smart people too much or too little?

You'll notice that many of these questions apply to fun parties and not just political parties. 

The excellent Arnold Kling adds insightful comment.

The economics of conglomerates

Jessica Crispin reports:

McGraw-Hill Cos., the owner of the Standard & Poor’s
credit-rating service, won’t be publishing a book on the financial
crisis that the author says addresses S&P’s role in the markets’

Barry Ritholtz, chief executive officer of equity-research firm
FusionIQ, said he withdrew the manuscript from the New York publisher
and plans to return his advance after the company tried to edit passages critical of S&P. McGraw-Hill says it wasn’t initially able to verify some of the book’s claims.

Addendum: Here is Barry's account.

Did the world almost come to an end Sept. 18th?

I've had so many of you write me and ask me what I think of this blog post.  The main claim is taken from Paul Kanjorski:

On Thursday (Sept 18), at 11am the Federal Reserve noticed a tremendous
draw-down of money market accounts in the U.S., to the tune of $550
billion was being drawn out in the matter of an hour or two. The
Treasury opened up its window to help and pumped a $105 billion in the
system and quickly realized that they could not stem the tide.
We were having an electronic run on the banks. They decided to close
the operation, close down the money accounts and announce a guarantee
of $250,000 per account so there wouldn't be further panic out there.

If they had not done that, their estimation is that by 2pm that afternoon, $5.5 trillion would have been drawn out of the money market system of the U.S.,
would have collapsed the entire economy of the U.S., and within 24
hours the world economy would have collapsed. It would have been the
end of our economic system and our political system as we know it.

The second paragraph is very much overstated (and I wonder about the exact numbers in the first paragraph).  My personal guess — and guess is the right word — is that if nothing had been done on this day, a disaster would have resulted, though not on the scale postulated here.  In my view there would have been an immediate bank holiday, partly improvised, plus complete insolvency for some very large financial institutions, followed by rapid nationalization.  There would have been a much tougher whack to the commercial paper market than what we saw.  Many businesses would have had problems meeting short-term payroll requirements.  The downturn in the real sector would have been much steeper than it has been.  In short, it would have been very bad but not the end of the world economy or democratic capitalism. 

Wartime recovery and bank balance sheets

Paul Krugman poses a very good question.  He points to:

…the role of WWII in cleaning up private-sector balance sheets.
During the war years there was very little private borrowing, thanks at
least in part to wartime restrictions; meanwhile there was both strong
economic growth and a lot of inflation. The result by the war’s end was
a very low private debt level relative to GDP.

How big a role did these improved balance sheets play in the fact that the postwar economy didn’t fall back into depression?

The economic history of these years, in my view, still remains to be written.

Assorted links

1. New Yale econ classes (open, on the web), including Robert Shiller on finance.

2. How good is Shane Battier? (by Michael Lewis), and comment by Al Roth.  So why aren't the Rockets better is my question.

3. China markets in everything fact of the day, hat tip to this very good China law blog.

4. NEA arts money ended up back in the stimulus bill.

5. Gramophone magazine, all the archives from 1923, now on-line and searchable.

He would kill to win

That's the subtitle, the title is Cruel Games: A Brilliant Professor, a Loving Mother, a Brutal Killing, and yes it is the "true crime" account of the well-known game theorist who murdered his wife.  Here is a review of the book.  Here is an excerpt:

During one of their brainstorming sessions, Gallen wrote down "Game Theory" on his to-do list.  With Robb as their primary suspect, they needed to understand better who he was and what made him tick.  It became Marino's job to do the digging which began with the Penn website, where he easily came across Robb's take-home final for his graduate course in game theory.  Marino read the exam and shook his head.  Perhaps it made sense to economics students, but not to him.  Given Robb's intellect and specialty, the detectives couldn't help but wonder if Robb was playing games with them.

Here is one Amazon review:

She, like many in the media, is quick to draw a connection between
Robb's expertise in game theory and him concocting a brilliant and evil
plan to kill his wife and avoid jail time. Nothing could be farther
from the truth. A game theory professor is very similar to a math
professor. They spend a lot of their time deriving proofs. They don't
know how to get away with a crime any better than anyone else.