Month: September 2010

*The Uses of Pessimism*

That is the new Roger Scruton book, which I finished with pleasure.  Here is one good passage:

Optimism…is the other side of a kind of existential despair, a longing to retreat from the complexities of the great society to the primordial simplicity of the undifferentiated tribe.  It expresses a kind of distrust of humanity, an inability to allow that we can actually move on from our original nature, and create a flexible, reasonable and charitable "we," which is not a collective "I" at all, but the by-product of individual freedom.  But this distrust is unfounded.  The world is, in fact, a much better place than the optimists allow: and that is why pessimism is needed.

Regulating the shadow banking system

There is a new paper by Gary Gorton and Andrew Metrick, and (part of) the abstract reads as follows:

We first document the rise of shadow banking over the last three decades, helped by regulatory and legal changes that gave advantages to the main institutions of shadow banking: money-market mutual funds to capture retail deposits from traditional banks, securitization to move assets of traditional banks off their balance sheets, and repurchase agreements (“repo”) that facilitated the use of securitized bonds in financial transactions as a form of money. All of these features rely on an evolution of the bankruptcy code that allows securitized bonds to be used as a form of privately created money in large financial transactions, a usage that can have significant efficiency gains and would be costly to eliminate. History has demonstrated two successful methods for the regulation of privately created money: strict guidelines on collateral (used to stabilize national bank notes in the 19th century), and government-guaranteed insurance (used to stabilize demand deposits in the 20th century). We propose the use of strict rules on collateral for both securitization and repo as the best approach for shadow banking, with compliance required in order to enjoy the safe-harbor from bankruptcy.

I liked this paper very much.  It has excellent detail on how the shadow banking system works, excellent conceptual analysis comparing shadow banking to America's earlier "free banking era," and the central point that we don't have enough safe collateral for repo (should the Fed issue a special form of such collateral?).  It uses the word "rehypothecation" and ends with an excellent (and to me somewhat scary) few sentences:

It seems that U.S. Treasuries are extensively rehypothecated and should be viewed as money…This means that open market operations are exchanging one kind of money for another, rather than exchanging money for "bonds."  "Quantitative easing" may well be the monetary policy of the future.

Addendum: Arnold Kling comments.

On Austro-European business cycle theory

On the origins of the crisis, Raghuram Rajan writes:

It is true that the European Central Bank was less aggressive, but only slightly so; It brought its key refinancing rate down to only 2 percent while the Fed brought the Fed Funds rate down to 1 percent. Clearly, both rates were low by historical standards. More important, what Krugman does not point out is that different Euro area economies had differing inflation rates, so the real monetary policy rate was substantially different across the Euro area despite a common nominal policy rate. Countries that had strongly negative real policy rates – Ireland and Spain are primary exhibits – had a housing boom and bust, while countries like Germany with low inflation, and therefore higher real policy rates, did not. Indeed, a working paper by two ECB economists, Angela Maddaloni and José-Luis Peydró, indicates that the ultra-low rates by both the ECB and the Fed at this time had a strong causal effect in relaxing banks’ commercial, mortgage, and retail lending standards over this period.

That is taken from Rajan's response to the recent Krugman-Wells review of his book.  I am especially interested in this passage because I once made a version of Krugman's argument myself.

If you read the whole review, and response, you will see that this has become what is known as a "contested exchange."  Hat tip goes to Clive Crook.

What’s holding back small business?

Catherine Rampell has a very useful graph, displayed here, and cited favorably by Krugman and also deLong.  Karl Smith correlates sales complaints with high unemployment and complains about Arnold Kling.


Krugman wrote, for instance, "Businesses aren’t hiring because of poor sales, period, end of story".

I didn't read this graph the same way.  I saw poor sales as a "biggest problem" for fifteen percent (or so) of small businesses in periods of full or near-full employment.  I also see "poor sales" as a "biggest problem" for about thirty percent of small businesses today.  That change — about fifteen percent of the total — struck me as relatively small and indeed puzzlingly small, if indeed we are in a liquidity trap and weak AD is the overwhelmingly dominant problem.  (In fact I might expect an Austrian to cite such a number in support of their story.)  I do think weak AD is an important problem to be addressed, I just don't think the absolute levels here imply "end of story."  I look at that graph and think "this is a multi-factor problem."

I also note that larger businesses have fairly high levels of profit right now and that the pattern of unemployment — lots of permanance, and among the less educated — is not obviously correlated with where we would expect to find either most nominal wage stickiness or the greatest lack of spending.

I note as well that the most plausible sectoral shift stories also imply that businesses will complain about poor sales.  Furthermore, many of the synthetic RBC-neo-Keynesian models — which long ago displaced the simple MC-driven RBC models of the early 80s — are consistent with these data as well.

A lot of the correlations in the diagram don't quite make sense, such as "inflation" becoming a much more serious problem in 2007, or how "insurance cost" changes.  And might such a diagram ever imply that we should lower taxes on business?  Russ Roberts comments:

In fact, if there had been one category called “Taxes and Government Regulations” it might have been seen as the biggest problem, listed by 36% of respondents, up from 29% in the year before and surpassing sales as the biggest problem.

One key question is how to get sustainably higher sales, most of all for wealth-elastic and income-elastic and credit-elastic goods and services.  This diagram doesn't tell me how to fix that problem or where that problem comes from, but that is a critical issue, maybe the critical issue.

Overall, I look at that chart and I think the jury is still out, to say the least.

Scary sentences

It seems the Obama administration is looking for any possible argument to justify its policy of assassinating U.S. citizens without legal restraint.  But that's not always easy to manage:

“The more forcefully the administration urges a court to stay out because this is warfare, the more it puts itself in the uncomfortable position of arguing we’re at war even in Yemen,”

The administration doesn't want any possibility of judicial review:

…they are seeking to have the lawsuit dismissed without discussing its merits. For example, officials say, the brief is virtually certain to argue that Mr. Awlaki’s father has no legal standing to file a lawsuit on behalf of his son.

Is the administration trying to figure out the law, and then follow it, or to simply push through whatever it wants to do?

Are clearing mandates inefficient?

A new Cato paper by Craig Pirrong says yes, they are inefficient.  This is a  useful paper for sorting out some issues, because it argues consistently on a conceptual level.  I especially like the point about how clearinghouses re-order the line of creditors, in favor of members, whether you like it or not.  Overall, though, I'm not convinced by the main arguments against mandated clearinghouses.  The phrase "not necessarily" is invoked too many times.  Contra his p.24, it seems to me that clearinghouses would have had a strong profit incentive to monitor or limit the kind of risk-taking which led to the A.I.G. debacle.  The key point is that a clearinghouse can more easily be forced to carry heavy capitalization and said capitalization, unlike with a current bank, cannot so easily be undone by off-balance sheet transactions or hidden leverage.  The clearinghouse has different incentives and is much easier to regulate and therefore we should put some more trust in them.  CME and NYSE and others did fine in a period of major market turmoil, so why not consider extending this model just a bit more?

I would think the main argument against mandated clearinghouses for CDS is simply the hair-trigger, discrete, non-smooth nature of default-linked payoffs, and whether any centralized intermediary has the predictive power to handle that and to demand sufficient collateral.  Still, that is one way of putting CDS contracts to a non-TBTF commercial test, albeit a regulated commercial test.  My worries about the actual CDS clearinghouse you will find here.

Gorillas and Girls

Ireland's science minister has pulled out of the launch of a book branding evolution a hoax after the event became mired in controversy.

Yes, that's right Ireland's science minister questions evolution. But, he says Mr May the author of the book he was to promote, "Just because you are anti-evolution doesn’t mean you are anti-science."  I suppose this is true if one doesn't count as science biology, molecular biology, botany, paleontology, zoology and a host of other fields that rely on evolution as a key concept.

So the controversy is obvious, right? Not quite. What would a controversy about science be without sex?  It turns out that the author of the book, non-ironically titled "The Origin of Specious Nonsense," is,

Mr May, a self-proclaimed marriage counsellor, writer, poet and philosopher, [who] has presented on various radio stations and once owned a public relations company.

But the ex-Christian evangelist teacher was also the one-time editor of Ireland’s first magazine devoted to sex.

All of this makes the name of the launch party that science minister Conor Lenihan was to attend even more interesting, 'Gorillas and Girls'. Hard to make this kind of thing up.

Hat tip to Dan Cole at Law, Economics, and Cycling.

*The Globalization Paradox*

The author is Dani Rodrik and the subtitle is Democracy and the Future of the World Economy and it is due out early next year.

It is a very good introduction to the Rodrik world view.  If you already know the Rodrik worldview, I am not sure it offers anything new.  Still, it is worth reading through the Rodrik worldview more than once.  I prefer the Rodrik "every country is different" tack to the "globalization, nation-state, democracy — choose two" emphasis (and here), and this book slants in that direction, though it has both. 

When it comes to the "choose two" approach, I wonder at what margin must we choose — doesn't Sweden have all three today?  Doesn't politics involve a lot of juggling balls in the air anyway?  A country with a high rate of productivity growth can manage all sorts of tensions and a country without such growth cannot; I would sooner start the analysis with that distinction.

What is the most likely source of doomsday in 2012?

Alek has a request:

1) While I'm far from a doomsayer, I'm wondering what is the best way to bet in favor of the world ending in 2012? Betting against is pretty obvious.

I am taking this to ask what is the most likely cause of the destruction of all civilization, circa 2012, and not how to collect on the bet, in which case he should read Pascal.  (If the 2012 end of the world won't be a total surprise, any leveraged short position should do, but spend the money quickly!)

Here are some hypotheses, but my answer is: destruction of the earth by space aliens.

Here are previous MR posts on The Fermi Paradox.  Rampaging space aliens would explain why we don't see more civilizations out there, plus predatory ways imply that contact is short-lived, thereby making our current lack of contact more likely in the Bayesian sense.

We could be living in some kind of "branching/splitting" theory where the highest number of branches come right before everything ends and for Bayesian reasons we expect to be right up against that final point.  Still, why should we think that maximum branching/splitting is coming in 2012?  After a Lakers threepeat, are there no more possible worlds to create?  

The overwhelming probability from a nuclear exchange, at least circa 2012, is that it would remain limited, albeit highly destructive.  A pandemic is unlikely to kill more than a billion people.  A very large asteroid or a super-volcano explosion can be considered other leading contenders for world-enders.

A few nights ago Natasha and I saw The Day the Earth Stood Still, 1951 version.  It's more a tract on foreign policy than science fiction and Klaatu of course is a stand in for the United States.  I hadn't seen it in over twenty years and I'm astonished how well the movie captures and presages today's current mix of paranoia and utter unpreparedness, vis-a-vis "aliens."  It works poorly when Klaatu dons the rhetoric and tactics of the United States in galactic affairs, combined with equally clumsy implied threats, backed by no moral authority but superior hardware.  It's one of the scariest, and best, movies to watch in 2010, with a superb Bernard Herrmann soundtrack and it also has good shots of WDC in 1951.  I won't give away the ending but a careful listen shows it's as pessimistic about the aliens as anything.  Supposedly the movie deeply influenced Ronald Reagan and brought him to the arms control table.

“Cash for Clunkers” failed

Here is a new paper by Atif Mian and Amir Sufi:

A key rationale for fiscal stimulus is to boost consumption when aggregate demand is perceived to be inefficiently low. We examine the ability of the government to increase consumption by evaluating the impact of the 2009 "Cash for Clunkers" program on short and medium run auto purchases. Our empirical strategy exploits variation across U.S. cities in ex-ante exposure to the program as measured by the number of "clunkers" in the city as of the summer of 2008. We find that the program induced the purchase of an additional 360,000 cars in July and August of 2009. However, almost all of the additional purchases under the program were pulled forward from the very near future; the effect of the program on auto purchases is almost completely reversed by as early as March 2010 – only seven months after the program ended. The effect of the program on auto purchases was significantly more short-lived than previously suggested. We also find no evidence of an effect on employment, house prices, or household default rates in cities with higher exposure to the program.

Ungated versions of the paper are here.

*Pictures of the Socialistic Future*

In his preface, Bryan Caplan writes:

Yet almost no one questioned the socialists' idealism.  By 1961, however, the descendents of the radical wing of the Social Democratic Party had built the Berlin Wall — and were shooting anyone who tried to flee their "Workers' Paradise."…Who could have foreseen such a mythic transformation?

Eugene Richter, that's who, in 1893.  There is now a reissue of Richter's Pictures of the Socialistic Future.  There is an interview with Bryan Caplan about the book here.  Here is the book on-line and free.