Month: November 2011
Remove the Austrian judgments about government vs. market and here is what you’ve got:
1. When the euro starts, in essence a bunch of unreliable countries write an irresponsible naked put, pledging that “a euro in a Greek bank is equal in value to a euro in a German bank.” It isn’t. They bust their fiscal futures, though few people see this up front.
2. At first markets believe these pledges and perceive expanded gains from trade, including from lending.
3. Trade and lending across Europe expand, and this includes housing bubbles in some of the countries. Some of this expansion is sustainable, but some of it isn’t. Eventually the parts which are not sustainable become manifest. The PIIGS are not up to the standards they set for themselves and ultimately they can’t credibly make good on those naked puts they wrote.
4. Eventual debt troubles induce (some would say require) fiscal austerity, rightly or wrongly. This brings about the original Prices and Production result that “the consumer demand simply isn’t there to support the new commitments.”
5. More fundamentally, at some point the bank deposits (yikes) are no longer there to see through the new projects and commitments at various local levels. That’s scary.
6. A Hayekian contraction ensues, compounded by Keynesian AD negative shock problems. The imposition of tougher capital standards on the banks, combined with bank attempts to unload the crummy bonds, speeds the downward path.
7. It also becomes revealed that the expansion of the German export sector isn’t quite as permanent as it seemed at the time. Periphery demands for German goods are down and if the eurozone splinters the new “deutschmark” could have quite a high value. Eventually a Hayekian contraction will ensue for Germany as well, although this is just starting.
8. What about the USandA? This is the least certain part of the story, but here goes. The creation of the eurozone financialized Europe to a much greater degree and U.S. borrowers assumed this financialization was permanent, more or less. It isn’t! Our shadow banking system could see a very significant whiplash from all of this turmoil, possibly culminating in (shadow) bank runs over here too. We are trying to gently unwind our shadow banking system connections with Europe but we may not have the time. By the way, trying to unwind those ties just causes Europe to unravel more quickly, so we are like a dog trying to chase our own tail.
And so ends my Austro-Austrian tract.
Addendum: For extra reading, see this recent paper by Claudio Borio and Piti Disyatat, “Global Imbalances and the Financial Crisis,” which is remarkably Austrian (cites Wicksell only, but just look at the names of the sections in the paper). p.15 gives some numbers on why European banks (rather than developing nations such as China) drove a “liquidity glut.” Here is Borio’s overall “macroprudential” framework. Here is Borio’s 2004 paper which more or less predicted the financial crisis, and got some key mechanisms right in a deep ways. Here is an audio interview with him. File Claudio Borio under Underrated Economists.
As we will see shortly, foreign banks’ US branches and subsdiiaries drive the gross capital outflows through the banking sector by raising wholesale funding in the US through money market funds (MMFs) and then shipping it to headquarters. Remember that foreign banks’ branches and subsidiaries in the US are treated as US banks in the balance of payments, as the balance of payments accounts are based on residence, not nationality.
The gross capital inflows to the United States represent lending by foreign (mainly European) banks via the shadow banking system through the purchase of private label mortgage-backed securities and structured products generated by the securitization of claims on US borrowers. In this way, European banks may have played a pivotal role in influencing credit conditions in the United States by providing US dollar intermediation capacity. However, since the eurozone has a roughly balanced current account while the UK is actually a deficit country, their collective net capital flows vis-a-vis the United States do not reflect the influence of their banks in setting overall credit conditions in the US. The distinction between net and gross flows is a classic theme in international finance, but deserves renewed attention given the new patterns of gross capital flows due to global banking.
p.s. It’s a somewhat neo-Austrian hypothesis.
A new website is assembling what it calls “the world’s best economics department” in a bid to give prominent academic economists a louder and unfiltered voice in key public-policy debates.
The site, run by the University of Chicago Booth School of Business, plans to pose one question a week and post answers from 40 senior professors at elite U.S. universities. The site went live Sunday, though the panel has been responding to questions for the past few weeks.
Alas, I cannot check the “weblogs” category for this post. The David Wessel article is here, the website itself is here. Let’s bet: pick your metric, how many site visits (or whatever) will they be pulling in six months from now? I bet Scott Sumner beats them with one hand tied behind his back.
Newly appointed Prime Minister Mario Monti must reform a country where free-market ideas don’t have a political base. Labor laws are, along with pensions, the third rail of Italian politics—literally deadly. Pietro Ichino, the senator who has spoken out strongly for labor reform, has lived under police protection ever since two professors of industrial relations were assassinated by left-wing terrorists because they advised the government on how to cut through the tangled labor laws.
The author is Ian W. Toll and the subtitle is War at Sea in the Pacific, 1941-1942. I loved this book and it should join my list of the very best books of the year. Every page was gripping and instructive. Here is an excerpt on “how to leave the dollar zone”:
The word HAWAII was overprinted on all paper currency — in the event of invasion the U.S. Treasury would declare the bills worthless.
I very much liked this passage:
Holmes added that a cryptanalyst “needs only time, patience, an infinite capacity for work, a mind that can focus on one problem to the exclusion of everything else, a photographic memory, the inability to drop an unsolved problem, and a large volume of traffic.”
I learned that Hawaii never interned its Japanese (with no problems), why the Japanese didn’t go after Australia and why they should have, and why the Japanese failed in the Battle of Midway. I had not known that MacArthur received a payment of $500,000 from the Philippine Treasury in 1942, and the U.S. knew about it and let him keep it.
Highly recommended, even if you don’t care about naval warfare per se. I am now ordering Toll’s other book.
Resilience and robustness, resilience and robustness, repeat three times after me.
Less than two years ago, it was a common meme that “Italy can handle all this debt, so can we.” And now suddenly they can’t. It is correct to point out that currency mismatch is a serious issue for Italy (though massive debt, inefficiency, and twelve years of no growth don’t help either!), but there are two points here.
First, it would be odd to argue that the importance of currency mismatch was misunderstood. Everyone has known about this factor for many years. The more plausible explanation is that the speed of fiscal collapse, and bond market adjustment, was underrated.
Second, let’s say the importance of currency mismatch had been underrated. Is it so convincing to proclaim “don’t worry, we won’t make that mistake again”? When currency mismatch is gone, is everything really OK?
What if we are misunderstanding something else about the current U.S. situation, just as previously the Italian situation had been misunderstood? Ever look at those Obama administration growth projections? Are they factoring in a partial collapse of the eurozone? The possibility of another “lost decade”? I don’t think so. Would a new Republican administration respect the need for medium-term fiscal balance? What if some “black swan” event hits?
And so on.
It remains the case that:
1. Short-term fiscal cuts usually hurt your gdp in the short-term and that can be disastrous. (It also may hurt social goals, since the cuts are not usually well targeted, for public choice reasons; has EU ag. spending gone down much?) It hasn’t worked for Greece for instance. The Keynesians have an absolutely essential point here and we ignore it at our peril. Still,
2. At some point, for most Western countries, those cuts will have to come,
3. Politicians don’t seem very willing to make those cuts in advance so you can’t count on technocratic fine-tuning, and
4. No individual should have such a firm or confident sense about the appropriate timing of such cuts. If nothing else, we don’t know when future cuts will be possible. And we don’t know when the bond market vigilantes will appear, just as we did not know for Italy.
The “pretense of knowledge” I have seen in these discussions is staggering. Roubini forecast the Italian crisis in 2006 (bravo to him), but overall how many people on the left were so wise to be calling for such Italian spending cuts in 2005, when the country had relatively low bond yields? How many, say in 2009, even ran the line of “It’s too late now, because of the Keynesian downward spiral problem, but they should have cut spending in 2006”? For that matter, are there 2011 left-leaning Keynesians insisting Italy should have cut spending radically in 2006, if only for reasons of resiliency and robustness? (Or is the preference to criticize German views on central banking and remain rather silent on Italian fiscal reforms?)
James Hamilton makes an essential point:
A year ago, the Italian government was able to issue 10-year bonds with an interest cost below 3.8%. Some might have argued that those low rates were a signal from the market that there was not much chance of Italy following Greece down the drain. At a visit to UCSD a few weeks ago, University of Maryland Professor Carmen Reinhart was asked whether that’s a correct inference to draw from a low government borrowing cost. Emphatically not, she said: “Yes, yields are low– until they’re not.” Historically, the changes can come pretty quickly, as the Italians discovered last week.
The correct response to the Italian situation is: “We didn’t think it could get so bad so quickly. We will take this as a sobering lesson more generally.”
That is not the response I have been seeing. There is too much at stake for us to take comfort in our own supposed abilities to foresee the future.
PS. Congratulations to Matt Yglesias on his new gig. He’s arguably the best progressive economist in the blogosphere, which isn’t bad given that he’s not an economist. I said “arguably” because Krugman’s a more talented macroeconomist. But Yglesias can address a much wider variety of policy issues in a very persuasive fashion. So he’s certainly in the top 5. His blog is the best argument for progressive policy that I’ve ever read. (But not quite persuasive enough to convince me.)
Scott writes more, on the euro.
Consider the innovative employment policy of the Internet shoe seller Zappos. At the end of a four-week training course, Zappos offers new employees a one-time offer of $3,000 to quit. In part, the company uses the offer as a screening device. If you’re the type who prefers a quick three grand to the opportunity to work at a great company, then Zappos isn’t the place for you.
2. The do-nothing plan is now > $7 trillion. Maybe too much gridlock is not the best way to describe the problem…
5. Bill Simmons on labor economics and sticky wages and the Coase theorem, essential reading.
Here is one recent report (insightful throughout, FT link):
But the scale of the problem is bigger than in 2008. Mr King notes there is $3,000bn of government bonds trading with spreads of more than 150bp to German Bunds. There were only $2,000bn CDOs outstanding at the peak.
The population of Germany is about 81 million, if you wish round that up to about 100 million, if you include some of the smaller Triple A countries. In other words, that is a guarantee of $30,000 per German, or $120,000 for a household of four. Note in passing that an ECB guarantee either requires recapitalization of the central bank or a higher rate of inflation, unless you think the whole thing is a self-sustaining free lunch and all the liquidity problems would vanish (unlikely, at this point). In any case a guarantee has to at least put resources on the table.
As of 2007, the median net wealth in Germany was about 15,000 euros per person, or well under the proposed guarantee, the exact figure depending on how you make the exchange rates over 2007-2011 commensurable. The mean net German wealth was 88,000 euros at that time, so maybe you could think of the guarantee as mostly backed by the wealthy.
Or maybe you could think that the numbers just don’t add up. Germany itself has a public debt to gdp ratio of about eighty percent, demographics are unfavorable, and taxes are already high.
Keep in mind I was sampling the stock of extant debt from the weaker countries and not even considering whether the future flow of debt would require a guarantee. I readily grant that I am mixing stocks and flows incorrectly, but I was trying to be generous to the possibility of a guarantee.
Addendum: Via Henry, here are yet further reasons why Germany will not bail out the periphery.
The author is Tanni Haas and the subtitle is The World’s Political Bloggers Share the Secrets to Success. There are interviews with Arianna Huffington, Jane Hamsher, Nick Gillespie, Lew Rockwell, Juan Cole, Matt Yglesias, Kevin Drum, yours truly, and others. Here is a comment from Kevin Drum:
When I started out, there was much more of a tendency to engage with the other side. Liberals and conservatives would attack each other, but we’d also engage with each other in at least a moderately serious way. Today, you get almost none of that. There’s very little engagement between left and right. And what engagement there is tends to be pure attack. There’s no real conversation at all. That’s a difference that I think professionalization has brought about. The political blogosphere has become more tribal.
A good point, but I blame professionalization less than Kevin does. Maybe some of us are simply a bit sick of each other, and the accumulated slights and misunderstandings weigh more heavily on our emotional responses than does the feeling of generosity from working together in the same “office.” I predict that a given experienced blogger is likely to feel more sympathy for new bloggers, but on average I doubt if the new bloggers are better or more tolerant.
Which means we mostly have ourselves to blame.
Addendum: Nick Gillespie comments.
It is estimated that up to 40 percent of prescriptions go unfilled…
That is from Ezekiel J. Emanuel, here is more. I read somewhere that Zeke has a memoir under contract somewhere, but now Google fails me. Can this be true?
1. Good interview with Jonathan Lethem, by the always-excellent Laura Miller.