Thursday, November 29, 2007

Real Estate Bubbles, Moral Hazard, and Financial Systems

. Thursday, November 29, 2007
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NPR had a nice piece on the financial impact of the deflating housing market bubble. Offers a straight forward explanation of how lenders package mortgages for sale in the secondary market.

Be sure to read the accompanying article that explores the moral hazard question prompted by the Fed's recent injection of liquidity into the market. Bottom line here is simple:

  • A federal bailout of shaky subprime lenders would amount to a "subsidy for risky behavior," says Christian Stracke, a senior credit strategist at the research firm CreditSights. "You would encourage future risky lending and borrowing by signaling that in extreme circumstances, the government … will bail out bad lenders," he says.
vs.
  • but some industries, indeed some companies, are so integral to the U.S. economy that they cannot be allowed to fail — nevermind how they got into trouble in the first place, argue others. The "too big to fail" theory came into play a decade ago, when the Federal Reserve intervened to rescue the giant hedge fund Long Term Credit Management. The fund, initially a huge success when it was founded in 1994, lost more than $4 billion in 1998. The Federal Reserve put together a bail-out by the major creditors to avoid a wider collapse in the financial markets.
Three related notes:
  • "Credit flowing to American companies is drying up at a pace not seen in decades, threatening the creation of jobs and the expansion of businesses, while intensifying worries that the economy may be headed for recession."
  • The Fed injected $8 billion into credit markets in preparation for the holiday season
  • Bernanke hinted today, in line with his deputy's hint yesterday, that the Fed is likely to cut interest rate cuts soon (again).

Wednesday, November 28, 2007

Petrodollars '00 Style

. Wednesday, November 28, 2007
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Petrodollars played a key role in the genesis of the Latin American debt crisis during the 1970s. Today's NYT examines how oil exporters are using their windfall from the current oil price rise. How big a windfall, you ask? "In 2000, OPEC countries earned $243 billion from oil exports, according to Cambridge Energy Research Associates. For all of 2007 the estimate was more than $688 billion, but that did not include the last two months of price spikes." On average, oil exporters are earning $1.8 billion per day.

Seems that oil exporters are pursing a more diversified investment strategy today than they did during the 1970s; rather than deposit the funds in Citibank, they are now buying big shares of Citigroup (Abu Dhabi is now the single largest share holder). More broadly, "the oil-rich nations are...investing more in real estate, private equity funds and hedge funds, analysts say, and increasingly they are investing the money on their own, bypassing the major financial institutions of the United States and Europe."

Interestingly, oil exporters, like China, are a bit uncertain about what to do in response to a weakening dollar. Some advocate shifting out of dollar-denominated assets in response to the falling dollar; others fear that shifting into euro-denominated assets will cause the dollar to weaken further, thereby reducing the value of the dollar-denominated assets they have accumulated.

Thursday, November 22, 2007

Happy Thanksgiving

. Thursday, November 22, 2007
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As we gather with our families today to give thanks, let's take a moment to consider the origins of the feast. The tradition we continue today began almost 400 years ago as destitute immigrants gathered in Virginia and Massachusetts to give thanks for their safe arrival (Virginia) and a bountiful harvest (Plymouth). In many important respects, therefore, Thanksgiving celebrates a fresh start of the first wave of immigrants that built the US.

Then, as now, the native population did not always welcome the new arrivals (e.g., the Indian Massacre of 1622). At other times, however, the native population helped the new arrivals adapt. This native uneasiness toward new residents has shaped America's approach to new arrivals ever since. Those who come early and become "native" grow wary of those who follow in their wake. Current unease about "illegals" is thus only the latest manifestation of a centuries-old pattern.

All of which leads me to suggest that as we gather to feast today try to remember how it is we came to be here; most of our ancestors came to this country to escape a life of grinding poverty by moving to a land of seemingly unbounded opportunity. So too with today's new arrivals.

Monday, November 19, 2007

Le Compression Grand

. Monday, November 19, 2007
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Paul Krugman makes much of the "Great Compression" , which is his term of choice for the dramatic reduction of income inequality that occurred in the United States between 1935 and 1945. He attributes this equalization of income to FDR and the New Deal. "So what happened to the rich? Basically the New Deal taxed away much, perhaps most, of their income" (Krugman COAL, page 48)

One of the scholars whose research Krugman cites produced a similar series on income inequality for France. The graph for French income inequality (click for larger image) between 1920 and 1945 looks strikingly similar to the graph for American income in the same period.

Surprisingly, Piketty does not attribute France's Great Compression to the New Deal. Instead, he concludes: "the decline in income inequality that took place during the first half of the 20th century was mostly accidental. In France and probably in a number of other developed countries as well ... the secular decline in income inequality is for the most part a capital income phenomenon: holders of very large fortunes were severely hit by major shocks during the 1914-1945 period, and they were never able to fully recover from these shocks, probably because of the dynamic effects of progressive taxation on capital accumulation and pre-tax income inequality" (page 29).

In short, financial crisis, depression, and global war reduced inequality by greatly reducing wealth and the return on wealth; postwar tax rates kept it from re-emerging (for a while). If this pattern is common across the industrialized world, just how important was FDR?

Sunday, November 18, 2007

G20 and Global Imbalances

. Sunday, November 18, 2007
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It is nice when world governments act so quickly to illustrate the processes we discuss in class. Last Thursday we focused on macroeconomic policy coordination as a solution to global current account imbalances. The Group of 20 met this weekend in South Africa and agreed the following:

"We also agreed that an orderly unwinding of global imbalances, while sustaining global growth, is a shared responsibility involving: steps to boost national saving in the United States, including continued fiscal consolidation; further progress on growth-enhancing reforms in Europe; further structural reforms and fiscal consolidation in Japan; reforms to boost domestic demand in emerging Asia, together with greater exchange rate flexibility in a number of surplus countries; and increased spending consistent with absorptive capacity and macroeconomic stability in oil-producing countries."

Craziest Sentence I Read Today

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“The fall of the dollar is not the fall of the dollar — it’s the fall of the American empire.” Hugo Chavez.

This one is a close second: “The U.S. dollar has no economic value.” Mahmoud Ahmadinejad

The Best Sentence I've Read Today

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(or How to Begin a Book Review)

"William Easterly has a problem on his hands--he's just not very rock 'n roll. While Easterly's developmental economics arch nemesis Jeffrey Sachs is living it up with the likes of Bono, Easterly is quietly plugging away, delivering an unpopular and decidedly uncool message. His message? The West's quest to end poverty is ill informed and misguided at best and detrimental to the poor at worst."*

Makes you want to read the rest, doesn't it?

*Written by a student in POLI 442, fall '07; name withheld.

Friday, November 16, 2007

China's Current Account Surplus and the Yuan

. Friday, November 16, 2007
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"If you think U.S. President George W. Bush's administration had a tough time dealing with China, the next occupant of the White House may have it worse." So claims yesterday's International Herald Tribune.

The article offers a clear explanation for the mechanism through which pegging the yuan to the dollar reinforces the savings - investment gap that underlies China's current account surplus.

It also hints at the dilemma the Chinese monetary authorities now face. Pegging the yuan requires continual purchases of foreign assets, which in turn expands the money supply, which in turn generates inflation. Stemming inflation requires higher interest rates, which may well pull in additional capital flows, thereby forcing the central bank to accumulate still more foreign exchange reserves, additional monetary expansion, and more inflation. In short, the desire to keep domestic prices stable is not easily reconciled with the desire to maintain the pegged exchange rate.

One obvious solution to this dilemma is to allow the yuan to float. No sign that this is likely to happen any time soon.

The Distributive Consequences of International Trade

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Dani Rodrik points out that trade economists often stress the gains from trade and de-emphasize its domestic distributional consequences. I have always found it puzzling that while political scientists have made the Stolper-Samuelson theorem the workhorse of their models of trade politics, trade economists have tended to downplay the domestic distributional consequences of trade. Rodrik points to recent papers by Josh Biven and Robert Lawrence that simulate the impact of trade between the US and developing countries on the relative wages of low and high skill workers in the US.

The Biven paper in a nutshell:
"This paper revisits the insights of Stolper-Samuelson and estimates the impact on American wages of trade flows between the rich U.S. economy and a poorer global economy...Despite a rather conservative methodology, this paper finds that:
• Trade with poorer nations had by 1995 led to a rise in relative earnings of skills vis-à-vis labor of just under 5%,
relative to baseline of no trade with poor nations. This is an amount roughly equal to 12.5% of the dramatic increase in earnings inequality that happened between 1980 and 1995.
• By 2006, trade flows between the U.S. and its poorer trading partners increased relative earnings inequality by just under 7% relative to a no - trade baseline."

The Lawrence paper reaches different conclusions: "while increased trade with developing countries may have played some part in causing greater wage inequality in the 1980s, surprisingly, over the past decade the impact has been too small to show up in aggregate wage data."

Wednesday, November 14, 2007

The Soaring Euro: Imitation is the Sincerest Form of Flattery

. Wednesday, November 14, 2007
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American exchange rate policy during the last 40 years has leaned heavily on a simple strategy: unwilling to use US monetary policy to influence the dollar's external value, it has sought to induce other governments to alter their policies. The logic, of course, is simple. All bilateral exchange rates are a function of the interaction between two monetary policies, and thus the exchange rate can be influenced via changes in either policy. During the 1960s and early 1970s, the US pressured (or, as one of my current [German exchange] students put it in class, coerced) Germany to accumulate and hold dollars to shore up the Bretton Woods System. During the 1980s, the US pressured Japan and, to a lesser extent Germany, to realign the mark-yen-dollar triangle. Currently, the US pressures the Chinese to revalue.

The EU seems to be embracing this policy as if they had invented it themselves. Sarkozy, during his recent visit to the States, scolded Congress and demanded the US take steps to stem the dollar's slide or face a trade war. An EU delegation is headed to China to pressure (coerce?) the Chinese to revalue the yuan. All of this on the heels of the ECB's decision that it prefers to keep interest rates steady, thereby refusing to use interest rates to stem the euro's rise.

EU tactics seem a direct consequence of monetary union. Fifteen years ago the French would have screamed at the Germans and then probably devalued the franc. Now, it does no good to scream at the Germans (althought Sarkozy did try that first, I guess old habits die hard), and the French can't devalue. Nor can they directly control ECB monetary policy. The only way to influence the euro's external value, therefore, is to pressure other governments to adjust their policies.

I had always considered American policy a consequence of American structural power and isolationism. The EU's embrace of this strategy makes me wonder if American policy isn't also a product of institutions, especially the independence of the Federal Reserve.

Monday, November 12, 2007

Krugman on the Dollar and Current Account Adjustment

. Monday, November 12, 2007
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I do like it when Paul Krugman uses his platform to talk about the things he knows best, in this case, current account adjustment and the falling dollar. It also is not everyday that one sees a public discussion about the savings-investment gap, so it's worth checking out for that reason alone..

Krugman has written two recent blog posts on this topic, one that emphasizes the need for a depreciating dollar in conjunction with rising savings, and another on the reasons for the dollar's current slide. The basic message is that current account adjustment without recession requires a rise in savings and a fall in the dollar. He elaborates these views in greater detail in a recent Economic Policy article (a shorter piece apparently derived from this by Robert Baldwin is also available).

Dollars per Second for High-Earning Americans

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According to Ken Rogoff, "The latest Forbes list of America’s wealthiest individuals showed that last year’s highest nine earners, whose ranks include New York City’s mayor, Michael Bloomberg, managed to increase their wealth by $5-9 billion last year. Yes, that is just the annual increase in their wealth. Collectively, their $55 billion in earnings outstripped the entire national income of more than 100 countries. To put these astronomical numbers in perspective, ... to be among the top nine earners in the United States, you had to pull in at least $150 per second , including time spent eating and sleeping. That is $9,000 per minute, or $540,000 per hour."

(hat tip to Greg Manikw)

Friday, November 9, 2007

Time Erodes all Meaning, or the Irony of TV

. Friday, November 9, 2007
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One of my all-time favorite movies is on tonight--the Wizard of Oz. Maybe it is just me, but it seems rather bizarre that the chief sponsor of this broadcast is the board game, "Monopoly."

Congress Votes on the Peru FTA

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The Times has a pretty cool interactive map depicting House votes on the US-Peru Free Trade Agreement. The map depicts every district, shows party, vote for and against, and allows you to look at votes in "high" and "low" income districts.

Pretty cool, though, I wish they would have meaningful district demographic characteristics--education level, for example, or economic structure.

Oh, the agreement passed. Who would have thought?

The Dollar and the Housing Market, Again

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1. One simple expectation: a real exchange rate appreciation raises the return to non-traded goods relative to traded goods. The intuition is straight forward: as the currency gains value, prices of manufactured goods (traded goods) fall, while prices of goods and services that do not readily cross borders (houses, for example) do not. Consequently, as a currency appreciates, people ought to invest less in the traded goods sector and more in the non-traded goods sector.

2. Two Simple Graphs:
A. Graph 1 (top) shows the dollar's substantial appreciation in real terms between 1995 and 2003; the dollar remained high relative to the early 1990s until 2005.
B. Graph 2 (bottom) shows the substantial increase in housing prices that began in 1995 and peaked in 2005.

3. One simple hypothesis: The real estate bubble was at least in part a consequence of the dollar's sharp real appreciation between 1995 and 2005.

4. One simple extension of temporal scope: Notice that the 1980s real estate boom also occurred in a strong dollar era.

5. Broader point: the Fed's current dilemma--target the dollar's external value or target the financial system--is merely the continuation of a deeper problem. The low-interest rate policy of the early 00s fed the housing bubble, but higher interest rates at that time would have yielded an even stronger dollar (and hence stronger incentives to shift into non-traded goods). Lower interest rates might have slowed the dollar's rise, but also fueled an investment boom somewhere else. Hence, pick your poison.

The deeper problem, of course is that the Fed has two policy targets (the exchange rate and the domestic economy) and only one policy instrument. The policy appropriate to meet one target is not always appropriate (and can have perverse consequences) for the other.

Wednesday, November 7, 2007

Weak Dollars, Subprime Messes, and Monetary Policy Dilemmas

. Wednesday, November 7, 2007
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When does the dollar's depreciation become serious? When Chinese officials start talking in public about shifting its $1.43 trillion of reserve holdings out of dollars and into other currencies. The markets are already a bit skittish; loose talk does not help.

Can the U.S. do anything to bolster the dollar? It appears that the U.S. is caught between the classic rock and hard place. On the one hand, domestic financial difficulties resulting from the subprime mortgage mess has encouraged the Fed to cut rates and inject liquidity to ease market conditions. Rate cuts and extra liquidity, however, weaken the dollar. If the Fed wants a stronger dollar, the required higher rates will squeeze financial institutions. Not much of a choice; bolster the dollar at the short-term cost of worsening the financial crisis; inject liquidity at the short-term cost of a weaker dollar.

The Fed's current dilemma is hardly unique. It is not fundamentally different than the dilemma Thai and Indonesian governments faced in 1997; not fundamentally different than the dilemma Austrian authorities faced in 1931. Not fundamentally different from the dilemmas posed by financial crises throughout history (the 1907 and 1894 panics come to mind as well). In all of these cases, monetary authorities had to choose between actions that saved key domestic financial institutions and actions that stabilized the currency. Yes, the contemporary US is different--no fixed exchange rate as a focal point for speculation; no precious metal reserve constraint--yet still, it must choose between internal and external objectives.

What surprises me is that even those at the Fed who oppose further rate cuts make no mention of the dollar as a reason for their resistance.

Subsidizing the Royal Farm

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Each semester I ask my students to look closely at the distribution of US agricultural subsidies. They are often surprised by the realization that most payments go to a small number of high-income "farmers." Today's IHT suggests an identical pattern in the EU.

The most delightful tidbit: the British Royals are among the big winners from the Common Agricultural Policy. "Data from the 2003-2004 farming year indicated that the queen [of England] and Prince Charles received €360,000; the Duke of Westminster €260,000; and the Duke of Marlborough €300,000...The queen and Prince Charles received a total of more than £1 million, or $2.1 million, in EU farm subsidies over two years."

Not surprisingly, recipients of large payments via the CAP have sufficient political influence to block reform.

If you wish, you can track EU recipients and US recipients. I am struck by the lack of transparency in the EU

Tuesday, November 6, 2007

Government Debt Clock

. Tuesday, November 6, 2007
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This, the self-proclaimed "Best Debt Clock in the USA," is mesmerizing--how long until the GDP reaches 14 trillion?

Monday, November 5, 2007

Who Exactly are the Vultures?

. Monday, November 5, 2007
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To read on vulture funds, check out a recent piece in Foreign Policy. More on this topic in a later post. If you wish to read more, check out Felix Salmon's spirited defense of vulture funds.

Sunday, November 4, 2007

Globalization and Inequality

. Sunday, November 4, 2007
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The World Economic Outlook (an IMF publication) dedicates a full chapter to exploring globalization's impact on income inequality. "Over the past two decades, income growth has been positive for all quintiles in virtually all regions and all income groups during the recent period of globalization. At the same time, however, income inequality has increased mainly in middle- and high-income countries, and less so in low-income countries."

The study highlights the distinct causal forces exerted by trade and foreign direct investment. Trade and trade liberalization reduce inequality; foreign direct investment increases inequality.

The bottom line, however, is that technological change rather than globalization per se is the main cause of rising income inequality.

The Natural Resource Curse

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The NYT Sunday Magazine has a terrific piece on Chavez's oil-financed Bolivarism, highlighting all of the classic elements of the natural resource curse. What is most striking, as my excerpts below highlight, is how predictable it all is...

The Cash Spigot:
"...Pdvsa is no longer an oil company...It now exists to finance Chávez’s transformation of Venezuela. The integration is illustrated by the fact that Rafael Ramírez, the minister of energy and petroleum, is also president of Pdvsa. “The Pdvsa that neglected the people and indifferently watched the misery and poverty in the communities surrounding the company premises is over,” Ramírez has said. “Now the oil industry takes concrete actions to deepen the revolutionary distributions of the revenues among the people.” If the Pdvsa of the 1990s thought it was Exxon, today’s Pdvsa amounts to the president’s $35 billion petty-cash drawer."

The Dutch Disease: "Oil caused the bolívar to be overvalued. Farms and factories are in trouble. They can’t export and must compete at home with products imported at the official exchange rate, which is now about a third of the market rate. And so the country is awash in artificially cheap imported products, from basic foodstuffs, like Brazilian cooking oil, to fancy cars."

Rent Seeking: "The disparity between the official exchange rate (2,150 bolívars to the dollar) and the black-market rate (6,200 bolívars at press time) has created a new class known as the Boliburgesía. Bankers, traders, anyone who works in finance or commerce, can get very rich manipulating the exchange rates. Buy all the imported whiskey and Hummers you want, is the message. Live a life of wild excess. Just don’t try to produce anything."

The Pattern: "This is classic oil curse, and Venezuela has seen it before. In 1973, and in 1981, Venezuela spent oil money wildly, without controls. Each time a boom ended, it left Venezuela worse off than before it began — per capita income in 1999 was the same as in 1960.

The Question: Are the gains sustainable this time around? And what happens if and when the spigot runs dry?

International Political Economy at the University of North Carolina: November 2007
 

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