Tuesday, March 31, 2009

Should Europe Do More?

. Tuesday, March 31, 2009
1 comments

McMegan restates the obvious:

But how sympathetic is the US taxpayer supposed to be? We pay for their military protection, we pay for the profits that develop the drugs and consumer goods they happily consume, and now we're supposed to pay for their economic bailout too. Europe could liberalize its markets, let in immigrants, develop a real military, instead of just critiquing the way we do it. We'll continue to let them free ride, because there's no way to stop it. But I'm starting to think we should rub it in a bit more.


The assumption in many quarters is that the rise of BRICs will come at the expense of the U.S., and recent rumblings from China and Russia that the days of the dollar as reserve currency are numbered are illustrative. But it will be a very long time before the BRICs surpass the political or economic clout of the United States. Europe, on the other hand, is well within reach. And the more that Europe aggravates the U.S. by complaining while free-riding, the more incentive the U.S. has to shift its focus away from Europe and towards Asia and the emerging Americas. Indeed, one reason why Europe has been able to afford such luxurious social programs is because the U.S. has effectively subsidized them through security guarantees and transfers of technology and intellectual property.

Now many E.U. leaders wish to "coordinate," by which they mean that they do little or nothing while the U.S. pays yet again. Yes, it's true that the Eurozone has less policy flexibility because of the common currency (and concomitant commitment to tight monetary policy), demographic realities, and already-deep public expenditures. But those problems are self-made, and whining about it, as Chancellor Merkel has done, accomplishes nothing.

Now Europe wants to bolster the IMF, primarily to bail out Eastern European countries that have been battered by the economic crisis. And where is the financing for that to come from? The largest chunk will come from the U.S., of course. Still, we'd probably be happy to contribute if Europe was willing to reciprocate with domestic stimulus, or help in other areas. But Europe is signaling over and over that they are only willing to coordinate on their terms, and if they don't get their way they'll take their ball and go home.

Eventually, the U.S. might call Europe's bluff, and look to the BRICs for future economic partnerships. Would this sting the U.S.? Of course it would. But the consequences would be far more dire for Europe.

Assorted Depressing Links

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-- Spain is in very bad shape.

-- Italy is in very, very bad shape.

-- Japan is in very, very, very bad shape.

(Japan, Italy, and Spain are the 2nd, 7th, and 9th largest economies in the world, by the way, and those links all point to A Fistful of Euros, an excellent site)

-- Putting all the emerging-market eggs in the IMF's basket?

-- World prices for food are likely to rise as supply drops.

G-20

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The current G-20 summit, like most, is often big on headlines but short on substance. There are the requisite anti-everything protests, the expected French threat to pick up their ball and go home if they don't get their way, the typically vague but high-minded communique, the downgraded expectations, and the regret.

So what can come out of this? The major players will continue to verbally commit to coordination, as they have always done, but coordination requires compromise, and so far no world leader seems interested in giving up some autonomy in exchange for policy convergence. And President Obama is either uninterested in setting the course for the G-20 or is unable to do so. His response toward the crisis has so far been to take care of his own first, and deal with the systemic global problems later (if at all). Remember: not only did Obama not attend the recent World Economic Forum in Davos, but he didn't bother to send a single high-ranking official either. So far, his attitude towards European leaders has been reminiscent of FDR, and not in a good way.

The U.S., France, and U.K. have found some common ground already: they're going after off-shore tax havens. Unfortunately, this has next-to-nothing to do with the present crisis.

The November G-20 meeting produced basically one commitment: to uphold free trade and refuse to resort to protectionism. How did that work out? As Drezner notes:

Sounds great, except that two days after the summit, Moscow announced that increased tariffs on imported cars. A day after that, India slapped a 5 percent duty on several iron and steel products. A month later, Brazil approved the idea of raising common external tariffs among the countries under the Mercosur agreement on a number of goods, including textiles and wine. China increased export tax rebates on more than 3,700 goods. The U.S. Congress approved "Buy American" provisions in the February stimulus package that blocked government procurement from most developing countries, including the BRIC economies. The World Bank recently reported that 17 of the 20 countries had imposed a total of 47 trade-restrictive measures. Simply put, the first G20 summit produced little action but copious amounts of hypocrisy.


Even further, there are few focal points for reaching agreements. China and Russia desire an end to the dollar as the world's reserve currency, Brazil has argued that the costs of global stimulus should be borne by the countries that caused the crisis, the EU refuses to consider further fiscal stimulus, and everybody seems to want broad, sweeping changes to the regulatory structure; what those changes actually entail, however, is TBD.

I have little hope that anything productive will come out of the G-20 meeting; coordinated action is just too difficult when each country has different challenges and priorities. But now that the first burst of stimulus is past, I do hope that a real commitment to maintain an open trading system is within reach. Perhaps the crisis can even force the resumption of Doha (I'm not holding my breath). Yes, an open trading system means that some stimulus intended for domestic constituencies will spill out into other countries. That's inevitable and also acceptable, especially since a retreat into protectionism could have very perverse effects for already-reeling economies.

The priority of the G-20 meetings should be to shore up the economic activity that we still have to use as a foundation for recovery. Roll back the creeping protectionism of the past 6 months, make a strong commitment to maintaining an open system of trade. True, it's only a marginal victory, but at this point I think that's all the G-20 can realistically hope for. Unfortunately, even that much may be too tall an order.

Wednesday, March 25, 2009

Ode to Paul

. Wednesday, March 25, 2009
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Catchy and just a little bit creepy KPC

Pick Your Poison

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What if you had to choose between saving large swaths of humanity from a "nasty, brutish, and short" existence and protecting the biosphere from the possibility of irrevocable harm? That's our present choice, says Freeman Dyson:

Beyond the specific points of factual dispute, Dyson has said that it all boils down to “a deeper disagreement about values” between those who think “nature knows best” and that “any gross human disruption of the natural environment is evil,” and “humanists,” like himself, who contend that protecting the existing biosphere is not as important as fighting more repugnant evils like war, poverty and unemployment.


No he's not talking about aid payments from the MDCs to the LDCs, but rather simply allowing LDCs to continue using dirty-but-cheap fossil fuels like coal to lift themselves out of poverty. If you'd prefer, you may think of this as trading off certain bad outcomes for people existing in the present and near future in exchange for preventing possible bad outcomes for people who might exist in the relatively-far future. (of course the magnitude of the two might not be equivalent.)

Via Wilkinson, who also lifts this quote:

To Dyson, “the move of the populations of China and India from poverty to middle-class prosperity should be the great historic achievement of the century. Without coal it cannot happen.” That said, Dyson sees coal as the interim kindling of progress. In “roughly 50 years,” he predicts, solar energy will become cheap and abundant, and “there are many good reasons for preferring it to coal.”


Of course, reasonable people can disagree about which is more important. But the point is that reasonable people cannot disagree that there are tradeoffs, and that policy choices in one area affect outcomes in others.

(Not that I should have to, but just to nip any partisan sniping in the bud: the above is true for all political orientations, and neither is more righteous in my view: there are good reasons to want to end present-day suffering, and there are good reasons for wanting to end future-day suffering. The point is to consider the tradeoffs.)

World's Biggest Banks

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And their market value. The corpses are in gray. It's easy to see why Europe has been hit so hard by the credit crunch and liquidity troubles, even if their exposure to toxic MBS was not direct (although it quite often was).

From the Guardian UK's intriguing new Data Blog.

Yes, But He Has Good Intentions

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Czech Premier Mirek Topolanek does not like the $2tn effort by the Obama administration to stimulate the U.S. economy. He does not like it one bit:

BRUSSELS -- The prime minister of the Czech Republic slammed President Barack Obama's plan to spend nearly $2 trillion to push the U.S. economy out of recession as "the road to hell" that European Union governments must avoid.

The blunt comments by Mirek Topolanek to the European Parliament on Wednesday highlighted simmering European differences with Washington over spending plans, ahead of a key summit next week on fixing the world economy. ...

"All of these steps, these combinations and permanency is the road to hell," Mr. Topolanek said. "We need to read the history books and the lessons of history and the biggest success of the [EU] is the refusal to go this way."

"Americans will need liquidity to finance all their measures and they will balance this with the sale of their bonds but this will undermine the liquidity of the global financial market," Mr. Topolanek said.


The last part is key: since all of the U.S. demand-side spending is funded by deficits, the result is reduced liquidity of dollars for the managing of international accounts. Since the dollar is still (for now) the world's reserve currency, this puts pressure on other central banks to manage their balance of payments accounts more carefully, at a time when many of them would prefer more flexibility to pursue counter-cyclical policies.

I hope to have more to say about this, and how it relates to America's de facto as role as organizer/stabilizer of the international macroeconomy, in the near future.

Friday, March 20, 2009

More on Punitive Taxation

. Friday, March 20, 2009
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Yesterday I complained that the left-leaning economists in the blogosphere were conspicuous in their absence from the AIG punitive tax debate. Today, we get some comment.

Brad DeLong says that we should give big bonuses to well-performing financial employees, just not the sort of bonuses these guys were given:

But thou shalt not bind the mouths of the kine that tread the corn: traders and financial executives who are willing to work very hard for what are now government-owned enterprises should be offered the carrot of long-term restricted equity stakes: that if they do their jobs well and if the government makes a healthy return because of their skill, forethought, and diligence, they should make healthy returns as well.


In the previous sentence he says that punitive taxation on employees on TARP-taking firms is justified. But the one doesn't follow from the other: if the government sets a precedent that it is willing to retroactively rewrite compensation contracts on an ad hoc basis, then why should employees have any assurance that future earnings will be safe from a similar confiscation? What incentive do well-performing employees have to stick with the troubled institutions and work hard to improve them? Effectively none.

Now, it may be the case, as Sarah argues, that labor markets in the financial industry aren't competitive right now so employees have no choice: either they stay at their present firm, or they don't work at all. Suppose this is true: faced with a 90% marginal tax rate, many of them might just take the unemployment route. Especially since these folks are being accosted at their homes with death threats, and being encouraged by at least one U.S. senator to commit suicide.

In the longer-run, of course, labor markets will be less rigid, and these sorts of actions virtually guarantee that any employees with good track records will move to other firms. Considering the fact that the government will likely be a partial owner of these firms for at least a few years, this can only put downward pressure on the quality of employees these firms will be able to attract and retain.

Krugman, on the other hand, thinks this is bad, unjust, "clumsy," "bad analysis, bad policy, and terrible politics," and demonstrative of a major failing of the Obama administration. Oh, but despite that, there was "little alternative" than to kowtow to "crude populism", so whatever: tar-and-feather the bastards.

Finally, as Henry Blodgett points out, this tax covers all household income over $250,000. So if you are a mid-level AIG employee with a compensation package skewed towards bonuses for good performance, and your spouse is a corporate lawyer who makes a $250,000/year, then nearly every penny you earn will be taxed at 90%. Blodgett closes:

Believe it or not, hidden inside these companies are thousands of decent, competent people whose households bring in more than $250,000 a year. Many of these folks had NOTHING to do with the gambling addiction that bankrupted their firms. Many of them still have a choice where to work. And now that they've learned that their family's pay will be capped at $250,000 indefinitely, many of them will quickly decide that now is a good time to pursue their careers elsewhere. (That is, unless their firm takes the easy and obvious step of just paying them a fatter salary, which just renders the whole thing a farce.)

Will everyone leave these firms? No. The folks whose households don't have the education, desire, ambition, skill, or time to make more than $250,000 a year won't. But a lot of the rest will. And however little our massive investments in these companies are worth now, they will soon be worth a lot less.


Of course, this says nothing of the moral hazard (needy firms now have incentives to refuse or return government investment), or legal complications, or the fact that $2.5bn in bonuses to Merrill Lynch employees aren't subject to the tax (total bonuses to AIG employees is roughly $170mn). But still.

(ht: Marginal Revolution for the Blodgett link)

The Market Norm of Non-Cooperation

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Check out this interesting read on new findings about how humans conceptualize of and are motivated by money.


Basically, humans seem to adhere to two different sets of norms: social and market.  When humans even think about money, we tend to abide by market norms.  In other words, just the thought of money makes us less likely to cooperate.

So, to what extent do these findings require IPE scholars to change their theoretical models?  Do we need to pay more attention to constructivist concerns about how preferences and structures develop?  How helpful are rational choice models at explaining a process that, at least at the individual level, doesn't seem at all rational?  What do "market norms" of non-cooperation say about the institutions argument?  And how much of this is old news, already exhaustively discussed during the emergence of prospect theory?

Pop Quiz

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Q. How do you simultaneously achieve all of the following?

1. Encourage excessive risk-taking in the financial sector when sobriety is desired;

2. Drive the best and brightest employees from firms under de facto government control, thus ensuring that taxpayer dollars are entrusted to less-qualified handlers;

3. Set a (possibly unconstitutional) precedent of retroactive punitive tax policy that effectively nullifies previously-made legal contracts.


A. Do what the House of Representatives just did.

I'm less sanguine about this than Conor Clarke, because I think that his mild cynicism/optimism mix is the absolute best-case scenario; The worst-case scenario has some major financial institution refusing necessary government assistance so as not to subject their past and future income to 90% tax rates, which causes that company to collapse, which triggers another Lehman-like counterparty panic, the government is forced to buy up the shards of the company, all the best employees flee like rats off a sinking ship, and the taxpayer is on the hook for even more than we would otherwise be.

Incentives do still matter. Srsly.

And the silence from the progressive economists in the blogosphere (read: Krugman, DeLong, Thoma) has been deafening.

Frankly, if public shame is in order, wouldn't've been better for the country to let them keep their bonuses and instead make them eat some grubs on Fear Factor as punishment? Or get yelled at by Simon Cowell? Or get out-smarted by a 5th-grader? Or be forced to appear on a sitcom with Charlie Sheen?

Wednesday, March 18, 2009

Cheetahs vs. Hippos: Against "Swiss Bank Socialism"

. Wednesday, March 18, 2009
1 comments

Ever heard a Ghanaian economist scream before? George Ayittey is unhappy with African governments, is trying to foster local entrepreneurial activity in Africa rather than external investment, and doesn't want any more foreign aid. Below is his talk from this year's TED conference. Most interesting to me is his argument that traditional African institutions promoted norms of decentralized power and community-based capitalism. The modern history of authoritarianism and corruption actually contradicts the long-standing legacy of Africa. Perhaps the point is debatable, but Ayittey uses it to stress that development programs may be more successful if they aims to strengthen traditional African, rather than Western, institutions.

For those in the Triangle, he will be speaking on campus Friday at 12:30 in 1301 McGavran-Greenberg (UNC Gillings School of Global Public Health). The lecture is free and open to the public, and the subject is "African Solutions to African Problems".

The Lone Ranger

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Can we get this man some &#*@%^% deputies, please? I mean, he's got a lot of work to do, and he could use some help.

UPDATE: forgot to ht Drezner

Saturday, March 14, 2009

What, Me Worry?

. Saturday, March 14, 2009
2 comments

It is normal to panic when faced with uncertainty, and the current financial meltdown has given rise to plenty of uncertainty. But how are economic and financial experts investing their own money? As far as I know there is no systematic study on the question, but we do have a few data points:

-- Nouriel "Dr. Doom" Roubini has written many words about the financial crisis, and he's on record as saying that things will get much worse before they get better. But his investment portfolio is comprised entirely of equities, and he keeps contributing every month (ht: DePalma, via Marginal Revolution). (By the way, that entire article, on behavioral finance, is recommended reading.)

-- Atlantic econoblogger Megan McArdle is a firm believer in the efficient markets hypothesis (at least in the long run), and I recall reading (tho I can't find the post right now) that her portfolio is made up of indexed mutual funds, roughly 70% domestic and 30% foreign. McArdle also pioneered the "Don't Look!" philosophy of investing in volatile times.

-- Tyler Cowen has maintained his "buy and hold and diversify" strategy.

-- Princeton economist Burt Malkiel is 80% indexed equities, and ~ 30% foreign.

-- Greg Mankiw is a believer in the efficient markets hypothesis, at least in part: "it may be true enough".

These are only a handful, but all are heavily invested in equities relative to bonds or commodities, and all seem to profess some level of belief in the efficient markets hypothesis. Roubini, McArdle, and Cowen are not at all bullish on the economy's short-run prospects, yet their personal investment strategies have not yet changed. What does this tell us?

Well, it could mean that they are ideologically biased by a prior belief in efficient markets, and are willing to sacrifice their portfolios on the altar of that hypothesis. Or, they might be unsure of which investment strategy is best in volatile times, but they know they are unlikely to profit from short-term buying-and-selling, so they stick with their previous long-term strategies, heavily discount the short-run (since none depend on return from investments as their primary source of income), and hope their long-run strategies are sound.

I'm interested in systematic studies of how experts or academics in economics and finance invest their own money, or even more individual anecdotes. If any readers know of anything like this, I'd appreciate some pointers.

Friday, March 13, 2009

Can the US Perform Hegemonic Functions?

. Friday, March 13, 2009
1 comments

Our friend Emmanuel from IPE Zone comments on my post about hegemonic stability: "In any event, I agree that the US cannot fulfill this role like it did in the past."

This is a fine conclusion, but I wonder if Emmanuel might sketch out the analysis that supports it. Don't worry, Emmanuel, I promise not to assign a grade to it.

Thursday, March 12, 2009

Who Fails the Hegemony Test?

. Thursday, March 12, 2009
1 comments

I wouldn't grade Dan Drezner's recent effort to grade American hegemony very highly. In fact, I believe I would give it an "F." Dan Writes: One of the benefits of having a hegemon is supposed to be greater provision of global public goods. According to hegemonic stability theory, if the United States is really still the hegemon, then it should be providing the following things:

  • Provisions of liquidity
  • Market for distressed goods
  • Long-term counter-cyclical lending

The U.S. did all of these things during the Asian financial crisis, for example. This time around, the U.S. grade is not as high. There has certainly been provisions of liquidity -- though if one defines the start of this crisis as the fall o 2007, then it's not like LIBOR has fallen to pre-crisis levels.

The U.S. is not a market for distressed goods. On the margins this is due to incipient protectionism, but mostly this is due to the U.S. economic contraction. Indeed, this is why the recession has so deeply affected Pacific Rim exporters.

The worst grade, however, is on counter-cyclical lending. (Here Drezner quotes:) The pursuit of capital suddenly seems like a zero sum game. A dollar invested by foreign central banks and investors in American government bonds is a dollar that is not available to Eastern European countries desperately seeking to refinance debt. It is a dollar that cannot reach Africa, where many countries are struggling with the loss of aid and foreign investment.

I give Drezner an F for the following reasons.
  • Provide liquidity: The Fed and Treasury are doing everything within the limits of the law to perform the lender of last resort function. Save for that scary period last fall, I don't think the problem in global financial markets has been a lack of liquidity. The problem is lack of capital and perceptions of very high counter-party risk.
  • Expand counter-cyclical lending Dan overlooks the fact that governments created the IMF in 1944 to provide counter-cyclical lending when private markets wouldn't (like now). Thus, the question is whether the US is facilitating the IMF's ability to act in this capacity. Here the US scores high--it is striving to increase the funds available to the IMF (New Arrangement to Borrow) from the current $250 billion to $750 billion, of which the proposed US contribution is $100 million.
  • Drezner also neglects the more obvious point that the US has a very large current account deficit. Hence, the American ability to attract capital inflows is an indication that counter-cyclical lending is functioning. Capital is flowing to a country that needs inflows to finance an external imbalance. In 1929, the US had a current account surplus and thus net capital inflows were perverse for the international economy.
  • Provide a market for distressed goods: Drezner argues that imports are down because of recession. He neglects to mention that in 2008, the US purchased $2.5 trillion of the world's goods and services. That's 5 percent of total world output (non-US) in 2008. Of course import demand will fall as we move into recession--the point is to avoid "Smoot-Hawleyism"
To which one might add two additional considerations.
1. Provide stimulus: the stimulus package of 5.5 percent of GDP is the largest stimulus enacted anywhere (except Saudi Arabia), in absolute terms and as a share of GDP. Perhaps we can consider this a corollary to Open Market for Distressed Goods, although the Buy American provisions are a bit discouraging.
2. Provide leadership: the Obama Administration is pressing G20 governments to do more. Thus far the prodding is having mixed results.

Finally, Drezner fails to offer a counterfactual. Yes, things are bad. One wonders how much worse they would be if the US was not performing these functions.

Wednesday, March 11, 2009

Hegemoaning

. Wednesday, March 11, 2009
1 comments

The argument that U.S. hegemony is beneficial on net to the rest of the world is most famously made in this book, but the arguments in support depend on the U.S. behaving a certain way. I was planning to write a post on how the United States is not fulfilling its unofficial responsibilities as hegemon to provide public goods in the midst of a global economic slowdown, but I see that Drezner has beaten me to the punch:

There's something else going on that should bother IR scholars. One of the benefits of having a hegemon is supposed to be greater provision of global public goods. According to hegemonic stability theory, if the United States is really still the hegemon, then it should be providing the following things:

Provisions of liquidity
Market for distressed goods
Long-term counter-cyclical lending
The U.S. did all of these things during the Asian financial crisis, for example.

This time around, the U.S. grade is not as high.


Drezner says the U.S. is doing the worst at counter-cyclical lending, linking to this NY Times piece that discusses how the continuing strength of the dollar indicates that the U.S. is hoarding capital that is strongly desired by other countries.

There's an aspect of this that may yield benefits for the rest of the world, however, especially countries that heavily rely on exports. The Times piece is about private capital flows to the U.S. Treasury, which have then been turned around and disbursed to the American populace as fiscal stimulus. If the stimulus has any positive effect at all, it will mean that U.S. consumers are spending their stimulus checks. And with the dollar high relative to almost every other currency in the world, that means that American consumers will be importing a lot. In other words, the American stimulus could function as something of a subsidy to the exporting industries of the rest of the world, which could boost employment and government revenues in places like Eastern Europe and Southeast Asia that desperately need a boost.

Indeed, this aspect is exactly what U.S. policymakers were hoping to avoid in the stimulus bill. Thus, the "Buy American" provisions. But those only apply to government infrastructure projects (and possibly not even then); American consumers are free to spend their money however they like. And discount chains like Walmart, which are often heavy importers, can reap some countercyclical benefits in a downturn. The net result could be a transfer from private investors to the U.S. Treasury, from the Treasury to American consumers, from consumers to retailers selling (imported) inferior goods, and from those retailers to the export-biased economies in the developing world.

It's not clear that this sort of movement is what the global economy needs, as it could prolong needed adjustment, but it is line with the theoretical role of the hegemon as a global stabilizer. The mechanism is more indirect, but that doesn't mean it isn't real.

Tuesday, March 10, 2009

Quants and the Limits of Certainty

. Tuesday, March 10, 2009
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Quants, those lovable braniac physicists-cum-financial forecasting gods, sure are taking a beating in the race to "uncover" the reasons behind the global financial crisis.  From David Li's copula to the unrealistic assumptions that underlie the Black-Scholes model of equity options, the news media seems keen to tell a story of smart guys whose propensity for abstract thinking rendered their models useless and even dangerous for any applied usage.

The New York Times has an excellent article today about the species that is the quant analyst.  Importantly, the article seems to draw a parallel between quants and other scientists whose work was used in controversial ways (read Manhattan Project).  Quants might not be the bad guys after all, but merely cogs in the wheels of CEOs engines of economic disaster.  In fact, it does seem important to emphasize that many quants knew the limitations of their models and tried to warn upper management about those limits.

The fact that those warnings went unheeded, however, leads to interesting questions about the role of regulation in financial markets.  As quantitative analysis expands the ways in which investment houses try to make money, and as increased correlation means the consequences for bad bets grows in breadth and depth, again the question becomes "should governments regulate the mechanisms by which financial institutions measure risk, and if so, how?".
 

Friday, March 6, 2009

Links for the Weekend

. Friday, March 6, 2009
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John Maynard Keynes: International Relations Theorist

The excellent Michael Lewis on Iceland. (If you haven't read it, his previous article on the causes of the financial crisis is well-recommended.)

William Easterly reviews the new Peter Singer book on ethics and aid.

Clive Crook contrasts the "European model" and American exceptionalism.

Video of a debate over stimulus.

Broader Unemployment Figure

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From the Economix blog at the NYTimes: 


The job market is getting ever closer to the depths that it reached in 1982.
Since the start of 2008, the economy has lost jobs at a steeper rate than at any other point in 50 years. That hadn’t been true until today’s report. But the 651,000 job losses in February — together with 161,000 additional job losses in previous months, a result of Labor Department revisions announced today — means that the decline is worse than it was at any point during the deep recessions of the mid-1970s and of the early 1980s.

The economy has now lost 3.2 percent of its jobs since January 2007. It lost 3.1 percent between the summer of 1981 and the end of 1982.

The job market still is not in as bad shape as it was in 1982, because unemployment entering this downturn was somewhat lower than it was in 1981. But it’s getting close.

The government’s broadest measure of unemployment and underemployment was 14.8 percent in February. That includes some of the people who have stopped looking for work because they don’t believe they can find jobs. It also includes part-time workers who want to be working full time.

The Labor Department did not keep such a statistic in the early 1980s. But it likely would have been in the neighborhood of 17 percent then. (Awhile back, I created a similar — though slightly narrower, for reasons of historical consistency — measure, with help from Labor Department economists. It peaked in 1982 at 16.3 percent in December 1982; it was 14.1 percent last month.)

So it’s still too early to call this the worst recession since the Great Depression. But it’s bad, and it’s still getting worse at a rapid rate.

Monday, March 2, 2009

Small Change in Cuban Cabinet...

. Monday, March 2, 2009
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Cuban President Raul Castro moved today to consolidate his power and control over the island nation by reassigning cabinet ministers left over from his older brother's reign, and replacing them with new ministers he believes are more in line with his vision for the future of Cuba. Raul is no stranger to experimentation and is well known to be more sympathetic to capitalist reforms of the beleaguered Cuban economy than Fidel. 

With the Cuban economy hamstrung by the world economy, Raul Castro may have decided it is time for him to make reforms of his own without worrying about second-guessing by his brother or his brother's allies, she said.

Vicki Huddleston, who led the Interests Section during the administrations of Presidents Bill Clinton and George W. Bush, and is a visiting scholar at the Brookings Institution in Washington, speculated that the changes could portend the government once again allowing private enterprise to flourish in Cuba.
Raul made these changes:
Felipe Perez Roque, the 43-year-old foreign minister, was replaced by his deputy, Bruno Rodriguez Aprilla.

Carlos Lage Davila, an economist, lost his job as Cabinet secretary, but no mention was made of removing him from his other post as vice president of the Council of State.

Lage, who helped guide the nation through its "special period" of dire economic times in the aftermath of the dissolution of the Soviet Union and the loss of billions in subsidies, was replaced by Brig. Gen. Jose Amado Ricardo Guerra.
Last year, Raul legalized the purchase of cellular phones, home computers, DVD players, and other technological goods as well as lifted the bans on renting hotel rooms in Cuban resorts. He did this even though Cubans themselves can not afford these goods on their own, but that's another story. 

Cuba relies heavily on imports of Venezuelan oil, food and other goods to keep their economy somewhat alive. However, with the steep drop in oil prices over the last 8 months, Venezuelan aid has begun to dry up as Hugo Chavez has faced budget shortfalls and a myriad of other domestic problems at home. His ability to financially support Cuba may be fading, and seeing this happen before his eyes, it seems that Raul Castro has decided that something must be done to get the Cuban economy moving or face the possibility of domestic turmoil in the near future. 

So what new reforms could he be considering? Here are a few that I think are on the table: 

1) Liberalize certain portions of the Cuban housing sector, especially in major cities. An underground market in apartment trading has sprouted over the last decade or so in Havana and by liberalizing the housing market, the government could seek to extract resources from housing transactions rather than allowing the trades and transactions to take place under the table. If you want to read more about the underground market for housing in Havana, this is a terrific article
2) Increase the fee on currency exchanges within the country. The government takes 10% out of each exchange of American dollars for Cuban dollars at this point in time. Increasing this to 15-20% and simultaneously hoping that the US raises the ceiling on remittances would be another way to extract resources.
3) Open up certain sectors such as oil and natural gas exploration, agriculture and manufacturing up to partnerships with foreign firms. Cuba has already done some of this, teaming up with German and Norwegian oil exploration companies, to explore a relatively large underwater oil field that was found off of the island's northern coast. This was mainly done because Cuba does not have the technology nor the capacity to do it by herself. Allowing certain public/private partnerships in carefully selected industries would increase government revenues and spur some economic development.

Notice that I have focused mostly on areas where the Cuban government can extract more revenue for their projects. Don't expect massive overhauls of the economic system, the establishment of private property,  or the sudden appearance of small businesses anytime soon. Raul's main goal is to consolidate his power. He will only implement those policies that enhance this goal, rather than seek to increase Cuba's growth and prosperity for the benefit of the populace. He is weary that the growth of a middle class and wealth among the citizenry would be a threat to the Communist experiment that has consumed the island for the last fifty years. 

P.S. Cuban VP Carlos Lage also just so happens to be one of my great-uncles. Interesting connection I know. At least he is still VP and didn't get completely canned, so if I fail my regression and game theory mid-terms this week, hopefully he knows who the hell I am and can offer me a job because I know I won't be able to find one in the US!

When Expectations Converge

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An open letter to Paul Krugman, from monetary economist Scott Sumner.

And Krugman's (non)response. It's embarrassing to see a Nobelist respond to serious arguments with snide put-downs. But here's the closest thing to a counter-argument offered by Krugman:

My view, which I thought was pretty clear, is that the liquidity trap is real: no matter how much the Fed increases the monetary base, it has no effect, because it just substitutes one zero-interest asset for another. If the Fed could credibly commit to inflation at rates higher than the 2-ish percent target it’s already believed to have, that would be effective. But right now I don’t see that as a realistic option, hence the emphasis on fiscal policy and bank recapitalization.


Presumably, Krugman thinks we are in a liquidity trap because the Fed can't credibly commit to boost future inflation. In other words, expectations of (low) future inflation prevent monetary policy from taking hold in the present circumstances, thus reducing the monetary "multiplier" (i.e. velocity of money). In Krugman's mind, this is so self-evident that he doesn't even need to consider things like quantitative easing or eliminating interest payments for excess bank reserves. Banks (and investors) have expectations of future inflation, which makes monetary policy ineffective in a liquidity trap, full stop.

Why, then, are Krugman and his minions so dismissive of the "Treasury View" that the fiscal multiplier is greatly diminished by crowding out private spending because of expectations of future tax increases? Why are one set of expectations enough to make monetary policy completely ineffective, but not have any effect on fiscal policy? For this view to be coherent, there must be some fundamental difference between expectations over future inflation and future taxes, but I can't see what it is. Both expectations come from beliefs about future real net income.

Especially since, as Krugman himself noted earlier today, both banks and consumers are hoarding cash right now. I would expect Krugman to say that we need to government to spend precisely because banks and consumers are hoarding cash. But that only moves the money once: after the government spend the cash, whoever receives it will just hoard it and there is no stimulative effect. In order to get the money moving on a more sustained basis, there has be a story about how consumer expectations improve when faced with fiscal stimulus but remain unchanged when faced with monetary stimulus.

So what's the story?

Through the Looking Glass...

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1. The Financial Times wrote: "The summit was called to reaffirm core EU principles, such as avoidance of protectionism and solidarity ... in the face of a crisis that is putting the bloc’s unity under severe pressure."

What they really said: Angela Merkel said: "We cannot compare Slovakia and Slovenia with Hungary,” referring to two countries that are to some extent sheltered from the financial crisis by being members of the 16-nation eurozone." Even East Europeans don't want to be lumped in with Eastern Europe:
“When it comes to any specific plans for eastern Europe, we don’t need those plans,” said Mikolaj Dowgielewicz, Poland’s EU affairs minister.

Not exactly "Unus pro omnibus, omnes pro uno," now is it?

2.
The Financial Times wrote: "European Union governments vowed on Sunday to conquer the financial crisis and recession gripping their economies by extending help to beleaguered eastern European states."

What they really said: “We help countries in need and we will do so further, particularly through international institutions,” Angela Merkel, Germany’s chancellor, told reporters.
Translation: Go to the IMF. Yeah, that's going to help.

The Dynamic Duo

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Good Post piece this morning about the dominant role of Timothy Geithner and Larry Summers in formulating economic policy in the new administration. Pretty good hint at their management style and their desire to be insulated from external pressure (such as that applied by automakers).

The piece also nicely describes the rather frenetic pace of policymaking in this era of the rolling crisis: "Last week alone, Geithner ran from meeting to meeting to craft a new rescue deal for Citigroup, talk with governors on the economic stimulus package, co-host a summit on the nation's fiscal issues, work with lawmakers on regulatory reform, refine a plan to help homeowners, discuss a major upcoming summit with his foreign counterparts and roll out the details of a "stress test" for banks."

You can decide for yourself who is Batman and who is Robin.

Gettin' Ugly in Ukraine...

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From today's NY Times:

Steel and chemical factories, once the muscle of Ukraine’s economy, are dismissing thousands of workers. Cities have had days without heat or water because they cannot pay their bills, and Kiev’s subway service is being threatened. Lines are sprouting at banks, the currency is wilting and even a government default seems possible.

Ukraine, once considered a worldwide symbol of an emerging, free-market democracy that had cast off authoritarianism, is teetering. And its predicament poses a real threat for other European economies and former Soviet republics.

The sudden, violent protests that have erupted elsewhere in Eastern Europe seem imminent here now, too. Across Kiev last week, people spoke of rising anger about the crisis and resentment toward a government that they said was more preoccupied with squabbling than with rallying the country.
As the article makes clear, financial disaster in the Ukraine, a large land mass of almost 50 million people strategically located on Russia's doorstep, would not be good for Western democracy, capitalism or interests. If the Ukrainian government collapses under the pressure of financial turmoil, there is little doubt that Russia would seek to meddle in Ukraine's domestic politics, expand and entrench its influence and seek to move Ukraine away from the goals of the 2004 Orange Revolution. Free-market capitalism has taken a beating in the country over the past year or so and Russia would like to continue to whither its support. It would also likely step up to aid Ukraine with its debt issues.
In February, the International Monetary Fund refused to release the next installment of a $16.4 billion rescue loan to Ukraine because the government would not adhere to an earlier agreement to pare its budget.

Around the same time, Ukraine’s finance minister resigned, saying that the job had been “hostage to politics.”

On Friday, the monetary fund projected that Ukraine’s economy would shrink by 6 percent this year, and said that it was continuing to work with the government to find a way to disburse the rest of the rescue loan.
Europe is failing to step up to offer Ukraine and other Eastern European countries a helping hand. Let us hope that the IMF and EU can put something together relatively soon to at least keep the Ukrainian economy afloat. 

Sunday, March 1, 2009

The Next Iceland?

. Sunday, March 1, 2009
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Some say it could be Ireland. The Celtic Tiger has been battered badly by the economic downturn, and like Iceland this is largely due to the fact that its banking sector is a very large part of its overall economy. Some companies are running "economic disaster tours" and they've even got their own Dr. Doom! Perhaps most importantly, Ireland and Iceland have similarly-spelled names.

But, as the saying goes, the Irish fundamentals are more sound than those of Iceland:

O'Neill and other prominent economists like Patrick Honohan, a former economist at the World Bank who teaches at Trinity College Dublin, argue that Ireland will never go the way of Iceland because Ireland's public debt is a manageable 40 percent of gross domestic product.

Ireland's banking sector, more than twice the size of the national economy, does not even approach that of Iceland, they note, which was about 10 times the size of its economy.


Still, Ireland's amazing recent run of economic growth was largely attributable to profit increases in the banking sector, which used derivative positions in real estate markets to make highly leveraged bets. Those bets weren't on American subprime mortgages, but rather in European real estate markets, but the real estate bubble may have been even more puffed up in Europe. Expected profits have gone way down as defaults has risen, the banks are over-leveraged, and counterparty obligations have spread the contagion throughout the entire system. Same story everywhere.

However Ireland was much less exposed than Iceland, so it seems likely that the luck of the Irish will be better than that of the Icelandic.

International Political Economy at the University of North Carolina: March 2009
 

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