I loved the Beeb's mini-series adaption of LeCarre's Tinker, Tailor, Soldier, Spy. It's a Cold War espionage classic, and Alec Guinness is fantastic as Smiley. This one will have to be different -- it must move more quickly, and keep theater audiences engaged -- but I'm still pretty excited. Such a great cast, plus the director from Let the Right One In.
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- IR Nerdcore - Tinker, Tailor, Soldier, Spy
- S&P Fires Shot Across the Bow
- Trouble in Egypt
- Regulatory Regret
- Capital Is Political
- If Hitler was on the $20 Bill, How Would the Jews ...
- The Importance of Learning from Crisis
- Sunday Afternoon Video
- Nye on European Power
- Basel Is Political
- Political Science Invented the Interwebs
- Trade, Exchange Rates, and Public Opinion
- Schelling and the Euro
- Who Doesn't Love a Grand Theory Debate?
- Over-Regulation Isn't Surprising
- Who Gets Optimized?
- The BIS Misses Monetary Moral Hazard
- The IMF Is Political, Not Technocratic
- Anonymous Goes After the Fed
- Eichengreen Podcast
- The Irony of TGS
- Krugman vs. Krugman
- The Politics of Housing Is Salient
- Follow-Up on TGS Graphs
- The Next Trade Spat?
- Creditor-Debtor Politics
- Re: That EMU Stealth Bailout
- The World's Central Banker
- *The Origins of Political Order*
- There Is No Great Stagnation, Only Great Redistrib...
- Too Big to Fail
- China's Growing Pains
- The International Forex Network, 1998-2010
- On Blanchard on Capital Flows and the IMF
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- The World's Central Banker
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Thursday, June 30, 2011
Wednesday, June 29, 2011
They'll downgrade US debt from AAA to D if the US misses a payment:
"If the U.S. government misses a payment, it goes to D. ... That would happen right after August 4, when the bills mature, because they don't have a grace period." The company would downgrade Treasury bills unaffected by the blown deadline, but not as much.
If you thought it was bad when AAA mortgage-backed securities turned out not to be AAA, just wait to see what happens when the full faith and credit of the US government is no longer credible. At that point, banking regulations under current definitions become essentially meaningless, since capital weights and risk-pricing models use "risk-less" Treasuries as their baseline. Using Treasuries as highest-quality collateral ends, and balance sheet accounting becomes a bloodbath. Under current capital requirements, which banks wouldn't be immediately insolvent if Treasuries went to D? I can't imagine a scenario in which this would not lead to a bigger financial crisis than 2008.
The international dimension is also important. China will be very, very unhappy, as you would be if your "safe" $1tn+ investment turned out to be not-so-safe; battered banking sectors in Europe and elsewhere would take another (bigger) hit; if the US banking system goes, everything else goes with it. This could be Creditanstalt times a thousand. Or a million. I don't even want to think about it.
Republicans seem to be worried that continued deficits will weaken the credibility of the US, eventually leading to higher bond rates. However, a default would guarantee that outcome immediately and catastrophically. It's like shooting yourself in the face today to prevent your future self from being mugged.
I'm not as pessimistic as many others concerning the US political system, so I still believe that a deal will get done*. And I understand that dancing closer to the edge of the cliff can be a good negotiation strategy**. But it's also perilous.
*Surely the GOP realizes that if they blow up the global economy not a single one of them will win re-election for a generation.
**All those people who said that IR work on nuclear deterrence was irrelevant post-Cold War might want to reconsider; this is the nuclear option.
[UPDATE: Here's Geithner's letter to the GOP. Nice invocation of Reagan. Nice job of telling them that they either don't know what they're are talking about, or are gambling recklessly with a precious resource.]
Or is this "UNC Everywhere"? Poli-sci professor Andy Reynolds is not optimistic about Egypt's coming election:
“This is the most opaque process we’ve seen,” said Andrew Reynolds, an associate professor of political science at the University of North Carolina at Chapel Hill who studies and advises on electoral systems in new democracies. “No one, not the political parties, the United Nations” or non-governmental organizations “knows who’s even writing the law,” he said. ...
The bottom line is that this system advantages the old parties,” he said. “The people who are going to lose out are the Tahrir Square groups and the liberal movements.”
The rest of the article is also good. The consensus (from the article) seems to be that the election should be postponed to give time for groups/parties to organize properly and for mechanical electoral institutions (rules, monitors, logistics) to be constructed, but the article cites a poll in which 75% of the population think the elections should go ahead as scheduled. This certainly bears watching. I'm not especially optimistic.
Suppose policymakers send a clear signal: banks that are "too big to fail" will be bailed out, so in return they must bear a stricter regulatory burden. Banks that are not too big to fail will not be bailed out, so they have a laxer burden. What incentive does that give to banks... get bigger to capture the guarantee, or get smaller to avoid the stricter regulation? Depends on the regulation. But I don't see any large bank responding to Basel III or Dodd-Frank or any other regulatory change by desperately trying to reduce size. That should provide some indication of what margin we're operating at. And even if the banks are small enough to fail without systemic consequences, that doesn't necessarily mean their creditors are:
Governments across the world are committed to allowing banks to fail in the future. Socialising bank losses is unpopular, and it creates moral hazard. However, when national banking sectors remain fragile, imposing burden-sharing resolution regimes is fraught with danger. Governments and regulators may chose safety first. Witness the ECB’s continuing refusal to allow haircuts for the senior bondholders of Irish banks. They, it seems, are definitely too big to fail.
Also remember 1907. The problem then wasn't too big to fail. It was too small so they failed. Larger institutions gain greater confidence than smaller institutions. The 1907 panic stopped only after JP Morgan (the man) intervened, so says the myth. That strategy repeatedly failed in 1929, as Galbraith's The Great Crash notes, but in 2008 the crisis may have been much worse if huge institutions didn't exist to merge with other huge institutions. Small institutions can't easily take on others' balance sheets in times of trouble, at any price.
The point is that there are downsides to decentralized finance. TBTF is a real problem, but it's not the only problem. Constructing regulations to punish TBTF firms could actually reward them. I can easily imagine Wall Street executives wearing their SIFI ("systemically important financial institution"*) designations as badges of honor. And counting on them as explicit blank checks from governments. Who wouldn't want a SIFI as a counterparty? Almost as good as a GSE.
*Subject to stricter capital requirements under Basel III.
Tuesday, June 28, 2011
Capital matters. Let me put that another way. The current fight over additional capital requirements for the banking industry, eye-glazing though it is, also happens to be the most important reform moment since the financial crisis broke out three years ago. More important than the wrangling over Dodd-Frank. More important than the ongoing effort to regulate derivatives. More important even than the jousting over the new Consumer Financial Protection Bureau.
And here's McLean:
Think about the past (the financial meltdown in 2008) and the present (the fear that a default by Greece will ignite another financial crisis ). If banks had held more capital, would we have avoided either mess? I'm afraid the answer is no.
Here's how I'd sum up the difference. McLean argues that all bank crises stem from runs on banks, and when a run is on no amount of capital can stop it. Yes, Nocera might respond, but runs are crises of confidence and higher capital requirements can increase confidence in the stability of financial institutions. Both could be right. But as McLean hints, the type of capital restrictions can end up backhandedly make financial institutions less safe:
Not only would higher capital requirements have failed to prevent these crises; conceivably they might have made them worse. The risk weighting that the regulators apply to assets encourages banks to hold more of the assets that are supposed to be low-risk. That's why banks all owned a lot of mortgage-backed securities—they were purportedly low-risk, and banks didn't have to hold much capital against them. Sovereign debt like Greece's was also purportedly low-risk; that why banks owned a lot of it. Subsequent events showed that the risk weightings left something to be desired. Because they were standardized, they incentivized banks engaged in the same risky behavior. If you believe that crises come about because too many banks do too many of the same dumb things, then faulty international capital requirements are arguably worse than no such requirements at all.
This is more-or-less the Friedman hypothesis [1, 2, 3, 4]: the regulatory code rewarded lending to governments and to vehicles for securitization, and no wonder. Regulations are political creations, so they will favor things that political actors want. Cheap access to government debt is one; plenty of cheap housing finance is another.
Nocera hasn't fully internalized this point -- he refers to regulators' decisions as "somewhat absurd" and to political bargaining over regulatory policy as "pathetic" and a "sorry sight" -- but he hones in on one important international dimension:
European banks, to be sure, have fought fiercely against higher capital requirements. It’s not really because they hope to get a leg up on the rest of the world, though. It is because these banks are in far worse shape than the banks in other parts of the world; they can’t afford higher capital requirements. If Europe began insisting that its banks begin holding enough capital to cushion against all the risk on their books — starting with Greek debt — the truth would be out: Their insolvency would suddenly be apparent. If Europe wants to keep kicking the can, by turning its back on the surest measure to increase the safety of its financial system, why on earth would we want to go along?
Tarullo will soon travel to Basel, Switzerland, (yes, that’s why they call them the Basel accords) to push for the highest capital requirements he can get the rest of the world to agree to. He will also try to convince the international standard-setters that a significant surcharge on the most systemically important banks is vitally important.
That surcharge, discussed here, represents just the most recent of several US (and UK and Switzerland) victories in the Basel negotiation process. The delayed phase-in was the main victory of the European contingent. But the takeaway needs to be that we need to understand the political process in order to understand what the purpose of regulations are, and the ways they shape firm behaviors.
Monday, June 27, 2011
I had a conversation with Sweet Mungowitz about our favorite "revolution rock", or anti-government, songs. His nomination is the below track from Corporate Avenger, with whom I was previously unacquainted but who shared members with the Kottonmouth Kings and No Doubt. The primary folks in Corporate Avenger seem to be anarchists, motivated by their Native American identity. The song below, for example, asks the question in this post's title*. The answer, which is evident from the song, is that they'd be pretty pissed off. Which is what Corporate Avenger is.
My nomination was "The Decline", NOFX's magnum opus and also the best political punk rock opera of all time.
In an e-mail to Mungowitz, I wrote the following about it:
This song was released in 1999, so it's a fascinating take of the political economy of that period. (They hated Dubya even more, later releasing an album called "The War on Errorism".) "The Decline" is simultaneously a great public choice take on state corporatism, a vicious attack on the War on Drugs and the prison-industrial complex, a finger-poke in the eye of religious social conservatism, and a harsh indictment of the contemporary bourgeois liberal class. You [Mungowitz] might appreciate the anti-gun stuff less, but the way they tie the movement to the Christian right is interesting.
Their take on democracy and institutions is mostly boilerplate and not particularly nuanced, but then that's a common problem (even among academics, unfortunately). It does anticipate Tea Party populism, in a way. Also attacks the know-nothing left that (mostly) comprises their own audience: "We are the whore/ intellectually spayed/ We are the queer/ Disfunctionally raised".
And how about this criticism of Burkean conservatism, which follows a movement that compares over-medication to religion in an opiate-of-the-masses sense (and references Nietzsche!): "And so we go on with our lives/ We know the truth but prefer lies/ Lies are simple, simple is bliss/ Why go against tradition when we can/ Admit defeat, live in decline/ Be the victims of our own design/ The status quo (built on suspect)/ Why would anyone stick out their neck?".
Or this prefiguring of the financial crisis: "The going get tough, the tough get debt/ Don't pay attention, pay the rent/ Next of kin pays for your sins/ A little faith should keep us safe".
Plus, musically, it's the most ambitious and successful example of a punk rock opera that I know of. Twenty minutes of tight, thoughtful, snotty dissent.
I might flesh that out a bit more and see if Fine Print wants it. Anyway, I'd love to see what protest/revolution songs others like.
*Just in case some dots need to be connected, Andrew Jackson is on the $20 bill, and his animus toward Native Americans is comparable in form and action to Hitler's animus toward Jews.
Sunday, June 26, 2011
MR points to this piece describing how Sweden has come through the recent financial crisis relatively well. The five reasons given really sum to two:
1. Have a terrible financial crisis fairly recently in your past, and learn from it.
2. Don't join the EMU, and ask the US Fed for help.
After the Swedish financial crisis in the 1990s, they passed a rule that balanced the budget and built up a surplus, and they stuck with it. They left them with plenty of cash to fund "automatic stabilizers" in the welfare state. The central bank also slashed interest rates to zero and pursued quantitative easing more aggressively than the US Fed. The central bank was able to do this, and adjust through the exchange rate rather than wage and price cuts, because it refused to adopt the euro. Meanwhile, the Fed opened up swap lines with the Riksbank that provided enough liquidity to keep the Swedish banking sector afloat. (Another data point that Bernanke has been the world's central banker, just as Kindleberger would've wanted.)
The above two points can lead to hope. Financial crises are painful events, but because of that they can lead to positive medium-run reforms that put the economy back on a proper path. The US political economy has frustrated a lot of folks lately, but we've come through worse crises in the past, as have other countries, and have usually been better for it.
I'm back from a trip, and should get into the flow again, but to tide you over here's a cool video of Timur Kuran and Douglass North talking about institutions and political economy in 2000.
Via Teppo Felin.
Friday, June 24, 2011
Can't remember if I've already linked to this or not, but here's Nye (pre-Libya) on the continuing relevance of European power. Seems like he should incorporate network dynamics more explicitly into his analysis. "Network" only appears once in the article, and it's in a quote from a Newsweek reporter.
Thursday, June 23, 2011
From Ezra Klein, upon watching Inside Job:
It was an excellent documentary for people who don’t want to understand the financial crisis but want to believe they would’ve seen it coming. Watching it, you’d think that the only people who missed the meltdown were corrupt fools, and the way to spot the next one is to have fewer corrupt fools. But that’s not true. ...
There’s a lot to dislike about Wall Street. The pay. The culture. In many cases, the people. But that doesn’t explain what happened in 2007 and 2008. ...
What’s remarkable about the financial crisis isn’t just how many people got it wrong, but how many people who got it wrong had an incentive to get it right. Journalists. Hedge funds. Independent investors. Academics. Regulators. Even traders, many of whom had most of their money tied up in their soon-to-be-worthless firms. “Inside Job” is perhaps strongest in detailing the conflicts of interest that various people had when it came to the financial sector, but the reason those ties were “conflicts” was that they also had substantial reasons — fame, fortune, acclaim, job security, etc. — to get it right.
And ultimately, that’s what makes the financial crisis so scary. The complexity of the system far exceeded the capacity of the participants, experts and watchdogs.
Extreme ignorance is still an underrated explanatory variable in models of the crisis.
I've previously written about a few of Inside Job's deficiencies here and here and here. A general rule is that smug explanations of the crisis are wrong.
Tuesday, June 21, 2011
Wonky technical point with large ramifications:
This year has seen some improvement. Data submitted by banks in May were subject to “peer review” by a committee of experts from the European Banking Authority (EBA), a pan-European college of regulators, which is administering the tests. The committee concluded that some banks had been over-optimistic in their self-assessment. In some cases different banks had estimated very different probabilities of default and losses on similar underlying assets. Results were meant to be out this month, but all banks have now been asked to do their sums again and resubmit by the end of July.
National regulators have not taken kindly to this. Germany’s regulator, BaFin, has been involved in a public war of words with the EBA over its definition of capital. The EBA has adopted the Basel III standard for Tier 1 capital. That excludes “silent capital”, bond-like instruments which Germany used to recapitalise its banks. Germany has pointed out that banks have several years to be Basel-III compliant. But so far the EBA has resisted German demands to recognise silent capital.
Why is this provision in Basel? Because US and UK banks don't use silent capital to pad their ratios, so if US/UK regulators were going to up the statutory capital requirements for their banks, they wanted to make sure those banks weren't competing against firms (esp in Germany and Japan) that were gaming the system, and gaining a competitive advantage from it. Basel III looks the way it does for a reason, and that reason isn't simply technocratic.
It's a series of tubes, right? Anyway, Errol Morris writes about how his brother helped set up the first e-mail system in the MIT political science department:
In 1965, at the beginning of the year, there was a bunch of stuff going on with the time-sharing system that Noel and I were users of. We were working for the political science department. And the system programmers wrote a programming staff note memo that proposed the creation of a mail command. But people proposed things in programming staff notes that never got implemented. And well, we thought the idea of electronic mail was a great idea. We said, "Where's electronic mail? That would be so cool." And they said, "Oh, there's no time to write that. It's not important." And we said, "Well, can we write it?" And we did. And then it became part of the system.
From political science to you, world. Kind of. Okay not really.
(How crazy is it that e-mail was originally deemed "not important".)
Monday, June 20, 2011
Blogging is likely to be light, as I'm in
an undisclosed location Sundance country for the week. I'm hoping to have some things to say about this post from Quiggin, as I've been thinking along similar lines lately (i.e. what value Marx actually adds to the contemporary left). There's some other stuff I'm hoping to get to also, but I have some time constraints so please bear with me.
Drezner wants to know what's up with Republicans not supporting free trade these days:
What's more disturbing, however, and uncommented until now, was the total lack of support for freer trade among the GOP field.
This came through loud and clear through what was said and what was not said in New Hampshire. Trade didn't come up all that much during the debate. Tim Pawlenty provided the only comment of substance, and it wasn't a productive one...
The other thing that was striking was what wasn't said during the debate. All of the candidates focused like sharks with frikkin' laser beams attached to them on the economy. The standard GOP litany of solutions for jump-starting the economy were offered: tax cuts, cutting regulation, tax cuts, cutting government spending, tax cuts, reigning in the Fed, tax cuts, ending Obamacare, tax cuts. Not one of the candidates, however, mentioned trade liberalization as part of their fornmula for getting America moving again.
This is more off-the-cuff observation than analysis, and I'm not sure how far it reaches (as Scott Lincicome points out in Drezner's comments), but let's take it as given and think about why might this be the case. Another of his commenters presents a typical explanation:
The obvious thing is that when most of the American people have been economically hammered for decades, they're not in an economically liberal mood. They've seen repeated free trade agreements lead directly to lower wages and layoffs, despite what the various propagandists have said.
Call this the "business cycle theory of trade attitudes": When economic times are good, public support for further liberalization is high. But during downturns, everyone wants protection. It's a fairly standard argument, and Drezner's co-blogger at FP makes it every day.
Thing is, there are good reasons to doubt it. Dr. Oatley recently published an article arguing that real exchange rate movements better predict calls for trade protectionism than the business cycle. His central finding?
The empirical analysis therefore provides robust support for the real exchange rate hypothesis. The number of antidumping petitions rises as currencies strengthen and falls as currencies weaken. This relationship holds even once we control for other likely causes of industry demand for protection such as import growth and changes in macroeconomic conditions. ...
Thus, real exchange rate movements provide at least as strong an explanation for temporal variation in protectionism than the most popular alternative business cycle hypothesis.
Douglas Irwin has a recent article on the link between exchange rates and trade policy in historical perspective. So what's happened to real exchange rates in the US?
Looking at this in light of Oatley's paper, it's not all that surprising that Bush wasn't able to do much on trade during the 2000s. He entered office during a period immediately following a huge exchange rate appreciation that peaked with the early-naughties recession. Second, though the exchange rate depreciated during the decade, that process slowed and mildly reversed in 2008-2009. Recall, as Drezner does, the anti-trade competition that Hillary Clinton and Obama engaged in during the 2008 primary. We're still living through that, so it shouldn't be too surprising that momentum for new trade agreements has stalled in both parties.
In other words, Drezner, Lincicome, and Oatley could all be right: elite Republican opinion on trade might not have changed all that much (Lincicome), but they are choosing to remain eerily quiet on the issue (Drezner) as real exchange rates have yet to depreciate enough to restore American competitiveness (Oatley). The optimistic take for the globalist is that real exchange rate movements are occurring, and if recent trends continue we should expect greater enthusiasm for more liberalized trade in the coming years.
Sunday, June 19, 2011
It's really a mess. But one thing should be clear: it's in the interest of all the negotiating parties to be as apocalyptic in their warnings as possible. If the Greeks don't draw a hard line, they get a raw deal, and the same goes for the European Union, and the constituent governments, and the ECB, and the IMF. Ultimately, everyone expects that the negotiators will back down and an agreement will be reached, but in the mean time it's worth it to negotiate like a madman. The big downsides to this are, first, that it gives everyone reading newspapers a fright. And second, when so many parties are playing this brinkmanship game, there's always a risk that something goes awry and a deal isn't reached. Frankly, Europe isn't giving markets a lot of reason to be confident that the process of handling Greek insolvency is actually, underneath all the posturing, under control.
The logic of brinksmanship was put famously (and well) by Thomas Schelling. He described nuclear deterrence as two countries, chained together, dancing closer and closer to the edge a cliff, over which they'd both tumble if one of them slipped. And I've written similar things along those lines over the past year or so. At this point, however, I wonder how well the metaphor fits. The Greek political economy does not remotely resemble a unitary actor, at this point. Tens of thousands rioting in the streets, government turnover and possible recall, etc. It looks like Greece is racing full-steam towards the edge, attached to the rest of the EMU by a fairly thin cord, while Germany and France stand well back from the edge, holding scissors and debating whether and when to cut loose.
It's unclear whether this puts "Greece" at any bargaining advantage, because it's unclear what "Greece" represents and therefore what it desires. More accurately, there is an internal battle in Greece over the value of Euro membership. Germany and France can alter the terms of that membership on the margins, mostly by buying time, but they can't change the game. Even if some elites wanted to, Germany and France are limited by their domestic polities as well.
We need a new metaphor.
Saturday, June 18, 2011
Well, me. Nevertheless, Nexon on Caverley, Caverley responds.
No deep thoughts from me, as I haven't read the article under discussion, but it seems that Caverley is arguing that neocons support democratization at least in part because it would weaken their (our?) enemies. Nexon argues that no neocons actually say that, nor do they have good reason to think it given their reliance on both neoclassical realism and some forms of (non-Wilsonian) liberalism, neither of which make that case. From where I sit that sounds right enough, and yet... even if neocons don't make that case, perhaps they should.
Academic IR writes all the time about how democracy can enfeeble states. And also about how it can strengthen them. Democracies supposedly constrain leaders by both making it difficult for them to go to war, but then make them try like hell to win once they get in one. Democracies are supposedly better are imposing audience costs, but that's a double-edged sword. Etc.
If we buy any of this*, then a statement like "democratization will strengthen states in some ways and weaken them in others" that is followed by a statement like "from the perspective of the United States vis-a-vis new democracies, the latter will usually out-weigh the former" is not implausible on its face**. Was Japan strengthened by post-WWII democratization, along with the economic integration that followed from it? I think so. Was Japan strengthened in its bilateral relationship with the U.S. by that process? Arguably no. It became completely dependent on the U.S. for its security, and to a large degree its economic prosperity. Relative to China, Japan got stronger. Relative to the U.S., perhaps not.
To think about it in another way: the neocon goal of a "league of democracies" would certainly have the U.S. as the most central node. Network externalities being what they are, the effect would be to reinforce American power. (Somewhat perversely, this isn't too far from Ikenberry's view.) It can then make an offer to other states: democratize and you'll get the benefits of being in the network, but only as a peripheral node. Such an arrangement could simultaneously increase America's relative power while improving material conditions for the new democracy. Thomas Friedman (does he count as a neocon?) would call it the "Golden Security Straitjacket". Speaking of the devil, Friedman has written a bunch about the benefits of authoritarianism.
So perhaps Nexon is right that neocons don't believe in "democratic enfeeblement". But maybe they should. It could follow from their other beliefs.
*I'm not necessarily saying we should. I hope Phil Arena chimes in.
**To be clear, Nexon doesn't argue that it is; only that Caverley's paper doesn't establish the claim that neocons actually believe this, despite using strange readings of cherry-picked texts.
Something very peculiar is afoot. Well after the bank regulatory reform debate was supposedly settled, central bankers seem to be reopening that discussion. It’s puzzling because the very reason the banks won so decisively was that central bankers were not prepared to get all that tough with their charges.
I’m not clear what has led central bankers to get a bit of religion. Is it the spectacle of the Bank of England talking about breaking up the banks (they won’t get their way thanks to bank lobbyist working over the Independent Banking Commission, but no one doubted their sincerity)? Or the Swiss National Bank imposing 19% capital requirements, which as we discussed, is likely to lead to the investment banking are of UBS being domiciled elsewhere (assuming a country capable of bailing it out will have it)? Or perhaps it is central bankers being forced to recognize that their Plan A of extend and pretend and super low interest rates simply won’t lead banks getting to meaningfully higher capital levels when the staff continues to take egregious amounts out in compensation? Or have they realized how bad bank balance sheets are in the Eurozone and how tight the linkages still are among the major capital markets players, and they belatedly realize they need them to be much more shock resistant?
The bottom line is that various central bankers have taken the surprising step of insisting their banks meet more stringent requirements for the biggest banks than those originally planned to be to be included in Basel III.
Basically, the point is that some countries' regulators are considering implementing stricter regulations than those agreed in the multilateral Basel accords. How "peculiar" is this? Not very. The above heat map* shows capital-to-asset requirements for about 140 countries in 2006. The data come from this World Bank survey, which was the third of its kind. The darker the color, the higher the minimum ratio required by governments. (White countries are missing data, which means non-respondents to the survey.) At the time, the Basel requirements were 8% capital, of which 4% needed to be equity capital, represented by the beige color of the United States. The interesting thing about this is the number of countries that had tighter restrictions than those minima. It's nearly half of the sample**.
This might surprise some, who believe that absent a tough international standard national governments will "race to the bottom" in order to give their firms a competitive edge. But that doesn't tend to happen. Nor does it happen much in the private sector. Banks routinely over-comply with capital requirements, as doing so signals to investors that they are safe firms, which in turn lowers their borrowing costs. Pre-crisis almost all of the major banks had capital ratios that were not only well above the Basel II requirements, but also above the proposed Basel III requirements as well***. Rather than push up against the regulatory capital minimum, banks tried to signal credibility by maintaining capital ratios that were often twice as large as legally required. In some cases, banks lobbied their governments for stricter regulations, especially if those could also be applied to their foreign competitors or otherwise shield them from competition. Note that the countries with darker colors above, i.e. those with stricter regulations, are most often middle income countries most in need of signaling credibility.
Obviously this over-compliance didn't do much good in 2008, but that doesn't mean it wasn't happening.
I presented some preliminary research on this at this year's International Studies Association meeting. It's not yet in suitable shape for me to post the paper, or to report any firm conclusions, but one thing I think is fairly clear: popular commentators, and most academics, have been thinking about the relationship between firms' and governments' preferences over regulatory policies in some pretty wrong ways. It isn't just a race to the bottom. There's more going on.
*Created using the wonderful, free Open Heat Map web program. Click for larger image.
**43%, if I remember correctly. And that doesn't include other "pseudo-regulations", like the US' requirement of 10% capital to be considered "well-capitalized" by the FDIC, that operated as de facto requirements.
***At least in terms of capital; leverage and liquidity is another thing entirely.
Wednesday, June 15, 2011
Ryan Avent reports on some research from the SanFran Fed that includes the above figure:
[I]t's clear what was going on; the ECB stood idly by while the periphery overheated because it was making policy with an eye toward the core nations. Now that the peripheral booms over which the ECB presided have collapsed, the central bank is...continuing to pursue a policy that's most appropriate for the core economies.
Now perhaps the ECB thinks it isn't responsible for managing divergent economic cycles within the euro zone. Indeed, the ECB may well be trying to force core nations to take on this responsibility and move toward closer fiscal union. If the ECB is unsuccessful in winning such progress from core governments, however, we shouldn't be surprised if peripheral economies find euro-zone policy intolerable and—eventually—drop out of the system entirely.
For those in the dark, the Taylor Rule is one simple device for determining what monetary policy should be. Krugman makes the appropriate caveat:
So here’s the thing: if you use the output gap Taylor rule that, for the US, corresponds to the unemployment version of the rule used in the SF Fed letter, it surely implies a negative interest rate. In short, the ECB has no business raising rates.
What is true, however, is that the rule might still point to a rate rise for Germany.
So the point is that while the ECB could suffer from a one-size-fits-all problem, the fact is that it isn’t even doing that; it’s tightening when only Germany even arguably needs it.
The deal underlying the foundation of the Euro was that peripheral countries would get a reduction in currency risk and therefore lowered borrowing costs. They would also get access to Europe's biggest markets at a fixed exchange rate. In exchange, they would lose monetary policy autonomy. That worked as long as their economies were growing, but obviously creates problems when the economy contracts. This is classic trilemma politics: fixed exchange rates are fine while there's growth, but monetary policy autonomy becomes more pressing during contractions. It's a lot like the Asian crises in the late 1990s.
Meanwhile, I see that Trichet is defending the eurozone by saying that the US is not an optimal currency area either. This gets said a lot, certainly more often than any definition of which currency area is "optimal" or even what that means, and there is certainly some truth to it. But my definition of what size zone is "optimal" would be something like: "As large as is politically feasible, as long as there is a fiscal adjustment mechanism included". In other words, I don't think size of area is the real problem. It's about the political organization of the area, and what other institutions come along with the currency.
Tuesday, June 14, 2011
However on one key issue the Bank of England’s FPC [Financial Policy Committee] appears to fall short. The potential trade-offs between monetary policy and financial stability are not addressed. In an opinion piece today, the former Bank of England Monetary Policy Committee [MPC] member Sushi Wadwhani has highlighted the dilemma.For example, suppose we have an emerging house price bubble and the FPC increases capital requirements which, through widening lending margins, slow the economy, and this leads the MPC to expect inflation to undershoot the target over the next two years. Under the proposed structure, it is envisaged that the MPC would lower interest rates in order to keep inflation at target. If so, would this not largely offset the actions of the FPC and keep the house price boom going?
The BIS report concedes that the short-term interests of monetary policy and financial stability policy may occasionally diverge. Mr Wadwhani argues this means a single committee should be responsible for both monetary policy and financial stability. While BIS accepts that would facilitate coordination and force policy makers to confront the trade-offs at stake, it concludes that responsibility for the two policies can be separated, as long as it is clear which takes priority.
What does this mean? In England, the the Monetary Policy Committee is tasked with conducting a monetary policy that will keep the economy on a path of steady growth with low and stable inflation. The Financial Policy Committee is tasked with maintaining financial stability. But there is an important tradeoff between monetary policy goals, which are counter-cyclical, and financial regulatory goals, which are pro-cyclical. Having two separate institutions pursuing opposite goals can be self-defeating, which is why Sushi Wadwhani suggests having a single institution responsible for both. And the BIS seems to agree:
The logic for central bank involvement is well established. The financial crisis showed that central banks are ultimately lenders of last resort to the financial system, and so should pay proper attention to its overall health. Moreover central banks’ primary policy mandate, monetary policy, has a strong influence on financial stability; think quantitative easing today, or the consistently low interest rates in America that encouraged a bubble in real estate prices in the 2000s.
The BIS wants all central banks to be given legal responsibility for financial stability, arguing that macroprudential regulation requires the same autonomy as monetary policy. ...
For now though, the direction of travel is clearly towards legally defined responsibilities for financial stability and the centralisation of power within central banks. Unusually that points towards emerging market structures, rather than American or European ones.
So the BIS wants a single institution -- the central bank -- to be responsible for both monetary policy and financial stability. It acknowledges the tradeoff between the two, but does not specify how that tradeoff is likely to be resolved. Note the bolded portions above. But what are appropriate ways to resolve the tradeoff? How do we make it "clear which [goal] takes priority"? Which goal should take priority?
I've argued in my research (currently under review and previously discussed here), building off of prior work by Copelovitch and Singer, that the tradeoff is resolved by central banks that also regulate in a way that the BIS might find perverse: by privileging banks' interest. Copelovitch and Singer find that regulatory central banks allow higher inflation -- i.e. more access for banks to cheap funds, which then fuels economic expansions -- than nonregulatory central banks. I extend that by arguing that banks respond to this policy dynamic by acting more riskily when regulated by central banks, because they believe that they'll have access to those funds in times of need. I call this "monetary moral hazard", distinct from the fiscal bailout moral hazard involved with TBTF firms, and support for such a relationship shows up in the data.
In other words, the BIS (and Bank of England) are correct that there is an important tradeoff between macroeconomic management and financial stability. But resolving that tradeoff by locating regulatory authority in central banks resolves the tradeoff in a way that may not promote financial stability, instead creating monetary moral hazard. One possible way to get around this dynamic (that I do not explore in the paper) is via much stricter statutory regulations by removing discretion from regulators, which is more or less the opposite of what the BIS is proposing. Many in England and elsewhere have called for stricter laws along these lines, and while the international Basel III agreement has taken a step in that direction, it's not a very large one.
Monday, June 13, 2011
To spell it out, Egypt and Belarus are both looking for around US$3 billion. Egypt gets it with an explicit deferment of structural reforms as long as there is an “action plan.” Belarus will have to do reforms before there’s a loan. Does anyone else see a political version of moral hazard here?
For more on this dynamic, see this excellent book by Grigore Pop-Eleches. The "Arab Spring" may end up as an out-of-sample test of his central hypotheses. For the US's role in conditioning the IMF's behavior, see this by Thacker, this by Oatley/Yackee, and much of James Vreeland's career.
I don't have too much worry of a moral hazard here, since it didn't very well serve Mubarak's interests to hang on for the best possible IMF deal.
As of tomorrow, June 14th (Flag Day?), the cyber hacktivist group Anonymous is beginning "Operation Empire State Rebellion". The goal: take down Bernanke, and who knows what else. The purpose: I'm not sure. Justice? Apparently Bernanke has given trillions of "taxpayer" dollars to bankers and other wealthy people, despite not actually possessing that ability. He also stands accused of not prosecuting bankers for the economic crisis, which he also does not have the ability to do. Bernanke has "devalued" the dollar, and just you nevermind for now that that is good for the unemployed and less good for the asset owners. (Indeed, progressives now call for more inflation and more devaluation of the dollar, while the wealthy call for less of both.) I don't know how replacing Bernanke, or destroying the banking system, is supposed to help the common man -- that's not why we call the 1930s depression "Great" -- but who cares? Let's smash some shit up.
Also making an appearance: our old friends the global banking cabal, which controls everything all the time. I was waiting for a more explicit reference to Jews, but (thankfully) it didn't quite sink to that level. And the Freemasons haven't shown up yet, either. But just you wait.
The conspiracies revolving around the Federal Reserve are not new of course. And there's certainly been a resurgence in recent years. There are elements both in the Tea Party movement (influenced by Ron Paul), and in the anti-corporatist/neo-anarchist sentiment that Anonymous is tapping into. A decent segment of the college-aged population has been exposed to Zeitgeist, which melded Christ-myth and 9/11 "trutherism" with old-fashioned bankers-run-everything to explain how the "one world government" will soon take over everything, and unfortunately many find it at least somewhat persuasive.
In belittling Anonymous and Zeitgeist I do not mean to say that monetary policy doesn't have important distributional implications, or that politics doesn't matter, or even that bankers don't have disproportional effect over politics. Regular readers will know that those are not my views. But unfortunately reality is not as simple as "the Fed gives away our tax dollars to international bankers". Policy has real tradeoffs, which should be debated and judged by an informed populace. But this type of conspiratorial propaganda obfuscates more than it enlightens.
So it will be interesting to see what Anonymous is able to do to disrupt the Fed. It has threatened the IMF, although the recently-disclosed attack appears to have come from another group, and clearly has geopolitical intentions. But let's hope, for the sake of the very people Anonymous purports to be defending, that they fail.
Friday, June 10, 2011
Russ Roberts interviews Barry Eichengreen. Audio here, both streaming and MP3. I haven't listened to it yet, but I will soon.
Tyler Cowen writes a new preface for the pulp-and-glue TGS, and quotes this bit:
The original publication of The Great Stagnation was in eBook form only, and I meant for that to reflect an argument of the book itself: The contemporary world has plenty of innovations, but most of them do not benefit the average household. After all, the average household does not own an eReader. It’s not even clear whether the average household buys and reads books. So I viewed the exclusive electronic publication, somewhat impishly, as an act of self-reference to the underlying problem itself. It was therefore a bit amusing when some critics suggested that the new medium of the eBook itself refuted the book’s stagnation theory—quite the contrary.
I obviously can't judge what Cowen's intentions were, but how many strange arguments are in this paragraph? First, when has the publication of any book ever benefitted the average household in the macroeconomic sense he's talking about? Publishing has been about superstar economics since Gutenberg. But if we're talking about information access, it's inarguable that the average household is way better off than it was in 1890 or 1973. Which fact does not support Cowen's thesis.
Does Cowen remember hearing about an obscure book or music album when he was a boy, and not being able to get it because the local shop didn't carry it? I do, and I'm quite a bit younger than him so I'm sure he does as well. Maybe there was mail-order, but that would take weeks and involve getting a cashier's check or a money order and mailing it off, with hope that you weren't being gypped. That world doesn't exist anymore. That is a good thing. No it hasn't added many high marginal product jobs, but the previous scarcity didn't add many either.
Second, maybe the average/median person does not have an eBook reader, but that's their own fault. eBook readers are literally free, once the hardware is obtained. The average/median person in America has a computer, tablet, smart phone, and/or ready access to one of those devices*. The eBook software on all of those devices is free. If they aren't reading, it's not because of Stagnation. It's because of taste.
Third, why is all this amusing? Tyler Cowen would be practically anonymous were it not for the innovations he now says are mostly inconsequential. Through those innovations he has a famous blog, a NYTimes op-ed column, a notable economics textbook, a book deal with a mainstream press, etc.
I certainly don't begrudge him any of those things... I'm a big fan. I never would have heard of Cowen were it not for 21st century technology, but through new media I've gained access to Cowen in a way I never would have before. Cowen is one of the lower-case superstars in a superstarish economy. He's been able to market himself and his skills because of the very technological innovations that he argues aren't terribly important. Without them, he wouldn't have the forum to make his argument. So the publication history of TGS is just an extension of Cowen's career to this point.
So yes, it is ironic. He can't shrug it off that easily.
*Note I didn't say everyone had access to them, just the mean/median person, who is probably the same person for these purposes.
What lies behind this trans-Atlantic policy paralysis? I’m increasingly convinced that it’s a response to interest-group pressure. Consciously or not, policy makers are catering almost exclusively to the interests of rentiers — those who derive lots of income from assets, who lent large sums of money in the past, often unwisely, but are now being protected from loss at everyone else’s expense. ...
No, the only real beneficiaries of Pain Caucus policies (aside from the Chinese government) are the rentiers: bankers and wealthy individuals with lots of bonds in their portfolios.
And that explains why creditor interests bulk so large in policy; not only is this the class that makes big campaign contributions, it’s the class that has personal access to policy makers — many of whom go to work for these people when they exit government through the revolving door. The process of influence doesn’t have to involve raw corruption (although that happens, too). All it requires is the tendency to assume that what’s good for the people you hang out with, the people who seem so impressive in meetings — hey, they’re rich, they’re smart, and they have great tailors — must be good for the economy as a whole.
Krugman a few weeks ago (emphasis added):
The past three years have been a disaster for most Western economies. The United States has mass long-term unemployment for the first time since the 1930s. Meanwhile, Europe’s single currency is coming apart at the seams. How did it all go so wrong?
Well, what I’ve been hearing with growing frequency from members of the policy elite — self-appointed wise men, officials, and pundits in good standing — is the claim that it’s mostly the public’s fault. The idea is that we got into this mess because voters wanted something for nothing, and weak-minded politicians catered to the electorate’s foolishness. ...
The fact is that what we’re experiencing right now is a top-down disaster. The policies that got us into this mess weren’t responses to public demand. They were, with few exceptions, policies championed by small groups of influential people — in many cases, the same people now lecturing the rest of us on the need to get serious. And by trying to shift the blame to the general populace, elites are ducking some much-needed reflection on their own catastrophic mistakes.
Note that the italicized portion leaves interest groups out of it; that column was attacking elite ideology rather than interest groups. I like the more recent Krugman better, for reasons I've already described. What was missing from the older Krugman was just this sort of interest group political story. Leaving them out of the story in the way older Krugman did before is thus missing a huge element. Interest groups come in all shapes and sizes, but right now the policy space does appear to be fairly strongly skewed in favor of creditors rather than debtors. There is a way to link the two Krugmans -- interest groups influence the elite via lobbying and contributions -- but in that case elites are merely an intervening variable, rather than the primary causal variable. The more recent Krugman is honing in on the fundamental cause.
I think the more recent Krugman probably overstates the case a bit, but it's an op-ed not a long-form essay so that's understandable. Anyway, I'm happy influential folks are starting to think and write in these terms. It's not too often that this kind of overt political economy is on the NYTimes op-ed page.
Thursday, June 9, 2011
An unprecedented alliance of organizations from the real estate industry, new home builders, mortgage companies, banks, civil rights groups and other lobbyists have descended on Washington, D.C. lawmakers to push against legislation that would require 20% down payments for a mortgage.
The Qualified Residential Mortgage “QRM” proposal would limit the number of home buyers qualified to make a purchase, require higher credit scores and send mortgage underwriting back more than 30 years. Members of Congress are struggling to reach a balance to provide new regulations for home mortgages, implement financial reform legislation and provide realistic reforms on home mortgages. ...
“The Qualified Residential Mortgage (QRM) will define who will and who will not get the most affordable mortgage products, potentially prohibiting a significant segment of qualified borrowers from being able to achieve homeownership,” said Mortgage Bankers CEO David H. Stevens. “Allowing more time for comment will enable us to prepare a more thoughtful and comprehensive analysis and response.” ...
Groups from both major political parties wrote to the six federal agencies last week implementing mortgage changes, which are the SEC, FDIC, HUD, the Office of the Comptroller of the Currency, the Federal housing Finance Agency and the Federal Reserve to urge them to focus of “sound underwriting, safe loans,” mortgage borrowers’ ability to repay loans and fully documented loans, and not to require larger down payments as they work on regulations to improve the mortgage finance system.
When major elements of both political parties line up with citizens' groups, finance, and a major industry (construction) on the same side of a policy, is it any wonder that policy gets pushed in that direction? This was what I was driving at in my previous posts on housing politics and the blame game.
Via Arnold Kling, who says that part of this is wrong: this is anything but "unprecedented"; it's been the same political dynamic for the past 20 years (some of which Kling observed directly, working at the Fed and Freddie Mac).
Wednesday, June 8, 2011
Daniel Davies and Alex Tabarrok objected to the graphs of GDP I included in this post on The Great Stagnation. Specifically, they didn't like the fact that the hypothetical lines I drew reflect constant linear growth rather than constant percentage growth. I.e., I didn't compound the growth when i drew those lines. They're right that the latter is a better measure of trend (it's what is used in almost all statistical analyses), so here's a new graph that takes that into consideration.
This graph shows the actual GDP per capita growth (circles) for the US, OECD, and entire world. The lines that begin in 1974 reflect what GDP per capita would look like if it had continued to grow at the 1960-1973 rate*. Note that a "Great Stagnation" hypothesis would expect significantly weaker growth post-1973, not the same amount and certainly not more. So the fact that the US was above the trend line until the early 2000s provides fairly strong evidence that if we're in a Great Stagnation it's more recent than Cowen argues, and doesn't correlate with stagnating median incomes all that well. In fact, the US does better than either the OECD or the globe, if "better" is defined as "closest to 1960-1973 trend", although the OECD trend line is quite a bit steeper**.
Anyway, just wanted to make sure I didn't leave the impression that my main point (about distribution) relies on faulty extrapolation.
*Specifically, I regressed a year counter on the log of GDP per capita (constant dollars, via WDI) from 1960-1973. The coefficient estimate represents the average growth in GDP per capita per year during that period. I then took that coefficient estimate and added it to 1973's GDP per capita to get 1974's predicted point, added the same constant to the predicted 1974 to get the predicted 1975, and so on.
**Of course the US is a big part of both OECD and world economies; if you removed the US from those groups the US would likely look still better in comparison. Although in the OECD's case, they added some countries during the series (e.g. Mexico, Slovakia) with lower per capita GDP than more established industrialized countries.
"The trade war between China and Europe will not break out over manufacturing industry, customs duties, dumping or the yuan exchange rate, but on a front that no one expected: in the sky," writes La Stampa, in the wake of a threat voiced by the Beijing representative at the IATA (International Air Transport Association) Conference to simply close Chinese air space "if the EU, as it has already decided, introduces an emissions tax on all intercontinental flights leaving the EU on 1st January." The European Commission plans to grant a "license to pollute" similar to those already esablished for other industrial sectors to every airline operating in Europe, explains Le Monde: 82% of emissions rights will be free, but a 18% will have to be purchased on "carbon credits market."
My understanding is that so long as the EU rules are applied non-discriminatorily, such an emissions tax is WTO-legal.
There's been some good discussion of this report by Robert Kuttner, explaining the political battle between creditors and debtors. Kuttner starts off:
Economic history is filled with bouts of financial euphoria followed by painful mornings after. When nations awake saddled with debts incurred to finance wars, episodes of failed speculation, or grand projects that haven’t paid off, they have two choices. Either the creditor class prevails at the expense of everyone else, or governments find ways to reduce the debt burden so that the productive power of the economy can recover.
Creditors—the rentier class in classic usage—are usually the wealthy and the powerful. Debtors, almost by definition, have scant resources or power. The “money issue” of 19th century America, about whether credit would be cheap or dear, was also a battle between growth and austerity.
These issues are treated as either impossibly technical or as non-debatable. They are neither. We need to democratize the money issue once again.
I like this framing because it moves us past lax psychological explanations ("pain caucus"), willful ignorance ("economists have unlearned what Say and Mill knew"), and hard-money/anti-debtor moralizing. It gets us to what's really important, which is the political dynamic of creditor-debtor relations, and the fact that different groups have different preferences over policies which are motivated by their interests. In other words, we're talking about political economy, which I obviously think is a step in the right direction. As I argued in my anti-econ rant from a few weeks back, talking about optimal policy makes little sense when you start from the assumption that there is not optimal policy; that policy is about distribution.
And there's a lot of research in IPE and CPE linking governments controlled by left parties to higher inflation, indicating that interest-based explanations work pretty well*. See, eg, this classic 1977 study by Hibbs, and this article by Franzese on how central bank independence is a myth. There's a lot of stuff since then too (see cites on the first page of this article on trade by Milner and Judkins).
I don’t mean to suggest that it’s all cynical; my experience is that there are relatively few people who consciously keep a secret set of intellectual books, who preach Neanderthal goldbuggism because it’s in their interests while rereading Keynes by dead of night to figure out what’s really happening. Instead, people generally manage to believe whatever is in their interests. ...
Still, thinking of what’s happening as the rule of rentiers, who are getting their interests served at the expense of the real economy, helps make sense of the situation.
In a follow-up, he took a rough cut at figuring out who belongs in which group. Yglesias notes that older people, who are out of the labor market, have fewer debts, and have more financial assets that could lose value via inflation, are another interested group. And, of course, older Americans tend to vote more often than younger votes.
Steve Randy Waldman picked up on the financial political economy angle:
Banks, after all, are not only creditors. They are also the economy’s biggest debtors. In theory, bank loyalties ought to be mixed. On the one hand, banks prefer deflationary, zero-forgiveness tight-money policies, to maximize the real value of their assets and of the lending spread from which they draw profits and bonuses. On the other hand, troubled banks are very happy to support loose money and expansionary policy, even at risk of inflation. For bank managers and shareholders, it is bad to have the value of past loans eroded by inflation. But it is much worse to lose their franchises entirely, to have their wealth, prestige, and freedom put at risk in the aftermath of an explicit bank failure. When banks are in trouble, they are perfectly happy to support all manner of expansionary policy, as long as short-term interest rates are kept low. Even a broad-based inflation helps troubled banks twice over, by increasing borrowers incomes and by steepening the yield curve. Increased incomes ensure that loans will be repaid in nominal terms, preventing insolvency due to credit losses. A steep yield curve permits banks to recapitalize themselves via maturity transformation, using deposits to purchase Treasury notes while the central bank promises to hold short rates low for a few years.
But banks’ interests are aligned with those of debtors only to the degree that banks, like debtors, are at risk of real insolvency. When we committed to a policy of “no more Lehmans”, when we made clear via TARP and TGLP and the Fed’s alphabet soup that big banks would have funding on demand and on easy terms, when we modified accounting standards to eliminate the risk that bad loans on the books would translate to failures, when we funded their recapitalization on the sly, we changed banks. We transformed them from nervous debtors into pure rentiers, who see a lot more upside in squeezing borrowers than in eliminating a crippling debt overhang. And since banks are, shall we say, not entirely disenfranchised among policymakers, we increased the difficulty of making policy that includes accommodations between creditors and debtors, accommodations that permit the economy to move forward rather than stare back over its shoulder, nervously and greedily, at a gigantic pile of old debt.
This dynamic is part of what drives the results I found in this paper, discussed here and here, except I added in politics of central banking and regulation as well. One implication is that regulatory central banks essentially have no choice but to provide easy money to banks during downturns. Banks know they'll have access to these funds when needed, so they act more riskily during booms. It's monetary moral hazard**. In other words, I believe this same rentier/debtor politics can make financial crises more likely.
There is another element to this. Increased inflation in the US will narrow the real exchange rate adjustment that is boosting American competitiveness relative to exporting countries like China. To the extent that we want to boost employment through exporting, increased inflation could prolong that process. And if the problem is not just immediate unemployment, but medium-run global rebalancing, then it might not be as simple as "poor want inflation, rich want deflation".
This political cleavage is what the current austerity/stimulus battles are about, in both Europe and the US. I previously surveyed some of the IPE literature on this question, discussing its findings in relation to the eurozone, here.
*Sometimes these are phrased in terms of resolving the Phillips curve tradeoff in one direction or the other. More recent econ work has questioned the validity of the Phillips curve, but that doesn't necessarily imply that the perceived politics changes. This isn't my area of substantive expertise, and I understand that there's a bit of controversy in the comparative literature, but I believe the implications for monetary politics hold up pretty well.
**Note that we haven't seen the ECB behave this way, at least not on the level of the Fed, which is why the political battles in Europe are over fiscal transfers.
See Daniel Davies' comments on my original post, plus this from Whelan at IIEA and this from Storbeck. Via Felix Salmon, who also had this to say.
The upshot is that this appears not to be the stealth bailout that I thought it was, although I have to admit that at this point I'm confused on a few points and will need a bit of time to sort through it all. Also, even if this isn't a stealth bailout I think that's probably a shame. The monetary authorities can do much more to help the Europeriphery, while the fiscal authorities are out of political bullets. So I'd rather have some clandestine bailouts than not.
Tuesday, June 7, 2011
If the global economy has been growing reasonably well over the last six months it is because what Nouriel Roubini once called a “wall of liquidity” is seeping out of the United States, where solvent domestic demand for credit is flat and will remain flat due to the private indebtedness problem (remember US “over consumption” (the high proportion of GDP which has been consumption driven) has only been the mirror image of Chinese “over investment” and we that live in a world which badly needs to rebalance).
This “wall of liquidity” has been force feeding strong growth in a number of key emerging markets, and this growth has been generating strong demand for exports from a number of developed economies, and most particularly from Germany. Thus the German boom is no mystery, and has been intimately tied to the implementation of QE2 in the US. Note, in the chart below, how the German manufacturing PMI was slowing in the summer of 2010, how it surged in the autumn (QE2) and how it is now swooning again. There is no mystery to these “soft spots”, all you need to ask yourself is where the demand is coming from. ...
Maybe it seems peculiar to be arguing that policy in the Federal Reserve should be partially conditioned by policy failures in countries like Italy, Spain and Greece, but such is the nature of the inter-connected world we live in.
This is Kindleberger's Decession Politics.
Francis Fukuyama has what looks like a Big, Important book out by that title, but I haven't seen much discussion. He was on Colbert, and Cowen got to it, but little from political scientists. Too soon?
Tyler Cowen's The Great Stagnation has gotten a lot of attention for both its form and content. (I.e., there's more than a little irony in the fact that a book alleging that technological progress has markedly slowed was the first notable electronic-only book, although it has since been released in pulp-and-glue as well.) In the video above he presents his main thesis at TEDxEast. For those unaware, the argument runs basically like this: since 1973 or thereabouts, there has been a slowdown in median American income growth, and that trend has increased in the past decade. That slowdown is mostly attributable to a decline in technological innovation. We've reaped the gains of past innovations -- cars, planes, electricity, plumbing -- but haven't made many new ones. We tweak the old innovations to our advantage -- we've made cars safer and added GPS -- but those are marginal improvements, not fundamental advances. The exception is the internet and communications more generally, but while those improve quality of life they do little to improve typical incomes.
Cowen's argument has bothered me on a number of levels. First, I think he understates the real, and monetary, value of the internet and improved communications technology for standards of living. Second, I think he makes a mistake by looking almost entirely at the U.S., and almost entirely at median income. I want to focus on the second of these, placing it in the context of the first.
I'm really late to this party... Cowen's book has been covered by everyone in the blogosphere and almost everyone in the corporate press, so I'm sure someone has written more or less exactly what I'm about to write, but I've haven't seen it in quite this form before. So to see why I think Cowen's thesis is wrong, or at least incomplete, let's start with some global data.
This graph shows global real gdp per capita from 1960-2009 (blue line). I've highlighted 1973's income level -- $1,148 -- to show what the world looked like around the time that Cowen thinks the Great Stagnation started in the US. In the following 35 years, per-person income increased by nearly 800%. If the pre-1973 trend had continued (red line), that number would be more than halved. If growth post-1973 had stagnated, we'd be below the red line. But that didn't happen, as we can see from this series. First, global growth in the 1970s was faster than in the 1960s. And while that trend wasn't consistent through the 1980s and 1990s (dark green line), global GDP growth in the 2000s was the fastest during the period. In fact, by the end of the decade we'd caught back up to where we'd be if the 1970s trend had been consistent, before the financial crisis knocked us back a bit. But the story here is of pretty rapid growth on a global scale that actually accelerated in the most recent decade. No Great Stagnation, on a global level at least.
Cowen agrees that global growth has been strong as other countries adopt the innovations the U.S. has already exploited. This "catch-up" growth may be fine for developing countries, which have a lot of low-hanging fruit, but he wants to focus on those at the edge of the technology frontier, especially the US. So let's look at what's happened to US growth over the same period.
The green line represents approximately where US incomes would be if we had stayed at the pre-1973 rate of growth. Average incomes would be less than half what they are now. If the economy had stagnated, as Cowen claims, average incomes would be below the green line. Instead, the rate of US growth actually increased over that period, at a more rapid pace even than the increase in global growth depicted in the first graph. This doesn't look like stagnation at all, much less a Great Stagnation. So what is Cowen going on about?
Ah, the picture looks a bit different if you compare mean GDP/capita to median GDP/capita. Before 1973 the two tracked each other very closely. Post-1973, mean GDP/capita (the white circles) kept growing at roughly the pre-1973 trend rate, while median GDP/capita (black diamonds) stagnated. But the economy overall did not. Just median incomes. That indicates, to me, that Cowen's preferred causal mechanism -- a stagnation due to slowdown in innovation -- is missing what's actually happened. There's been enough growth, it just hasn't gone to the median earner. The result has been higher inequality.
Why has that happened? Theories abound. Some political scientists have recently made the case that rising inequality is a result of wealthy groups hijacking politics for their own economic benefit. In other words, the distribution of growth is zero-sum, and it's been redistributed towards the wealthy in the form of tax cuts, decline in union membership, erosion of the welfare state, and deregulation. I think there's something to that, but I think it's too focused on developments specific to the US. To get the whole picture, I think we need to situate the US in a global context.
It's difficult to find reliable estimates of global median income in a time series (in fact I couldn't... pointers welcome), but indications are that inequality is increasing within many countries, and across them as well. This is also not consistent with Cowen's argument, since the movement towards the technology frontier in the US was associated with rising median income, not rising inequality. If that's the process that rapidly-growing economies like China and India are in, then we should see less inequality, not more. And if the Great Stagnation is something that afflict the US specifically, we might expect the gap between the US and the rest of the world to narrow, not widen.
So I think a more nuanced theory is needed. Specifically, we need to be able to explain two things: stagnating median, but not mean, incomes; global, not just local, trends. So what do we know about the major ways in which the global economy has changed over the past 40 years? I think three things are most relevant:
1. The global economy has become more integrated. This is partially due to politics, as more countries opened their economies to trade and investment. Average tariff rates have fallen dramatically during the GATT/WTO tenure. Capital accounts have been opened by many countries. Additionally, technological improvements have lowered transaction costs. International trade and investment have increased dramatically as a result. The consequence of this movement is a larger (global) market with more middle- and high-income consumers, and increased competition in production. This leads to point #2.
2. The US's post-WWII advantage was conducive to broad-based growth. The US share of global manufacturing was nearly 50% immediately after the war. The other industrialized economies were mostly decimated by the war, and many countries had not yet industrialized. For an American worker during this period, a high marginal product (relative to a foreign worker) did not require large amounts of human capital. Relatively low-skilled workers could mix with (non-human) capital in fairly lucrative ways. In a sense, the median American worker was able to collect rents from the rest of the world from 1945-1973, because the de-industrialization in Europe and pre-industrialization in much of the rest of the world operated as barriers to competition. By the early 1970s those advantages had waned, and trade agreements made it difficult for the US to protect domestic workers. The increased competition from workers in Europe and the Asian NICs (which shifted to export-biased development in the 1960s-70s) led to the US's share of global manufacturing output to fall to 20-25% by 1973, where it has stayed more or less ever since. This hit high-wage/less-skilled workers in tradable industries the hardest, since those were the workers that would face international competition directly. It isn't surprising that incomes would stagnate as those "rents", born of circumstance, are competed away.
3. These same processes benefit high-skilled workers with lots of human capital, as did the technological improvements, particularly in information technology and communications. The rise of the rest has increased the market into which they can sell their labor (demand curve shifts right), but the high skills required to compete with them provide a continuing barrier to entry (supply curve sticks). Compensation for those high-skill workers (and innovators) goes up, but is stuck for everyone else. We get a weak version of "superstar economics", where the highly-skilled are able exploit lower transaction costs to sell into an ever-enlarging global market, while the lower-skilled face increased competition. It's a two-track economy.
Cowen dismisses globalization-rooted theories of the Great Stagnation (around minute 12 in the video above), but (to my knowledge) he hasn't dealt with the sort of mechanisms I'm discussing in any kind of detail. Somewhat bizarrely, Cowen also claims that modern innovations (the internet, satellite-based telephones) have not contributed to GDP very much. But then how to explain how GDP growth, and total worker productivity, have increased post-1973 at the same rate as pre-1973? Median incomes have stagnated because those innovations, unlike previous innovations in manufacturing, do not require the mobilization of huge numbers of workers to increase output. A few computer programmers or financiers can create generate output on their own.
There's another aspect to this that I think Cowen has missed. Increased inequality and a move to a superstarish economy should create more of an incentive for innovation, not less. And while Cowen complains that scientists are no longer heralded by society as they once were, innovators most definitely are. We make movies about them and their social networks, and then give awards to the movies. We make them the richest people in the world. And, contra Cowen, we have seen a lot of innovation in the past 35 years. Cowen focuses on innovations in two major areas that led to the pre-Stagnation growth: transportation and energy. He may be correct that innovation in transportation has declined, although the rise in high-speed rail (outside the US) might be one counterpoint), but part of that is because innovations in communication and information technology has made transportation less necessary. In terms of energy, there have been more breakthroughs in new energy sources from 1980-now than there was from 1945-1973.
There's more I could discuss, but this is long enough. So in short: I do not see a world economy that has stagnated overall. I don't even see a US economy (pre-2008) that has stagnated. I see a redistribution from a certain class of American workers to workers with similar skills in other countries, and to workers with very high skills in the US that can market those skills to a global economy. This doesn't have to be a bad thing, if the government can respond by encouraging innovation by high-skilled workers, and even encourage a lot of compensation for them, but provide for the rest with a fairly robust safety net. And, in fact, the major political cleavages of the present focus on precisely these issues. The political battles aren't about stagnation, but about distribution.
UPDATE: A few folks thought the graphs above are misleading, and they've got a point. So rather than just draw some lines in Powerpoint, I did a more reasonable comparison here. It doesn't change the substantive conclusion of this post, but it was worth doing.
I watched the HBO adaptation of Andrew Ross Sorkin's book last night, and I liked it quite a bit. I'm predisposed to like it, having both read the book and followed the news at the time and since then. The story is well done and accurate, the film itself is very well made. The cast is phenomenal and the acting delivers on that promise.
There isn't a whole lot of overt politics in it, but politics is like a fog hanging over everything in the story. Government actors routinely feel constrained by democratic politics, and end up being all but forced to make decisions that they despise. Politicians try to use the crisis for electoral gain. Private sector actors try to collect as many rents as they can, and in the end some of them get quite a lot, while others get nearly none. The movie is pessimistic in general.
Hank Poulsen (excellently played by William Hurt) is portrayed as something of a tortured saint overcome by events. Somewhat odd, given both his rough real-life demeanor and his involvement in the excesses that culminated in the financial crisis, but I believe the portrayal of his moral judgment is true to life. Anyway, William Hurt probably can't play anything but a noble figure -- at one point an aide tells him to get some sleep, as he looks worn down; except he doesn't -- but there is perhaps some nobility in the way Poulsen abandoned his guiding principles when events changed. I guess that's a matter of opinion.
Geithner (Billy Crudup) is a crass-talking pragmatist who seems to have no ideology at all, other than "don't let this blow up". Bernanke (Paul Giamatti) pops in from time to time to remind everyone of the gravity of the situation for the entire economy, not just their firms. I have no idea if the rest of the cast -- notables include Fuld (James Woods), Dimon (Bill Pullman), Blankfein (Evan Handler), Thain (Matthew Modine), Mack (Tony "Monk" Shalhoub), Buffett (Ed Asner), plus Topher Grace and Cynthia Nixon as Treasury Dept officials -- match their characters well or poorly, but the overall ensemble works very well. The dialogue and plot move quickly, and I fear that viewers without a fairly strong base of prior knowledge will have difficulty following what's happening. There are a few moments when characters (semi-awkwardly) try to break down what's going on for a slow-on-the-uptake staffer or Congressperson, but it's fairly clearly for the benefit of the audience. That's fine; those instances are few and brief and necessary.
Most of all, one gets the same sense from the film as from the book: nobody understood just what they were up against. Every CEO thought his (they were/are all men) firm was stronger than it was. Every regulator had no idea what was going on in those firms. Nobody understood how susceptible they were to a run. Nobody seemed to be aware of how reliant they all were on AIG, and how fragile AIG was. When Poulsen gets on his knees before Nancy Pelosi (a true anecdote), it's hard to tell whether he's asking for help or to be put out of his misery.
The story is about ignorance, throughout the financial sector and indeed the broader economy. And when things go wrong, the ignorant panic. And when panic sets in, the game's up. It's a confidence game.
The parts of the movie that fall the flattest are the ones that try to "humanize" some of the characters. Poulsen agonizing to his wife. Buffett entertaining his grandkids. Fuld cursing the gods (over and over). There isn't very much of that, but the film could still do with less. Other than those minor distractions, I liked it quite a lot.
Monday, June 6, 2011
Jon Western goes to China, and comes away impressed. Not impressed with China's improvements, although that too, but with its challenges. In a way, they are the same problems the US faces, but magnified:
1. ... In many ways, America's challenges with the future of Social Security pale in comparison to what China faces in the coming decades...
2. ... This has led to rising inequality in housing consumption as well as a new homeless population. Furthermore, while the financial industry is largely protected because of strict regulations and high downpayment requriements (a problem that ironically exacerbates the challenges to reduce domestic savings rates and jump start domestic consumption among young males), the housing prices -- especially in urban cities -- are at all-time speculative highs and many analysts now anticipate major price corrections that could well send significant shock waves through the economy. ...
3. Though China's domestic industry has grown more competitive throughout the world, there is some question about the degree and magnitude of technology upgrades in its domestic industries -- a key requirement for future development and growth. ...
For us IR scholars, we tend to focus on the data points that suggest American decline -- the US budget deficit, its military over-commitments, and the dysfunctional national politics and such. Yet, if we look closer at the internal issues within China, despite its impressive levels of economic growth over the past two decades, it's not at all clear that we are on the verge of some kind of global power transition -- at least not any time soon.
We've sounded similar notes before here, and I think it is important to remind people that growth is a long, uneven process. Over the past three decades China has shown a lot of resilience and agility, but the challenges continue to mount. I'm not a China doomsayer -- I think they'll continue to grow and modernize -- but it won't necessarily be at a linear pace. And in terms of global power, there is too much space, and too many intervening variables, to be talking in terms of "power transition" yet. China has quite a lot of maturing to do before then.