Is Obama the New Nixon?

So asks Stephen Walt, and he also compares the current president to Carter and Clinton. This is Stephen Walt, so he's mostly talking about security initiatives, but there's a bit of IPE as well. Obviously, we have no reason to think that Obama shares the personal flaws of Clinton or Nixon; the post is purely about policy.

I tend towards Clinton for the obvious reasons: he's come into office following a Republican (Bush) administration, carries a "third way" flavor, has quickly ingratiated himself to other world leaders, has been exceptionally ambitious (but has probably bit off more than he can chew this early in his administration), and seems to have taken a pragmatic/technocratic approach to governance.

Obama is his own man, and parallels are in the eye of the beholder, so I wouldn't want to stretch anything too far. And yeah, this sort of game is kind of pointless, but it's also fun.

Cognitive Dissonance and the Financial Crisis

Good stuff from Niall Ferguson:

For reasons to do with human psychology and the failure of most educational institutions to teach financial history, we are always more amazed when such things happen than we should be. As a result, 9 times out of 10 we overreact. The usual response is to introduce a raft of new laws and regulations designed to prevent the crisis from repeating itself. In the months ahead, the world will reverberate to the sound of stable doors being shut long after the horses have bolted, and history suggests that many of the new measures will do more harm than good. ...

Human beings are as good at devising ex post facto explanations for big disasters as they are bad at anticipating those disasters. It is indeed impressive how rapidly the economists who failed to predict this crisis — or predicted the wrong crisis (a dollar crash) — have been able to produce such a satisfying story about its origins. Yes, it was all the fault of deregulation.

There are just three problems with this story. First, deregulation began quite a while ago (the Depository Institutions Deregulation and Monetary Control Act was passed in 1980). If deregulation is to blame for the recession that began in December 2007, presumably it should also get some of the credit for the intervening growth. Second, the much greater financial regulation of the 1970s failed to prevent the United States from suffering not only double-digit inflation in that decade but also a recession (between 1973 and 1975) every bit as severe and protracted as the one we’re in now. Third, the continental Europeans — who supposedly have much better-regulated financial sectors than the United States — have even worse problems in their banking sector than we do. The German government likes to wag its finger disapprovingly at the “Anglo Saxon” financial model, but last year average bank leverage was four times higher in Germany than in the United States. Schadenfreude will be in order when the German banking crisis strikes.

This reflects one of my greatest fears. Most people know that the stock market indices are down over the past decade. Most people know that we are in a deep and serious recession. Most people (even academics and educated professionals) believe that this is due is "deregulation," although they do not have any knowledge about which specific deregulatory actions are responsible, nor do they have the faintest idea what regulatory changes would have prevented this crisis (or could prevent the next one). Some countries with relatively strict regulatory policies (e.g. India) have done fairly well in this crisis. Others have not. Some pessimistic economists (Roubini and Krugman) famously predicted a recession, but they had the trigger wrong (currency depreciation from mounting debt and trade deficit, rather than banking crisis) and incorrectly predicted recessions for years before this one came (perhaps they deserve credit for continuing to cry wolf until one actually materialized; perhaps not). Some have said that this financial crisis is the fault of the Bush administration and the Republicans, but the same people were not saying the same things during the last financial disruption in the late-1990s... when Clinton was in charge.

Ferguson goes on to say that much of the blame for the crisis can be chalked up to bad regulation (esp. Basel I and II) rather than deregulation. But as Ferguson notes earlier in the piece, "Financial crises will happen," and it's not easy to see in advance what the proximate causes of the next crisis will be. Basel I was a reaction to the exposure of Western banks to the Latin American debt crisis, while Basel II was a reaction to the Asian financial crisis. There is already a strong movement towards international regulatory policy harmonization in response to this crisis. But given recent history, there is little reason to be optimistic that regulators will be capable of preventing the next crisis. If the generals are always busy fighting the last war, how will they succeed in preventing the next one?

So what should be done? In my view, we should accept that financial crises will be a semi-regular feature in our economy, and try to institute regulatory institutions that will minimize the severity and duration of these crises. How to do that? By focusing our regulatory efforts on promoting transparency rather than trying to force banks into behaving well, by making our regulatory efforts counter-cyclical to give flexibility when needed, by limiting moral hazard (esp. the sort that leads to regulatory arbitrage), and by pursuing monetary and macroeconomic policies that lessen boom-and-bust cycles in the financial sector as well as the broader economy.

The last of these may be the most difficult, but also the most critical. The global savings glut and international macroeconomic imbalances had much more to do with the current financial crisis than any regulatory policy. In the future, we should understand that persistent macroeconomic imbalances will eventually correct, one way or the other. A gradual adjustment through the exchange rate mechanism is preferred to financial collapse and crisis. In the future, we should push for more flexible exchange rates, less public debt, and more openness in the financial system. This will not completely eliminate financial crises, but it may make them less severe.

The Risks of the Intertemporal Carry Trade

Back in February, I noted that Obama was engaged in a sort of intertemporal carry trade with the U.S. currency: he was gambling that the money he borrows in the present will be worth more than the money he has to pay back in the future. At the time, this made sense, since he could borrow at interest rates near zero (occasionally even at or below zero), and future inflation expectations were positive. Therefore, the present value of money actually was higher than the (expected) future value. Obama was arbitraging the system, and could have his cake and eat it too; he could spend today, pay back tomorrow, and earn a bit of profit on the side. He was able to do this because nobody wanted to lend to private corporations due to risk, and U.S. government bonds are perceived as being nearly "risk-less".

But there are signs that those days may be over. In March there was a failed bond auction in the U.K., indicating that bond traders were not interested in funding more deficits at rates the British government was willing to pay. Last week, something similar happened in the U.S.: the demand for T-bills was tepid, and investors demanded higher interest rates before buying. Why is this happening? For one, now that the dust has somewhat settled from the financial meltdown, investors are more willing to lend to (some) corporations. This creates competition for investment funds ex ante, which means that the government will have to pay a higher price to get the funds it needs to spend in deficit.

There is another aspect to this, however. Because of Obama's expansive deficits, which according to CBO estimates (see picture above) will still be well over $1tn in 2019, there is a rising fear that the U.S. will have to either default on its debt or inflate it away. In other words, there is a growing risk that the U.S. government debt will stop being considered "risk-free," and investors will demand a risk premium on T-bills. If that happens, then Obama will either have to scale back his spending programs (as Gordon Brown has done), raise taxes on a broader slice of the population than just the top 5%, or both.

Obama's carry trade bet looked like a win-win a few months ago. But that was contingent on demand for T-bills remaining high, keeping yields down, and allowing the government to arbitrage a profit (or very small loss). If that doesn't hold, then the whole thing will blow up in Obama's face, and the consequences for common Americans won't be pleasant either.

As many investors discovered last fall, the risks of carry trading are always the same: you don't want to be holding the potato when the music stops. The costs of unwinding are high.

In Which French Winemakers Act, Well, French

My previous post was about how large agri-business conglomerates capture much of the E.U.'s (and U.S.'s) farm subsidies. But common farmers and vintners get some too. And when you've been capturing rents for generations, being forced to give them up is a bitter pill.

Mr. Jeune, along with most French winemakers, opposes European Union plans to relax strict rules governing the making of rosé, or blush, wines just as they are starting to gain respect — and sales. Currently, red grapes are usually crushed and left to ferment briefly with the skins, the two being separated before the juice colors fully. The E.U. proposal would allow Europeans to simply blend red and white wine to create a pink blend — giving them the freedom to adopt the same, less complex, methods as New World producers.

“If you do this, why not allow people to make wine without any grapes at all?” Mr. Jeune asks, growing steadily more voluble over a glass of his own — “real” — rosé, from grapes grown in Provence. “You could do it in a laboratory, with alcohol, water, artificial flavors.”...

Though the French government seemed to go along with the blending proposal in January, it has since sought to block the measure after a backlash in the countryside. Because of its resistance, a final E.U. vote has just been deferred until June.

In France, a land reliant on agricultural subsidies, tiny producers with distinctive wines have a special place in national affections. Makers of the most exclusive French wines are prospering but, with competition from the New World growing, rosé is a rare midmarket success story — quite something for a product long considered inferior by wine snobs.

Yeah, yeah, I know: this all sounds very quaint. We in America often chuckle at these little squabbles. But these people are serious:

In March, La Baume winery in Languedoc suffered a bomb attack — the second in five years — and a shadowy group opposed to the “industrialization” of winemaking is blamed.

La Baume, a large winery once owned by an Australian company, Hardys, but since bought by a big French producer, Les Grands Chais de France, is seen as a symbolic target.

I suppose the message is clear: "If you don't use redistribution and government supports to protect our noble way of life from competition, then we'll blow you up, Weather Underground-style." Sounds like something Hollywood could work with, but I'd bet the noble French farmer wouldn't care much for that, either.

Speaking of films, Mondovino is a recent (last few years) documentary on the wine industries in Italy and France -- and the pressures they face from burgeoning winemakers in the Americas and elsewhere -- covers these issues very nicely. It focuses on the culture, but gets into some of the politics and economics as well. It is recommended viewing for those interested in agricultural policy, the differences between Americans and Europeans, IPE, and wine. Needless to say, I enjoyed it quite a bit.

Anyway, at least some are willing to put things into perspective:

But Anne Sutra de Germa, who runs a small winery, Domaine Monplézy, and also opposes change, is more optimistic.

“In some ways it’s good to have stupid laws,” she said, “because the consumer who wants good wine will, eventually, find us.”

Touché.

Who Gets E.U. Farm Subsidies?

French chicken farmers, Irish pudding makers, and Italian banks. Not at all the small-time farmer that proponents of farm subsidies often champion.

The U.S. is no better, by the way.

More 'Crisis of Capitalism' Hyperbole

In a recent op-ed, anthropologist David Moberg says that the current economic crisis is proof-positive that the institution of capitalism, and especially the cross-national finance flows that fuel it, need some serious re-thinking:

“Another ideological god has failed,” Financial Times columnist Martin Wolf wrote on March 9, referring to the neoliberalism—deregulation of markets, combined with state support for corporations—that President Ronald Reagan and British Prime Minister Margaret Thatcher first promoted aggressively in the ’80s. “The era of liberalisation contained seeds of its own downfall.”

Former Federal Reserve Chairman Alan Greenspan admitted his fundamental operating assumptions that banks would wisely judge how much risk they could assume had been wrong. Former General Electric Chairman Jack Welch now says that the notion he promoted—that corporations should just focus on shareholder value—is “the dumbest idea in the world.”

The entire contemporary financial system was based on the assumption that financial markets were always efficient and rational. That idea fell off the cliff along with the world economy that it helped to wreck.

The build-up to the conclusion is disingenuous. Greenspan thought that banks would judge risk better than regulators. The banks surely performed badly, but there is little evidence that regulators would have done better. Indeed, the regulators that did exist failed just as badly as the private firms. Additionally, countries with stronger domestic regulators have not necessarily performed better in this crisis than countries with laxer regulatory structures. But this is mostly quibbling.

However the last paragraph cited above is flat wrong. The assumption is absolutely not that markets are always efficient and rational, which is why Alan Greenspan's most famous quote is about "irrational exuberance". On the other side, John Maynard Keynes (of whom Moberg approves) is famous for observing that "markets can remain irrational longer than you can remain solvent". The assumption is that markets are efficient in the long run; indeed, much more efficient than the beliefs of one or a handful of people, including regulators. In the short run there will booms and busts, since information is not perfect and investors are "irrationally exuberant". These bubbles will then crash as investors become "irrationally pessimistic". People still move in packs, and investors are as prone to herd behavior as anyone else.

But in the long run these differences wash out. In the long run, information is perfect, or very near it. In the long run, markets aggregate information better than any other mechanism developed by man. This especially includes regulators. That assumption is what the financial system was based on, and that assumption has not been disproved. This economic downturn, like all economic downturns before it, has not damaged that idea.

Much of the rest of Moberg's essay is remarkable for its blandness: global imbalances certainly contributed to the economic crisis (however, he does not note that these imbalances were primarily caused by illiberal economic policies). He contends that regulatory change is needed, but casts aside proposals by Stiglitz and Rodrick in favor of... "a small tax on financial transactions". He says that we should "us[e] markets, not be used by them". Color me unimpressed. In the end, Moberg's subtitle -- "It is time to rethink capitalism" -- is proved vacuous: Moberg doesn't offer any clear proposals for change, nor any suggestions for what improvements could be made if we did reconsider capitalism.

But of course that's all Moberg can say. He knows that replacing capitalism as the dominant economic paradigm is both impossible and undesirable. Which is why I contend, yet again, that when the chips have fallen and the cards are down, the New Economic Order will look an awful lot like the Old Economic Order.

Pass the Cheese

Happy Day! The U.S. and E.U. have reached an agreement (pending approval by the necessary governments) whereby the U.S. lowers its prohibitive tariffs on Roquefort cheese, Italian mineral water, and other E.U. delicacies in exchange for laxer E.U. prohibitions on American beef. Believe it or not, but this brouhaha has lasted for 13 years, although it was amped up this Winter when Pres. Bush, in one of his last acts in office, hiked up these tariffs to bring the situation to a head (and then pass it off to Obama).

This Is How We Do It

At UNC, this is how we celebrate the end of a semester before we even take our finals. A bit presumptuous? Perhaps. But we prefer to think of it as confidence in the face of danger.

And at least it took place in the library, right?



(ht: KPC)

Hedge Funds Fight Back

Hedge fund manager Cliff Asness has written an open letter to President Obama that has generated quite a lot of discussion in the blogosphere. Asness was apparently put off by Obama's claim that owners of Chrysler's debt should sell that debt to the government at whatever prices the government wishes to pay, and if they do not sell then they are "speculators" who "refuse to sacrifice like everyone else" and who are merely holding on "for the prospect of an unjustified taxpayer-funded bailout". Several of the juicier quotes:

Let’s be clear, it is the job and obligation of all investment managers, including hedge fund managers, to get their clients the most return they can. They are allowed to be charitable with their own money, and many are spectacularly so, but if they give away their clients’ money to share in the “sacrifice”, they are stealing. ...

The President's attempted diktat takes money from bondholders and gives it to a labor union that delivers money and votes for him. Why is he not calling on his party to "sacrifice" some campaign contributions, and votes, for the greater good? Shaking down lenders for the benefit of political donors is recycled corruption and abuse of power. ...

I am ready for my “personalized” tax rate now.

Asness has a right to be angry. Hedge funds have not taken TARP money. Hedge funds are not seeking bailouts, nor would they expect them if they started to go under. Hedge funds are not part of the state bureaucracy, nor do they have obligations to the state, nor to President Obama's preferred interest groups. They have obligations to their clients, and their clients probably want them to get as much of their money back from Chrysler as they can. It is unreasonable for Obama to demand private corporations to act in his own personal political interests. If hedge fund managers did this, and sacrificed their clients money in the process, it would be theft. And if they did it under threats of duress from the government then it would be political cronyism, and possibly criminal.

There's already been some of this strong-arming: the forced axing of GM CEO Rick Wagoner without prior approval of the shareholders; the unilateral ouster of the heads of Fannie Mae and Freddie Mac; the coerced purchase of Merrill Lynch by Bank of America; the attempted punitive, retroactive, "personalized" taxes on AIG bonuses.

It is true that desperate times call for desperate measures. But in our haste to stabilize the financial system we should first guarantee that we leave our legal institutions intact. If we sacrifice one to save the other, we may soon find that we have retained neither. If we are willing to sell off long-standing rights of the debt-holder for temporary political gain, then the government will find itself unable to attract any new "partners" for future recovery efforts (such as the PPIP program).

We all want to help suffering autoworkers, but the Robin Hood model is unsustainable. Especially when the redistributor is King John.

We Can't Stop Carbon Emissions

So says Peter Huber:

We no longer control the demand for carbon, either. The 5 billion poor—the other 80 percent—are already the main problem, not us. Collectively, they emit 20 percent more greenhouse gas than we do. We burn a lot more carbon individually, but they have a lot more children. Their fecundity has eclipsed our gluttony, and the gap is now widening fast. China, not the United States, is now the planet’s largest emitter. Brazil, India, Indonesia, South Africa, and others are in hot pursuit. And these countries have all made it clear that they aren’t interested in spending what money they have on low-carb diets. ...

The grand theory for how the developed world can unilaterally save the planet seems to run like this. We buy time for the planet by rapidly slashing our own emissions. We do so by developing carbon-free alternatives even cheaper than carbon. The rest of the world will then quickly adopt these alternatives, leaving most of its trillion barrels of oil and trillion tons of coal safely buried, most of the rain forests standing, and most of the planet’s carbon-rich soil undisturbed. From end to end, however, this vision strains credulity.

His argument is simple: even if we (in the developed world) cut our carbon consumption markedly, the reduced demand will lower the price. Energy-starved developing economies will then take advantage of the lower price by ramping up their consumption by at least as much, and the net effect on emissions will be nil. We can't prevent them from doing this, nor we can afford to simply buy them off, because their sheer numbers are too great. In other words, we simply can't get past the economics of this even if we (in the developed world) were willing to sacrifice quite a lot to reduce emissions.

What can be done? Huber suggests that we cease spending time and money trying to hold back the inevitable tide. Instead we should invest in sequestering the carbon and sinking it back into the ground. This is best done, in Huber's mind, by investing in reforestation and other land use reform. In other words, Huber suggests taking better advantage of the earth's built-in stabilizers.

Would this be sufficient? Even Huber doesn't seem fully convinced. But there are reasons to think that the probability of sequestering working is greater than the probability of getting a bunch of treaties signed, ratified, and enforced. And sequestering comes with the added benefit of encouraging poor countries to grow out of poverty, rather than forcing them to stay poor.

For a different take, proposed by a Republican Congressman and member of the Pigou Club, see this letter.