Thursday, October 30, 2008

Obama on Trade

. Thursday, October 30, 2008

Today I voted for Obama for president, but I did so with some reticence. On balance, I feel that he is a much more acceptable candidate than McCain, but this does not make him above reproach. One columnist for The Times of India channels some of my concern:

McCain is one of the few American politicians in either party with the courage and conviction to stand up to protectionist populism. By contrast, Obama embodies protectionism.

Look at the accompanying chart. It shows that McCain has voted 88% of the time against bills creating trade barriers, and 90% of the time against export subsidies for US producers. Few other senators have such a splendid record.

Obama has served a much shorter time in the Senate, and avoided voting on many key issues. He has voted against trade barriers only 36% of the time. He supported export subsidies on the two occasions on which he voted, a 100% protectionist record in this regard. ...

Unlike Obama, McCain voted against imposing trade sanctions on China for supposedly undervaluing its currency to keep exports booming and accumulate large forex reserves. India has followed a similar policy, though with less export success than China. But if indeed India achieves big success in the future, it could be similarly targeted by US legislators and, will need people like McCain to resist.

Obama favours extensive subsidies for US farmers, hitting Third World exporters like India. This has been one of the issues on which the Doha Round of WTO is gridlocked. McCain could open the gridlock, Obama will strengthen it.

Obama also favours subsidies for converting maize to ethanol. The massive diversion of maize from food to ethanol has sent global food and fertiliser prices skyrocketing, hitting countries like India. But McCain has always opposed subsidies for both US agriculture and ethanol. While campaigning, he had the courage to oppose such subsidies even in Iowa, an agricultural state he badly needs to win if he is to become president.

There is more at the link, but this commentator isn't the first to express concern over Obama's protectionist leanings. Indeed, some have gone so far as to argue that Obama is actually lying, and if elected would actually follow in W.J. Clinton's footsteps on trade. Austan Goolsbee, one of Obama's chief economic advisors, intimated as much to representatives of the Canadian government after one NAFTA-bashing session earlier in the campaign. Perhaps. But Obama's voting record and rhetoric argue against the idea. One of the many major policy mistakes of the Great Depression was the institution of the Smoot-Hawley Tariff. A similar move at this juncture might be similarly disastrous. In my view, this is a strictly non-partisan issue; regardless of who we personally support for president, we should hope that if Obama is elected he will have learned from history.

Wednesday, October 29, 2008

Airlines, Recession and Going Bust

. Wednesday, October 29, 2008

So far this year, about 30 airlines have gone bust around the world, including ATA, Aloha, Skybus, Sterling, and Frontier Airlines, all relatively small airlines with mostly regional coverage. However, these small carriers declaring bankruptcy does not bode well for an aviation industry staring down a global recession, tight credit, and decreasing demand. These bankruptcies have produced ripple effects throughout the aviation sector and have left tens of thousands of travelers stranded in airports around the world. Will we continue to see more bankruptcies? Will we see consolidation in the airline industry much like we've started to see in the banking industry?

Last month, Willie Walsh, CEO of British Airways predicted that by the end of this year, 30 more airlines will declare bankruptcy as a result of the current economic climate, causing more headaches and stranding more passengers worldwide. Furthermore, analysts are predicting consolidation within the aviation industry in order to take advantage of economies of scale. 

Today, the Justice Department approved the merger between Delta Airlines and Northwest Airlines, after a six-month investigation as to the impact of the merger on consumers. This deal will create the largest airline in the world. Also today, Lufthansa, the German carrier, came to terms to purchase BMI, the British airline, and is also seeking to purchase major stakes in Austrian Airlines and Alitalia. Major carriers like British Airways, Air France-KLM, and Virgin are also positioning themselves to buyout smaller carriers and expand their networks.

However, most analysts are overlooking one important obstacle to airline consolidation, especially on a global scale. The main obstacle to airline industry consolidation globally is that it is illegal, and has been since 1938, for foreigners to own US based air carriers. The United States caps foreign ownership of domestic carriers at 25%, thus ensuring that the only consolidation in the US market can come from within. We will most likely see less consolidation than most are predicting, and the consolidation that we do see, will be a wave of "intra-market" mergers, especially within the US and the EU.

Because the sources of continued financing and merger are limited to "intra-market" transactions, especially in the US but also in Europe, our wave of consolidation may be much smaller in scope and not sufficient enough to ensure that the airline industry continues to function at its current capacity. In the short run, as a result of tighter credit, decreased consumption of aviation industry services and a global recession, we may see further bankruptcies and more headaches for travelers because airlines will not be allowed to merge across borders and take advantage of economies of scale. In the long run, none of this matters b/c we're all either dead or won't need airlines. (Hopefully someone invents Star Trek style teleportation!)

Meaningful Announcements


If lowering the Fed funds rate doesn't matter much at present, it doesn't mean that institutions don't have an important role in the financial crisis. Today the IMF announced a new short-term lending facility for emerging markets, which will provide quick liquidity with "no conditions attached once a loan has been approved". And the Fed announced temporary lending to four EMs: South Korea, Mexico, Brazil, and Singapore. It remains to be seen whether these actions will be sufficient, but they were necessary and are a step in the right direction.

Even better, these organizations were able to quickly enact these new policies because they are not constrained by domestic politics. Contrast that to the drawn-out legislative wrangling required before the modified Paulson plan was passed in the U.S. Congress. The resulting bill was a bloated, bastardized mess. The IMF and Fed, however, are able to move swiftly and relatively cleanly when they deem intervention necessary. International institutions are often criticized because their leaders are not democratically elected and so a lack of accountability exists. In normal times this criticism carries some weight. In crisis situations, however, it is unclear whether the circumvention of politics is a bug or a feature. There is some trade-off between transparency and flexibility, and in a crisis the appropriate margin may skew towards greater flexibility.

(ht: Dani Rodrik)

Global Electoral College


If the world could vote in the American presidential election, who would win?

The Economist has a very fun global electoral college map which allows citizens of every country to vote for either McCain or Obama. Is it surprising that Obama is winning with 9,120 electoral votes compared to McCain's 252 electoral votes? At least McCain's winning Iraq, Angola, Namibia, the Congo and Sudan.

Check it out and have some fun!

Pushing On a String


The Fed cuts the funds rate by 50 basis points, down to 1%. But at this point who really cares? This is becoming akin to a zen koan, or a Douglas Adams novel:

Q. I know the normal effect of monetary policy in normal times, but what effect does monetary policy have in the context of a massive TED spread, nationalized banking systems in the most liberal economies in the world, and rapidly-expanding currency crises throughout the emerging world?

A. 42

I mean, I guess a cut couldn't hurt, but it still seems like a non sequitur. Oh well. Don't panic, and don't forget to bring your towel.

Tuesday, October 28, 2008

The Coming IMF Controversy

. Tuesday, October 28, 2008

The IMF is suddenly relevant again, having already agreed to a loan for the Ukraine while similar loans to Hungary and Iceland are on the way. So it should be expected that criticisms of the agency will also come back to the fore. While everyone hopes and prays that the agency learned some lessons from its missteps in Russia and Asia in the 1990s, it also worth recalling Kenneth Rogoff's response to Joseph Stiglitz's criticisms of the IMF in Globalization and Its Discontents:

Let's look at Stiglitzian prescriptions for helping a distressed emerging market debtor, the ideas you put forth as superior to existing practice. Governments typically come to the IMF for financial assistance when they are having trouble finding buyers for their debt and when the value of their money is falling. The Stiglitzian prescription is to raise the profile of fiscal deficits, that is, to issue more debt and to print more money. You seem to believe that if a distressed government issues more currency, its citizens will suddenly think it more valuable. You seem to believe that when investors are no longer willing to hold a government's debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF—no, make that we on the Planet Earth—have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.

Joe, throughout your book, you condemn the IMF because everywhere it seems to be, countries are in trouble. Isn't this a little like observing that where there are epidemics, one tends to find more doctors?

The whole thing is worth reading, if only because policy disagreements are rarely so theatrical. But there are also serious arguments here. As described by Rogoff, Stiglitz is essentially advocating a Keynesian response to currency crises: stimulate aggregate demand through fiscal and monetary policy, and expect that to bring the economy back to full employment which will in turn stabilize the currency. Indeed, Stiglitz expressed this sort of pure-Keynesianism in an article this week. Rogoff is saying that that response is either insufficient or has already been tried and has failed. If you inject more cash through stimulus or debt-spending, the result will likely be more inflation, a less-valuable currency, and further shattering of confidence. It's bad to introduce that trifecta when an economy is performing well; when an economy is in free-fall, it can be disastrous.

The IMF response has traditionally been to propose a bitter pill: slash government spending and raise interest rates in exchange for a bail-out. As critics of the IMF are quick to point out, this spreads the virus which is already plaguing a local economy. Proponents of the IMF note that the chances of the economy healing itself without such actions are virtually non-existent, so it's better to get pain over with all at once in the hopes of speeding up the recovery. IMF critics see IMF prescriptions as a disease; IMF proponents see the same policies as an antibiotic.

There's one more aspect to this which may be familiar to students of social science: often a needed policy may be difficult or impossible to enact because of domestic political constraints. So a policy-maker may intentionally choose to cede decision-making power to an outside institution as an end-around maneuver. In this way, the veto points in the system may be bypassed, and the political consequences of making an unpopular decision are mitigated, all while the needed policy is carried out. IMF actions aren't always explained by this model of course, but the theory is still worth considering.

For more, see this from Megan McArdle, and Dani Rodrik advocating strong and swift action from the IMF.

Monday, October 27, 2008

There go the Emerging Markets

. Monday, October 27, 2008

We talked in class today about Sweden's need to raise overnight lending rates to ridiculous levels in its attempt to defend the kroner in the fall of 1992. I read tonight that Romania has a current account deficit of 14 percent of GDP and has pushed overnight rates to 900 percent to defend its peg against the euro.

As was the case with Sweden, this is likely insufficient. "Merrill Lynch has advised its clients to take "short" positions against the leu. "The fundamental picture suggests that Romania may face a currency crisis in the near term, similar to what Hungary has gone through over the last week," it said. The bank also warned that Turkey and the Philippines are vulnerable."

Things look pretty grim for emerging markets and western Europe. "Stephen Jen, currency chief at Morgan Stanley, says the emerging market crash .. threatens to become “the second epicentre of the global financial crisis”, this time unfolding in Europe rather than America.:

  • "Austria’s bank exposure to emerging markets is equal to 85pc of GDP – with a heavy concentration in Hungary, Ukraine, and Serbia."
  • Exposure is 50pc of GDP for Switzerland, 25pc for Sweden, 24pc for the UK, and 23pc for Spain.
  • Spanish banks have lent $316bn to Latin America, almost twice the lending by all US banks combined ($172bn). Hence the growing doubts about the health of Spain’s financial system as Argentina spirals towards another default, and Brazil’s currency, bonds and stocks all go into freefall.
  • The US figure is just 4pc.

Thursday, October 23, 2008

IMF Rising

. Thursday, October 23, 2008

Another phase of the global credit crisis has begun; developing nations are running to the IMF for emergency aid.   And finance ministers across the world don't see many other options for how to survive a crisis created by developed credit markets.  Capital flight, wide-swinging currency fluctuations, tightening private market credit - we've seen this all before.  

Now the IMF has begun talks to increase their lending capabilities to as much as $1 trillon.  Considering the bank has $200 million in collateral, they'll need quite a bit of supplemental cash.  Perhaps most telling of how weak the US economy is, the IMF has failed to even approach the Fed for support.  Instead, the bank is in talks with Japan and oil-producing companies.

So, is the IMF poised for a renaissance?  Gordon Brown certainly hopes so (interesting that Brown chaired the IMF's policymaking committee for several years).  The IMF's leader, Dominique Strauss-Kahn, stresses that the Fund will eliminate many of the loan conditions that made leaders such as Hosni Mubarak of Egypt refer to the IMF as the International Misery Fund.  However, new conditions have not yet been outlined and a recent study in the Harvard Medical Review found that IMF lending in the post-communist European Bloc directly led to decreased health conditions in recipient nations.  

Check out this map of Eastern European Countries and their debt load (source:

Tuesday, October 21, 2008

The Politics of Farm Subsidies

. Tuesday, October 21, 2008

In honor of tomorrow's exam in POLI 442, I bring you a segment from last week's 20/20 with John Stossel on Agricultural subsidies. He's a libertarian, and does not pretend to be unbiased.

My favorite quote (by a legislator): "I would say to you, then, you don't want to push us." It comes right at the end.

Live by the crude, die by the crude


The NY Times has a nice article on how collapsing oil prices are starting to affect the ambitions of Hugo Chavez, Mahmoud Ahmadinejiad, and Vladimir Putin. As oil prices sky-rocketed, these leaders found plenty of cash for building international alliances and shoring up domestic support through lavish social spending programs. This domestic support in turn provided these leaders with the flexibility to pursue more aggressive foreign policies with the hopes of expanding their international influence, particularly in opposition to the U.S. But it now appears that they may have over-reached: inflation is over 30% in both Venezuela and Iran, and the Russian stock market has dropped by two-thirds in recent months. Meanwhile oil prices, and thus revenues, continue to decline. If the trend continues, these leaders may have to start making hard choices between populist domestic social programs and expansionary foreign policy.

Even so, there are still some signs that the relative economic power of the U.S. may be in decline. European leaders have been at the forefront of the response to the financial crisis, and some of the U.S. government's actions are partially explained by international concerns (e.g. the Fannie/Freddie conservatorship was necessary because of heavy Chinese investment; the AIG bailout had major international implications). And does anyone remember the strong words the U.S. had for China regarding currency manipulations? There've been crickets coming from that corner for awhile.

Still, as Daniel Drezner notes, it doesn't appear that any other country is quite ready to fill the U.S.'s shoes:

However, this interdependence cuts both ways. Because of its slowing growth, China has no choice but to continue purchasing dollar-denominated debt in order to goose its export earnings. As for Russia, $500 billion in reserves has not prevented the crash of its own equity markets.

The bottom line seems to be this: the U.S. may be incapable of continuing to run the international finance system entirely on its own as it has done since the end of WWII, but the rest of the world is incapable of controlling the system without the U.S. So the story may not be de-coupling, as some had thought; Indeed, we may see more interdependence rather than less in the near future.

Saturday, October 18, 2008


. Saturday, October 18, 2008

I don't see that they've achieved what they should have been trying to achieve. So my verdict on this present Fed leadership is that they have not really done their job.

That is Anna Schwartz, one of the foremost economic historians in America, particularly in the areas of the Fed, the Great Depression, and monetary policy in general. More here.

(ht: Mankiw)

Friday, October 17, 2008

To Grandmother's House We Go

. Friday, October 17, 2008

If banks are the bridges of the financial industry, and world governments are able to prop them up sufficiently well as to avoid any more major collapses, then where do we find ourselves? According to Gordon Brown, the next step is the development of a new Bretton Woods system. Nevermind the poor historical analogy; if Bretton Woods I was formally constructed as an international security measure while WWII was still raging, and if Bretton Woods II was informally constructed by the U.S. running current account deficits in order to finance cheap current consumption, which in turn boosted export-biased growth in developing countries (with the U.S. dollar as the de facto reserve currency for the world), then I'm interested in what Bretton Woods III would look like. What formal or informal structure will emerge in the coming years as the controlling mechanism for the world economy? Or, more specifically, what institutions might be developed which would prevent future crises from resembling the present one? I see several possibilities, none of which strike me as being especially likely.

1. The development of a new international agency, with the scope and resources of the IMF, dedicated to providing short-term liquidity directly to major banks (or investment firms with large counter-party obligations?) in any country, without the approval of that bank's host country. This agency would have the authority to demand structural changes to lending or investment practices of the banks they aid. In other words, the loans would be tied to some actions. These demanded actions may include things like higher reserve requirements, equity stakes in the banks in exchange for the capital, preclusion from engaging in credit default swap markets or taking on other investments with large exposure to system risk. It's possible that this could be done under the auspices of the IMF if certain changes were made to its charter, tho considering the P.R. problems facing the IMF, it may be better to develop an entirely new agency.

2. The development of a global version of the Securities and Exchange Commission, which closely regulates the balance sheets of major banks, and has strict restrictions on what types of investments certain banks may make. Although, given that these sorts of regulatory agencies had no real positive preventative effect on the current crisis, it seems unlikely that a global agency would've done much better. There are also corruption problems in many countries. And would countries with a nationalized banking system accept foreign control? Of course not.

3. The development of a global FDIC, which guarantees depositors in traditional bank accounts and money market funds. This, however, is a rather mild symptom of the global contagion; it isn't the disease itself. And many countries in the developing world have incredibly corrupt banking systems. It would require a massive reform of a corrupt political culture in order to make such a plan feasible in those countries; that, obviously, would be quite hard to do.

What else? In my opinion, #2 and #3 would have little effect on the international financial system, plus enforcement would be mostly impossible even if enaction weren't. #1 is essentially the same as recapitalization of banks, and this can already be done by private investors or local governments in most cases. When that proves problematic, the IMF (see: Hungary, Ukraine) or neighboring countries (see: Iceland, Pakistan) are capable of pitching in.

Perhaps I'm missing something obvious, but Bretton Woods I picked the low-hanging fruit in a time when the Western economic powers were capable of forcing the agenda. Bretton Woods II was an informal mechanism in which the world voluntarily tied its sails to the fortunes of the dominant economic powers by organizing their economies to sell to the world's biggest markets. I don't really see a realistic place for a third organizational system at present. If folks have ideas, put them in the comments. Or, if folks have things they'd like to see in a BWIII, even if they aren't realistic, put those ideas in the comments also (I'm looking specifically at you, Emmanuel).

Thursday, October 16, 2008

Americans are saving?!

. Thursday, October 16, 2008

What?! Since when do Americans save? Well, according to the latest figures, the personal savings rate in the United States was up to almost 3% for the second quarter of '08, the highest its been in at least five years, and is predicted to at the very least stay at this level for a while. This is an interesting development. 

This news bodes well for the American economy in the long run, as "domestic savings create a pool of money from which companies can borrow to invest in new plants and equipment, creating the jobs that push living standards higher over time. A growing domestic savings pool could also reduce America's need to borrow money overseas - which would make the U.S. less beholden to foreign creditors who now supply us with hundreds of billions of dollars in financing every year."

However, in the short run, "saving more means spending less - which translates into more hard times in retail and other consumer-driven businesses like the auto industry. The latest evidence of the shift came in Wednesday's steeper-than-expected pullback in retail sales. They dropped 1.2% in September, in their first year-on-year decline in six years and only their third drop in the past 16 years. Given that two-thirds of economic activity is consumer spending, today's thrift [may] exacerbate a general downturn and [may] weaken the impact of the massive interventions the government has made in the financial markets."

This development has consequences for the predicted (or actual, depending on your definition of the term) recession and recovery.  If Americans aren't willing to go out and do what they do best (shop and eat) and instead stuff their money under the mattress, it is a signal that the American economy may be in for a longer and deeper recession than originally predicted. Furthermore, the recovery from the Great Financial Crisis of 2008 (catchy huh?!) and its ensuing recession may take longer than we thought it would. (We may be sitting here in the 3rd and 4th quarter of 2010, still awaiting the recovery to begin.) 

So I say unto you America, shop, baby, shop!



"Ukraine, Hungary, and Serbia are all in emergency talks with the International Monetary Fund, raising fears that an exodus of foreign investors will set off a systemic crisis across Eastern Europe."

The worst may be yet to come in euroland as well: "the ECB is now deeply alarmed by the crunch facing European banks as a violent unwinding of debt leverage across the world forces them to repay huge sums in dollars. Goldman Sachs estimates that non-US banks have liabilities of $12 trillion on dollar balance sheets. The European, British, and Swiss banks make up the lion's share, and they have used leverage far more aggressively than US banks. Analysts say the European banks will need to raise $400bn in fresh capital – no easy feat at a time when burned investors are keeping their distance.

Meanwhile, Gordon Brown is "Calling for "very large and very radical changes," ... nothing less than "a new Bretton Woods."Speaking at a summit of European Union leaders in Brussels, Mr Brown said the recent crisis proves the need for much more international co-operation on the regulation of banks and other financial institutions. "We now have global financial markets, global corporations, global financial flows. But what we do not have is anything other than national and regional regulation and supervision." More thoughts on this later.

Wednesday, October 15, 2008

Explaining the Mess

. Wednesday, October 15, 2008

Crisis explainer: Uncorking CDOs from Marketplace on Vimeo.

Untangling credit default swaps from Marketplace on Vimeo.

Here are a couple of videos from Marketplace that explain the financial relationships at the center of the current crisis.

Monday, October 13, 2008

Institutions Matter

. Monday, October 13, 2008

UPDATE: Congratulations, Paul Krugman, winner of 2008 Nobel Prize in Economics (okay, The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel).

Paul Krugman lauds Gordon Brown's weekend efforts: "you don’t expect to see Britain playing a leadership role. But the Brown government has shown itself willing to think clearly about the financial crisis, and act quickly on its conclusions. And this combination of clarity and decisiveness hasn’t been matched by any other Western government, least of all our own."

Fair enough; yet Krugman offers little explanation for this puzzle beyond his distaste for the Bush administration--"I also wonder how much the Femafication of government under President Bush contributed to Mr. Paulson’s fumble. All across the executive branch, knowledgeable professionals have been driven out; there may not have been anyone left at Treasury with the stature and background to tell Mr. Paulson that he wasn’t making sense." Yet, just a few column inches above, Krugman notes how Bernanke favored the capital injection approach--surely Ben mentioned this to Paulson?

Perhaps institutions account for the difference. Gordon Brown did not need to testify before the legislative branch, nor did he need to build a majority in the upper and lower houses. Instead, parliamentary government and strong party discipline enabled Gordon Brown to formulate a concise plan and "act quickly on its conclusions." Not so in the U.S., where Paulson must plead for the necessary authority and resources and required two votes in the House to pass a much altered version of the plan he proposed. I am not sure how that institutional process promotes clarity of thought or rapidity of response.

Indeed, Paulson's initial proposal might be seen in this light: more about gaining broad authority to do what was necessary and less about the specific details. Sell the request for authority based on vague details that would sell; once you have the authority use it to do what is needed to stabilize the system (including recapitalization, now in vogue). Hence, the plan was short on details about how to solve the crisis, and explicit about Treasury authority. Yet, Krugman was no big fan of that plan, in part because it gave Treasury so much unchecked authority.

Maybe we can't have our cake and eat it too? If we want clear thought and quick action, we need unfettered executive power. If we want to constrain executive power, we must accept policymaking through a slow process in which outcomes often fail to embody clarity of thought.

Saturday, October 11, 2008

Beyond the Blow-by-Blow

. Saturday, October 11, 2008

Most of the talk of the financial crisis has rightly focussed on the breaking news and new developments. Even on a Saturday the news is significant: the Bush administration has reversed course and is now committed to partially nationalizing major banks rather than just providing liquidity (which begs the question: is it legal to use the cash in a way not approved by Congress?). Meanwhile, the much-ballyhooed G7 meeting has been underwhelming. A joint statement was issued, but it only included platitudes in place of actual concrete plans of action.

But it is sometimes helpful to step back, look at this crisis in context, and try to find ways to improve the future performance of the financial system. For example, everyone is calling for changes to the regulatory system, although those calls tend to vary along partisan lines. Left-leaning commentators are keen to increase any and all regulation, while those on the right tend to ask for "better" regulation, as if the system in place before the crash was intentionally or predictably deficient. Both views are understandable, but Avinash Persuad thinks they are both misguided:

This is the seventh international financial crisis I have lived through. At the end of each the focus on avoiding the next one has always been the same trinity: more transparency, more disclosure and more risk management. This is an inadequate response to systemic crises. At the heart of new, internationally co-ordinated regulatory initiatives, must be counter-cyclical capital charges a la Goodhart and Persaud. Crises do not occur randomly; they always follow booms. This is my fourth policy initiative. But there also needs to be shift in the focus of regulation, away from sensitivity to the market price of risk and notions of equal treatment for all institutions, to a greater sensitivity to risk capacity and a better appreciation that diversity is the key to liquidity. This is the fifth step. Systemic resilience requires different risks being held in places where there is a natural capacity for that type of risk. In the name or risk-sensitivity and equal treatment we ended up with institutions who had no liquidity, holding liquidity risk and those with little capacity to hedge or diversify it, owning credit risk.

Meanwhile, Arvind Subramanian wants China to give the U.S. an IMF-style "tied loan" in exchange for some structural adjustment. That'd be a bitter pill to swallow, but we may end up having no choice. Meanwhile Michael Clemens takes the long view and thinks that we'll be alright:

This is the best estimate of real income per capita in the United States since 1820. Over these years we had violent financial crashes of various types, bank panics, piles of recessions and a huge depression, many foreign wars and one enormous domestic war, had a central bank and didn’t, were on the gold standard and weren’t, had governments topple in scandal and multiple leaders assassinated, and what did it all amount to in the medium to long run? In per-capita income terms: Nothing. The overall trend does not bend or shift. Every bad year was followed by a good year that returned us to trend. The US average growth rate of real per capita incomes over the last 190 years has been 1.8% a year, and the same rate over the last 10 years has been…. 1.8% a year. Stare at that graph: The Great Depression was traumatic in countless ways, but astonishingly, it’s not clear that we are any worse off today than we would be if the whole thing never occurred. Anyone who made such a claim in the 1930s would have been scoffed at, but that’s what happened.

Here's his graph:

Friday, October 10, 2008

Drugs: The Anti-Drug

. Friday, October 10, 2008

The PSA above is infamous for its, er, lack of subtlety. But there is an underlying issue at stake: one of the unintended consequences of the convergence of the War on Drugs with the War on Terrorism in Afghanistan is that we have incentivized poor Afghan farmers to grow poppy. It is easy grow, has quick yields, and many farmers have no other viable alternative. It's either grow poppy or live in even greater destitution. And so Afghanistan now produces 93% of the world's opium supply. The illicit opium trade generates an estimated $4bn in yearly exports in a country with an official GDP (PPP) of $35bn. Much of this opium money finds its way into the hands of the Taliban, who use it to fund their insurgency. It is clear that a direct means of fighting the Taliban is to cut off their funding. To that end, NATO forces will now begin to directly attack opium production facilities in the hopes of destroying crops. If the history of the War on Drugs is any indication, this new strategy tactic strategy will have lackluster success at best (see: Colombia).

So what to do? Christopher Hitchens proposes a new strategy: if you can't beat 'em, co-opt 'em. In other words, rather than trying to shut down the drug trade, buy the opium and use it in the production of prescription painkillers, of which there is a global shortage, particularly in the developing world. In fact, Turkey has government-controlled opium production, and it sells its crop to the U.S. and other countries for the development of medicines. There are issues of policing, but if the U.S. is willing to pay a high price than the Taliban, then we may be able to weaken the Taliban, improve the security and economy of Afghanistan, improve the standards of living for some of the most destitute people on earth, increase access to pharmaceutical drugs in the developing world, and lower the global costs of the same drugs, and (potentially) prevent the loss of life that a NATO attack might occur. In fact, much of the success of the Anbar Awakening can be attributed to the shift in U.S. policy from fighting local leaders to (ahem) bribing them. Perhaps it's worth trying something similar in Afghanistan. We may improve the security situation and the local economy in one fell swoop, while reducing the global supply of illicit street drugs, thus raising their price and reducing the quantity demanded.

Yes, this is a bit of a pie-in-the-sky view. Yes, there are certainly complications, not least of which are domestic political feasibility issues. The Canadian government is one dissenter from this view. A summary of their arguments is here. But alternative scenarios are even less rosy. For more in-depth analysis in support of making the illicit Afghani drug trade licit, see Poppies for Medicine, a years-in-the-making study conducted by the Senlis Council, which examines feasibility issues and proposes an economic and policy model for enaction.

Thursday, October 9, 2008


. Thursday, October 9, 2008

As G7 finance ministers gather in DC this weekend in connection with the annual IMF and World Bank meetings, one can't help but notice the increasingly strident pleas for concerted and coordinated action coming from economists I greatly respect. Their stridency makes me worried.

One hopes that finance ministers will take concrete steps this weekend. One hopes that someone will emerge as a leader. One hopes, at the very least, that they are not unable to do something. The disaster of this week suggests quite clearly, I think, how markets react when governments prove themselves incapable of coordinated action. One also worries, however, as Sarah and Alex express below, that governments really don't know what they are doing, and lack the conviction to act forcefully anyway.

Financial Contagion?


Iceland is near bankruptcyCredit crisis hits CanadaBelgium, France, Luxembourg intervening to save bank after bank. The Euro falls to 14 month low as credit crisis spreads throughout Europe. Asian equity markets continue their deep slide.

$700 billion bailout. 50 basis point emergency global coordinated rate cut. Banking deposit guarantees. Governments taking equity stakes in banks (yes, including here in the US). 

Is there any further action that can stem the spread? Can the government do anything? Is this too little too late? Is a global recession inevitable? 

Wednesday, October 8, 2008

Shock and Awe

. Wednesday, October 8, 2008

Reading the news feeds, one can't help but wonder if governments know what the heck they're doing.  New three-point plans, rate cuts, and proposals are exploding onto the scene like the finale in a fireworks display, often to no avail at stemming the depressing tail-spin of global equity markets.  Now, we have a whole lot of smart people working on a whole lot of stop gap solutions, and a very capable Bernanke using his knowledge of the Great Depression to try to make sure monetary policy doesn't make things worse.

Still, it seems through all the noise, the policy makers are missing the core problem - you can cut interest rates and provide increased government funds for short-term lending all you want, but banks still are simply not lending to one another.  Robert Pozen of MSF Investments has an opinion piece in the Wall Street Journal today calling for governments to guarantee short-term interbank lending.  This, in turn, will provide the time and space for the Economic Stabilization Act to generate more liquidity through the absorption of toxic debt.

It's clear from the increased international cooperation that governments understand and are willing to act (to varying extents) in concert to avoid the worst of the worst scenarios of deep and protracted global depression.  But, willingness to act is not enough.  Let's hope that global leaders are willing to cut through the noise and the panic to enact the correct combination of stop-gap and systemic measures to limit the damages and strengthen global credit and equity markets for the long term.

More Overnight/Early Morning Developments


The Federal Reserve, along with the European Central Bank, the Bank of England and the Swiss, Canadian and Swedish central banks enacted, a coordinated, emergency cut in their benchmark interest rates early this morning. This comes in response to massive stock market declines in Japan, Russia, Indonesia and many other global indexes overnight along with further market interventions by European governments and central banks to prop up failing institutions, as Tom observed. The cut's timing also shows the urgency of central bank officials attempting to stem the fear of the aforementioned developments from further battering European and American markets during today's trading.

This is purely and clearly a psychological move by the world's central banks. Something needed to be done, in a coordinated way, to show the markets that the central banks were ready and able to intervene to stem any remote possibility of global financial collapse and the central banks believed further liquidity was the answer. But the problem is not liquidity, its confidence. How lowering a target rate that does not actually really matter (check out the data on the effective FFR over the past 3 weeks), will fix the problem, I can not see. Lowering the target as a purely psychological tool to attempt to impact investor confidence, may have an impact. How much of an impact and will the impact be enough? I have no idea but, I guess we'll see.

Overnight Developments


Britain announced a three-part multibillion-dollar bailout for its beleaguered banks, and Spain moved to mount a separate rescue of its own banking sector.

And the Fed is now in the commercial paper business.


In Moscow, the Micex index plunged 15.5 percent at the opening and exchange officials suspended trading until Friday.

Japanese stocks plunged 9.4 percent Wednesday, leading the Nikkei 225 to at 9,203.32, the lowest since 2003. It was the biggest single-day loss in the index since October 1987. The selloff followed Tuesday’s drop of more than 3 percent. The index is now down 40 percent in 2008.

Indonesia’s stock exchange halted trading after a morning plunge of 10.4 percent.

Looks like another bumpy day. Anybody have any idea about what to do? If so, post them in the comments section. I will offer some further thoughts later. Gotta go teach now.

Monday, October 6, 2008

Now What?

. Monday, October 6, 2008

European governments appear "dazed and confused," said Jim Reid, a strategist at Deutsche Bank. "And this isn't helping confidence and will probably end up costing them more in the long run." Not surprising that they are dazed and confused, given the sharp about face that has occurred in most EU members in the last two days. Seems that guaranteeing bank deposits is not such a bad idea after all.

Press reports hint that Sarkozy is seeking an emergency G8 meeting this week. Not obvious that this is a good idea. Market reactions to the non-agreement EU-4 summit and post-non-agreement scramble to bailout Hypo Real Estate and other European financial institutions suggest that market participants do not believe that EU governments fully appreciate the stakes. "Until now the solutions have appeared to be uncoordinated, so perhaps it's time for a more coordinated approach globally," said Torsten Slok, an economist at Deutsche Bank AG in New York. Indeed. Yet, calling an emergency G8 summit merely adds fuel to the fire unless EU governments have a meaningful coordinated response to announce at its conclusion. (H/T to Calculated Risk).

Krugman posted a short paper elaborating his thoughts on contagion. He makes a concise argument about why the EU can't hide.

Update: Just noticed that Tuesday's NY Times has a piece that (finally) criticizes EU governments for their head-in-the-sand attitudes and failure to embrace a coordinated response. “It’s mind-boggling that the Europeans have coordinated so little up until this point” (Simon Johnson, former Chief economist at the IMF).

Sunday, October 5, 2008

Sauve Qui Peut

. Sunday, October 5, 2008

French President Nikolas Sarkozy, in his capacity as EU President, called an emergency summit this weekend among the four largest EU members to discuss EU cooperation in face of the financial crisis.

The gathering failed to produce a constructive response. They agreed on the need to work together, but proved unable to agree on how this cooperation might be best pursued.

EU leaders seem torn between two unproductive orientations.

Along one path, EU governments seem determined to see this as an American crisis that they can somehow avoid, rather than a global financial crisis that they cannot. Gordon Brown said pointedly that the crisis “has come from America.” Mr. Berlusconi claimed that “Europe is not facing and never faced the risks in the American system.” Europeans, he said, “set aside money in savings.”

Along the other path, EU leaders have pursued uncoordinated national responses and then criticized each other for the half measures each takes (see how EU governments have reacted to Ireland's decision to guarantee 100 percent of deposits). Such behavior has prompted Peter Mandelson to warn of the dangers of a “new wave of economic nationalism”, which would create “distortions” and lead to an approach of “every man for himself”.

I fear that this approach reflects a failure to comprehend how the world has changed, and is more likely to aggravate than mitigate the crisis in which we find ourselves.

Saturday, October 4, 2008

The End of an Era?

. Saturday, October 4, 2008

We've been mostly focusing on the domestic aspects of the financial crisis, but it's important to remember that this is a global crisis. In Europe, the major leaders are coming together to coordinate their responses:

French President Nicolas Sarkozy along with Germany's Chancellor Angela Merkel said Saturday that the "global financial crisis needs a global response."

Ms. Merkel and Mr. Sarkozy were speaking to the press ahead of a summit in Paris of leaders of the European members of the Group of eight leading countries, along with Eurogroup Chairman Jean-Claude Juncker and European Commission President Jose-Manuel Barroso, to discuss the financial turmoil.

"It's a global crisis that requires a global response. In today's world, Europe must show the will for a solution. That will reassure everyone, including savers," Mr. Sarkozy said.

Ms. Merkel said that all countries must take responsibility in sorting out the financial crisis and added that "those who caused the damage will have to contribute to the global effort.

In the past, this sort of coordinated European action would have been undermined by the U.S., and without U.S. support such a proposal would wither on the vine. As Drezner notes, both Japan and Europe tried something similar following the Asian financial crisis a decade ago, but the U.S. scuttled the efforts. If Europe is successful this time around, it may signal the decline of America as the hegemon of the global financial system.

International Political Economy at the University of North Carolina: October 2008




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