Brad DeLong--Economics Only

Greg Ip: Bernanke Breaks Greenspan Mold

Ben Bernanke sends signals that interest rate cuts are not foreordained, and that orderly markets can be maintained without cutting rates:

Bernanke Breaks Greenspan Mold - WSJ.com: The Fed historically has had two major economic duties. Maintaining financial stability is one. Controlling inflation while preventing recession is the other. To Mr. Greenspan, market confidence and the economy's growth prospects were so intertwined as to make the Fed's two duties almost inseparable. He cut rates after the 1987 stock-market crash and the near-collapse of hedge fund Long-Term Capital Management in 1998 to prevent investor reluctance to take risks from undermining the nation's economic growth.

By contrast, Mr. Bernanke distinguishes between the central bank's two functions. So, on Aug. 17, the Fed cut the interest rate and lengthened the term on loans to banks from its little-used discount window in hopes banks would use the window -- or at least the knowledge it was available -- to lend to solid borrowers having trouble getting credit amidst the market turmoil. The action was aimed at restoring the normal functioning of disrupted credit markets, not primarily at boosting growth. The Fed, meanwhile, hasn't cut the far more economically important federal-funds rate, charged on loans between banks, which is the benchmark for all short-term U.S. borrowing costs.... "There's no doubt they were trying to draw a distinction between using the main tool of monetary policy, which is the federal-funds rate, and aiming the discount rate at restoring the plumbing," says Alan Blinder, a former Fed vice chairman....

Neither Mr. Bernanke nor his closest colleagues, some of whom served under Mr. Greenspan, believe there ever was a "Greenspan put," a reference to a contract that protects an investor from loss. Yet officials acknowledge the perception that the Fed has bailed out investors in the past. When the stock market crashed in 1987, Mr. Greenspan, then on the job for just two months, used aggressive open-market operations -- buying and selling government securities -- to pump banks full of cash, which caused the federal-funds rate to fall to about 6.75% from 7.25%. His priority was to keep banks well supplied with cash so that strapped securities dealers wouldn't fail for lack of financing....

Al Broaddus, research director and later president of the Federal Reserve Bank of Richmond during Mr. Greenspan's tenure, says Mr. Greenspan's response in 1987 was right. "A 20% drop in the stock market was a clear threat to economic conditions." But he says that in 1998, he and some others were skeptical of the need for such drastic action to deal with market instability. "If we could have argued for something like Bernanke is doing this time as opposed to three funds-rate reductions, we might have done that"...

NOOOOOOOOOO!!!!!!!!!!!

It is always a mistake to surf over to *National Review*. Always: >Pour in the Cash [Larry Kudlow]: [M]y campaign to get the Fed to permanently inject new cash into the banking system and deal with the dysfunctional commercial paper market — as well as the general credit freeze-up. There’s housing price deflation... commodity deflation.... Stock prices for materials are off nearly 13 percent since July 19, while metal and mining shares are off 16 percent. There’s the deflation of loan values, both CDOs and CLOs. >And there’s the deflation of the Treasury bill rate from 5 percent to 4 percent... Does Larry Kudlow really not know that three-month Treasury bills are worth 98.76 when the bill rate is 5% and are worth 99.01 when the bill rate is 4%? That the prices of Treasury bills rise--hardly a sign of "deflation"? Can he really be that ignorant? Can he really be that thoughtless?

Department of "Huh?"

Eric Hobsbawm, Age of Empire, p. 50:

The world merchant marine, whose growth roughly indicates the expansion of the global economy, had remained more-or-less static between 1860 and 1890. Its size fluctuated between 16 and 20M tons. Between 1890 and 1914 it almost doubled...

But the fleet of 1860 is a sailing fleet. The fleet of 1890 is a steam fleet. What with the changability of the wind, a steamship can sail about three times as fast as a sailing ship. the 20M tons of 1890 had three times the cargo-carrying capacity of the 20M tons of 1860.

Slouching Towards Utopia? The Economic World of the Twentieth Century: Chapter 7.2: The World in 1900: Poverty

7.2: The World in 1900: Poverty

Poverty

Let us begin with how poor the world was in the last generation of the nineteenth century. In some ways the world economy at the start of the twentieth century was still remarkably preindustrial. Most human beings still earned their bread out of the earth by the sweat of their brow. Most human beings could not read. Most human beings had not seen a steam engine up close, or travelled in a railway train, or spoken on a telephone, or lived in a city. For most human beings life expectancy was still low--little higher than it had been in most parts of the world since the neolithic revolution. At the start of the twentieth century Germany was the world's third superpower, more powerful and more industrialized than any other nation save Britain and the United States. When Adolf Hitler's Nazi Germany went to war against France in the spring of 1940, four-fifths of the wheeled and tracked vehicles in its army were powered by horses. And mules.

Even where things were different in the rapidly-growing half-industrialized core of the world economy, there was still a sense in which what we would call modern life was a thin and new crust on top of older patterns that still owed much to traditional agrarian and commercial patterns. Great Britain was the economic heart of the late nineteenth-century world. It was not the richest country in the world--its settler colonies of Canada and Australia and its ex-settler colony of the United States were richer because of their large farm and ranch sizes and their abundant natural resources. Half a continent will, said economic historian J.H. Clapham speaking of the United States, in the end raise more coal and melt more steel than one small densely-populated island. But the relative wealth of Canada and Australia and the United States at the end of the nineteenth century was due as much to human and animal muscles and lucky geography as to industry.

In Great Britain alone was the economy primarily industrial at the turn of the twentieth century. And even in Great Britain the veneer of modernity was little more than a veneer. It was true that the share of the labor force employed in agriculture was dropping toward 15% at the start of the twentieth century. The eve of World War I saw agriculture account for only twelve percent of the British labor force; while manufacturing and construction accounted for 38%; and distribution and services for 32%. But a quarter of Britons were still illiterate as late as 1870. Primary school enrollment did not become universal until the eve of World War I. Life expectancy at birth was still fifty years or less. And less than five percent of the population went to secondary school. Britain’s--precocious--decline in the share of the labor force in agriculture suggested an economy more advanced, more industrialized, and more rich than was in fact the case.

And Britain was by far the most advanced and industrialized of the world’s economies. In the United States, and in Europe outside of Britain, farmers still made up the largest single occupational group. More than half the population still lived in the country, farming the land or providing the basic goods and services that farmers needed. Agriculture was still a very substantial share of GDP in the late-nineteenth century. It was only halfway through its long decline to its present role as a very small share of economic activity in industrialized economies. In the American west, and in the other countries that Arthur Lewis named "regions of European settlement"--Canada, Australia, New Zealand, and Argentina--farming was not only the core of the economy but farmers were relatively rich, both compared to those dwelling in the cities and compared to those who had remained in Europe.

The eve of World War I still saw more than one out of three Americans at work at work in agriculture, and one in thirty at work in mining. And with the exception of Belgium, other European countries were much closer to the American than the British pattern in their distribution of the labor force between town and country, and among sectors. This turned out to have powerful implications for politics as World War I drew closer: too much political influence was still exerted by agrarian landlords who saw themselves as the descendents of knights who fought for their kings with their swords, and proved their worth through battle.

Many of the processes that have blossomed since to make our industrial--post-industrial--economy were clearly underway by the start of the twentieth century. But they were for the most part only seedlings. In what matters most, in the warp and woof of everyday life, our counterparts in the industrial core of the world economy around 1900 still had more in common in their styles of life with their predecessors of 1600 or 1700 than with us today.

For example, in 1905 an anonymous American college professor--"G.H.M."--wrote a four-page article for the Atlantic Monthly in which he pleaded for more money for college professor salaries, and claimed to be vastly underpaid. The first thing to note is his salary: he claimed that the "average college professor’s salary"--the salary that he saw as clearly inadequate and unfairly low--"is about $2,000" in the dollars of that day, 1900. Yet Stan Lebergott's estimates in the Historical Statistics of the United States are that the average annual earnings of an employee in America in 1905 were $490 dollars if employed for the entire year (or $451 taking account of the hazards of unemployment): $2,000 was four times average of GDP per worker at the turn of the century. In order to match turn-of-the-century professors in terms of income relative to the national average, a professor today would have to make an academic salary of $300,000–a height rarely attained, and far above any average.

The second thing to note is that our professor sees himself as a reasonable and badly underpaid man. He is not asking for what he would see as the "large salar[y], commensurate with what equal ability would bring in other lines of work ($10,000 to $50,000)"–or 20 to 100 times the then-current average level of GDP per worker. Today, 20 to 100 times average GDP per worker would be between $1,600,000 and $8,000,000 a year: the salaries of CEOS. At 60 times average GDP per worker (roughly the mid-point of G.H.M.’s range, corresponding to a salary of $2.5 million a year), we are down to less than 45000 households in today’s United States.

That an ordinary professor could feel that his talents ought, in some sense, to earn such an enormous multiple of the average income is a sign of how unequal an economy and society the turn of the twentieth century U.S. was. We have not yet meade it back to Gilded Age heights of inequality. Yet as this professor goes through his budget, he expects his readers to understand that his family is indeed strapped for cash and cannot support an appropriate and tolerable lifestyle. And what strikes us is how poor that start of the twentieth century century upper-class genteel lifestyle is. G.H.M.'s feeling of being sharply constrained by material necessity is real: as this professor goes through his budget, he expects the highly-literate and elite readers of the Atlantic Monthly to nod and agree (and we modern readers do indeed nod and agree) that his family is strapped for cash.

"We must pay $25 [at 1900 prices] a month for even a passable servant"; that is $300 a year. Add to that $10 a month for laundry, for the "servants will do no laundry work." $1 a month for haircuts. $2 a month for a gardener. On personal servies alone we are up to $445 a year, and the good professor sees these expenditures as absolute necessities. He cannot economize on them. He has no choice but to make such large expenditures on personal service--if he does not, his household will fail to make a properly upper-middle-class impression, for the lawn must be trimmed, the house dusted, the clothes cleaned, and the children washed. And "shall we expect our wives to bear and rear children, do all of the housework, sustain their social duties, and remain well and strong" without servants? G.H.M. has no gasoline-powered lawnmower, no electric hedge clippers, no vacuum cleaner, no dishwasher, and neither a washing machine nor a dryer. Consumer durables take the place now of what took servants’ time sweat for college professors’ households (and housewives', daughters', and aunts' sweat for others) a century ago.

The professor says that his food bills average $55 year-1900 dollars a month--$660 a year, which is once again about average GDP per worker back then. enough to buy 170 pounds of veal cutlets or 500 pounds of pot roast or 1000 pounds of bread. It was hard to economize on food at the start of this century: food and fuel consume almost half of consumer expenditure for the average household in 1885, but only a fifth of consumer expenditure in 1987. G.H.M.: his food bills are roughly a quarter of his annual expenditure, while my non-restaurant food bills are less than a twelfth of mine (and I buy a lot of food at a much more advanced stage of preparation today than G.H.M. could back a century ago). Somebody spending average annual GDP per worker on pot roast today could buy not 500 pounds but instead 25000 pounds.

Professor G.H.M cannot afford to live within walking distance of campus. He cannot afford to keep a horse and carriage. So he must use one of the new technologies of the 1890s, and bicycle to work. A single case of appendicitis costs $1200--the same multiple of an average worker's income that $160,000 would be today.

Last, note G.H.M.'s plea for culture: he and his wife's long and sophisticated education "has given us a refined appreciation of the drama, and we have a knowledge of and love of the best music. The annual football game is a social event which every loyal member of the college community is supposed to attend. We cut this out long ago. Grand opera exists for us only in the memory of our German days. Let us keep the spark alive by taking our wives once a month to a cheap concert; say $1" [a month] $12 a year--perhaps 1 1/2 percent of annual per-worker spending--to to hear perhaps 18 hours of live music played by professional musicians. And how little his family gets for it! Even the wealth of 1900 feels to us like grinding poverty. And G.H.M. does believe he is near-poor: just one racing shell-length ahead of the working class, of being barely able to afford the necessities and some of the conveniences of life.

Yet before we feel too sorry for G.H.M., reflect that working-class families at the turn of the century lived much more differently from Professor G.H.M. than working class families do from his successors today. A few miles east of the anonymous G.H.M.'s college in 1905 was the steel town of Homestead, Pennsylvania. Steel jobs were good jobs at good wages--hard, brutal jobs, but good jobs that people held on to as hard as they could and crossed oceans to get.

Few households in Homestead in 1900 had running water or a hot water heater. Water came in buckets from a faucet in the street into the house, and then heat it on the stove. In the–relatively prosperous for its time–factory steel town of Homestead, Pennsylvania at the start of the twentieth century, only one in six working class households had indoor bathrooms in 1910. Half of "Slav" and "Negro" families lived in one or two room houses. Most white families lived in four room houses. And most households in Homestead in their one or two or four-room houses had boarders: male, unrelated, single workers sleeping and eating in the house. The work of the housewife thus brought income directly into the household. Remember the three farmhands in the Wizard of Oz, set in 1890s Kansas? Odds are they slept in the house with Dorothy, her Uncle, and Auntie Em--or they slept in the barn.

A quarter of American households in 1900 had boarders or lodgers (compared to two percent today). Half of American households in 1900 had fewer rooms than persons (compared to five percent today). A quarter of American households in 1900 had running water (compared to ninety-nine percent today). An eighth of American households in 1900 had flush toilets (compared to ninety-eight percent today). Less than a fifth had refrigerators, less than one-twelfth had gas or electric lights, less than one-twentieth had telephones or washing machines, and of course there were no radios or televisions or vacuum cleaners or central heating, to list just those major appliances that have greater than ninety percent coverage today.

And even if you did have a four room house, could you afford to heat more than one room of it? Many Homestead four-room houses became two-room houses--the kitchen and the bedroom--in the depths of the western Pennsylvania winter.

The diets of workers in Homestead, Pennsylvania at the turn of the century were composed primarily of meat of widely variable quality, bread, butter, potatoes, oatmeal, and tea and milk–with luxuries such as sweets added in more or less regularly. We would find the diet somewhat monotonous (however, a lot of time and effort went into Þnding different ways to make potatoes). Almost always the first luxury that a working-class family moving up would purchase would be the services of a laundress: since laundry was expensive and difficult, few working-class families could maintain upper-middle-class standards of cleanliness. How often would you take baths if the water had to brought in from an outside pump, and then heated on the stove? How often would you wash your clothes if everything had to be washed out in the sink, if the fabrics were three times as heavy and the detergents one-third as powerful as the ones available today, and if as a result the laundry was a full day’s chore? Hand laundry was not a two hour a week task. Those who could afford the resources to maintain bourgeois styles of cleanliness flaunted it. White shirts, white dresses, white gloves are all powerful indications of wealth in turn of the century America. They said "I don't have to do my own laundry and ," and they said it loudly.

As a rule married women did not work outside the home–unless they were African-American, in which case they might well do their own family’s housework and be paid for doing a share of some white family’s housework as well. Meal preparation was not a one-hour-a-day but a four-hour-a-day task. Barring a shift toward larger-scale communal or cooperative living–a shift which simply did not happen even though anticipated, hoped for, and worked for by many feminists–within-the-household production and maintenance soaked up one-third the potential adult work hours. It made it next to impossible for married women (unless they were quite rich, or quite poor) to have independent careers and still fulfill the social expectations of household maintenance.

Infant mortality at the turn of the century was high. One in five babies in Homestead, Pennsylvania died before reaching his or her Þrst birthday. Adult men died, too, like flies (and adult women faced substantial risks in childbirth). Accident rates in the factory were such as to leave 260 injured per year–30 dead–out of a total population of 25,000 and a steel mill working population of 5,000. Each year, five percent were injured enough to miss work for some time (although only one percent per year were permanently disabled), and 1/2 percent per year were killed in factory accidents.

You can do the math. Start to work for U.S. Steel when you are 20. There is one chance in seven that the factory will kill you before you reach 50, and almost one chance in three that the factory will disable you. Is it any wonder that life insurance–disability insurance--group lodges that provide benefits (because the company provides few)--loom so large in American working class consciousness at the turn of the century? And is it any wonder that the Þrst component of the welfare state put into place, in many parts of the United States, was workmen’s compensation? Of course, in 1910 Homestead (or in 1930 Detroit, or in Los Angeles today) the most arduous and difficult jobs were done by minorities and immigrants: in 1910 Homestead by Slavs, in 1930 Detroit by Blacks, and in 2000 Los Angeles by Hispanics. At the micro level, such groups are concentrated in the most arduous and lowest-paid jobs because they are poor, because they have limited other options.

Most of the Homestead workforce only worked six days a week: for four out of five workers, the mill was shut on Sundays. U.S. Steel viewed this--shutting most of the mill on Sundays–as a major concession on their part, a concession that they hoped would produce large public relations benefits. From U.S. Steel’s perspective, each hour that a modern plant like Homestead stood idle was tremendously expensive. Variable costs--wages, raw materials, and transportation--made up perhaps 2/3 of total costs. The remainder were fixed: capital costs on the construction of the plant, and maintenance that had to be performed whether the plant was operating intensively or not.

Were U.S. Steel to move from two 12-hour shifts a day to one 12-hour shift, its output would be halved but its costs would be reduced by only 1/3, so total costs per ton of steel made would rise by 1/3. This was not a margin that U.S. Steel could afford. As long as it could Þnd workers willing to work the night shift, the Homestead mill (depressions and recessions apart) stayed open 24 hours a day on weekdays. And when things did change, they changed all at once-from two 12-hour shifts before and during World War I, to two 8-hour shifts (or three 8-hour shifts) during the 1920s, and during and after World War II. Yet Homestead jobs--at least Homestead jobs taken by native-born Americans--were good jobs by the standards of the United States. As historian Ray Ginger put it:

their expectations were not ours. A man who grew up on a Southern farm did not think it cruel that his sons had to work as bobbin boys [collecting spun thread in a textile mill]. An immigrant living in a tenement and working in a sweatshop yet knew that for the Þrst time in his life he was wearing shoes seven days a week...

And Homestead, Pennsylvania jobs paid well both by the standards of the United States and much more so by the standards of the world economy of the time. White households could make around $900 (of 1910 value) a year, placing them well the upper third of the U.S. population in terms of income per household in 1910. Relative to what could be earned by people of similar skill levels anywhere else in the world, a job in the Homestead mill was a very attractive job. Even the unequal America at the turn of the century was a very attractive place compared to the rest of the world. America was exceptional. In spite of the hours, in spite of the risk of death or injury, in spite of the working conditions, these were very good jobs by international standards: jobs worth moving 7,000 miles for, from Hungary or Lithuania to suburban Pittsburgh. For the economy of the late nineteeth century was for the first time in human history a truly global economy, filled with long-distance trade and migration, so people could take advantage of the opportunities opened up by industrialization.

Slouching Towards Utopia? The Economic World of the Twentieth Century: Chapter 7.1: The World in 1900: The View from 1900

7.1: The World in 1900: The View from 1900

The View from 1900

What did the world look like in the last generation of the nineteenth century? It was a much emptier world: 1.2 to 1.5B people instead of our 6.4B. It was a much poorer world--of the 1.2B people in 1870 perhaps 1.0B lived like our preindustrial ancestors because they were our pre-industrial ancestors. It was a much less technologically-advanced world: the technological-industrial frontiers of that age were the oil well, the internal combustion engine and the electric light. Nevertheless, six processes were ongoing--not, from out perspective, in full swing but definitely ongoing--that were changing the world: industrialization, urbanization, globalization, marketization, colonization, and democratization.

Let's for a moment take a broader view, and pretend we are not just studying the past of our great-grandparents but take the perspective of a seventh-millennium professor teaching his or her class (or, perhaps more probably, downloading avatars into xe’s students’ personal AIs), with a very limited amount of time and attention span in which to flag key concepts and ideas. What would such a professor think were the things that students should remember about the world economy at the start of the twentieth century?

At most, seven things:

First, that the world at the start of the twentieth century–even the most advanced economies at the start of the twentieth century–were very, very poor relative to how they would be at the century’s end. But that was about to change.

Second, that the spread of ploughs that pulled themselves and looms that wove by themselves was about to end the pre-industrial era, and promise to make the world amazingly rich by all previous standards.

Third, that the ten thousand years in which people had lived largely in small groups in villages was about to end: people were starting to live in large groups in cities.

Fourth, that in the late nineteenth century transportation costs had finally fallen low enough and transport speeds had become high enough to make mass intercontinental shipment of goods and people possible: a global economy and, because of telegraph and all the rest, a global polity too. This fall in transportation costs had for the first time created the possibility of a global economy–an economy in which movements of people and goods across oceans and between continents were central to how the economy worked, rather than mere precious and luxury froth on the surface of a deep ocean.

Fifth, that this global economy was on its way to becoming a global market. The era in which goods were either consumed at home, consumed by you relatives, traded among your neighbors, or offered up to keep the thugs with spears or the thugs with quills from killing you was also coming to an end. Supply and demand would rule--which does not mean that thugs would not use force to manipulate supply and demand.

Sixth, that the fall in transport costs and rise in transport speeds had come about when the military-force gap between the North Atlantic and the rest of the world was at its maximum--which meant imperialism, formal or informal, and colonialism, open or masked.

Seventh, that the people were standing up politically. In proportion as populations became urbanized and as rural populations became commercialzed and plugged into the global communications network, politics became democratized: rulers found themselves depending in fact as well as in noble flights of fancy on the consent of the governed--a consent that could be extracted for a while at gunpoint or gramophonepoint.

Much of the economic history of the several decades around 1900--the period immediately before World War I--can be read as the working-out of the economic, political, and technological logic of the–relatively sudden--creation of the first true global economy. In the long run, however, the patterns of migration, of international investments, of the international division of labor, and of economic growth established in the decades before World War I would not last. They were destroyed by wars, politics, and changes in technology in the three decades after 1914. When the global economy and polity was knit back together in the decades after World War II, it was knit back together in a different pattern–and now it is reweaving itself into yet a different pattern still.

Hoisted from Archives: Upper-Class Living Standards in 1900

The past is a different country. Even the relatively recent past of, say, a century ago is a very different country.

In 1905 "G.H.M.", an anonymous college professor, wrote a four-page article for the Atlantic Monthly in which he pleaded for more money for college professor salaries, and claimed to be vastly underpaid. The first thing to note is the relative level of professorial salaries back then: he claimed that the "average college professor’s salary"--the salary that he saw as clearly inadequate and unfairly low--"is about $2,000." Stan Lebergott's estimates in the Historical Statistics of the United States are that the average annual earnings of an employee in America in 1905 were $490 dollars if employed for the entire year--or $451 taking account of the hazards of unemployment. What G.H.M. says is the average college professor's salary is more than four times annual average earnings of the time.

Today's professors don't make such large relative salaries (except in business, law, and medical schools). In order to match turn-of-the-century college professors in terms of income relative to the national average, a professor today would have to make an academic salary of roughly $250,000--a height far above any professorial average, and one attained only by academic celebrities.

The second thing to note is that our professor sees himself as a reasonable and badly underpaid man. He is not asking for what he would see as the "large salar[y], commensurate with what equal ability would bring in other lines of work ($10,000 to $50,000)"--or 20 to 100 times the then-current average level of GDP per worker, the equivalent today of between $1,100,000 and $5,500,000 a year. At 50 times average GDP per worker (roughly the mid-point of G.H.M.'s range, corresponding to a salary of $2.5 million a year), we are down to perhaps 4000 households in today’s United States (according to Piketty and Saez (2001)). That an "ordinary" professor could feel that his talents ought, in some sense, to earn such an enormous multiple of the average income is a sign of how unequal an economy and society the turn of the twentieth century U.S. was. Yet G.H.M.'s feeling of being sharply constrained by material necessity is real: as this professor goes through his budget, he expects the highly-literate and elite readers of the Atlantic Monthly to nod and agree (and we modern readers do indeed nod and agree) that his family is strapped for cash.

The first large expense G.H.M. lists is for personal services: "We must pay $25 a month for even a passable servant," and add to that $10 a month for laundry (for the regular "servants will do no laundry work") $1 a month for haircuts, and $2 a month for a gardener. Already, on personal services alone, we are up to $445 a year--the average annual earnings of a manufacturing worker in 1905.

G.H.M. offers two rationales for these large personal-service expenditures. The first is that they are necessary to keep the load of domestic work from sending his wife to an early grave. "Shall we expect our wives to bear and rear children, do all of the housework, sustain their social duties, and remain well and strong?"

The second rationale is that these expenditures are required for him to face the world without shame. For the professor, however, these expenditures on personal services are completely non-negotiable. If he doesn't spend, his household will fail to make a properly upper-middle-class impression: the lawn must be trimmed, the house dusted, the clothes cleaned, and the children washed. He has no gasoline-powered lawnmower, no electric hedge clippers, no vacuum cleaner, no dishwasher, and neither a washing machine nor a dryer. Consumer durables take the place now of what took servants' sweat (at least for college professors' households) a century ago.

G.H.M.'s food bills average $55 a month on food--enough back then to buy 170 lbs. of veal cutlets (present market value perhaps $1000), or 500 pounds of chuck roast (present value perhaps $1200), or 1000 lbs. of bread (present value perhaps $1300). Note that $55 a month works out to be $660 a year, again considerably more than a year’s average GDP per worker. G.H.M. spends more than 100% of an average worker's budget on food alone. In general it was hard to economize on food at the start of this century: food and fuel consume almost half of consumer expenditure for the average household in 1885, but only a sixth of consumer expenditure today. It is the same for G.H.M.: his food bills are roughly a quarter of his annual expenditure, while my non-restaurant food bills are less than a twelfth of mine (and I buy a lot of food at a much more advanced stage of preparation today than G.H.M. could back a century ago).

A third thing to note is the cost of (effective) medical care: $1200 to treat a single case of appendicitis. That's nearly three years' worth of an average worker's income--the same share of GDP per worker then that $160,000 would be today. Appendicitis today is a serious illness--but think what it was like before antibiotics, before laproscopy.

And a fourth thing to note is G.H.M.'s plea for culture: he and his wife's long and sophisticated education "has given us a refined appreciation of the drama, and we have a knowledge of and love of the best music. The annual football game is a social event which every loyal member of the college community is supposed to attend. We cut this out long ago. Grand opera exists for us only in the memory of our German days. Let us keep the spark alive by taking our wives once a month to a cheap concert; say $1." $12 a year--perhaps 1 1/2 percent of annual per-worker spending--to to hear perhaps 18 hours of live music played by professional musicians. And how little his family gets for it!

The overall impression to us is one of grinding poverty. And the overall feeling that G.H.M. has is of near-poverty--of being just one racing shell-length ahead of the working class, of being barely able to afford the necessities and some of the conveniences of life.

Yet according to GHM the average college professor stood in 1905 in roughly the same relative position in the distribution of income in America then as somebody in roughly the 99.5 percentile does today...

G.H.M. (1905), "What Should College Professors Be Paid?" The Atlantic Monthly 95:5 (May), pp. 647-50.

G.H.M. (1905), "What Should College Professors Be Paid?" The Atlantic Monthly 95:5 (May), pp. 647-50.

A great deal has been written of late, especially in the annual reports of college presidents, regarding the inadequacy of the compensation received by university teachers. The writer, to whom the question is one of vital importance, has seen many of these general statements, but has failed to find any which has taken up the matter in conclusive form. This he hopes to do here concisely.

Primarily the question is one of standard of living. If a grocery clerk can maintain his family in a suitable degree of decency and comfort on seventy-five dollars a month, have we a right to expect that a college instructor can do the same? The answer to this involves the demands which society makes upon the respective individuals.

To get at this point the writer analyzed the itemized household accounts which his wife has kept for the past nine years, during which time he has been connected with one of our large and wealthy universities. Two years were spent as an instructor, two as assistant professor, and the next five as associate professor.

Summing up his total expenditures for these nine years, and in like manner his salary for the same period, he finds his expenditures have been to his salary in the ratio of 2.1 to 1.

His average annual expenditure has been $2794.27.

His average salary has been $1328.15

For the privilege of teaching he has paid the difference, of $1466.12 annually, from private means.

Even the unbusinesslike professor must pause before such a state of affairs, and try to fathom the reason for this discrepancy, when his firm belief is that he is living on as low a scale of economy as is possible for him in his position.

In order to find out where the bad management might be, -- if bad management there was, -- he divided his expenditure account into thirty-one separate items, arranged in tabular form under the following heads: --

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He believes that, assuming that a college professor has the right to marry and have two or three children, there is not a single one of these items which may be omitted from a consideration of expenses to cover a period of years. The whole question, then, resolves itself into this: how much per year is it reasonable to allow for each of these items?

In the community in which he lives, with a family of two adults, two children, and one servant, at the present high prices of the necessities of life, he believes that the sums he mentions are the very least upon which his household can be conducted. And he bases this belief upon a most accurate analysis of fully itemized accounts.

Taking up the items in detail: --

1. Household furnishing and repairs. This item must cover, for a period of years, the original cost of household furniture of all descriptions. In addition, it must look after natural wear, tear, and breakage of furniture, glass, dishes, kitchen utensils, rugs, curtains, bedding, etc., as well as carpentry, plumbing, and the like. It must also provide for pictures, "works of art," and household adornments in general. Does $75 a year seem excessive for this? Say $6 a month.

2. For five persons a grocery bill of $25 per month, a meat bill of $15, milk $5, fruit, vegetables, butter and eggs, $10, or a total of $55 ($11 per person), should not seem unreasonable.

3. We must pay $25 a month for even a passable servant. Shall we expect our wives to bear and rear children, do all of the housework, sustain their social duties, and remain well and strong?

4. Kitchen, fireplace, and furnace fuel will aggregate $120 per year, or $10 a month.

5. Light and water average with us just $5 a month.

6. The labor of a gardener one day a month is $2.

7. Our laundry averages just $10 monthly. Our servants will do no laundry work.

8. An investment of $5000 in house and lot, together with personal property and poll tax, makes this $10 a month. If there were no house owned, the rent item (11) would have to be increased.

9. To protect the family of a man who is not in a position to save, $5000 life insurance is not too much. The monthly premium on this amount, assuming a twenty-payment ordinary life policy, will be $10.

10. $3000 insurance on house, and $2000 on personal property, makes $18 per year, or $1.50 a month.

11. Six per cent on $5000 invested in house and lot is $300 annually, or $25 a month. This does not provide for depreciation, maintenance, and repairs. No desirable house on the campus can be rented for less than $35.

12. Not caring to pay so large a rent, we live off the campus and use bicycles. Their depreciation and repairs average $2 a month. Keeping a horse would cost $8 a month.

13. An experience of ten years shows us that not less than $10 a month may be set down for doctors and dentists for the family. A single attack of appendicitis in ten years will take the whole of this.

14. Hospitals, nurses, and drugs average $5 a month.

15. Since the average duration of life is about forty years, in a family of four individuals one death is to be expected every ten years. this item may be set down at $2 a month.

16. Occasional notary and minor legal services average $1 a month.

17. Certain expenses, like life insurance and taxes, being payable in large amounts, necessitate loans from the bank, which are gradually repaid. This item may be set down at fifty cents monthly.

18. For a live family with connections, postage, stationery, telegrams, telephones, express, freight, cartage, and allied items, will aggregate $3 a month.

19. Newspapers, books, and periodicals. A college professor is supposed to revel in this kind of thing. Suppose we allow him $5 a month.

20. To clothe four individuals neatly and completely cannot cost less than $180 a year, can it? This is $15 a month.

21. Learned society and social club initiation fees and dues must amount to at least $2 monthly.

22. University gifts and supplies, typewriting, etc. We are constantly going into our pockeets for small items which the university will not or cannot furnish without unbearable delay; or we may be working on lines of investigation that call for outlay. Say $1 a month.

23. In our case, our children are of the kindergarten and primary school age, so this item is only $9 a month. Older colleagues, whose children have advanced to the music lesson and preparatory school age, say they must allow $50 to $60 monthly.

24. Some families belong to a church. We all have charitable instincts, we are of that class to which the call of needy or suffering humanity appeals. May we allow $2 a month?

25. Our education has given us a refined appreciation of the drama, and we have a knowledge of and love of the best music. The annual football game is a social event which every loyal member of the college community is supposed to attend. We cut this out long ago. Grand opera exists for us only in the memory of our German days. Let us keep the spark alive by taking our wives once a month to a cheap concert; say $1.

26. We have children and friends; there are birthdays and anniversaries; as well as Christmas. Is $50 a year too much? This is $4 a month. Dinners, receptions, and the like, are not for us.

27. Occasionally a man is jaded; he has a wild desire to "blow himself." May he have $1 a month pocket money, to share with his wife?

28. Most of us can shave ourselves, but we cannot cut our own hair, although we may invert a bowl over the heads of our youngsters, and trim around the edges. Here is another $1.

29. When summer comes, a teacher is pretty nearly always exhausted. His work is trying and confining. His family requires an occasional change of air. His professional needs may call for a long journey to attend an important meeting of fellow workers, etc. For an average geographical location $100 a year, or $8.50, is not too much to cover these items. For an exceptional location, like the extreme Pacific coast, this item should be trebled.

30. The writer has known many colleagues whose educational expenses had put them under obligations which they were pledged to repay. In most cases it takes ten years to wipe out these obligations. Sometimes at the end of this period not even the beginning of discharging the debt has been made. Our college professors often come from families whose means are small. The support of aged parents or other relatives may have to be borne by them in common with their brothers or sisters. Every man is apt to have some such claim on himself or his wife. To cover these items let us allow him $10 a month.

31. A few, a very few, of our colleges pay pensions to their old and worn-out teachers. In such cases perhaps there is no need for a man to lay aside something for his old age, or to make provision for his children's start in life. Perhaps he owes a duty to his children to give them as good an education and chance as he himself received. If so, he must begin to lay aside for it. Where there is no pension, should he not aim, after thirty years of faithful service, to have $10,000 laid aside? He is not in a position to know of places where he can get large returns on his small investments. Shall we allow him $250 a year to put aside (providing there are no "exceptional and unusual" expenses that year, as there always are)? Let us say $20 per month.

SUMMARY

These are certainly not great demands. Yet, summing them up, taking the smaller of the two when two sums are mentioned, we have $262.50 monthly, or $3150 per year. Let us talk no more of bad management, -- we and our wives face an impossible problem.

CONCLUSION

If this seems extravagant to those who have to determine upon the proper minimum compensation for a man of long training, education, and refinement, we must ask them to look over these items carefully, one by one, and put down what they think a fair sum for each item for a family of the college professor's social status. Then let them foot up the total. The average college professor's salary, in the United States, is about $2000. The inevitable deduction from the table of analyzed expenses, borne out by the experience of the writer and of all his colleagues whom he has consulted, is that this must be increased sixty per cent, -- the increase to be uniform in all grades, from instructor to head professor.

If the profession of teaching is to attract the highest type of efficient manhood, a living salary must be paid. A man who devotes his life to the cause of the advancement of education must feel a "call" to it. He should be of a type which joyfully relinquishes all desire to accumulate worldly wealth or to live in luxury. Large salaries, commensurate with what equal ability would bring in other lines of work ($10,000 to $50,000) might be just, but would be undesirable, as they would tend to serve as bait to attract mercenary and lower types of men.

but a man fit to occupy a chair in a university shoul dbe paid enough to enable him to live in decency and comfort, rearing and educating his children, and retiring in his old age to something other than absolute penury.

The writer would commend a careful study of his table to all college trustees.

Can a man, whose energies are spent in so unequal and impossible a struggle to make both ends meet, maintain freshness and vigor in his work, be an inspiration to his students, and fulfill in scholarship the promise of his early years? The alternative demanded by the conditions is celibacy.

The First Wave of Globalization

A few guestimates...

Paul Krugman Says: Recessions Are Evil!

His strictures against neo-Hayekian economics. It is the best refutation of investment-overshoot-plus-frictional-adjustment around. From BobbyK's Paul Krugman archive:

THE HANGOVER THEORY: Are Recessions the inevitable payback for good times? SYNOPSIS: The constantly occuring idea of helpful recessions is incoherent and faulty

A few weeks ago, a journalist devoted a substantial part of a profile of yours truly to my failure to pay due attention to the "Austrian theory" of the business cycle--a theory that I regard as being about as worthy of serious study as the phlogiston theory of fire. Oh well. But the incident set me thinking--not so much about that particular theory as about the general worldview behind it. Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.

The hangover theory is perversely seductive--not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.

Powerful as these seductions may be, they must be resisted--for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality--with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression--with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.

The many variants of the hangover theory all go something like this: In the beginning, an investment boom gets out of hand. Maybe excessive money creation or reckless bank lending drives it, maybe it is simply a matter of irrational exuberance on the part of entrepreneurs. Whatever the reason, all that investment leads to the creation of too much capacity--of factories that cannot find markets, of office buildings that cannot find tenants. Since construction projects take time to complete, however, the boom can proceed for a while before its unsoundness becomes apparent. Eventually, however, reality strikes--investors go bust and investment spending collapses. The result is a slump whose depth is in proportion to the previous excesses. Moreover, that slump is part of the necessary healing process: The excess capacity gets worked off, prices and wages fall from their excessive boom levels, and only then is the economy ready to recover.

Except for that last bit about the virtues of recessions, this is not a bad story about investment cycles.... But... [w]hy should the ups and downs of investment demand lead to ups and downs in the economy as a whole?... [T]he key to the Keynesian revolution in economic thought--a revolution that made hangover theory in general and Austrian theory in particular as obsolete as epicycles--was John Maynard Keynes' realization that the crucial question was not why investment demand sometimes declines, but why such declines cause the whole economy to slump.... As a matter of simple arithmetic, total spending in the economy is necessarily equal to total income.... [I]f people decide to spend less on investment goods, doesn't that mean that they must be deciding to spend more on consumption goods--implying that an investment slump should always be accompanied by a corresponding consumption boom? And if so why should there be a rise in unemployment?

Most modern hangover theorists probably don't even realize this is a problem for their story. Nor did those supposedly deep Austrian theorists answer the riddle. The best that von Hayek or Schumpeter could come up with was the vague suggestion that unemployment was a frictional problem.... But... why doesn't the investment boom--which presumably requires a transfer of workers in the opposite direction--also generate mass unemployment?...

A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money? You may tell me that it's not that simple, that during the previous boom businessmen made bad investments and banks made bad loans. Well, fine. Junk the bad investments and write off the bad loans. Why should this require that perfectly good productive capacity be left idle?

The hangover theory, then, turns out to be intellectually incoherent.... Few Western commentators have resisted the temptation to turn Asia's economic woes into an occasion for moralizing on the region's past sins. How many articles have you read blaming Japan's current malaise on the excesses of the "bubble economy" of the 1980s--even though that bubble burst almost a decade ago? How many editorials have you seen warning that credit expansion in Korea or Malaysia is a terrible idea, because after all it was excessive credit expansion that created the problem in the first place?

And the Asians--the Japanese in particular--take such strictures seriously.... [T]hey are in trouble partly because they insist on making hard choices, when what the economy really needs is to take the easy way out. The Great Depression happened largely because policy-makers imagined that austerity was the way to fight a recession; the not-so-great depression that has enveloped much of Asia has been worsened by the same instinct. Keynes had it right: Often, if not always, "it is ideas, not vested interests, that are dangerous for good or evil."

Yet More Seminars to Go to This Semester

David Romer's Econ 291--unfortunately, it's W 4-5:30, and that's when Jim Powell scheduled me to teach...

Econ 291, Fall 2007:

*September 12: Raghuram Rajan, University of Chicago: "The Persistence of Underdevelopment: The Role of Constituencies and Competitive Rent Preservation" * September 26: Peter Klenow, Stanford University: "Misallocation and Manufacturing TFP in China and India" * October 10: Samuel Kortum, University of Chicago: "Unbalanced Trade" * November 7: Nathan Nunn, Harvard University: "Ruggedness: The Blessing of Bad Geography in Africa" * November 28: Enrico Moretti, University of California, Berkeley: "To Be Announced" * December 5: Emmanuel Saez, University of California, Berkeley: "Uncovering the American Dream: Inequality and Mobility in Social Security Earnings Data since 1937"

Dollar Diplomacy

Niall Ferguson praises the Marshall Plan, and cites yours truly:

Dollar Diplomacy: Books: The New Yorker: This positive reassessment echoes the argument advanced in the early nineties by Brad DeLong and Barry Eichengreen (in an article that is absent from Behrman’s bibliography). Marshall Aid was indeed vital, but more in terms of political economy than macroeconomics. It helped get the European economies through a balance-of-payments crisis, to be sure. More important, though, it helped European governments balance budgets and reduce inflation. It forced them to shift from wartime controls to free-market mechanisms. And it played an important part in moving Europe from a dysfunctional system of labor relations based on strike action and class conflict to one based on wage restraint and productivity growth. In all of this, the Marshall Plan resembled the “structural adjustment programs” the International Monetary Fund imposed on borrowers in the developing world during the nineties, but on a larger scale and with much better public relations. As Marshall had foreseen, tackling the food bottleneck was beneficial both materially and psychologically. One Dutch baker displayed a sign that read, “More than half of your daily bread is baked with Marshall wheat.” Wherever the red-white-and-blue Marshall shield could be seen, its motto resonated: “For European Recovery: Supplied by the United States of America.” The most important strings attached to such supplies were the ones tying Europe to the new American model of managerial capitalism.

Behrman goes still further, however. He also sees the Marshall Plan as having been instrumental to the process of European economic integration, presaging today’s European Union in the Organization for European Economic Cooperation. And he accepts the claim that the Marshall Plan defused potentially revolutionary situations in Western Europe and helped prevent a Communist tide from engulfing West Berlin, Italy, and perhaps even France. He has no interest in the once fashionable arguments of Cold War revisionists that the Plan was—in the memorable phrase of Stalin’s economic adviser Yevgeny Varga-—“a dagger pointed at Moscow.” If the Soviets chose to decline Marshall Aid for themselves and their clients, more fools they. The notion that Marshall and his colleagues aimed at “economic and political subjugation of European countries to American capital,” to quote another Soviet source, is presented as unworthy of serious consideration.

His is a timely book, reminding us of the good things that the United States has achieved within living memory. Not for nothing do economists call aid payments “unrequited transfers.” It is also useful to recall just how poisonously partisan Washington was after 1947, as Joseph McCarthy’s witch hunt gathered momentum. This was no golden age of cross-party consensus. Yet there is a need for caution. Historians have a duty to immerse themselves in contemporary testimony, as Behrman has clearly done. But they must also beware of uncritically accepting contemporary judgments....

Ultimately, the North Atlantic Treaty mattered more than the Marshall Plan in checking the Soviet advance. In all likelihood, then, Western Europe could have pulled through without the Marshall Plan. But it certainly could not have pulled through without the United States. At the time that Marshall made his speech in Harvard Yard, no one could be sure that all would turn out for the best in postwar Western Europe. No one could even be sure that the United States would deliver on Marshall’s pledge. All people could remember was the sad sequence of events that had followed the previous World War, when Western Europe was swept by general strikes and galloping inflation, while the United States Senate reneged on Woodrow Wilson’s “plan” for a new order based on collective security. The Marshall Plan was not the only difference between the two postwar eras, but, to West Europeans struggling to make ends meet, it was the most visible manifestation of American good will—and a mirror image of the Soviet policy of mulcting Eastern Europe. This, more than its macroeconomic impact, explains its endurance in the popular imagination. At a time when, according to the Pew Research Center, only thirty-nine per cent of Frenchmen and thirty per cent of Germans have a positive view of the United States, that is something worth remembering, and pondering.

Recommending "The Strange Death of Tory England"

Another book I should add to the pile:

On its last legs or healthy enough to be milked?: In The Strange Death of Tory England, a book full of great lines, Geoffrey Wheatcroft writes,

Just as the labour movement had never been quite sure whether the capitalist system was on its last legs and needed only a final push to be toppled, or was healthy enough to be milked over and again, so the cultural-intellectual left had never quite decided whether it liked increasing prosperity or not.

I highly recommend this book to anyone who has a sense of who's who in British politics of the past 40 years. It's the best political book I've read in awhile--maybe it helps to read about another country, it gives some distance on things.

Anyway, I like the above quote. I would add something analogous for conservatives, that they have never been quite sure whether the capitalist system is an amazing wealth machine with even low-income people being rich on an absolute scale, or whether the system is so fragile that people can barely afford to pay their taxes and that any particular tax or regulation will bankrupt the system. [Unfortunately, try as I might, I can't manage to phrase this as aphoristically as Wheatcroft did]...

Larry Summers Asks Questions: Why Haven't the Conforming Mortgage Cap Amounts Been Raised?

Larry Summers:

Economists' forum: A premise of the US financial system is that banks accept much closer supervision in return for access to the Federal Reserve’s payments system and discount window. The problem this time is not that banks lack capital or cannot fund themselves. It is that the solvency of a range of non-banks is in question, both because of concerns about their economic fundamentals and because of cascading liquidations as investors who lose confidence in them seek to redeem their money and move into safer, more liquid investments. Central banks that seek to instil confidence by lending to banks, or reducing their cost of borrowing, may, as the saying goes, be pushing on a string. Is it wise to push banks to become public financial utilities in times of crisis? Should there be more lending and/or regulation of the non-bank financial institutions?...

[W]hat is the role for public authorities in supporting the flow of credit to the housing sector? The lesson learnt during the S&L debacle was that it was catastrophic to finance home ownership through insured banking institutions that borrowed short term and then offered long-term fixed-rate home mortgages. Now a system reliant on securitisation, adjustable rate mortgages and non-insured financial institutions has broken down.

I am among the many with serious doubts about the wisdom of the government quasi-guarantees that supported the government-sponsored entities, Fannie Mae, the Federal National Mortgage Association, and Freddie Mac, the Federal Home Loan Mortgage Corp , as they have operated in the mortgage market. But surely if there is ever a moment when they should expand their activities it is now, when mortgage liquidity is drying up. No doubt, credit standards in the subprime market were too low for too long. Now, as borrowers face higher costs as their adjustable rate mortgages are reset, is not the time for the authorities to get religion and discourage the provision of credit...

These are wise questions. I don't understand why the conforming mortgage dollar caps have not already been raised substantially.

We Bought a Prius

It makes financial sense given the likely future trajectory of gasoline prices. And it is lots of fun to be driving a car that is an exciting piece of technology.

Moreover, trying to maximize one's gas mileage in the Prius by maximizing regenerative braking and minimizing friction braking losses is a highly cool video game one can play.

more later...

Jim Hamilton: Latest Economic Indicators

Jim Hamilton writes:

Econbrowser: Latest economic indicators: New home sales picked up in July, and new orders for durable and capital goods grew strongly. But that was then and this is now.... [T]he seasonally unadjusted drop in home sales from June to July was more modest than might be expected in a typical year. Even so, it's unquestionably still been a pretty bad year.... On the other hand, there's no denying that today's numbers for manufacturing orders from the Census Bureau were quite strong. New orders for durable goods were up 5.9% within July alone.... But all these numbers predate the fun and games in financial markets of the last two weeks, which continued yesterday with more Fed injections to the tune of $14 billion in 12-14 day repurchase agreements (meaning those reserves will come back out of the system in two weeks) and $3.5 billion in overnight. This again came on a day when the effective fed funds rate ended up at only 4.88%, confirming that the Fed is not currently targeting the effective fed funds rate. It's also interesting that the recent trend in which there is a huge range of prices at which fed funds get traded each day is continuing....

One interpretation consistent with all this is that there are two sets of banks, one of which, despite the high level of excess reserves in the system, needs to offer over 5% to obtain funds, and the others which could usually borrow at a much lower rate. The goal of the repeated reserves injections is perhaps then to keep the former from paying too much over the 5.25% "target". That would also be consistent with the otherwise mysterious decision of four big banks to borrow 30-day funds from the Fed at 5.75%.

And it also suggests that the liquidity crunch for such institutions is far from over, making it difficult to expect today's good news on home sales and capital goods orders to be repeated next month.

What Is A Bank?

Buce has a nice take on the subprime crisis:

Underbelly: Matt Yglesias and the Great Depantsing: Matt Yglesias has an uncharacteristically (for Matt) unsophisticated post up about the mortgage meltdown and the practice of banking (link). Matt puzzles over why the mortgage meltdown is creating such a pervasive problem. He discovers that the mortgage enterprises are, in some sense, like banks, and finds this insight, on the whole, comforting....

What’s a bank? The conventional old-style definition is that a bank is an entity that (a) takes deposits and (b) makes loans. Fair enough, but consider a life insurance company.... I read somewhere that Toyota isn’t a car company, it’s just a bank that happens to sell cars.... [F]or Toyota—-indeed for any car company, maybe for any big-ticket inventory seller—-the installment credit side of the business may come to dominate, leaving the “inventory” side as some kind of a loss leader. This is the kind of pitch banks make when they argue that they play on an unfair playing field—-they are constrained by regulation, but others are not.

I’ve got a lot of sympathy with this argument, but... at the end of the day... banks really are different from any other kind of enterprise. Banks are party of a system that runs on trust, and once trust ends, the whole system unravels. So banking is the only system in which one does not gain from the failure of one’s competitor. I’ve heard people describe it as the situation you get in a rugby scrum when somebody loses his pants: all the players mill around and make a racket while the unfortunate recovers his dignity. Then they give high fives all round and charge off again down field. I must say, I don’t envy Ben Bernanke tonight, as he tries to play “lender of last resort” (cf. Charles Kindleberger, passim (link)) for an entire galaxy. Is anyone strong enough to rectify the great depantsing. Anyone? Anyone?

I would say this: I think a bank is something (a) takes deposits, (b) provides loans, (c) pretends to its depositors that their money (its liabilities) are more liquid than its assets, (d) collects net interest as a result, and (e) gets away with it almost all the time.

For those times when it looks like they might not get away with it, we have reserve requirements, capital standards, central banks, and other lenders of last resort.

New Home Sales and Recessions: The Graph

Courtesy of Calculated Risk:

So far we have dodged the recession bullet. I am not quite sure how. It may be that what we see in 1973-5, 1979-82, and 1990-1 is restrictive inflation-fighting monetary policy raising interest rates and thus curbing spending of all kinds, including spending on new homes. In 2000-1 we didn't see those kinds of interest rate increases--and hence the recession caused by the bursting of the dot.com bubble wasn't associated with a sharp fall in new home sales. Now we have a very sharp fall in new home sales, but will it carry the rest of the economy down with it?

Stay tuned...

Algorithmic Trading Strategies Are Short the Volatility of Volatility in the Short Run, but Long the Volatility of Volatility in the Long Run

I think this from the thoughtful and intelligent Emanuel Derman is wrong:

Emanuel Derman's Blog: Algorithmic Trading Strategies: It always seemed to me, and recent occurences seem to confirm it, that most algorithmic trading strategies are long volatility but short volatility of volatility...

It seems to me that this is probably wrong in a subtle fashion. When volatility declines, the value of the current positions held by a smart algorithmic trading strategy are likely to rise--it is going to report gangbusting profits in its current accounting period. But the decline in volatility means that it has little opportunity to exploit mispricings now and in the future. So when volatility declines funds pursuing smart algorithmic trading strategies are worth less of a premium going forward. So a fall in volatility should lead them to (a) report large profits, but (b) cut their fees because they can offer less value-added in the future, and (c) reduce their scope of operations.

By contrast, a rise in volatility sees funds pursuing smart algorithmic trading strategies get absolutely hammered. But they have great opportunities going forward.

Hence we right now have the interesting spectacle of people saying today: (a) we lost half our clients' money, but (b) our strategies are sound and (c) are opportunities going forward are unbelievable, so (d) you should invest and (e) we should raise our fees because we can offer more value added, and (f) we are expanding our operations.

The problem of course, is that when you have just lost half your clients' money it takes either an incredibly sophisticated or an incredibly unsophisticated investor to take that as a sign of your fundamental excellence. See, once again, Shleifer and Vishny. See also John Meriwether, trying to make these points to his investors in the LTCM context in 1998: http://delong.typepad.com/sdj/2005/06/an_historical_d.html.

The Rhetoric of Undervaluation and Overvaluation

Felix Salmon writes:

Finance Blog - Market Movers by Felix Salmon: Paulson Hoist on His Own Petard (Yuan Version) - Portfolio.com: Most analyses of the value of the yuan show it to be undervalued, some by as much as 40% relative to the dollar. Congress, unhappy about the huge trade deficit with China, has threatened to impose sanctions if China does not allow its currency to appreciate. (Aside: this desire for a rise in the yuan falls in the category of "be careful what you wish for," since a lower trade deficit also means lower capital inflows. In other words, kiss cheap foreign funding goodbye).

China responds badly to threats, so Paulson looked to the IMF to act as an honest broker. But that move has backfired spectacularly, with the IMF declaring the dollar to be overvalued. The focus was supposed to be on the yuan and how the Chinese needed to stop meddling; now it has shifted to the dollar, and by implication, our low savings rate (the Chinese have taken the position that it is we, not they, that need to get their house in order). And since the US hasn't gotten what it wanted, it is now demonizing the very organization it once touted as expert and fair.

From Bloomberg:

Treasury officials recruited the IMF to be a currency cop as China and other countries meddle with exchange rates to gain a trade advantage. Instead, the international lending organization took aim at the dollar, calling it overvalued in an Aug. 1 report.... "The U.S. Treasury has cut the legs from under the IMF before it even started the race," said Michael Mussa, the IMF's chief economist from 1991 to 2001 and now a fellow at the Peterson Institute in Washington. "This was foolish and unnecessary when they could have just said nothing."

By rejecting the IMF's analysis, the Treasury may have jeopardized its own effort to use international leverage to help narrow China's $118 billion trade surplus with the U.S. Members of Congress are threatening sanctions if the Treasury doesn't succeed in getting China to stop suppressing the value of its currency....

IMF staff economists told U.S. officials in meetings ended July 27 that their research showed the dollar was 10 percent to 30 percent overpriced, according to an account included in the 54-page Aug. 1 report...

"Overvalued" is, as I discovered at my personal lifetime analytical nadir in the summer of 1994, a delicate term of art. One first has to figure out what sustainable equilibrium long-run capital flows are and are going to be. One then has to figure out what exchange rate will in the long-run produce a current account balance that corresponds to those capital flows. Only then can one talk about overvaluation and undervaluation. In the end, perhaps, "overvaluation" means "net capital inflows should or must or will drop," and "undervaluation" means "net capital inflows should or must or will rise."

The problem, I think, is that the IMF worries about "global imbalances," and imbalances always have two sides. The Bush administration thought it could use the IMF to do some China-bashing, and then use that to appease Congress and so discourage Congress from doing any serious China-bashing.

Jonathan Spence on the Qing Dynasty at Its Apogee

From Jonathan Spence, In Search of Modern China: On the shaky grasp the Qing Dynasty held on China even in its early days of apogee:

Spence, pp. 72-73: [The Emperor] Kangxi... seems to have accepted... that no comprehensive new survey [of land] was possible under existing social circumstances; he also perpetuated the late Ming sytem in which the taxes... were commuted to silver. Only a small fraction of this money stayed in the counties.... Local officials sought to supplement their resources with a wide range of extra surcharges... for themselves... superiors... or... presents to Peking to make sure that the relevant ministries did not investigate their conduct too closely.

As a consequence... life in the rural areas remained a grim struggle... bandits... no paid and armed militia to oppose them... junior staff... little recourse for minors or widows.... Private feuds often led to violence and homicides that harried officials had neither the time nor the staff to investigate....

In 1712 [Kangxi] froze the assesments of able-bodied men registered as working a given area of agricultural land and decreed that however much the population increased in a particular area, the state would not thereby raise that area's taxes. Local officials could thus report population increases accurately, without fearing the burden of a raised assessment....

China's land-tax system was now doubly frozen: land... remained registered according to... 1581... Emperor Wanli... numbers subject to tax assessment... based on... 1712.... This was seriously to impede any attempt by Kangxi's successors to rationalize China's finances...

Bring Back the Punchbowl!

Martin Wolf says that the Federal Reserve must make sure that American households keep spending:

FT.com / Columnists / Martin Wolf - The Federal Reserve must prolong the party: Has the Federal Reserve been a serial bubble-blower? Or has it been responding to exceptional macroeconomic conditions? Not surprisingly, the implication of Ben Bernanke’s celebrated speech on the global “savings glut” implies the second view. Yet his self-exculpatory perspective is far from universally shared. So who is right? My answer is both. The Fed can indeed be accused of being a serial bubble-blower. But this is... because it has been managed by competent people responding to exceptional circumstances....

[There] is an excess of savings over investment (or income over spending) in much of the world, largely offset by an excess of investment over savings (or spending over income) in a limited number of countries among which the US is predominant.... The US has been the world’s spender and borrower of last resort.... [E]xcess savings elsewhere have been “crowding in” US spending. How has this worked?... [F]oreign governments did supply as much as 48 per cent of the net financing of the US current account deficit. This should be viewed as “vendor finance”, intended to provide the US with money needed to buy the exports.... If foreigners are net providers of funds, some groups in the US must be net users: they must be spending more than their incomes.... The US government moved massively from financial surplus into deficit.... Household spending grew considerably faster than incomes from the early 1990s to 2006. By then they ran an aggregate financial deficit of close to 4 per cent of GDP. Nothing comparable had happened since the second world war, if ever....

[T]he Fed has, willy nilly, pursued a monetary policy capable of inducing a huge and unprecedented financial deficit among US households... through... asset-backed borrowing and lending.... Nothing that has happened has been a product of Fed folly alone.... US households must spend more than their incomes. If they fail to do so, the economy will plunge into recession unless something else changes elsewhere.

This is why the Fed is sure to cut interest rates if today’s crisis seems likely to reduce the supply of credit (as surely it will).... Today’s credit crisis, then, is far more than a symptom of a defective financial system. It is also a symptom of an unbalanced global economy. The world economy may no longer be able to depend on the willingness of US households to spend more than they earn. Who will take their place?

I share Martin Wolf's belief that if housing prices start to collapse and thus credit and spending fall, the Fed will rapidly respond by lowering interest rates. It will do that as long as there is a sweet spot where it can do so without igniting inflation. But what will happen if it then turns out that inflation is ignited, and there is no sweet spot?

Why, Yes, I Am Picking Up Another Course from Scratch, Now that You Mention It...

A very rough cut at the syllabus:

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Political Economy 101: "Modern" Political Economy

http://delong.typepad.com/pe101/

J. Bradford DeLong, 601 Evans, 925-708-0467, delong@econ.berkeley.edu, T 12:30-2:30 and by appointment.

TTh 11-12:30 Hearst Annex A1

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August 28: Overview of the Course

Readings: "Notes: Political Economy at Berkeley Overview"

Assignments: Web assignment 0: introductions due by noon on August 29

August 30 and September 4: The World in 1900: Colonization, Democratization, Marketization, Industrialization"

Readings: "Notes: The World in 1900". John Hobson, "Imperialism" http://www.econlib.org/library/YPDBooks/Hobson/hbsnImptoc.html. Joseph Schumpeter, "Imperialism" http://www.mises.org/books/imperialism.pdf. George Orwell, "Shooting an Elephant" http://gutenberg.net.au/ebooks02/0200141.txt. Friedrich Hayek, “The Use of Knowledge in Society” http://www.econlib.org/library/Essays/hykKnw1.html. Karl Marx and Friedrich Engels, "Manifesto of the Communist Party" http://www.marxists.org/archive/marx/works/1848/communist-manifesto/index.htm.

Assignments: Web assignment 1: Hobson vs. Schumpeter due by 5 PM on September 7

September 6: NO CLASS

September 11 and 13: World War I

Readings: "Notes: The Strange Death of the Classical Liberal World." Norman Angell, "Peace Theories and the Balkan War" http://www.gutenberg.org/files/11895/11895-8.txt. John Maynard Keynes, "The Economic Consequences of the Peace" http://socserv2.socsci.mcmaster.ca/~econ/ugcm/3ll3/keynes/peace

Assignments: Web assignment 2: why was Norman Angell wrong? due by 11 AM on September 13

September 18 and 20: The Interwar Crisis

Readings: "Notes: Failing to Rebuild the Classical Liberal World." John Maynard Keynes, The End of Laissez-Faire http://www.panarchy.org/keynes/laissezfaire.1926.html. John Maynard Keynes, Essays in Persuasion (New York: W.W. Norton: 0393001903). Barry Eichengreen, “Hegemonic Stability Theories of the International Monetary System” http://www.nber.org/papers/W2193

*Assignments: Web assignment 3: John Maynard Keynes's mission due by 11 AM on September 18

September 25 and 27: Trapped between Hitler, Stalin, Mao, and Tojo

Readings: "Notes: World War II." George Orwell, "The Road to Wigan Pier" http://gutenberg.net.au/ebooks02/0200391.txt. George Orwell, "Homage to Catalonia" http://gutenberg.net.au/ebooks02/0201111.txt. John Maynard Keynes, "Trotsky on England" http://www.marxists.org/history/etol/document/comments/keynes01.htm

Assignments: Web assignment 4: George Orwell's dilemmas due by 11 AM on September 25

October 2 and 4: The Post-WWII Order: Social Democracy and Bretton Woods

Readings: "Notes: Building Social Democracy." Karl Polanyi, The Great Transformation (Boston: Beacon Press: 080705643X). Robert Bates, "Lessons from History" http://links.jstor.org/sici?sici=0002-8282%28199305%2983%3A2%3C409%3AWIRSCT%3E2.0.CO%3B2-G. Roosevelt’s Inaugural Address, 1933 http://www.yale.edu/lawweb/avalon/presiden/inaug/froos1.htm. Bradford DeLong and Barry Eichengreen, "The Marshall Plan" http://econ161.berkeley.edu/pdf_files/Marshall_Large.pdf

Assignments: Web assignment 5: Polanyi's well-governed market due by 11 AM on October 2

October 9 and 11: Really Existing Socialisms; Really Existing Nationalisms

Readings: "Notes: Socialisms and Nationalisms." Benedict Anderson, Imagined Communities (London: Verso: 1844670864) Milovan Djilas, The New Class (New York: Harvest/HBJ: 015665489X). Karl Marx, "Wage Labour and Capital" http://www.marxists.org/archive/marx/works/1847/wage-labour/index.htm.

Assignments: Web assignment 6: Anderson or Djilas due by 11 AM on October 9

October 16 and 18: Politics, Markets, and Bureaucracies

Readings: "Notes: Thirty Glorious Years and Twenty Not So Great Ones." Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press: 0226264211). Charles Lindblom, Politics and Markets (New York: Basic Books: 0465059589). Ronald Coase, “The Problem of Social Cost” http://www.sfu.ca/~allen/CoaseJLE1960.pdf

Assignments: Web assignment 7: Friedman's challenge due by 11 AM on October 16. First 1000-word paper due on October 19.

October 23 and 25: Late Development: Failures

Readings: "Notes: Difficulties of Late Industrialization." James Scott, Seeing Like a State (New Haven: Yale University Press: 0300078153). Kevin Murphy, Andrei Shleifer, and Robert Vishny, "Why Is Rent-Seeking so Costly for Growth?" http://links.jstor.org/sici?sici=0002-8282%28199305%2983%3A2%3C409%3AWIRSCT%3E2.0.CO%3B2-G

Assignments: Web assignment 8: government failures due by 11 AM on October 23

October 30 and November 1: Late Development: Successes

Readings: "Notes: East Asia Stands Up." James Fallows, Looking at the Sun. Paul Krugman, “The Myth of Asia’s Miracle” http://web.mit.edu/krugman/www/myth.html

Assignments: Web assignment 9: guided development successes due by 11 AM on October 30

November 6 and 8: The Crisis of Social Democracy

Readings: "Notes: Does Social Democracy Have a Neoliberal Future?" Stephen Holmes, “The Liberal Idea” http://www.prospect.org/cs/articles?article=the_liberal_idea. Robert Reich, The Work of Nations (New York: Vintage: 0679736158)

Assignments: Web assignment 10: Robert Reich's domestic neoliberalism due by 11 AM on November 6

November 13 and 15: Does History Have an End?

Readings: "Notes: Is There a Washington Consensus?" Jessica Stern, Terror in the Name of God (New York: Harper: 0060505338). Benjamin Barber, “Jihad vs. McWorld” http://www.theatlantic.com/doc/199203/barber. Francis Fukuyama, “The End of History?” http://www.wesjones.com/eoh.htm. Bradford DeLong, Christopher DeLong, and Sherman Robinson, "The Case for Mexico's Rescue" http://econ161.berkeley.edu/Econ_Articles/themexicanpesocrisis.html. Fareed Zakaria, “The Rise of Illiberal Democracy” http://www.fareedzakaria.com/ARTICLES/other/democracy.html

Assignments: Web assignment 11: is Francis Fukuyama an idiot? due by 11 AM on November 13

November 20: NO CLASS

Assignments: Web assignment 12: Taliban studies due by 11 AM on November 20

November 27 and 29: Challenging International Neoliberalism

Readings: "Notes: The Second Great Era of Globalization." Joseph Stiglitz, Making Globalization Work (New York: Norton: 0393330281). Dani Rodrik, “After Neoliberalism, What?” http://ksghome.harvard.edu/~drodrik/After%20Neoliberalism.pdf. Harry Kreisler, "Power and Culture in International Affairs: Conversation with Josef Joffe" http://globetrotter.berkeley.edu/people/Joffe/joffe-con0.html. Bradford DeLong and Barry Eichengreen, "Between Meltdown and Moral Hazard" http://www.j-bradford-delong.net/Econ_Articles/CIEP/CIEP_revision06102001.PDF

Assignments: Web assignment 13: Joe Stiglitz's international anti-neoliberalism due by 11 AM on November 27

December 4: FEEDBACK: WHAT WORKED IN THIS COURSE AND WHAT DIDN'T

Assignment: Second 1000-word paper due 5 PM December 4

December 6: REVIEW: MODERN POLITICAL ECONOMY

Assignments: Web assignment 14: improvement due by 11 AM on December 11

Saturday December 15: 5-8 PM: FINAL EXAM

Are Fundamentals "Sound"?

Dean Baker fears that they are not:

The inventory of unsold new homes is more than 50 percent higher than its previous record (1990). The number of vacant ownership units is almost 100 percent higher than its prior record (also 1990).... [T]he number of new homebuyers is about 7 percent higher. This... looks to me like... house prices are likely to plunge. In such an environment, it does not surprise me that rational investors do not want to hold mortgage backed securities. Nor does it surprise me that the Wall Street crew desperately want the Fed and Congress to find some way to take this dreck off their hands...

I guess the big difference is that I don't think that home prices are likely to plunge. Why not? Because Ben Bernanke is more aware than any other possible Fed Chair that large-scale housing asset price deflation threatens to have the same bad consequences as large-scale commodity price deflation, and I don't see a future in which he allows housing prices to fall without first taking major steps to prevent it.

John Berry Says that the Fed *Might*--Not *Will*--Cut Interest Rates

The Fed doesn't want to be locked in to any particular policy path right now:

Commentary by John M. Berry: Aug. 21 (Bloomberg) -- Federal Reserve policy makers haven't acted hastily in dealing with the financial market upheavals of the past two weeks, and they aren't going to. Neither the U.S. nor the world economy is collapsing, so Fed officials are doing exactly what they should be doing now: taking measured steps to ensure that creditworthy borrowers can get credit.

Whether the Fed's 5.25 percent target for the overnight lending rate gets cut in coming weeks will depend on how soon markets stabilize and how much the outlook for growth turns out to deteriorate. The Fed has added liquidity to the financial system through open market operations, and on Aug. 17 it announced a 50-basis point cut in the discount rate, to 5.75 percent. Moreover, in a highly unusual conference call, officials encouraged banks to borrow at the regional Fed banks' discount windows for 30 days or longer rather than just overnight....

The discount rate cut and the encouragement to borrow were intended to ensure the smooth functioning of the financial system,'' Jen said. The [FOMC statement] wasto properly respond to changing risks to growth and inflation'' without promising a series of rate cuts....

Economists at Deutsche Bank Securities drew a parallel between this market turmoil and the stock market crash of October 1987.... This time around... if central banks ``make it clear that they stand ready to keep credit open to credit-worthy borrowers, there is still a chance that the dynamics of 1987 will reassert themselves, leading to a stabilization of markets and a continuation of the world economic expansion.''...

The remarkable -- though not unprecedented -- thing about the past two weeks is how doubts about the scope of losses on securities backed by packages of subprime mortgages spread fear throughout credit markets. At $50 billion to $250 billion, the estimated likely losses associated with the default of U.S. subprime borrowers are small compared with the assets of private investors and commercial banks....Corporate balance sheets are healthy,'' Geithner said. ``The six-month trailing bond default rate has stayed near zero this year, and the delinquency rate on commercial and industrial loans at banks remains extremely low.''

All of that is still true. It may not remain so.... [Nevertheless the] real economy hasn't gone into the ditch... a lot of assets remain ``fundamentally sound'' and moral hazard is a very real issue. So the Fed is taking only measured steps while ready to do more if necessary.

Since I was a rate cutter three months ago, I'm even more of a rate cutter now. But I can see how a FOMC that wasn't a rate cutter three months ago might not want to cut rates the next time it meets.

Willem Buiter, Anne Siebert, and Walter Bagehot

William Buiter and Anne Siebert write:

Maverecon - Willem Buiter's Blog: Central banks in a time of crisis: a preliminary scorecard: Martin Wolf, Chief Economics Commentator of the Financial Times is correct in stating, in his FT column of August 15, 2007,

Fear makes a welcome return, that in a crisis the central bank must save not specific institutions, but the market itself.

It is, however, necessary to be precise about what it means to save the market, about which markets may need saving and about how the central bank should go about saving the market in such a way as to minimise undesirable side effects.... [W]e have sketched the role of a modern central bank as ‘market maker of last resort’ (MMLR). This MMLR is the analogue, in a world where intermediation is increasingly through financial markets, to Bagehot’s lender of last resort (LOLR) in a world where most intermediation took place through banks.... The market maker of last resort function can be fulfilled in two ways. First, the central bank can make outright purchases and sales of a wider range of securities than they currently do. Second, central banks can accept a wider range of securities as collateral in repos, and in collateralised loans and advances at the discount window than they currently do. Following Bagehot’s rule, the MMLR should buy these securities outright or accept them as collateral only on terms that would imply a stiff financial penalty to the owner....

Making a market for a particular type of illiquid financial asset, say a collateralised debt obligation (CDO), may require knowledge that central banks currently do not have.... [T]he solution is not to hire the financial engineers and quants, who are so good at exploiting ‘arbitrage’ opportunities and extracting the large returns to risk bearing in ordinary times, but whose lack of consideration for and/or understanding of economic fundamentals significantly contributed to the current market disarray. Instead, central banks should hire economists with solid training in macroeconomics, financial economics, micro-market structure and behavioural economics and then encourage them to become interested in and knowledgeable about financial markets that may become illiquid.

From the perspective of saving or supporting markets, acting as market maker of last resort where appropriate and necessary, the recent actions of the Fed, the ECB and the Bank of England have all left something to be desired. The ECB simply drowned the markets in high-grade liquidity, adding well over $200bn worth of liquidity against high-grade collateral. As this did nothing directly to assist the markets for illiquid and low-grade securities.... The Fed cut the (primary) discount rate from 100bps above the Federal Funds target rate to 50bps above the Federal Funds target rate. This was a mistake and a missed opportunity. The problem was... that these financial institutions are holding a lot of assets which have suddenly become illiquid and cannot be sold at any price.... The Fed should instead have effectively created a market by widening the set of eligible collateral....

[O]n balance, the Fed and the ECB are addressing the credit crunch with a larger dose of liquidity-provision-as-usual under orderly market conditions. In addition, the Fed has provided an unnecessary subsidy to discount window users. There is a real risk that either or both may be pushed into cutting monetary policy rates not because they fear developments in inflation... but as a way of addressing a credit crunch and liquidity crisis....

On the whole, these central banks have not exactly covered themselves with glory...

I don't think this is right. Bagehot's rule has many formulations, but I think the central one is that the central bank should close down insolvent institutions and lend freely (at a penalty rate) to illiquid ones, where "illiquid" means that after the crisis passes and asset prices return to normal levels and the dust settles we will see that the institution is indeed solvent--it is just that right now the possibility that it will have to liquidate assets at distress prices means that we are not sure what would happen if it were closed down today.

The central bank doesn't need to make a market in dodgy assets, according to Bagehot--and there were lots of dodgy assets in the late nineteenth century. The central bank just needs to make normal-time solvency judgments. I don't think the central bank should get into the business of buying dodgy assets. But that seems to be what Buiter and Siebert want it to do with their "market maker of last resort."

I'm skeptical.

Kevin Drum Enthusiastically Praises Jonathan Chait on Bush the Class Warrior

Kevin Drum writes: