Z: **Inactive:** Brad DeLong--Economics Only

The ATM on Turtle Ridge, Irvine, California

Felix Salmon sends us to Irvine Housing Blog:

Rudolph the Red-Nosed Reindeer: Address: 24 Shady Lane, Irvine, CA 92603. Beds: 3. Baths: 3.5. Sq. Ft.: 2,629. Lot Size: 5,053 sq. ft. Area: Turtle Ridge. County: Orange. MLS#: S512996: From Redfin:

Best deal around. Great plan 1 in private cul de sac location in the prestige Ledges at Turtle Ridge. Home shows as new very clean private location and great value for the Ledges estate. Nice rear yard area and great street appeal. Truly great deal here priced below most homes in area...

Let’s look at the loan history on this property.... The property was purchased in January 2005 for $1,157,000. The combined first and second mortgages totalled $1,156,730 leaving a downpayment of $270. Let’s just call it 100% financing. By April, they owners were able to find refinancing through Countrywide with a $999,999 first mortgage... Option ARM with a 1% teaser rate... a simultaneous second mortgage for $215,000 pulling out their first $58,000. So look at their situation: They are living in a million dollar plus home in Turtle Ridge making payments less than those renting, and they “made” $58,000 in their first 4 months of ownership.

Apparently, these owners liked how hard their house was working for them, so they opened a revolving line of credit (HELOC) in August 2005 for $293,000. Did they spend it all?... In December of 2005, they extended their HELOC to $397,990. In June of 2006, they extended their HELOC to $485,000. In April of 2007, the well ran dry as they did their final HELOC of $491,000. I bet they were pissed when they couldn’t get more money.

So by April 2007, they have a first mortgage (Option ARM with a 1% teaser rate) for $999,999, and a HELOC for $491,000. These owners pulled $333,000 in HELOC money to fuel consumer spending. Assuming they spent the entire HELOC (does anyone think they didn’t?), and assuming... negative amortization... the total debt on the property exceeds $1,500,000. The asking price of $1,249,000 does not look like a rollback, but if the property actually sells at this price, the lender on the HELOC (Washington Mutual) will lose over $300,000.

These owners will probably just walk away. I doubt they have any assets. They never put any money into the deal, they pulled out $333,000 in cash, and they got to live in Turtle Ridge for 3 years. Not a bad deal — for them...

Needless to say, this is not a typical case.

Herb Gintis Reviews Paul Krugman's "The Conscience of a Liberal"

Herb Gintis reveals that his years on the left have transformed him into a man who buys the substantive argument of how the world works made by the right. Herb writes that more progressive income taxes are bad for the middle class in the long run:

Krugman should know that if the wealth were redistributed to the middle class, the US investment rate would fall, since the rich save their money and it is translated into investment, whereas the middle classes would spend their gains on consumption, thus driving out investment. A "soak the rich" policy simply cannot work to the advantage of the middle classes...

Marty Feldstein could not put it better.

Here is the whole review, on Amazon:

Amazon.com: H. Gintis' review of The Conscience of a Liberal: "Being progressive,'' says Paul Krugman in the concluding pages of The Conscience of a Liberal, "means being partisan." Like Krugman, my training lies in economics, but unlike Krugman, I am not partisan. Rather, I take a policy orientation to social issues: there are problems to be solved in order to enhance the lives of citizens, and it is our job to discover and publicize solutions to these problems.

Krugman's partisan stance only clouds the issues. For Krugman there is a "union movement" rather than a "bureaucratic labor aristocracy," critics of the welfare states want to "turn back the clock," rather than streamline and curb the inequities of the welfare state, conservatives have won by "exploiting cultural backlash" rather than by mounting a principled opposition to the explosion of crime, drug abuse, and single-headed households in a manner that resonates with the voting public. Critics of the wealth tax are "financed by a handful of [super-rich] families," with the public being ignorant dupes of the slick politicians.

This book epitomizes what is wrong with American liberalism. Krugman was a fine, perceptive international trade theorist, but he is a political hack, with nothing new to offer. There is one problem as far as Krugman is concerned: inequality. But inequality is an intellectual abstraction, not a politically motivating issue. People hated the Robber Barons because they were robbers and barons, not because they were rich. Oprah Winfrey and Bill Gates do not send the Pinkerton men out to protect their ill-gotten gains; nor to the other super-rich.

Socialists' ringing political slogans dealt with fairness, social progress, and power to the people, not "inequality." Moreover, a truly progressive movement must built on technical progress that is impeded by the reigning powers that be (Sam Bowles and I call this efficiency-enhancing egalitarian redistribution), not the beggar-thy-neighbor, zero-sum-game sort of redistribution favored by Krugman.

I suspect Krugman is correct in saying that the degree of inequality in the USA today is the product of politics, not economic necessity. This is because some advanced industrial countries have more equal distributions of income and wealth that the USA (e.g., France, Germany). But, these countries are plagued by bureaucratic inefficiency and deeply threatened by the "lean and mean" up-and-coming countries like Poland, the Baltic States, Romania, India, et al. The USA has purchased a thriving economy and full employment at the cost of having a bunch of super-rich families. Not a bad deal, after all.

Krugman's vision for the future has three key premises, all wrong.

First, he believes progressives can win on a platform of redistributing from the rich. However, no one cares about inequality. People care about injustice, unfairness, poverty, sexual predators, family values, gay marriage, terrorism, and many other problems of everyday life. People don't care about Gini distributions and other abstractions. Moreover, Krugman should know that if the wealth were redistributed to the middle class, the US investment rate would fall, since the rich save their money and it is translated into investment, whereas the middle classes would spend their gains on consumption, thus driving out investment. A "soak the rich" policy simply cannot work to the advantage of the middle classes.

Second, Krugman would strengthen the labor unions, which he credits for their egalitarian effects. However, unions were strong only when industry was highly non-competitive in such areas as automobiles and steel. The oligopolistic character of mid-twentieth century industry, with a few countries in the lead, made fighting over the excess profits highly rewarding. With globalization, there are no excess profits to be fought over. Thus, it is not surprising that most successful unions in the USA are public service, not private (e.g., teachers, government employees). There is no future in unionism, period.

Third, Krugman believes that liberalism can be restored to its 1950's health without the need for any new policies. However, 1950's liberalism was based on southern white racism and solid support from the unions, neither of which exists any more. There is no future in pure redistributional policies in the USA for this reason. Indeed, if one looks at other social democratic countries, almost all are moving from corporate liberalism to embrace new options, such as Sarkozy in France (French socialists have the same pathetic political sense as American liberals, and will share the same fate).

I am sorry that we can't do better than Krugman. There are very serious social problems to be addressed, but the poor, pathetic, liberals simply haven't a clue. Conservatives, on the other, are politically sophisticated and hold clear visions of what they want. It is too bad that what they want does not include caring about the poor and the otherwise afflicted, or dealing with our natural environment. Politics in the USA is no longer Elephants and Donkeys; it is now conservative Pigs and liberal Bonobos. The pigs are smart but only care about what's in their trough. The Bonobos are polymorphous perverse and great lovers, but will be extinct in short order.

One final comment. Herb "conservatives... are politically sophisticated and hold clear visions of what they want... too bad that what they want does not include caring about the poor and the otherwise afflicted, or dealing with our natural environment... conservative pigs... are smart but only care about what's in their trough" claims that he is non-partisan?

Citigroup Replenishes Its Capital

Steve Goldstein and Greg Morcroft write:

Citigroup gets $7.5 billion infusion from Abu Dhabi investors: Citigroup said it has received a $7.5 billion injection from the Abu Dhabi Investment Authority, a much-needed shot in the arm as the financial-services giant weighs massive job cuts and slashing the value of debt securities on its balance sheet. "This investment, from one of the world's leading and most sophisticated equity investors, provides further capital to allow Citi to pursue attractive opportunities to grow its business," said Win Bischoff, acting chief executive of the Dow Jones Industrial Average component. Citigroup's shares rose 2% Tuesday morning, adding 59 cents to $30.39. The stock, which had dropped below $30 for the first time in more than five years on Monday, has lost 40% of its value this year.

Citigroup, in a statement issued late Monday, said the "long-term" investor will receive no more than 4.9% of its capital and won't get a seat on the board. This holding would exceed the 3.6% controlled by Prince Alwaleed bin Talal bin Abdul Aziz al Saud of Saudi Arabia. Abu Dhabi is getting bonds that must be converted and will yield 11% annually. They'll convert into stock priced at $31.83 to $37.24 a share, with the conversion to occur between March 2010 and September 2011. Stefan-Michael Stalmann, analyst at Dresdner Kleinwort, said that while the coupon rate of 11% looks high, the after-tax cost of funding is equivalent to Citi's current dividend yield of about 7.25%. Stalmann called the deal "relatively attractive" and said Citi is issuing delayed equity at a premium of 8% to 25% to the current share price -- thus avoiding the discount that a current rights issue would have required. "In exchange for being able to issue equity at a guaranteed premium, Citi only gives up the opportunity to issue straight equity at a higher share price in the future," he said...

Economic History Seminar: Jonathan Rose: "Hoover's Truce: Nominal Wage Rigidity in the Onset of the Great Depression"

ECONOMIC HISTORY SEMINAR: Jonathan Rose, UC Berkeley: "Hoover's Truce: Nominal Wage Rigidity in the Onset of the Great Depression": November 26, 2-4 p.m., 597 Evans.

• The sluggishness of wage declines during the Great Contraction
• Data from International Harvester
• David Romer: "Keynes's Keynesian model does not do too badly..."
• Hoover's conferences
  • Were they significant?
  • Did anybody comply with Hoover's pleas to firms not to cut wages?
  • Wage cuts in 1930-31 as compared to 1920-21
  • Herbert Hoover as corporatist crypto-socialist triangulating b------

Bernanke Effectively Brings Inflation Targeting to the Fed

Willem Buiter writes:

FT.com | Willem Buiter's Maverecon: It has taken a while, just under two years since Ben Bernanke took over from Alan Greenspan as Chairman of the Fed, but the deed now is done: the Fed has moved to de-facto inflation targeting... inside the twin Trojan horses of improved communications and greater transparency. An indeed, these proposals are likely to improve the clarity of the Fed’s communications to the market and the public at large and to enhance its transparency. But there is more....

The Fed’s modus operandi under Greenspan could be described as formally symmetric but in fact biased towards low unemployment, extremely flexible inflation targeting without a firm, let alone a numerical, inflation target.... There can be no doubt, however, about another asymmetry in the reaction function of the Greenspan Fed. With unemployment at or near the best guestimate of the natural rate, when faced with the choice between a rate cut that would reduce the likelihood of an increase in the unemployment rate at the expense of a higher risk of excessive inflation, or tighter monetary policy that would increase the likelihood of higher unemployment but would lower the risk of excessive inflation, the Greenspan Fed would opt for lower unemployment. 

This is no longer true for the Bernanke Fed.... [T]he new three-year horizon for the forecasts will provide the equivalent of a numerical point inflation target.... The Fed will no doubt continue to pay lip service to what is deemed (both by the Fed itself and by Congress) to be its official, legal dual mandate - maximum employment and stable prices. Congress will continue to insist on parity for these two objectives, and Fed officials and Governors will nod and agree....

During the 32-year period 1965-2007, the headline CPI increased 24 percent more than the headline PCE index, an average annual difference in inflation rates of around 0.67 percent.  the core CPI increased 28 percent more than the core PCE index, an average annual inflation rate difference of 0.77 percent. A core PCE target of 1.75 percent therefore would correspond to a core CPI target of 2.5 percent...

Leveraged Super Senior Trades and the Liquidity Put - Portfolio.com

Felix Salmon writes:

Market Movers: Today we're learning a lot about something known as leveraged super senior trades, or LSS.... In an LSS, investors made a leveraged bet on the super-senior tranches of mortgage-backed securities. But the leverage wasn't the kind of leverage that the Bear Stearns hedge funds used. The Bear Stearns funds simply went to their banks (or "prime brokers", as they're known in the hedge-fund world) and borrowed the money against the value of their portfolios. When those portfolios dropped in value, the prime brokers started making margin calls, forcing the funds to sell their paper at a loss.

An LSS, by contrast... borrowed the money to create its leverage by issuing asset-backed commercial paper, or ABCP... at very short maturities... [backed by] the assets of the LSS. And those investors had two reasons to be sure that they would get repaid in full. The first was that the assets of the LSS, being super-senior, were therefore super-safe... The second was that the banks which created these structures, like Citigroup, promised that they would step up and buy the ABCP if no one else would. That is the famous liquidity put...

Now the ABCP is asset-backed, so Citi could and presumably did take possession of the super-senior paper which was held by the LSS vehicle. The original investors in the LSS will have been wiped out, left with nothing. But the value of that super-senior paper as now fallen so far that it's worth much less than Citigroup paid for the ABCP...

I May Have to Regard Arnold Schwarzenegger Not as an Empty Suit but as a Man

Given the history I have lived through during the past five decades, it goes against the grain to regard any Republican at all as a sophont possessing functional organs of generation. But I may have to regard Arnold Schwarzenegger not as an overpromising empty suit but as a man. This looks well done--if it holds together. Matthew Garrahan and Krishna Guha report in the world's best newspaper, the Financial Times:

FT.com / In depth - California homes deal to avert defaults: Arnold Schwarzenegger is once again leading US states to action on policy reform ahead of lawmakers on Capitol Hill. The California governor... has now moved to slow the rate of home loan defaults brought on by the collapse in the subprime mortgage market. Mr Schwarzenegger’s deal with four of the state’s biggest mortgage lenders – Countrywide Financial, GMAC, Litton and HomeEq – is “nothing less than jaw-dropping in its ambition and implications.”... Under the scheme, the four lenders will extend for a “sustainable” period their low introductory rates on adjustable subprime loans to homeowners at risk of foreclosure. That would address a serious headache for policymakers – the large number of adjustable-rate home loans taken out at low introductory rates and due to reset at higher rates in the next few years.

Adjustable rate mortgages (ARMs) make up about 30 per cent of all US home loans and are more prevalent in the low-quality subprime market. More than $350bn (£170bn,€236bn) in ARMS will reset to higher rates in the next 18 months. Analysts and ratings agencies alike say these resets will increase the frequency of loan defaults as falling house prices leave borrowers with negative equity and no chance of refinancing. That could hit consumer spending, with knock-on effects on the US and world economies.

Attempts to avert such a scenario by encouraging mortgage lenders and servicers to renegotiate home loans have not gone as far as policymakers would hope. While investors generally agree that in many cases everyone is better off if a loan is restructured rather than going into default, there is great resistance to standardised work-outs based on simple criteria such as type of loan and status of borrower. Many investors feel such standardised solutions will benefit borrowers who can afford to make higher payments, and want to proceed instead on a case-by-case basis, albeit with the aid of standardised systems....

California has not promised any financial or legislative incentives to the lenders, says a spokeswoman for Mr Schwarzenegger. “This is a public-private partnership that does not involve public dollars.” Instead, the agreement is backed by “safety in numbers”. “If only one of these companies was modifying its loans . . . they would lose out to the competition and [house] prices would keep falling. It would be a double whammy,” she said. However, with four mortgage lenders representing 25 per cent of subprime mortgages signing up to the plan, the risk to the lenders has been minimised. The agreement with the lenders will cover only those homeowners “making timely payments”. Beneficiaries will also need to prove they cannot afford a rate rise.

A U.S. Recession Is Now Probable (but Not Yet Inevitable)

A U.S. recession is probable because sentiment now believes that a U.S. recession is probable. Gillian Tett, Jennifer Hughes, and Krishna Guha writing in the world's best newspaper, the Financial Times:

FT.com / World - Investors fear new round of turmoil: Investors fear the financial system is moving into new credit turmoil, which could create further losses for financial institutions – and potentially hurt sentiment in the “real” economy. Credit markets are trading at levels which imply that investors assume that the US is heading for a recession, bank analysts and economists have warned. “Recession is getting priced in,” said Jan Loeys, economist at JPMorgan, adding that markets went into “virtual panic mode” last week. “Pressure is building for central banks to become a lot more active and vocal [this] week if they want to avert a collapse in credit markets.” Swaps spreads rose sharply in UK gilts and US Treasuries, amid a flight to quality and fear of bank defaults. Spreads on high-yield corporate bonds and the yen-dollar exchange rate also leapt dramatically, while liquidity evaporated in many corners of the credit markets.

Peter Sutherland, chairman of both Goldman Sachs International and BP, joined those voicing concern. “The US economy is in a mess,” he told TV3, an Irish TV channel, yesterday. “There is a whole big issue...which has not fully played out in regard to providing credit and liquidity to institutions, so I think it is a dangerous period for the world. I think we are going to go through next year, certainly the first half of next year, with considerable traumas.” Rising market tension prompted the European Central Bank to announce on Friday that it would provide fresh emergency injections of liquidity from this week. In recent days, liquidity has evaporated in parts of the European credit markets, as banks have become nervous about trading with each other. Investors are watching to see whether the US Federal Reserve will also provide additional liquidity into the US system. Analysts speculate that the Fed could extend the scale or duration of long-term open market operations, lower the discount rate at which it lends directly to banks, or even announce more radical steps.

Ben Bernanke, Fed chairman, is also likely to reassure the market that the US central bank recognises the threat to growth posed by the relapse.

One factor undermining investor confidence is that the projected size of this year’s credit shock is now rising rapidly. The US government initially forecast $50bn losses on subprime securities. However, investment banks now expect $200bn-$500bn subprime losses – and additional massive losses in other debt markets, such as credit card loans. Lawrence Summers, former US Treasury secretary, writing in today’s Financial Times, says: “The odds now favour a US recession that slows growth significantly on a global basis.” A second problem is continued deep uncertainty about which institutions hold these losses...

The Glamour of Technology: Subnotebook Department

Gordon's Notes sends us to Charlie Stross, who promptly succumbs to the Glamour of Technology:

Charlie's Diary: Commoditizing our future: I've spouted off previously in this blog about my lamentable poor saving throw versus shiny! — not to mention my irritation at the refusal of the consumer electronics industry to render me bankrupt by actually giving me what I want. Trouble is, at long last they've turned around and done it. I have in my possession an Asus Eee subnotebook... £220... right now there's a certain scarcity value attached, and they haven't yet sunk to their real price, somewhere around thruppence ha'penny. But the process is becoming clear.

Back in 1998, I bought a notebook... Hewlett-Packard... 166MHz processor, 80Mb of RAM, a 4Gb hard disk, an external CDROM drive (reader, not writer), and a docking station... full-whack £1900 that bundle was going for a few months earlier.... Compare with the Eee. On processor and memory... 900MHz and 512Mb respectively. The disk space is the same, except the Eee uses solid state memory rather than a spinning mechanical thingy.... For an extra £80, I bought the Eee 8Gb of additional storage media (an SDHC card), an upgrade to 1Gb of RAM, and an external CD/DVD rewriter....

Moore's Law suggests that every component of a PC halves in price on a roughly 18-month cycle. A desktop PC today should be roughly 100 times as powerful as a desktop PC of similar price 10 years ago.... A naive soul with no prior experience of consumer capitalism might ask why, instead of doubling in power, the manufacturers don't concentrate on cutting prices? But that's not how the industry worked. Until now....

A couple of years ago Nicholas Negroponte of the MIT Media Lab launched the idea of a $100 laptop for education in the developing world. Well, the OLPC XO-1 is now out.... Intel's reaction was the Classmate reference design, their own purported rival to the XO-1; the Asus Eee is what you get when a large far eastern OEM thinks "hang on, can we commoditize this and sell it in bulk?" Microsoft... failed to make it onto the Eee bandwagon because they wanted $40 for a Windows XP license — on a machine that starts at $250 for the stripped-down version. Mine runs Linux perfectly well, thank you, and comes with the basic stuff you need to be productive; OpenOffice, Thunderbird for email, Firefox as a web browser, and some other gadgets (like Skype and a webcam).

The Eee... is close to an order of magnitude cheaper than previous ultra-lightweight subnotebooks. And I think I'm going to use it as a pointer to a future trend.... The Eee is about 8 times as powerful as that 1998 Omnibook, at a quarter the price.... The dirty little fact everybody in the consumer computer trade have been trying to ignore... is that the computer biz is overdue for commoditization. There is no intrinsic reason why a kilogram of plastic and metal with a couple of silicon chips in it should sell for more than its weight in silver.... Apple have staked out a boutique territory for themselves, and more power to them for noticing that they needed to do that in order to survive: but that's a small lifeboat, and not everyone can market themselves on being cooler than everyone else.

The Eee isn't quite the disposable computing resource I've been wanting — they'll have to shave a zero off the price tag for that — but it's close enough for now. It does the basics I need, runs portable cross-platform applications and editing open file formats, and if I leave it on a train or sit on it or something my immediate reaction will be to swear, check my backups, and buy another one, rather than to whimper and go talk to my bank manager...

Hoisted from Comments: Cranky Observer on Corporate Nationality

Apropos of:

Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: Manufacturing does not add much value any more.

Cranky Observer writes:

That's what people who work in or for New York financial services entities tend to think, anyway. Those of us who still work in US-based manufacturing tend to see things a bit differently. Knowledge comes from doing, not from viewing on a computer screen - and certainly not from viewing financial statements on a computer screen. When that knowledge is gone (or transferred to others) the capabilities follow very shortly. And, I and many others (including many German policy analysts) would argue, the underlying economy some time thereafter.

Seriously - when all the value-adding work is moved to China and India what exactly is the US going to do? England is a cute tourist destination - perhaps we will do the same?

I would suggest reading (1) the history of Hewlett-Packard's calculator division, including the decision to outsell the whole thing to China and what happened when they tried to bring it back in-house (2) Boeing's recent experience and statements with super-outsourcing major structural components of the 787.

ERP Expert

Note to Self: Six Interesting Questions About Corporate Nationality:

1. Does it matter that a huge hunk of Citigroup is owned by Alaweed
   ibn Saud rather than some guy who lives on Kentucky or Alberta?

2. Does it matter that Applied Materials--the company that makes the
   equipment other companies use to make the chips other companies use to
   make the gadgets other companies use to market the lifestyle--has its
   headquarters in San Jose, California rather than in Stuttgart or
   Shanghai?

3. Does it matter that Applied Materials has its engineers in San
   Jose, California and not in Kuala Lampur or Rio de Janeiro?

4. Does it matter that venture capital firm Kleiner-Perkins is in Palo
   Alto, California and not in Tokyo or Milan?

5. Does it matter that Citigroup's headquarters is in New York rather
   than in London or Bombay?

6. Does it matter that Apple's iPods are made in Shenzhen, China,
   rather than in Austin, Texas, or Window Rock, Arizona?

---

Related Issues:

• National regulation: class A stock * National regulation: official supervision and merchant management * Sovereign wealth funds * IBM and Lenovo * James Fallows on the :-) and China: resources, assembly, and design
  and marketing * Political pressure, financial pressure, and post-WWI technology
  transfer from Germany to the U.S.; was political or national financial
  pressure used? * Peter Drucker and his predictions about pension-fund socialism * Alto Adige and Trentino * Gazprom and P&O?

Hoisted from Comments: Low-Tech Cyclist Watches the Utterly Disgusting Fecklessness of the Washington Post

Hoisted from Comments: Low-Tech Cyclist Writes:

Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: I know bringing up Fred Hiatt is like shooting fish in a barrel on this score, but the WaPo has a subset of its unsigned editorials where it comments on what it calls "the ideas primary."

Five of the last seven Ideas Primary editorials have been on the Social Security 'crisis.' There have been 15 editorials in this series. One has been on global warming - the greatest crisis of our era - and two have been on our greatest domestic crisis, the lack of universal health care and the upcoming crisis in the Medicare trust fund. None have been on Iraq and the power vacuum we've created in the center of the Middle East.

Interesting set of priorities, huh?

http://www.washingtonpost.com/wp-dyn/content/linkset/2007/04/27/LI2007042701687_1.html

As I have said before, there is something very wrong with everybody who is currently helping to put the Washington Post in newsprint on the streets of Washington these days. In the future everybody involved is going to be claiming that they spent the Graham-Downie-Hiatt years representing tobacco companies or lobbying for the government of Sudan.

Richard Baldwin on Martin Feldstein’s View of the Dollar

Baldwin writes:

Feldstein’s view on the dollar | vox - Research-based policy analysis and commentary from Europe's leading economists: In a May 2007 essay, Martin Feldstein argued that a drop in US mortgage refinancing would raise US personal saving and this would necessitate a fall in the dollar. That’s looking pretty good at the moment.... Something that stumps every undergraduate, and not a few PhD economists, is how a nation’s trade deficit, or more precisely, its current account deficit can be two things at once: #1) The gap between national investment and national savings, and #2) the difference between exports and imports. This is not a ‘can be’ relationship; it is a ‘must be’.

Number two requires no explanation; it’s just a definition. Number one follows from a line or two of national-accounts algebra. A nation’s aggregate purchase of goods is the sum of what its public and private sectors spend on consumption and investment. Its aggregate sales of goods equal the value of what its public and private sectors produce and this, in turn, is its aggregate income. Plainly, the difference between a nation’s spending and earning must be its trade balance with the rest of the world; if its aggregate purchases exceed its production/income, then some foreign goods must, on net, be coming in to satisfy the excess demand. Finally, since income must be either consumed or saved, the spending-earning gap is also the investment-saving gap; consumption cancels from both sides of the equation.

Feldstein makes a bold simplification that helps him to think clearly about the messy world. He takes US savings and investment as primitives and views the value of the dollar as the variable that adjusts to make things fit. As he writes it: “This line of reasoning leads us to the low level of the U.S. saving rate as the primary cause of the high level of the dollar.”... The US’s net purchase of foreign goods is predetermined by its savings/investment gap and the dollar must jump to make people happy buying and supply the necessary net flow of foreign goods.... The real explanation comes in understanding why US savings was so low relative to its investment.

Feldstein focuses on personal savings. “Two primary forces have been driving down the household saving rate,” he wrote, “increasing wealth and, more recently, mortgage refinancing.”... Feldstein not only calls the dollar’s drop, he links it to developments in the US housing market. True, his logic did not lead him to predict the subprime crisis, but that is more a matter of how, not what.... The rest of the essay discusses why the foreign exchange market didn’t anticipate the adjustment that Feldstein said must occur. His reasons are less remarkable – Asian official intervention and myopic investors....

Feldstein... also considers... that the whole thing could unwind.... “The primary risk... is that the decline of the dollar and the rise of the saving rate will happen at different speeds, leading to domestic imbalances.”... If the US saving rate rises without a dollar drop, there is no narrowing of the trade gap to offset the closing saving/investment gap. Aggregate demand falls and we get a US recession... “the domestic weakness will occur unless the dollar decline precedes the rise in saving.”

Put that way, it sounds paradoxical. It seems better to phrase it thus:

The domestic U.S. recession will occur unless the fall in the dollar and the boom in exports preceded the cutback in consumption spending...

For a rise in savings is a fall in consumption spending.

Another One from Paul Krugman

Paul Krugman writes:

Thinking about the dollar: I have to do some teaching on the subject of the falling dollar and whether it’s recessionary. So herewith some ruminations.... [T]hink of the Fed as setting “the” interest rate (more on that later), and facing two tradeoffs. On one side, the lower the interest rate the higher is employment. On the other side, the lower the interest rate the lower the dollar. In normal times the Fed tries to set the interest rate so as to achieve more or less full employment, and lets the dollar fall where it may.

Now along comes a change in investor expectations that makes the dollar weaker at any given interest rate... a weaker dollar means stronger exports and less imports.... We’d expect [this] to lead to a weaker dollar (duh) and also higher interest rates — but the latter effect would happen only because the Fed is trying to offset the expansionary effect of that weaker dollar. It shouldn’t depress the economy at all.

OK, so how do we make this story more pessimistic?

One way is to argue that the Fed will have to raise interest rates more than is necessary to stabilize employment... the falling dollar will be inflationary, so the Fed will have to support the dollar with higher interest rates to ward off this inflation. OK, this could be right, but I have a hard time making the numbers look big enough to get worried about.... Another argument I used to make was that a dollar plunge would pop the housing bubble.... But the bubble popped all on its own....

Finally, there’s a fairly subtle argument about term structure and timing. You see, the Fed only controls short-term interest rates, while investment spending depends on long-term rates. Meanwhile, the effects of a weak dollar on exports take a while, maybe as much as two years, to take full effect.... This story depends on the effect of interest rates on demand working faster than the effect of the exchange rate on exports. I guess this could work. But it’s a fairly tricky story, and a lot subtler than the alarm I’ve been hearing....

When people wonder why anyone would invest in the US without a rise in interest rates, you have to make the distinction between a falling dollar and a fallen dollar. If the dollar gets really weak, investors will see US assets as a bargain.... The question is how far the dollar has to fall to make that happen, and whether the Fed can let that big a fall happen.

Floyd Norris on the Financial Sector

He writes:

As Bank Profits Grew, Warning Signs Went Unheeded: The banks were doing a lot better than they should have been doing.... There were signs that banks were either lying about their results or were taking large risks that were not fully disclosed, but investors were oblivious.... Consider how banks make money. They pay low rates on short-term deposits and charge higher rates on long-term loans. So they love what are known as positively sloped yield curves. And they like to see big credit spreads.... By that light, nothing was going right in 2006 and early this year. The yield curve was inverted, or at best flat. And credit spreads were at historic lows.... And yet the bank stocks were buoyant, and so were reported profits....

Instead of being suspicious, many analysts believed that banks had found a new way to prosper. Making a loan and keeping it on the balance sheet until it was repaid was so old-fashioned. It was far better to collect fees for arranging transactions and passing on the risk to others. We did not ask why passing on risks should be so profitable to the risk-passers. In reality, it was not. In recent weeks, we have learned of many risks the banks kept. Not only did we not understand them, but there is every indication that senior managements did not either....

There were many other funny ways to bolster profits, like specialized investment vehicles, or SIVs. These creatures bought those C.D.O. securities, paying for them with money borrowed in the commercial paper market. Just like banks, the SIVs borrowed short and lent long. The spreads might be thin, but they could employ leverage to make narrow margins go a long way. The SIVs did not have much capital, but so long as everyone believed in C.D.O.’s, they did not need it. The banks that set up the vehicles swore they had no continuing interest in them, and so they also vanished from any balance sheet that investors could see. Now they are costing banks money to prop them up.

Jamie Dimon, the chief executive of JPMorgan Chase, told investors this week that “SIVs don’t have a business purpose” and “will go the way of the dinosaur.” Will they take the securitization system with them? The answer to that question may be crucial in determining how soon the financial system recovers...

Willem Buiter Cries "Doom! Doom!" for the Dollar

Willem Buiter:

Our currency and our problem: In 1971, the then US Secretary  of the Treasury, John Connolly told his European counterparts: "the dollar is our currency but your problem." So far, Connolly's statement continues to be true.  Every time the dollar weakens, US exporters and US import-competing industries are gaining competitive advantage and/or increasing their profitability.  The explosive growth of US export volumes... is part of the reason that, despite the collapse of US housing construction, the US economy is still expanding.... The weaker dollar also improves the US net external investment position.... With so much of US external liabilities denominated in dollars, every time the dollar weakens, the world largest debtor feels a little wealthier. The Chinese authorities, despite moves to diversify their foreign asset holdings, still... hold over a trillion dollars... in US Treasury... The Japanese authorities have a similar exposure... have re-confirmed their reputations for being among the world's worst portfolio investors.... [T]he Chinese and Japanese authorities... presenting their tax payers with a further $200bn to $300bn capital loss... a heavy price to pay for access to US markets for your exports, especially for a poor country like China....

I fear, however, that the good news about dollar weakness for the US is about to come to an end. Sooner rather than later, the weakness of the dollar, and fear of its future weakening, will trigger a large increase in long-term US interest rates, nominal and real.... The further weakening of the US dollar will continue to boost the tradable sectors of the US economy, but any sharp increase in long-term nominal and real interest rates will hit investment spending.... It won't be pretty.  Expansionary monetary policy measures will be limited because a collapse of the dollar will have non-trivial inflationary consequences...

It is not clear to me what model Buiter is working in. In economists' default model, expectations are, in general, not of a particular rate of change of the dollar but of a future level for the dollar. If domestic interest rates are high (relative to interest rates abroad, adjusted for risk and other factors) then the value of a currency will be above its long-run expectation. If If domestic interest rates are low (relative to interest rates abroad, adjusted for risk and other factors) then the value of a currency will be below its long-run expectation. But it is not the case that expectations of decline drive up domestic interest rates--not unless a central bank is driving up domestic interest rates because it wants to keep a currency worth more than its long-run expectation. And the U.S. Federal Reserve is not in the business of pushing up domestic interest rates in order to keep the value of the dollar high.

So how then is it that Buiter expects "the weakness of the dollar, and fear of its future weakening" will "trigger a large increase in long-term US interest rates"?

One possibility is the following chain of causation:

• Past declines in the value of the dollar push up import prices.
• Rising import prices produce inflation.
• Existing inflation leads workers, managers, and savers to expect future inflation.
• The Federal Reserve has to raise interest rates to create mass unemployment to keep those expectations of future inflation from turning into actual high inflation.

But there seems to be another line of argument back there: one in which demand for dollar-denominated bonds is diminished by the mere fact that they have been a money-losing asset class in the past, and that this is a source of excess volatility in the currency markets. Such excess volatility is a bad thing for U.S. consumers of imports--they will face lousy terms of trade. It is a good thing for U.S. manufacturing companies and their workers. It is probably a small net minus for the country as a whole. However, it is not enough of a net minus to justify the Federal Reserve hitting the economy on the head with a brick--raising interest rates to recessionary levels--in order to prop up the value of the dollar.

The potential problem is only if rising import prices make people scared of rapidly-rising inflation. This makes me think that a suggestion Greg Mankiw made once--that the Federal Reserve should focus on and disseminate not core inflation--inflation ex food ex energy--but supercore inflation--inflation ex food ex energy ex imports.

A Keynes Story (Actually a Lydia Lopokova Story) I Had Somehow Never Heard

Why I am glad I do not spend my summers in Washington DC. From Rick Atkinson, The Day of Battle:

Only the Washington heat remained inhospitable. The wife of the economist John Maynard Keynes was found perched, entirely nude, in front of the open door of a Westinghouse refrigerator in the Georgetown house where the couple were staying...

Hoisted from Comments: Bonnie on Vioxx

Hoisted from Comments: Bonnie on Vioxx:

Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: I took Vioxx for 3 and half years and had no heart problems; but, I did have major pain relief. While I was switched to Celebrex, I still have not had the pain relief I had from Vioxx. I took Paxil and had some serious adverse affects long before I took Vioxx. I was outraged and wanted Paxil taken off the market. Yet, since then, I have found some friends and relatives who have benefited greatly by Paxil. Now, with both experiences under my belt, I believe if the people are provided good information about the product and they choose to take it, it should be available.

The thing about all these drugs is that they ALL will help some people miraculaously and hurt some people terribly. However, I resent that I am not able to choose to use Vioxx because of the dishonesty of the drug company and the fear created by the way this issue has been handled. Of course, the other reality is that if there is only a small portion of the public who can use a drug, the companies will not offer them, such as the case of orphan drugs. However, the real problem seems to be the ignorance of doctors and the public about these drugs.

Most of the doctors and the public do no research to find out if what the drug salesman has provided good information beyond the "selling" propaganda. If that occurred the drug company would have more reason to be forthcoming with the studies.

Maybe.

FireDogLake Does a Bad Bad Thing...

Mona of Unqualified Offerings sends us to the usually-excellent FireDogLake, where Jane Hamsher does bad bad thing in introducing Naomi Klein. Jane writes:

Firedoglake: The political impulse to take advantage of social upheaval in order to implement unpopular policies that a citizenry would otherwise fight against seems to be throughout history a rather intuitive one. In The Shock Doctrine, however, Naomi Klein looks at how Milton Friedman and “The Chicago Boys” — fundamentalist free marketeers whose orthodoxy was incubated under Friedman at the University of Chicago — codified it into economic writ:

[Friedman] observed that “only a crisis — actual or perceived — produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.”

Those who remember the hasty passage of the Patriot Act and wondered at how the government could suddenly disgorge a tome of civil rights-infringing legislation the size of the Manhattan phone book only weeks after 9/11 and then proceed to bludgeon members of Congress into voting for it in the name of combating terrorism will find the blueprint achingly familiar. If Ronald Reagan was the original White House prophet of Friedman’s views, George Bush has been its most devoted acolyte...

One would imagine from this that Milton Friedman approved of the Un-Patriot Act--which he most definitely did not. Unlike Hayek, Friedman believed in individual liberty and autonomy first, and order and hierarchy second if at all.

One would imagine from this that Milton Friedman approved of George W. Bush. Friedman did think that George W. Bush was a better president than almost any Democrat, but Friedman did spend much of his 90th birthday lunch at the White House telling Bush that his fiscal policy was a disaster.

I take the Friedman quote to be a totally unexceptionable statement of the duty of the intellectual. It is the duty of the intellectual to think and discuss and argue, so that when the crisis does come the plans that are picked up off the shelf and hastily implemented are not-stupid ones.

Paul Krugman Writes About the Long-Term Budget Math of Social Security

Paul says:

Long-run budget math - Paul Krugman: Start with the current position. Last year, federal spending on Social Security, Medicare, and Medicaid was 8.5 percent of GDP, equally divided between Social Security and the health care programs. Dismal long-run projections, like those of the GAO, have this total rising by 10 percentage points of GDP by mid-century.

So, how much of this is a Social Security problem? Pundits like Tim Russert love to point out that in its early days Social Security had 16 workers paying in for every retiree receiving benefits. But this is irrelevant; looking forward, we’ll see the worker-beneficiary ratio fall from about 3 to 2 as the baby boomers retire. This will raise the percentage of GDP spent on Social Security from about 4 to 6 — that is, a rise of about 2 percentage points of GDP, which is a small fraction of the entitlements problem.... What’s more, Social Security has already been strengthened to deal with this rise. In 1983 the payroll tax was increased and adjustments made to the retirement age, so as to build up a trust fund.... This brings us to the claim that the trust fund doesn’t exist, because it’s invested in government bonds. The full explanation of why this is sophistry is here.

The bottom line is that Social Security is just not the major problem. Now, part of the projected rise in Medicare and Medicaid costs represents the effects of an aging population. But as a new report from the CBO explains, demography is only a minor factor — mainly it’s rising health care costs. What’s more, the proposed “solutions” for the Social Security problem have no relevance to the issue of rising Medicare costs.... The Beltway obsession with Social Security is a classic case of a little knowledge being a dangerous thing. People have picked up a few facts about demography, and think they understand the long run budget problem. They don’t.

PS: OK, from some communications I see that 2017 — the projected date at which payroll taxes no longer cover benefit payments — has raised its ugly head. But there is no interpretation under which 2017 matters. Social Security legally has its own dedicated funding; if you believe the government will honor the law, the surpluses the system is now running are building up a trust fund, which will finance the system for decades after 2017, and maybe forever. If you think the law will be ignored, then Social Security doesn’t really have its own budget — the payroll tax is just one of many taxes, and SS benefits are just one of many government costs. In that case the relationship between payroll taxes and benefits is irrelevant.

The only way to make 2017 matter is to change the rules midway: when SS runs surpluses they don’t count, but when it runs deficits they do.

Vioxx...

As background, Dr. David Graham, Associate Director for Science and Medicine in the FDA's Office of Drug Safety, in 2004:

Dr. Graham's Testimony to Senate Committee on Vioxx, FDA Failures: Prior to approval of Vioxx, a study was performed by Merck named 090. This study found nearly a 7-fold increase in heart attack risk with low dose Vioxx.... In November 2000, another Merck clinical trial named VIGOR found a 5-fold increase in heart attack risk with high-dose Vioxx.... In 2002, a large epidemiologic study reported a 2-fold increase in heart attack risk with high-dose Vioxx.... About 18 months after the VIGOR results were published, FDA made a labeling change about heart attack risk with high-dose Vioxx, but did not place this in the Warnings section. Also, it did not ban the high-dose formulation and its use..... In March of 2004, another epidemiologic study reported that both high-dose and low-dose Vioxx increased the risk of heart attacks compared to Vioxx's leading competitor, Celebrex....

If you apply the risk-levels seen in the 2 Merck trials, VIGOR and APPROVe, you obtain a more realistic and likely range of estimates for the number of excess cases in the US. This estimate ranges from 88,000 to 139,000 Americans. Of these, 30-40% probably died. For the survivors, their lives were changed forever...

If you believe Dr. Graham--which I am not sure that I do--we have 30,000 excess deaths from Vioxx. A $5 billion settlement amounts to $170,000 per extra death caused, which does not seem to me to be grossly out of line on the high side as a sanction on a company whose marketing department did not want warning labels.

The usually-reliable Joseph Nocera has a different view:

Forget Fair; It’s Litigation as Usual: They had the kits ready to go. The “trial package,” they called it... the plaintiffs’ bar always develops a trial kit when a mass tort gets to a certain point; it’s one of the weapons trial lawyers use to put pressure on the company they are attacking. The big-time lawyers who bring the early cases... wind up spending $1 million to $1.5 million developing their case... expert witnesses... discovery... depositions... jury consultants.... And then they put their collective knowledge in a neat little package of documents and videotaped depositions and suggested lines of attack, so that all the other lawyers who have sued the same company can partake of their acquired scholarship, and bring their own trials — for a lot less money. “Ours would have allowed a lawyer to try a legitimate case for under $200,000,” said Mr. Herman, with no small touch of pride. He was talking, of course, about the Vioxx litigation, which the drug’s manufacturer, Merck, settled late last week for the tidy sum of $4.85 billion.

Mr. Herman has 120 of the 27,000 cases — that’s right, 27,000 — that were brought against Merck, which took Vioxx off the market three years ago after a study made it clear that the medication increased the risk of a heart attack or stroke. He was also one of the key architects of last week’s settlement. When I spoke to him a few days ago, he defended the settlement as a fair one, which, as he put it, “balances the scales between two competing parties.” He made it sound like standard business negotiation. Which it was.

But he also said something plaintiffs’ lawyers don’t often say out loud — at least not when a reporter is within hearing distance. “A corporate defendant cannot afford to defend thousands of cases where there is an alleged mass disaster at one time,” Mr. Herman said.... [A]s mass torts have evolved over the last decade, it is that it scarcely matters anymore whether the facts are on the plaintiffs’ side — not when a thousand lawyers are armed with those kits.... Is a mass tort really the right mechanism to settle disputes about product safety, or to punish corporate wrongdoing?

Vioxx was hardly Merck’s finest hour. I’ll readily concede that point. The company did things it shouldn’t have.... Vioxx... was a painkiller that was originally aimed at a pretty small group... people who suffered serious stomach problems as a result of taking aspirin regularly. But Merck spent hundreds of millions of dollars marketing Vioxx... as some kind of miracle pain reliever.... [T]here were rumblings... that Vioxx might increase the risk of heart attacks or strokes. It’s not quite right to say that Merck completely ignored those potential problems — but the company certainly tried to avert its eyes....

There are many problems with viewing product liability lawsuits as a means to right wrongs, which is how we see them in this country. They often make lawyers rich while the people who say they were hurt wind up with very little. The legal system gives corporations zero incentive to step forward if there is evidence that a drug might have a harmful side effect — because, after all, they’ll get sued as soon as they make such an admission. Third, even the smartest lawyers aren’t the Food and Drug Administration, which is charged with making decisions about which drugs should be allowed on the market and how their risks should be disclosed. Mass torts have become a rogue form of regulation, and not necessarily in the public interest. And finally, when you get right down to it, litigation is a crapshoot, and it can be cruelly unfair.

That was certainly true of Vioxx, whose potential side effect is one of the most common serious conditions known to mankind: a heart attack. It is impossible to know what causes someone to have a heart attack, just as it is impossible to know why someone develops cancer. In the Vioxx litigation, the plaintiffs’ lawyers were arguing, in effect, that the way to punish the company’s bad behavior was to make it hand their clients large sums of money, even though they couldn’t prove that the clients’ heart attack had been induced by Vioxx. Meanwhile, the company argued that it was just as likely, if not more likely, that some other risk factor was involved, like smoking or obesity — even though it had put a product on the market that increased heart attack risk.

As a result, a handful of lucky people who may well have been victims of their own bad habits — and not of Vioxx — won large sums of money. (Although they haven’t seen a penny yet: every case the plaintiffs won is on appeal.) And some people who may well have suffered because of Vioxx lost their cases and didn’t get a penny. How does such a system even approximate “justice”?...

[W]hy, then, did Merck settle? Because it had no choice. The four judges managing most of the cases had decided that the time had come to settle the litigation, and Merck was not in a position to say no to the judges.... Besides, Merck had won enough cases that it felt it could devise a settlement that it could live with. Which it did.... [T]he stock jumped when the $4.85 billion deal was announced....

As for the plaintiffs’ lawyers, they are likely to pocket around $1.5 billion of the settlement money, which means that Merck will wind up feeding the beast, just like every other company that finds itself embroiled in a mass tort. That money will go to funding the next mass tort...

A good newspaper story on this would answer three questions about these cases:

1. Is the settlement too large or too small as a sanction on Merck--as a two-by-four to the head of the CEO to make sure that he understands that his job is to curb the enthusiasm of his marketing product when he has a new product with dangerous side effects?
2. Are the lawyers' fees too large or too small--does it give lawyers too much of an incentive to crank up this mass-tort machine as a way of providing drug companies with an incentive to do the right thing?
3. Does the settlement money get to the people who were harmed--to the victims?

My answers in this case to these three questions right now are: (1) probably about right, (2) I don't know but I fear too large, and (3) somewhat but not largely.

My first beef with Joseph Nocera is that his story does nothing to help me get better answers to any of these questions. My second beef is that his story pushes a less-informed reader towards answers--too large, too large, and no--that are largely wrong. My third beef is that Joseph Nocera doesn't set out any ideas about how one might create a better system. My fourth beef is that Joseph Nocera pushes readers wrong answers by playing intellectual three-card monte--if he's going to make a big deal about how large the 27,000 case number is, he has a moral obligation to set it alongside the 30,000 net excess heart attack death number.

And my fifth beef is that Nocera knows damned well that he has a moral obligation to raise the level of the debate, and that he is ducking that obligation.

Why oh why can't we have a better press corps?

"If God Had Not Meant Them to Be Sheared, He Would Not Have Made Them Sheep!" Blogging

Over at Seeking Alpha, Roger Ehrenberg writes:

Nothing New About 'Liquidity Puts': "Liquidity puts" - yet another new and ominous sounding term for something that has been in existence for a long, long time.... [D]on't sit there and tell me that these risks are new, special and different. They're not. It is only that certain investors have been awakened from their heavenly slumbers by a heaping dose of reality. And whose fault is that? If you want to play in the world of complex instruments than read the documents. Very. Carefully. Don't rely on the rating agencies - they won't save you. And don't count on clear and useful accounting rules or detailed company disclosures to bail you out. You've got only your own brains, perspective and diligence to count on. And if any of these three are lacking - look out...

The other view, of course, is that your brains, perspective, and diligence are to be applied in looking at a firm's balance sheet--that if it is not on the balance sheet, it is not an asset or a liability of the company. And Ehrenberg quotes from Fortune:

Citi... insert[d] a put... into... CDOs that were backed by subprime mortgages.... The put allowed any buyer of these CDOs who ran into financing problems to sell them back - at original value - to Citi...

And from Wikipedia:

Securitization occurs when a company groups together assets or receivables and sells them in units to the market through a trust.... Companies often do this in order to remove these assets from their balance sheets and monetize an asset. Although these assets are "removed" from the balance sheet... that does not end the company's involvement. Often the company maintains a special interest.... Any payments from the trust must be made to regular investors in precedence to this interest.... The aforementioned brings into question whether the assets are truly off balance sheet given the company's exposure to losses on this interest...

And Ehrenberg goes on:

Liquidity puts and its variants are strewn across the entire securitization landscape and have been for a few decades, and any investor that buys and sells the shares of financial institutions without understanding this concept is in for a lot of pain. The likelihood of incurring this pain has always been there, it is only that today's markets being as they are that the fat tail of the distribution has finally come along...

Perhaps I am naive. But I think that any company that writes out-of-the-money puts should carry them on its balance sheet.

Apres Moi le Deluge Intellectual History Blogging

Re: Michael Sonenscher, Before the Deluge: Public Debt, Inequality, and the Intellectual Origins of the French Revolution.

The book begins:

The phrase après moi le deluge... by... Mme. de Pimpadour... and the various attitudes toward impending disaster it might have been intended to express... have often been associated with the French Revolution.... [T]he phrase was current... before 1789... applied to public debt. This... was how it was used... by Victor Requeti, Marquis de Mirabeau.... Mirabeau applied the phrase to... government borrowing and, more particularly, to the practice of using life annuities to fund the costs of government debt. Life annuities, he wrote, were the quintessence of what he called "that misanthropic sentiment [ce sentiment ennemi] après moi le deluge."... [T]hey were a way of drawing bills on posterity. Like all forms of public credit... consumed wealth before it was produced... leaving a state... having to face the future without the accumulted assets... to maintain its long- term domestic prosperity and external security... could... destroy... "civilization."

I am going to have to go read Mirabeau pere's Etretiens d'un Jeune Prince avec Son Governeur. It sounds to me that the phrase is applied by Mirabeau pere to describe not a feckless government that borrows long (to fund wars, canals, or harbors) but rather a feckless father who invests the family wealth in annuities that end on his death. After all, from the viewpoint of long-run governmental fiscal prudence, life annuities are not the quintessence of badness--they are, in fact, vastly preferable to consols. It is only from the viewpoint of the dynastic family that life annuities are especially bad.

Is this a good thing to do at the very opening of a book that presents itself as deriving new insights from close readings of old texts?...

Pay-as-You-Go

From Obsidian Wings:

The Difference Between The Two Parties In A Nutshell: [I]f Congress does not do something, the AMT is going to hit 23 million families with higher taxes this year. The House has passed a bill preventing this from happening. Since, to their credit, they passed PAYGO rules that require that any tax cut or spending increase be paid for, they had to find some way to raise taxes. They found a loophole that allows various fund managers, who earn millions of dollars a year, to count those millions as capital gains, and thus to pay much lower taxes than the rest of us, and they closed it.

For this, they are being excoriated by Republicans. David Dreier thinks that PAYGO rules shouldn't apply to "mistakes":

"But anti-tax Republicans said the AMT was a mistake and thus offsets were unneeded. ''What absolute lunacy,'' said Rep. David Dreier, R-Calif., ''paying for a tax that was never intended.''"

What a fascinating principle: you don't have to pay for costs you incur by mistake. I wonder if our creditors will go for that? And why not extend it to other things as well? The Iraq war, for instance, was never expected to last this long: why should we bother to come up with the billions and billions of dollars we are still paying for it? If it comes to that, why not just throw fiscal responsibility out the window? As far as I can tell, David Dreier thinks that that's the only non-lunatic thing to do.

Similarly:

Rep. Jim McCrery (La.), the ranking Republican on the House Ways and Means Committee, argued that such "a fiscal straitjacket" should not even apply to the alternative minimum tax, reasoning that all Congress is trying to do is keep the taxes of 23 million families from going up. Since that is not really a tax cut, he said, its $52 billion cost to the Treasury should not be paid for...

This exchange makes the issues pretty clear:

"Congress can and must stop this middle class tax hike before Thanksgiving -- without raising taxes," Senate Republican leader Mitch McConnell of Kentucky said Friday. But Pelosi said that "we have an understanding with the Senate that this legislation, in order to go forward, must be paid for." "Raising revenues takes political courage," said House Majority Leader Steny Hoyer, D-Md. "There is no courage whatsoever in plunging our country into debt, spending and not paying"...

Nobody who calls himself a fiscal conservative has any business being a Republican. Nobody. Shutting down the Republican Party and starting over is the best we can do.

Not Yet Record Oil Prices

Tim Harford sends us to Evan Davis:

BBC NEWS | The Reporters | Evan Davis: Imagine. $100 dollars. It is a lot for a barrel of oil. In fact, it's way up there. Since the 1860s, when people stopped killing whales for oil and dug it up in Pennsylvania instead, the price has averaged a little over $25 a barrel in today's money. We're at four times the long term average price. And as recently as 1998, only nine years ago, oil - on some measures - dipped below $10 a barrel. Although in today's money, for the year as a whole the price was more like 17.

It's clear that $100 a barrel is very high. Although it's worth saying, it's still not a record. 1864 was in fact the most expensive year for oil. It was over $104 in today's money. Notwithstanding that record (and most of us in the media will ignore it when talking of record highs in the next few weeks - we'll be using the high of $104.7 reached in 1980 after the Iranian revolution) we can at least say an impending $100 barrel is getting historically significant...

I Do Not Understand This

Felix Salmon writes:

Market Movers by Felix Salmon: Did Anyone Other Than Citigroup Have Liquidity Puts? Why hasn't this "liquidity put" thing gotten greater play? I never made it down to the 11th paragraph of Carol Loomis's interview with Bob Rubin, where she introduces the concept more than 900 words into her article. Floyd Norris, today, does a bit better, taking less than 400 words to get to them. A gold star, then, should go to Peter Cohan of BloggingStocks, who read the Loomis article, realized what he was looking at, and promoted the liquidity puts to headline status back on Monday.

Liquidity puts are a big thing, and indeed it seems that they were more or less singlehandedly responsible for the downfall of Chuck Prince at Citi. Basically, Citi told the world – and kidded itself – that it had sold billions of dollars in CDOs to investors. In reality, however, those CDOs had "liquidity puts" attached, which essentially transformed the CDO "sales" into glorified (or debased) repos. Any time that the investor found the CDO difficult to sell – and CDOs are always difficult to sell – he had the option to put the CDO back to Citi at par. And that's exactly what happened; it was those return-to-sender CDOs which were written down the same weekend Prince resigned.

I do not understand this. Which CDOs? What obligations, exactly, did Citigroup assume? Is this something I already know about under another name? It's not as though Loomis or Norris are comprehensive in their explanations...

Department of Uh-Oh!

Barry Ritholtz writes:

The Big Picture | Why Thain Over Fink?: Here's something you may not have heard: The surprise selection of NYSE CEO John Thain as Merrill's new CEO over the more widely expected  BlackRock CEO Larry Fink was based on reasons you may not be aware of.  What are those reasons? Well, according to CNBC.com, Fink would only agree to take the position if Merrill was willing to give a full and complete accounting of it's subprime exposure:

Merrill's selection of Thain was a surprise because the firm had recently indicated to BlackRock CEO Larry Fink that the job was his if he wanted it. CNBC has learned that Fink said he would take the job but only if Merrill did a full accounting of its subprime exposure. At that point, Merrill, which owns 49% of BlackRock, moved in a different direction and decided to go with Thain instead.

I obviously have no way to verify that, but I give the benefit of the doubt to CNBC reporters like Charlie Gasparino and Herb Greenberg.  (UPDATE: I have just confirmed with Charlie Gasparino that he was the one who's fine investigative work uncovered this; You can see some of the discussion via CNBC video here, right margin, labeled "The New Bull at Merrill").

Note: I don't know who uncovered this. 

If the story is true, and Fink passed on the position (or was passed over) because of his insistence on a complete sub-prime accounting, apparently not accommodated by Merrill, it makes one wonder what the old lady is hiding.

The Massachusetts Individual Mandate Health Plan

Michael Tanner says he told us so:

Cato-at-liberty » Not to Say We Told You So, But...: The latest reports from Massachusetts warn that with just seven weeks left until the state’s mandate for individual health insurance goes into effect, more than 100,000 residents have failed to buy the required insurance. That represents nearly 20 percent of the state’s uninsured population and more than half of the uninsured with incomes too high to qualify for subsidies. According to insurance industry insiders, the plans are too costly for the target market and the potential customers — largely younger, healthy men — have resisted buying them. How could anyone know that an individual mandate for health insurance would be unenforceable? Oh yeah, we told them.

http://www.cato.org/pubs/pas/pa565.pdf

The Thoughtful, Articulate, and Witty Stan Collender Has a Weblog

He is certainly my favorite inside-the-beltway budget analyst:

Capital Gains and Games | Washington, Wall Street and Everything in Between: Policymakers and the financial services community think about each other all the time, but neither really understands what the other is doing. This blog, written by Stan Collender, is intended to change that...

Memo to Self: Krugman Calculations

Paul Krugman writing in Economic Policy estimates that at a real dollar depreciation rate of 2% per year the US is headed for a steady-state capital-account position of -15 months' GDP, and that at a rate of 4% per year is headed for -7 months' GDP. Yet foreigners--both private and central bank--are not demanding any yield premium on US assets.

This worries him, very much: situations in which large numbers of speculators, investors, and financiers hold irrational expectations are situations that could rapidly move southward overnight should reality intrude into the mind of the capital market.

How Large Are the Distributional Effects of Increased Trade?

ODani Rodrik suspects that they are smaller than Josh Bivens thinks they are:

Dani Rodrik's weblog: The pains from trade: The workhorse model of international trade (the 2x2 Heckscher-Ohlin model) has very stark implications for the effect of trade with poor, labor-abundant countries. Low-skilled workers in rich countries (read the U.S.) must end up as losers--not in relative terms, but in absolute terms.  Moreover, the larger the overall gains from trade, the bigger must this adverse distributional effect be.  In that world, it is inconsistent to claim there are large gains from globalization while downplaying the distributional impacts. Which is why many economists teach the model in their classrooms, but shift to other, more complicated models when they engage in the public debate about the effect of trade on wages.

A recent paper by Josh Bivens carries out a quantitative simulation of the basic 2x2 model which suggests that the increase in U.S. trade with the developing countries between 1995 and 2006 would have reduced labor earnings by 4 percent while increasing the payment for skills by 3 percent, for a 7% increase in the differential altogether.  This is an interesting exercise, to be compared to that undertaken by my colleague Robert Lawrence. The latter gives much less of a role to trade, in large part because it finds there is little reduction in real earnings once adjustments for productivity, prices and benefits are made. 

One clear difference between the two perspectives is the extent to which one thinks of trade with developing countries as competing directly with U.S. production.  Lawrence says that developing country exports hardly displace any domestic production anymore because much of that activity has already shut down.  So whatever adverse impact may have existed in the 1980s, the current situation is much more benign. (But of course, less impact on productive re-allocation means fewer overall gains from trade too!). In Bivens' world (and that of the standard 2x2 model), by contrast, head-to-head competition is critical in driving the distributional effects.

I am on Dani's side, only more so. Two additional points are important, I think:

1. For competition to be head-to-head, the two countries have to be making very similar goods with similar production processes. Hand-spinners in Pakistan don't compete with labor here in the United States but with the capital embodied in our large automated spinning mills.

2. What trade does to our distribution of income can be undone by normal domestic redistributionist policies. The right way to deal with the issue is to (a) maximize the third world's ability to take advantage of our demand to spur its own growth, and (b) use domestic redistribution here to compensate for any adverse distributional impact.

Robert Waldmann Makes a Catch on Health Care Financing...

Robert writes:

Robert's Stochastic thoughts: Jonathan Cohn puts a baseball on a tee and Jonathan Cohn hits it out of the park

The treatment Mike [Kinsley] received is called Deep Brain Stimulation, or DBS for short. [snip] It is also very costly. Medtronic, a company that makes the electrodes, says the whole procedure costs between $50,000 and $60,000. And, because the treatment's main effect is to suppress and delay the onset of symptoms, rather than cure the disease, Mike started wondering whether a system of universal health insurance would pay for it--and, if so, in which cases....

[snip]

And that prompted another thought--not from Mike but from me. All of this was assuming DBS even existed. The United States is famously the world leader in medical innovation--in part, it would seem, because we spend like a drunken sailor when it comes to medical care...

it would seem that Cohn is setting up a straw man (the kind who mixes metaphors with baseballs on tees). So it is. DBS was discovered in the French public sector in the University of Grenoble. More generally, while the US is the leader in medical innovation, this is largely due to the huge immense gigantic public sector effort called the NIH.

I made the same point at Brad's blog 2 years ago (and I didn't set up the straw man myself) http://delong.typepad.com/sdj/2005/10/delong_smackdow.html.

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update: Not only is Brad DeLong a hero of intellectual honesty for his "DeLong Smackdown Watch" posts, but this post http://delong.typepad.com/sdj/2007/11/flu-shots.html is awesome. Brad scores a goal for universal health care (with an assist from Alex Tabbarok).

Alex Tabbarok notes http://www.marginalrevolution.com/marginalrevolution/2007/11/kiss-me-im-va-1.html:

People who have the flu spread the virus so getting a flu shot not only reduces the probability that I will get the flu it reduces the probability that you will get the flu. In the language of economics the flu shot creates an external benefit, a benefit to other people not captured by the person who paid the costs of getting the shot.

Brad recalls:

The person ... said that she was on Medi-Cal and didn't have to pay the $25 for the [flu] shot--and didn't have the money to pay the $25 in any case. But the Sutter Visiting Nurse Association apparently does not take Medi-Cal.... Note that people covered by Medi-Cal are NOT counted as among the 47 million uninsured.

Flu Shots

Alex Tabarrok gets his flu shot, and opines:

Marginal Revolution: Kiss me, I'm vaccinated: I just had my flu shot.  Please send your checks to my George Mason address. People who have the flu spread the virus so getting a flu shot not only reduces the probability that I will get the flu it reduces the probability that you will get the flu.  In the language of economics the flu shot creates an external benefit, a benefit to other people not captured by the person who paid the costs of getting the shot.  The external benefits of a flu shot can be quite large.  Under some conditions each person who is vaccinated reduces the expected number of other people who get the flu by 1.5.

Since a large fraction of the benefits of the flu shot, perhaps even a majority of the benefits, go to other people and not to the person paying the costs, the number of people who get a flu shot in the United States is well below the efficient level.  I only got the shot because, as you well know, I'm altruistic.  I care about you.  But do send your checks, that will help. In lieu of a check I'm thinking of having some buttons made up to encourage people to get their shot.  Here are some possible slogans:

• Kiss me, I'm vaccinated.
• Take one for the herd!
• Get a flu shot.  The life you save may not be your own.
• Madison Avenue here I come!

Of course, we know from the Coase Theorem that there is an alternative approach.  We could charge people who do not get their flu shots. (Thus, if you haven't had a shot you must still must send me a check.)  Or to reduce transaction costs we could fine people who get the flu.  I kind of like that last one.  (But what to do about the 36,000 a year who die from the flu - charge their estates?) What do you think?  Leave your suggestions/slogans for how to encourage getting a flu shot in the comments.

Yesterday we went to a church in Concord--Nuestra Señora Reina de Todos los Santos--where a visiting nurse was giving out flu shots in order to get my wife her flu shot. The person in line after her said that she was on Medical and didn't have to pay the $25 for the shot--and didn't have the money to pay the $25 in any case. But the Sutter Visiting Nurse Association apparently does not take Medi-Cal:

Flu Shot: Each year, Sutter Visiting Nurse Association (VNA) & Hospice offers flu shots and pneumonia shots at convenient local sites, in September, October, November, and December.

• Flu shot cost - $25.00
• With proof of Medicare Part B, we will bill Medicare for the cost of the vaccine

• Find a flu shot clinic near you

• Pneumonia vaccine - cost $35.00

• With proof of Medicare Part B, we will bill Medicare for the cost of the vaccine...

Note that people covered by Medi-Cal are NOT counted as among the 47 million uninsured.

Models of Fiscal Policy, the Trade Deficit, and the Dollar

Paul Krugman writes:

Robert Rubin is wrong about the dollar: He says: “You could have had [budget] surpluses that affected the savings rate and would have helped the trade balance. I think you would have had more confidence in the policy framework and you would have had a [stronger] dollar.”...

This is what John Williamson of the Institute for International Economics calls “the doctrine of immaculate transfer.”... Here’s a (somewhat) plainer English version:

The problem becomes apparent if one asks how a higher savings rate translates into a smaller trade deficit. It is not enough to insist that the accounting ensures that it must. A consumer deciding between a Ford and a Honda cares nothing about the US’s national income accounts. How does a lower US budget deficit persuade Americans to buy fewer foreign goods and foreigners to buy more US products?...

The chain of events would look something like this: a fall in the budget deficit reduces demand in the US economy; to avoid a recession, the Federal Reserve lowers interest rates; as a result, the dollar falls; this lower dollar makes US goods cheaper compared with foreign substitutes, causing the necessary switch in expenditure.... [I]t is naive to imagine that changes in the government’s financial balance can translate directly into changes in physical trade flows, without working through a mechanism such as the exchange rate. That is the fallacy of ‘immaculate transfer’ - confusing the accounting principle which says that the current account balance equals the savings-investment balance with the process that enforces that constraint on decision-makers...

And apparently the old fallacy continues to hold sway.

I think that Rubin is implicitly working in a different model than the NIPA-based monetarist workhorse that Krugman (and I!) instinctively reach for first. I think that in Rubin's mind the chain of causation looks something like this:

1. A government establishes a sane, balanced long-run fiscal policy.
2. Businesses conclude that the country is a safe one in which to invest to build export capacity: since they do not fear future random and confiscatory taxation or inflation, factories making internationally-traded goods that would have been built abroad are built here at home instead.
3. With more export capacity at home and less abroad, exports rise and imports shrink at the current exchange rate.
4. Supply and demand leads the domestic currency to appreciate in order to balance trade.

Rubin's channel is: good fiscal policy --> expanded export supply --> export surplus --> higher currency value.

By contrast, Krugman's channel is: good fiscal policy --> lower domestic interest rates --> reduced currency value --> export surplus.

Which side am I on? I tell my undergraduates:

• At a time horizon of 0-3 years, be a Keynesian: the most important things are the fluctuations in unemployment, in real demand, and in capacity utilization.

• At a time horizon of 3-8 years, be a demand-side monetarist: you can assume (provisionally) that fluctuations in employment, real demand, and capacity utilization die out; the most important things are the fluctuations in the composition of real demand (investment vs. consumption vs. government vs. net exports) and in inflation- and deflation-causing nominal demand assuming (provisionally) stable growth of the economy's productive capacity.

• At a time horizon of 8 years or greater, be a sane supply-sider: the most important things are the processes of investment in physical, human, and organizational capital that raise the economy's productive capacity.

Thus I was happy telling my undergraduates in 1985 that the reason the dollar was strong was because of the five years of Reagan deficits--high domestic interest rates, you see, pushing up the value of the dollar (and raising the trade deficit). And I was happy in 1992 telling my undergraduates that the reason the dollar was weak was because of the twelve years of Reagan-Bush deficits--large budget deficits starving the economy of capital that made us less productive than in some counterfactual in which we had elected some Eisenhower Republican in 1981.

And so today I call this one for Paul Krugman: we are only in year six of the Bush II derangement of American fiscal policy, and so I think the dollar is a little higher than it would be if the U.S. budget deficit were lower. But in two years I may have a different answer.

Agreeing to Negotiate on Trade Issues...

At the FT, Eoin Callan sees good news on trade. It is, however, kinda scary that they are not negotiating--that they are just negotiating about how to negotiate:

FT.com / World - US and Europe aim to resolve trade disputes : Diplomats from the US and European Union are laying the groundwork for an unprecedented round of bilateral bargaining in which all of the main transatlantic trade disputes would be put on the table and negotiated in one go. The talks between the world’s two largest trading blocs would link the resolution of billions of dollars-worth of simmering trade disputes and aim to “clear the decks” with one all-encompassing deal, officials said. The negotiations would tie the fate of a range of US and European industries, including computer manufacturers and producers of genetically modified foods, to a back-and-forth round of bartering that would produce “winners and losers on both sides”, a senior European official said.

The plans appear to have originated in Brussels and coalesced around the Transatlantic Economic Council, which met for the first time on Friday in Washington and brought together senior policymakers from the Bush administration and European Commission. Officials concede the drive for a single round of bilateral trade negotiations is ambitious, fraught with drawbacks and could quickly falter. They are also concerned that some industry groups and influential companies will try to scupper the effort because they fear their bargaining position will be weakened. But a European trade official said the transatlantic economic relationship was sufficiently mature that there was potential to “build consensus around bilateral issues”....

Officials said they saw a chance in the new year to press Boeing and Airbus to sit down to negotiate a dispute over airline subsidies that is being heard by the World Trade Organisation. The areas of trade friction include politically controversial differences over hormone-treated meat, genetic