Megan McArdle writes:
Megan McArdle: So if the only support for your positions [on the minimum wage] comes from movement think tanks (plus maybe a few marginal academics), your position is probably extremely weak...
Paul Krugman gets it wrong, I think:
Gas tax hysterics - Paul Krugman - Op-Ed Columnist - New York Times Blog: OK, this has gone overboard. Hillary Clinton’s proposed gas tax holiday is not, in my view, a good idea. But the furor over what is, when all is said and done, a small and temporary policy proposal is entirely disproportionate. What’s going on?
Part of it, clearly, is the fact that many people in the media really, really want Obama to win and Clinton to lose — read Kurt Andersen — and have seized on the gas tax as their latest proof that she is ee-ee-vil. But there’s also something going on with economists, a phenomenon I recognize wearing my other hat: the tendency to place excessive weight on issues where professional judgment differs from lay opinion.... [E]conomists then become like the little boy with a hammer, to whom everything looks like a nail. Because protectionism is an issue on which they believe they have some special insight, they inflate its importance, and make free trade versus protectionism THE crucial issue in economic policy — which it isn’t. Trade barriers are a minor issue.... Yet economists talk much more about trade than they do about health care policy, because they think they know something about it in a way the laity don’t.
The gas tax holiday is in this category.... There’s a lot of troubling stuff in both Democrats’ proposals. Mandates aside, Obama is seriously low-balling the cost of health care reform, and promising way too much in middle-class tax cuts. Clinton’s numbers don’t quite add up either, though she’s probably closer to the mark — and both Dems are towering figures of responsibility compared with McCain. Amid all this, the gas tax holiday is a real issue, but a small one; don’t let economist’s tendency to overemphasize their areas of expertise distort your view.
Two points...
First, there's not a lot of troubling stuff in both Democrats' proposals. There's a little troubling stuff in both Democrats' proposals. All in all, they are quite good--economists these days sit around their department lounge and feel pity for John McCain's guy Doug Holtz-Eakin; they don't feel pity for Austan Goolsbee or Laura Tyson.
Second, it is important that presidential candidates fear economists even in the campaign. If they don't fear their economists, then we get campaign promises of really lousy economic policy, some of which will then make it into post-election real policy, and then we are in trouble. Republican politicians have not feared their economists since... the Eisenhower administration, I think, and so Republican economic policy is overwhelmingly lousy. Democratic politicians have in the past and still today fear the bad headlines that are generated if their own economic advisers say that they are full of it. And so their campaign rhetoric is less out-to-lunch. And their post-election policies are better.
For Paul to take steps to diminish Democratic politicians' fear of economists... Well, it's contrary to guild rules. Just saying...
Barry Eichengreen (1997), "The Baring Crisis in a Mexican Mirror" http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1031&context=iber/cider:
Conventional wisdom has it that the Mexican crisis of 1994-5 was "the first financial crisis of the 21st century." In this paper I argue that it may be better understood as the last financial crisis of the 19th. The crisis in Mexico exhibits striking similarities to the Baring Crisis of 1890, an event that did much to shape modern opinion about the causes and consequences of financial crises and the role for official management.
Parallels between the two episodes are extensive.... Mexico was the benchmark for investors in emerging markets in the 1990s (it was the single largest borrower, and the spreads it commanded set the floor for other borrowers), Argentina, the country whose financial difficulties ignited the Baring Crisis, was commended to investors as "The United States of South America"... the single most important destination for British capital outside the United States and the British Empire... the wheels of international finance were greased by declining interest rates worldwide, associated with Goschen's debt conversion in the 1880s and recession- induced cuts in interest rates by the Federal Reserve in the 1990s. In both cases investors who had been slow to join the bandwagon climbed on board in the final stages of the boom.
While foreign borrowing was portrayed as financing investment in productive capacity, in both cases capital inflows fueled rising levels of consumption. Foreign capital flowed through the banking system, and bank lending financed purchases of luxury imports as well as capital goods. Governments failed to boost their savings to offset dissaving by the private sector. In both cases powerful opposition existed to the government in power, leaving officials reluctant to tighten monetary and fiscal policy for fear of alienating their core constituencies. Hence, they did little to damp down the impact on the economy of international capital flows.
But increased demand did not automatically elicit increased supply. Investment in capacity took time to translate into improved export performance.... Political shocks (strikes and an incipient coup in Buenos Aires in 1889-90, the Chiapas revolt and Colosio assassination in 1994) then raised doubts about the ability of the government to carry out adjustment. Better-informed investors grew wary significantly in advance of the crisis.
The crisis itself drove the Argentine government, like the Mexican government after it, to the brink of default. The fallout destabilized the banking system. It provoked a major recession. And it spilled over to other countries. In 1995 the Tequila Effect was felt in Argentina, Brazil, Thailand and Hong Kong. In the wake of the Baring Crisis, interest rates rose in Brazil, Uruguay, Venezuela and Turkey. Countries as far afield as Australia and New Zealand found it difficult to access external finance....
At the same time there are important differences.... Monetary and fiscal excesses were more clearly evident in Argentina in the 1880s than in Mexico in the 1990s.... In 1995 the Clinton Administration and the IMF saw the need to help Mexico avert a suspension of debt-service... in 1994 there was no single financial institution as exposed as Baring Brothers. In 1890 the fear was for the stability of financial markets in the First World, not the Third. Where the U.S. government's first reaction in 1994 was to assemble financial aid for Mexico, in 1890 the Bank of England and the British Government arranged a rescue fund for Baring Brothers, not for Argentina....
Where the Bank of England could make arrangements with other financial institutions before news of Baring's difficulties became public, the 1995 crisis was a very public affair....
In a sense, then, the Mexican crisis is both the last financial crisis of the 19th century and the first financial crisis of the 21st. Its implications resemble those of the Baring Crisis.... But today's international financial today being even more nimble and decentralized than that of the 1880s, it anticipates the kind of crises that will become increasingly prevalent in the 21st century....
Information on the recent Mexican episode is abundant, and interpretations abound. Hence, I assume that the reader is familiar with the outlines of the Mexican crisis. I concentrate mainly on Argentina in the 1880s, providing just as much information on the Mexican crisis as is needed to place the comparison in relief...
Peter Goodman of the New York Times writes that Milton Friedman "would surely be unhappy with this turn" of events as the Federal Reserve intervenes in financial markets to cushion the impact of things like the collapse of Bear Stearns.
No, Peter Goodman, you are wrong. Friedman would have welcomed the Fed's intervention in Bear Stearns as a way of preventing a downward move in the deposit-currency ratio and thus a fall in the money stock.
On a deeper level, I really think that Peter Goodman of the New York Times gets Milton Friedman wrong. Milton Friedman said that prosperity springs from markets as long as:
Had Peter Goodman actually read anything Milton Friedman wrote about the Great Depression, Goodman would know that when Milton Friedman "attributed the worst economic unraveling in American history to regulators," he placed special stress on Depression-era regulators' refusal to move aggressively to handle bank failures--in Friedman and Schwartz's The Great Contraction, the moment when a normal recession becomes the Great Depression comes about when the Bank of United States fails and the Federal Reserve refuses to step in to handle the situation. Friedman was very much pro-bailout as far as bank depositors were concerned when a failure to do so would lead to a systemic reduction in the money stock.
And Friedman's line was always not that market are perfect, but rather that while markets can and do fail governments have more common and worse modes of failure--except for a narrow range of core functions: rule of law, systemic financial stability, increasing-returns infrastructure, et cetera.
There are tens of thousands of people--left, right, and center--who know Milton Friedman's work, and who would not have committed the elementary error of writing "Friedman... would surely be unhappy with this turn" of government--chiefly the Federal Reserve--working to contain and stem the current financial crisi.
So why is ink given to Peter Goodman, far out of his depth? Why oh why can't wett have a better press corps?
Reconsidering Milton Friedman's Legacy: A Fresh Look at the Apostle of Free Markets: Joblessness is growing. Millions of homes are sliding into foreclosure. The financial system continues to choke on the toxic leftovers of the mortgage crisis. The downward spiral of the economy is challenging a notion that has underpinned American economic policy for a quarter-century — the idea that prosperity springs from markets left free of government interference. The modern-day godfather of that credo was Milton Friedman, who attributed the worst economic unraveling in American history to regulators, declaring in a 1976 essay that “the Great Depression was produced by government mismanagement.”...
Just as the Depression remade government’s role in economic life, bringing jobs programs and an expanded welfare system, the current downturn has altered the balance. As Wall Street, Main Street and Pennsylvania Avenue seethe with recriminations, a bipartisan chorus has decided that unfettered markets are in need of fettering. Bailouts, stimulus spending and regulations dominate the conversation. In short, the nation steeped in the thinking of a man who blamed government for the Depression now beseeches government to lift it to safety. If Mr. Friedman, who died in 2006, were still among us, he would surely be unhappy with this turn....
Mr. Friedman’s brand of libertarianism rested on the assumption that economic and political freedom were one and the same. It meshed with and fed the cold war thinking of his time, as the United States offered up capitalism as liberty itself in contrast to the authoritarian Soviet Union. Among professional economists, Mr. Friedman’s analytical mastery was near-universally admired.... His greatest contribution came the following decade, when Mr. Friedman dismantled the consensus view that inflation was a tolerable byproduct of high employment. He demonstrated that high inflation would eventually cost jobs, as businesses were discouraged to invest by the higher wages they had to pay.
“This triumph, more than anything else, confirmed Milton Friedman’s status as a great economist’s economist, whatever one may think of his other roles,” Paul Krugman, an economist (and a New York Times columnist) wrote last year in The New York Review of Books.
Mr. Friedman captured the era with a new formulation known as monetarism: that the government should gradually and predictably inject cash into the financial system, and then let the market figure out where it should go. “Any honest Democrat will admit that we are now all Friedmanites,” Lawrence H. Summers, the Harvard economist and former Clinton administration Treasury secretary, wrote in an appreciation published in this newspaper when Mr. Friedman died. “He has had more influence on economic policy as it is practiced around the world today than any other modern figure”...
Paul Krugman has his own complaint about Goodman:
Paul Krugman: [O]n behalf of economists everywhere, I want to protest about [Goodman's] description of [Friedman's] natural rate hypothesis:
He demonstrated that high inflation would eventually cost jobs, as businesses were discouraged to invest by the higher wages they had to pay.
This is deeply unfair to Friedman -- it makes a quite profound insight sound like nothing more than a rant.
Here's how I described the natural rate hypothesis in the NYRB piece:
He argued that after a sustained period of inflation, people would build expectations of future inflation into their decisions, nullifying any positive effects of inflation on employment. For example, one reason inflation may lead to higher employment is that hiring more workers becomes profitable when prices rise faster than wages. But once workers understand that the purchasing power of their wages will be eroded by inflation, they will demand higher wage settlements in advance, so that wages keep up with prices. As a result, after inflation has gone on for a while, it will no longer deliver the original boost to employment. In fact, there will be a rise in unemployment if inflation falls short of expectations.
What would Friedman be thinking now, if he were still alive? He would be worried about regulatory overreach. He would be conflicted because he would also be well-aware that organizations capable of generating systemic risk need to be regulated in some way in order to diminish the scope for moral hazard (hence Friedman's calls, at times, for extremely strict banking regulation: 100% reserve banking, in fact).
He would mostly, however, be focused on two graphs of the behavior of the money stock:
And he would have been approving of Federal Reserve policy as long as it kept both these lines from either (a) falling or (b) exploding upward.
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Chris Blattman writes:
Chris Blattman's Blog: Berkeley rocks out: From the latest Berkeley Econ skit party, I Can't Get No Dissertation: Highlights have to include econometricians Paul Ruud and Jim Powell on guitar, Ted Miguel in the perennial African shirt, and Brad Delong crying into someone's dissertation. If that weren't good enough, who ever thought you could combine economics, killer robots, Brad Delong, and econometricians firing lasers guitars? Apparently, the grad students at Berkeley: I can't believe that I'm trying to convince two of the lead singers--Owen Ozier and Pam Jakiela--to work on a project with me in Uganda. ;)
If they had separate weblogs with different color schemes I would confuse them less often. Whatever, Alex Tabarrok is puzzled by two things:
Tyler--no, it's Alex--writes:
Marginal Revolution: Foul Weather Austrians: I am puzzled by the resurgence of Austrian Business Cycle theory among Sachs, Krugman, Baker and many others who you would not ordinarily associate with the theory. Sachs, for example, writes:
...the US crisis was actually made by the Fed... the Fed turned on the monetary spigots to try to combat an economic slowdown. The Fed pumped money into the US economy and slashed its main interest rate...the Fed held this rate too low for too long.
Monetary expansion generally makes it easier to borrow, and lowers the costs of doing so, throughout the economy. It also tends to weaken the currency and increase inflation. All of this began to happen in the US.
What was distinctive this time was that the new borrowing was concentrated in housing....the Fed, under Greenspan's leadership, stood by as the credit boom gathered steam, barreling toward a subsequent crash.
What is puzzling about this is two-fold. First, there is no standard model that I know of (say of the kind normally taught in graduate school) with these kinds of results. Second and even more puzzling is that the foul-weather Austrians don't seem to draw the natural conclusion from their own analysis.
If the Federal Reserve is responsible for what may be a trillion dollar crash surely we should think about getting rid of the Fed? (n.b. I do not take this position.) The true Austrians, like my colleague Alvaro Vargas Llosa, have long taken exactly this position. So why aren't Sachs, Krugman et al. calling for the gold standard, a strict monetary rule, 100% reserve banking, free banking or some other monetary arrangement? Each of these institutions, of course, has its problems but surely after a trillion dollar loss they are worthy of serious consideration.
Nevertheless, I haven't heard any ideas, from those blaming the crash on the Fed and Alan Greenspan, about fundamental monetary reform. (Can Sachs, Krugman et al. really believe that it was Greenspan the man and not the institution that is to blame? That seems naive.)
Instead, the foul weather Austrians seem at most to call for regulatory reform. But that too is peculiar. Put aside the fact that banking is already heavily regulated, have these economists not absorbed the Lucas critique? In short, suppose that whatever regulation these economist want had been put in place in earlier years. Would the crash have been avoided or would the Fed have simply pushed harder to lower interest rates? After all, the Fed lowered rates for a reason and if the regulation reduced the effectiveness of monetary policy in creating a boom well then that just calls for more money.
I, too, am puzzled. I will try to think about this today.
N.B.: Add Mike Mussa to the list of Foul-Weather Austrians: http://www.iie.com/publications/papers/paper.cfm?ResearchID=205
Policy interest rates are exceptionally low in most industrial countries: zero in Japan and Switzerland, 1 percent in the United States, 2 percent in the euro area, and at or near historic lows in the United Kingdom and Canada.... The very low level of policy interest rates is an imbalance (relative to normal conditions) that reflects exceptionally easy monetary policies to combat economic weakness. This policy imbalance poses an important challenge for the future conduct of monetary policy. Situations of low policy interest rates and low inflation tend to be associated with unusual inertia in the processes of general price inflation, which makes traditional indicators of rising inflationary pressures less reliable as measures of the need to begin to tighten monetary conditions. Also, these situations tend to be associated with high valuations of equities, real estate, and long-term bonds, which can become fertile ground for large, unsustainable increases in asset prices. In this situation, if monetary policy is tightened too much too soon (perhaps because of worries about unsustainable increases in asset prices), the result can be an unnecessary asset market crunch and economic slowdown, and monetary policy may have relatively little room to ease in order to counteract this outcome.
On the other hand, if monetary policy remains too easy for too long (perhaps because subdued general price inflation gives no clear signal of the need for monetary tightening), then large asset price anomalies may develop before corrective action is taken. The monetary authority would then confront the grim choice of trying to keep an unsustainable asset price bubble alive or trying to combat the collapse of such a bubble without a great deal of room for monetary easing...
The stats:
UC Berkeley Events Calendar: Symposium: Deterrence in the world of Thomas C. Schelling
Conference/Symposium | March 4 | 9 a.m.-4:30 p.m. | Alumni House, Toll Room
Panelist/Discussant: George Akerlof, Daniel E. Koshland, Sr. Distinguished Professor of Economics, Nobel Laureate 2001, UC Berkeley Economics Department
Sponsor: Goldman School of Public Policy
You are cordially invited to a symposium honoring the work of
Thomas C. SchellingDistinguished University Professor, Department of Economics and School of Public Affairs, University of Maryland, Lucius N. Littauer Professor of Political Economy, Emeritus, Harvard University, and Nobel laureate in Economics 2005
Several panels will discuss Professor Schelling’s work in Strategy, International Relations, Industrial Organization, National Security, and Tipping Points in Social Behavior. Among other notable participants are Nobel laureates George Akerlof, Kenneth Arrow and Daniel McFadden
Target audience: All Audiences
Open to audience: All Audiences
RSVP info: RSVP online.
Refreshments: Refreshments provided.
John N. Gray is supposed to be a reputable British academic, a professor at the London School of Economics, a respected political theorist.
John N. Gray writes, in Straw Dogs:
Financial markets are moved by contagion and hysteria. Mesmer and Charcot are better guides to the new economy than Hayek or Keynes...
I very much doubt that John N. Gray has ever read a word written by John Maynard Keynes.
Stupidest man alive...
Let's give the mike to John Maynard Keynesa, The General Theory of Employment, Interest and Money, chapter 12, "The State of Long-Term Expectation":
The General Theory of Employment, Interest and Money by John Maynard Keynes. Chapter 12. The State of Long-Term Expectation: WE have seen in the previous chapter that the scale of investment depends on the relation between the rate of interest and the schedule of the marginal efficiency of capital corresponding to different scales of current investment, whilst the marginal efficiency of capital depends on the relation between the supply price of a capital-asset and its prospective yield. In this chapter we shall consider in more detail some of the factors which determine the prospective yield of an asset.
The considerations upon which expectations of prospective yields are based are partly existing facts... partly future events which can only be forecasted... future changes in the type and quantity of the stock of capital-assets and in the tastes of the consumer, the strength of effective demand from time to time during the life of the investment under consideration, and the changes in the wage-unit in terms of money.... We may sum [these] up... as being the state of long-term expectation....
It would be foolish, in forming our expectations, to attach great weight to matters which are very uncertain.... For this reason the facts of the existing situation enter, in a sense disproportionately, into the formation of our long-term expectations; our usual practice being to take the existing situation and to project it into the future, modified only to the extent that we have more or less definite reasons for expecting a change....
The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention. But economists have not analysed it carefully.... Our conclusions must mainly depend upon the actual observation of markets and business psychology.... The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made. Our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible. If we speak frankly, we have to admit that our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing; or even five years hence. In fact, those who seriously attempt to make any such estimate are often so much in the minority that their behaviour does not govern the market....
With the separation between ownership and management which prevails to-day and with the development of organised investment markets, a new factor of great importance has entered in, which sometimes facilitates investment but sometimes adds greatly to the instability of the system. In the absence of security markets, there is no object in frequently attempting to revalue an investment to which we are committed. But the Stock Exchange revalues many investments every day and the revaluations give a frequent opportunity to the individual (though not to the community as a whole) to revise his commitments. It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between 10 and 11 in the morning and reconsider whether he should return to it later in the week. But the daily revaluations of the Stock Exchange, though they are primarily made to facilitate transfers of old investments between one individual and another, inevitably exert a decisive influence on the rate of current investment. For there is no sense in building up a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; whilst there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit. Thus certain classes of investment are governed by the average expectation of those who deal on the Stock Exchange as revealed in the price of shares, rather than by the genuine expectations of the professional entrepreneur. How then are these highly significant daily, even hourly, revaluations of existing investments carried out in practice?
In practice we have tacitly agreed, as a rule, to fall back on what is, in truth, a convention. The essence of this convention — though it does not, of course, work out quite so simply — lies in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change. This does not mean that we really believe that the existing state of affairs will continue indefinitely. We know from extensive experience that this is most unlikely.... [T]he above conventional method of calculation will be compatible with a considerable measure of continuity and stability in our affairs, so long as we can rely on the maintenance of the convention.... But it is not surprising that a convention, in an absolute view of things so arbitrary, should have its weak points. It is its precariousness which creates no small part of our contemporary problem of securing sufficient investment. Some of the factors which accentuate this precariousness may be briefly mentioned.
(1) As a result of the gradual increase in the proportion of the equity in the community’s aggregate capital investment which is owned by persons who do not manage and have no special knowledge of the circumstances, either actual or prospective, of the business in question, the element of real knowledge in the valuation of investments by those who own them or contemplate purchasing them has seriously declined.
(2) Day-to-day fluctuations in the profits of existing investments, which are obviously of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd, influence on the market....
(3) A conventional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield; since there will be no strong roots of conviction to hold it steady. In abnormal times in particular, when the hypothesis of an indefinite continuance of the existing state of affairs is less plausible than usual even though there are no express grounds to anticipate a definite change, the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning and yet in a sense legitimate where no solid basis exists for a reasonable calculation.
(4) But there is one feature in particular which deserves our attention. It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it “for keeps”, but with what the market will value it at, under the influence of mass psychology, three months or a year hence. Moreover, this behaviour is not the outcome of a wrong-headed propensity. It is an inevitable result of an investment market organised along the lines described. For it is not sensible to pay 25 for an investment of which you believe the prospective yield to justify a value of 30, if you also believe that the market will value it at 20 three months hence.
Thus the professional investor is forced to concern himself with the anticipation of impending changes, in the news or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced. This is the inevitable result of investment markets organised with a view to so-called “liquidity”. Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is “to beat the gun”, as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.
This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.
Or, to change the metaphor slightly, professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.
If the reader interjects that there must surely be large profits to be gained from the other players in the long run by a skilled individual who, unperturbed by the prevailing pastime, continues to purchase investments on the best genuine long-term expectations he can frame, he must be answered, first of all, that there are, indeed, such serious-minded individuals and that it makes a vast difference to an investment market whether or not they predominate in their influence over the game-players. But we must also add that there are several factors which jeopardise the predominance of such individuals in modern investment markets. Investment based on genuine long-term expectation is so difficult to-day as to be scarcely practicable. He who attempts it must surely lead much more laborious days and run greater risks than he who tries to guess better than the crowd how the crowd will behave; and, given equal intelligence, he may make more disastrous mistakes. There is no clear evidence from experience that the investment policy which is socially advantageous coincides with that which is most profitable. It needs more intelligence to defeat the forces of time and our ignorance of the future than to beat the gun. Moreover, life is not long enough; — human nature desires quick results, there is a peculiar zest in making money quickly, and remoter gains are discounted by the average man at a very high rate. The game of professional investment is intolerably boring and over-exacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll. Furthermore, an investor who proposes to ignore near-term market fluctuations needs greater resources for safety and must not operate on so large a scale, if at all, with borrowed money — a further reason for the higher return from the pastime to a given stock of intelligence and resources. Finally it is the long-term investor, he who most promotes the public interest, who will in practice come in for most criticism, wherever investment funds are managed by committees or boards or banks. For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally....
These considerations should not lie beyond the purview of the economist.... As the organisation of investment markets improves, the risk of the predominance of speculation does, however, increase.... Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.... These tendencies are a scarcely avoidable outcome of our having successfully organised “liquid” investment markets. It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges.... The introduction of a substantial Government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise....
The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except by reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only. But a little consideration of this expedient brings us up against a dilemma, and shows us how the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is “liquid” (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk....
Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; — though fears of loss may have a basis no more reasonable than hopes of profit had before....
This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man. If the fear of a Labour Government or a New Deal depresses enterprise, this need not be the result either of a reasonable calculation or of a plot with political intent; — it is the mere consequence of upsetting the delicate balance of spontaneous optimism. In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends....
[A]ter giving full weight to the importance of the influence of short-period changes in the state of long-term expectation as distinct from changes in the rate of interest, we are still entitled to return to the latter as exercising, at any rate, in normal circumstances, a great, though not a decisive, influence on the rate of investment. Only experience, however, can show how far management of the rate of interest is capable of continuously stimulating the appropriate volume of investment.
For my own part I am now somewhat sceptical of the success of a merely monetary policy directed towards influencing the rate of interest. I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest.
Ezra Klein observes:
EzraKlein Archive | The American Prospect: MIKE HUCKABEE'S PLAN TO GIVE US ALL FLUS: Via Matt comes this exchange between Mike Huckabee adviser Jim Pinkerton and David Corn in which Pinkerton trots out an argument we're likely to see a lot of in the coming year, which is, Democrats are gonna give health care to immigrants!
Ugly stuff. As it happens, it's hard for me to imagine any Democrat proposing a health care plan that covers illegal immigrants, not because doing so would be bad policy from a public health perspective, but because they would be demagogued by Jim Pinkerton. So, instead, we'll continue to eat food handled by ill immigrants, ride buses with sick children, take change from sniffling cashiers, and generally cut off our stuffed noses to spite our angry faces. It's charming stuff. Meanwhile, it's a useful insight into the assumed contours of contemporary politics that Pinkerton thinks the fact that Huckabee won't give health care to illegal immigrants is more electorally powerful than the fact that he also won't give health care to Americans.
Yet another sign of the feckless corruption of centrist politics is that Jim Pinkerton's name is one of the two that "centrists" typically bring up as a "reasonable" conservative (the other is Ramesh Ponnuru).
Matthew Yglesias directs highly effective suppression fire two seats to the right at the Atlantic Monthly:
Matthew Yglesias: The Goods: McMegan points to John Henke's compendium of quotes by Paul Krugman which is supposed to illustrate Megan's earlier contention that "Paul Krugman has predicted eight of the last none recessions under the Bush administration." If this is the best Henke's got, then he really doesn't have the goods. Henke has nine quotations. Three of them are recent enough that they seem to me to be predicting the economic slowdown that is now widely believed to be underway (see, e.g., Ben Bernanke and other Republicans who obviously aren't grinding anti-Bush axes).
Krugman's May 2005 prediction that we were nearing the end of a speculative bubble in the housing market, similarly, looks really good in retrospect -- prices were about flat throughout 2006, and are now headed downward. Again, in April 2005 Krugman said "rising inflation in an economy still well short of full employment - has already arrived" and, indeed, it had; the inflation rate was rising and the employment-population ration remained quite a bit lower than it had been in the late 1990s. With five out of nine correct forecasts, this Krugman guy is looking pretty smart.
Similarly, Henke wants to mock the April 2004 observation that "An oil-driven recession does not look at all far-fetched" but it would be worth reading the actual column to see what Krugman's talking about:
Could an oil shock actually lead to 1970's-style stagflation — a combination of inflation and rising unemployment? Well, there are several comfort factors, reasons we're less vulnerable now than a generation ago. Despite the rise of the S.U.V., the U.S. consumes only about half as much oil per dollar of real G.D.P. as it did in 1973. Also, in the 1970's the economy was already primed for inflation: given the prevalence of cost-of-living adjustments in labor contracts and the experience of past inflation, oil price increases rapidly fed into a wage-price spiral. That's less likely to happen today.
Still, if there is a major supply disruption, the world will have to get by with less oil, and the only way that can happen in the short run is if there is a world economic slowdown. An oil-driven recession does not look at all far-fetched.
In context, that's a not-especially-alarmist warning that I think looks fine in retrospect. The others look a bit better for Henke. But Krugman's track record looks pretty good, even in the context of a series of quotes cherry-picked to make him look bad.
I find the endless array of complaints people pretend to have with Krugman's work fascinating. Krugman is an effective and high-profile advocate for progressive politics. Lots of people want progressive politics to fail. Therefore, they don't like Krugman's columns. That's not so hard to say! But nobody seems willing to say it. Instead, you get a lot of bizarre tut-tutting as if I were to fret that Charles Krauthammer should really write more serious psychology columns or something.
Mark Kleiman is embarrassed by Slate:
The Reality-Based Community: Shorter Steven Landsburg: If Mike Huckabee had proposed a completely different tax plan that has one point of similarity with the idiotic, doesn't-add-up, Scientologist-designed "FairTax" plan he actually proposed, then that completely different plan might be a good idea. So it is unfair to criticize him for offering the plan he actually offered.
As a sorta-kinda economist myself, I deeply resent the fact that many Slate readers probably think that Landsburg's stuff represents the way actual economists think, rather than being more finger exercises in vaguely economic reasoning: sometimes amusing, often disgustingly heartless and wrong-headed, never intellectually or morally serious.
John Berry writes:
Bloomberg.com: Opinion: Some analysts were predicting a recession would hit the U.S. economy in the fourth quarter as consumers, hurt by falling house prices and the high cost of gasoline, cut spending. It didn't happen, and there's no reason to think it's going to this year either....
Given the turmoil in financial markets, the risk of a recession is hardly zero. Nevertheless, the current state of the economy simply doesn't show the signs usually associated with one....
"Expansion peaks tend to be characterized by overhangs in inventories, too many employees and excess capital stock relative to output," [Mickey] Levy said. None of those conditions exists in the U.S. economy and the Fed has eased to the point that rates are "now consistent with sustained growth in demand," he said.
Many of the forecasts calling for a recession are based on an assumption that large losses associated with subprime mortgages and the securities backed by them will force banks to reduce lending big time. The resulting credit crunch will undermine business investment and consumer spending, the forecasters say. There are scant signs of that happening... the National Federation of Independent Business.... "Only three percent of the owners cited the cost and availability of credit as their number one business problem."...
Instead of a slump in consumer spending and the beginning of a recession, households increased their outlays at a 2.5 percent annual rate in the fourth quarter, possibly more, according to estimates by a number of economists. On Dec. 26, Macroeconomic Advisers said consumer spending probably rose at a 2.8 percent rate.... The gross domestic product probably increased at a 1.1 percent pace in the fourth quarter and will do slightly better in the first quarter, the firm said...
David Brooks writes:
The Sidney Awards II - New York Times: Three other essays are worth your time.... In the Chronicle of Higher Education, J. Bradford DeLong wrote “Creative Destruction’s Reconstruction” on why Joseph Schumpeter matters to the 21st century...
Blush.
Don't get me wrong--I like the essay I wrote a lot, and Tom McGraw's Schumpeter biography is excellent. But even I don't think it's in the world's top 20 essays for 2007...
And what credit there is should be shared with Alex Kafka, the editor on the piece, who did do a bang-up job, I thought.
Note to self: I really need to rethink and expand this. I have the sense that there are absolutely dazzling and important insights back there somewhere that did not make it out of my brain when I wrote:
J. Bradford DeLong (2005), "Sisyphus as Social Democrat," _ From Foreign Affairs, _ (May/June): Review of Richard Parker (2005), John Kenneth Galbraith: His Life, His Politics, His Economics. Farrar, Straus & Giroux, 2005, 820 pp. $35.00.
Summary: John Kenneth Galbraith's dazzling career as an economist and public intellectual has left an oddly thin legacy. A new biography sets out to explain why -- tracing, in the process, the rise and fall of twentieth-century American liberalism.
J. Bradford DeLong is Professor of Economics at the University of California at Berkeley.
If there were justice in the world, John Kenneth Galbraith would rank as the twentieth century's most influential American economist. He has published several books that are among the best analyses of modern U.S. history, played a key role in midcentury policymaking, and advised more presidents and senators than would seem possible in three lifetimes. Yet today, Galbraith's influence on economics is small, and his influence on U.S. politics is receding by the year.
In this lively and thoughtful biography, Richard Parker sets himself the task of explaining Galbraith's career: why it was so dazzling, and why its long-term impact has turned out to be so much less than expected. The result is not only the story of a smart, witty, and important man, but also a fascinating meditation on the rise and fall of twentieth-century American liberalism...
I do not think that this essay paragraph is an accurate precis of Friedrich Hayek (1945), "The Use of Knowledge in Society," American Economic Review:
On the flip side, we have Hayek, who believed in collectivization. He believed that to help with the economic gap, the government should hand out rations and resources. This process, he claimed, would be expedited by the price mechanism, which would openly share all information so as to increae productivity and reduce waste. In other words, he wanted a communist regime to battle poverty and social and economic disparity...
The rest of the essay is very good, however. I'm giving it an A nevertheless.
And you might, I suppose, argue that the main point of TUoKiS is that libertarian capitalism is a much more effective and just Free Society of Associated Producers than any other possibility...
Matthew Yglesias writes:
Jim Glassman, America's New Salesman: One point people have tried to make over the past few years is that the Bush administration needs to stop thinking of public diplomacy as simply a need to put a better sales pitch on the same American policies. Our pitch is actually fine and people understand what we're saying -- they just don't like it.
Relatedly, someone told me earlier today that Jim "Dow 36,000" Glassman was replacing Karen Hughes. I laughed at this pretty funny out-of-left-field joke. Obviously, the same George W. Bush who thinks public diplomacy is just about salesmanship wouldn't give the job to one of the least credible salespeople on the planet. Funny stuff. And imaginative! But no, this is really happening.
Time to hoist from the archives!
http://www.j-bradford-delong.net/movable_type/2005_archives/000025.html [Kevin Hassett and James Glassman,] the authors of Dow 36000: The New Strategy for Profiting from the Coming Rise in the Stock Market, pretend, once again, that their book did not say what it said:
TCS: Tech Central Station - DOW 36,000: Five years ago, economist Kevin Hassett and I wrote a book called Dow 36,000.* Maybe you have heard of it. The book made the bestseller lists and won accolades from, among others, the current chairman of the president's Council of Economic Advisors. For some, however, the book became an object of derision because -- just in case you haven't noticed -- the Dow hasn't actually risen to 36,000 yet.... Dow 36,000 was not a prognostication. Sure, the Dow will hit 36,000 and probably, eventually, 360,000. But I don't know exactly when, and I don't believe investing is a game of forecasting what's going to happen tomorrow or next year...
However, those of us unlucky enough to own Dow 36000: The New Strategy for Profiting from the Coming Rise in the Stock Market can go to our bookshelves, pull it down, and read that "the Dow should rise to 36000 immediately"--i.e., in October, 1999. But Hassett and Glassman say, they are going to be cautious and conservative. They are not going to forecast that the Dow will rise to 36000 tomorrow, but instead they "believe the rise will take some time, perhaps three to five years..." (p. 18).
However, they acknowledge that they might be wrong: the rise might come much quicker. As they go on to say later on the book, the fact that Glassman and Hassett "conservatively" don't expect the rise of the Dow to 36000 to occur for three to five years--i.e., until 2002 or 2004--does not mean that investors should delay. Investors should "seize the opportunity now [i.e., in 1999] to profit from the rise in the Dow to 36000 (p. 125)."
On pages 18 and 19 of the book they go so far as to sneer at one of their American Enterprise Institute colleagues--someone who told them back in 1998 what Glassman is saying now. For when one AEI colleague heard their title, he gave a cynical laugh and said, "As long as you don't say when [the Dow will reach 36000], I suppose it is all right." Glassman and Hassett's response was: "we aren't laughing. The case is compelling.... 36000 is a fair value for the Dow today... stocks should rise to such heights very quickly. As you read on, you will... learn to invest in ways that take advantage of a remarkable time in financial history..."
Glassman's investment advice today is good. He is right when he writes that "stocks are a far better place than bonds and cash to put the vast majority of your money for the long run." But his flat-out claim that this "was the unequivocal message of [Dow 36000: The New Strategy for Profiting from the Coming Rise in the Stock Market]" is flat-out false. That "stocks are a far better place than bonds and cash to put the vast majority of your money for the long run" was the unequivocal message of Jeremy Siegel's Stocks for the Long-Term. Glassman and Hassett may wish that they had written the book that Seigel wrote, but they didn't.
Moreover, we haven't even gotten into the fact that Glassman and Hassett got their math wrong. As the Economist's Clive Crook told them in May 1998, the 36000 number was "wrong, plain wrong.... Your reasons for believing that the Dow should be at 36,000 are wrong in the same way that it's wrong to say two plus two equals five.... Using your own method, provided only that you put the right variable into the formula, the market is about fairly valued."
Note how they don't dare mention the subtitle of their own book--it would make the falsity of the claim that "Dow 36000 was not a prognostication" too obvious.
It would be an elementary point to say that somebody who cannot tell the truth about his own book shouldn't be held out as the public face of American diplomacy by any administration. But this point eludes Condi Rice and the rest of the Bushies.
UPDATE: In fact, this point eludes the usually-reliable James Fallows, who after writing:
James K. Glassman: face of America: I have known and liked Jim Glassman for a very, very long time.... He is a lively, funny, and creative guy, and there are lots of jobs for which I would happily sign him up.
But as the head of America's public-diplomacy efforts?... America's idea is still powerful and attractive, and America still has the opportunity to present a compelling and authentic face to the world.... I have met... many true-blue patriotic Americans who have spent their careers learning how... America could best engage [foreign countries]. Jim Glassman, despite being a great guy, is not one of these...
Reverses field:
Further on JK Glassman and public diplomacy: This hasn't happened in a while, but after taking a few hours to to think it over, I've changed my mind.... The idea of America, in its authentic version, should be attractive and inspiring to people around the world.... If the world doesn't feel that way right now, it's largely though not entirely our own fault.... I'm still exasperated at the damage done to my country's reputation and name, and I have very low expectations of what Karen Hughes's successor... will be able to accomplish... the current president and vice president will still be in office. But it is possible that the verve, energy, and ingenuity Jim Glassman has shown through his career could be just the traits the person in that situation needs... let's see what he can do in this next year.
I'm going to be cynical, and note that Fallows did not follow the advice of Dow 36000--did not say "let's see what [Glassman] can do"--did not borrow as much as he could and invest everything in the stock market in October 1999 to take advantage of the "coming rise of the stock market" to Dow 36000 that Glassman was saying would happen in 3 to 5 years. Risks worth running with America's global diplomatic effort are not risks worth running with one's own financial portfolio.
:-)
Post fact-checker Michael Dobbs demonstrates that he has no clue what a fact-checker is or does:
The Fact Checker Fact Checks The Post - Fact Checker: I have spoken with the principal author of the [Post] editorial, but I am not going to identify that person.... The editorial writer got the information... from a Mexican embassy slide show... by Antonio Ortiz-Mena, a well-known Mexican economist. Slide Six shows an increase in Mexican Gross Domestic Product from $200 billion dollars in 1987 to $875 billion (estimated) in 2007.
The slide does not provide... information about the source of the data... does not say whether the dollars are current or constant.... [T]he data tables of the International Monetary Fund... show that the Mexican economy grew from $148 billion in 1987 to $886 billion in 2007.... If you adjusted these figures for inflation, you might get a result similar to the figures used by The Post.
UPDATE: Actually, as a couple of readers have pointed out, this seems a stretch... the [Mexican] cost of living has increased 79 percent... $148 billion [measured] in 1987[-value dollars] is the equivalent of $265 billion [measured] in 2007[-value dollars, not $200 billion]....
It turns out there are several other ways of looking at the same statistics.... IMF peso figures, adjusted for inflation... works out at a growth rate of around 83 per cent....
To help me adjudicate this dispute, I turned to Paul Blustein, a former international economics reporter for the Post, now with the Brookings Institution, where he is writing a book about international trade. He said he was "sorry to go against my old alma mater," but he came down on the side of the critics. His explanation:
Constant dollars can be a good way of looking at a country's economy, but when there have been huge moves in that country's currency against the dollar, it is better to rely on the local currency. This would have raised a red flag with me. I don't think any economy in the world has quadrupled in twenty years. That would be an amazingly fast rate of growth. I doubt that even the Chinese economy has done that....
[T]he IMF... suggested a third way... PPP... the purchasing power of the average Mexican has risen by around 125 per cent between 1987 and 2007.
So take your pick. Depending on the statistics you use, Mexican economic growth over the last two decades has been either 337 percent, 125 percent, or 83 percent.... This is a case study of how statistics can be used to support virtually any argument....
[T]he Post editorial board should have been much clearer about the source of the statistics, and explain why dollars are the appropriate measure for the growth of a peso-based economy. The claim of a quadrupling in the size of the Mexican economy over two decades is misleading, and should have raised some eyebrows. Two Pinocchios for the Post.
The critics were also sloppy in their use of statistics, but at least they pointed out the source. One Pinocchio for them.
Why oh why can't we have a better press corps?
An excellent piece from Steven Pearlstein, who is still at the Washington Post:
It's Not 1929, but It's the Biggest Mess Since: It was Charles Mackay, the 19th-century Scottish journalist, who observed that men go mad in herds but only come to their senses one by one. We are only at the beginning of the financial world coming to its senses after the bursting of the biggest credit bubble the world has seen. Everyone seems to acknowledge now that there will be lots of mortgage foreclosures and that house prices will fall nationally for the first time since the Great Depression. Some lenders and hedge funds have failed, while some banks have taken painful write-offs and fired executives. There's even a growing recognition that a recession is over the horizon. But let me assure you, you ain't seen nothing, yet.
What's important to understand is that, contrary to what you heard from President Bush yesterday, this isn't just a mortgage or housing crisis. The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts. It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will.
At the center of this still-unfolding disaster is the Collateralized Debt Obligation, or CDO. CDOs are not new -- they were at the center of a boom and bust in manufacturing housing loans in the early 2000s. But in the past several years, the CDO market has exploded, fueling not only a mortgage boom but expansion of all manner of credit. By one estimate, the face value of outstanding CDOs is nearly $2 trillion. But let's begin with the mortgage-backed CDO.
By now, almost everyone knows that most mortgages are no longer held by banks until they are paid off: They are packaged with other mortgages and sold to investors much like a bond. In the simple version, each investor owned a small percentage of the entire package and got the same yield as all the other investors. Then someone figured out that you could do a bigger business by selling them off in tranches corresponding to different levels of credit risk. Under this arrangement, if any of the mortgages in the pool defaulted, the riskiest tranche would absorb all the losses until its entire investment was wiped out, followed by the next riskiest and the next. With these tranches, mortgage debt could be divided among classes of investors. The riskiest tranches -- those with the lowest credit ratings -- were sold to hedge funds and junk bond funds whose investors wanted the higher yields that went with the higher risk. The safest ones, offering lower yields and Treasury-like AAA ratings, were snapped up by risk-averse pension funds and money market funds. The least sought-after tranches were those in the middle, the "mezzanine" tranches, which offered middling yields for supposedly moderate risks.
Stick with me now, because this is where it gets interesting. For it is at this point that the banks got the bright idea of buying up a bunch of mezzanine tranches from various pools. Then, using fancy computer models, they convinced themselves and the rating agencies that by repeating the same "tranching" process, they could use these mezzanine-rated assets to create a new set of securities -- some of them junk, some mezzanine, but the bulk of them with the AAA ratings more investors desired. It was a marvelous piece of financial alchemy, one that made Wall Street banks and the ratings agencies billions of dollars in fees. And because so much borrowed money was used -- in buying the original mortgages, buying the tranches for the CDOs and then in buying the tranches of the CDOs -- the whole thing was so highly leveraged that the returns, at least on paper, were very attractive. No wonder they were snatched up by British hedge funds, German savings banks, oil-rich Norwegian villages and Florida pension funds.
What we know now, of course, is that the investment banks and ratings agencies underestimated the risk that mortgage defaults would rise so dramatically that even AAA investments could lose their value. One analysis, by Eidesis Capital, a fund specializing in CDOs, estimates that, of the CDOs issued during the peak years of 2006 and 2007, investors in all but the AAA tranches will lose all their money, and even those will suffer losses of 6 to 31 percent. And looking across the sector, J.P. Morgan's CDO analysts estimate that there will be at least $300 billion in eventual credit losses, the bulk of which is still hidden from public view. That includes at least $30 billion in additional write-downs at major banks and investment houses, and much more at hedge funds that, for the most part, remain in a state of denial.
As part of the unwinding process, the rating agencies are in the midst of a massive and embarrassing downgrading process that will force many banks, pension funds and money market funds to sell their CDO holdings into a market so bereft of buyers that, in one recent transaction, a desperate E-Trade was able to get only 27 cents on the dollar for its highly rated portfolio. Meanwhile, banks that are forced to hold on to their CDO assets will be required to set aside much more of their own capital as a financial cushion. That will sharply reduce the money they have available for making new loans. And it doesn't stop there. CDO losses now threaten the AAA ratings of a number of insurance companies that bought CDO paper or insured against CDO losses. And because some of those insurers also have provided insurance to investors in tax-exempt bonds, states and municipalities have decided to pull back on new bond offerings because investors have become skittish.
If all this sounds like a financial house of cards, that's because it is. And it is about to come crashing down, with serious consequences not only for banks and investors but for the economy as a whole. That's not just my opinion. It's why banks are husbanding their cash and why the outstanding stock of bank loans and commercial paper is shrinking dramatically. It is why Treasury officials are working overtime on schemes to stem the tide of mortgage foreclosures and provide a new vehicle to buy up CDO assets. It's why state and federal budget officials are anticipating sharp decreases in tax revenue next year. And it is why the Federal Reserve is now willing to toss aside concerns about inflation, the dollar and bailing out Wall Street, and move aggressively to cut interest rates and pump additional funds directly into the banking system.
This may not be 1929. But it's a good bet that it's way more serious than the junk bond crisis of 1987, the S&L crisis of 1990 or the bursting of the tech bubble in 2001.
...a contribution to Framing Theory’s Empire. John Holbo writes:
The Valve - A Literary Organ | Framing Theory’s Empire - Event and Text: It’s finally a book! Framing Theory’s Empire [amazon]; or get it from the publisher, Parlor Press, directly. You can download the entire book as a free PDF from the Parlor site. I’m still waiting for my paper copy to show up. (Any of you contributors out there gotten yours yet?) I think the cover is rather handsome. But, then: a father should love his child. The lovely Belle Waring and I designed it together.
A book, eh? See here! What’s all this about? ‘Theory’? Yes, exactly! In the English/humanities department sense: the idiomatically ofless sort, you might say; as in, ‘I do theory’. The stuff that started in the 60’s, got really big in the 80’s. Then either went away or is still hanging around, depending who you ask. (If you ask me: it’s still hanging around.)
If you spent late 2005 in a coma and missed all the glory, we staged a ‘book event’, round-table reviewing the Patai and Corral edited Theory’s Empire (Columbia UP, 2005). See the sidebar for link. Framing Theory’s Empire contains contributions to that event, cleaned up, polished up, edited. (I’ve written an introduction, talking about these issues. If you care to read it.)
The contributors are: Scott McLemee (he generously contributed a preface), John Holbo, Mark Bauerlein, Michael Bérubé, John McGowan, Scott Kaufman, Sean McCann, Daniel Green, Adam Kotsko, Tim Burke, Amardeep Singh, Jonathan Mayhew, Jonathan Goodwin, Chris Cagle, Christopher Conway, Kathleen Lowrey, Brad DeLong, Matthew Greenfield, Morris Dickstein, Jeffrey Wallen, John Emerson, Mark Kaplan, Jodi Dean, Kenneth Rufo, Daphne Patai, Will H. Corral. (Patai and Corral were kind enough to contribute an “Afterword”. At the moment Amazon is giving them erroneous prominence, in the author line. I’ll have to see whether I can get Amazon to correct that. Not that I mind so very much. They themselves will probably be even more annoyed, because it might create some product confusion with Theory’s Empire itself.)
It’s the perfect stocking stuffer for the humanities graduate student on YOUR list!
I think it turned out to be a really great book. In addition to several posts that turned out to be just plain really solid essays, there is some lively, sharp conversation between several participants. There’s intelligent back and forth, actual addressing of critical points and hashing of differences, which is not something one always gets in themed anthologies. I think the informal quality of many of the pieces turns out to be a real virtue as well. It suits the topic. But you tell me. What do you think of the book? What do you think about our event, two years on?
I’m glad to get this done as well because, frankly, my Glassbead Books efforts for Parlor haven’t been quite rolling off the assembly-line, as I had originally hoped. It turns out making books is incredibly hard and time consuming, and folks don’t do stuff when you tell them to, and it’s hard to get folks to commit to helping out. Academics are always busy. I’m hoping that, with a grand total of TWO titles out now we’ve actually got a series. That is, a line, not just a single point. Anyway, next comes our Moretti book - I think. I want to get these things rolling out a lot faster.
Scott Eric Kaufman writes:
Acephalous: Google's Images, Searched for Me: A reader who attended a function I'd planned to (but, due to illness, could not) attend suggested I spend a few minutes skimming the results of a Google Image Search for my name. (He wanted to be sure he could spot me in the crowd.) Intrigued, I took him up on his offer. The results are ... interesting. A search for my full name, bookended by quotation marks, returns: a photo of Eric Lott on the beach; Scott McLemee's Simpson's self; some books McLemee bought for Kotsko in Canada a few years in; the header of the Iranian Supreme Leader's blog.... Chard Orzel; Salma Hayek; an angry duck; Salma Hayek; Brad DeLong; Salma Hayek... Salma Hayek... Salma Hayek.... Something must've gone horribly wrong with Google. I don't even like Salma Hayek, much less—what do you mean "Page Rank"? This post will do what? Seriously?...
At least it is not Friedrich Hayek.
And "Chard" Orzel?
Professor David Romer, having won the struggle with Professor Emmanuel Saez for possession of Berkeley's copies of Statistics of Income:
Graduate student Andy Jalil with his evening's light reading:
Professor Joachim Voth fulfills his long-time ambition to be featured on this weblog:
From <>:
Adam Smith - An Inquiry into the Nature and Causes of the Wealth of Nations - The Adam Smith Institute: To transfer from the owners of... land and capital stock... persons immediately interested in the good condition of every particular portion of land, and in the good management of every particular portion of capital stock, to... the creditors of the public... must, in the long-run, occasion both the neglect of land, and the waste or removal of capital stock.... [A] creditor of the public, considered merely as such, has no interest in the good condition of any particular portion of land, or in the good management of any particular portion of capital stock....
The practice of funding has gradually enfeebled every state which has adopted it. The Italian republics seem to have begun it.... Spain seems to have learned the practice from the Italian republics, and (its taxes being probably less judicious than theirs) it has, in proportion to its natural strength, been still more enfeebled.... France, notwithstanding all its natural resources, languishes under an oppressive load.... The republic of the United Provinces is as much enfeebled by its debts as either Genoa or Venice. Is it likely that in Great Britain alone a practice which has brought either weakness or desolation into every other country should prove altogether innocent?
The system of taxation established in those different countries, it may be said, is inferior to that of England. I believe it is so. But it ought to be remembered that, when the wisest government has exhausted all the proper subjects of taxation, it must, in cases of urgent necessity, have recourse to improper ones.... To the honour of our present system of taxation, indeed, it has hitherto given so little embarrassment to industry that, during the course even of the most expensive wars, the frugality and good conduct of individuals seem to have been able, by saving and accumulation, to repair all the breaches which the waste and extravagance of government had made in the general capital of the society. At the conclusion of the late war, the most expensive that Great Britain ever waged, her agriculture was as flourishing, her manufacturers as numerous and as fully employed, and her commerce as extensive as they had ever been before.... Great Britain seems to support with ease a burden which, half a century ago, nobody believed her capable of supporting. Let us not, however, upon this account rashly conclude that she is capable of supporting any burden, nor even be too confident that she could support, without great distress, a burden a little greater than what has already been laid upon her...
Creative Destruction's Reconstruction: Joseph Schumpeter Revisited: my review of Tom McCraw's excellent Schumpeter biography for the Chronicle of Higher Education. Thanks to Alex Kafka for editing it into shape.
Print: Creative Destruction's Reconstruction: Joseph Schumpeter Revisited - ChronicleReview.com: http://chronicle.com/free/v54/i15/15b00801.htm: From the issue dated December 7, 2007: THE MATERIAL WORLD: Creative Destruction's Reconstruction: Joseph Schumpeter Revisited
My guess is that average literate Americans know of three 20th-century economists: John Maynard Keynes, Milton Friedman, and Alan Greenspan. Perhaps they also know of Paul Samuelson (but as textbook author, not economic theorist), of Friedrich Hayek (but think that he is the father of an actress), and of John Kenneth Galbraith (as William F. Buckley Jr.'s friend who appeared on TV). The rest of us disappear into a blur of gray suits, spectacles, and, usually, baldness — an assemblage of personalities too bland to be successful accountants.
In Prophet of Innovation: Joseph Schumpeter and Creative Destruction (Belknap Press/Harvard University Press, 2007), Thomas K. McCraw, an emeritus professor of business history at Harvard Business School, tries to add another name to the list — Joseph Schumpeter. From the start, you should know that I am partial to Schumpeter; McCraw quotes me and Larry Summers saying that if Keynes was the most important economist of the 20th century, then Schumpeter may well be the most important of the 21st. McCraw's fascinating book details why that is so, but McCraw, too, is so partial to Schumpeter that he fails to fully explain how Schumpeter tripped himself up over a political understanding as clumsy as his economic understanding was brilliant.
Schumpeter was born in 1883 in what is now the Czech Republic, and died in America in 1950. When he was four, his father died. When he was 10, his mother remarried and moved to Vienna, where his aristocratic stepfather helped him enter elite schools. He was a star: youngest professor in the empire at 26, finance minister of Austria (briefly) at 36, a bank president, and then a professor again. His mother, wife, and newborn son died in rapid succession in 1926 — an awful and tragic shock. He was important enough for Harvard to pluck him from Europe in 1932 to make him one of its superstars. And, after his move to America, he was one of the most famous American economists.
But as fascinating as his life was, it is Schumpeter's economics that sing to me, because he tried to set long-term economic growth — entrepreneurship and enterprise — at the top of the discipline's agenda.
Over the previous two and a half centuries, three different economic worldviews, in succession, reigned. In the late 18th and early 19th centuries, Adam Smith's was the key economic perspective, focusing on domestic and international trade and growth, the division of labor, the power of the market, and the minimal security of property and tolerable administration of justice that were needed to carry a country to prosperity. You could agree or you could disagree with Smith's conclusions and judgments, but his was the proper topical agenda.
The second reign was that of David Ricardo and Karl Marx. Their preoccupations dominated the late 19th and early 20th centuries. They worried most about the distribution of income and the laws of the market that made it so unequal. They were uneasy about the extraordinary pace of technological, organizational, and sociological change, and about whether an ungoverned market economy could produce a distribution of income — both relative and absolute — fit for a livable world. Again, you could agree or disagree with their judgments about trade, rent, capitalism, and machinery, but they asked the right questions.
The third reign was that of John Maynard Keynes. His agenda dominated the middle and late 20th century. Keynes's theories centered on what economists call Say's Law — the claim that except in truly exceptional conditions, production inevitably creates the demand to buy what is produced. Say's Law supposedly guaranteed something like full employment, except in truly exceptional conditions, if the market was allowed to work. Keynes argued that Say's Law was false in theory, but that the government could, if it acted skillfully, make it true in practice. Agree or disagree with his conclusions, Keynes was in any case right to focus on the central bank and the tax-and-spend government to supplement the market's somewhat-palsied invisible hand to achieve stable and full employment.
B ut there ought to have been a fourth