J. Bradford DeLong's Grasping Reality with a Prehensile Tail

And I Was Just This Morning Saying That the World Economy Had Dodged a Bullet...

Silly me. The bullet is still headed this way...

Robin Wigglesworth in Abu Dhabi and Simeon Kerr in Dubai:

Dubai rejects guarantee for Dubai World: The government of Dubai on Monday said it would not guarantee the debt of Dubai World as it sought to clarify comments made last week by the state-owned entity that sent shockwaves through global markets. In its first public comments since the crisis erupted over the liabilities of its public companies, Dubai’s department of finance on Monday outlined its policy towards the outstanding loans, which total $59bn. Abdulrahman al-Saleh, director general of Dubai’s department of finance, said in an interview with Dubai TV that creditors had to take responsibility for their own lending decisions and differentiate between advances to companies and the state. He also said global markets had overreacted to the news. Mr Saleh admitted that creditors of Dubai World, which owns DP World, the ports operator, and Nakheel, the property investment company, would be affected in the short-term but claimed there would be long-term benefits as the government restructured the business.

The Dubai department of finance said last week it would request a standstill on all Dubai World’s debts, including a $4bn sukuk or Islamic bond payable on December 14. Global investors were confused by the standstill request as Dubai officials had said for the previous three months that the trading and financial hub would face no problems in paying off its debts. The local Dubai Financial Market closed down 7.3 per cent on Monday, its biggest drop in a year, in its first trading session since the Eid al-Adha holiday. Other Gulf markets were closed because of the holiday. But shares in DP World, one of Dubai’s most valuable state assets, tumbled 15 per cent on the Nasdaq Dubai bourse. Five-year credit default swaps for Dubai rose on Mr Saleh’s comments, widening to 594.6 basis points according to CMA Datavision, after earlier tightening on UAE central bank intervention announced on Sunday.

Elsewhere, Dubai World has made the payment owed today on a Dh130m coupon on a sukuk issued by the Jebel Ali Free Zone Authority, the industrial park next to Dubai’s largest port owned by Dubai World, bankers said. But Nakheel, the company at the centre of Dubai’s financial woes, on Monday asked for all three of its sharia-compliant bonds worth $5.25bn to be suspended from trade “until it is in a position to fully inform the market”. Sentiment was not helped by a note from EFG-Hermes, a local investment bank, which said that the estimates of Dubai’s $80bn debt burden, consisting of bonds and syndicated loans, could rise to $120bn-$150bn if bilateral loans and other missing information were included.

In Dubai the mood among traders returning to work after the religious holiday was sombre. “We are very disappointed – we had expected the market to drift down. Instead it fell down ... just like that,” said Muhammed, a private investor, as he looked at a ticker covered in red. “This is punishment day. Why didn’t we sell last week? This is punishment for the unexpected news from Dubai World last week,” he added. The UAE markets limit trade on liquid stocks when they fall 10 per cent. Emaar, a major listed developer in Dubai and an important bellwether for the emirate, slumped 9.9 per cent as soon as the DFM opened.

The Abu Dhabi Stock Exchange, the third bourse in the United Arab Emirates, lost more than 8 per cent in heavy trading. “It’s a short-term panic sell-off,” said Emad Mostaque, an emerging markets fund manager at Pictet in London. “There are 100m sell orders on all the higher traded shares.” The UAE markets close again on Wednesday and Thursday for the country’s national day, before reopening on Sunday.

Egypt’s bourse lost 7.9 per cent as international investors take a more negative view over regional risks.

Dubai: Why, Yes, Our Collateral Is Underwater. Why Do You Ask?

Paul Krugman is judicious and sober:

Rashomon in the desert: Dubai or not Dubai — that is the question. Dubai’s sorta-kinda default (a state-owned enterprise seeking a rescheduling of its debts) is, by itself, not that big of a deal. But who else looks like Dubai? What kind of omen is this for the next stage in the financial crisis?

As far as I can tell, there are three ways to look at it — three stories, if you like, about what Dubai means.

• First, there’s the view that this is the beginning of many sovereign defaults, and that we’re now seeing the end of the ability of governments to use deficit spending to fight the slump. That’s the view being suggested, if I understand correctly, by the Roubini people and in a softer version by Gillian Tett.

• Alternatively, you can see this as basically just another commercial real estate bust. Either you view Dubai World as nothing special, despite sovereign ownership, as Willem Buiter does; or you think of the emirate as a whole as, in effect, a highly leveraged CRE investor facing the same problems as many others in the same situation.

• Finally, you can see Dubai as sui generis. And really, there has been nothing else quite like it.

Gillian Tett is less happy:

Greece and Dubai show system remains unstable: A watershed in the derivatives world could be reached this week: the cost of insuring against a bond default by Greece, using credit derivatives, may rise above the comparable metric for Turkey for the first time.... [O]n Thursday – as markets reeled from the Dubai shock and investors fled from risk – the bid-offer spread on five-year Greek CDSs was 201bp-208bp, according to Markit. That of Turkish CDSs was 207bp-212bp, leaving them neck and neck (and according to Bloomberg data, in some trades the Greek CDS was even higher than Turkey). All this is a bitter blow to Greek pride. However, there is a much bigger moral here, which cuts to the heart of the Dubai saga, too.

Two years ago, global investors generally did not spend much time worrying about so-called “tail risk” (a banking term for the chance that seemingly remote, nasty events might occur). After all, before 2007, when the world was supposedly enjoying the era of the “Great Moderation”, the world seemed so stable and predictable that it was hard to imagine truly unpleasant events occurring. But in the past two years, a seemingly safe financial system has crumbled, and – to paraphrase Lewis Carroll – investors have repeatedly been asked to believe six impossible things before breakfast, ranging from the collapse of Lehman Brothers to the implosion of Iceland (and much else). Tail risk, in other words, has leapt into investor consciousness. And while the financial markets have stabilised in the past six months, that lesson about tail risk cannot be easily unlearnt... has left investors looking like veterans from a brutal war. Long after the fighting has stopped, the mere sound of a “bang”, is apt to leave them running for cover.

All this does not mean – let me stress – that it is correct to expect the world to melt down imminently.... [But t]ail risk has resurfaced with a vengeance.... For while investors used to assume that it was just emerging market countries that were prone to suffering truly nasty fiscal shocks, the debt fundamentals in Dubai are not necessarily so different from those in developed nations... the fundamental imbalances that created the crisis in the first place – such as excess leverage – have not yet disappeared. Beneath any aura of stability huge potential vulnerabilities remain. If Thursday’s events prompt investors to remember that, so much the better; not just in Dubai but in Greece, too.

Hoisted from the Archives (2002): Mark-My-Beliefs-to-Market Time: Argentina

Hoisted from the Archives:

Mark-My-Beliefs-to-Market Time: Archive Entry From Brad DeLong's Webjournal: I am reading Michael Mussa's brand-new very short book on the latest Argentinian financial crisis [Michael Mussa (2002), Argentina and the Fund: From Triumph to Tragedy (Washington: Institute for International Economics: 088132339X)]. In The Importance of Being Earnest, Oscar Wilde gets a laugh out of the idea that a chapter on a rupee crisis is too exciting for young ladies--out of the idea that a technical discussion of anything having to do with international finance can be anything but deadly boring. But reading this is different.

First, I'm weird: I'm an economist, which means (these days at least) that I don't even have the sparkle and flash, the willingness to take risks and go out on limbs, that accountants have. Second, the Argentine crisis is an important setback for human happiness--a much more important tragedy even than the closing of a Zambian copper mine. Plus the crisis has important lessons for international economic policy in the future.

Third, Michael Mussa--former chief economist at the IMF for a decade--is a fearless and witty guy: he (reportedly) spoke of his boss at the IMF, Michel Camdessus, as a man who was 'so optimistic he always sees the glass as half full, even when there's no glass at all'; in this book, he writes of the IMF following its standard approach when a government fails to meet the policy targets it has committed to--the standard 'three-monkeys approach: see no evil, hear no evil, speak no evil'; he writes of the proposals of the Meltzer Commission for IMF reform as '...unnecessary, unworkable... fundamentally misguided...'; and he writes of the Fund staff's spring 2001 analysis of the dynamics of Argentina's debt, '...if, if, if... if my grandmother had wheels, she would be a bus...'

Thus I had no trouble staying awake through the book.

Toward its end, Mussa calls for a thorough evaluation of the Fund's role in Argentina, an evaluation to take the broadest possible scope. He writes (p. 71) that:

.>.. it is my view that the Argentine government's basic decision to combine efforts at macroeconomic stabilization with market-oriented reforms was the right policy approach... the spectacular success of the Argentine economy throughout most of the past decade is attributable to this basic policy choice... the spectacular collapse in 2001 is due to the failure to implement this strategy sufficiently vigorously, especially in... fiscal discipline. Others... may be inclined to the view that the policies... are fundamentally wrong and were doomed form the start.... An evaluation of the Fund's role in Argentina should reflect on this broad question...

And so I have begun thinking: What if I wanted to make the argument that the neoliberal policy mix adopted by President Carlos Menem and Finance Minister Domingo Cavallo was a big mistake, that it was all doomed to failure from the beginning and should not have been undertaken, that from the moment he proposed his Convertibility Plan to stop Argentina's hyperinflation the Sunday Horse was pulling the Argentine cart down a track that led nowhere? What would that argument look like?

As I see it, such an argument would have five steps:

First, the neoliberal program pushed by Domingo Cavallo demanded free markets--the end to protectionism, the end to quantitative restrictions of all kinds, the end of limits on freedom of contract, and most importantly the end to controls on the ability of not just goods but money to flow into and out of Argentina, and the end of the government's ability to force Argentines to denominate their wealth in a unit of account--the peso--whose value it controlled.

Second, the neoliberal program pushed by Domingo Cavallo required a hard peg of the value of the peso to the dollar: nothing else would convince Argentines that the days of hyperinflation had passed, and that they no longer had to dissipate resources and waste time insuring themselves against inflation, but could trust the unit of account.

Third, Argentina is a country in which the government constantly promises the people more than it can deliver. It promises rich oligarchs that it will not collect too much in taxes. It promises workers and consumers a generous social insurance state. It promises rapid economic development, large expenditures on infrastructure, jobs for politically well-connected boys, and so forth. An unequal distribution of income and wealth, a lack of social comity between the working and the middle classes, a viciousness in politics going back to General Galtieri, the Dirty War, Juan Peron and his enemies, and even before means that claims on national product and demands that the government enforce those claims are inevitably going to mount up to more than 100% of what is available. The basic political fight over how national product is to be distributed among social classes is unresolved, and any political movement that makes only promises it can keep is doomed to rapid defeat.

Hence, fourth, in Argentina government deficits--large government deficits--are a law of nature, a fact of life. Moreover, everyone knows that large government deficits are a fact of life and a law of nature. Hence interest rates on Argentine debt will be low and reasonable only rarely and for short periods.

Fifth, points one through four mean that the neoliberal reform program in Argentina in the 1990s had exactly the same chance of avoiding disaster as one would expect if one gave a modern gene-splicing biochemistry lab to Doctor Frankenstein. The fundamental unresolved conflicts of Argentine politics mean that debt is going to mount. The fact that everyone knows that Argentine politics generates chronic deficits means that the interest payments due on that debt are likely to explode. Exploding interest payments mean that the dynamics of Argentine debt are unstable, and thus that the hard-currency exchange-rate peg cannot last. And free access to international capital markets, to dollar-denominated bank accounts, and so on, and so forth, means that when the crisis caused by the contradiction between the hard currency peg and the fundamentals of Argentine politics comes, it will be five times as bad: at least with tight controls on foreign exchange and a primitive, underdeveloped banking system, the amount of damage a government default can do to normal economic life is limited.

From this perspective, pushing neoliberal, market-opening reforms on Argentina looks as wise as giving a supply of gasoline to a bunch of pyromaniacs, on the grounds that gasoline is a very useful and powerful fuel.

My intellectual problem right now is that this argument I have just constructed--which was supposed to be a strawman that I, a card-carrying neoliberal, could easily demolish--feels too convincing.

Michael Mussa (2002), Argentina and the Fund: From Triumph to Tragedy (Washington: Institute for International Economics: 088132339X).

Bergsten, p. viii: "[Mussa's] conclusion that the Fund's last pre-crisis loan to Argentina in August 2001 was 'the greatest mistake the Fund made in my ten years there' is thus of considerable importance in the ongoing debate over this crucial and tragic case."

p. 3: "...in other cases... Mexico in 1995; Indonesia, South Korea, and Thailand in the Asian crisis... Brazil... a Fund-supported program was started only after the crisis was already under way. Thus, any failures of the Fund in the pre-crisis period were those of its relatively low-intensity surveillance activities. For Argentina, the failures of the Fund are clearly associated with the core of the Fund's [activities]... when it is providing financial assistance and when the policy and performance of the member are subject to the intense scrutiny of Fund conditionality..."

p.3: "The end result in Argentina has clearly been a disaster... not intended or, until recently, broadly anticipated--by the Argentine authorities, the Fund, or anyone."

p. 4: "...the Fund did make at least two important mistakes... failing to press the Argentine authorities much harder to have a more responsible fiscal policy, especially during the high growth years... extending financial support to Argentina during the summer of 2001, after it had become... clear that... efforts to avoid default and maintain the exchange rate peg had no reasonable chance of success."

pp. 5-6: "...if the Argentines had decided to move to an alternative, more flexible exchange rate and monetary policy regime that maintained reasonable monetary policy discipline, this would also have been acceptable to the Fund. Indeed, at least some in the Fund... would have welcomed serious consideration of such a move..."

p. 6: "As the crisis deepened... and the deficit targets set in the Fund-supported program were missed, the Argentine authorities sought to undertake further austerity measures. The Fund supported these efforts.... However, had the Argentine authorities decided at some time during 2000-2001 ... to pursue an alternative... debt restructuring and a possible change in the exchange rate regime, the Fund would have supported responsible efforts in this direction..."

pp. 9-10: "In sum, if things had broken more in Argentina's favor, this surely would have helped to preserve the success.... Enumerating the many things that contributed to Argentina's tragedy, however, should not obscure the critical, avoidable failure of Argentine economic policy that was the fundamental cause of the disaster--namely, the chronic inability of the Argentine authorities to maintain a responsible fiscal policy..."

pp. 15-16: "In sum, during the period 1993-1998 when the Argentine economy was performing very well [average annual real GDP growth rate of 4.1%] and the Argentina government was receiving substantial nonrecurring revenues from privatization and enjoyed other temporary fiscal benefits [that amounted to 2 percent of a year's GDP], the public-sector debt-to-GDP ratio nevertheless rose by 12 percentage points [from 29 to 41 percent of GDP]. This clearly was not an adequately disciplined or sustainable fiscal policy..."

p. 16: "Because most industrial countries have government debt-to-GDP ratios above 50 percent and some above 100 percent, it might be asked why a debt-to-GDP ratio of just above 40 percent was worrying for Argentina. There are at least five important reasons. First... Argentina has had little success in raising tax revenues (including social security contributions) of more than 20 percent of GDP.... Second... government debt denominated in foreign currency... held externally, Argentina faced the dual challenge of persuading creditors that it was capable both of raising sufficient fiscal revenues to service its debt and of being able to convert these revenues into foreign exchange with an exchange rate that was rigidly pegged to the U.S. dollar.... the ratio of external debt to exports... more than 400 percent.... Third, it is not just the level of the government debt... it is also how the debt has been behaving.... Fourth... Argentina... was potentially vulnerable to external economic shocks.... the collapse of Brazil's crawling-peg exchange rate in early 1999 had important negative spillovers... the debt-to-GDP ratio jumped from 41 percent in 1998 to 50 percent in 2000.... Fifth... Argentina was clearly vulnerable to changes in financial market sentiment... [that might become] self-fulfilling..."

p. 18: "When the actual fiscal deficit began to exceed the program targets during 1995 because of an economy that was weaker than expected, the Fund... showed unusual flexibility (by past Fund standards) in allowing an upward revision of the deficit target. In my view, this was the right approach.... Unfortunately, the Fund's flexibility... was not applied symmetrically. Starting in late 1995, the Argentine economy began three years of very rapid recovery... one would have expected that the Argentine government's fiscal deficit would have come in well below the permitted target... [but] it was just below or even slightly above.... During 1995, when the recession turned out to be steeper... there was plausible reason to grant waivers.... At other times... it is difficult to understand why the Fund did not make active use of its conditionality to press the Argentine government to maintain a more responsible fiscal policy.... And the fiscal targets were significantly less demanding than they appeared to be (even allowing for stronger-than-expected economic growth) because they conveniently ignored... government borrowing that were viewed by the Argentines as off-budget..."

p. 24: "...the fundamental choice of Argentina's monetary policy framework and exchange rate regime was a choice for the duly constituted government of Argentina. The Fund could advise.... However, the basic choice of regime is a decision of the [Fund] member--at least up to the point where the chosen regime has no reasonable chance of success.... Thus, though an independent observer might conclude that the rigidities of the [exchange rate] Convertibility Plan deserve relatively more weight, and the failures of Argentine fiscal policy relatively less weight, in the blame for the tragedy that ultimately befell Argentina, this is not the relevant perspective from which to view the role of the Fund. For the Fund, the relevant question was--given the choice of Argentina to adopt and maintain the Convertibility Plan--what other policies were necessary to make the stabilization and reform effort a success. Given the plan, failure to maintain a sufficiently prudent fiscal policy would likely prove a fatal error. The Fund, having accepted the Convertibility Plan, had the responsibility to press very hard to avoid this fatal error."

pp. 27-30: "For the Fund, the deteriorating situation in Argentina in the autumn of 2000 presented a critical challenge.... A star pupil that the Fund had praised and supported as a model of economic liberalization and reform was in danger of turning into a basket case.... One approach would have been to continue with an essentially standard Fund-supported program... [of] up to 100% of its Fund quota.... The main difficulty... was that... it was clearly inadequate. A second approach would have been to conclude that because of the continuing recession... further official [Fund] support would be available only on the condition that Argentina reach agreement with its private creditors that would substantially reduce its financing requirements in the coming years.... Necessarily, this rescheduling of private credits could not be entirely voluntary.... [A] decision by the Fund in late 2000 to press Argentina into a debt restructuring that would have amounted to a de facto sovereign default would have been a very weighty matter. The Argentine government was dead set against such action.... At the Fund... there was little enthusiasm for such an approach... the Argentine situation was not seen as without realistic hope.... The third approach... actually adopted... [was] levels of support substantially greater than in standard Fund-supported programs... the deficit target would be set so as to carefully balance the need to keep borrowing within responsible limits... against the very real economic and political difficulties of fiscal consolidation in a deepening recession. Official financing would... meet virtually all of Argentina's projected external financing requirements for 2001, assuming the program's fiscal objectives were met..."

pp. 45-8: "By August 2001... prospects for a favorable outcome were pure fantasy.... [I]nterest rate spreads... were... in the range of 1300 to 1600 basis points. This implied nominal interest rates for the Argentine sovereign... of 18 to 22 percent, with real interest rates even higher due to deflation. Economic recovery was impossible in this situation.... The Argentine government's fiscal policy... could not meet its targeted objectives.... The political consensus to raise the huge primary surplus... required to demonstrate sustainable debt dynamics... was, quite understandably, nowhere apparent.... An emergency injection of another $6 billion in cash from the Fund was urgently needed just to stave off immediate default and keep the farce going for another few months.... [A] wide range of analysts... often with differing views on many issues concluded that the game was over for Argentina. Only a fool would conclude otherwise. Why, then, did the Fund... acquiesce in this folly?... Here there was a failure of intellectual courage... and a failure of moral courage.... Argentina was not helped... assistance that was potentially far more valuable in helping to contain the damage once a de facto sovereign default had occurred was instead squandered in a futile effort to avoid the inevitable..."

pp. 60-64: "What should be the elements of the policy program...? Six elements can be delineated.

First, the program should be based on realistically optimistic economic assumptions... real GDP will likely fall 10 to 15 percent in 2002... the value of the peso at the end of 2002... 20 or 25 U.S. cents... domestic inflation... headed over 200 percent [in 2002]...

Second.. the government budget needs... the deficit... within the bounds of what can be financed without... hyperinflation.... Tax revenues are likely to be very low because of the economic collapse and very poor tax compliance... substantial costs to the government from dealing with the mess it has created in the Argentine banking system... the absolutely essential task of reining in the deficits of the provinces and terminating their discretionary authority to borrow...

Third... a reasonable framework for monetary policy... contain the initial inflationary surge from the collapse of the peso and then bring the inflation rate down to more moderate levels during the course of the next two years...

Fourth... [a] unified floating exchange rate... the peso inevitably will depreciate very substantially (from its old parity) in real terms--and even more so in nominal terms...

Fifth, something needs to be done to clean up the horrendous mess in the Argentine banking system.... Four actions of the Argentina government have made the banking system... insolvent.... (1) The government defaulted on its... own dollar-denominated debt... held by Argentine banks. (2) The government reneged on... the Convertibility Plan.... (3) The government mandated that dollar-denominated loans of Argentine banks were payable in pesos. (4) The government mandated that dollar-denominated deposits at Argentina banks be converted into pesos at a [higher] exchange rate...

The first three actions together effectively forced a massive write-down in the dollar value of [bank] assets... a write-down that was unavoidable.... The Argentine government.. lacked the political courage to tell the Argentine people... that the U.S. dollar value of their deposits... was being sharply reduced as a result of government actions. Instead, through the fourth action, the Argentina government sought to purvey the fiction that most of the dollar value of deposits could be preserved... and shift the blame for the losses of depositors from the government to Argentine banks. Now the Argentine public has, with good reason, lost confidence in the banking system and... the government.... Moreover, the owners of Argentine banks... robbed of all their invested capital... have little reason to believe any promises of the Argentine government... no incentive for [anyone]... to put in new capital to refloat the banking system... Sixth... signal their intention to pursue good-faith efforts to deal responsibly with their external sovereign debt.... [F]oreign creditors... need to recognize that... they will not be made whole, but... need to share in the enormous economic losses.... Argentine authorities must ensure that foreign investors are... not forced to accept disproportionately large losses...

p. 67: "The Fund is expected to... act both as a sympathetic social worker and as a tough cop."

"the 'three-monkeys approach' to dealing with government failures to meet policy targets that it has promised the Fund: see no evil, hear no evil, speak no evil..."

p. 71: "... it is my view that the Argentine government's basic decision to combine efforts at macroeconomic stabilization with market-oriented reforms was the right policy approach... the spectacular success of the Argentine economy throughout most of the past decade is attributable to this basic policy choice... the spectacular collapse in 2001 is due to the failure to implement this strategy sufficiently vigorously, especially in... fiscal discipline. Others... may be inclined to the view that the policies... are fundamentally wrong and were doomed form the start.... An evaluation of the Fund's role in Argentina should reflect on this broad question..."

p. 74: proposals of the Meltzer Commission as "...unnecessary, unworkable... fundamentally misguided..."

p. 78: of the Fund staff's spring 2001 analysis of Argentina's debt dynamics, '...if, if, if... If my grandmother had wheels, she would be a bus...'

Global Unemployment: A Panel Discussion

An event:

Berkeley Law - Global Financial & Economic Crisis Series: Global Unemployment:

WEDNESDAY OCTOBER 28TH, 2009; 12:30 - 1:45 PM; BOOTH AUDITORIUM; BERKELEY SCHOOL OF LAW   A panel discussion featuring:

• John Quigley, Goldman School of Public Policy
• J. Bradford DeLong, Department of Economics
• David Card, Department of Economics
• Andrew Rose, Haas Business School

---

---

Now what was the Booth Auditorium called the last time I was in it? And where is it?

Paul Krugman's Guide to Reading the Wall Street Journal Editorial Page

1) The WSJ editorial page is wrong about everything. 2) If you think the WSJ editorial page is right about something, see rule #1.

Paul Krugman:

Modified goldbugism at the WSJ: So I was peacefully drinking my coffee this morning, and was accosted by someone waving the latest WSJ editorial on the dollar in my face, demanding my reaction. Um, this is not cool. Also, with apologies to Brad DeLong, when reading WSJ editorials you need to bear two things in mind:

1. The WSJ editorial page is wrong about everything.
2. If you think the WSJ editorial page is right about something, see rule #1.

After all, here’s what you would have believed if you listened to that page over the years: Clinton’s tax hike will destroy the economy, you really should check out those people suggesting that Clinton was a drug smuggler, Dow 36000, the Bush tax cuts will bring surging prosperity, Saddam is backing Al Qaeda and has WMD, there isn’t any housing bubble, US households have a high savings rate if you measure it right. I’m sure I missed another couple of dozen high points.

Today’s editorial was in the grand tradition. A few months ago falling stock prices showed Obama’s failure — never mind, we meant the falling dollar. And just to provide extra spice, the editorial cited David Malpass as the wise expert on all this. But more specifically, you need to see the Journal’s fear of a weak dollar in terms of its long-term gold-bug position. The Journal has always maintained that changes in exchange rates play no useful role, that stable exchange rates — preferably enforced by some barbarous relic like the gold standard — are the essence of sound policy. I explained why this is all wrong a long time ago. But it’s especially important to understand the wrongness of this view right now. If there’s one overwhelming lesson from the Great Depression, it is that putting a higher priority on stabilizing your currency than on domestic recovery is utterly disastrous. Barry Eichengreen pointed out years ago that major economies went off gold in the following order: Japan, Germany, Britain, US, France.... The WSJ may not realize it, but it wants us to be France in the 1930s. Let’s not.

Our Only Chance to Improve Financial Regulation Is Now

Ah. When Clive Crook is not putting his thumb on the scales to hide the fact that the arguments of America's Republicans weigh no more than a feather, he is his old self again, saying smart things:

Deal with the banks while they are down: One of the clearest messages from the first summit of this crisis, in November last year, was the collective commitment to hold back protectionism. Since then, every government has been bending or breaking international rules... they have shown some restraint, for which one is grateful.... On the very eve of the Pittsburgh summit, Barack Obama’s administration raised tariffs on Chinese tyres. This was probably technically legal under the World Trade Organisation’s “safeguard” procedures. It is protectionism nonetheless, and in plain breach of the earlier commitment, which Mr Obama has repeatedly affirmed. We shall see whether kneeling down to the unions in this case abates the demand for further protection, or stimulates it. My guess is the latter.

Ordinarily, this gap between words and deeds is a shame but not a disaster.... [T]he optimal policy of economists’ fantasies often calls for co-ordination.... But the point is that domestic politics, especially in the US, all but rules out this sort of co-operation. Balanced growth requires a dramatic change in US fiscal policy. The US has every selfish reason to do this unilaterally. In the end it will, even though the country cannot yet bring itself to think about it. But if the administration was ever to ask Congress to raise taxes because the US had promised other countries that it would curb its public borrowing, that would doom the proposal on the spot. Muddling through is the best that can be done, and more often than not it suffices.

Why then is 2009 different? Because stronger financial regulation is now so central in what needs to be done – and because unco-ordinated financial regulation, unlike unco-ordinated fiscal policy, cannot succeed.... Tim Geithner, the US Treasury secretary, won tentative, sometimes grudging agreement to his main ideas for stronger regulation... requiring banks and shadow banks to hold more capital.... [H]e also called for minimum levels of liquidity, and for “living wills” to allow the orderly winding up of failing financial firms. All this makes excellent sense.... [B]ank regulation better had be strengthened, and in a closely co-ordinated way, or else governments will be leaving their countries as exposed as before to the risk of another financial crisis....

[G]overnments will need to stick together in facing down the pressure for a less onerous bank capital regime. If co-ordination fails and some governments adopt tougher rules than others, this pressure will be far stronger, probably overpowering. Banks and shadow banks will argue that stronger capital rules in the US, for instance, put American financial institutions at a competitive disadvantage. It will be true, and Congress is fiercely attentive to that kind of argument.... The presidents and prime ministers meeting this week are not going to nail those details down. But they can affirm the principles of Mr Geithner’s proposals without equivocation. They can mean it. Most important, in private, they can come to a frank understanding: they will have to press the issue far beyond the point at which their financial firms start to complain, and resolve to stick together.

Hoisted from Archives from September 2005: The Coming Dollar Crisis?

Grasping Reality with Both Hands: The Coming Dollar Crisis?: As is often the case, the most interesting things I learned at last August's round of conferences came not in the formal conference sessions but in the informal small-group conversations before, around, in the interstices of, and after the conference.

Take the Federal Reserve Bank of Kansas City's "Greenspan Era" conference. It was held in Jackson Hole, at the Jackson Lake Lodge in Grand Teton National Park, in the shadow of the Grand Tetons, which are perhaps the most impressive mountain range in North America. ("Perhaps" because the Canadian central bankers present pointed out the Canadian Rockies from Lake Louise to Jasper, while Federal Reserve Bank of San Francisco president Janet Yellen sang the praises of the mountains of her own Federal Reserve District: the east face of the Sierra Nevada as seen from the Owens Valley, to be specific.) You spend the mornings in windowless conference rooms, and the afternoons outside--on the Snake River, hiking, climbing, looking for moose, looking for elk, hoping that bear are not looking for you.

But the afternoons--and the formal and informal breaks in the mornings when you flee the windowless conference room for the fresh air of the west lawn of the lodge to stare at Mount Moran and company across the lake--are filled with arguments. Go with Federal Reserve Governor Don Kohn on an afternoon hike up Cascade Canyon, I am told, and expect to gain 3000 feet in two hours while being quizzed intently about technical details of monetary policy. Try to keep from grounding yourself on sand bars in the Snake River, and you will hear ex-senior executive branch officials of both political parties give their assessments of why neither of the Bush II Treasury Secretaries has been able to make effective use of the thousand or so people who work directly for him.

This time the most interesting rounds of break-and-afternoon conversations I heard were sparked by Sebastian Edwards's paper about the U.S. current account deficit. My conversations quickly exposed a deep fault among the conference attendees. Those who analyzed or forecast the U.S. domestic macroeconomy agreed that a steep decline in the value of the dollar sometime in the next five years was overwhelmingly likely, but by and large they did not think that such a decline would pose a big problem for the U.S. economy. (They agreed that it might well pose a very big problem for some of America's trading partners.) By contrast, those who analyzed or forecast the international economy as a whole were typically terrified by the prospect of a steep (30% or more, perhaps much more) decline in the value of the dollar: they thought a severe U.S. recession was a definite possibility, and that the situation would require exceptionally skillful handling to keep from becoming a serious economic problem.

Why this disjunction?

The domestic macroeconomists would typically argue more or less like this:

Yes, the dollar is likely to decline steeply either when foreign central banks stop buying dollar-denominated assets to keep the values of their currencies down or when international speculators lose confidence or both. But so what? The fall in the value of the dollar will boost foreign demand for U.S. exports. Workers will be pulled out of other sectors into the export sector. The effects of the dollar decline are much more likely to be a plus for employment rather than a minus, a boom rather than a recession.

To this, the international economists would respond more-or-less like this:

When foreign central banks stop buying or international speculators lose confidence in the value of the dollar and thus stop buying U.S. long-term bonds, two things happen: the value of the dollar falls, and the rate of interest on dollar-denominated long-term bonds spikes. The spike in long-term interest rates discourages investment spending directly, and also discourages consumption spending because higher interest rates mean lower housing and stock prices and thus lower consumer wealth. The fall in domestic spending happens now. The rise in exports as the falling dollar makes U.S.-made products more attractive to foreigners happens two years from now. In between, a lot of people are unemployed--and as they are unemployed, they cut back further on their spending. Plus there is the risk that the fall in the value of the dollar and the fall in long-term asset prices generated by the interest rate spike will cause enough bankruptcies among financial institutions to cause a flight to quality--which will further raise non-safe interest rates, and further discourage investment and consumption spending

This then puzzled the domestic economists:

Why should interest rates spike? The Federal Reserve controls American interest rates. If it wants to keep the price of the ten-year Treasury bond high, it can simply start buying bonds until the price of ten-year Treasuries is what the Fed wants it to be. There's no reason for employment in construction and other interest rate-sensitive sectors to fall before employment in exports and related sectors rises--at least not unless the Federal Reserve makes a big mistake and allows rising interest rates to shoot the economy in the head.

And at this point the response of the international economists fragmented:

Some said that the falling dollar would create inflation--with imports at 1/6 of GDP, a 40% fall in the dollar would, if fully passed through to import prices, add 6% to the U.S. price level. The Federal Reserve would feel honor-bound to maintain its reputation as an inflation-fighter, and so would allow interest rates to go high enough to produce enough unemployment to push nominal wages down far enough to offset this rise in import prices. Thus the Federal Reserve would welcome the spike in interest rates as appropriate, and take no steps to offset it.

Others said that the adjustment to the fall in the dollar would require that ten million workers shift out of construction, retail, and consumer services occupations and into export and import-competing manufacturing industries. You cannot move ten million American workers from one sector to another in a matter of a year or two without creating lots of structural unemployment.

Still others said that financial stress would be the key: perhaps some major Wall Street firms would discover big unhedged risks in their derivative books; perhaps perhaps others would find that the values of their portfolios were more responsive to changes in long term interest rates than they had thought. In either case, it is financial distress and chaos that really triggers the recession.

And the domestic side had rebuttals to each of these three points:

1. If the Federal Reserve announces now that it is targeting a measure of inflation that is not grossly affected by import prices--that it is targeting nominal wage growth, say--there is no need for the Federal Reserve to defend its credibility by attacking the economy. Just as the Federal Reserve has trained observers that it is more important to worry about 'core inflation' than 'headline inflation', so the Federal Reserve ought to be preparing observers to recognize that inflation produced by rising import prices is a one-time event, not an inflationary spiral that needs to be fought by triggering a deep recession.

2. A large structural shift will cause high unemployment only if the transition is quick and brutal, and only if workers are pushed out of job-losing rather than pulled into job-gaining sectors. Whether it is quick or gradual and whether it is push or pull depends, once again, on the path of interest rates. Only if the Federal Reserve fails to do its job and allows for a massive interest rate spike is there a problem.

3. Financial stress is something that can be managed: if the Federal Reserve keeps the path of interest rates smooth, great financial stress is unlikely.

And the domestic side of the argument pointed to the historical experience of the U.S. from 1986-1990: Between 1985 and 1989 the value of the U.S. dollar declined by 40%. Between 1986 and 1990 the U.S. trade deficit declined from 4.0% of GDP to 0.5% of GDP--without a big recession, or significant macroeconomic distress.

Before dinner one evening I was lectured by a prominent Washington-area international finance economist about all the reasons that the 1986-1990 U.S. experience was likely to be a bad guide to the future:

1. 1986-90 began with a 50% decline in world oil prices, a powerful stimulus to the world economy. This time the process is beginning with a doubling of world oil prices.

2. 1986-90 saw Europe growing rapidly. Europe has a high propensity to buy U.S. exports, and the European boom meant that U.S. exports grew much faster in the late 1980s than anyone had expected. This time it is Asia that is booming, not Europe. And Asia has a relatively low appetite for U.S. exports.

3. The Japanese government was willing to buy very large amounts of dollar-denominated assets in the late 1980s to keep the decline in the value of the dollar "orderly." In so doing, it inflated its domestic credit base and touched off its own property bubble. No foreign government is going to risk this again just because the U.S. would rather that the decline in the dollar was slow and orderly.

4. The problem then was half as big relative to the size of the U.S. economy as is the problem now.

One way I found myself thinking of the argument is that the domestic-side economists look at the goods market and think of a decline in the value of the dollar as a supply shock, and as not that big a supply shock: if half of the adjustment in import prices is taken in reduced margins by producers abroad, and if the shock is spread out over four years, then 40% / 2 x 16% / 4 = 0.8% increase in inflation relative to baseline over three consecutive years. The Federal Reserve could easily allow that to happen without--providing it explained its causes well--running any risk of damaging the credibility of its commitment to effective price stability. No big deal. International finance economists, by contrast, look at the asset markets. A 40% decline in the dollar over four years is a decline at the rate of 10% per year. Once financial markets convince themselves that such a decline is coming and that they need to be compensated for it, that ought to drive a 400 basis point wedge between U.S. and foreign long-bond expected returns. And that is a very big deal.

Martin Feldstein said something very smart just after we had both taken off our shoes at Jackson Hole airport. He said that the domestic-side economists were keying off the past experience of the U.S. after 1985 and of Britain after 1982, and so were saying "no big deal"; while the international finance economists were keying off of the experiences of developing countries that had run large current-account deficits--Mexico 1994, East Asia 1997, Argentina 2001. Each side had its own preferred models that functioned very well at explaining the past historical cases that they focused on. But there was no way right now of settling, empirically, whether a model built to explain the U.S. in 1985 or Korea in 1998 was more applicable to the U.S. in 2006--you had to make a bet, either that continuities in U.S. economic structure were important, or that financial globalization was important, in choosing your model and your terms of analysis.

It was very interesting. And very disturbing. Brilliant economists, thinking hard, unable to reach even the beginnings of analytical agreement about how to model the distribution of possible futures.

Econ 115 Lecture Notes: September 10, 2009: Lecture 5: One Economic World, Indivisible, 1870-1914

To download a pdf of Lecture 5, go to:

Open publication - Free publishing - More econ 115

Monetary Expansion Cures Incipient Depression in Small Open Economies with Flexible Exchange Rates

Yves Smith:

naked capitalism: Iceland Proves That in a Financial Crisis, Breaking Glass and Trashing Currency is a Good Remedy: The headline exaggerates, but not by much. Back in April, a Vanity Fair story about Iceland's remarkable financial blow up was grist for a Vanity Fair story by Michael Lewis, "Wall Street on the Tundra". The quick version is that Icelandic men were not merely reckless, that is such a common male pathology as to barely warrant mention, but were possessed of a particular fondness for physical aggression and bullheadedness that helped made Iceland ground zero for the most spectacular banking industry boom and bust in the history of man. Iceland managed to go on a debt party that saw its obligations soar to 850% of GDP, leaving America at a mere 350% firmly in the dust.

So how is Iceland faring now? One would assume still broke and chastened. One would be dead wrong.

The krona is down 50% from its peak, and it seems to have sparked a speedy revival. I remarked when Iceland fell apart that someone should swoop in and buy a business that sold strictly in international markets (I had thought fish oil would be a good candidate). But that takes time, legwork, and walking around money.

This is the same remedy that the Nordic countries used in their banking crises, save they nationalized the banks, put in new management, cleaned them up, and reprivatized them, But they also devalued their currencies versus the ECU.

But Iceland and the Nordic countries can make move like that without precipitating competitive devaluations. What works individually does not work collectively.

Barry Eichengreen, the Samwickian Fallacy, the Role of the Economist, and Chinese Economic Policy

Barry Eichengreen said he never understood the math of the stimulus:

All Stimulus Roads Lead to China: Now that the “green shoots” of recovery have withered, the debate over fiscal stimulus is back with a vengeance. In the US, those who argue for another stimulus package observe that it was always wishful thinking to believe that a $787bn package could offset a $3tn fall in private spending. But unemployment has risen even faster and further than expected. Combine this with the continued fall in housing prices, and it is understandable that consumer spending remains depressed. The banks, having been recapitalised only to the extent necessary to keep them afloat, still have weak balance sheets. Their consequent reluctance to lend constrains investment. Meanwhile, state governments, seeing revenues fall as a result of lower taxable incomes last year, are cutting back like mad. If there was a case for additional stimulus back in February, that case is even stronger now...

And then I think Barry takes a misstep:

But the case against additional stimulus is also strong. The US federal deficit is an alarming 12% of GDP, and public debt as a share of national income is already projected to double, to 80% of GDP. The idea that the US can grow out of its debt burden, as did Finland and Sweden following their financial crises in the 1990s, seems unrealistic...

At a 3% per year average inflation rate, the trend growth rate of nominal GDP in America is somewhere between 6% and 7%. The U.S. Treasury can currently borrow at 3 years for a nominal interest rate of 1.62%, for ten years at a nominal interest rate of 3.72%, and for 30 years at a nominal interest rate of 4.58%. When the growth rate of your economy is greater than the interest rate you have to pay, that is the definition of "grow[ing your way] out of [your] debt burden--as long as you can keep your budget in primary balance: keep non-interest spending at or less than your revenues so that your net nominal debt issues are zero.

Is the U.S. in primary balance? Almost--if you take the CBO's "Alternative Fiscal Scenario" as your baseline, which you should, it wouldn't take much in the way of tax increases to get us there by 2012. We should, I firmly believe, put those tax increases in place now: pass legislation with standby triggers so that if we are not in primary surplus by 2012 the surtaxes kick in. And doing so does not seem unrealistic to me at least.

CBO Extended Baseline:

CBO Alternative Baseline:

The fact is that the approporiate fiscal policy for the U.S, right now is to pass: (a) a bigger stimulus over the next two years, (b) a standby tax increase to return the federal budget to primary surplus by 2012, and (c) devout and lengthy prayers that confidence in the dollar doesn't collapse and send interest rates on U.S. Treasuries above the economy's growth rate--in which case the situation changes from its current value of "dire" to "catastrophic."

But Barry appears to think differently:

[M]ore deficit spending will only stoke fears of higher future taxes and inflation... encourage the reemergence of global imbalances... not reassure consumers or investors.... [T]he politics all point in one direction. The US Congress lacks the stomach for another stimulus package.... Disappointment over the effects of the TARP has already destroyed popular – and Congressional – support for more public money to recapitalise the banks. So, even those who find the economic logic of arguments for fiscal activism compelling must acknowledge that the politics are not supportive. A second stimulus simply is not in the cards...

Or does he? I suspect that Barry agrees with me on what the appropriate fiscal policy for the U.S. is, he just believes that it is politically unrealistic to argue for such a policy. I believe that Barry is committing a common fallacy what I call the Samwickian fallacy, after Andrew Samwick's explanation of the failure of the Bush administration Council of Economic Advisers to argue for the imposition of a carbon tax:

Republicans and Gas Taxes: [Politics] sets the framework for all policy outcomes--not the CEA--even on economic issues. CEA... works to generate the best outcomes within that framework. And if the President is not interested in a gas tax, then it becomes a very short conversation...

The Samwickian fallacy is the claim that economists should censor themselves and not argue for the best policies when those policies are not politically attainable, but should instead argue for the best politically-attainable policies. That, I think, mistakes the economist's role. First of all, economists are lousy at figuring out what is and what is not politically attainable. Second, to make powerful and convincing arguments that policies that are not politically attainable are in fact best for the country and the world is the best way to stretch the boundaries of the politically attainable.

It is Barack Obama's, Rahm Emmanuel's, Nancy Pelosi's, and Harry Reid's job to figure out what is politically attainable. It is our job to figure out what it would be best to do. It's not at all clear to me that a combination of (a) more stimulus now, (b) standby taxes later, and (c) health and climate-policy reforms that promise to improve the country's fiscal balance after 2012 will not be very politically possible come September--if those of us who know enough to know that such policies are best for the country and the world spend the rest of the summer strenuously arguing for them.

Barry, however, despairs and seeks to persuade not the U.S. government but the government of China to do what is economically good for the U.S and the world:

If there is going to be more aggregate demand, it can come from only... emerging markets like China. The problem is that China has already done a lot to stimulate domestic demand, both through government spending and by directing its banks to lend. As a result, its stock market is frothy, and it is experiencing an alarming property boom. Through May, property prices were up 18% year on year. Understandably, Chinese officials worry about bubble trouble. The obvious way to square this circle is [for China] to spend more on imports... purchase more industrial machinery, transport equipment, and steelmaking material, which are among its leading imports from the US. Directing spending toward imports of capital equipment would avoid overheating China’s own markets, boost the economy’s productive capacity (and thus its ability to grow in the future), and support demand for US, European, and Japanese products just when such support is needed most. This strategy is not without risks.... But these are risks worth taking if China is serious about assuming a global leadership role.

The question is what China will get in return.... China is worried that its more than $1tn investment in US Treasury securities will not hold its value.... It therefore wants to see a credible program for balancing the US budget once the recession ends. And, tough talk notwithstanding, the Obama administration has yet to offer a credible roadmap for fiscal consolidation. Doing so would reassure American taxpayers worried about current deficits. Just as importantly, it would reassure Chinese policymakers.We live in a multipolar world where neither the US nor China is large enough to exercise global economic leadership on its own. For China, leadership means assuming additional risks. But for this to be tolerable, the US needs to relieve China of existing risks. Only by working together can the two countries lead the world economy out of its current doldrums.

The problem is that China's economy is only one-quarter the size of America's. It is a generation too early for global macroeconomic stabilization policy to be made in Beijing and Shanghai rather than Washington and New York. To call for China to assume the role of the Hegemon in the world economy is even less realistic than to call for the government in Washington to live up to its responsibility to boost demand in the short run and lay out a convincing roadmap for fiscal consolidation in the medium run.

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UPDATE: Andrew Samwick is unhappy:

In http://delong.typepad.com/sdj/2009/07/barry-eichengreen-the-samwickian-fallacy-the-role-of-the-economist-and-chinese-economic-policy--opinion.html, that you would misquote one post from my blog and attribute such a recommendation to me is contemptible.

The full paragraph you are quoting is:

The word "emerging" is in quotes, referencing a theme of the article, which is that it is much easier for people who have worked inside a Presidential administration to advocate for politically unpopular ideas when they are on the outside. That's true but only to a point. It's not that Greg Mankiw ever said anything other than what he now says about the gas tax while on the inside. It's that the President sets the framework for all policy outcomes--not the CEA--even on economic issues. CEA, like every other part of the administration, works to generate the best outcomes within that framework. And if the President is not interested in a gas tax, then it becomes a very short conversation.

You make three errors:

1. You misquote me. You substitute the word "Politics" for the words "The President." You are correct that economists may be lousy at determining what is politically attainable when considering all of the political institutions in the argument you are making in your post. You are not correct that economist serving as CEA chair is necessarily lousy in determining what is politically attainable when the President, after taking part in the conversation, has decided that a particular policy is off the table.

2. The sentence before the one you misquote indicates that I do not claim that Greg censored himself in his internal conversations about policy while CEA chair.

3. Even if you believe that sentence indicates that he did censor himself in his internal discussions about policy while CEA chair, I have not in any way made the normative statement that this is what "should" happen.

I apologize. I do think that economists of both parties in and out of government censor themselves too much in the interest of presenting positions that they think are palatable to their political masters. But I do not think the Bush administration CEA was culpable of this mistake to a significantly greater extent than the CEA under other administrations. (The Bush OMB, Treasury, and NEC, on the other hand...)

When Other Countries Have the Money...

The Chinese government has in the past mostly parked its wealth accumulations in low-yielding Treasuries. Now it is about to shift--in a way that will have important but at this moment hard-to-foresee consequences.

Jamil Anderlini of the FT:

China to deploy foreign reserves: Beijing will use its foreign exchange reserves, the largest in the world, to support and accelerate overseas expansion and acquisitions by Chinese companies, Wen Jiabao, the country’s premier, said in comments published on Tuesday. “We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises,” he told Chinese diplomats late on Monday.

Mr Wen said Beijing also wanted Chinese companies to increase its share of global exports. The “going out” strategy is a slogan for encouraging investment and acquisitions abroad, particularly by big state-owned industrial groups such as PetroChina, Chinalco, China Telecom and Bank of China.

Qu Hongbin, chief China economist at HSBC, said: “This is the first time we have heard an official articulation of this policy ... to directly support corporations to buy offshore assets.” China’s outbound non-financial direct investment rose to $40.7bn last year from just $143m in 2002.

Mr Wen did not elaborate on how much of the $2,132bn of reserves would be channelled to Chinese enterprises but Mr Qu said this was part of a strategy to reduce its reliance on the US dollar as a reserve currency. “This is reserve diversification in a broader sense. Instead of accumulating foreign exchange reserves and short-term financial assets, the government wants the nation to accumulate more long-term corporate real assets.”

State-owned groups, particularly in the oil and natural resources sectors, have stepped up their hunt for overseas companies and assets on sale because of the global crisis. China Investment Corp, the $200bn sovereign wealth fund, has been buying stakes in overseas resources companies and has taken a 1.1 per cent stake in Diageo, the British distiller.

In an interview published in state-controlled media, the chairman of China Development Bank said Chinese outbound investment would accelerate but should focus on resource-rich developing economies. “Everyone is saying we should go to the western markets to scoop up [underpriced assets],” said Chen Yuan. “I think we should not go to America’s Wall Street, but should look more to places with natural and energy resources.”

Global Imbalances Continue...

Lex:

FT.com / Lex / Finance & governance - China’s $2,000bn foreign reserves: It appears the great unwinding of global imbalances and the dollar’s ensuing demise are notions that belong up there with the tooth fairy. China added $178bn to its foreign reserves in the second quarter, taking its total booty past $2,000bn, the equivalent of twice the annual economic output of New York

Although there are no official statistics on how China has apportioned these new reserves, US data supports the thesis that China is not yet jettisoning the dollar, however antsy Beijing gets about the greenback’s global dominance. Even so, the pattern of China’s reserve accumulation is changing. While China is still buying more US debt, it is not necessarily doing so with cash recycled from American consumers. The sum of China’s trade surplus and foreign direct investment, the usual driver of reserve accumulation, was the lowest in three years. At about $60bn, it was also almost half last year’s quarterly average of $100bn, according to Royal Bank of Scotland. Rather, China’s hoarding is being driven by hot money.

After all, China, the world’s favourite green shoot, is back in bubble land; its reserve growth is just one indication of this. Estimates vary widely, but between $30bn and $70bn of speculative capital flowed into China in the second quarter. Some of that may be anticipating a possible revaluation of the renminbi. More likely are flows into real assets such as property or the stock market, where volumes are running at as much as three times last year’s levels. Hong Kong residents, having spent much of the past year grinding down their renminbi deposits, added more funds in May.

To mop up some of this liquidity, Beijing has started selling one-year sterilisation bills again (so far this year, the central bank has actually injected net cash into the system). Last year, it issued an estimated $170bn of these bills. Roaring reserves, a bubbly stock market and the tentative start of monetary tightening: all these recall the glory days of 2007-08. Still, don’t expect everything to return full cycle. Exports, for one, are weak. While that remains the case, renminbi appreciation is off the cards.

DeLong: Econ 202b April 23, 2009 Lecture: Notes on the 1997-1998 East Asian Financial Crisis

Download now or preview on posterous

• Audio File: http://www.j-bradford-delong.net/2009_mov/20090423_202b_east_asia.mov

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Posted via email from http://braddelong.posterous.com/delong-econ-202b-april-23-2009-lecture-notes

Kevin O'Rourke Praises the IMF WEO

Kevin writes:

The second draft of history: Economic historians and others interested in the Great Depression still turn to the economic publications of the League of Nations as a basic source for understanding the economic catastrophe of the 1930s.... [T]he publications of today’s international organisations, such as the IMF’s World Economic Outlook which was published in full last week, will also serve as a first port of call for the historians of decades hence. So: how are they shaping up Extremely well, is my reaction after having finally given the April WEO the attention it deserves. This is essential reading for people seeking a global overview of the crisis,  and advice as to how to get out of it...

Things to Read: Eichengreen's "Meet the Economists: How the Thinkers Followed the Herd"

It's supposed to be in the May/June issue of The National Interest, published by the Nixon Center (eeeuuuwww!). But where is it?

Britain Is Off the Euro

And Paul Krugman thinks that is a very good thing:

A quick note on Britain: Paul Krugman Blog: The Darling budget is basically a confession that Britain doesn’t dare do any significant discretionary fiscal stimulus. But it should be pointed out that Britain is getting a serious monetary expansion — much more than other troubled European economies.... Britain has, despite worries about its budget, managed to cut rates significantly vis-a-vis the core eurozone countries... the fall in the pound has made British products a lot more competitive.

I think the Spanish comparison is instructive. Like Britain, it’s had a major housing bust. But Spain has basically had nothing happen to offset that shock.

So I’m actually fairly hopeful about Britain; right now, the fact that it’s not on the euro is serving it well.

Ezra Klein Approves of the IMF as Well

"IMF FTW," he writes:

EzraKlein Archive | The American Prospect: The final "communique" from the G-20 meeting has emerged. Most of it is the happy togetherness talk you'd expect to emerge from such a conference, but this bit is fairly real:

The agreements we have reached today, to treble resources available to the IMF to $750 billion, to support a new SDR allocation of $250 billion, to support at least $100 billion of additional lending by the MDBs, to ensure $250 billion of support for trade finance, and to use the additional resources from agreed IMF gold sales for concessional finance for the poorest countries, constitute an additional $1.1 trillion programme of support to restore credit, growth and jobs in the world economy. Together with the measures we have each taken nationally, this constitutes a global plan for recovery on an unprecedented scale.

That's money that will largely go towards supporting the economies of developing countries.Which means that they are less likely to collapse. Which means that we're less likely to have to deal with nation-state chaos atop the turmoil in the markets. I also like Yglesias's point that this is a fair coup for liberal internationalism."More importantly," he says. "[this] will make sure that the IMF can continue to function as an important and valuable element of international governance. Getting this done would probably constitute more diplomatic work than the Bush administration managed to pull off in eight years."

Obama Succeeds at the G-20

We actually have some successful international policy coordination!

Paul Krugman:

An IFI success: Credit where credit (line) is due: the G20 outcome was better than I expected, with something substantive and important emerging — namely, much bigger funding for international financial institutions (IFIs), plus expanded trade credit. This will help smaller, currency-crisis countries a lot. A turning point? No. But realistically, most big-time international meetings produce nothing; this did something significant.

Jennifer Loven:

Obama's scorecard: Some setbacks but a good summit: Thursday's daylong gathering of the G-20 nations pledged $1.1 trillion in loans and guarantees to struggling countries, agreed to crack down on tax havens, large hedge funds and other risky financial products, rejected protectionism that hampers foreign trade and committed to upgrading an existing financial forum to flag problems early in the global financial system. Those were all elements Obama was seeking.... Overall, the outcome seemed more robust than the one global leaders were able to muster at a first summit held last fall....

Still, the leaders, many wary of piling up debt, did not sign off on large new stimulus packages for their own countries. Obama's administration had initially pushed for such a commitment.... "The steps that have been taken are critical to preventing us sliding into a depression," he said. "They are bolder and more rapid than any international response that we've seen to a financial crisis in memory."...

"I do not buy into the notion that America can't lead in the world," Obama said. "America is a critical actor and leader on the world stage and that we shouldn't be embarrassed about that. But ... we exercise our leadership best when we are listening"...

The IMF's willingness to turn its funds into resources that countries can count on is especially nice to see:

Flexible Credit Line (FCL). The IMF is introducing this new credit line for countries with very strong fundamentals, policies, and track records of policy implementation. Access to this credit line would be most useful for crisis prevention purposes—although use of this instrument for crisis resolution is also allowed. FCL arrangements would be approved on request to countries meeting pre-set qualification criteria. Access under the FCL would be determined on a case-by-case basis. Disbursements under the FCL would not phased or conditioned to policy understandings as done under a traditional Fund-supported program. This is justified by the very strong track records of countries that qualify to the FCL, which give confidence that their economic policies will remain strong and that corrective measures will be taken in the face of shocks.

The establishment of the FCL represents a significant shift in delivering Fund financial assistance, even relative to the Short-term Liquidity facility (SLF), which will therefore be discontinued. While the SLF was also designed to cater only to very strong-performing members, several of its design features—including its capped access and short repayment period, as well as the inability to use it on a precautionary basis—limited its usefulness to potential borrowers. The concept of a credit line available for either crisis prevention or resolution and dedicated for only very strong-performing members, with all its flexible features is new. The FCL’s flexibility includes:

• Assuring qualified countries of large and upfront access to Fund resources with no ongoing (ex post) conditions; • Meeting rigorous upfront qualification criteria to signal the Fund’s confidence in the qualifying member’s policies and ability to take corrective measures when needed; • Renewable credit line, which at the country’s discretion could initially be for either a six-month period, or a 12-month period with a review of eligibility after six months; • Longer repayment period (3_ to 5 years versus maximum rollover period of 9 months in the SLF); • No hard cap on access to Fund resources, which will be assessed on a case-by-case basis (the SLF had a cap on access of 500 percent of quota); and • Flexibility to draw at any time on the credit line or to treat it as a precautionary instrument (which was not allowed under the SLF)...

G-2

Geoff Dyer:

FT.com / Asia-Pacific - China agrees on need for co-operation: The meeting on Wednesday between Barack Obama and Hu Jintao, his Chinese counterpart, on the sidelines of the G20 summit had been described by some as “the G2” and marked the first encounter between the two men. During the meeting Mr Hu stressed China’s commitment to strengthen macro-economic control and expand domestic demand, the White House said. The two leaders agreed to work together to renew world economic growth, strengthen the financial system and establish a “strategic and economic dialogue” group that would first meet in Washington later this year. The White House also announced that Mr Obama would visit China in the second half of the year....

While talk of an emerging “G2” ignores the increasingly multilateral basis of financial diplomacy, it does reflect the reality that on a growing range of international issues, little can happen without agreement between the US and China.... The more assertive stance also reflects anger building in China about criticism that its large current account surplus and reserves helped create the crisis and the realisation that its huge holdings of US bonds give it little direct leverage over US policy. “In my 16 years of covering China I have never seen the country approach an international forum in such a proactive way,” says Dong Tao, economist at Credit Suisse. “China has traditionally been passive on the international stage, being a listener rather than an opinion leader, but this time it’s different. China wants to make sure [its] voice is being heard.”

On the IMF issue, China has been under pressure from the US and the UK to make a substantial contribution to boosting the Fund’s coffers, similar to the $100bn already pledged by Japan and the European Union. China initially pushed back strongly against the idea, arguing that it was still a poor country. Yet over the past two weeks the Chinese line has softened somewhat, prompting speculation that it will inject substantial new funding. However, Chinese officials have also made clear that their condition is accelerated reform of the IMF to boost China’s voting rights. More-over, Hu Xiaolian, deputy governor of the central bank, said last week that a quicker way for the IMF to raise new funds might be for it to issue bonds that China and other countries would buy...

G-20 Meeting Forecast

1. Obama will tell the G-20 leaders what they ought to do.
2. They will complain.
3. They will do about half of it.
4. That they do half of it will be an extraordinarily good outcome--the best episode of international policy coordination since Bretton Woods itself.
5. Will them doing half of what they ought to do be good enough? Ah, that is the question

If we judge the Obama administration based on performance relative to the difficulty of the dive, I think their scores are good: 9.7, 9.3, 8.7, 9.1, and a 4.4 from the East German judge...

Martin Wolf Is Such a Cheerful Polyanna!

He writes:

Why G20 leaders will fail to deal with the big challenge: The summit of the Group of 20 leading high-income and emerging countries in London on Thursday seems set to achieve progress. But achievement must be measured not just against past performances, but against “the fierce urgency of now”. Unfortunately, it will come up short.

The Organisation for Economic Co-operation and Development now forecasts a 4.3 per cent contraction in the economies of advanced countries this year, followed by stagnation in 2010. In advanced member countries, joblessness may rise by 25m by 2010. Meanwhile, the International Monetary Fund forecasts that the global economy will shrink by between 0.5 and 1 per cent this year. This would be an increase in the “output gap” (gap between actual and potential output) of some 4 per cent.

Will the G20 rise to  these exceptional challenges? No, is the answer. What is needed is a large increase both in aggregate demand and a shift in its distribution, away from chronic deficit countries, towards surplus ones. On both points, progress will be far too limited....

In last week’s FT interview with Angela Merkel, the German chancellor said that: “The German economy is very reliant on exports, and this is not something you can change in two years.” Moreover, “It is not something we even want to change.” To paraphrase: “The rest of the world needs to find a way of absorbing our excess supply, but sustainably, please.” Yet what happens if that cannot be achieved for the excess potential supply of all surplus countries together? In 2007, the three countries ran current account surpluses of $835bn (€629bn, £585bn). Logically, counterpart deficit countries must spend that much more than their incomes. Yet today deficit countries have run out of willing and creditworthy private borrowers.

That change is what this crisis is all about, as the charts show. Between 2007 and 2009, the crisis-hit private sectors of the US, UK and Spain will, on these forecasts, shift their financial balances (the difference between their incomes and expenditures) massively towards surplus, as savings rise and spending is cut. In Spain, the shift is forecast to be 11.7 per cent of GDP. The main offsets in these deficit countries will be huge jumps in fiscal deficits, although the current account deficits are also, inevitably, shrinking.

Surplus countries, which relied on the private sectors of deficit countries to do their irresponsible borrowing for them, show a very different pattern: their private sector [savings-investment] balances will change rather little and, in all cases, will be in large surplus throughout: big current account surpluses nearly always mean private sector excess savings. But, as their external surpluses shrink, fiscal deficits will grow....

This is not a path towards a durable exit from the crisis. It is a path on which the fiscal deficits needed to offset persistent current account deficits, and collapsing private spending in external deficit countries, continue indefinitely. Unless and until surplus countries recognise that this cannot continue, no durable escape from the crisis will be achieved. Understandably, but foolishly, they are unwilling to do so.

So what is to be done? That must be a central agenda item of the next G20 summit. The world economy cannot be safely balanced by encouraging a relatively small number of countries to spend themselves into bankruptcy. The answer lies partly in changing the policies of surplus countries. But it lies as much in rethinking the international monetary system. The case for sizeable and ongoing allocations of special drawing rights – the IMF’s reserve asset – is powerful, as, among others, Zhou Xiaochuan, governor of the People’s Bank of China, has argued in a fascinating recent paper. I hope soon to return to this huge challenge and opportunity. In the meantime, the G20 summit is largely dealing with the immediate symptoms of the illness. Finding a longer-term cure for chronic global excess supply still lies ahead.

The Importance of the G-20 Meeting

It looks as though Obama is going to get about half of what he asks for--which is a failure not on his part but on the part of the Europeans. Let's hope that that is enough.

Paul Krugman:

America the Tarnished: Like many other economists, I’ve been revisiting the Great Depression, looking for lessons that might help us avoid a repeat performance. And one thing that stands out from the history of the early 1930s is the extent to which the world’s response to crisis was crippled by the inability of the world’s major economies to cooperate.

The details of our current crisis are very different, but the need for cooperation is no less. President Obama got it exactly right last week when he declared: “All of us are going to have to take steps in order to lift the economy. We don’t want a situation in which some countries are making extraordinary efforts and other countries aren’t.”

Yet that is exactly the situation we’re in. I don’t believe that even America’s economic efforts are adequate, but they’re far more than most other wealthy countries have been willing to undertake. And by rights this week’s G-20 summit ought to be an occasion for Mr. Obama to chide and chivy European leaders, in particular, into pulling their weight.

But these days foreign leaders are in no mood to be lectured by American officials, even when — as in this case — the Americans are right...

Ah. Supply and Demand Does Work for the Dollar After ALl

Peter Garnham of the FT:

Dollar falls as haven status slips: The dollar resumed its fall against major currencies on Thursday after a sharp sell-off in the previous session following the Federal Reserve’s surprise decision to embark on a quantitative approach to monetary policy. The announcement by the Fed on Wednesday that it was to buy $300bn in long-term Treasuries surprised investors who were expecting the central bank to wait to see the effect of previously announced measures to ease credit conditions.

Sean Shepley at Credit Suisse said although this final step towards full-on quantitative easing in the US was desirable and ultimately necessary, it went against the grain of recent Fed commentary and came earlier than anticipated. He said the Fed decision was “significantly bearish” for the dollar for several reasons. “The decision will allow the Fed to reverse quickly the shrinkage in its balance sheet that has occurred in recent weeks and will allow the monetary base to begin expanding again,” he said. “The Fed’s commencement of significant purchases of US Treasuries probably involves taking foreign investors out of their Treasury holdings, at least indirectly, creating a need for these investors to acquire other US assets or to sell dollars.”

The dollar, which had its weakest performance against the euro since the creation of the single currency in 1999 in the previous session, fell further on Thursday. The dollar fell 0.7 per cent to $1.3616 against the euro, lost 1 per cent to $1.4451 against the pound , dropped 0.7 per cent to SFr1.1300 against the Swiss franc and eased 1.3 per cent to Y94.72 against the yen...

Memo Question for March 18: The Atlantic Economy

Mar 18: Weekly memo question: The economies settled from northwestern Europe--the United States, Canada, Australia, New Zealand--were all resource rich. So why did they industrialize early? Why didn't they simply become gigantic Denmarks, shipping agricultural and other resource-based products to the European industral powers in return for manufactures?

We Need a Hegemon Who Won't Drive Us Crazy...

There is a Rodrik Roundtable over at Economist.com...

Dani Rodrik writes:

[T]he most fundamental objection to global regulation... [is that f]inancial regulation entails trade-offs along many dimensions. The more you value financial stability, the more you have to sacrifice financial innovation.... Different nations will want to sit on different points along their “efficient frontiers”. There is nothing wrong with France, say, wanting to purchase more financial stability.... Nor with Brazil giving its state-owned development bank special regulatory treatment, if the country wishes, so that it can fill in for missing long-term credit markets. In short, global financial regulation is neither feasible, nor prudent, nor desirable. What finance needs instead are some sensible traffic rules that will allow nations (and in some cases regions) to implement their own regulations while preventing adverse spillovers.... Similarly, a new financial order can be constructed on the back of a minimal set of international guidelines. The new arrangements would certainly involve an improved IMF with better representation and increased resources. It might also require an international financial charter with limited aims, focused on financial transparency, consultation among national regulators, and limits on jurisdictions (such as offshore centres) that export financial instability. But the responsibility for regulating leverage, setting capital standards, and supervising financial markets would rest squarely at the national level...

This seems to me to be dangerously wrongheaded. Let me try to explain why:

Go back to 1825, when the Bank of England first explicitly takes on its monetary policy mission in an attempt to stem the systemic impact of the banking crisis of 1825. Before 1825 or so a sudden shock that makes investors seek to hold portfolios of shorter duration and less risk does not have a great impact on values: the economy responds by unloading the trade goods from the ships about to sale for Hudson’s Bay or Batavia or Madras and selling them on the domestic market instead, and the fall in demand for long-duration and risky assets is met by deleveraging the real economy without much impact on values. But by 1825 the capital stock of the economy now has large components that cannot be deleveraged: plantations, canals, factories, and soon railroads. So a crisis shock to the demand for duration and risk now has a big depressing effect on asset prices—and that in its turn has a feedback effect further decreasing demand for duration and risk. And so it is in and after 1825 that we see the origin of central banking: the judgment by First Lord of the Treasury Lord Liverpool that the prices of risky and long-duration assets are too important to be left to the free play of market forces: that it is important for the government to support them, at least in crisis, to prevent mass unemployment by making sure that the firms that should be expanding and hiring workers can get finance to do so on terms that make it profitable for them to expand.

From this perspective monetary policy is and always has been about supporting asset prices at a level that allows firms that ought to be expanding to obtain finance and expand profitably. And ever since 1825 the central bank has done this by, whenever it needs to, taking long-duration and risky assets into its own portfolio--and thus off of the stock that must be held by the private sector whose risk tolerance has collapsed. Given that there are going to be sudden shocks to risk and duration tolerance on the part of global investors, we need a global institution to provide support for asset prices in an emergency: a global lender of last resort.

That lender of last resort needs two things if it is to function. First, it needs to be able to "print money"--to have its own liabilities be and be perceived to be the safest assets in the world so that when it borrows it calms markets by giving them more of the high-quality short-duration low-risk paper for which they suddenly have such a great craving. Second, it needs to know what it is buying--to have sufficient regulatory oversight and control over global finance to be able to limit the growth of potentially toxic assets beforehand and then to understand what prices it should offer when it does decide that it is time to support the market.

As my old teacher Charlie Kindleberger taught me (or, rather, taught Barry Eichengreen, who in turn taught me), when the global financial system has had a hegemonic lender-of-last-resort with the power and the will to exercise this function, things have gone relatively well. And when the possible candidates for the role have lacked either the power or the will, things have gone relatively badly.

Back in the 1997-1998 crisis the U.S. Federal Reserve and Treasury acting alongside the IMF had the power and the will. Right now the U.S. Federal Reserve and the Treasury in cooperation with the IMF and the ECB have the power (but they may not have the will). In the future the world is likely to become a more complicated place without a single hegemonic and dominant public financial institution. To my mind, this creates grave dangers for the next quarter century. But Dani does not see them.

Olivier Accominotti: Contagion and the Sterling Crisis of 1931

Marx: The Future Results of British Rule in India

Memo to self: make the 210a students read this:

Karl Marx (1853),"The Future Results of British Rule in India," New York Daily Tribune (August 8): The political unity... imposed by the British sword, will now be strengthened and perpetuated by the electric telegraph. The native army, organized and trained by the British drill-sergeant, was the sine qua non of Indian self-emancipation, and of India ceasing to be the prey of the first foreign intruder. The free press, introduced for the first time into Asiatic society, and managed principally by the common offspring of Hindoos and Europeans, is a new and powerful agent of reconstruction.... From the Indian natives, reluctantly and sparingly educated at Calcutta, under English superintendence, a fresh class is springing up, endowed with the requirements for government and imbued with European science. Steam has brought India into regular and rapid communication with Europe, has connected its chief ports with those of the whole south-eastern ocean.... The day is not far distant when, by a combination of railways and steam-vessels, the distance between England and India, measured by time, will be shortened to eight days, and when that once fabulous country will thus be actually annexed to the Western world.

The ruling classes of Great Britain have had, till now, but an accidental, transitory and exceptional interest in the progress of India. The aristocracy wanted to conquer it, the moneyocracy to plunder it, and the millocracy to undersell it. But now the ... millocracy have discovered that the transformation of India into a reproductive country has become of vital importance to them, and that, to that end, it is necessary, above all, to gift her with means of irrigation and of internal communication. They intend now drawing a net of railroads over India. And they will do it....

I know that the English millocracy intend to endow India with railways with the exclusive view of extracting at diminished expenses the cotton and other raw materials for their manufactures. But when you have once introduced machinery into the locomotion of a country, which possesses iron and coals, you are unable to withhold it from its fabrication. You cannot maintain a net of railways over an immense country without introducing all those industrial processes necessary to meet the immediate and current wants of railway locomotion, and out of which there must grow the application of machinery to those branches of industry not immediately connected with railways. The railway-system will therefore become, in India, truly the forerunner of modern industry. This is the more certain as the Hindoos are allowed by British authorities themselves to possess particular aptitude. for accommodating themselves to entirely new labor, and acquiring the requisite knowledge of machinery. Ample proof of this fact is afforded by the capacities and expertness of the native engineers in the Calcutta mint, where they have been for years employed in working the steam machinery, by the natives attached to the several steam engines in the Burdwan coal districts, and by other instances. Mr. Campbell himself, greatly influenced as he is by the prejudices of the East India Company, is obliged to avow “that the great mass of the Indian people possesses a great industrial energy, is well fitted to accumulate capital, and remarkable for a mathematical clearness of head and talent for figures and exact sciences.” “Their intellects,” he says, “are excellent.”

Modern industry, resulting from the railway system, will dissolve the hereditary divisions of labor, upon which rest the Indian castes, those decisive impediments to Indian progress and Indian power.

All the English bourgeoisie may be forced to do will neither emancipate nor materially mend the social condition of the mass of the people, depending not only on the development of the productive powers, but on their appropriation by the people. But what they will not fail to do is to lay down the material premises for both. Has the bourgeoisie ever done more? Has it ever effected a progress without dragging individuals and people through blood and dirt, through misery and degradation?...

The devastating effects of English industry, when contemplated with regard to India, a country as vast as Europe, and containing 150 millions of acres, are palpable and confounding. But we must not forget... [t]he bourgeois period of history has to create the material basis of the new world — on the one hand universal intercourse founded upon the mutual dependency of mankind, and the means of that intercourse; on the other hand the development of the productive powers of man and the transformation of material production into a scientific domination of natural agencies. Bourgeois industry and commerce create these material conditions of a new world in the same way as geological revolutions have created the surface of the earth. When a great social revolution shall have mastered the results of the bourgeois epoch, the market of the world and the modern powers of production, and subjected them to the common control of the most advanced peoples, then only will human progress cease to resemble that hideous, pagan idol, who would not drink the nectar but from the skulls of the slain.

Talking Points for Asia Trip

Talking Points for Asia Trip

Governance:

• America has only one president at a time.
• The genius of the British Empire was that Britain used its time as the world's hyperpower to make a world in which Britain could live comfortably after other superpowers had arisen.
• Richard Cheney and George W. Bush are not geniuses.
• Barack H. Obama and Joe Biden ate not fools.

International Trade:

• In the United States we--that is, my faction within the Democratic Party--have lost the argument over whether trade is good for America's middle class.
• This is very frustrating: trade is good for America's middle class.
• But the era of increasing globalization has also been an era of rapidly-increasing income inequality--and people think that there is a connection.
• So for the next decade free trade will have to be sold within the U.S. as part of broader foreign policy--free trade as a soft-power tool for security and global environmental goals.
• Nevertheless, the Obama-Biden administration is certain to be better on free trade than the Cheney-Bush administration.

Financial Crisis:

• Since 1844 and the Westminstet debate over the renewal of the Bank of England charter, it has been accepted doctrine that avoiding deep depression requires that central banks keep financial assets from collapsing.
• At least one price is too important to be left to the market.
• Delicate issues of moral hazard: seek also to minimize "Greenspan puts."
• Kindleberger: the lender-of-last-resort must always arrive, but its arrival must never be relied on in advance; this is a tricky business.
• Usually central banks can manage asset prices in a crisis sufficiently by managing the price of duration--buying safe but longer-term assets in exchange for cash that served as reserves and means of payment.
• Sometimes not: default, risk, information. What then?
• Keynes:
• Government spending.
• Tax cuts.
• Danger: debt accumulation can crack government's status as provider of safe assets...
• Bernanke--and Trichet, and King
• Making it up as they go.

Global Imbalances:

• All the issues of global imbalances we used to worry about remain.
• As do all the long-run global warming issues.
• As do all the long-run global aging issues.

Global Capital Markets: Water Flowing Uphill

Matthew Yglesias says that these questions are too hard for him. Well, they are too hard for me too:

Matthew Yglesias: Questions That Are Too Hard for Me: The way this is “supposed” to work is that Chinese people, being poor but growing rapidly, consume more than they produce. The current accounts balance out because savers in rich countries should be investing money in China — building up China’s capital stock and so forth. Investments in capital-poor developing countries “should” offer a high rate of return for developed world savers, and the injection of foreign capital should speed China’s growth. And for “China” you can substitute “Mexico” or “India” or what have you. The world, however, doesn’t actually work like that. Instead, China has been running persistent surpluses. And so have various energy-rich developing countries. So money keeps getting plowed into various US investments. But the US isn’t a poor, developing, capital-poor country. And so a lot of the investment in the United States seems to be going into speculative bubbles — first dot-com stocks, then MBS. Now people are buying up no-interest treasury bonds.

Paul Krugman wrote the other day about how to achieve rebalancing:

That’s where things get complicated: a lower US trade deficit means lower surpluses and/or higher deficits elsewhere. Who’s the counterpart to our adjustment? OK, the Middle East, which no longer has its oil windfall. But China is having its own slowdown, as is Japan.

In other words, trying to figure out where we go from here is a sort of global jigsaw puzzle — and I haven’t managed to solve it yet.

So, yeah, he wrote about it but he didn’t have the answer. Brad DeLong offers this:

If it weren’t for the fact that the furshlugginer dollar refuses to fall in value, the answer would be obvious: we will have a boom in import-competing manufacturing (and exports). But then the rest of the world has a long-run problem: if we decide to no longer be the world’s importer of last resort, than what serves as a locomotive to keep it near full employment?

But if the dollar doesn’t fall, then we have a long-run problem. The only answer I can think of is for the U.S. to then become the world’s largest private-equity fund: they lend us their money, and we then invest the money back in their economies–in industries and companies that then have a very high demand for U.S. high-tech goods and for U.S. services exports.

I’ve heard some economists argue that we’re pursuing some kind of misguided strong dollar policy that’s responsible for our currency’s refusal to devalue, but I don’t actually see what policy that might be. We appear to be doing everything you would do to shake investor confidence in U.S. public finances and spark a decline in our currency.

Maybe the answer to these difficult questions is lurking inside CAP’s global new deal report. I’ll need to read it.

Spinning the Wheels

I think that if the G-20 summit was worthwhile, it was the conversations that were not part of the formal summit that were worthwhile--and I do not know what they were.

I do know that Dani Rodrik is disappointed:

Dani Rodrik's weblog: I was not expecting any substantial agreement on international regulatory coordination or any semblance of a new Bretton Woods, so I am not disappointed on that score.  What I was looking for were three things: (i) coordination on fiscal stimulus; (ii) a commitment to provide more liquidity support, as needed, to prevent a further spread of the crisis to emerging nations; and (iii) a clear commitment not to engage in trade protection, with a monitoring mechanism to ensure the pledge is being observed.

How does the statement do in these regards?  So-so.  There is no coordination in the fiscal arena, the promises made to emerging markets are vague, and even though there is a clear statement on protection and export subsidization, there is no monitoring or enforcement mechanism.

What about the longer-term issues? The fundamental dilemma of financial globalization is that regulation and supervision remains national while financial markets are international.  The statement recognizes this dilemma...

Britain Decides to Reflate

Or Mervyn King does, at least:

Heard on the Street: ike Prime Minister Gordon Brown, Bank of England governor Mervyn King woke up just in time to the scale of the banking crisis confronting the U.K. If the banking system has now stabilized, it's thanks to the multibillion-pound recapitalizations and the BOE's far bigger liquidity injections of the past few weeks. Mr. King has had another epiphany, which might spare the country from a full-blown depression as lower interest rates take effect and a much weaker pound eventually boosts exports. In a speech Tuesday noting the U.K. has undergone its worst banking crisis since the First World War, Mr. King said that rarely has economic activity slowed as fast as it has in recent months. His warning about a sharp and prolonged downturn in domestic demand suggests a recession will prove more severe than the technical definition of two consecutive quarters of negative growth.

Mr. King has cleared the way for a series of rate cuts aimed at stimulating an economy suffering from tight credit and low confidence, but which no longer faces the inflationary pressure of rising commodity prices. Revealingly, Mr. King's discussion of inflation was relatively cursory. Only a month ago, Mr. King's deputy John Gieve had said the task of driving inflationary expectations lower remained at the forefront of the central bank's thinking. With economists forecasting the BOE's base rate will have halved by late next year, that's bad news for the pound as the sharp overnight fall in sterling against the dollar attests to. But Mr. King also spelled out how the dynamics of the U.K. economy have changed, which is why sterling has further to fall.

The willingness of foreign creditors to lend to U.K. banks explains much of the currency's strength in the past four years. Today, the banks' wholesale-funding model is bust. So it's a weak pound and a narrowing trade gap -- reflecting the loss of foreign financing that has supported the current record deficit, rather than any near-term strength in exports -- which will help characterize the country's economic misfortunes for some time to come.

The Baldwin-Eichengreen Little Booklet Is a Success...

Richard Baldwin writes:

Dear All,

The instant booklet seems a hit; we've had about 10,000 downloads in the first 24 hours, Krugman's blog called it a "Must read", and much more. The download pace is only accelerating as the word spreads in the US blogosphere. Let's hope the leaders do the right thing.

-Richard

Barry Eichengreen and Richard Baldwin, eds. (2008), Rescuing Our Jobs And Savings: What G7/8 Leaders Can Do To Solve The Global Credit Crisis (London: CEPR: VoxEU):

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The Introduction to the Baldwin-Eichengreen 24-Hour Booklet

Barry Eichengreen and Richard Baldwin:

Rescuing our jobs and savings: What G7/8 leaders can do to solve the global credit crisis: Without rapid and coordinated action by G7/8 leaders, this financial crisis could turn into a jobs crisis, a pension crisis and much more. This column introduces a collection of essays by leading economists on what the G7/8 leaders should do this weekend. The dozen essays present a remarkable consensus on a few points: we need immediate, coordinated global action that includes recapitalisation of the banks.

We are in the throes of what is almost certainly the most serious economic and financial crisis of our lifetimes. The crisis is no longer a US crisis, or even a US and European crisis; it is a global crisis. It has spread from the financial sector to the real economy. It is not just investment portfolios and retirement accounts at risk, continued turmoil will soon start to destroy jobs.

There is a need for urgent action. The policy response needs to be decisive. It needs to be global. With this sense of urgency in mind, we have assembled a group of leading economists to offer priorities for crisis response. This is not a homogenous collection of experts. The contributors are from different continents and different schools of thought.

The G7/8 finance ministers meeting: An opportunity

Global economic and financial leaders are convening this weekend in Washington DC for the annual meetings of the IMF and World Bank. G7/8 finance ministers will meet Friday on the sidelines of the Fund/Bank meetings to craft their response. The global financial community will assemble the next day at IMF headquarters. This is a golden opportunity for agreeing a coordinated plan. The authors of the thirteen essays do not agree on every point (there was little or no coordination among them as this initiative was launched on mid-morning of 8 October). Nevertheless, there is a remarkable degree of consensus on what must be done. Policy makers must move boldly to stabilise the financial system. The basic elements are:

• A quick bank recapitalisation with global coordination
• A guarantee of deposits and/or loans with global coordination
• Further, coordinated macroeconomic stimulus.

All the authors agreed on the first, many on the second and a good number on the third. Here is the link to the short booklet entitled “Rescuing our jobs and savings: What G7/8 leaders can do to solve the global credit crisis.” It is only 38 pages long.

The authors are: Alberto Alesina, Michael Burda, Charles Calomiris, Roger Craine, Stijn Claessens, J Bradford DeLong, Douglas Diamond, Barry Eichengreen, Daniel Gros, Luigi Guiso, Anil K Kashyap, Marco Pagano, Avinash Persaud, Richard Portes, Raghuram G Rajan, Guido Tabellini, Charles Wyplosz and Klaus Zimmermann.

As Paul Krugman Says, the Stock Market Is Not the Big Problem

The flow of finance to expanding companies--or, rather, the not-flow of finance to companies that ought to be expanding employment--is the problem.

Paul:

Dow 9,000!: Stock prices are, however, the least of our worries. The money markets are frozen; the TED spread is 4.14%. G7 meeting tomorrow, IMF-World Bank over the weekend. Now is the time for major action — an announcement of coordinated capital injections, liquidity measures, and more. If we’ve had nothing except vague assurances by Monday...

Let me repost this:

The Wrong Financial Crisis

J. Bradford DeLong
Professor of Economics, U.C. Berkeley
Research Associate, NBER

delong@econ.berkeley.edu

October 8, 2008

We—all of us from Nouriel Roubini to Lawrence Summers to John Taylor to Tim Geithner (except perhaps Ben Bernanke, who really did seem to believe in a long-run global savings glut)—were expecting a very different financial crisis. We were expecting the Balance of Financial Terror between Asia and America to collapse and produce chaos. We were expecting a free fall in the dollar’s value that would push and be pushed by large-scale capital flight from America that would produce high interest rates and a collapse of construction and investment. We were expecting a collapse of imports into the United States that would produce a free fall in employment and in political stability in Asia. We expected the Federal Reserve and the U.S. Treasury to be powerless—for we expected the safe asset that banks and investors would scramble for in the chaos to be anything but U.S. Treasuries and reserve deposits at the Fed. And for the avoidance of a catastrophic balancing-down of the world economy we expected the United States to have to depend on the kindness of, well, not strangers exactly but of a disorganized congerie of national Treasuries and central banks that were unused to a world without a Kindlebergian hegemon.

We are not having that financial crisis. And it looks like we will not have that financial crisis: if the past year’s financial chaos in New York has not provoked a run on the dollar, it is hard to envision a scenario that would. Instead we are having a very different financial crisis: catastrophic failures of risk management throughout the entire banking sector have caused a relatively minor—by the standards of the global economy—collapse in housing prices in Riverside County, CA, Dade County, FL, and a few other places to freeze up global finance to a degree that has not been seen since the Great Depression. The first good thing about this situation is that it does not call for different central banks and Treasuries to do different things, but rather for them all to do the same thing in unison without fouling each other’s oars.

That should be relatively easy to arrange.

What we need right now are:

• Coordinated fiscal expansions across the globe: if the world economy is not now in something close enough to a liquidity trap to make no difference, it soon will be.
• Coordinated monetary expansions across the globe: a bank is any organization that borrows or accepts investments short and lends long; the durations of its assets and liabilities are deliberately mismatched; when the entire banking sector is insolvent at current market prices, anything that reduces interest rates all along the yield curve helps reduce the magnitude of the insolvency.
• Coordinated banking sector recapitalizations across the globe: since at least 1844 there has been broad consensus that the short-term price of safe liquidity is too important to be left to the market; now there is growing consensus that the price of risk is too important to be left to the market as well. For the government to operate on the price of risk through Operations Twist on a Galatic scale is infeasible. That means that the aggregate degree of capitalization of the banking system must become the object of policy choice. Call it socialism in one sector.

We need these now.

In an ideal world, Richard Cheney would resign, George W. Bush would appoint Barack Obama vice president, George W. Bush would then resign, and President Barack Obama would recall the congress to set it to work. We don't live in an ideal world. In a less-ideal world, this would happen on November 5. I don't think we live in a less-ideal world. But we should do what we can.

What we need in the longer term are:

• Global rules to make outsized compensation incentive-compatible; the Princes of Midtown Manhattan and Canary Wharf need to know that their fortunes will be lost if their institution blows up within a decade of their handing over operational control—only such can you make them truly long the fortunes of their firms and of the global economy rather than simply long volatility.

• More progressive global tax systems: we wish we could build a better global economic system, but we do not know how to build one that does not contain a solid safety net for plutocrats, and the systems we do know how to build are politically unsustainable unless all voters know and believe that from those who have much will be taken away.

The global market economy continues to evade all our attempts to make it foolproof—in large part because our greater fools are so ingenious. But there is not yet any requirement that this global economic downturn reach the magnitude of 1982, or even 1975.

---

From:

Barry Eichengreen and Richard Baldwin, eds. (2008), Rescuing Our Jobs And Savings: What G7/8 Leaders Can Do To Solve The Global Credit Crisis (London: CEPR: VoxEU):

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---

J. Bradford DeLong (2008), "The Wrong Financial Crisis," VoxEU (October 9, 2008):

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Economists Advise the Great and Good Meeting in Washington

Just in time for the IMF/World Bank meetings: a small book produced in less than 24 hours:

Barry Eichengreen and Richard Baldwin, eds.: Rescuing our jobs and savings: What G7/8 leaders can do to solve the global credit crisis: Without rapid and coordinated action by G7/8 leaders, this financial crisis could turn into a jobs crisis, a pension crisis and much more. This column introduces a collection of essays by leading economists on what the G7/8 leaders should do this weekend. The dozen essays present a remarkable consensus on a few points: we need immediate, coordinated global action that includes recapitalisation of the banks.

---

Barry Eichengreen and Richard Baldwin, eds. (2008), Rescuing Our Jobs And Savings: What G7/8 Leaders Can Do To Solve The Global Credit Crisis (London: CEPR: VoxEU):

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---

J. Bradford DeLong (2008), "The Wrong Financial Crisis," VoxEU (October 9, 2008):

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Paul Krugman's Currency Crisis Reading List

Take Econ 553 from the privacy of your desk!

Crisis on my mind: The plan was to discuss portfolio models of the exchange rate in Econ 553. But I’ve decided to switch the order of things, and move up the currency crisis discussion. Last minute list of readings for this morning:

• Garber and Svensson, “The operation and collapse of fixed exchange rate regimes,” NBER WP#4971
• Obstfeld, “Currency crises with self-fulfilling features”, NBER WP#5285
• Allen, Roubini, et al, “A balance sheet approach to financial crisis,” IMF WP, 2002
• Calvo and Talvi, “Sudden stop, financial factors and economic collapse in Latin America,” NBER WP#11153
• Eichengreen, Rose, Wyplosz, “Contagious currency crises,” Berkeley WP
• Kaminsky et al, “The unholy trinity of financial contagion,” NBER WP#10061

With bonus Paul Krugman Washington Post Death Spiral snark!

Of course, these papers are all figments of my imagination; Robert Samuelson assures us that the study of financial crises has been at the fringes of economics.

The Recession Gathers Force...

Nick Godt of MarketWatch:

U.S. stocks fall as economic fear trumps rescue vote: Last update: 10:50 a.m. EDT Oct. 2, 2008: NEW YORK (MarketWatch) -- U.S. stocks fell Thursday, with concerns about the economy returning to the fore as rising jobless claims and plunging factory orders offset hopes that the $700 billion financial bailout will pass Congress after getting the nod from the Senate.... The rise in jobless claims, ahead of Friday's employment report for September, "suggests the economy is now on a slippery road toward a consumer-led recession," Cardillo said.... The S&P 500 index ($SPX: 1,131.87, -29.19, -2.5%) fell 27 points, or 2.4%, to 1,133, while the Nasdaq Composite (COMP: 2,015.84, -53.56, -2.6%) surrendered 52 points, or 2.5%, to 2,018.

Jobless claims remained at their highest level in seven years, the Labor Department reported Thursday, as people in the hurricane-hit states of Louisiana and Texas filed for benefits. For the week ended Sept. 27, seasonally adjusted first-time claims for unemployment benefits rose 1,000, to 497,000 -- the highest level since late September 2001.... Meanwhile, the Commerce Department reported in factory orders for August fell 4%, the biggest such drop in two years....

The dollar rallied sharply, especially against the euro, as European Central Bank president Jean-Claude Trichet acknowledged a deteriorating European economy and that the ECB had considered cutting interest rates. The central bank, however, kept rates steady at 4.25% Thursday. The euro touched a one-year low against the dollar.

Once again, all I can do in response to the last is to say "Huh?" There is a sudden rise in U.S. risk, and the dollar increases in value? Something is wrong with this picture.

A Very Large Invisible College Indeed: Analogies to teh Great Depression

So I surf to Mark Thoma's website physically located 400 miles north of my office in order to find the smart things being written eight feet to my north, on the other side of my office wall. Barry Eichengreen:

From Wall Street to Main Street: Lessons from the Great Depression: A couple of months ago at lunch with a respected Fed watcher, I asked, “What are the odds are that US unemployment will reach 10% before the crisis is over?” “Zero,” he responded, in an admirable display of confidence. Watchers tending to internalise the outlook of the watched, I took this as reflecting opinion within the US central bank.... The Fed and Treasury were on the case. US economic fundamentals were strong. Comparisons with the 1930s were overdrawn.

The events of the last week have shattered such complacency. The 3 month treasury yield has fallen to “virtual zero” for the first time since the flight to safety following the outbreak of World War II. The Ted Spread, the difference between borrowing for 3 months on the interbank market and holding three month treasuries, ballooned at one point to five full percentage points. Interbank lending is dead in its tracks. The entire US investment banking industry has been vaporised. And we are in for more turbulence. The Paulson Plan, whatever its final form, will not bring this upheaval to an early end.... So comparisons with the Great Depression.... Which ones have content, and which are mainly useful for headline writers? 

First, the Fed now, like the Fed in the 1930s, is very much groping in the dark. Every financial crisis is different, and this one is no exception. It is hard to avoid concluding that the Fed erred disastrously when deciding that Lehman Bros. could safely be allowed to fail. It did not adequately understand the repercussions for other institutions of allowing a primary dealer to go under. It failed to fully appreciate the implications for AIG’s credit default swaps. It failed to understand that its own actions were bringing us to the brink of financial Armageddon.

If there is a defence, it has been offered [by] Rick Mishkin, the former Fed governor, who has asserted that the current shock to the financial system is even more complex than that of the Great Depression. There is something to his point. In the 1930s the shock to the financial system came from the fall in the general price level by a third and the consequent collapse of economic activity. The solution was correspondingly straightforward. Stabilise the price level, as FDR did by pumping up the money supply, and it was possible to stabilise the economy, in turn righting the banking system.

Absorbing the shock is more difficult this time because it is internal to the financial system. Central to the problem are excessive leverage, opacity, and risk taking in the financial sector itself. There has been a housing-market collapse, but in contrast to the 1930s there has been no general collapse of prices and economic activity. Corporate defaults have remained relatively low, which has been a much-needed source of comfort to the financial system. But this also makes resolving the problem more difficult. Since there has been no collapse of prices and economic activity, we are not now going to be able to grow or inflate our way out of the crisis, as we did after 1933.

In addition, the progress of securitisation complicates the process of unravelling the current mess....

That said, we are not going to see 25% unemployment rates like those of the Great Depression. Then it took breathtaking negligence by the Fed, the Congress and the Hoover Administration to achieve them. This time the Fed will provide however much liquidity the economy needs. There will be no tax increases designed to balance the budget in the teeth of a downturn, like Hoover’s in 1930. Where last time it took the Congress three years to grasp the need to recapitalise the banking system and provide mortgage relief, this time it will take only perhaps half as long. Ben Bernanke, Hank Paulson and Barney Frank are all aware of that earlier history and anxious to avoid repeating it.  

And what the contraction of the financial services industry taketh, the expansion of exports can giveth back.... The ongoing decline of the dollar will be the mechanism bringing about this reallocation of resources. But the US economy, notwithstanding the admirable flexibility of its labour markets, is not going to be able to move unemployed investment bankers onto industrial assembly lines overnight. I suspect that I am now less likely to be regarded as a lunatic when I ask whether unemployment could reach 10%.

Three points. (1) We could inflate our way out of it--in the 1930s we had a 30% product price deflation, and now we have had a 30% housing price deflation. Balanced inflation would remove the debt overhang in both cases. We may well not want to resolve the problem via inflation--and I suspect that even by raising the theoretical possibility I have reduced my chances of attaining high office in the Eccles Building to something indistinguishable from zero--but we could.

(2) Barry is right. Particularly, it looks as though Barry is right about Lehman Brothers. In retrospect, the decision to let Lehman fail without rescue, control, or supervision looks to be the first significant misstep that Bernanke and Paulson have made in the past fifteen months. Clearly it looked to them to be a good idea at the time, and clearly they have more information than I do, and it is impossible to dance this dance and put every foot right. I'm sure that had I been at the Treasury or the Fed I would have made worse mistakes by now than they have made. But:

It looks like it is the failure to cushion the losses of the creditors of Lehman than has produced the need for emergency action. If the Fed and the Treasury had offered Sunday night to buy as much of Lehman debt as the market offered at 75% of the previous Friday's market price, I don't think we would be staring into this particular abyss right now.

(3) Nevertheless, I said a year ago that if the unemployment rate stays below ten percent then it is a win for monetary policy. And I still think we have an 80% chance of achieving that...

Capital and Its Complements

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Berkeley Finance Seminar

Guohua Jiang, Charles Lee, and Heng Yue, "Tunneling in China: the Remarkable Case of Inter-Corporate Loans" http://www.haas.berkeley.edu/groups/finance/JLY_080530.pdf:

Recent events in China provide a historical opportunity to study the expropriation of minority shareholders. In this paper, we document the use of inter-corporate loans by controlling shareholders to extract funds from Chinese listed firms. Using accounting information from public sources, we show how tens of billions of RMB were siphoned from hundreds of companies during the 1996 to 2006 period. Specifically, we show the nature and extent of these abuses, evaluate their economic consequences, explore their cross-sectional determinants, and report on the extensive efforts by auditors and regulators that eventually contained this practice. Collectively, our findings shed light on the nature and severity of the tunneling problem in China, and the on-going challenges associated with regulatory reform in the country.

Memories of Chester Crocker, Mark Hopkins, Colis Huntington, and Leland Stanford:

The Central Pacific Railroad is chartered at Sacramento, California, on June 28, 1861.... Watervliet, New York-born retail merchant-turned-politician Leland Stanford, 37, is president (and wins election as governor of California), Colis P. Huntington vice president, Mark Hopkins an officer, and Troy, New York-born storekeeper-turned-politician Charles Crocker, 39, head of construction...

Notes for PEIS 101 Guest Lecture: August 15, 2008

GLOBALIZATION AND ITS DISCONTENTS

What was traded: 1500 and before:

• Silks, gems
• Spices
• Slaves
• Knowledge (but very slowly: 500 years from China to Europe): spaghetti, compass, printing, gunpowder

What was traded: 1500 to 1800: add:

• Textiles
• Sugar
• Intoxicants (coffee, tea, chocolate, tobacco, opium)
• Slaves (industrial plantation slavery: middle passage)

All due to the ocean-going caravel; digression on Zheng He

What was traded: 1800-1870: add:

• Cotton
  • Consequence: U.S. Civl War (300K dead of 1.2M white southerners; 300K dead of 6M white northerners and Blacks; same number maimed)

What was traded: 1870-today: add:

• All staple commodities that don't spoil
• the iron-hulled ocean going steamship
• the submarine telegraph cable

---

How cheap is trade today?:

• A standard container, 5500 cubic feet
• An iPhone, worth $200, in a box 1/32 of a cubic foot
• One container can carry $35M in iPhones
• Costs $8000 to ship a container across the Pacific (used to be $3000)

---

Economic Growth:

• Current U.S.: $25/hr ($2008)
• U.S. 1900: $3/hr ($2008)
• U.S. 1800: $1/hr ($2008)

Today: You can buy 80,000 calories of potatoes from a day's wages at $1 an hour

• 1700 Beijing: 2000 calories purchased with a day's wage
• 1700 Leipzig: 3000 calories purchased with a day's wage
• 1700 London: 8000 oat calories, but only 3500 wheat calories

International income differentials on the order of 2-1

Today:

• U.S.: $25
• Coastal China: $6
• Interior China: $3
• India: $2
• Ethiopia, etc.: $1

---

Post-WWII Development Strategies:

• Soviet (seems a good idea because no Great Depression in the Soviet Union, and Soviet victory over the Nazis in WWII)
• "Commanding Heights"
• Import substitution
• Independence as a magic bullet

All failures

---

The Washington Consensus:

• Maximize economic contact--eliminate trade barriers
• Minimize regulation--an excuse for bureaucracy and bribery
• Shrink the state--outside of East Asia and maybe western Europe, emerging market economies can establish property rights and enforce contracts, and that is pretty much all they should dare try to do...

---

Rodrik:

• Regulatory arbitrage on health and safety--race to the bottom
• Capital mobility: is the constraint savings, or investment demand?
• Perverse savings flows
• Needed: global scale institutions (like the EU, only more so)

---

Immigration:

U.S.:

• 300M people
• 150M workers

Mexico:

• 100M people
• 35M workers
• Of whom, 9M in U.S.

Winners from immigration:

• Mexican migrants bigtime
• Mexican stay-at-homes (remittances, larger farms)
• American businesses
• American consumers
• American workers who become straw bosses

Losers:

• Past legal immigrants
• African-American males with little education

PE 101 Guest Lecture: Non-Powerpoints: August 14, 2008

GLOBALIZATION AND ITS DISCONTENTS

What was traded: 1500 and before:

• Silks, gems
• Spices
• Slaves
• Knowledge (but very slowly: 500 years from China to Europe): spaghetti, compass, printing, gunpowder

What was traded: 1500 to 1800: add:

• Textiles
• Sugar
• Intoxicants (coffee, tea, chocolate, tobacco, opium)
• Slaves (industrial plantation slavery: middle passage)

All due to the ocean-going caravel; digression on Zheng He

What was traded: 1800-1870: add:

• Cotton
  • Consequence: U.S. Civl War (300K dead of 1.2M white southerners; 300K dead of 6M white northerners and Blacks; same number maimed)

What was traded: 1870-today: add:

• All staple commodities that don't spoil
• the iron-hulled ocean going steamship
• the submarine telegraph cable

---

How cheap is trade today?:

• A standard container, 5500 cubic feet
• An iPhone, worth $200, in a box 1/32 of a cubic foot
• One container can carry $35M in iPhones
• Costs $8000 to ship a container across the Pacific (used to be $3000)

---

Economic Growth:

• Current U.S.: $25/hr ($2008)
• U.S. 1900: $3/hr ($2008)
• U.S. 1800: $1/hr ($2008)

Today: You can buy 80,000 calories of potatoes from a day's wages at $1 an hour

• 1700 Beijing: 2000 calories purchased with a day's wage
• 1700 Leipzig: 3000 calories purchased with a day's wage
• 1700 London: 8000 oat calories, but only 3500 wheat calories

International income differentials on the order of 2-1

Today:

• U.S.: $25
• Coastal China: $6
• Interior China: $3
• India: $2
• Ethiopia, etc.: $1

---

Post-WWII Development Strategies:

• Soviet (seems a good idea because no Great Depression in the Soviet Union, and Soviet victory over the Nazis in WWII)
• "Commanding Heights"
• Import substitution
• Independence as a magic bullet

All failures

---

The Washington Consensus:

• Maximize economic contact--eliminate trade barriers
• Minimize regulation--an excuse for bureaucracy and bribery
• Shrink the state--outside of East Asia and maybe western Europe, emerging market economies can establish property rights and enforce contracts, and that is pretty much all they should dare try to do...

---

Rodrik:

• Regulatory arbitrage on health and safety--race to the bottom
• Capital mobility: is the constraint savings, or investment demand?
• Perverse savings flows
• Needed: global scale institutions (like the EU, only more so)

---

Immigration:

U.S.:

• 300M people
• 150M workers

Mexico:

• 100M people
• 35M workers
• Of whom, 9M in U.S.

Winners from immigration:

• Mexican migrants bigtime
• Mexican stay-at-homes (remittances, larger farms)
• American businesses
• American consumers
• American workers who become straw bosses

Losers:

• Past legal immigrants
• African-American males with little education

Brad DeLong's Guest PE 101 Lectures, August 2008

Class Topics:

• W Aug 13: Twentieth-century political economy
• Th Aug 14: The discontents of globalization
• F Aug 15: The coming of the second gilded age

Background Readings:

• Dani Rodrik (2008), "The Death of the Globalisation Consensus".
• Dani Rodrik (2008), "Globalization Anxiety as Mass Hysteria?".
• Ricardo Hausmann, Dani Rodrik, and Charles F. Sabel (2007), "Reconfiguring Industrial Policy: A Framework with an Application to South Africa" http://ksghome.harvard.edu/~drodrik/Reconfiguring%20Industrial%20Policy%20August%2031%20final.pdf.
• Dani Rodrik and Arvind Subramanian (2008), "Why Did Financial Globalization Disappoint?"http://ksghome.harvard.edu/~drodrik/Why_Did_FG_Disappoint_March_24_2008.pdf.
• Dani Rodrik (2007), "How to Save Globalization from Its Cheerleaders" http://ksghome.harvard.edu/~drodrik/Saving%20globalization.pdf
• Claudia Goldin and Lawrence Katz (2007), "Long-Run Changes in the Wage Structure: Narrowing, Widening, Polarizing" http://www.economics.harvard.edu/faculty/goldin/files/GoldinKatz_Brookings.pdf
• Chye-Ching Huang and Chad Stone (2008), "Average Income in 2006 up $60,000 for Top 1 Percent of Households, Just $430 for Bottom 90 Percent".

---

http://tinyurl.com/682bbw

Ken Rogoff Puzzles Paul Krugman

Paul writes:

The Rogoff doctrine - Paul Krugman: Ken Rogoff is one of the world’s best macroeconomists, so I take whatever he says seriously. But — you know that’s the kind of statement that is followed by a “but” — I’m having a hard time understanding his demands for a world slowdown. Ken tells us that

The huge spike in global commodity price inflation is prima facie evidence that the global economy is still growing too fast.

And then he calls for

a couple of years of sub-trend growth to rebalance commodity supply and demand at trend price levels

Um, why? Basically, the world is employing rapidly growing amounts of labor and capital, but faces limited supplies of oil and other resources. Naturally enough, the relative prices of those resources have risen — which is the way markets are supposed to work. Since when does economic analysis say that the way to deal with limited supplies of one resource is to reduce employment of other resources, so that the relative price of the limited resource returns to “trend”?

Presumably there’s some implicit argument in the background about why a sharp rise in the relative price of oil is more damaging than leaving labor and capital underemployed. But that argument isn’t there in Ken’s recent pieces. Model, please? I agree that

Dollar bloc countries have slavishly mimicked expansionary US monetary policy

and that’s a real issue: the Fed is pursuing very loose policy to deal with a US financial crisis, and that’s inflationary in countries that are pegged to the dollar without facing our problems. But that’s an argument for breaking up Bretton Woods II; it’s not an argument for tighter Fed policy.

Since this is coming from Ken Rogoff, I assume that there’s some deeper analysis here. But I can’t infer it from the articles I’ve read. Please, sir, can I have some more?

Greenspanism Looking Pretty Good...

Martin Wolf is gloomy:

A year of living dangerously for the world: It is now almost a year since the US subprime crisis went global. Many then hoped that the repricing of risk would be no more than a brief interruption.... Such hopes have been disappointed.... So where is the world economy now? And where might it go? Here are some preliminary answers to these questions.

The answer to the first comes in two main parts: continued financial distress and commodity price rises.... Equity investors are not the only people worried about the health of banks. The banks themselves are also worried. Spreads between rates of interest on inter-bank lending in dollars, euros and sterling and expected official rates... [o]n six-month loans... are now as high as at the two previous peaks, in September and December of last year.... This is no mere liquidity crisis. The banks are expressing concern about the solvency of their peers....

Meanwhile, the price of oil is close to $150 a barrel.... has doubled over the past year. In real terms, the price of oil is now 25 per cent higher than in 1979.... [W]hy are commodity prices soaring when the world economy is slowing?... Producers will leave oil in the ground if the rise in real oil prices is expected to be faster than the return on the alternative assets. What determines the current price then is the expected future price. The most important drivers have been the prospective growth in the demand of emerging countries, particularly China, and gloom about alternative sources of supply....

So what happens to the world economy next?... It is hard to see any outcome other than a sustained slowdown in the world economy.... [R]isks could combine in dangerous ways. An attack on Iran might push the price of oil above $200.... If the ongoing deleveraging of the US economy weakened US consumption, the economy might go into a deep recession. US fiscal deficits would then soar and long-term US interest rates might jump. This could make the debt dynamics of the US government look very unpleasant. A flight from the dollar and dollar bonds might even ensue. Who would then want to be running the Federal Reserve?

The good news is that the world economy has held up surprisingly well. The bad news is that the risks remain squarely on the downside...

My reading is somewhat different. Back in the second half of the 1990s, various people went into Alan Greenspan's office. "Raise interest rates!" they said. "Let unemployment go up! The Phillips curve can't have shifted in this far! The natural rate of unemployment can't have fallen so far so fast! These stock market valuations can't be rational! We are headed for a big crash, or a big inflationary spiral--unless you change course now!"

Alan Greenspan responded that there was no sign of overly-tight labor demand, no sign of accelerating demand-pull or wage-push inflation that would warrant interest rate increases. People were indeed investing enthusiastically in high-tech start-ups and those buying stocks at outsized price-earnings ratios. But the people doing the buying and investing were relatively well-off, and were grownups. If it turned out to be a serious bubble, and if the unwinding of the bubble triggered a financial panic and threatened to produce a high-unemployment recession, then would be the moment for the Federal Reserve to step in and clean up the mess. In the meanwhile, it would be a shame to destroy millions of jobs and wreck a period of 4%+ economic growth just because the Federal Reserve thought that it knew better than grownup investors what prices they should be paying for stocks and shares in high-tech startups, and feared that there might be trouble in the future.

Similarly, in the middle years of the decade of the 2000s, various people went into Alan Greenspan's office. "Raise interest rates!" they said. "Let unemployment go up! Long-term interest rates cannot stay this low for long! The sustainable pace of construction can't have risen so far so fast! These real estate valuations can't be rational! We are headed for a big crash, or a big inflationary spiral--unless you change course now!"

Alan Greenspan responded that there was no sign of overly-tight labor demand, no sign of accelerating demand-pull or wage-push inflation that would warrant interest rate increases. People were indeed building houses and buying mortgages and taking out home-equity loans enthusiastically at outsized price-rental and mortgage-value income ratios. But the people doing the buying and investing were relatively well-off, and were grownups. If it turned out to be a serious bubble, and if the unwinding of the bubble triggered a financial panic and threatened to produce a high-unemployment recession, then would be the moment for the Federal Reserve to step in and clean up the mess. In the meanwhile, it would be a shame to destroy millions of jobs and wreck a period of 3%+ economic growth just because the Federal Reserve thought that it knew better than grownup investors what prices they should be paying for mortgages and houses, and feared that there might be trouble in the future.

The unwinding of the dot-com bubble in 2000-2002 went remarkably well: no significant macroeconomic distress, and less financial panic and distress than I believed possible. The unwinding of the real estate bubble in 2007-2009 is so far not going well. There is, by contrast, more financial distress than I believed possible. Who thought that quantitatively sophisticated hedge funds would have enormous unhedged exposure to subprime risk? Who would have thought that highly-leveraged investment banks with an originat-and-sell business model would keep lots of the securities they had originated in their own portfolios--and kept them because they were high yield for their rating, i.e., because the market did not believe they were as low risk as the investment banks had bamboozled the ratings agencies into claiming? Who would have thought that those buying subprime mortgage securities from the likes of Countrywide had done no investigation into how Countrywide was screening out borrowers?

But so far--look: In the dot-com boom of the 1990s we were the winners. The rich investors of America built out a huge amount of fiber-optic cables and conducted an enormous amount of experimentation in business models from which we all benefit. In the real-estate boom of 2000s the rich investors of America and the world built an extra four million houses and loaned the rest of us money at remarkably low interest rates for five years. Those who moved into newly-built houses with teaser-rate mortgages wish those teaser rates would continue--but they won't, and in the meantime they got to live in a nice house for quite a low rent. Those of us who took out big home equity loans wish the low interest rates would continue--but they won't. And those of us who felt rich because our house values have appreciated wish we still could think of ourselves as sleeping on a pile of gold--but we can't.

The dot-com bubble and the real-estate bubble were bad news for the investors in Webvan, WorldCom, Countrywide, FNMA, and securitized subprime mortgages. But they were, by and large, good news for the rest of us. And investors are supposed to take care of themselves.

Now we are not yet out of the woods. If the tide of financial distress sweeps the Fed and the Treasury away--if we find ourselves in a financial-meltdown world where unemployment or inflation kisses 10%--then I will unhappily concede, and say that Greenspanism was a mistake. But so far the real economy in which people make stuff and other people buy it has been remarkably well insulated from panic at 57th and Park and on Canary Wharf.

Transparency...

From Deborah Solomon:

Real Time Economics: Paulson to Putin: You Say Potato, I Say Sovereign Wealth Fund: Treasury Secretary Henry Paulson, in Russia for high-level talks with top officials, found himself locked in a game of semantics with Prime Minister Vladimir Putin.

Paulson, at a meeting in the Kremlin that was open to reporters, told Putin his discussions with Russian Finance Minister Alexei Kudrin were productive, including their talks about Russia’s sovereign wealth fund.

“We don’t have a sovereign wealth fund,” Putin interrupted, telling Paulson that he must be confusing Russia with someone else.

Russia is sitting on vast reserves of money, buoyed by rising oil and gas prices, and is looking for places to invest those resources. While there’s no dictionary definition of a sovereign-wealth fund, they are generally described as government-owned or controlled assets that are often invested overseas...

Sovereign Wealth Funds are Non-Market (or Quasi-Market) Actors in a Global Market Economy

Non-market actors in a market economy: a historical parable:

Trade around the Indian Ocean before 1500 was a largely peaceful, stable process. Empires, kingdoms, sultanates, and emirates ruled the lands around the ocean, but they did not have the naval strength or the orientation to even think of trying to control the ocean's trade. Pirates were pirates--but only attacked weak targets, and needed bases, and for the land-based kingdoms providing bases for pirates disrupted their own trade.

Then came 1500, and a new entity appeared in the Indian Ocean: the Portuguese seaborne empire.

The European Seaborne Empires I: "To Serve God, to Win Glory for the King, and to Become Rich

From David Abernethy (2000), The Dynamics of Global Dominance: European Overseas Empires 1415-1980 (New Haven: Yale), p. 242 ff: Malacca... located on the Malayan side of the narrow strait... the principal center for maritime trade among Indian Ocean emporia, the Spice Islands, and China.... Because of monsoonal winds, vessels sailing from the Indian Ocean to China (and vice versa) had to lay over for a few months before continuing the journey. An alternative was for ships to unload their wares in Malacca, returning to their respective home ports with goods from the others' ships as well as gold, spices, and precious woods from the offshore islands. The city and strait of Malacca were extraordinarily cosmopolitan places....

The Chinese government's impact on Malacca was far more limited in scope and duration than might be expected given the country's wealth and size. Zheng He's armada of hugh junks, with thousands of well-armed soldiers aboard, was designed to ensure attention and respectful deference to China's rulers from elites elsewhere.... But the admiral was unwilling to use the military might at his disposal to conquer Malacca, there being no plans to administer distant lands.... The emperor politely received the king of Malacca when the king later journeyed to Beijing, bearing tribute. But assertion of China's superior political status was made by the inferior party visiting the Celestial Court, not by the latter reaching out aggressively beyond its borders....

China's private sector had a more substantial and long-lasting impact on Malacca... the existence... of a separate section of the city reserved for Chinese merchants.... That many Chinese merchants in Malacca were long-term residents did not signify that they were overseas agents of Chinese power... they tried to avoid contact with Chinese officials rather than to work with them.... The Chinese did not carry a missionary religion to Malacca because they had none....

Arabs visited Malacca as long-distance merchants, staying in a quarter of the town set aside for Muslims.... [T]hey did bring a missionary religion.... Malacca's rulers had been Muslim for about a century before the Portuguese arrived. One may thus speak of an alliance between Arab mercantile and religious interests resembling the European pattern. But Arabs in teh Indian Ocean basin were not like Europeans. First, they were not... agents of a polity eager to assert itself overseas.... Their prospects for profitable trade were most favorable if none of [the Arab city states] advanced political claims beyond its immediate domain. Traders and sailors moved on monsoonal winds from one trading center to another, intermediaries among several autonomous units rather than agents of any particular one....

The limited, functionally diffuse character of Chinese and Arab/Muslim relations with Malacca posed an isoluble dilemma for the city's sultan when he encountered Europeans.... The sultan faced toward Mecca when praying and toward Beijing when oferring tribute. But for quite different reasons he could count on neither to help counter the new foe....

As Muslim merchants predicted, the Portuguese launched a tripole assault on Malacca. The city was captured in 1511... fifteen hundred soldiers... Viceroy Afonso d'Alburquerque... permanent political control.... Construction of a stone fortress was begun as soon as the battle was won, and it was kept well supplied with soldiers and cannon. The city was a Portuguese possession until the Dutch took it in the seventeenth century... an integral part of a grand scheme to capture gains from Indian Ocean trade. Political control of enclaves throughout the ocean basin was considered a necesary as well as desirable mans to an economic end. Albuquerque appealed to the profit motive as explicitly as one could: "If we take this trade of Malacca out of [the Moors'] hands, Cairo and Mecca are entirely ruined, and to Venice will no spiceries go except that which her merchants go and buy in Portugal."...

[R]eligious dimension.... Albuquerque waited to launch his attack until the day of Saint James.... Non-Muslims were spared following the battle. But "of the Moors, [including] women and children, there died by the sword an infinite number, for no quarter was given to any of them.".... The Portuguese were unlike the Chinese and Arabs in the number and variety of sectoral institutions at their disposal, in the stretch of these institutions far from their home base, and in the way agents of different sectors worked together.... Portugal's grand strategy in the Indian Ocean was to capture gans from a lucrative seaborne trade that had functioned for a long time. Malacca was valued as an enclave... profits literally floated past in the form of ships carryhg spices, precious stones, textiles, chinaware, carvings, and so on through a narrow strait. There was no economic or strategic reason for Albuquerque to invade the Malayan interior.... Not until the nineteenth century did Europeans consider the Malayan interior worthy of their attention. Under British direction, exports from rich tin mines were increased and rubber plantations laid out... a plant Europeans had found in the New [World]... a mode of production perfected earlier in the Americas...

Barry Eichengreen: Like the 1930s, in Reverse

Barry Eichengreen, in the hall outside my office, says:

There are now fifty countries in the world with inflation rates over 10%. It's like the early 1930s, but just reverse the sign: back then everybody with their currency linked to the dollar imported deflation; now everybody is importing inflation.

The solution then as now is the same: delink your currency from the dollar.

This is the first major test of inflation-targeting in emerging markets. I wrote up a little something on this this morning, but I have been unable to submit it anyplace because for some reason my email is down...

To All to Whom These Presents Come, Greetings...

Steve Cohen and I are going to spend part of the summer writing up our thoughts on Sovereign Wealth Funds and other non- or not-very-market actors in our global economy.

To assist in this end, I am now seized of--that is, hold seisin over--Room 203 of 2234 Piedmont Avenue, Berkeley, CA.

All know that I shall with lance and sword defend my seizure of Room 203 of 2234 Piedmont Avenue against all comers save Laura D'A. Tyson alone, whose deanly books from London Business School appear to already occupy the office...

This could be dangerous: there are too many good books here that are not mine, that I have not read, and hence against which I have no immunity...

DeLong: Capital and Its Complements

J. Bradford DeLong (2008), "Capital and Its Complements: International Capital Mobility and Economic Growth in the Twenty-First Century" http://www.j-bradford-delong.net/2008_pdf/20080521_capital.pdf

The old "write a paper to figure out what you think about an issue" trick has gone wrong: I still don't know what I think about the issues at hand...