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March 31, 2009

Economist's View - 6 new articles

Asia and the "Bond Bubble"

Yu Qiao says Asian countries are worried about their large investment in dollar denominated US assets and would like one of those one-sided, heads we win, tails the taxpayers loses deals that everyone else seems to be getting:

Asia is the victim if the bond bubble bursts, by Yu Qiao, Commentary, Financial Times: ...Most of Mr Obama's stimulus spending is devoted to social programmes rather than growth promotion, which may exacerbate America's over-consumption problem and delay sustainable recovery. On top of this, the unprecedented fiscal stimulus, with the Federal Reserve's move to inject money into credit markets, contains self-destructive seeds. ... In the long term, America may seek to resolve its economic mess by devaluing the dollar at best and a default at worst. ... It is the foreign holders of US obligations denominated in dollars that would end up paying.

Analysts have warned of the dangers of the US Treasury bond bubble that developed in late 2008. ... If this bubble burst, east Asians would be victims..., the consequences would devastate Asians' hard-earned wealth and terminate economic globalisation.

No other international monetary system offers a viable alternative. However, we can make the main reserve currency power more accountable by creating an instrument to help manage the global crisis.

The basic idea is to turn Asian savings, China's in particular, into real business investments rather than let them be used to support US over-consumption... [E]quity claims on sound corporations and infrastructure projects are at less risk from a currency default. But Asians do not want to bear the risk of this investment because of market turbulence and a lack of knowledge of cultural, legal and regulatory issues in US businesses. However if a guarantee scheme were created, Asian savers could be willing to invest directly in capital-hungry US industries.

First, Asian countries could negotiate with the US government to create a crisis relief facility. The CRF would be used alongside US federal efforts to stabilise the banking system and to invest in capital-intensive infrastructure projects such as a high-speed railway from Boston to Washington DC.

Second, Asians could pool a proportion of their holdings of Treasury bonds under the CRF umbrella to convert sovereign debt into equity investment. Any CRF funds, earmarked for industrial commitment, would still be owned and managed by their respective countries. In return, Asians would hold minor equity shares that would, like preferred stock, be convertible .

Third, the US government would act as the guarantor, providing a sovereign guarantee scheme to assure the investment principal of the CRF against possible default of targeted companies or projects. Fourth, the Fed would set up a special account with the US government to supply liquidity that the CRF requires to swap sovereign debt into industrial investment in the US.

The CRF would lessen Asians' concern about implicit default of sovereign debts caused by a collapsing dollar. It would cost little and help the US by channelling funds to business investment. Conventional Keynesian policies – fiscal and monetary expansion on a national basis – cannot solve the problem but will make it worse.

If China and other Asian countries were to fix their under-consumption problem, that would help too (though not right now, if the cheap foreign loans dry up that will make recovery harder).

"The End of Universal Rationality"

Yochai Benkler discusses the use of the "assumption of universal rationality and a sub-assumption that what that rationality tries to do is maximize returns to the self" as a primary analytical foundation for our models of sociological, political, and economic behavior:

The End of Universal Rationality, The Edge: The big question I ask myself is how we start to think much more methodically about human sharing, about the relationship between human interest and human morality and human society. The main moment at which I think you could see the end of an era was when Alan Greenspan testified before the House committee and said, "My predictions about self-interest were wrong. I relied for 40 years on self-interest to work its way up, and it was wrong." For those of us like me who have been working on the Internet for years, it was very clear you couldn't encounter free software and you couldn't encounter Wikipedia and you couldn't encounter all of the wealth of cultural materials that people create and exchange, and the valuable actual software that people create, without an understanding that something much more complex is happening than the dominant ideology of the last 40 years or so. But you could if you weren't looking there, because we were used in the industrial system to think in these terms.

A lot of what I was spending my time on in the 90s and the 2000s was to understand why it is that these phenomena on the Net are not ephemeral. Why they're real. But I think in the process of understanding that, I had to go back and ask, where are we really in between this what's-in-it-for-me versus the great altruists and the stories of Stahanovich and the self-sacrifice for the community? Both of them are false. But the question is, how do we begin to build a new set of stories that will let us understand both? The stories are actually relatively easy. How we build actual, tractable analysis that allows us to convert what in some sense we all know, that some of us are selfish and some of us aren't. That actually most of us are more selfish some of the time and less selfish other of the time and in different relations. That we don't all align according to the standard economic model of selfish rationality, but that we're also not saints. Mother Teresa wouldn't be Mother Teresa if everybody were like her.

So this is the puzzle that I'm really trying to chew on now, which is how we move from knowing this intuitively and having a folk wisdom about it to something that probably won't in any immediate future have the tractability and precision of mainstream economics. Not, by the way, that as we sit here today, mainstream economics necessarily enjoys the high status that it might have a few years ago, but nonetheless so that we will be able to start building systems in the same way that we thought about building organizational systems around compensation, like options that ties the incentives of the employees to that of the business, like we thought with regard to political science that's completely pervaded today by the understanding of, how does politics happen? Well, it depends on what the median voter wants and what the median Senator wants, and all of that.

We have a lot of sophisticated analyses that try, with great precision, to predict and describe existing systems in terms of an assumption of universal rationality and a sub-assumption that what that rationality tries to do is maximize returns to the self. Yet we live in a world where that's not actually what we experience. The big question now is how we cover that distance between what we know very intuitively in our social relations, and what we can actually build with. ... [...continue reading or watch the video...]

Lessons from the New Deal

The Senate committee for Banking, Housing, and Urban Affairs held a hearing today on "Lessons from the New Deal":

Panel 1

  • Honorable Christina Romer Chair, Council of Economic Advisors

Panel 2

  • Dr. James K. Galbraith Lloyd M. Bentsen Chair Lyndon B. Johnson School of Public Affairs, University of Texas at Austin
  • Dr. J. Bradford DeLong Professor of Economics University of California Berkeley
  • Dr. Allan M. Winkler Professor of History Miami (Ohio) University
  • Dr. Lee E. Ohanian Professor University of California, Los Angeles

Here's the video:

View archive webcast (starts at the 29:00 minute mark)

DeLong: Kick-Starting Employment

Brad DeLong:

Kick-Starting Employment, by J. Bradford DeLong, Commentary, Project Syndicate: Unemployment is currently rising like a rocket... In response, central banks should purchase government bonds for cash in as large a quantity as needed to push their prices up as high as possible. Expensive government bonds will shift demand to mortgage or corporate bonds, pushing up their prices.

Even after central banks have pushed government bond prices as high as they can go, they should keep buying government bonds for cash, in the hope that people whose pockets are full of cash will spend more of it...

In addition, governments need to run extra-large deficits. Spending ... boosts employment and reduces unemployment. And government spending is as good as anybody else's.

Finally, governments should undertake additional measures to boost financial asset prices, and so make it easier for those firms that ought to be expanding and hiring to obtain finance on terms that allow them to expand and hire.

It is this point that brings us to US Treasury Secretary Timothy Geithner's plan to take about $465 billion of government money, combine it with $35 billion of private-sector money, and use it to buy up risky financial assets. The US Treasury is asking the private sector to put $35 billion into this $500 billion fund so that the fund managers all have some "skin in the game," and thus do not take excessive risks with the taxpayers' money.

Private-sector investors ought to be more than willing to kick in that $35 billion, for they stand to make a fortune when financial asset prices close some of the gap between their current and normal values. ... Time alone will tell whether the financiers who invest in and run this program make a fortune. But if they do, they will make the US government an even bigger fortune. ...

The fact that the Geithner Plan is likely to be profitable for the US government is, however, a sideshow. The aim is to reduce unemployment. The appearance of an extra $500 billion in demand for risky assets will reduce the quantity of risky assets that other private investors will have to hold. ... When assets are seen as less risky, their prices rise. And when there are fewer assets to be held, their prices rise, too. With higher financial asset prices, those firms that ought to be expanding and hiring will be able to get money on more attractive terms.

The problem is that the Geithner Plan appears to me to be too small - between one-eight and one-half of what it needs to be. Even though the US government is doing other things as well -fiscal stimulus, quantitative easing, and other uses of bailout funds - it is not doing everything it should.

My guess is that the reason that the US government is not doing all it should can be stated in three words: Senator George Voinovich, who is the 60th vote in the Senate - the vote needed to close off debate and enact a bill. To do anything that requires legislative action, the Obama administration needs Voinovich and the 59 other senators who are more inclined to support it. The administration's tacticians appear to think that they are not on board - especially after the recent AIG bonus scandal - whereas the Geithner Plan relies on authority that the administration already has. Doing more would require a legislative coalition that is not there yet.

We're losing, roughly, 600,000 jobs per month, which is about 20,000 per day. There are many costs associated with job loss, but I wonder how many foreclosures per day are generated from the loss of 20,000 jobs? And that's in addition to the foreclosures we'd have anyway.

The administration has an obligation to protect people from cyclical fluctuations in the economy, to help them avoid losing their jobs, their houses, and other sources of security. For example, if bank nationalization is the safer path to pursue ex-ante to stabilize the banking system, then that means convincing the 60th vote in the Senate, one way or the other, to support the action. If more fiscal stimulus, or a larger version of the Geithner plan is needed, then there should be no rest until the votes are there. If the "tacticians appear to think that they are not on board," or someone takes the time - as I hope they did - to ask them and finds out that, in fact, they aren't aboard, then do whatever it takes to change that.

Maybe the effort was there prior to the Geithner plan, and maybe the effort is there now to try to enhance the Geithner plan through legislative authority, to set the stage for a second stimulus in case it's needed, and to change the public perception of what has been done to date. Perhaps a lot of it is behind the scenes, and all that can be done, is being done. Maybe the administration is saving political capital for other things. But prior to the announcement of the Geithner plan, I had the impression that many of the minds within the administration that counted the most were already made up, or if not fully made up that they had a preference for clever market-based solutions (that the public had no hope of understanding, which makes obtaining the public's support much more difficult), and that stood in the way of a true full court press toward nationalization. As for now, I also wonder if concerns within the administration about the deficit are causing hesitation to pursue more aggressive policies. So I'm not so sure that Voinovich was and is (or will be) the only thing standing in the way.

links for 2009-03-31

"Why Bother with Adam Smith?"

Gavin Kennedy reacts to some of the recent criticism of economists for reading and citing the sacred texts and ancient tomes:

Thought for the Day - 3, Adam Smith's Lost Legacy: ...There is a debate underway among historians of economic thought on whether economists really need to study the history of ideas in what we may loosely term our discipline. Those economists who take the view that the history of economic ideas really has nothing to do with modern economics, point to it being unnecessary for 'real scientists' to read the works of Isaac Newton, and his lesser luminaries, so why bother with Adam Smith and the rest? My views on this debate (I have not joined in, so far) are predictable. The physical world is fairly constant – each and every carbon atom is assumed to behave the same way, and has done so through the ages, and unless that changes in known circumstances, its properties and relationships with other atoms are not expected to change. Knowledge gains in hard sciences build upon earlier knowledge gains, and future knowledge gains continue the process. Turning to economics – part of human sciences – it is quite different. We hardly know about past economic history; even recent history is controversial and is well short of arriving at a settled view. There are political views of economic behaviours – as far as I know, we do not have 'leftwing' or 'rightwing' carbon atoms – and we do not have a settled view on what constitutes economic society or on what would constitute a society that could be said to be the basis for all further societies without (controversial) changes.

As economics was derived from political economy, shedding within a century, philosophy, sociology, anthropology, history, politics, psychology, and such-like, though, unfortunately not shedding mysticism, idealism, utopianism, and, eventually, all traces of real human beings, an imaginary world has replaced the real world.

Now, that there were great gains from this process is not disputed, of course, but questions arise as to the costs in what the great 'gains' do not explain. Apart from which there is genuine concern about the usefulness of the abstract when directed at policy-making in real human societies. Even among the most mathematically-oriented of economists there is no agreement as to whether policy A is 'better' than policy B (or policy C to Z).

It is not as if modern economists are better fitted in 2009 to understand (stepping down from 'to advise') than their predecessors, already starting down the road we've travelled, in 1909 (or for that matter 1809). The current 'global crisis' has not produced a consensus among the brightest in our profession (Nobel prize winners stand on opposite sides with different prescriptions) as what should be (could be) done, even if the players in the mix of, say, the G20 were minded to accept whatever advice the equations would give them. And that's the rub. The players do not behave as the mythical Homo economicus prescribes, and neither do all the other players in all the levels below them. The aggregates in an economy, however expressed neatly in well-behaved functions, do not capture what the models require of them. And their authors are impotent to make them do so. It is not as if we are talking about wildly improbable outcomes from clearly defined categories (the effect of heat on molecules of a specific quality as taught in Physics 101). For a 'hard science', surely we can expect a straight answer to a simple operation like 'quantitative easing' and its likely affect on activity? My colleagues among the historians of economic ideas are debating, hotly, just now about what constitutes money. Unlike, the physicists, who agree on the role of gravity, modern economists are not so sure about the venerable role of money. No wonder, that ideas of modern economics fall foul to the barely understood ideas of past economists, where they are not simply made up (as has been the fate of Adam Smith among many modern economists who assert his so-called ideas shamelessly without reading him). We may not need to read Newton's Principia to add to the knowledge base (so far it has not let us down, though it has been improved upon safely because its foundations were so strong), but where did our ideas about money, for instance, come from, and where may our ideas about money be built on less secure foundations than the 'certainties' we were taught recently? I leave these thoughts for the thoughtful readers...

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