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May 15, 2009

Economist's View - 5 new articles

Sachs: Rethinking the Global Money Supply

Jeff Sachs says the dominance of the dollar should end, and probably will end:

Rethink the Global Money Supply, by Jeffery Sachs, Scientific American: The People's Bank of China jolted the financial world in March with a proposal for a new global monetary arrangement. The proposal ... has much to commend it. ...

President Richard Nixon delinked the dollar from gold in 1971 (to offset the U.S.'s expansionary monetary policies in the Vietnam era), and major currencies began to float against one another... But most global trade and financial transactions remained dollar-denominated, as did most foreign exchange reserves held by the world's central banks. The exchange rates of many currencies also remained tightly tied to the dollar.

This special role of the dollar in the international monetary system has contributed to the global scale of the current crisis, which is rooted in a combination of overly expansionary monetary policies by the Federal Reserve and lax financial regulations. Easy money fed an unprecedented surge in bank credits, first in the U.S. and then elsewhere, as international banks funded themselves in the U.S. money markets. As bank loans flowed into other economies, many foreign central banks intervened to maintain currency stability with the dollar. The surge in the U.S. money supply was thus matched by a surge in the money supplies of countries linked to the U.S. dollar. The result was a temporary worldwide credit bubble...

China has now proposed that ... nations peg their currencies to a representative basket of others rather than to the dollar alone. ... U.S. monetary policy would accordingly lose its excessive global influence...

The U.S. response to the Chinese proposal was revealing. Treasury Secretary Timothy Geithner initially described himself as open to exploring the idea; his candor quickly caused the dollar to weaken in value—which it needs to do for the good of the U.S. economy. That weakening, however, led Geithner to reverse himself...

Geithner's first reaction was right. The Chinese proposal requires study but seems consistent with the long-term shift to a more balanced world economy in which the U.S. plays a monetary role more coequal with Europe and Asia. No change of global monetary system will happen abruptly... We will probably move over time to a world of greater monetary cooperation within Asia, a rising role for the Chinese yuan, and greater symmetry in overall world monetary and financial relations.


Shiller: Story Time for the Economy

Robert Shiller uses his ideas on the role of animal spirits in driving booms and recessions to cast doubt on the idea that recent sightings of green shoots portend quick recovery for the economy:

Story Time for the Economy, by Robert J. Shiller, Project Syndicate: Since hitting bottom in early March, the world's major stock markets have all risen dramatically. ... Does this suggest that the world economic crisis is coming to an end? Could it be that everyone becomes optimistic again at the same time, bringing a quick end to all our problems?

Speculative booms are driven by psychological feedback. Rising stock prices generate stories of smart investors getting rich. People become envious of others' successes, and begin to wonder if rising prices don't portend further increases. A temptation arises to get into the market, even among people who are fundamentally doubtful that the boom will continue. So rising prices feed back into more rising prices, and the cycle repeats again and again – for a while. ...

But one must ask what would sustain such a movement now. There seems to be no dramatic fundamental news since March other than the price increases themselves. ... The only way world confidence can return dramatically is if our thinking coordinates around some inspiring story beyond that of the price increases themselves.

In my 2009 book with George Akerlof, Animal Spirits, we describe the ups and downs of a macroeconomy as being substantially driven by stories. Such narratives, especially those fueled by accessible human-interest stories, are the thought viruses whose contagion drives the economy. The contagion rate of stories depends on their relation to feedback, but plausible stories have to be there in the first place. ...

The stock markets' rebound since March seems not to be built around any inspirational story, but rather the mere absence of more really bad news and the knowledge that all previous recessions have come to an end. At a time when the newspapers are filled with pictures of foreclosure sales – and even of surplus homes being demolished – it is hard to see any cause for the markets' rebound other than this "all recessions come to an end sooner or later" story.

Indeed, the "capitalists triumphant" story is tarnished, as is our faith in international trade. So, here is the problem: there isn't a plausible driver of a dramatic recovery.

Starting an economic recovery is like launching a new movie: nobody knows how people will react to it until people actually get to see it and talk about it among themselves. Our efforts to stimulate the economy should be focused on improving the script for those stories, making these stories believable again.

This means making capitalism work better, and making it clear that there is no threat of protectionism. But the rationale must be to get the world economy out of its current risky situation, not to propel us into yet another speculative bubble.


Paul Krugman: Empire of Carbon

Paul Krugman says that if we want to save the planet from global warming, China's participation will be required:

Empire of Carbon, by Paul Krugman, Commentary, NY Times: I have seen the future, and it won't work.

These should be hopeful times for environmentalists. Junk science no longer rules in Washington. President Obama has spoken forcefully about the need to take action on climate change; the people I talk to are increasingly optimistic that Congress will soon establish a cap-and-trade system... And once America acts, we can expect much of the world to follow our lead.

But that still leaves the problem of China, where I have been for most of the last week. Like every visitor to China, I was awed by the scale of the country's development. Even the annoying aspects — much of my time was spent viewing the Great Wall of Traffic — are byproducts of the nation's economic success.

But China cannot continue along its current path because the planet can't handle the strain.

The scientific consensus on ... global warming has become much more pessimistic over the last few years. ... Why? Because the rate at which greenhouse gas emissions are rising is matching or exceeding the worst-case scenarios. And the growth of emissions from China ... is one main reason for this new pessimism.

China's emissions, which come largely from its coal-burning electricity plants, doubled between 1996 and 2006. ... And the trend seems set to continue: In January, China announced that it plans to continue its reliance on coal... That's a decision that, all by itself, will swamp any emission reductions elsewhere.

So what is to be done about the China problem?

Nothing, say the Chinese. Each time I raised the issue..., I was met with outraged declarations that it was unfair to expect China to limit its use of fossil fuels. After all, they declared, the West faced no similar constraints during its development; while China may be the world's largest source of carbon-dioxide emissions, its per-capita emissions are still far below American levels; and anyway, the great bulk of the global warming that has already happened is due not to China but to the past carbon emissions of today's wealthy nations.

And they're right. It is unfair to expect China to live within constraints that we didn't have to face when our own economy was on its way up. But that unfairness doesn't change ... that letting China match the West's past profligacy would doom the Earth as we know it.

Historical injustice aside, the ... climate-change consequences of Chinese production have to be taken into account somewhere. And anyway, the problem with China is not so much what it produces as how it produces it. ...

The good news is that the very inefficiency of China's energy use offers huge scope for improvement. Given the right policies, China could continue to grow rapidly without increasing its carbon emissions. But first it has to realize that policy changes are necessary.

There are hints ... that the country's policy makers are starting to realize that their current position is unsustainable. But I suspect that they don't realize how quickly the whole game is about to change.

As the United States and other advanced countries finally move to confront climate change, they will also be morally empowered to confront those nations that refuse to act. Sooner than most people think, countries that refuse to limit their greenhouse gas emissions will face sanctions, probably in the form of taxes on their exports. They will complain bitterly that this is protectionism, but so what? Globalization doesn't do much good if the globe itself becomes unlivable.

It's time to save the planet. And like it or not, China will have to do its part.


"Health Costs Are the Real Deficit Threat"

This shouldn't surprise anyone. The rising cost of health care, not Social Security, is the biggest budget problem:

Health Costs Are the Real Deficit Threat, by Peter Orszag, Commentary, WSJ: This week confirmed two important facts -- that health-care costs are the key to our fiscal future, and that even doctors and hospitals agree that substantial efficiency improvements are possible in how medicine is practiced.

The numbers speak for themselves. The Medicare and Social Security trustees' reports released this week show that health-care costs drive our long-term entitlement problem. An example illustrates the point: If costs per enrollee in Medicare and Medicaid grow at the same rate over the next four decades as they have over the past four, those two programs will increase from 5% of GDP today to 20% by 2050. Despite the attention often paid to Social Security, spending on that program rises much more modestly -- from 5% to 6% of GDP -- over the same time period. Over the long run, the deficit impact of every other fiscal policy variable is swamped by the impact of health-care costs.

Spiraling health-care costs are not just some future abstraction, however. Right now, families across America who have health insurance are seeing their take-home pay reduced and their household budgets strained by high costs and spiraling premiums. ... And the growing weight of health costs on state budgets translates into an inability to make investments in areas such as education, hindering our overall economic growth.

The good news is that there appear to be significant opportunities to reduce health-care costs over time without impairing the quality of care or outcomes. ...

For example, health-care costs vary substantially across regions of the United States and across hospitals and doctors within a region -- even for patients with a similar diagnosis. Medicare spending in 2006 varied more than threefold across U.S. regions... The kicker is that Medicare enrollees in areas with higher spending do not appear to have better health outcomes... Expenditures in the last six months of life have been shown to be nearly twice as high for Medicare patients at certain leading academic medical centers than at others -- again, with no better medical outcomes. Uwe Reinhardt ... put it best: "How can it be that 'the best medical care in the world' costs twice as much as 'the best medical care in the world?'"

The answer is it shouldn't. If we can move our nation toward the proven and successful practices adopted by lower-cost areas and hospitals, some economists believe health-care costs could be reduced by 30% -- or about $700 billion a year -- without compromising the quality of care.

This may all seem academic, but this week a stunning thing happened: Representatives from some of the most important parts of the health-care sector ... met with the president and pledged to take aggressive steps to cut the currently projected growth rate of national health-care spending by an average of 1.5 percentage points in each of the next 10 years. ...

Health-care costs are already so high and the power of compound interest so strong that reducing the growth rate by 1.5 percentage points per year would ... reduce national health expenditures by more than $2 trillion over the next decade -- and could help to put roughly $2,500 in the pockets of the average American family every year. ...

How can we move toward a high-quality, lower-cost system? There are four key steps: 1) health information technology, because we can't improve what we don't measure; 2) more research into what works and what doesn't...; 3) prevention and wellness, so that people ... avoid costs associated with health risks such as smoking and obesity; and 4) changes in financial incentives for providers so that they are incentivized rather than penalized for delivering high-quality care.

Already, the administration has taken important steps in all four of these areas. ... But more must be done ... to ... put the nation on a sustainable fiscal path and build a new foundation for our economy for generations to come.

Some people argue that we should solve the (relatively) easier problems first, if we can, and hence that we should take on Social Security now. But solving problems is not free, it costs political capital to take on a difficult issue, and that capital should be spent where the marginal return per dollar spent is the highest. In addition, if using up all your political capital on health care reform only takes you part to your goal, and hence still means that one more dollar of political capital spent on health care reform - if you had it - would still yield a higher return than spending it on Social Security reform, then Social Security reform should not enter the picture at all. All of your effort should be devoted to health care reform where the return is the highest.

In any case, the political cost of reforming Social Security is very high and the returns are low (because the problem is not very big), so the highest return per dollar of political capital spent is in health care reform, not reforming Social Security, and until that changes health care reform is where our efforts ought to be.

[Note: In more wonkish terms, political capital should be spent where MU/P is the highest, and we should continue to spend political capital on that type of reform until the return from spending one more dollar falls below the return from spending it somewhere else. In equilibrium, of course, MUA/PA = MUB/PB = ..., unless, as above, we are at a corner solution and spend everything on one of the goods.]

Update:

Obama Says U.S. Long-Term Debt Load 'Unsustainable', by Roger Runningen and Hans Nichols, Bloomberg: President Barack Obama, calling current deficit spending "unsustainable," warned of skyrocketing interest rates for consumers if the U.S. continues to finance government by borrowing from other countries.

"We can't keep on just borrowing from China," Obama said at a town-hall meeting ... outside Albuquerque. "We have to pay interest on that debt, and that means we are mortgaging our children's future with more and more debt."

Holders of U.S. debt will eventually "get tired" of buying it, causing interest rates on everything from auto loans to home mortgages to increase, Obama said. "It will have a dampening effect on our economy."

The president pledged to work with Congress to shore up entitlement programs such as Social Security and Medicare and said he was confident that the House and Senate would pass health-care overhaul bills by August.

"Most of what is driving us into debt is health care, so we have to drive down costs," he said. ...

Update:

Health Care Leaders Say Obama Overstated Their Promise to Control Costs: Health care leaders said they promised gradual spending cuts, not the $2 trillion over 10 years the president has cited.


links for 2009-05-15

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