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June 21, 2010

Latest Posts from Economist's View

Latest Posts from Economist's View


Paul Krugman: Now and Later

Posted: 21 Jun 2010 01:08 AM PDT

Starving the economy during the recovery period risks a relapse and, further, this can cause long-run damage. Getting the economy back to the best possible health will require addressing our long-run budget issues, but best to wait until the economy has recovered its health before starting it on a strict diet:

Now and Later, by Paul Krugman, Commentary, NY Times: Spend now, while the economy remains depressed; save later, once it has recovered. How hard is that to understand?
Very hard, if the current state of political debate is any indication. All around the world, politicians seem determined to do the reverse. They're eager to shortchange the economy when it needs help, even as they balk at dealing with long-run budget problems. But maybe a clear explanation of the issues can change some minds. So let's talk about the long and the short of budget deficits. ...
America has a long-run budget problem. Dealing with this problem will require, first and foremost, a real effort to bring health costs under control — without that, nothing will work. It will also require finding additional revenues and/or spending cuts. As an economic matter, this shouldn't be hard..., a modest value-added tax, say at a 5 percent rate, would go a long way toward closing the gap, while leaving overall U.S. taxes among the lowest in the advanced world.
But if we need to raise taxes and cut spending eventually, shouldn't we start now? No, we shouldn't.
Right now,... a severely depressed economy ... is inflicting long-run damage. Every year that goes by with extremely high unemployment increases the chance that many of the long-term unemployed will never come back to the work force, and become a permanent underclass. Every year that there are five times as many people seeking work as there are job openings means that hundreds of thousands of Americans graduating from school are denied the chance to get started on their working lives. And with each passing month we drift closer to a Japanese-style deflationary trap.
Penny-pinching at a time like this isn't just cruel; it endangers the nation's future. And it doesn't even do much to reduce our future debt burden, because stinting on spending now threatens the economic recovery, and with it the hope for rising revenues.
So now is not the time for fiscal austerity. ...[B]udget deficit should become a priority when, and only when, the Federal Reserve ... can offset the negative effects of tax increases and spending cuts by reducing interest rates.
Currently, the Fed can't do that, because the interest rates it can control are near zero, and can't go any lower. Eventually, however, as unemployment falls ... the Fed will want to raise rates to head off possible inflation. At that point we can make a deal: the government starts cutting back, and the Fed holds off on rate hikes so that these cutbacks don't tip the economy back into a slump.
But the time for such a deal is a long way off — probably two years or more. The responsible thing, then, is to spend now, while planning to save later.
As I said, many politicians seem determined to do the reverse. Many members of Congress, in particular, oppose aid to the long-term unemployed, let alone to hard-pressed state and local governments, on the grounds that we can't afford it. ... Yet efforts to control health costs were met with cries of "death panels."
And some of the most vocal deficit scolds in Congress are working hard to reduce taxes for ... heirs to multimillion-dollar estates. This would do nothing for the economy now, but it would reduce revenues by billions of dollars a year, permanently.
But some politicians must be sincere about being fiscally responsible. And to them I say, please get your timing right. Yes, we need to fix our long-run budget problems — but not by refusing to help our economy in its hour of need.

Tim Duy: China Moves. Or Not.

Posted: 21 Jun 2010 12:24 AM PDT

Is China's announcement that it intends to increase the RMB exchange rate flexibility "more smoke than fire"?:

China Moves. Or Not., by Tim Duy: Futures markets are abuzz with excitement over the Chinese currency proclamation issued this weekend. The announcement was quickly hailed by observers worldwide as a major policy shift, yet I am inclined to side with the analysis provided by Yves Smith - the statement leaves plenty of wiggle room, and never really promises to do much of anything. At the moment, the Chinese announcement feels like more smoke than fire.

The Wall Street Journal's initial reporting was just want the Bejing and Washington wanted you to believe:

China's decision to abandon its currency peg is a victory of pragmatism over divisive politics, the result of careful diplomacy by leaders in Beijing and in Washington, each side vulnerable to powerful domestic lobbies.

In the end, both sides agreed that a more flexible exchange rate was good for China, good for the U.S. and good for the global economy. Yet timing was everything.

The implication is that hard-working policymakers on both sides of the Pacific have risked all to foster the greater good. But what exactly has changed? From the Chinese statement:

It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.

In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market

What exactly will be the basket of currencies? On what timetable? Is this really a change? And why not widen the floating bands? I see no commitments here, vague or otherwise. Of course, there are not meant to be. From the Wall Street Journal:

Yet, by returning the yuan to a managed float against a basket of currencies, Beijing won't have to cede too much in the near term when it comes to the bilateral dollar/yuan rate. The euro's weakness-the yuan is up 14% against the euro this year-should mitigate the speed of any yuan appreciation against the dollar.

Looks like China is picking a policy direction that requires little deviation from current policy. Nor do they even admit there is a need for significant change. The Chinese announcement appears to preclude the possibility of meaningful adjustments.

China´s external trade is steadily becoming more balanced. The ratio of current account surplus to GDP, after a notable reduction in 2009, has been declining since the beginning of 2010. With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist.

Is "large-scale" 5%? 10%? 20%? The tone of subsequent reporting changed as journalists not sourced directly by Washington and Bejing began to realize the thinness of the Chinese announcement. From the Wall Street Journal:

China's announcement that it will let its currency appreciate puts it in a strong position going into a summit of the Group of 20 on Saturday, but does little to ease pressure from the U.S. Congress.

...But China's announcement was short on details about how much it would let the yuan appreciate. In Brazil, the central bank governor, Henrique Meirelles, said he welcomed the Chinese announcement, but wanted to see results. "It is necessary to await further developments," he said in a statement.

Is the Chinese announcement anything more than an effort to buy time ahead of next weekend's G-20 meeting? The yuan was likely to be a primary topic, but the announcement now provides cover for Chinese officials, pushing the attention on fiscal policy in Germany and Japan. A clever diplomatic trick, but will China follow through with anything more than a token rate change? They need to, as Congress will not be held at bay much longer:

In the U.S., New York Democratic Sen. Charles Schumer, who has spent a decade ramping up pressure on China over currency issues, remains skeptical that Beijing's announcement will make an appreciable difference. On Sunday, reacting to Chinese suggestions that change would be gradual, Mr. Schumer said he would move forward on legislation to penalize China for undervaluing its currency.

"Just a day after there was much hoopla about the Chinese finally changing their policy, they are already backing off," he said in a statement.

Schumer's skepticism is justified. Where is the yuan going, and how quickly will it get there? Estimates are all over the map. From Bloomberg:

The yuan's appreciation may be limited to 1.9 percent against the dollar this year, a survey of economists showed. The currency will climb to 6.7 per dollar by Dec. 31, according to the median estimate of 14 analysts.

Later in the same article:

"We can't exclude the possibility of yuan depreciation," said Shen Jianguang, Mizuho Securities Asia Ltd.'s chief economist for Greater China, who said a 2.5 percent drop is possible this year if the dollar-euro rate is unchanged.

From the Wall Street Journal:

U.S. government officials expect a slow, steady increase, similar to the way China boosted the value of the yuan between 2005 and 2008.

Another opinion from the same article:

Eswar Prasad, a Cornell University economist who was formerly the IMF's top China expert, said the size of the increase during the coming month will give a hint at the "trajectory" Beijing is anticipating.

He says that in periods of economic calm, China "is comfortable with" an increase in the value of the yuan of about 10% to 15% a year.

Congress will be closely watching for any signs of foot dragging on the part of China. I am not confident they will tolerate anything less than a 15% move this year. Note too that China is not the only one buying time with this announcement. US Treasury Secretary Timothy Geithner can now release the delayed report on currency practices, which will surely not label China a manipulator. That hot potato can go back into the oven for another six months. Geithner is clearly betting the Chinese will have shown enough results between now and then to placate Congress. If not, Congress will start sharpening the knives; the tolerance for Chinese resistance will be almost negligible of this announcement is revealed to be nothing more than smoke and mirrors.

Bottom Line: On the surface, the Chinese announcement looks like just what the doctor ordered - a step toward a meaningful effort at rebalancing global activity. But the details are thin, very, very thin. Thin enough that one can reasonably look straight through the statement and conclude it is little more than an effort to keep China off the hot seat at the next G20 meeting. Time will tell if China actually intends a substantial change in currency policy. I hope this is in fact their intention, as the probability of a disastrous trade war will skyrocket if Congress believes they have been the victim of a classic bait and switch.

Update: Reality sets in quickly. From the Wall Street Journal:

China kept the yuan's exchange rate unchanged against the dollar Monday, surprising markets after announcing over the weekend it was unhitching its de facto peg.

Underscoring its vow to move gradually in liberalizing its rigid foreign-exchange regime, the central bank set the yuan's central parity rate, an official reference level for daily trading, at 6.8275 yuan to the dollar, exactly the same as Friday's central parity rate. The fixing put the yuan slightly weaker than Friday's close in over-the-counter trading of 6.8262 yuan to the dollar.

links for 2010-06-20

Posted: 20 Jun 2010 11:04 PM PDT

Never Let the Threat of a Manufactured Crisis Go to Waste

Posted: 20 Jun 2010 01:09 PM PDT

There's been a lot of speculation about the motives of the Austerians -- those who want to begin balancing budgets now because they believe that's what markets want. For example, Paul Krugman attributes it, in part, to

moralizing and posturing. Germans tend to think of running deficits as being morally wrong, while balancing budgets is considered virtuous, never mind the ... economic logic. "The last few hours were a singular show of strength," declared Angela Merkel ... after a special cabinet meeting agreed on the austerity plan. And showing strength — or what is perceived as strength — is what it's all about.

But there is another argument based upon the notion of "never let a crisis -- or the manufactured threat of one -- go to waste." This is an opportunity to "starve the European Beast" in the eyes of many European conservatives, and there are those who are using the "that's what markets want" argument as cover for an ideological agenda:

The spectre of laissez-faire stalks Britain, by Jeremy Seabrook, CIF: The relish with which David Cameron announced that our whole way of life would be affected for years by impending cuts, and no one in the land would be exempt from the asperities about to be inflicted, suggested to many that he and his fellow cabinet-millionaires will probably weather the coming storm better than the rest of us.
His parade of Margaret Thatcher, who resembled nothing so much as a faded kabuki performer, outside 10 Downing Street, was also highly symbolic. It was a redemptive moment, the "ultimate" triumph of policies she advocated (but did not entirely follow) 30 years ago. It exhibited the qualities of purification ritual, reversion to a more severe form of capitalism; and in the process a transformation of nanny state into stepmother state.
Nick Clegg's pious assertion that cuts would be fair and compassionate was at odds with Cameron's gusto, which is familiar enough in Conservative rhetoric: Cameron confronting an overweening state, which will be shrunk so the private sector might flourish once more. When he said the effects of his policies would be felt for decades to come, he meant something more than a mere diminution of the structural deficit. He admitted as much...

While cutting back big government may appear a matter of severe practicality,... this is also a declaration of faith, a solemn renewal of Conservative vows. ... The right continues to yearn with insistent nostalgia for a free market, burdened only by minimal demands of government, defense and law and order. The greatest obstacle to this state of perfection is, of course, the poor, whose demands upon the state have always been seen as an encumbrance to its sublime mechanism.

"Pauperism" long ago took on the color of culpability. The distinction between the idle and improvident poor and the "deserving" goes back at least to the Elizabethan poor law. It took on a new force in the early industrial era, which saw an unprecedented growth in pauperism. The enthusiasts of laissez-faire concluded that the evil was compounded by efforts to relieve it, and helping the poor only increased their number. Everything indicated that "natural" processes should be allowed to take their course.
Today's detestation of "big government" stems from this same source, and the affection of Cameron and his colleagues for the "big society" is a euphemism for the reduction of public funds in assisting the poor: rolling back the state, leaving the market to distribute its rewards in accordance with the natural order of things. Those who have rarely come closer to nature than on a golf course depend heavily for their ideological rationale upon an archaic natural imagery...
In this version of the world, the market mechanism is as flawless a creation as the earth, and should remain untouched by the hand of meddlers, whose only effect is to upset its power to enrich us all. ...
Whatever the real extent of the "structural deficit", the Conservatives, true to their faith in the economy-as-nature, have a powerful urge to wield the axe to dead wood; as they do so, they are bound to exaggerate the pruning required to cut back the luxuriant growth of Labour's state. ...

[Just to be clear about my own views on the role of government, I am advocate of government intervention to fix important market imperfections (and I don't think markets fix these on their own), and I don't think we are aggressive enough in this area. I also think government has a large role to play in stabilizing the economy, and that's where the deficit spending discussed above comes in, at least in part. But I am not much of a redistributionist. I would rather have the playing field be level so that everyone has a relatively equal chance at success, and the chips will fall where they fall. Some people may still need assistance under such a system, but mostly the outcome would be fair. That's the first best choice for me, government intervention to ensure that everyone has a relatively equal chance in life. But we are far from that outcome, important inequities still exist that disadvantage some people relative to others, and so long as those inequities persist government has a role to play in correcting them. This may necessarily involve some redistribution of income, especially the income earned as a result of the unfair advantage.]

Reducing the Influence Banks Have over Monetary Policy

Posted: 20 Jun 2010 11:07 AM PDT

I don't have anything to post, so until I do, here's something I posted at MoneyWatch a few days ago. The post addresses the latest proposal for financial reform, in particular the proposal to change the way the District Bank presidents are chosen in an attempt to reduce the power banks have over monetary policy. One part of the proposal was to have the NY Fed president chosen by the president rather than the NY Fed's Board of Directors because of the NY Fed's special role in the implementation of national monetary policy. One question I ask at the end of this post is whether the NY Fed needs to have a special role in monetary policy and be elevated above all other District Banks. Why can't the execution of monetary policy be housed in a separate agency under the control of the FOMC (or, alternatively, the Board of Governors)? There was a time when proximity to Wall Street was essential, but that has changed in the last 70 years, and, in any case, the agency could be located as close to Wall Street as needed. Communication with Washington, to the extent it's needed, could us digital technology. This would put the NY Fed on a more equal footing with the other Fed's, and solve the problem of how to represent both regional and national interests in the selection of the NY Fed president:

Reducing the Influence Banks Have over Monetary Policy: There's some news on the Dodd proposal for financial reform, something I wrote about when the details of the proposal initially came out.

First, what is the Dodd proposal? This is from the earlier post (if you are familiar with the structure of the Federal Reserve District Banks, you can skip the first part of this):

What's Wrong With the Dodd Proposal to Restructure the Fed: A proposal from Senate Banking Committee Chairman Christopher Dodd changes the selection process for key positions within the Federal Reserve system. Unfortunately, this proposal makes the selection process worse, not better. If this proposal is passed into law, it would further concentrate power within the Federal Reserve system, and it would politicize the selection process, both of which are the opposite of where reform should take the system.

The Current Structure of the Federal Reserve System

The Federal Reserve System consists of a Central Bank in Washington and twelve Federal Reserve District (or regional) Banks. The Central Bank's authority resides with the seven member Board of Governors, one of which serves as chair (currently Ben Bernanke).

Each of the District Banks has a nine member Board of Directors along with a bank President. It is the selection of the Board of Directors that is at issue. [The reason this is an issue is that the Board of Directors selects the bank president, and the bank president is a member of the monetary policy committee, the FOMC. This is of particular concern for the president of the New York Fed because the NY Fed carries out monetary policy, and, unlike other regional bank presidents who have rotating positions as voting members of the FOMC, the NY Fed president is a permanent member. In addition, the president of the NY Fed often plays a key role in brokering bailout deals with Wall Street firms during financial crises.]

Currently, the nine member Board of Directors at each of the District Banks consist of three Class A directors, three Class B directors, and three Class C directors. Class A directors are elected by member banks within the district and are professional bankers. Class B directors are also elected by member banks in the district, but these are business leaders, not bankers. Finally, Class C directors are appointed by the Board of Governors and are intended to represent the public interest.

Class B and Class C directors cannot be officers, directors, or employees of any bank, and Class C directors may not be stockholders of any bank. One Class C director is selected by the Board of Governors to serve as Chair of the Board of Directors. The Board of Directors selects the President of each District Bank, but the President must be approved by the Central Bank's Board of Governors.

What is the reasoning behind this structure? When the Fed was created in 1913, there was a concerted attempt to distribute power across geographic regions; between the public and private sectors; and across business, banking, and the public interests. The geographic distinctions were important because it's not unusual for economic conditions to differ regionally -- conditions can be booming in some places and depressed in others -- and the regions would favor different monetary policies. Thus, it's important to bring these different preferences to the table when policy is being determined so that the best overall strategy can be implemented. ...

Over time, however, power has been increasingly concentrated in Washington. So how would the Dodd proposal have changed this structure? Continuing:

Under the proposal, the Board of Directors for each District Bank would be chosen by the Central Bank's Board of Governors (who are themselves chosen by the President with the advice and consent of the Senate). The chair of the Board of Directors at each District Bank would be chosen by the President and confirmed by the Senate. ...

Here's what I didn't like about this proposal:

This means that the key figures within each District Bank would be chosen by Washington, and unlike the present system, there is no attempt at all to represent geographic, business, banking, and public interests explicitly in this arrangement. In addition, it no longer has the explicit safeguards contained in the current rules to prevent bankers from dominating the directorships (e.g. under the new rules the Chair of the Board of Directors could be a banker, currently that can't happen). Given that the appointments are coming from Washington (as opposed to a vote of banks within the District for six of the nine positions on the Board like we have now), there is no guarantee that the District bank Boards won't be stacked with one special interest or another. Thus one of the main reasons given by Dodd for the change in the selection process -- to remove the influence of bankers -- is actually undermined by his proposal because it removes the safeguards against the Board being dominated by banking interests. ...

However, that's not to say that the present system is fully satisfactory:

I fully agree that the selection process for the Directors and the District Bank Presidents could and should be changed (that includes redrawing geographic districts). It's not clear that the present system does the best possible job of representing the array of interests that have a stake in the outcome of policy decisions. But concentrating power in Washington is not the way to solve this problem.

So what is the proposed change in the way bank presidents are chosen?:

Lawmakers Agree to Limit Banks' Influence on Regional Fed Presidents, by Michael Crittenden, RTE: U.S. House and Senate negotiators finalizing financial-overhaul legislation agreed Wednesday on a proposal to reduce the influence of commercial banks on the appointment of regional Federal Reserve bank presidents.

Senate lawmakers on the financial overhaul "conference committee" moved toward accepting a House proposal that would eliminate the vote of "class A" directors in picking regional Fed bank presidents... Directors deemed "class A" are elected by banks to represent the interests of the industry, as opposed to the public.

The agreement between the two sides would also eliminate a Senate proposal that called for the president of the Federal Reserve Bank of New York to be presidentially appointed. Critics of the proposal said it would have politicized the position. ...

Senate conference members still need to vote on the agreement... Sen. Christopher Dodd (D., Conn.) ... put off a vote until Thursday morning because of concerns raised by Sen. Jack Reed (D., R.I.), who ... still favors having the head of the New York Fed be a presidential appointee.

If this passes, I don't have any particular objection to it. If anything, it improves the balance of interests in picking the regional bank presidents. Currently, banks elect six of the nine Board members in their districts, so they essentially control six of the nine Board votes. This proposal would change the composition to three and three with the added restriction on Type B directors outlined above. i.e. they cannot be bankers.

As for the proposal that the NY Fed presidentially appointed, there is an argument that points in this direction. The NY Fed has a larger influence over monetary policy than the other regional banks for the reasons outlined above, and hence national interests ought to be represented in the selection of the NY Fed president. One way to do that is to give the president control over the decision. However, there are also regional interests to consider, and there is also the problem that this makes the NY Fed president beholden to the president who made the selection further politicizing the Fed.

For this reason, it would be better to reduce the influence of the NY Fed over monetary policy, i.e. to leave the selection process as it is and put the NY Fed on more equal footing with the other regional banks. This would require administrative changes that put control over the day to day execution of monetary policy (i.e. the buying and selling of financial assets as directed by the monetary policy decisions) into the hands of the Board of Governors, or some other agency within the Fed, and those would be big changes. But given the present ability to do much of this electronically (though not all) from Washington, or to locate an agency of the Board of Governors proximate to Wall Street, it is within the realm of possibility.

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