Category: Economics

Econned, by Yves Smith

Learning from Dogs muses the new book from Yves Smith

In Econned, Yves Smith, founder of Naked Capitalism, argues that the economy was doing just fine in the regulated environment up to the 1970s. Then began the work of the Chicago economists who challenged Keynesian economics and touted the benefits of deregulation which eventually led to the financial crisis we have today.

Yves argument is internally consistent and well researched, but ignores some factors that I think would change the conclusions drawn from her work.

First, Yves notes that the primary reason that economists are not useful to the real world is that economic research presumes equilibrium. Smith misses the point here, but it is understandable. It took me years of study and contemplation to fully appreciate that an equilibrium simply gives economists a point of reference, a common base, from which to study shocks and movements. In and of itself, equilibrium is not interesting or important. But movements to and from equilibrium are of real interest because they enable us to study and try to predict how individuals will react to incentives and changes in market conditions.

Second, we have to put the contributions of the Chicago economists of the 1970s into context. Up until that time, the only real school of thought in macroeconomics was based on Keynes, who presumed that markets fail and that the government must play an active and large role – primarily through government spending and taxes — for the economy to perform well. Keynes’ work was a reaction to the Great Depression.

Friedman’s monetarism also sought to explain the Great Depression, but focused on the role of monetary policy on the economy. This work showed that the missteps of the Federal Reserve was the primary cause of the depth and length of the Great Depression, and that long-term accommodative monetary policy causes inflation. This body of work did not stress deregulation, although it did lean more heavily on enabling private market solutions than on replacing them with government solutions. Neither theory is complete; Keynes focused on the short run (“In the long run, we are all dead” is a rather famous Keynes quip) and Monetarism focused on the long run.

There was a second large body of work that came out of the University of Chicago during the late 1960s and 1970s. This research documented the tremendous costs of regulation. I know this literature personally and believe that its conclusions are very sound: it shows that any effective regulation limits either the quantity or price of a good or service away from what it would have been without the regulation. In fact, in my view, it was the passage of regulations requiring certain lending behavior that set off the series of events that led to the crisis, which is the exact opposite argument from what Ms. Smith makes.

By Sherry Jarrell

Greece, Oh Greece!

Fancy a Greek Isle?

Germany is baulking at a Greek bailout ….. 84% of the people are opposed according to polls, and Frau Merkel is decidedly lukewarm. This is no surprise; the Germans are pretty commonsensical after all. They are going through a “spot of fiscal turbulence” themselves and hardly in a mood to bail out a feckless, tax-avoiding, economic basket case on the flaky south of the Brusselian Empire ….

Instead, they have come up with a cunning plan; the Greeks should sell some of their islands. I can see the attraction; at knock-down prices, no doubt a good many Germans themselves – short of coast in the homeland – would be only too keen to snap up a firesale bargain.

But if I were Greek I would beware of Germans with cunning ideas. After all, it could be the islands today and the Acropolis tomorrow. Selling capital assets to clear debts built up on a binge of tax-avoided short-term consumption is hardly the long-term solution, and it is remarkable how we humans do tend to go for short-term, quick-fix solutions (see my post on the Fat Pill) . Of course, in Europe at least the Sun (can I capitalize it? It is after all the source of my existence …) plays a large part here, for the further south you go the hotter it is, the more corruptly-shambolic the taxation system, the flakier the economy and the higher the debt. Of course, Britain is an exception to the rule, since it must be put in the Mediterranean basket of cases even though it is far up in the north. Still, Britain was ever exceptional ….

No, I would advise the Greeks to hang on to their islands for a rainy day and do the right thing, which is take the medicine, invest long-term rather than on frivolous consumption and in general live within your means. Selling the islands is desperation stakes, even if the ultimate solution would be to sell the whole country to the Germans and let them sort out the mess, and – more to the point – pay for it all as they did with East Germany.

But though this is hardly a laughing matter – especially for innocent Greeks (I assume there are some!!) – I did have a chuckle yesterday when I saw the headline.

“Greece calls for EU to play its part.” – in other words, bung in billions to bail them out. I am I confess mystified to understand exactly why the thrifty Danes should play their part in bailing out the hapless Greeks, though I suppose we do still owe them for democracy and stuff. When does the statute of limitations run out on this?

Well, good luck Greece, but don’t count on my pfennig, and don’t sell the islands either!

By Chris Snuggs

Kucinich’s Early Retirement Idea is Nuts!

Save a job – retire earlier! Duh!

Representative Dennis Kucinich (Democrat – Ohio) is on the media circuit promoting his rather novel idea on how to “create” jobs for younger people who are trying to enter the work force but can’t because of the recession.

The Congressman has proposed legislation that would allow people to take voluntary early retirement at age 60 instead of age 62, as the law now stands.

Kucinich, who ran for the Democratic nomination for President in both 2004 and 2008, estimates that about 25% of those eligible to retire at age 62, or about 1 million people, would choose to take early retirement under his plan. He claims that this is a conservative estimate, since about 70% of those who can retire at 62 do so now.

These early retirees would, of course, collect social security earlier, after having worked fewer years and contributed less to Social Security. And then we’d have to assume that these workers would be replaced by the younger people now looking. And that they would generate the same tax revenues for the government that the early retirees did.

What a plan! Lock in higher costs, with no guarantee of any benefits. This is the kind of logic that put the U.S. into this pickle in the first place.

How does Mr. Kucinich propose to pay for this plan? Why, with government funds, of course! Specifically, with the “extra” unspent stimulus and TARP funds. This, despite the fact that he has spoken repeatedly about voting against the TARP funds because he opposes government interference in the private economy. But, hey, he goes on to say, “Since the money is lying around anyway, let’s use it!” You’d think tax revenues fall out of the sky!

I do not know which is worse, the hypocrisy or the ignorance. What folly! This man has absolutely no business talking about how to create jobs when he has no idea how the economy actually works.

Here’s an idea that is guaranteed to help the economy recover. Why doesn’tMr. Kucinich take voluntary early retirement!

By Sherry Jarrell

Latest US GDP Figures

Growth in final GDP hides disturbing weaknesses in economy

The U.S. GDP grew at an annual rate of 5.9% in the last quarter of 2009 which may look good at first glance, but when we dig a little deeper, we find some concerns about the implications for sustainable growth. A large fraction of this reported growth came from businesses selling off accumulated inventories, which has more to say about past production than current. Exports were also a significant source of fourth quarter growth, driven in large part by a weak dollar.

Of course, a weak dollar is a very mixed blessing for the economy, and is hardly a sign of a strong or recovering economy.

Real residential fixed investment increased 5.0 percent, helped along by the extension of the home purchase tax credits from the federal government.

new housing. jpg — New housing helps spur growth in GDP

Real nonresidential fixed investment increased 6.5 percent. This figure nets out nonresidential structures, which decreased at a troubling rate of 13.9 percent, and equipment and software, which increased 18.2 percent. Investment in equipment and software consists of capital account purchases of new machinery, equipment, furniture, vehicles, and computer software; dealers’ margins on sales of used equipment; and net purchases of used equipment from government agencies, persons, and the rest of the world. Own-account production of computer software is also included, which is production performed by a businesses or government for its own use.

Again, the underlying figures show that those variables most associated with building a sustainable productive capital base for the economy – nonresidential fixed investment –are declining at an alarming rate. This, combined with a 9.7% unemployment rate and the specter of rising debt levels, energy prices, and taxes, paints a picture of a slow to non-existent recovery to a robust economy any time in the next year.

http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

by Sherry Jarrell

The Magic Solution

A Magic Pill for Everything?

I am always struck by Man’s desperate groping for a Magic Solution to each and every problem. It is a bit pathetic but also of course rather funny, especially if one tries to see things from the perspective of a visiting alien from outer space.

Looking for a Magic Pill?

Let’s take “The Fat Pill”. What we really want is not to eat properly and cut down our vast consumption of just about everything but especially burgers, chips, popcorn swamped in sugar, honey or chocolate, giant steaks and pizzas, crisps, candy, and of course alcohol and simultaneously combine this with a healthy lifestyle involving regular exercise that makes us pant (to get the heart going – nothing to do with sex, though Tiger Woods is clearly pretty fit)!

No, what we prefer is to keep on stuffing ourselves and then take a FAT PILL! Whoever invents this is going to make Bill Gates look like a starving rickshaw- puller in India.

Then there is the ALCOPILL. Rather than drink in moderation to the benefit of all and sundry many of us prefer to binge ourselves to the point of death and then, just before hitting the sack (if we make it that far), grope for the magic pill. I believe pharmaceutical companies worldwide are working furiously on this in the hope of hitting the jackpot. Much more profitable than boring old stuff with malaria, which kills millions every year.

It may be cynical old age, but I’m currently off magic solutions. As a language teacher, I saw the desperate scrambling for nirvana when language laboratories came in. Every school had to have one; every timetable was hacked about; teachers would become redundant ….. Oh dear … most language labs are now broken-down, dusty and abandoned piles of junk at the bottom of some rubbish tip somewhere. Are wind-turbines in the same category?

dot.com? This was the magic pill of the late 1990s! The new paradigm. Everything would be different; billions could be made without doing any real work. Oh, and does this remind us of the banker’s world? Of course, they are an exception because DESPITE everything they can STILL make billions for doing no real work.

As for government finance (a quite different animal), the current British magic pill is to print money and bung it into the economy in the hope of stimulating “growth”. None of this “living within our means”, taking “a bit of strong medicine” stuff. No, we’ll go for the magic pill so we can get back to normal levels of debt and spending. Patience, virtue, moderation and commonsense are much less fun than the magic pill of printing money.

And there is a VERY GOOD reason for this of course: the GENERAL ELECTION is around the corner and we don’t want any pain BEFORE then, do we? After, of course – if we get the right result – we will have a bit of commonsense back. Not that we want to, but it’ll be forced on us by the markets … but then we can blame it all on someone else. In Britain’s case, Mrs. Thatcher will probably still come in for considerable stick, even though she left power nearly twenty years ago.

Magic? Sadly, one can see the same desperate groping for the easy solution in religion. We are metaphysically, morally, spiritually and practically lost, so let’s look for some magic to provide a solution, even if there is not the slightest proof of the existence of God that would stand up in court.

Our epitaph may well be: Homo Sapiens – the Magic Species. Unfortunately, magic is best left to conjurors; it is not a recipe for managing society.

by Chris Snuggs

Health Care Summit

Political leadership or grandstanding?

What has become very clear to me, after watching the U.S. Health Care Summit between Democrats and Republicans as objectively as possible, is that the President’s goal was not to craft a thoughtful approach to shoring up and improving the U.S. health care system.

Obama at healthcare summit — Pres. Obama making one of many points at Healthcare Summit

No, the reason for the President and the Democratic leadership to convene the so-called summit was to grandstand; to make a show; to create a photo opportunity; and, most importantly, to try to garner enough support from the Democrats in Congress to ram through the Reconciliation option on the behemoth, disastrous 2000-plus page version of the bill, filled with incomprehensible, internally conflicting doublespeak.

A sad day for American politics. A very sad day for American citizens. We deserve better.

In or out of recession?

A friend on another site just posed this question.

Why is it that a recession is described as two or more successive quarters of “negative growth”, but being out of recession is just one quarter of (estimated) growth?

I felt emboldened to pen an answer as follows ….

In Britain, the definition of recession-emergence is from the same school of economics as growth predictions for next year (any year), which are always about 5 zillion% more than actually turns out to be the case.

Britain in recession — Recession in Britain

The cunning idea is that future growth will be vast enough to cover the even vaster existing debts and commitments. And, of course, by the time we KNOW what the growth actually turned out to be, most people will have forgotten the predictions on growth from the financial and economic wizards running the country. That’s also one of the great things about a new mess or crisis; it always takes the mind off previous crises, which are likely to be ongoing but less in the media and therefore not to be bothered about too much.

This is, of course, in addition to the fact that growth in itself is incompatible with reducing global warming, but here we are getting a bit too technical.

Well, that’s how we do it in Britain anyway. How do you manage it over there?

by Chris Snuggs

A reply from a U.S. economist.

Hello there Chris!

Recession in the U.S. is also defined as two successive quarters of negative GDP growth. At least, that’s how its officially defined. And to add my answer to your friend’s question — either the economy is either in a recession — i.e., two or more consecutive quarters of negative GDP growth — or it isn’t, which means that the string of negative GDP growth rates is broken. And that only takes one quarter of positive growth.

Most of the economists I know personally tend to look at a bigger picture than the stated GDP figures, however. I focus on capital and labor utilization rates as I believe that they are more important measures of a well-functioning economy. The final GDP figures in both of our countries are national income accounting figures, and have all the weaknesses of any income statement variable. They are flow variables, which ignore the stock of economic wealth. For example, if you invest $100 this year in the stock market, and it grows in value by $20, only the $100 is counted. The increase in wealth is never captured in measures of GDP.

Another problem with current measures of GDP and GDP growth is that government spending is considered on par with private spending, which brings into question the sustainability of growth measures based on GDP, although President Obama and perhaps Prime Minister Brown are both fine with growth rates being fueled by large increases in government spending. Finally, a significant fraction of economic activity, like the value of work in the home — is not measured.

So, yes, the official measurement of GDP is all wrapped up in technicalities. But most economists I know pay little attention to it. They are more concerned with how well the economy is functioning, whether the growth is sustainable, and whether people who want to work can find work. If you are unemployed, the economy is in a recession, regardless of what the GDP figures say!

by Sherry Jarrell

In praise of Yves Smith

Helping thousands better understand this crisis

Yves’ Blog Naked Capitalism has been mentioned many times on Learning from Dogs. Indeed, she was one of the Blog authors highlighted recently in this Post.

I fail to understand how she finds the hours in the day to write in such detail – but those of us interested in getting under the skin of our present economic situation are all the better for it. Here’s a great example that was published on the 23rd February. I quote the opening paragraphs and then link to the rest of her post. From here on is her piece:

———————–

Martin Wolf, the Financial Times’ highly respected chief economics editor, weighs in with a pretty pessimistic piece tonight. This makes for a companion to Peter Boone and Simon Johnson’s Doomsday cycle post from yesterday.

Let us cut to the chase of Wolf’s argument:

Now, after the implosion, we witness the extraordinary rescue efforts. So what happens next? We can identify two alternatives: success and failure.

By “success”, I mean reignition of the credit engine in high-income deficit countries. So private sector spending surges anew, fiscal deficits shrink and the economy appears to being going back to normal, at last. By “failure” I mean that the deleveraging continues, private spending fails to pick up with any real vigour and fiscal deficits remain far bigger, for far longer, than almost anybody now dares to imagine. This would be post-bubble Japan on a far wider scale.

Yves here. Notice he associates success and failure with polar options. But how can you “reignite the credit engine” when the financial system is undercapitalized even before allowing for the need to take further writedowns? The IMF has found the converse in its study of 124 banking crises, that purging bad debt is a painful but necessary precursor to growth. So I fail to understand how Wolf envisages that “skip Go, collect $200″ of releveraging quickly comes about. And in fact, it turns out that Wolf’s “success” is a straw man:

[to read the rest click here, Ed]

By Paul Handover

Should you invest in U.S. bonds?

Could the U.S. government default on its bonds?

I’ve been asked many times over the years for advice on investing. “What is the market going to do?” “Should I be invested in stocks or bonds?” And, especially in the last few weeks, “Should I hold U.S. or foreign government bonds?”

Those are some good questions! The answers are not as “good.” The factors that drive the yields on treasury bills and bonds are complex and, despite Ben Bernanke’s pronouncements to the contrary, less well understood than stock returns, and I don’t have a crystal ball, but I can at least begin to frame an answer to these questions here. I will come back to expand on this topic over time, as markets, economies, and world events evolve.

The return on both bonds and stocks is measured as the percent change between the market price today, and the cash flows received later. The cash flows of a bond, namely coupon payments and principal, are specified in a contract; if they are not paid, the issuer is in default, and the bondholder has the right to take them to court. The cash flows on stock, dividends and capital gains, are residual; they are discretionary, and are paid out only after debt payments and other obligations are paid. For this reason, bonds are considered to be less risky than stocks, and the nominal yields on bonds are generally lower than those of stocks. The risk-adjusted returns on stocks and bonds may be the same, but the nominal yields on bonds are typically lower.

There is an important distinction between the nature of the returns on bonds and stocks. With bonds, the future cash flows are known. Movements in the bond’s yield are determined simultaneously with movements in the bond’s price. Once a bond is issued, only changes in interest rates (yield, risk) drive unexpected changes in its price. Stock prices, on the other hand, fluctuate as either risk or residual cash flows change. As a result, changes in a bond’s price, hypothetically at least, are a much cleaner indicator of the market’s expectations of future market rates of interest than a stock’s price.

One problem that distorts the information about expected future interest rates that is revealed by changes in the bond’s price is that bonds are less frequently traded than stocks, so the price data on bonds is less comprehensive and complete. In addition, the reported price data that form the basis of bond yield models often diverge from actual market-clearing prices, so that bond pricing models may not describe actual market behavior. Lastly, there is such a tremendous volume of economic and policy information, some of it conflicting, that is crammed into this one variable, the bond price which, given the coupon and principal, summarizes the market’s referendum on future interest rates.

by Sherry Jarrell

Next time: Sources and types of risk in U.S. and other bond prices.

Predicting lost decades for Britain

…. and most likely other ‘Western’ nations

This Post is taken in its entirety from the website Contrary View. Contrary view number 73 has just been published, as follows. Please see note after signature. [The Japanese Nikkei 225 index was 10352 at the time of writing this Post – 0800 MT, 23rd Feb.]

There is plenty of evidence from Japan about lost decades for investments. Japan has now lost two decades in equity and property investment, during which time only Government Bonds provided any sanctuary. All policy options failed, because none tackled the real problem, which is that there is already too much debt. What lessons can be drawn for Britain?

Shares here [in Britain] have certainly had a lost decade. On the Japanese evidence, they may well suffer another lost decade. Property has only hit minor bumps, so the Japanese experience suggests that property may suffer a long decline for two decades. In the UK, the Bank of England’s support for mortgages will be withdrawn over the next two years, which itself threatens prices. Why, though, the hysteria about Government debt?

It is questionable whether pundits appreciate the extent of the private sector debt problem, which explains why two groups of economists can offer totally contradictory remedies. In a world with no Gold standard and therefore no anchor to the monetary system, Government debt is relatively safe. The global economy is perched on a knife edge, with a permanent loss of output that must cause income loss and therefore restrict the capacity of households to service their debts. Seeing the commercial risks, banks are still restricting lending, which means there can be no sustained recovery.

There is a misconceived demographic argument being touted at present, which completely ignores the real driver of the post-1945 expansion, namely increased credit. That credit growth has simply gone too far and now brings its own problems. For those people who neither saw the credit crunch nor the long fall in interest rates and inflation coming, to now be credible in predicting a lost decade for bonds, is itself unbelievable.

By Paul Handover

Note: Until very recently, the author was a client of Kauders Portfolio Services, the publisher of the Contrary View website. Please see the warning about these views posted on that site.

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