naked capitalism

This is a short clip and I am sure you’ll enjoy it.

Sadly, I can’t embed it, so you’ll have to click on the link. Watch the segment here.

By Marshall Auerback, a hedge fund manager and portfolio strategist. Cross posted from New Economic Perspectives

Nearly one Spaniard in four is unemployed, according to data released on Friday, as the country’s economic and financial predicament prompted a government minister to talk of a “crisis of enormous proportions”.The data from the National Statistics Institute showed 367,000 people lost their jobs in the first three months of the year. At this pace, Spanish job losses are equivalent to 1 million per month in the United States. That means more than 5.6m Spaniards or 24.4 per cent of the workforce are unemployed, close to a record high set in 1994.

Spain has become the new Greece. Actually, in many respects Spain is now worse than Greece. The Spanish unemployment rate is already so high and unlike Athens, Madrid has made no headway in reducing its public debt levels (whereas the Greeks are close to running a primary fiscal surplus at which point they could leave and turn the problem back on to Brussels). Moreover, Spain has a huge private debt burden that is twice that of Greece.

Although I have warned on these pages before that Spain’s austerity program was leading the country to disaster, my reaction to this economic catastrophe has been one of amazement. Just take a look at this employment data

Spain First Quarter Unemployment: Summary (Table)
2012-04-27 07:00:00.13 GMT

Yet, until now Rajoy Administration has been saying that the marginal decline in GDP estimated by the Bank of Spain for the first quarter was exaggerating economic weakness. Now we have the spectacle of the Spanish government suggesting that the Bank of Spain estimate of a .4% decline in Q1 Spanish GDP is too pessimistic. But in light of these numbers, what kind of GDP decline should one realistically expect when employment falls two percent non annualized in a quarter? At least a four percent annualized decline. more likely much higher. Yet who is talking discussing that as a real possibility in Brussels? Nobody. Everybody remains asleep at the wheel.

For years, the Spanish GDP figures have been hard to square with the underlying collapse in industrial production and rise in unemployment, both of which were more realistically reflecting the scale of the country’s collapse into depression.

When I said a few months ago that the Spanish government was lying about their numbers, I was attacked by a few Spanish readers of this blog, who claimed I was a nefarious hedge fund manager, likely loaded up to the gills with CDSs on Spanish debt who was trying to foment panic. For the record, I have never bought a credit default swap in my life. If anything, I was trying to foment panic because I was horrified by the new ultra austerity stance adopted by the recently elected Rajoy Administration.

Now consider the reality: the economy is crashing, hence the unemployment rate rise. Yet German Chancellor Angela Merkel and the ECB President, Mario Draghi, continue to insist that one can have both fiscal restriction and a lower domestic price level despite the fact that Spain has a non financial private debt to GDP ratio of 230%.

Interestingly enough, Dutch levels of private debt to GDP are even higher, at 249%, the highest in Europe. By contrast, the Italians still have net household savings. So who are the real “profligates” in Europe?.

Those who embrace these ruinous austerity policies will soon be seeing the experiencing much the same kinds of conditions as the Spanish (albeit from less depressed levels) including the moralistic Dutch, whose finance minister has been a crusader in favour of even harsher fiscal rules than those embodied in the Stability and Growth Pact.We have also recently witnessed a big surprise decline in the German consumer confidence index last week as well as a collapse in an Italian retailing sentiment index. The austerity disease is intensifying the crisis, even in the core.

It is inconceivable to me that Super Mario Draghi won’t be changing his tune soon, in spite of what he and the Merkel government are now saying for public consumption. To continue with this present course will not only precipitate a collapse of the euro, but a political collapse across Europe.

There is no question that larger deficits are needed to support aggregate demand at desired levels. However, as all of us who have contributed to this blog have long noted, the problem is the national governments are currently like US states and as such are revenue constrained because they are USERS, rather than ISSUERS of the currency (as opposed to, say, Canada or the US, both of which are sovereign issuers of their own currency).

So relaxing the deficit limits without some kind of ECB funding guarantees can cause markets to abstain from funding the national governments, which creates a solvency crisis of the kind we are experiencing today. Said another way, without the ECB the euro members are currently deep into ‘Ponzi’, as my friend, Warren Mosler has described it. In reality, they have all been in ‘Ponzi” since day one. But it took a crisis of the magnitude of 2008 to make this manifest for the markets.

At some level, the ECB understands that, as it always”writes the cheque” when a systemic crisis pushes the system to the brink. It can be no other way, as it is the sole issuer of the euro. But for the most part, Europe’s policy making elites remain in denial, as they continue to turn away from the one entity that could address the insolvency issue.

And let’s be clear once and for all. The US government does not face the same kind of crisis as the Spanish, the Greeks, the Dutch or even the Germans. The US government has expanded its public debt ratio considerably in recent years but yields remain low and when the ratings agencies downgraded their assessment of the US sovereign debt the demand for it rose. Whither the so-called “bond market vigilantes”?

The Euro governments are in a different camp altogether. All those who actually understand that the member governments are using a foreign currency and thus are not at all like Japan, the US or the UK governments, appreciate that their is default risk attached to the paper issued from the EMU governments.

They also appreciate that with the non-elected eurocrats of Brussels insisting on a decade or more of austerity and implementing fiscal rules that these would ensure a crisis every time there has been a serious downturn in aggregate demand. And with that, the risk of default with government debt has risen. That is what we are seeing today across the euro zone. And in Spain it is writ large.

The mainstream austerity line is trapping Spain (as well, as Greece, Portugal, Italy, Ireland and soon the core of the euro zone) in a dangerous downward spiral of lost income and increased unemployment. I still think Francois Hollande’s likely election could well change the political dynamics in the euro zone, even though he generally buys into the mainstream neo-liberal euro line. Hollande is an “austerity lite” character, as opposed to being a genuine reflationist. But even he cannot be oblivious to the looming political and social dangers which await France, if he continues to pursue the policies embraced by the current President, Nicolas Sarkozy.

So far, Brussels has not let facts get in the way of a good neo-liberal theory, but it’s getting increasingly hard to ignore this emerging horror show.

This is a bit of a sleeper of a presentation from the recent INET conference. It was from a session titled “What Can Economists Know?” which might cause willies among non-economists as being too much about epistemology and not enough about issues that might give insight, say, into why the overwhelming majority of economists in early 2007 thought a global financial crisis was impossible.

This talk by Gerd Gigerenzer is about heuristics, and why they are often superior to the more formal methods of analysis and decision-making fetishized by economists. He argues that one of the big things that economists miss is how to approach decision-making under conditions of risk (when probabilities of outcomes can be estimated with some accuracy) versus uncertainty (when you can’t estimate the odds of outcomes and/or may face unknown unknowns).

James Kenneth Galbraith is currently a professor at the Lyndon B. Johnson School of Public Affairs and at the Department of Government, University of Texas at Austin. He is also a Senior Scholar with the Levy Economics Institute of Bard College. His latest book is ‘Inequality and Instability: A Study of the World Economy Just Before the Great Crisis’ (also available on Kindle).

Interview conducted by Philip Pilkington.

Philip Pilkington: Let’s start with the obvious question that the book raises. Namely, why studies on inequality have, until this point, been so poor. You point out in the book that the studies that have been done have been competently researched but that they simply don’t have access to the correct types of data etc. Could you talk a little about this (without getting too technical, of course) and maybe speculate a little about why this important issue has been sidetracked by the economic profession?

Jamie Galbraith: I have great respect for the many researchers around the world who have conducted income surveys over many decades, and also for those at the World Bank and elsewhere who have tried to assemble this work into useful data sets. But there are two major problems. The first is that surveys are relatively scarce, especially in poorer countries; in many countries they are available only for a few widely-scattered years. The second is that the concept – what is being measured – can vary widely from place to place and from time to time. For instance, some surveys measure the inequality of incomes; others the inequality of spending. In some cases the measures are for households; in others they are for individuals. And so forth.

The result is that when these very disparate measures are brought together, the data are sparse and very noisy, it is very hard to find clear patterns, and in quite a few cases apparent comparisons between countries just don’t make sense. This prompted us to look for other types of economic information that could be used to fill in gaps and improve the quality of the measures.

What we found, is that there is quite a lot of raw information that can be useful for this purpose, so we set about collecting it and making calculations. Our approach has its own limitations – which I’m careful to describe. But it does fill in many gaps and it does reveal clear patterns, both through time and across countries. So it permits us to use our inequality measures as a new source of insight into how the world economy is bound together, especially by the far-reaching forces of global finance.

PP: You mention that surveys are scarce. From the book I get the impression that this is bit of a dark corner in the economics profession. Why do you think this is the case?

JG: Two reasons primarily. One is that surveys are expensive. The other is that for many years there wasn’t that much interest in economic inequality among economists; growth, development, trade and finance were all more fashionable fields. More recently there has been an explosion of interest in inequality — but it’s too late to go back and take surveys for past years, let alone past decades.

So the challenge for us was to find other types of data, which could fill in some of the missing information.

PP: As pretty much everyone knows by now, inequality has been rising in most advanced countries in the past few decades. One of the interesting points you make in the book is that you don’t believe rising inequality in many advanced countries could have been turned to electoral advantage. Could you please explain how you came to this conclusion?

JG: Inequality rose almost everywhere – both in the advanced countries and in the rest of the world – very sharply from 1980 to 2000. After that, the global picture becomes less clear, since lower interest rates, rising commodity prices and political change improved the picture in many places, including especially Latin America. We have strong evidence of declining inequality in parts of Latin America after 2001.

The book includes a chapter on the relationship between inequality and electoral outcomes in the United States. The US is interesting because what is relevant for presidential electoral outcomes – thanks to the Electoral College – is inequality within states. Getting good measures of inequality within states was a very interesting challenge, all by itself.

What we found is that when you look at inequality in that way, you find that higher inequality is associated with lower voter turnout. But it’s also true that states with more inequality of a very particular type, namely states that tend to have a lot of geographical stratification between the rich and the poor, tend toward the Democratic Party. And states for which this is less true tend Republican. There is very striking evidence for the 2000 election: you can practically predict which way a state went in that election by the measure we developed, right down to the tie vote in Florida.

We conclude two things: first that higher inequality inside a state is associated with policies that discourage voting by the relatively poor, and second that when the rich and poor tend to live in separate local political jurisdictions (which is more common in big states like California and New York) the rich don’t interfere with the poor as much as they do when both are voting in the same places.

Anyone who lives (as I do) in the American South will, I think, not find this surprising. It’s very much consistent with, for instance, the history of the Voting Rights Act.

PP: And how then did you conclude that the left could not have turned the rising inequality into electoral victory over the past few decades?

JG: That’s a question with an ironic answer, at least for the US.

A rise in inequality – while it lasts – can and often does appear to be a moment of prosperity.

We saw our largest rise in income inequality under a Democratic President, Bill Clinton. Why? Because he presided over a stock market and information-technology boom. And of course the beginnings of that boom helped win him re-election in 1996.

So you might say that rising inequality did help produce electoral victory for ‘the left’ – or what passes for ‘left’ in this country, at least on that occasion. But not in the way most people imagine.

The problem is that expansions of this type cannot and do not last.

PP: If I understand correctly you also found that nations have very little control over their own levels of inequality. How did you come to this conclusion?

JG: A nation’s level of inequality has a lot to do with its underlying economic structure and level of development: agrarian, industrial, or high-technology. But we also found, in examining the movement of inequality in the world economy over 40 years, that there was a very strong common pattern. This suggests that *changes* in inequality have a common source. Looking at the major turning points, which were in 1971-3, 1981 and 2000, a leading candidate for that source emerges: the changes in the world financial system.

Until 1971, the world’s economies were largely stabilized under the Bretton Woods system. After 1973, there was a widespread commodities-and-debt boom that tended to reduce inequality in developing countries. After 1980, high interest rates and the debt crisis raised inequality almost everywhere. And finally in 2000 there was a peak; after that interest rates fell, commodity prices recovered, and inequalities around the world tended to ease.

In the face of these global pressures, it’s possible for some countries with very stable policies and strong institutions to resist for a time: for example Denmark does not show rising inequality in our data. Or a country may be insulated from global shocks, as China and India were from the debt crisis in the 1980s (but not in the 1990s). But these cases are very few. In most cases the global forces dominate the picture.

PP: Right, so finance tears away any protective veils the nation-state tries to use to maintain equality and stability. Are you then implying that finance, or at least finance when it grows to a certain level and gains a certain amount of power, becomes a redistributive mechanism?

JG: Of course.

PP: But finance is supposed to channel investment. What shift takes place that causes it to act in such a strange manner?

JG: I suppose that is what they say. In reality, whether banks distribute resources from lenders to borrowers or back from borrowers to lenders depends on the terms of the loan. In the high-interest-rate environment of the 1980s and 1990s, the redistribution vastly favoured the lenders, which is to say, the wealthy. This is not surprising. My father once coined a “Galbraith’s Law,” which held that, as a rule, “people with money to lend have more money than people who do not have money to lend.”

PP: Mainstream economics doesn’t deal much with income distribution, why do you think this is?

JG: For many years the study of income distribution held no interest for economists, in part because the distribution seemed to be stable or becoming more equal over time. That changed in the 1980s. And beginning in the early 1990s, the mainstream did get into the act, with many papers offering up the hypothesis that inequality was driven by technology and the demand for skill. This was called “skill-biased technological change” and it became the standard explanation for rising inequality in mainstream circles. I wrote one of the earliest critiques of this, in a book called “Created Unequal” that was published in 1998. Since then, numerous applied economists have also broken ranks on this interpretation, although some continue to promote it.

PP: What was your interpretation of this rise in inequality?

JG: As my title back in 1998 suggested, it was “created.” I did a lot of original data work, creating new time series measures, which enabled me to show exactly when pay inequality rose during this period. It was clear that what we measure as *pay* inequality was very closely related to unemployment and to involuntary part-time at the low end of the pay scale. That’s not the entire story but it’s the biggest piece of it.

Inequality of *incomes* in the US is different, because measured incomes (reported on tax forms) include money made from capital gains, stock options, and the payout from venture capital investments, all of which are highly concentrated in a relatively few places, companies and people. When you look at income inequality, it’s clear that the major driver is the movement of the stock market, especially the NASDAQ. But that’s capital- asset valuations; it’s not “demand for skill.”

I’ve often said it’s actually redundant to measure income inequality in the US. You can watch it go by on cable TV, on the stock ticker.

PP: I’m pretty sure that mainstream macroeconomics doesn’t pay much attention to income distribution, but it seems probable that income distribution would have important macroeconomic effects. Do you think that income distribution has macroeconomic effects? If so, what do you think are the most important?

JG: The evidence is pretty clear that a very bad income distribution leads to economic instability; that is to panic, slump and collapse. The reason is that the bad distribution emerges from growth driven too much by private credit: from too much debt taken on by the middle and lower strata, ending in crisis. That is what we observed in the US stock market euphoria that peaked in 1929. That is what we observed in the housing finance disaster that peaked in 2007.

But one can also say that the reverse is true: the income distribution is driven by macroeconomic forces.

The act of extending credit – a macroeconomic force – generates fees and capital gains and other incomes that accrue, largely, to the top strata. You can see this very plainly in US data, but also in most other countries we’ve looked at, from Brazil to China. In sectoral data, it shows up in the fact that rising inequality is closely associated with relative gains by the financial sector.

One of things Inequality and Instability shows is that there is a common pattern in the movement of inequality around the world. A very clear pattern. It isn’t just an American phenomenon. That suggests that there must be a common global force behind it. And that would have to be a macroeconomic force, by definition.

I’m hoping to get this point across to economists, as well as to the wider public. It should have an effect on how they conduct research into inequality, dislodging them from their fixations on such matters as education and training and even immigration and trade. Such local and country-specific forces cannot be working in such a powerful common way, all across the globe, as we observe.

Of course, the wider public is much more open to evidence and to common sense, than are my professional colleagues – for the most part.

PP: So, if we accept that most inequality is generated through the finance sector, how do solve this problem? From what you say it appears that the entire economy is structured around this inequality. It seems that in order for policymakers to attack this they would have to target multiple points of the architecture simultaneously. Where would you start?

JG: In Argentina and Brazil, as I show in the book, inequality started to decline almost immediately once the financiers were knocked off their thrones. In Brazil the share of income passing through the financial sector was extraordinarily large, but over the course of twelve years and three presidencies, it has gradually been reduced, making room for expanded public services, improved social conditions and reduced inequality.

In the United States, the government has the power to bring the financial sector under control. It should use that power. Our problem is that the financial sector controls those parts of the government that set policy for finance. The banks are leading funders for presidential campaigns. The leading personnel in the Treasury and other financial agencies come from the banks, and if they do a good job (from the banks’ point of view), they can be confident that a lucrative sinecure awaits them, back at the banks, later on. This provides a very strong disciplinary effect on their conduct in office.

So – where to start? I’d *start* by breaking that link between the banking sector and the public sector.

One practical way would be to create a truly independent, effective and well-financed financial crimes enforcement unit, beyond the control of the political appointees at the Department of Justice, Treasury and the captive regulatory agencies. Also restore mark-to-market accounting and place the full control of audits and stress tests in hands that do not have an obvious conflict of interest viz. the results.

PP: People in the US – especially due to the Occupy movement – are becoming increasingly concerned about campaign financing by, among other groups, the banks. This seems to be the tie between the two sectors that ensures nothing gets done about Big Finance. I understand that you’ve spent some time around policy circles and the like. Maybe you could say something about this, the effect it has on regulation and policymaking and the potential to do something about it?

JG: I was on the staff of the House Banking Committee in the second half of the 1970s. At that time, the Committee hearing room in the Rayburn Building had just two rows of desks for members. Today there are four rows, and barely space for a table of witnesses, let alone anyone else. In other words, the size of the Committee has about doubled.

Why is this? Because the leadership in the House uses that committee as a fund-raising magnet, especially for Members who might be a little bit vulnerable. Once a Member has a spot on the banking committee, money problems go away. And one can hold practically any position on other issues that may be convenient — liberal, conservative, the banks don’t care. All you have to do is be friendly to bankers.

This is a formula for locking down the Congress. As I said, with the executive branch, it’s a bit different; while campaign financing is a significant question, so too is the actual staffing of the government, which is controlled by bankers; people come in from the banks and go back to the banks. It’s not a secret, for instance, that Robert Rubin’s protégés took a very large share of the top policy positions on economics and finance in the Obama administration — from Larry Summers on down. It’s not a secret that Peter Orszag, the first director of OMB under Obama, took a well-paid position at Citigroup on leaving the White House.

I have no simple formula for dealing with this, beyond what I keep repeating: 1) enforce the laws against financial fraud and 2) downsize the financial sector as a matter of public policy.

PP: You note that things have gotten better with regards inequality and instability in many parts of Latin America after their financial crises. Yet, such has not been the case in the US post-2008. Are you optimistic about the future?

JG: According to our most recent measures, using county-level data, income inequality in the US did fall after 2008 and then rose again – tracking the stock market as I found in the book. For lower-income workers, for older workers and for homeowners, the bottom fell out in the crisis and it has not been repaired.

The grip of see-no-evil economics has been broken in many parts of the world, and especially in South America. But in the US and in Europe, especially in Northern Europe and in the UK, it remains very strong. This means that our two continents have actually less open debate, and so fewer political options, than is now the case in many other places.

We have seen, though, that severe events do have a way of opening up peoples’ eyes and minds, and so there is always hope. I don’t rely on hope, though. My friend William K. Black, the criminologist, likes to quote William of Orange: it is not necessary to hope in order to persevere.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

The pain in Spain continues with the government releasing the country’s latest budget which has been described by some Spanish economists as ‘the most severe since Franco’:

Spain’s government has announced $36 billion in new budget cuts, as it attempts to reassure the European Union that it will not need a financial bailout.

The budget savings will take the form of a freezing of civil servant wages, ministerial spending cuts and new corporate taxes, announced Soraya Saenz de Santamaria, the country’s deputy prime minister, on Friday.

“The ministries will see an average reduction of 16.9 per cent … there will be adjustments of over 27 billion euros [$36 billion] through revenues and through spending,” she said, after she and her cabinet colleagues passed the draft budget at a meeting in Madrid.

“This government will not raise value added tax but is calling for an extra effort within corporate taxes,” she said. Overall, government spending cuts will amount to $22.7 billion.

The government has also decided to freeze civil servants’ salaries, but to maintain unemployment benefits and planned pension increases.

Jose Manuel Soria, the country’s industry minister, further announced that electricity bills for small consumers would also rise by seven per cent during a quarterly review due in April.

De Santamaria termed the budget proposal severely austere, but essential. The measure is to go to parliament on Tuesday, and is expected to be formally passed in June.

The aim of these cuts are to reduce the Spanish budget deficit from 5.3 per cent of its gross domestic product from 8.5 per cent last year, €27 billion is equivalent to 2.5% of GDP. As we have seen from both Greece and Portugal this sort of abrupt cut in government spending has some serious negative flow-on effects to the broader economy which tends to lead to further unemployment and lower industrial production. Those problems, however, didn’t enter the minds of the Eurocrats as they congratulated the Spanish government:

European officials praised Spain’s 2012 budget measures and urged Prime Minister Mariano Rajoy’s government to implement them without delay.

“The unambiguous commitment of the Spanish government to the target of 3 percent fiscal deficit in 2013 is indeed of paramount importance,” European Union Economic and Monetary Commissioner Olli Rehn said in Copenhagen yesterday. “I expect this will be substantiated soon by a convincing path of fiscal consolidation” along with economic reforms to put Spain on a “more sustainable growth model.”

There is nothing sustainable about this path, the Spanish have not written off any debts yet are setting themselves a path of even lower national income. Unemployment is over 20% and rising, bad debts in the banking system are still rising, bank deposits are flowing out of the country, lending to the private sector is falling all while households attempt to repair their balance-sheets as they continue to lose wealth from falling house prices.

However, with the Spanish private sector in dire straits members of the European bureaucracy want us to believe that taxing them more will somehow lead to growth. I guess I shouldn’t be too surprised by this madness, Olli Rehn has a history of making political statements that make no economic sense and inevitably turn out to be embarrassingly incorrect.

From 15th August 2010

There is no possibility that Greece will default on its debts and no reason to doubt Germany’s commitment to an EU pledge to help Greece, the European Union’s monetary chief said on Thursday.

Economic and Monetary Affairs Commissioner Olli Rehn told a conference in Brussels that Greek default was not an issue, saying: “There will be no default.”

a year later, August 29th 2011

Jean-Claude Trichet, president of the European Central Bank, said there was no shortage of liquidity in the European banking system. EU economic commissioner Olli Rehn insisted that the health of EU banks had improved over the last year.

I don’t think I need to go on, but maybe the best thing for all us is that these people resign, or at the very least just stop talking.

It seems almost inevitable now, given the budget the Spanish are about to enacted and the complete lack of debt write-downs, that the country’s economy will weaken further over the next 12 months. Excluding some unforeseen positive event I think it is very likely that the country will require external help shortly. Which brings me to the other news of Europe over the weekend.

European officials announced on Saturday that the European Financial Stability Facility (EFSF) has committed an additional €200 billion in funds to the European Stability Mechanism (ESM) which technically brings the total availability to €500 billion with an overall firewall figure of €800 billion. It all sounds very positive but, as I have explained previously, neither of these mechanism are as exciting as they seem on the surface.

If we look at what will actually be available we find that €100bn of the €800bn is money from the EFSM, a small fund set up by the EU commission, that has is already allocated to Ireland, Portugal and Greece. Another €200 billion has been counted for the EFSF, but again this has already been allocated to existing bailout programs. So there is €300bn in double counting.

The ESM is supposed to be available, but as you would have noticed in the statement the talks about accelerating the “paid-in” capital. What this means is that by the end of 2012 the ESM won’t actually have all of its funds available because the €80bn in “paid in” capital will not have actually been “paid-in”. That being the case the mechanism is likely only to be able to generate €200- 250bn in the first year. Because the ESM isn’t actually ready the summit has decided to allow the EFSF to borrow up to its €500 bn limit if need be. Whether or not this change needs to be ratified by any national parliaments is an open question, but let’s assume for now that this isn’t the case.

What you will have noticed is that although the headline figure is €800 billion at no time will Europe have given itself access to greater than €500bn in new funds. Whether it can actually raise them is another question, which presents a new set of problems.

Firstly there is the existing programs. We have already seen admissions from the Greeks that they will probably need an additional bailout and it is becoming increasingly likely that something extra will need to be done about Portugal. Also, as you may have realised by now, and I have spoken about before, the ESM doesn’t actually have all the money. At best they are aiming for a 15% capital injection from member states that will be used as an insurance against default for additional funds borrowed by the program. The ESM is backed by all contributing nations, which means at the time of a default the 15% buffer will be used first, but any additional losses will be worn by the countries themselves.

At present Spain is a contributing country but, as I stated above, it is reasonable to assume that this will soon not be the case. In fact I think it is credible to believe that this will occur before they have actually paid in any capital themselves. Spain is supposed to be the 4th largest contributor to the ESM and the country has combined private and public sector debts that dwarf the €500bn in new funds, even if they were available. If Spain becomes a user of the fund then the burden will fall on Germany, France and Italy to take up the slack which is both politically and economically unsustainable.

I think that is the real reason you are seeing Eurocrats like Olli Rehn making such odd statements about Spain. He desperately wants the world to believe that the EuroZone actually has a credible plan because Spain is such an unmanageable problem. But the EuroZone has never had one, and still doesn’t. Releasing media statements with such obvious rubbery figures certainly isn’t going to help the union’s credibility.

Once again it appears, at least to me, that the European financial elite are their own worst enemies.

EuroGroup EFSF ESM Statement

By Michael Olenick, creator of FindtheFraud, a crowd sourced foreclosure document review system (still in alpha). You can follow him on Twitter at @michael_olenick or read his blog, Seeing Through Data

While researching a HUD database for clues on Thomas Lawler, the frequently-cited foreclosure and heavy-metal loving “housing economist” often cited by the business media, and a favorite of Calculated Risk, I came across background information that raises more questions than it answers.

In the spirit of CR’s former housing writer, Doris “Tanta” Dungey, who did not seem to hesitate to present puzzling information and ask her readers what they thought it meant, I thought I’d do the same. Tanta passed away of cancer at the age of 47 in late 2008 and it’s a shame CR has discontinued the practice.

Starting in 1998 Thomas Lawler held the job of SVP Portfolio Management, SVP Financial Strategy, and SVP of Risk Strategy at Fannie Mae until he unceremoniously left in January, 2006, following an $8 billion financial fraud that occurred under his watch. Lawler, along with the rest of Fannie’s executive team, cooked the books spectacularly. That was back in the early 2000s, when a billion dollars was still real money.

Lawler’s Project Libra

It’d be impossible to summarize Lawler’s ethical mosh-pit better than OFHEO, Fannie’s former regulator which morphed into the FHFA, already did so I’ll just cut-and-paste from their 2006 “Report of the Special Examination of Fannie Mae” (emphasis mine):

According to Thomas Lawler, Senior Vice President for Portfolio Management, when Fannie Mae entered the income-shifting REMIC transactions, the Enterprise was concerned that the steep decline in interest rates in 2001 would cause higher near-term and lower long-term recognition of income under GAAP. Mr. Lawler explained that in the context of developing strategies to address that concern, Peter Niculescu, Senior Vice President for Portfolio Strategy, may have suggested the income-shifting REMIC idea. He was not aware of anyone senior to Mr. Niculescu playing a role in initiating the transactions.

Andrew McCormick, Senior Vice President for Portfolio Management (then reporting to Mr. Lawler), indicated he believed Goldman Sachs (Mr. Niculescu’s former employer and the underwriter of the transactions) was the source of the idea.209 In fact Goldman Sachs described the proposed transaction in a November 19, 2001, presentation to Fannie Mae. David Rosenblum, a Goldman Sachs managing director, attached PowerPoint slides for the presentation to a December 3, 2001, e-mail to Mr. Niculescu. Mr. Rosenblum referred to the project as ‘Project Libra.’

Mr. Lawler acknowledged that a motive for creating the REMICs was to effect ‘a change in the expected [pattern of] recognition [of income].’ He also emphasized that without the income-shifting REMICs he did not believe the GAAP earnings that the company would have realized would have accurately reflected the underlying economics. Although he referred to economics, Mr. Lawler was actually talking about the GAAP accounting mismatch Goldman Sachs cited. In an e-mail to a colleague, Jeff Juliane, who, as a member of the Office of the Controller had operational responsibilities for accounting for premiums and discounts on the tranches Fannie Mae retained, ‘these (REMICs) were structured to transfer income from 2002 to out-years.’

Is it just me or, in much the same way every fairy tale starts with “Once upon a time,” every government report on a major scam seems to include the line “Goldman Sachs described the proposed transaction.”

Back to the point, the report makes it clear that Thomas Lawler’s Fannie Mae didn’t play well with Patrick Lawler’s (no relation) OFHEO. At one point when OFHEO provided Congress with Fannie executive compensation Fannie “suggest[ed] that members of Congress might face criminal sanctions if they made the information public,” according to the OFHEO report.

A few months before that scathing report was released Thomas Lawler unsurprisingly left Fannie Mae, moving to a rural farm and into semi-retirement. But Thomas Lawler’s version of “retirement” was to join the Board of Directors of one of John Paulson’s hedge funds as Paulson was famously buying CDS short positions.

Unsurprisingly once Lawler jumped to Paulson he quickly became bearish on real-estate prices. “Poison Said It All in 1990 in a Song Reportedly Inspired by a Mortgage Lender After Housing Crashed that Year, and Low/No Doc (“Liar”) Loan Defaults Skyrocketed,” Lawler wrote in his presentation, going on to spell out the lyrics. That presentation ends with a cute graphic of “Franklin, the Fair Housing Fox,” a likely reference to Lawler’s former boss Fannie Mae CEO Franklin Raines.

Somehow between the heavy-metal lyrics and kitschy graphic I can’t find a disclosure anywhere that Lawler’s new boss was massively shorting the housing market. An oversight, I’m sure, as Lawler was focused on remaking himself from an executive at the center of a massive scam to a “housing economist” in the public image.

Soon after it became clear that the payout to Paulson looked inevitable Lawler switched his position again, arguing the now well-known Big Lie that increased foreclosures also increases home prices. As early as June 13, 2008, while Bear Stearns was barely dead and Lehman Brothers still barely alive, the Wall Street Journal quotes Lawler opining about the economic benefits of “bargain hunters scooping up foreclosed homes from banks,” no matter that these same “bargain hunters,” likely ended up massively upside-down soon after.

Lawler also went after the jugular of real economists who disagreed with him, most notably Yale University economist Robert Shiller, co-inventor of the famous Case-Shiller home price index, which Lawler called “bogus,” in an April 24, 2009 WSJ article announcing that Thomas Lawler has created his own index: “Mr. Lawler has created an adjusted version of the Shiller chart, backing up [Thomas Lawler's] view that house prices already are nearing a bottom in much of the country.” Shiller responded in the article that Lawler was making “wild allegations.”

I suppose “wild allegations” is a toned down version of what most people would have said, which would be something along the lines of “WTF – Lawler’s a known housing fraudster who cooked the books in an $8 billion scam: why are you listening to him?” though academics rarely talk like that, unfortunately.

Needless to say, Lawler’s 2008 housing bottom didn’t quite work out that way, nor did his view that Shiller’s index was incorrect, but most pundits pass over those small issues the same way that prosecutors passed over indictments in the Fannie accounting fiasco.

The Surprise In the Desert

Back to that primary research based on the HUD data during and after the time that Lawler was managing Fannie’s portfolio, financials, and risk. It turns out that Fannie had an appetite for financing homes in some ZIP codes at rates wildly higher than others. I compiled about 26 million loan-level records that Fannie and Freddie acquired between 2004-2007. Fannie and Freddie don’t lend directly — they buy loans from banks — so this data-set would be from the time Lawler was at the height of influence setting policy there.

Fannie and Freddie’s loans use MSA rather than ZIP codes but I cross-referenced them to ZIP codes using tables provided by the Census Bureau. MSA codes sometimes span a small number of ZIP codes, so when there were multiple ZIP code possibilities I’d choose the ZIP code with the highest proportion of residential properties. This could result in slight overconcentration, though the error rate doesn’t matter given the extremes I found in the data.

Certain communities were much more likely to receive loans from the GSE’s than others. Surprise, AZ, in ZIP code 85374, is #1 with 24,788 loans, a 14.7 standard-deviations above the other 20,821 ZIP codes which have a mean loan volume of 532 loans each. The Census Bureau reports Surprise, AZ grew 281% from 2000 to 2010, to the current population of 117,517. As Yves would say, Quelle Surprise, though this time literally.
There are 52,586 housing units in Surprise so it’s safe to say the town is akin to some sort of modern Hoover Dam project, a large scale building project, in the middle of nowhere, built with government money. Except the spending occurred during an economic boom, and is now curtailed thanks to a corresponding economic bust. Actually, the government didn’t really mean to spend the money — during that time Fannie and Freddie were private — so it was GSE executives, especially Lawler, who decided to build a town in the middle of nowhere.

One statistic that comes through clearly is Lawler’s preference for fast foreclosures. All top ten ZIP codes by loan volume are in non-judicial foreclosure states: five in CA, two in AZ, and one each in NV, NC, and TX. We have to drill down to the seventeenth position until we find a judicial ZIP code.

It isn’t clear how Fannie and Freddie decided to hyper-concentrate their loans in a few distinct areas since majority of ZIP codes received less than 1,000 loans. Almost all the high volume ZIP codes are exurban construction boom-towns: environmentally irresponsible far-flung bedroom communities that externalize the cost of construction to everybody except the builders who disappear even faster than the demand for shiny new properties to flip.
Other stats also pop out. For example, the average age of the primary borrower in this large sample is 44 1/2, so they’ll pay off their 30-year mortgages when they’re a spry 74.5 years-old. That obviously doesn’t bother Fannie and Freddie who wrote at least 9,821 loans to people 90 years and older. Fifteen loans went to people one hundred years and older. I understand that age discrimination is illegal but given all the other exemptions Fannie and Freddie received — which includes virtually everything — you’d think they’d lobby for the ability to question the ability of centenarians to repay their 30-year loans.

Many people question the role Fannie and Freddie played in the subprime meltdown. Gretchen Morgenson and Josh Rosner convincingly argue in their book on the subject, Reckless Endangerment, that the GSE’s created an anything-goes culture which private lenders picked up to compete. This data supports that theory: Fannie and Freddie led the way while private money followed.

It’s not clear why CR and so many mainstream media outlets blindly quote Fannie Mae’s former economist, allowing him to “move on” from some spectacularly poor decisions that led to painful costs borne by everybody else. We continue watching the bailout money quietly flow and I wonder when “personal responsibility” for one’s prior decisions became an exclusive obligation only for those neither wealthy nor well connected.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

Back in November last year I posted on my confusion over the jubilation shown by the citizens of Spain as they elected Mariano Rajoy as their new political leader. Mr Rajoy’s strategy during the election campaign was to say very little about what he was actually intending to do to address his country’s financial problems, preferring to simply let the incumbent party fall on its own sword so that he could take the reins. It became obvious soon after the election that, despite his party’s best efforts to dodge questions, the intention was simply to continue with even more austerity.

Since that post I have continually warned that although Spain is obviously a different country to Greece in regards to how its problems have manifested, it still faces significant macroeconomic challenges that were not being correctly reflected in the bond market.

…. Spain which I consider to be the major unrecognised problem. The country has seen its yields tumble since December on the back of the ECB’s 3-year LTRO but there hasn’t been anything in the economic metrics of the country to support such action. Spain has 23% unemployment and still rising, the banking system is under-capitalised and still has unknown exposure to the country’s housing market collapse. On top of that the rising unemployment rates is pushing up bad loans in the banking system to 7.4%, a 17-year high, and is still rising.

As I mentioned this week, since I made those comments bad loans have risen further , house prices have continued to fall and the government’s debt position has worsened.

So it should come as little surprise to MacroBusiness readers that overnight the bank of Spain announced that the country has now fallen back into recession:

Spain’s economy is suffering its second recession since 2009, the Bank of Spain said, obstructing the government’s efforts to reorder public finances as it prepares the budget for this year.

“The most recent information for the start of 2012 confirms the prolongation of the contraction in output in the first quarter of this year,” the Madrid-based central bank said in its monthly bulletin today.

Spain’s gross domestic product declined 0.3 percent in the fourth quarter of last year, less than two years after emerging from the last recession. Prime Minister Mariano Rajoy will present his 2012 budget on March 30, amid growing pressure from investors and European peers to rein in the deficit, which was 8.5 percent of GDP last year.

And so, once again, we see failings of economic logic creeping back into Europe. The reason that Spain’s economy is suffering is because the government sector is attempting to de-leverage in the face of the same behaviour from the private sector after the collapse of the Spanish housing market. You can obviously point to all sort of things that happened in the past and claim they never should have been allowed to occur. Where were the bank regulators? the macro-prudential oversight ? the fiscal policy in order to push against the housing bubble?. All good questions, but none of them change the fact that the Spanish economy is demonstrating its current behaviour because of the government sectors attempt to lower its deficit.

As I have explained previously in terms of national income, a country with a long running current account deficit has been borrowing goods and services from the rest of the world. In order to support this one, or both, of the non-external sectors of the economy will have expanding debt positions and due to this the economy tends to restructure around consumption over investment and production. Because the external sector is a net drain on capital from the country, the government and/or private sector must continually expand their debt in order to maintain economic growth.

In many cases this debt accumulation leads to asset bubbles, because the expanding debt drives asset prices which attracts speculation and in doing so accelerates the external borrowing. This in turn drives up national income, which in turn drives higher prices and further speculation. In the EuroZone, if either sector’s debt is accumulating faster than its income then at some point in the future a limit will be reached and the rate of debt accumulation will fall. This leads to falling asset prices and national income, which ultimately leads to a crisis as accumulated debts start to sour.

This is what we have seen in Spain. The private sector accumulated large debts on the back foreign capital inflows leading to a housing bubble. This bubble has since collapsed leaving the private sector in a position of significant wealth loss and indebtedness, the banking system holding significant and growing levels of bad debts and the economy structured around the delivery of a failed industry.

Prices for Spanish homes fell 3.4 percent in the first quarter from the previous three months as the euro area’s fourth-largest economy shrank and reduced mortgage lending crimped demand, according to Idealista.com.

Sellers cut asking prices for existing homes by an average of 2.9 percent in Barcelona, 1.9 percent in Madrid and 2.2 percent in Valencia, Idealista, Spain’s largest property website, said in an e-mailed statement today.

“Prices have continued to fall due to difficulty in obtaining mortgage financing,” said Fernando Encinar, co- founder of Idealista. “Legislation passed by the government in February to push banks to provision for real estate will result in similar declines over the remaining quarters of the year.”

Prime Minister Mariano Rajoy is battling to turn around a slump in the real-estate industry. His government forecasts an economic contraction of 1.7 percent this year that will push Spain’s unemployment rate, the European Union’s highest, to 24.3 percent. The government passed a decree in February forcing Spanish banks to make deeper provisions for losses linked to real estate in an effort to push down prices and boost sales.

The growing unemployment is leading to a slowing of industrial production, which means that even though the country is importing less it also appears to be exporting less. Combine this with the interest payments on borrowings from the rest of the world and at this point Spain continues to run a current account deficit which, in the most basic terms, means Spain is still paying others more than it is being paid back. That is, the external sector is still in deficit.

So with the external sector in this state and the private sector unable and/or unwilling to take on additional debt as it attempt to mend its balance sheet after an ‘asset shock’, the only sector left to provide for the short fall in national income is the government sector. If it fails to do so then the economy will continue to shrink until a new balance is found between the sectors at some lower national income, and therefore GDP.

It may appear logical to you that this must occur, and I don’t totally disagree, but that doesn’t change the fact that under these circumstances there is simply no way that the private sector will be able to continue to make payments on the debts it has accumulated during the period of significantly higher income. This is a major unaddressed issue.

This is why we continue to see a rise in bad and doubtful debts in the Spanish banking system which, under direction from the Government, banks continue to merge.

Spain’s biggest bank in terms of assets has been created after CaixaBank bought Banca Civica for 977m euros ($1.3bn, £817m). The government has amended laws to encourage mergers between banks, many of which collapsed following the bursting of the property bubble.

Banca Civica itself was formed by combining four troubled “cajas”, or regional savings banks. The merged bank will have 14 million customers.

CaixaBank will have 342bn euros in combined assets, deposits of 179bn euros and loans totalling 231bn euros, the bank said. The CaixaBank deal will be completed by the third quarter and will generate cost savings and other benefits of 540m euros by 2014.

The problem is that, apart from economies of scale, merging banks doesn’t actually help that much because impaired assets don’t suddenly disappear. The other issue is that Spanish banks have been large users of the ECB’s 3 year LTRO facility which means they have continued to load up their balance sheets with their own countries sovereign debt in order to participate in the carry trade.

It is quite possible, as I explained above, that the LTRO was masking the true value of those sovereign bonds and that Spanish banks have made a terrible decision by making those purchases. Here are the current 10 year yields for Spanish government bonds, courtesy of Bloomberg:

If yields continue to rise, and I see no reason to discount this possibility, then Spanish banks are eventually going to have to front-up more capital to cover those ECB loans. Where exactly is this going to come from?

And so I am starting to get a bit of deja vu.

The eurozone’s public debt crisis is not over despite calmer financial markets this year, the OECD said on Tuesday, with a warning that the bloc’s banks remain weak, debt levels are still rising and fiscal targets are far from assured.

As the eurozone heads into its second slump in just three years, the Organization for Economic Co-operation and Development (OECD) said the 17-nation area needed ambitious economic reforms and there could be no room for complacency.

“Market confidence in euro area sovereign debt is fragile,” the Paris-based economic think tank said in a report on the state of the eurozone’s health. “The outlook for growth is unusually uncertain and depends critically on the resolution of the sovereign debt crisis,” it said.

….

OECD chief Angel Gurria has called for “the mother of all firewalls” – some 1 trillion euros – but finance ministers look more likely to agree to a level nearer 700 billion euros.

I’m sure we’ve been here before.

The US nominee to lead the World Bank, Jim Yong Kim, has come under attack for editing a book called “Dying for Growth.” It apparently performs the cardinal sins of questioning whether a relentless pursuit of growth produces necessarily produces good outcomes and taking issue with neoliberalism. From the Financial Times:

Some economists are arguing that Dying for Growth, jointly edited by Dr Kim and published in 2000, puts too great a focus on health policy over broader economic growth.

“Dr Kim would be the first World Bank president ever who seems to be anti-growth,” said William Easterly, professor of economics at New York University. “Even the severest of World Bank critics like me think that economic growth is what we want.”

Dr Kim, who is president of Dartmouth College and a former head of the HIV/Aids programme at the World Health Organisation, was a surprise pick for the top job at the World Bank, which traditionally goes to a US citizen.

Little is known about his views on economic policy because his background is in health. But if he cannot set out a strong vision for how the World Bank will fuel growth, it may boost the campaigns of heavyweight rivals such as Ngozi Okonjo-Iweala, the Nigerian finance minister and former World Bank managing director.

Dr Kim’s book contains several inflammatory lines. For example, the introduction, which he and two other academics co-authored, says: “The studies in this book present evidence that the quest for growth in GDP and corporate profits has in fact worsened the lives of millions of women and men.”

But colleagues of Dr Kim and officials at the US Treasury said that when taken in context he was simply arguing that the distribution of gains from economic growth decides whether it makes life better for the poorest. They pointed out that such criticisms were widespread in the late 1990s and the World Bank had since changed its practices to take account of them.

It isn’t hard to see how self serving these attacks are. Notice who is making them: economists! When I was at the Atlantic Summit the week before last, Larry Summers made a remarkably transparent “why you need economists” pitch: all the problems the US was facing (big military commitments, need for more healthcare spending, perceived need to reduce the deficit as a percent of GDP) could all be solved with one magic bullet: growth!

Summers failed to acknowledge two inconvenient facts. First is that the world is running into serious resource constraints, with potable water the most pressing. Second is that economists haven’t done so well with their prescriptions. Advanced and quite a few developing economies have been redesigned along the lines recommended by orthodox economists, and the result has been greater income disparity, lower growth in the US as it abandoned giving wage growth policy priority, and more frequent and severe financial crises. In keeping, France is funding an effort led by Joe Stiglitz, Amartya Sen, and Jean-Paul Fitoussi to come up with a better measure of economic performance than GDP, since it focuses simply on output and misses other important considerations, such as social stability and environmental impact.

But Kim may indeed have demonstrated himself to be unsuited for a top bureaucratic post. Saying the emperor has no clothes will not make you popular with the emperor’s tailors.

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

Anyone who has been following my European commentary for any length of time will know that I have been running a number of risk themes on Europe due to what I consider to be misguided and one-sided policy which will ultimately be counterproductive.

These themes come under the major trend that I see in the Eurozone:

.. Periphery nations weakening, France in the middle, Germany outperforming, but the whole ship slowly sinking.

This analysis is based on the sectoral view of the European periphery which I explained on Monday in a discussion of the Australian economy:

As we have seen from nations like Greece and Portugal, a country with a long running current account deficit and a private sector with a desire – or no choice to save (austerity) – has significant problems trying to reach a government surplus. Once you understand that the external sector and the private sector are a net drain on national income it isn’t hard to see the problem. Under these circumstances there is simply no room left in the economy for savings in the government sector and attempts to reach government surpluses become counter-productive as this simply accelerates the decline.

If a country’s current account deficit is structural ( I’ll explain this later ) then these efforts are very dangerous because this can easily develop into a damaging feedback loop. The loss of income through the external sector leads to a loss of income in the private sector, this then drives the stronger desire to save, meaning government revenues fall further. This inevitably leads to calls for higher taxes, which once again drain income from the private sector … and around we go. The result of this dynamic is a rise in unemployment, therefore national production and income, meaning once again the government sectors revenue decline while private sector spending and investment fall further.

And the story is the same if you look at this from the perspective of national income. A country with a long running current account deficit has been borrowing goods and services from the rest of the world. In order to support this the non-external sectors of the economy will have expanding debt positions and due to this an economy structured around consumption over production. Because the external sector is a net drain on capital from the country, the government and/or private sector must continually expand their debt in order to maintain economic growth.

In many cases this debt accumulation leads to asset bubbles, because the expanding debt drives asset prices which attracts speculation and in doing so accelerates the external borrowing. This in turn drives up national income, which in turn drives higher prices and further speculation. If a sector’s debt is accumulating faster than its income then at some point in the future a limit will be reached and the rate of debt accumulation will fall. This leads to falling asset prices and national income, which ultimately leads to a crisis as accumulated debts start to sour.

This is what we have seen across the European periphery, although the debt has accumulated in different sectors of the economy across different countries. Ultimately, however, once a European country falls into crisis the debt has ended up in the government sector, even if it didn’t start there, because Europe has chosen to keep banks alive at all costs. This ideology, however, is the major issue with the “Austerity” plan.

After a financial crisis the private sector tends to have lost significant amounts of wealth which leads to both the loss of demand for, and ability to support new borrowing. The debts to the rest of the world still exist which tends to mean the external sector is still in deficit even with lower demand for imported goods. This means that in order for the nation’s income to remain at the previous level the government sector must go into deficit to offset the fall in private sector credit creation. If this does not occur then the economy will shrink until a new balance is found between the sectors, which basically means the economy will try to find equilibrium at some lower national income, and therefore GDP.

This is the sort of deflationary policy that Europe is endeavouring to implement in the European periphery. There is just one BIG problem. At a lower national income the country has no ability to service the debts that it accumulated on its previous income, yet that is what Europe expects to occur. This is simply delusional, because it is a mathematical impossibility and in trying to break these basic laws of arithmetic Europe is slowly destroying the economies of the European periphery which will, in turn, bring down the stronger economies.

Which brings me to last night’s Flash PMI data.

Flash Germany Composite Output Index(1) at 51.4 (53.2 in February), 3-month low.
Flash Germany Services Activity Index(2) at 51.8 (52.8 in February), 4-month low.
Flash Germany Manufacturing PMI(3) at 48.1 (50.2 in February), 4-month low.
Flash Germany Manufacturing Output Index(4) at 50.5 (53.9 in February), 3-month low.
Flash France Composite Output Index(1) falls to 49.0 (50.2 in February), 4-month low
Flash France Services Activity Index(2) remains unchanged at 50.0
Flash France Manufacturing PMI(3) drops to 47.6 (50.0 in February), 4-month low
Flash France Manufacturing Output Index(4) declines to 47.0 (50.8 in February), 7-month low
Flash Eurozone PMI Composite Output Index(1) at 48.7 (49.3 in February). 3-month low.
Flash Eurozone Services PMI Activity Index(2) at 48.7 (48.8 in February). 4-month low.
Flash Eurozone Manufacturing PMI (3) at 47.7 (49.0 in February). 3-month low.
Flash Eurozone Manufacturing PMI Output Index(4) at 48.8 (50.3 in February). 3-month low

And so you can see that the major theme continues. Stemming from that major theme ,and associated analysis, I have had some major expectations.

1. That Portugal would follow Greece.

This now appears to be occurring in ernest:

Portugal’s core public deficit nearly tripled in the first two months of 2012, showing a deepening economic slump is denting tax collection and stoking concerns the country may miss its budget targets and follow Greece in requiring more rescue funds.

The gap widened to 799 million euros ($1.06 billion) from 274 million euros a year earlier, when the deficit had slumped by more than 70 percent, the finance ministry’s budget office said on Tuesday.

2. Spain was a large unrecognised problem that would return to the spot light:

The country has seen its yields tumble since December on the back of the ECB’s 3-year LTRO but there hasn’t been anything in the economic metrics of the country to support such action. Spain has 23% unemployment and still rising, the banking system is under-capitalised and still has unknown exposure to the country’s housing market collapse. On top of that the rising unemployment rates is pushing up bad loans in the banking system to 7.4%, a 17-year high, and they are still rising.

Since I made that statement bad loans have risen further, house prices have continued to fall and the government’s debt position has worsened.

3. Italy could grow out of its economic slump but was unlikely to owing to history, structure and demographics:

The real problem in Italy is that its economy has been stagnant for nearly the entire decade. According to the IMF, among all countries in the world between 2000-2010 Italy only grew faster than Haiti and Zimbabwe. In 2010, Italian GDP was only 2.5% higher than in 2000. This problem is actually made worse by the fact that this is such a long term trend. Italy’s per-capita GDP growth was 5.4% in the 1950s, 5.1% in the 1960s, 3.1% in the 1970s, 2.2% in the 1980s and 1.4% in the 1990s. Since the new millennium the country has hardly moved forward and if we extrapolate out that trend Italy will spend the next decade in contraction.

On top of stalling growth, Italy has a demographics issue. With a debt to GDP ratio at 120% along with a population with a median age of approximately 45 Italy really does look like the Japan of Europe. The only problem is Japan is competitive, runs a trade surplus and is sovereign in its own currency. Italy has none of these things.

The latest stats from Italy appear to show that the economy continues to weaken and GDP continues on its long running downward trend.

4. Although the ECB’s emergency response to the crisis may have averted the crisis in the short term, it is likely to lead to a zombification of the periphery banking system and therefore add to the downward pressure on periphery economies.

The jury is still out on this one because we need to wait for the ECB’s Quarterly bank lending survey to get the results. This was noted by FTAlphaville overnight:

The effectiveness of the LTROs, and other extraordinary operations of the ECB, can at the moment be judged by some metrics (and general sentiment) positively. However, it seems a bit rash to call them an “unquestionable” success until the liquidity is actually shown to improve bank funding markets, and ultimately land in the real economy.

So we will just have to wait and see on that one. Overnight we also saw news that Ireland, the strongest of the periphery in terms of export potential, fell back into recession due to falling trade volumes.

In total, it is fairly clear to me that Europe’s troubles are far from over because the area continues to meet my predictions. That, however, didn’t stop Mario Draghi from trying to convince the world otherwise:

European Central Bank President Mario Draghi has said the worst of the eurozone crisis is over. In an interview with Germany’s Bild newspaper, he said the situation in Europe was “stabilising”.

Mr Draghi also said that some economic data, including inflation and budget deficits, showed that Europe was doing better than the United States.

The European crisis and the associated delusional rolls on.

I hate beating up on Gillian Tett, because even a writer is clever as she is is ultimately no better than her sources, and she seems to be spending too much time with the wrong sort of technocrats.

Her latest piece correctly decries the fact that no one has the foggiest idea of what might have happened if Greece defaulted (note that we are likely to revisit this issue in the not-too-distant future). But she makes the mistake of assuming the problem could have been solved (in the mathematical sense, that the outcome could have been predicted with some precision) by having better data. That is a considerable and unwarranted logical leap:

Today banks and other financial institutions are filing far more detailed reports on those repo and credit derivatives trades, and regulators are exchanging that information between themselves. Meanwhile, in Washington a new body – the Office of Financial Research (OFR) – has been established to monitor those data flows and in July US regulators will take another important step forward when they start receiving detailed, timely trading data from hedge funds, for the first time.

But there is a catch: although these reports are now flooding in, what is still critically unclear is whether the regulators – or anybody else – has the resources and incentives to use that data properly. The bitter irony is that this information tsunami is hitting just as institutions such as the Securities and Exchange Commission are seeing their resources squeezed; getting the all-important brain power – or the computers – to crunch those numbers is getting harder by the day.

That means that important data – on Greece, or anything else – could end up languishing in dark corners of cyberspace. That is a profound pity in every sense. After all, if the data could be properly deployed, it might do wonders to show how the modern global financial system really works (or not, in the eurozone.) Conversely, if data ends up partly unused, that not just creates a pointless cost for banks and asset managers – but could also expose government agencies to future political and legal risk, if it ever emerges in a future crisis that data had been ignored.

Since important information about the last crisis has been given short shrift, it’s a given that more data won’t necessarily yield a commensurate increase in understanding. We’ve lamented how, for instance, a critically important BIS paper debunking the role of the saving glut in the crisis and the use of the “natural” rate of interest in economic models, has been largely been ignored. Similarly, from what we can tell, there is perilous little understanding of how heavily synthetic and synthetic CDOs turned a US housing bubble that would have died a natural death in 2005 into a global financial crisis.

And Tett’s focus on “data”, no doubt reflecting the preoccupation of the officialdom, is a big tell. Economists routinely exhibit “drunk under the streetlight” syndrome: they prize analyzing big datasets, aren’t good at developing them (this was a huge beef of Nobel Prize winner Wassily Leontief), and pretty bad at doing qualitative research (they’d rather to do thought experiments and even when they undertake survey research, the resulting studies have strong hallmarks of a failure to do proper development and validation of the survey instrument).

Now, to the prospects for performing diagnostics and preventing the next crisis. One the one hand, it is a disgrace that the authorities didn’t have a good grip on who was on the wrong side of Greek credit default swaps. The US banks were thought to be reasonably exposed; that’s one reason Treasury Secretary Geithner was unduly interested in this situation (recall when Geithner intervened what was seen as decisively against an Irish effort to haircut €30 billion of unguaranteed bonds?). This is inexcusable, particularly in the wake of the financial crisis. We’ve harped on the fact the likely reason that Bear was bailed out was due to its credit default swap exposures. At the time of the Bear failure, Lehman, UBS, and Merrill were seen as next. The authorities went into Mission Accomplished mode rather than putting on a full bore, international effort to get to the bottom of CDS exposures. And the Greek affair suggests they’ve continued to sit on their hands.

This matters because, as Lisa Pollack illustrated in a neat little post, supposedly hedged positions across counterparties can quickly become unhedged if one counterparty fails. So a basic data gathering exercise would at least help in identifying who is particularly active and has high exposures to specific counterparties and products.

But this is of less help with big financial firms than you might think. While Lehman was correctly seen as being undercapitalized well in advance, pretty much no one foresaw Bear’s failure. It went down in a mere ten days. Confidence is a fragile thing. Similarly, while some positions are not very liquid or all that easy to hedge (think of our favorite bete noire, second liens on US homes), in general big financial firms have dynamic balance sheets. With more extensive reporting, could regulators have seen and intervened in MF Global’s betting the farm on short-dated Italian government debt? Even if they had perceived the risk, Corzine would have argued that the trade would have worked out (and it did even though the firm failed by levering it too much).

And think what would have happened if the regulators had gone in. In our current overly permissive regime, intervening to shut down MF Global would have been seen as the impairment or destruction of a profitable business. No one would know the counterfactual, that the firm would not only die but also lose customers boatloads of money. Or a swarm by regulators could have precipitated a customer run, again taking the firm down. In the current environment where executives have good access to the media and highly paid PR professionals to present their aggrieved messaging, it’s going to take some pretty tenacious and articulate regulators to swat back their arguments.

While it is hard to object to having better data, and we desperately need better information in some key policy areas (the lack of good information in the housing/mortgage arena and in student debt is appalling), more data is unlikely to get us as far in the financial markets sphere as Tett hopes. The problem is, as we and others have discussed before, is that the financial system is tightly coupled. That means that processes progress rapidly from one step to another, faster than people can intervene. The flash crash is a recent example.

There are many reasons why tightly coupled systems are really difficult to model. They tend to undergo state changes rapidly, from ordered to chaotic, and you can’t see the thresholds in advance. And financial systems also have the nasty tendency for products that were uncorrelated or not strongly correlated to move together as investors dump risky positions and flee for the safest havens. So exposures that might not seem to all that problematic can become so when the system comes under stress (who in fall 2007 would have thought that auction rate securities would blow up, for instance, or more important, in the heat of the crisis, even Treasuries were not accepted as repo collateral?).

And this problem is made worse by the fact that economists have long been allergic to the sort of mathematics and modeling approaches best suited to this type of analysis, namely systems dynamics and chaos theory. I discussed both these aesthetic biases at length in ECONNED, but the very short version is that following Paul Samuelson, economists have wanted to put the discipline on a “scientific” footing, and that meant embracing the “ergodic” axiom. Warning: a lot of natural systems aren’t ergodic. The ergodic assumption means no path dependence and no tendency to equilibrium. If you get a good enough sample of past behavior, you can predict future behavior. If you think these are good foundation for modeling financial markets, I have a bridge I’d like to sell you.

If we want to reduce the frequency and severity of financial crises, it isn’t a data problem. It’s a systems design problem. As Richard Bookstaber wrote in his book A Demon of Our Own Design, published before the crisis, the most important thing to do in a tightly coupled system to reduce risk is reduce the tight coupling. Measures to reduce risk in a tightly coupled system often wind up increasing them because the tight coupling means intervention is likely to be destabilizing. And we all know what the big culprits are. It does not take better data capture to figure this out. Tett flagged two in her piece. The obvious one is credit default swaps. They serve no social value and are inherently underpriced insurance (adequate CDS premiums for jump to default risk would render the product uneconomic to buyers). Underpriced insurance, given enough time, blows up guarantors who take on too much exposure (AIG, the monolines, and the Eurobanks like UBS who had near death experiences by being de facto guarantors by holding synthhetic/hybprid AAA CDO tranches are all proof). But has anyone in the officialdom taken the remotest interest in addressing a blindingly obvious problem? No.

Similarly, Tett mentions that a Fitch study that ascertained that banks were back to their old habit of using structured credit products as repo collateral. We’ve also discussed how problematic that is; the BIS flagged it more than a decade ago. And despite the fact that it should be bloomin’ obvious that using anything other than pristine collateral for repo is a source of systemic risk, since it was a cause of trouble before, the officialdom is loath to intervene. They’ve bought the “scarcity of good collateral” meme pushed by the banks. While narrowly that is correct, they haven’t sought to question why so much collateral is really necessary. The big driver pre-crisis, as we pointed out, was the explosion in derivatives (as values fluctuate, counterparties have to post collateral or have their position closed out). The growth in those dubious CDS was a major contributor. Moreover (and this comes from someone who has worked with derivatives firms), many, if not most over the counter derivatives (and certainly the most profitable) are used to manipulate accounting and for regulatory arbitrage. The overwhelming majority of socially valuable uses of derivatives can be accomplished via products that can be traded on exchanges, but regulators have been unwilling to push back on the industry’s imperial right to profit, no matter how much it might wind up creating for the rest of us. (We admittedly have additional drivers post crisis, such as QE eating up Treasuries, but there is perilous little critical examination of the demand side of the equation).

So the answer does not lie in better data. It lies in the willingness of the authorities to stare down the financial services industry. And the next financial crisis is likely to be a necessary, but perhaps even then not sufficient, condition for that change in attitude.

Yves here. This post from MacroBusiness provides a good point of departure, and I’ll provide some comments further down.

By Sell on News, a global macro equities analyst. Cross posted from MacroBusiness

A little known fact about John Maynard Keynes, detailed in Jane Gleeson-White’s book “Double Entry” is that he was responsible for the development of national economic statistics and that he expected them to be aggregated only on a temporary basis.

It was being done for the war effort, and would, he reasoned, not be necessary afterwards. This certainly puts “Keynesianism” in a different perspective, and poses the intriguing question: where would we be without economic statistics?

The Economist recently had a leader “Don’t Lie to Me Argentina” in which it accused Argentina of some kind of unforgivable treachery for politicising its economic statistics. As if economic statistics aren’t political in their very nature (a heavy bias towards capital and against labour, for instance).

So in contrast to H&H [a fellow MacroBusiness blogger], who enthuses that without economic data we are “naked, bereft of meaning” I wish to present a very different perspective. I wish to briefly examine what it would mean not to have economic statistics. Here are a few implications, I submit:

1. We would have to stop being lazy in the way we construct meaning and do the work of creating meaning ourselves.
The worship of economic statistics encourages a certain passivity of mind because it presents us with a picture ready made that we can then seek to interpret. Trouble is, that picture is heavily biased. Imagine, for instance, if it included unpaid housework as was proposed in Keynes’ time? Economics just presents transactions and makes little distinction between good transactions and bad ones.

A natural disaster, for instance, is generally thought to be bad, but in statistical terms it is not because typically the reconstruction creates a lot of economic activity (witness the Japanese growth figures post Fukushima). What happens is that transactions are not seen as a reflection of reality; rather reality has to be fitted into the transactions. “We all must change our behaviour because GDP is not growing fast enough, or productivity is not improving enough”.

2. We would embrace a broader sense of meaning, one that did not involve just what can be measured.
Most economic growth statistics measure the exchange of consumer goods, because it is easy. Much harder to measure assets, because they are not continually transacted — that was why the asset bubbles in America were ignored for so long, because they are hard to measure – and harder again to measure long term infrastructure investment. It is impossible to measure culture, yet culture is essential to well being. Indeed, well being is not really measured, and when they have tried to use broader measures it is generally found that life has improved little despite the economic growth.

3. We would not have a financial/economics sector purporting to understand what they do not understand.
For example, the “inter-relationships” between various economic indicators (such as Friedmanites v Keynesianism). This is for the most part an intellectual fraud. There are the obvious conclusions – you can’t spend more than you own, for instance – that derive from housekeeping (that being the etymology of economics). But anything beyond that is either unknowable or a circular argument (for instance Friedman’s maxim inflation is always and everywhere a monetary phenomenon is a tautology dressed up as insight).

4. We would have a greater sense of how we can impel affairs as thinking creatures with free will, rather than being pushed about by the “economic system”.
There is a reason why economists are so poor at anticipating the future. Economic statistics are always retrospective and tell us little about what people are going to do – and it is what people DO that shapes the future. Of course the past will shape what people do, but it does not determine it. Money is a social construct and transactions are social arrangements. They are subject to individual and collective will, not the logic of a mathematical system.

5. We would not have the giant casino that is amusingly referred to as the global capital markets.
The use of algorithms, which poses deep dangers to the system, is only possible because of the blizzard of data and statistics. That is exactly what is being codified and manipulated. Intriguingly, one of the geeks made an interesting comment, saying that a 2-3% variation, which makes all the difference in GDP statistics between acceptable growth and recession is all but inevitable in his geek world. he could not understand why it is considered so significant. But that is our world, dominated by economic statistics.

So there are five reasons why we would probably be a lot better without all that data. Far from being naked, bereft of meaning, I would suggest we could put on some decent clothes and find some more substantial, dare I say it, real meaning.

Yves here. While I would come up with a different list of implications, I’ve long been struck with the fetishization of numbers, particularly when all numbers are not created equal. Transaction data, say the price at which a particular stock traded at for a specific order, is a hard number. But the overwhelming majority of economic statistics are “soft” in that they are constructions, and statisticians care a great deal about consistency over time. That is useful up to a point. The procedures that produce consistency mean that if the measurement fails to capture or underweights an issue that is becoming increasingly prominent, it will have obtained consistency at the expense of representativeness (the notorious non-farm payrolls “birth-death adjustment” is a classic of this type). And the caliber of official statistics had decayed due to reduced staffing thanks to budget cuts.

I wrote about some of the problematic behaviors that result from the propensity to give quantitative information, no matter how poor it may actually be, great weight, in an article, “Management’s Great Addiction.” One the symptoms, and it takes place way too often, is when people rely unduly on a single or very few metrics to analyze a complex phenomenon (think of the use of VAR to measure firm wide risk!). If you must measure to get a grip on a complicated situation, use more rather fewer views in (provided you don’t go for more just to have more but can find pretty reliable measures of different, important aspects of a complex situation).

And perhaps the most important habit to adopt is to be aware of the limits of your knowledge.

Yanis Varoufakis is a Greek economist who currently heads the Department of Economic Policy at the University of Athens. From 2004 to 2007 he served as an economic advisor to former Greek Prime Minister George Papandreou. Yanis writes a popular blog which can be found here. His treatise on economic theory ‘Modern Political Economics: Making Sense of the Post-2008 World’, co written with Nicholas Theocrakis and Joseph Haveli is available from Amazon.

Interview conducted by Philip Pilkington.

Philip Pilkington: Without getting into too much technical detail what is it that you refer to in your book Modern Political Economics: Making Sense of the Post-2008 World the ‘inherent error’ in all economic theories and models?

Yanis Varoufakis: The essence of the economists’ inherent error is that they erred into thinking it is possible to tell a credible story about how values and prices are formed in complex (multi-sector) economies that grow through time. For decades economists struggled to produce such a narrative. But all their best laid plans for piecing it together crashed on the shoals of indeterminacy. Put simply, their mathematical models could not be solved. At that point economists did one of two things: Either they accepted that it could not be done, or they introduced hidden (and sometimes not to hidden) assumptions that ‘closed’ their model at the expense of credulity (e.g. an assumption that the economy comprises a lone Robinson Crusoe-like figure, or a single commodity, or that all exchanges occurred in a timeless universe and at a flash of a fleeting moment). The former scholars were forgotten by history, as their papers never saw the light of day. The latter built up careers, sometimes radiant ones. Alas, their economics were riddled with only thinly disguised ‘tricks’ the purpose of which was to disguise economics’ ‘inherent error’.

PP: One consequence of this is that you believe a meaningful theory of value cannot be established, right? In this estimation both the old Marxist/Ricardian labour theory of value is as meaningless as the supposedly sophisticated marginal theory of value. Can you give a gloss on why this is the case and what consequences it has for political economy?

YV: Allow me to be tactful about what our book refers to as the economists’ inherent error (including Ricardo’s and Marx’s): If a theory of value cannot be ‘closed’ properly (or embedded in a mathematically appropriate manner) within a theory of growth, then we have to cut corners to do it.

Neoclassical economists cut corners either by telling stories about how an economy creates relative prices in the absence of time, or by narrating the real-time growth of some single-sector or single-individual economy. Ricardo and Marx, in contrast, allow for different sectors to grow concurrently but introduce a single sector economy through the backdoor by implicitly assuming that the degree of capital utilisation in the same across all sectors (so as to ensure that profit rates are also equal across sectors). In the end, the same inherent error rears its ugly head and pushes economists into interminable debates of little or no value. The consequence of this, for political economics, is that we get absorbed in a self-referential, introverted mindset that allows us to lose sight of a really-existing capitalist reality which refuses stubbornly to fit into well-behaved models.

PP: You mention that economists seem to always want to ‘close’ their models. This appears to me to be a somewhat desperate desire to create a deterministic system. Yet, even in physics determinism is generally recognised to be incomplete and ‘open’. Why are the economists still stuck back in the 19th century in this regard?

YV: All model builders have a natural tendency to ‘close’ their models. When we see a system of equations we immediately wonder whether it can be solved. When (and if) we discover a solution –‘closure’ in other words – we feel a sense of pride and, even, joy. So, yes, if you are in the business of building models, it is natural to aspire to mathematical ‘closure’. This aspiration comes natural to all: mathematicians of course but also economists and physicists (the latter have been, after all, gunning for the Theory of Everything for a long, long while). The difference between economists and physicists lies not in their ambition to ‘close’ their models. It lies in the following:

Physics is blessed with an object of study – let’s call it Nature – that does, normally, not give a damn about the physicists’ theories of it (the Heisenberg Principle excluded). This means that Nature provides an impassionate assessor of the physicists’ models. If their models have been ‘closed’ in a manner that defies logic (i.e. by means of illegitimate hidden axioms), then Nature will expose them. It will defy their predictions in the laboratory (or thought the telescope) in a manner that forces the physicists back to the drawing board. So, if a particular model cannot be ‘closed’ (because it is not solvable), Nature will ensure that the physicists come clean and admit that this is so.

Economics on the other hand, by virtue of being a social science, is caught up in the famous infinite regress problem. What this means is that there exists no neat separation between (a) the economists’ object of study and (b) our theories about it. Indeed, our theories are part and parcel of the world of phenomena that we are trying to theorise about (unlike a theory of thermodynamics which is quite independent of the thermodynamic phenomena under study). Thus, on the one hand, our models can never be properly ‘closed’ (since they are, by construction, ‘open’ theories/beliefs about theories/beliefs etc.) while, on the other hand, when they are illegitimately ‘closed-shut’ by the economists (by means of hidden axioms whose purpose is to ‘close’ the damned models at all cost) there is no objective test that can either confirm or deny the validity of these models. Put differently, the Social Economy can never come to an objective verdict on our economic models (e.g. on some theory of bond markets) simply because these models are an intimate part of our Social Economy (i.e. of the larger game within which agents form beliefs about particular bonds and about the bond market in general).

This great difference between physics and economics means that, whereas physicists gain their discursive power in society from managing to explain and to predict the world we live in, the economists gain their discursive power exclusively from:

(i) convincing the rest (who are not sophisticated enough to be able to discern that they managed to ‘close’ their models utilising logically incoherent and well hidden axioms) that they managed successfully to ‘close’ their models, and

(ii) the great utility that these models offer to financiers who use similar models in order to pretend to value risky assets (e.g. CDOs)

(iii) the political utility offered by these ‘closed’ models to anyone who wants to argue that capitalism is a socio-economic system as natural as Nature itself, and thus amenable to the 19th century mechanistic approach which helped humanity conquer electromagnetic and other such natural phenomena.

PP: But some might say that the economists DO have a reality to contend with and that reality came screaming back in 2008. This certainly isn’t the first time that a crisis has occurred and yet economists remain evasive or they arrogantly assert that their models can in fact deal with it, when it is clear to any objective observer that they cannot. Does this not indicate that there is something fundamentally different happening in the economics profession?

YV: Economists may very well have a ‘reality’ content, to the extent that they are creatures of this really-existing world. The problem is that their own circumstances, within this reality, are improved significantly the less their own models of this reality has to do with actual… reality. In other words, the economics profession concentrates its rewards (tenured positions, large research grants etc.) onto the economists whose models subscribe to certain norms. The most important of these norms is that the truth of the offered economics be self contained within ‘closed’ models whose ‘solution sets’ are rather narrow. To meet this demand economists must ensure that their models leave no room for inconveniently open-ended phenomena like… crises.

This leads us to the question (that you pose): So, how do economists respond when some real crisis hits? How do their account for the fact that when their model had left no room for it? The fascinating answer is that they assume the crisis to have been the result of a random ‘disturbance’. Something like a meteor falling on an otherwise harmonious Earth; an event that is to be untheorised per se. Then, they employ all their mathematical prowess in order to ‘study’ how the ‘system’ (i.e. capitalism) absorbs this shock. As you may imagine, the result of this ‘recovery’ path is founded on assumptions which can only yield one plausible answer: The process of adjustment to the shock of the crisis is best left to the markets which, prior to the crisis, were assumed incapable of causing a crisis!

PP: That’s really twisted. How do you think students are responding to this chicanery after the crisis? And maybe you could say something about how students are imbued with this mindset in the first place.

YV : There have been some interesting studies that reveal how common decency and ‘other’-regarding norms are weeded out of students of economics very early in their undergraduate career. Take the example of the generalised prisoner’s dilemma below:

Young men and women are given some money (e.g. $10) and asked to contribute (each one separately from the rest, and in perfect anonymity) all or part of it to a common purse. Then, the contents of the purse are multiplied by the factor of, say, three and the contents redistributed among all of them independently of their contribution. Clearly, the best outcome for the group is that each contributes all of his or her windfall to the common purse and, that way, each gets a return three times as large. The problem here is that there is a temptation to let others contribute while you do not (since that way you get your share of three times of their contributions and, to boot, you have also kept your own money).

What we find in experimental studies involving real students, who play the above game with real money, is something quite startling: students of economics were significantly less willing to contribute to the common purse. Moreover they were more pessimistic about the prospects that others would contribute! So the question arose: Is it that economics attracts the less cooperative, more ruthless young persons? Or is it that exposure to economics makes them relatively more ruthless, pessimistic and aggressive?

To find out, the experiments were repeated separately for first semester first year undergraduates (before they were ‘contaminated’ with economics or other subjects) and for students who had just graduated. Guess what: Amongst the fresh(wo)men who played the game, the ones that had chosen to major in economics did not behave differently to the rest. They were equally willing to contribute. Therefore no evidence was found supporting the hypothesis that economics attracts misanthropes. On the other hand, amongst graduates those with an economics training stood out from the rest: they were much less likely to contribute, and more pessimistic about the others. The conclusion is inescapable: a training in economics significantly increases the probability that a person becomes less sociable, more aggressive, less cooperative; in short, miserable.

Why and how is this indoctrination taking place? The answer is simple: Economists are all about creating determinate models; ‘closed’ models that predict behaviour. To do this, they need to assume a particularly narrow minded form of rationality (which I call ‘instrumental rationality’): you are rational to the extent that you deploy your means efficiently in the pursuit of given objectives. When a young person is told repeatedly that to be rational means to be ruthlessly instrumental (i.e. to treat others as a means to one’s own ends), and that contributing in this game is for sissies (or, more ‘scientifically’, irrational), is it any wonder that a training in economics makes young persons more brutish and nastier?

The end result is that youngsters with a heightened sense of civic responsibility either drop out of economics, in a bid to retain it, or manage gradually to shed it; to adopt ‘instrumental rationality’ in their own daily life and mindset. Suddenly, the models begin to shape the modellers, rather than the other way round. It is a subtle process of change that turns economists into simulacra of themselves in a hopeless pursuit of ‘closed’ models that validate their own sad ‘conversion’. Seen from a different perspective, what we have here is a remarkable Darwinian process that guarantees the survival and dominance, within economics departments, of the anti-social, aka instrumentally rational, fools.

As for the Crisis and its effects on economics students and departments, I am afraid it has done nothing to ameliorate this Darwinian mechanism within existing economic departments. The norms of instrumental reasoning are so powerful that not even the earthquake of the Crisis has had the power to unsettle them. I have a hunch, however, that what the Crisis will do is speed up further the rate of decline in the number of youngsters interested in studying economics. This is the good news. The bad news is that they will not turn to other social studies but to pseudo-disciplines like marketing, business, advertising etc.

PP: That’s fascinating, let’s continue to run with this for a moment. If what you say is true – and I believe the evidence is unquestionable in this regard – then economics is not a science whatsoever. It more so resembles a school of morality or even a philosophical cult. The old Greek Stoics spring to mind. They were a school of philosophy that not only taught certain ideas but demanded that their followers live these ideas in their day-to-day lives. But in economics the students aren’t even told that they’re signing up for a moral vision, a sort of religion or belief system, they’re told that they’re being initiated into an objective science. Perhaps you could reflect a little in that direction and its implications?

YV: Quite so. It is a priesthood that truly believes it is not a priesthood but, rather, a community of scientists. How do they manage to maintain this delusion? The simple answer is because their incantations involve rather advanced mathematics and their rituals are steeped in statistical tests and projections.

Indeed, in aesthetic terms, the economists’ papers, models, presentations seem indistinguishable from those of physicists, bio-statisticians etc. The only difference is that, unlike the latter, economists generate nothing more than analytical propositions about economic variables which are, as Popper would have pointed out, profoundly non-falsifiable. And here is the rub. Once their non-falsifiable (and thus non-verifiable) propositions are expressed, the statistical tests that follow (usually referred to as econometrics) give economists a great excuse to imagine that their models have been tested. But tested they never are!

Let me explain this in more detail, as it goes to the heart of your question: The economist first builds a model – say: M – that seeks to explain one or more variables (e.g. wages and employment). Once that complex mathematical model is ‘solved’ (just like a system of two equations in two unknowns, y and x, can be solved by means of a function that links y to x; e.g. y = 3x+5), a so called ‘reduced form’ equation (or system of equations) is derived from that solution. Let’s call this R. What economists are good at doing is demonstrating that R corresponds to M (i.e. when the mathematical relationship R holds, this is consistent with the solution of model M). The virtue of R is that is can be checked statistically: data is collected and used to show that, indeed, there is no evidence that R does not hold in real life. At that point, the economist celebrates with yelps of joy: “My model M has been proven to be consistent with reality.” Alas, what the economist forgets to add is the crux of the matter. And what is that? Two crucial facts:

(a) There is a plethora of models, in addition to M, that are also consistent with R. Which means, naturally, that there has been no demonstration whatsoever that model M has been verified (since an infinity of alternatives could explain R just as competently). Now, of course this is also true in non-experimental sciences like astronomy. Yet, economics is unique. This is why:

(b) Model M, like all possible economic models, can only squeeze their ‘reduced form’ R out of their edifice if dodgy assumptions are made regarding time and/or complexity; i.e. only if they axiomatically dismiss what I call the economists’ ‘inherent error’. The practical importance of this is that the imposition of these assumptions may have succeeded in deriving R out of M but that success is bought at the price of having lost any capacity to predict what a complex economic phenomenon will generate (as outcomes) in the future (recall that if you account properly for both complexity and time in model M, no R is possible). It is in this sense that, as I claimed above, no test of M’s predictive capacity (regarding events unfolding in real time) is possible.

This is a most peculiar failure: The hapless economist uses the same tools as acclaimed physicists and astronomers. She has trained for years to speak precisely the same language as them, to understand the same advanced mathematics, to deploy most complex statistical methods which are an essential part of the scientific toolbox. It is, understandably, incredibly difficult to accept that her work is a form of higher order superstition; a religion couched in the language of mathematics and statistics. Tragically, this is precisely what it is. Come to think of it, what is it that separates science from mythology? The fact that scientific propositions are not self-referential. That, in science (unlike in mythology), when the facts clash with the theory it is too bad for the theory.

E.E. Evans-Pritchard (the famous anthropologist) once offered a brilliant insight into the social success of the priesthood within the Azande society. The question he asked is similar to yours (regarding economists): If they get it so wrong so often, how should we explain their continuing dominance? When the Azande priests and oracles failed to predict or avert disasters, why did people continue to believe them? His explanation of the Azande’s unshakeable belief in witchcraft, oracles and magic goes like this:

Azande see as well as we that the failure of their oracle to prophesy truly calls for explanation, but so entangled are they in mystical notions that they must make use of them to account for failure. The contradiction between experience and one mystical notion is explained by reference to other mystical notions. Evans-Pritchard in his Witchcraft, Oracles and Magic among the Azande, 1937

Economics, I submit to you, is not much different. Whenever it fails to predict properly some economic phenomenon (which is more often than not), that failure is accounted for by appealing to the same mystical economic notions which failed in the first place. Occasionally new notions are created in order to account for the failure of the earlier ones. For instance, the notion of natural unemployment was created in order to explain the failure of the market to engender full employment and of economics to explain that failure. More generally, unemployment and excess demand (or supply) is ‘proof’ of insufficient competition which is to be fought by the magic of deregulation. If deregulation does not work, more privatisation will do the trick. If this fails, it must have been the fault of the labour market which is not sufficiently liberated from the spell of unions and government social security benefits. And so on. The fact that these ex post rationalisations of theoretical failure are narrated in mathematically complex language, and accompanied by myriad statistical ‘tests’, adds to their social power to silence critics without and doubts within.

Yves here. This is a short post, but don’t underestimate the significance. The big picture is that Chinese government has been tightening credit to try to lower inflation, with some success, and various commentators have been calling a soft landing outcome. But residential real estate sales took a tumble in November, and electricity use fell in January (although that may be in part due to the Chinese New Year). This is another sign that just as American economists were unduly confident in their ability to fine tune the economy in the 1960s, so too may analysts be overly optimistic about the ability of Chinese leadership to control its economy.

Cross posted from MacroBusiness

A week ago Phat Dragon was oozing calm in relation to what the January credit figures would say about the economy. Either an even 1 trillion yuan would be disbursed (the consensus), which would been fine, or a larger number would print, which would mean that the turnaround in monetary policy, as expressed through bank lending, was unambiguously here. Having now seen the new lending figure – a genuine tiddler at just 738 billion – (if that were a hooked fish, you’d throw it back in disgust) that state of calm has rapidly evaporated. The last time that a January month produced a smaller nominal new lending flow was in 2007. The economy has expanded by 77% since that time. Unless new lending jumps sharply in February – and by sharply Phat Dragon means a lift beyond even the extravagances of 2009 – then an annual loan supply north of 8 trillion yuan (and thus a total social financing provision that keeps pace with nominal GDP) is under serious threat.

A huge problem with relying on that to happen is that February lending has exceeded January lending exactly … let me just count this on my talons , … exactly, … bear with me … – exactly never. If an appropriate credit supply is not forthcoming, downside risks to already decelerating aggregate demand will emerge swiftly. In sum, Phat Dragon will reconsider his baseline 2012 forecasts if February loans do not break all sorts of records in addition to the Sinitic laws of seasonal motion.

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Wired’s Joel Johnson has written a stunning bit of PR for Foxconn, now-controversial supplier to the consumer electronics industry, duly wrapped in credibility-enhancing guilt over Western materialism.

The article, “1 Million Workers. 90 Million iPhones. 17 Suicides. Who’s to Blame?” pretends to be about Foxconn’s factories. But Johnson admits he’s a tech toy writer who apparently has no knowledge of manufacturing (I know I’ve had only limited contact with manufacturing, yet reading his piece, I’d bet serious money that I’ve seen more manufacturing operations than he has by dint of being a coated paper brat and doing due diligence on some oddball tech deals over the years, as well as visiting a motherboard maker back in the stone ages when motherboards were made in the US). Yet he’s remarkably uninhibited in using his fantasies and abject ignorance as a basis for making sweeping generalizations about the Taiwanese powerhouse. For instance:

In the part of our minds where Americans hold an image of what an Asian factory may be, there are two competing visions: fluorescent fields of chittering machines attended by clean-suited technicians, or barefoot laborers bent over long wooden tables in sweltering rooms hazed by a fog of soldering fumes.

When we buy a new electronic device, we imagine the former factory. Our little glass, metal, and plastic marvel is the height of modern technological progress; it must have been made by worker-robots (with hands like surgeon-robots)—or failing that, extremely competent human beings.

But when we think “Chinese factory,” we often imagine the latter. Some in the US—and here I should probably stop speaking in generalities and simply refer to myself—harbor a guilty suspicion that the products we buy from China, even those made for American companies, come to us at the expense of underpaid and oppressed laborers.

Huh? Is he serious about this? Anyone who has been following China even slightly would imagine Chinese factories aren’t like Japanese car-makers, heavy on robotics, but are mainly labor intensive (with the exception of some sparkling new capital intensive factories where China is trying to go up the value added chain), and if they are in the Pearl River Delta, makers of watches, clothing and toys (hence not much soldering). And if higher tech, the operations HAVE to be pretty to very clean. But no, everyone in the Wired readership is assumed to share his blinkered imagination.

This extract really does serve as a window onto the entire piece, because it is unduly involved in his inner process, and is remarkably ungrounded in reality-vetting. Yes, he did visit a Foxconn factory, on a guided tour organized and led by executives and PR giant Burson Marsteller. That fails the objectivity smell test. Did he try to talk to Foxconn workers outside the factory? Ex Foxconn workers? Apparently not. The only perspective he has outside his guided tour and his noisy imagination is from one Paul, a “steward for Western electronics companies seeking to procure components or goods from one of the city’s thousands of suppliers.” Do you think someone who makes his living connecting Western tech executives to Chinese manufacturers is going to say ANYTHING bad about the biggest fish in the electronics pond?

The piece goes to obvious lengths to soften the perception of the situation. He frames his account in terms of the suicides, when the recent New York Times series on Apple and Foxconn did not focus on those deaths, but the extreme hours and sometimes grinding physical toll (such as workers getting swollen feet from standing and working more than 24 hours straight). So the article skips almost completely over that issue, juxtaposing the seeming niceness of the clean factory he visited versus the deaths, and only very much later gets to the conditions that produced the suicides.

Johnson is quick to claim that the Foxconn suicides are one-fourth the level of that of college students. So even the most attention getting factoid is not so bad, right? Not so fast. The right comparison is not the number of suicides to Foxconn’s total workforce, since only the employees who killed themselves on site are probably the ones that are included in that total. If a worker killed themselves off site, you can be sure it would be attributed to something else (and it would be hard to parse out the causes). Moreover, it is the workers who live on site, who are about 1/4 of all employees, who are subject to the most extreme work hours (the New York Times recounts how they were roused at midnight to meet an Apple production demand). So this means the suicide rate at least as high as that of college students.

And to be apples to apples (pun intended), you’d need to compare suicides at Foxconn to suicides by college students on campus, which would presumably be more closely correlated with the stress of campus life, than of students who were simply enrolled in college. So it is very likely that a more accurate measurement would have Foxconn showing a markedly higher suicide rate than those of college students.

Finally, and I hate to be morbid, but a highly regimented, low privacy environment like Foxconn probably reduces the number of suicides below what you might otherwise observe. You have many fewer options for offing yourself available to you if you are living on site at Foxconn compared to a US college student (I am not making this up: gunshot is out, pills are probably too costly to procure, slitting your wrists actually takes proper technique). And Foxconn now has netting up to prevent jumping off most buildings and presumably also has its guard force on closer watch. That means the suicide rate probably understates the level of stress experienced by the workers who live on site.

He also bizarrely tries to bifurcate the work content, which he makes sound OK but boring, from what critics charge are more than occasional extreme hours, and completely ignores safety problems that add to the Foxconn death count, highlighted in a New York Times article at the end of January:

But the work itself isn’t inhumane—unless you consider a repetitive, exhausting, and alienating workplace over which you have no influence or authority to be inhumane. And that would pretty much describe every single manufacturing or burger-flipping job ever.

Huh? “Every single manufacturing job ever”? Some manufacturing jobs ARE inhumane. Start with the meatpacking industry in the US. But there is a lot of light manufacturing where the work is not highly repetitive, and that is also true in highly capital intensive factories like the paper industry. This “all manufacturing jobs are bad, therefore Foxconn is not so bad” is simply a baldfaced assertion.

Now I am not saying that there is not a case to be made in defense of Foxconn. But this article is an embarrassment. It’s an intellectually lazy way to assuage the guilt of Wired-reading gadget-owners. For instance, he resorts to “everyone in an advanced economy is guilty” as a way of diminishing the issues specific to Foxconn:

Every last trifle we touch and consume, right down to the paper on which this magazine is printed or the screen on which it’s displayed, is not only ephemeral but in a real sense irreplaceable. Every consumer good has a cost not borne out by its price but instead falsely bolstered by a vanishing resource economy. We squander millions of years’ worth of stored energy, stored life, from our planet to make not only things that are critical to our survival and comfort but also things that simply satisfy our innate primate desire to possess. It’s this guilt that we attempt to assuage with the hope that our consumerist culture is making life better—for ourselves, of course, but also in some lesser way for those who cannot afford to buy everything we purchase, consume, or own.

There is a huge, unexamined leap between “things critical to our survival” and those critical to what we have come to define as our comfort. It’s the unwillingness to examine the difference between the two, or any serious question raised by the role of Foxconn, that makes this piece so dubious. (And this is not an idle observation in my case. Your humble blogger fights planned obsolescence tooth and nail: I used a NeXT computer for 10 1/2 years, a TiBook for over 8, and am still using a Nokia that is probably from 2005. I am writing this post using an Apple monitor from 2002).

I find this little chart (hat tip Richard Smith) from ninety9 via Alea (who is the antithesis of a socialist) to be more though-provoking than the entire Wired piece:

There have been numerous articles complaining about how the Chinese don’t consume enough, and the blame is laid on the high savings rate, which is in turn attributed to the lack of social safety nets (and a second, related issue is the lack of retail infrastructure). Yet it was a sonofabitch capitalist, Henry Ford, that helped create the American middle class in 1914 by paying his workers double the prevailing rate, which partly paid for itself by reducing costly turnover and increasing productivity (well paid workers are grateful workers and want to help their company what a thought!). But the big benefit for Ford was the higher wages were in large measure met by manufacturers in other cities, and created a consumer base for Ford’s own big ticket product. It was not safety nets that created higher consumption and greater American prosperity; it was higher wages.

Ford didn’t see his pay raise as a wage increases but as profit sharing. The chart Alea highlighted shows Apple could kick start a revolution in China that would help American companies, including Apple, at comparatively little cost to itself. What stood in the way when Jobs was alive was his monumental ego and his desire to leave a legacy though his products rather than his conduct as an industrialist. And now that he is dead, Apple’s practices are likely to be guided by American short-sightedness and bad incentives for executives of public companies.

By Marshall Auerback, a portfolio strategist and hedge fund manager. Cross posted from New Economic Perspectives

Another day andthe markets remain fixated on whether Greece comes to a “voluntary” arrangement with its creditors. The key word is“voluntary” because the myth of “voluntary compliance has to be sustained so that those deadly credit default swaps avoid being triggered.

But let’s face it: Greece is a pimple. If the rest of the euro zone could cut itlose with a minimum of systemic risk, Athens would have long gone the way of Troy. The real issue is whether the credit default swaps trigger such a huge mess with the counterparties that it creates renewed systemic stress which more than offsets the benefits to the holders of the CDSs.

The more interesting question is: suppose Greece finally does get a deal? I realize everybody says it is a “one-off”, but do you really think the Irish, Portuguese, or even the Spanish and Italians will go along with that, particularly if (as is likely) they continue to experience double digit unemployment and minimal growth?

Now you could argue that Portugal and Ireland, like Greece, are but small components of the European Union and could well be covered in one form or another via the existing backstops established over the last several months, notably the European Financial Stability Fund (EFSF) and the European Stability Mechanism(ESM).

But you can’t say this about Spain, which remains the real elephant in the room – not Italy – even though Spain’s borrowing costs remain lower than Italy’s. This is perverse.

Though Italy has a high sovereign debt, it has a low private debt (the product of years of high budget deficits, but that’s the story for another blog). Italy has a fiscal deficit that is low relative to most economies today. It already has a primary surplus.The greater than expected past expansion of the ESCB and the current ongoing LTROs are likely to absorb panic and forced selling of Italian debt. The Italian 10-year yield could fall back below 5% (having already fallen from the 7% plus levels, pertaining a mere 6 weeks ago).

In theory, this rally in bond yields should lead to a reassessment of the gravity of the Italian problem and therefore the European sovereign debt and banking problem. That could be positive for equity markets and, indeed, has been so since the start of the year.

But does Spain truly deserve the borrowing advantage it now has in relation to Italy? Its 10-year bonds are yielding some 60 basis points lower. True, its sovereign debt to GDP ratio is low at about 75%, but partof its enormous private debt will almost certainly have to be “socialized.” Moreover, Spain has virtually the highest non-financial private debt-to-GDP ratio of all the major economies. Its ratio is almost twice that of Italy’s. Its fiscal deficit last year was probably higher than the official estimates, close to 9% of GDP (the previous Socialist government routinely lied about its figures – in fact, no country, not even the US, has lied more extensively about the condition of its banks. Spain, relative to GDP, has the largest shadow real estate inventory in the world, with the possible exception of China, which probably doesn’t even have a reliable second or third set of books).

Let’s be clear about one thing: this is not a tale of Mediterranean “profligacy”, as least as far as public spending was concerned. Anybody looking at Spain through a sensible financial balances framework in the mid-2000s would have observed that the private sector was being squeezed badly by the fiscal drag. The external position was in deficit (current account) which means the public and external balances were draining growth from the economy. Yet it still boomed up into the onset of the crisis. How did that happen?

The profligates were all in the private sector, although you could readily argue that the government’s “responsible” fiscal policy created the conditions for a private sector debt binge. Prior to 2008, the Spanish economy was held out as the darling of Europe however the reality was quite different. The country was running budget surpluses by 2005 and foreign investment was booming. Most of this investment went into construction which was stimulated by a massive real estate boom.

A few years ago, using data from the Banco de España (central bank) Bill Mitchell graphed the national budget deficit as a percentage of GDP for Spain and the EMU overall from 1989to 2008 (data for the EMU clearly didn’t start until 1995). As Mitchell notes, one can observe the tightening of fiscal positions as the Growth and Stability Pact provisions were forced on the EMU nations:

EMU and Spain: Budget deficit % of GDP,1989 to 2008

Consistent with a tightening fiscal position leading to surpluses in 2005, the only way that this boom could continue was for the private sector to go increasingly into debt.That is exactly what happened and because the property boom was so large the debt levels were also very high – average household debt tripled. And that, in contrast to Italy, is the core problem with which Spain is dealing today to a substantially greater degree than Italy. So it’s wrong to lump the two together interchangeably as the markets have been doing. Paella and pasta don’tmix well together.

Okay, but that was the previous Zapatero Administration. Now we supposedly have a new “responsible” conservative government that promises to carry out the same policies even more resolutely. And look how successful they’ve been: Spain’s joblessclaims shot up a further 4% in January from December to 4.59 million, a sign that the euro zone’s fourth-largest economy is still shedding jobs at a record rate. All sectors posted more claims but the rise was sharpest for services at5.1%. In construction, weighed down by a four-year property slump, the number of residents registered as job seekers rose 2.1%. Compared with the same perioda year ago, overall claims rose 8%. GDP contracted 0.3%.

Okay, “give them time”, argue the defenders of the new government. And, if the Rajoy Administration was truly embarking on a new policy course, that would be a fair comment. Unfortunately, this government has signed onto even tighter fiscal policy rules. Somehow they are expected to suck demand out of their economies through tax increases and spending cuts, but when the slower growth that results in means the target for deficit reduction is not met, the Spanish, like their Greek, Irish, Portuguese and Italian counterparts, will be punished for it.

Eventhe Rajoy Administration implicitly appears to recognize this danger, as it is already moving the goalposts in regard to its spending cuts targets as a percentage of GDP. Unfortunately, they blame this on external circumstances beyond their control. To the extent that they agree to submit themselves to rules which were routinely disobeyed by the Germans and French during the EMU’s inception, that is true, although theSpanish government refuses to acknowledge that their resolute tightening fiscal policy ex ante might well have something to do with the fact that Spain’s economy continues to deflate into the ground ex post. Remember, the history of the Stability and Growth Pact has long demonstrated that these nonsensical rules are already impossible to keep within during a significant downturn. And now the new Spanish government wants to tighten them even further and invoke pro-cyclical fiscal reactions earlier.

This, at a time when the national unemployment rate is approaching 23%, and the youth unemployment rate (25 yearsor younger) is at 49%, according to the latest Eurostat data.

Sonearly 50 per cent of willing workers under the age of 25 in Spain are without work and will remain like that for years to come. That will damage productivity growth for the next decade or more. It is an indication that the monetary system has failed and attempting to reinforce those failures with more austerity will only make matters worse. The new government’s proposed fiscal policy “reforms” are particularly toxic policy mixture for Spain.

Of course, the ongoing threat of a disorderly default in Greece also remains a potentially dangerous area if it is not contained by the ECB’s actions. But it’s more interesting to see what happens as the magnitude of Spain’s problems become more apparent. Will the troika tell Spain that a Greek style 70% haircut is not in the cards? Will they try to suggest that the government is rife with corruption, that the country is chock-a-block full of scoff-laws and tax evaders, and that the efficient Germans would do a much better job of collecting taxes?

Spain is still a relatively young democracy. The transition began a mere 37 years ago when Francisco Franco died in 1975, but there was an attemptedcoup by Antonio Tejero as recently as 1981. This is worth pondering whilst observing the implosion of Spain’seconomy. The decision for Europe’s bosses is this: they must ultimately confront the consequences of their policy choices. They can destroy the eurozone by continuing with the same failed mix of policies or by salvaging it by adding what has been missing from the outset: a mechanism for shifting surpluses to the deficit regions in the form of productive investments (as opposed to handouts or loans). Turning states like Spain into sundrenched economic wastelands within the eurozone, andforcing the rest of the currency area into a debt-deflationary spiral, is a most efficient way of blowing up the whole system and possibly threatening the very existence of Spanish liberal democracy itself.