Category Archives: Economic fundamentals

Richard Alford: If War Is Too Important To Be Left To The Generals, Isn’t Economic Policy Too Important To Be Left To Economists?

By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.

Apologies to both Clemenceau (Prime Minister of France 1917-1920) and General Jack D. Ripper (Dr. Strangelove 1964)

The recent crisis and continuing economic and financial dislocations has led many to question the usefulness of the current macroeconomic paradigm, if not economics more generally. Raghuram Rajan, whose paper, “Has Financial Development made the World Riskier,” was summarily dismissed at the Fed Jackson Hole Conference in 2005, has recently posted a piece titled “Why Did Economists Not Foresee the Crisis?” In this piece, Rajan rejects three popular explanations for the failure of economics and economic policy, i.e. the absence of “models that could account for the behavior”, “ideology”, and “corruption”. Rajan offers alternative explanation(s): “I (Rajan) would argue that three factors largely explain our (economists) collective failure: specialization, the difficulty of forecasting, and the disengagement of much of the profession from the real world.” The logical conclusion of Rajan’s explanation(s) is that to avoid future crises, the role of economists, or at least academic economists, in the policy formulation process should be reduced. More troubling yet for economists, including Rajan, is some recent work by Frydman and Goldberg which argues that current economic models are inherently flawed.

Rajan dismisses the argument that economics lacked relevant models. He cites the fact that academic economists have studied and modeled many of the factors that contributed to the crisis. Rajan does, however, cite the compartmentalization of economics which leaves macroeconomists ignorant of findings in other sub-disciplines of economics.

In Rajan’s view, the inability to forecast accurately reflects shortcomings in the current model. All models of the economy abstract from the complexities of the economy and financial system. Models are simplifications of realty. Hence the models are incorrect. (We will return to this point later.) The only questions are how large and costly will the model-driven errors be.

Observers should not be surprised by the fact that the models employed by economists contained simplifying assumptions. However, they should be disturbed by the recent performance of policymakers. They ought to ask the question: why did economists remain wedded to their model despite the growth of all the macro-economically important economic and financial imbalances and unsustainabilities that existed in the years prior to the crisis?

Steve Keen: Dude! Where’s My Recovery?

By Steve Keen, Associate Professor of Economics & Finance at the University of Western Sydney, and author of the book Debunking Economics. Cross posted from Steve Keen’s Debtwatch.

I initially planned to call this post “Economic Growth, Asset Markets and the Credit Accelerator”, but recent negative data out of America makes me think that this title is more in line with conversations currently taking place in the White House.

According to the NBER, the “Great Recession” is now two years behind us, but the recovery that normally follows a recession has not occurred. While growth did rise for a while, it has been anaemic compared to the norm after a recession, and it is already trending down. Growth needs to exceed 3 per cent per annum to reduce unemployment—the rule of thumb known as Okun’s Law—and it needs to be substantially higher than this to make serious inroads into it. Instead, growth barely peeped its head above Okun’s level. It is now below it again, and trending down.

Chinese Real Estate Bubble Finally Imploding?

The warnings of successful shorts like Jim Chanos, old Asia hands like Frank Verneroso, and economists like Victor Shih and Michael Pettis have failed to curb enthusiasm for the belief that the rise of China is inevitable and unstoppable. As someone who was deeply involved with Japan when it was seen as destined to replace the sclerotic US, I’ve learned to regard more or less straight line growth projections with considerable skepticism.

China has accomplished the impressive feat of bringing literally hundreds of millions out of poverty in a comparatively short time frame. It has also studied the Japanese playbook and managed to avoid some of its pitfalls (of course, it has the advantage of not being a military protectorate of the US), in particular refusing to liberalize its financial markets (some accounts of the Japanese bubble and burst give considerable weight to overly rapid deregulation and the growth of what was then called zaitech, or financial speculation). is also hostile to neoclassical economists.

China escaped much of the impact of the global financial crisis by ramping up investment even higher than its pre-crisis level. It now has investment approaching 50% of GDP, an unheard of level on a sustained basis. A big chunk of that is housing related (housing is an estimated 13.5% of GDP), and prices have long been considerably out of line with incomes, a telltale sign of a bubble. In Beijing, admittedly one of the hottest markets, an average priced new apartment was equal to 57 years of average worker savings (and if you tried to pay for it with a super-long dated mortgage, you’d be in hock even longer, since you would also need to cover the interest charges).

Another warning sign is inventory overhang; the Wall Street Journal reports tonight that Standard Chartered forecasts that level of unsold apartments in secondary cities will amounts to roughly 20 months of sales by year end (and that’s before considering that many of the apartments are being acquired as investments rather than for use).

The Journal story tonight provides evidence that the Chinese housing market is going into reverse

William Dudley on Economic Policy

Cross -posted from Credit Writedowns New York Fed Chief William Dudley gave a speech yesterday called “U.S. Economic Policy in a Global Context” (hat tip Yves Smith). Dudley’s overall aim was to show that one must regard US policy in an international context and not based on domestic factors alone. I think the whole Speech […]

Philip Pilkington: Down in the Hole – Is America Becoming the Next Japan?

Philip Pilkington is a journalist currently sinking, together with the rest of his fellow countrymen, down into the hole in the Irish banking system

Will all your money
Keep you from madness
Keep you from sadness
When you’re down in the hole

Cause you’ll be down in the gutter
You’ll be bumming for cigarettes
Bumming for nylons
In the American Zone
–‘Down in the Hole’, The Rolling Stones

Everyone who is anyone is saying it: the US looks set to become the next Japan. Yet the particulars of the argument are never really trashed out. Certainly both countries suffer from the same malady – namely, a bursting asset bubble punching gigantic holes in private sector balance sheets. This leads to similar policy approaches – not to mention similar policy failures. But beyond this overarching comparison people tend not to tread.

Let’s start from the beginning; the asset bubbles that set off the crises.

Kevin O’Rourke on the Irish/Eurozone Mess

This INET video focuses on how Ireland got into its mess as well as the domestic and international political dynamics as to how it is being resolved. There is an interesting tension between the cool talking head style and some of the coded descriptions of the stresses and the stark choices at hand.

Alexander Gloy: Merkel to Sinn: “In my office. NOW.”

Yves here. Outbreaks of candor and foresight among the political classes are so rare that they bear watching. As Gloy’s sighting suggests, they have to be arrested quickly lest they prove to be contagious.

By Alexander Gloy, CIO of Lighthouse Investment Management

Hans-Werner Sinn, head of German research institute Ifo, has just put his life into peril. He had to pick a Swiss magazine (“Bilanz”) to express what nobody else is allowed to mention in Germany: “Greece is a bottomless barrel”.

Quelle Surprise! Banks are Concerned About Mortgage Slowdown

An old Yankee saying: “Fool me once, shame on thee. Fool me twice, shame on me.”

It seems not to have occurred to the banking industry that relying people to be fools on an ongoing, large scale basis is not a viable business model. Investors have come to realize a bit late in the game that private label securitizations were structured so as to be far too favorable to the originators and servicers: too little disclosure, too many abuses, too little accountability, combined with impediments to seeking redress in court. Borrowers feel every bit as stung between deteriorating housing markets, foreclosure malfeasance, and doubts over chain of title.

It isn’t simply that banks have been slow to ‘fess up and clean up; instead, they’ve kicked and screamed at every possible reform measure, from pro investor reforms such as a very good FDIC proposal that got watered down to nothingness and a weak 5% risk retention rule (which Dean Baker estimates will add all of 0.13% to the yield on a mortgage) to pretty much anything that would help borrowers. And that’s before we get to widespread evidence of incompetence (continuing stories of foreclosing on people who don’t have mortgages is the tip of the iceberg) and fraud.

It’s yet another sign of Banker Derangement Sydrome that the industry can think anyone outside of cash buyers in markets that have arguably bottomed would be keen about buying a house. But this American Banker reports reveals how they appear unable to recognize their role in creating this mess. They seem simply puzzled and a tad depressed that super low interest rates are producing only refis as opposed to home sales:

Michael Hudson: Will Greece Let EU Central Bankers Destroy Democracy?

Yves here. This is a long and important post. Hudson reports that he has gotten a great deal of correspondence from Greece saying that articles like this arguing against the pending stripping of Greece by banks are being translated and circulated widely to provide moral support. If you cannot read this piece in full, please be sure to read the discussion at the end of how Iceland stared down its foreign creditors.

By Michael Hudson, a research professor of Economics at University of Missouri, Kansas City and a research associate at the Levy Economics Institute of Bard College. Cross posted from CounterPunch.

Promoting the financial sector at the economy’s expense

When Greece exchanged its drachma for the euro in 2000, most voters were all for joining the Eurozone. The hope was that it would ensure stability, and that this would promote rising wages and living standards. Few saw that the stumbling point was tax policy. Greece was excluded from the eurozone the previous year as a result of failing to meet the 1992 Maastricht criteria for EU membership, limiting budget deficits to 3 percent of GDP, and government debt to 60 percent.

The euro also had other serious fiscal and monetary problems at the outset. There is little thought of wealthier EU economies helping bring less productive ones up to par, e.g. as the United States does with its depressed areas (as in the rescue of the auto industry in 2010) or when the federal government does declares a state of emergency for floods, tornados or other disruptions. As with the United States and indeed nearly all countries, EU “aid” is largely self-serving – a combination of export promotion and bailouts for debtor economies to pay banks in Europe’s main creditor nations: Germany, France and the Netherlands. The EU charter banned the European Central Bank (ECB) from financing government deficits, and prevents (indeed, “saves”) members from having to pay for the “fiscal irresponsibility” of countries running budget deficits. This “hard” tax policy was the price that lower-income countries had to sign onto when they joined the European Union…..

At issue is whether Europe should succumb to centralized planning – on the right wing of the political spectrum, under the banner of “free markets” defined as economies free from public price regulation and oversight, free from consumer protection, and free from taxes on the rich.

The crisis for Greece – as for Iceland, Ireland and debt-plagued economies capped by the United States – is occurring as bank lobbyists demand that “taxpayers” pay for the bailouts of bad speculations and government debts stemming largely from tax cuts for the rich and for real estate, shifting the fiscal burden as well as the debt burden onto labor and industry.

“Debtors’ Prison”: Bob Kuttner on the Costs of Rentier Rule

Bob Kuttner has an elegant and important article at American Prospect, “Debtors’ Prison“. It’s an evocative, historical form of the argument made here and elsewhere: that advanced economies have gone down a disastrously bad path in not writing down debt that can’t realistically be paid.

The usual poster child for “why not writing down debts is a bad idea” is Japan, but that isn’t gripping enough to evoke the right responses. Even though its post-bubble growth has been dreadful, Japan is still a well-run, tidy country with a low crime rate, universal health care, long life expectancy, and tolerable unemployment. That in turn is due to factors that do not obtain much of anywhere else: Japan was very cohesive to begin with, and its elites chose to have their incomes fall relative to everyone else to save jobs. Wage compression at large companies has increased dramatically. This is the polar opposite of what has happened in the rest of the world, where the gap between the haves and the have-nots has widened.

Kuttner provides another set of examples as to why we need to get the creditor boot off all our necks:

Philip Pilkington: Debt, public or private?: The necessity of debt for economic growth

By Philip Pilkington. Journalist, writer, economic anti-moralist and aficionado of political theatre

‘Tis not due yet; I would be loath to pay him before
his day. What need I be so forward with him that
calls not on me? – Falstaff, ‘Henry VII’

The Anxieties of Government and Debt

Apart from debt, there is perhaps one other economic phenomenon that generates exceptionally large amounts of emotive nonsense both on the internet and in real life – and that is government. So it’s quite unsurprising that when government debt is the discussion of the day, passions flare, accusations are hurled and the coming apocalypse is invoked.

It would be interesting to undertake a psychological study of modern man’s aversion to government and to debt. If I were to guess I would say that many people tend to associate government with authority and debt with obligation. Authority and obligation – surely in our era of selfish hedonism no other potential restraints are so terrifying to so many. These phenomena intrude rudely on one of our most cherished contemporary ideological myths: individualism. More specifically, that outlandish individualism conjured up by marketing men to flog their wares and crystallised in novels and narratives written by lonely and isolated individuals like Ayn Rand. It is, of course, a fantasy individualism; one that few truly adhere to in their day-to-day lives – but it is, like the religions of days gone by, an important determinate in the messages people choose to accept and those they choose to reject.

To put the questions of individualism and of liberty aside though, from an economic point-of-view debt is inevitable.

Bribes Work: How Peterson, the Enemy of Social Security, Bought the Roosevelt Name

Bribes work. AT&T gave money to GLAAD, and now the gay rights organization is supporting the AT&T-T-Mobile merger. La Raza is mouthing the talking points of the Mortgage Bankers Association on down payments. The NAACP is fighting on debit card rules. The Center for Budget and Policy Priorities and the Economic Policy Institute supported the extension of the Bush tax cuts back in December. While it seems counter-intuitive that a left-leaning organization would support illiberal extensions of corporate power, in fact, that is the role of the DC pet liberal. This dynamic of rent-a-reputation is greased with corporate cash and/or political access. As the entitlement fight comes to a head, it’s worth looking under the hood of the DC think tank scene to see how the Obama administration and the GOP are working to lock down their cuts to social programs.

And so it is that the arch-enemy of Social Security, Pete Peterson, rented out the good name of Franklin Delano Roosevelt, the reputation of the Center for American Progress, and EPI. All three groups submitted budget proposals to close the deficit and had their teams share the stage with Republican con artist du jour Paul Ryan. The goal of Peterson’s conference was to legitimize the fiscal crisis narrative, and to make sure that “all sides” were represented.

Now this tidy fact is not obvious if you check the Peterson Foundation publicity for its “Fiscal Summit:”

Michael Hudson: Replacing Economic Democracy with Financial Oligarchy

By Michael Hudson, a research professor of Economics at University of Missouri, Kansas City and a research associate at the Levy Economics Institute of Bard College. Cross posted from CounterPunch.

Soon after the Socialist Party won Greece’s national elections in autumn 2009, it became apparent that the government’s finances were in a shambles. In May 2010, French President Nicolas Sarkozy took the lead in rounding up €120bn ($180 billion) from European governments to subsidize Greece’s unprogressive tax system that had led its government into debt – which Wall Street banks had helped conceal with Enron-style accounting.

The tax system operated as a siphon collecting revenue to pay the German and French banks that were buying government bonds (at rising interest risk premiums). The bankers are now moving to make this role formal, an official condition for rolling over Greek bonds as they come due, and extend maturities on the short-term financial string that Greece is now operating under. Existing bondholders are to reap a windfall if this plan succeeds. Moody’s lowered Greece’s credit rating to junk status on June 1 (to Caa1, down from B1, which was already pretty low), estimating a 50/50 likelihood of default. The downgrade serves to tighten the screws yet further on the Greek government. Regardless of what European officials do, Moody’s noted, “The increased likelihood that Greece’s supporters (the IMF, ECB and the EU Commission, together known as the “Troika”) will, at some point in the future, require the participation of private creditors in a debt restructuring as a precondition for funding support.”

The conditionality for the new “reformed” loan package is that Greece must initiate a class war by raising its taxes, lowering its social spending – and even private-sector pensions – and sell off public land, tourist sites, islands, ports, water and sewer facilities. This will raise the cost of living and doing business, eroding the nation’s already limited export competitiveness. The bankers sanctimoniously depict this as a “rescue” of Greek finances.

Will China’s bad debt problem affect employment?

The major talking point this morning has been the Chinese bad debt cleanup. Following Yves’ post on China, this post is the second of three on China from Credit Writedowns this morning. Read Michael Pettis’ take and my take on that action here. This post is going to be more about where China and the […]