Greetings from Beijing, where one can say simultaneously that a) the air is unhealthy; and b) comparatively speaking, this is good news relative to the air quality from last week.
I'm sure the economic zeitgeist has moved past Larry Summers' IMF speech from earlier this month. It has received praise from Paul Krugman, Martin Wolf, James Pethokoukis, and Business Insider. The precise from BI:
The Fed cut the rate to zero, but we still have had a slow recovery.
The problem is that the natural interest rate — where investment and savings bring about full employment — is now negative. However, the Fed cannot cut the nominal rate below zero because people will choose to hoard money instead of putting it in the bank. This is called the zero lower bound and has reduced the power of Fed policy....
If another recession were to hit now or in the next couple of years, the Fed will have even less power to combat it since rates are already at zero. This is what Summers warned of in his speech at the IMF.
"Imagine a situation where natural and equilibrium interest rates have fallen significantly below zero," Summers said. "Then conventional macroeconomic thinking leaves us in a very serious problem because we all seem to agree that whereas you can keep the federal funds rate at a low level forever, it's much harder to do extraordinary measures beyond that forever, but the underlying problem may be there forever."....
I think that [what the] world has underinternalized," he said, "is that it is not over until it is over, and that is surely not right now and cannot be judged relative to the extent of financial panic, and that we may well need in the years ahead to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activities, holding our economies back below their potential."
Call this the "secular stagnation" hypothesis.
Now let's stipulate that Larry Summers is a much smarter person than I am in general, and that on macroeconomic policy he is several orders of magnitude smarter than I am. Furthermore, an awful lot of smart people across the ideological spectrum in economics thinks he has made a Really Important Point. And about half of my rational brain thinks he is right.
Here's the question the other half of my rational brain is pondering: how much of this "secular stagnation" argument is the flip side of arguments made at the peak of a bubble proclaiming that the bubble is sustainable? The longer an asset bubble lasts, the more intellectual arguments are made positing why the bubble is really the new normal, and economic reality has shifted (in a positive direction). The longer a bubble lasts, the more smart people conclude that this time is different.
A lot of attention has been focused on the errant prognostications and economic theories that emerge during boom times. Has the same level of attention been paid to busts? In other words, there's a way in which Summers' secular stagnation argument fits nicely with Tyler Cowen's Great Stagnation argument or Robert Gordon's technological slowdown hypothesis. I'm not saying all of these arguments are completely wrong -- but I am saying that they tend to become more fashionable to make during periods when economic growth is lackluster at best and negative at worst.
As anemic as the recovery has been in the United States, it's still been better than ex ante predictions would have been made based on Reinhart and Rogoff's dataset on past financial crises. So while I share the concerns voiced by pessimists, and kinda sorta worry that Summers is right, I do wonder if the economics commentariat is suffering from a version of This Bust Is Different.
What do you think?
Yesterday was, in many ways, 40th birthday of my academic subfield. What is called "international political economy" (IPE), or, increasingly, "global political economy," really got its start with two events in the early 1970s -- the collapse of the Bretton Woods monetary system, and the 1973 OPEC oil embargo during the Yom Kippur War, which was launched forty years ago yesterday. Those two events reminded international relations scholars that, gee, economics can affect world politics too. It suddenly became much more legitimate to use the words "political economy" in an international relations article.
Speaking from experience, 40 is all about "reflecting on lost youth" and "thinking about middle age" and "meh movies where Megan Fox is sorta funny." So given the august anniversary, it's worth considering how OPEC is doing as it approaches middle age.* Meghan O'Sullivan provides an excellent appraisal of this very question over at Bloomberg View. Some good parts:
Most commentators have focused, with good reason, on the West’s greatly enhanced ability to withstand similar shocks were they to occur today. Equally important, although generally overlooked, is the reality that OPEC has no incentive or real ability to inflict them on the world.
Go to OPEC’s website and you will be greeted not by articles remembering the havoc the organization caused in the name of Arab unity 40 years ago, but by a banner touting “Communication and cooperation.” That much of the Western world is remembering the embargo this week, while OPEC makes no mention of it, is not an effort by the organization to disguise its latent power and ambitions. Rather, it is almost inconceivable that OPEC would launch such an embargo today....
the most powerful OPEC members don’t want to see huge spikes in oil prices. There are still “price hawks” within the organization: countries such as Iran and Venezuela, which see a higher price of oil as their only path to greater revenues, given constraints on increasing their production. But OPEC as a whole learned some powerful lessons from the 1973 embargo. The 1980s oil glut, and the correspondingly low oil prices, was directly related to the price spikes of 1973 and 1979. This contributed to the “stagflation” that plagued Western economies and tempered their demand for oil.
The 1973 crisis also launched widespread efforts in the West to find and develop “non-OPEC” oil, to increase energy efficiency, and to bring alternative sources of energy online. OPEC has no self-interest in tanking the fragile economic recoveries of today with high oil prices -- or in further catalyzing the already vigorous pursuit of non-oil energy sources.
Finally, re-creating a 1973-type oil embargo would require OPEC to take oil production off the entire market, not just ban its export to specific countries. OPEC’s decision then to reduce oil production by 5 percent per month is what caused the embargo to pinch; this was in contrast to the two largely unremarkable oil embargoes undertaken in 1956 and 1967, which simply barred exports to specific countries, resulting in initial hiccups that were quickly and relatively inexpensively resolved through the redirection of oil trade.
A commitment to an across-the-board reduction today would require a level of discipline and coordination that may be beyond OPEC’s capabilities. Unlike the 1970s, when the annual oil revenues of many OPEC countries exceeded their immediate and pressing costs, most OPEC countries today need all the revenue they can get to meet their budgets. In the wake of the Arab revolutions, governments are wary of measures that would require reining in the generous social and other expenditures seen as necessary to stave off political unrest. While Saudi Arabia has the discipline to bear the burden of cutting oil production each month, it also has grave concerns about steps that could jeopardize overall revenues -- and invite political instability to the kingdom.
All this is not to say that OPEC will never use the “oil weapon” again. But if I had to put money on it, I’d say the cartel is far more likely to increase global oil supply for political reasons than it is to restrict it. Fixated on avoiding a repeat of 1973, most of us tend not to appreciate that OPEC -- and, again, Saudi Arabia in particular -- has more recently used its ability to lower the price of oil to achieve political objectives than it has to raise it.
Read the whole thing. If anything, O'Sullivan underplays some of the economic trends working against OPEC, including the diversification of energy sources, the raising of CAFE standards for U.S. automobiles, and the insatiable energy appetite of OPEC members. Not all of these trends will be game-changers -- it is certainly true, for example, that the growing energy capacity of the United States will not reduce the energy dependence of other countries on OPEC oil -- but combined, they suggest that OPEC's economic power has been greatly diminished.
More generally, this 40-year anniversary should be a reminder to other actors who might think that the power of supply is what matters in the global political economy *cough* China and rare earths^ *cough*. That's the most ephemeral form of economic power in world politics.
So, happy anniversary, OPEC! And happy birthday to IPE!
*Yes, I know OPEC is actually more than fifty years old, but let's just let this metaphor run on, shall we?
^Yes, I know that it's not entirely clear whether China ever embargoed rare earth exports a few years ago, but that doesn't matter for the point I'm making.
There's a pretty strong consensus among economists that any difficulties created by not raising the debt ceiling would be, to use the technical term, "really bad." That's the same consensus that foreign leaders have when looking at the United States. Financial markets are starting to freak out as well. At the same time, there's a raft of recent articles about the large number of GOP congressmen who don't think that going past the October 17th drop-dead date would be such a bad thing. See the Financial Times, New York Times, Politico, New York Times again, and Washington Post, just for starters.
What's particularly surprising about this is that one would have expected some learning from the last time the "debt kamikazes" emerged during the 2011 debt ceiling showdown. Even though there was a deal., the brinksmanship alone cost the U.S. government close to $19 billion. And yet, this time around, the debt denialist caucus seems to have grown even louder.
This raises an interesting and disturbing question for social scientists: why is there such resistance to the expertise offered by economists? Why does an ever larger group of Republican politicians pooh-pooh expert warnings?
I'd offer the following mélange of reasons:
1) The overall expertise of economists has been devalued. As Christopher Hayes pointed out in Twilight of the Elites, this hasn't been a good decade for those in traditional positions of authority. That applies to traditional experts as well. The same profession that seemed mostly copacetic with financial deregulation a decade ago and mostly sanguine about the implications of the subprime mortgage crisis before Lehman Brothers collapsed has lost a fair amount of its luster. So it doesn't matter what they're saying now.
2) GOP politicians are listening to their own experts. Someone from Brookings or the Peterson Institute for Inteernational Economics or a lesser Ivy League school won't get much rhythm from Republicans. They have their own experts ensconced in think tanks across DC. Mike Konczal conducted a little experiment and contacted conservative think tanks to get their experts' opinion of what will happen if the debt ceiling is breached. His finding:
The Heritage Foundation immediately responded with a quote from this post, stating, “Congress still has some time and options. Even if the debt limit is not raised by mid-October, Boccia writes, ‘the Treasury would not necessarily default on debt obligations,’ as it can ‘reasonably be expected to prioritize principal and interest payments on the national debt, protecting the full faith and credit of the United States above all other spending.’”
They added, “In other words, risk of a default is practically nil—unless the President and Treasury choose to default, an unprecedented and almost inconceivable course of action.”....
The Cato Institute put me in touch with their senior fellow Dan Mitchell, who said, “I think the likelihood of an actual default is zero, or as close to zero as you can possibly get, for the simple reason that the Treasury Department has plenty of competent people who would somehow figure out how to prioritize payments.”
3) Wolf has been cried too often. Economists warned about bad macroeconomic effects when the sequester kicked in... and GDP growth accelerated. Economists warned about the bad macroeconomic effects of a government shutdown... and the most prominent news story became the fact that some World War II veterans got blocked from visiting a monument. So they've heavily discounted warnings about a failure on the debt ceiling -- and since it's never happened before, even the economic experts can't say for sure that the apocalypse will happen.
4) It's why they ran for office. For the record, I think U.S. representative Ted Yoho (R, FL) is an ignorant jackass when it comes to what will happen if there's no debt ceiling increase. But he's not wrong when he says, "I ran on not raising the debt ceiling." And Politico's Ben White and Seung Min Kim ain't wrong when they point out that, "Other members say they based entire campaigns on not boosting the borrowing limit." They're acting like Millian representatives. Crazy as it sounds, it's democratic.
5) Barack Obama wants to raise the debt ceiling. And whatever Obama wants must, by definition, be bad. I'll just close with this quote from Tim Huelskamp in the Financial Times:
Mr Huelskamp is not nervous that a default is on the horizon, and he says neither are his constituents back in Kansas. “They don’t trust this administration. This is the same administration that on one hand tells them what’s going to happen on October 17 and on the other hand they’re saying Obamacare is a wonderful thing for businesses. They have no credibility,” he says.
The bitter irony of all of this is that if the debt ceiling is breached, the only way for economists to regain their credibility is if something really calamitous happens.
Am I missing anything?
I see I have some company this a.m., as the Guardian's Suzanne McGee puzzles out why people are continuing to hoard/buy gold despite its falling price:
For centuries – even millennia – people have turned to gold in times of trouble. Its advantages remain numerous: it's ultra-portable (no matter how far they roamed, Marco Polo or famed Moroccan traveller Ibn Battutah could use gold to buy food and shelter for themselves and their camels); it's fairly lightweight relative to its value; it doesn't spoil over time. Heck, it doesn't even tarnish.
But gold is very different from other commodities in which people can invest. You can use corn to feed livestock or make Corn Flakes; copper has countless industrial applications, from power transmission wires to building material; and many of us rely on coffee to jump-start our working day.
Gold, however, doesn't have this kind of "fundamental" demand. Sure, die-hard fans of the precious metal will argue that the transformation of gold into jewelry represents a kind of end-user demand, especially in countries like India. The problem with that argument is that, for the most part, jewelry is simply a decorative form of gold coins and bars. It's still serving the same role: preserving wealth.…
So why own gold at all?
It boils down to fear – or at least, to emotion. After all these centuries, gold's price still depends largely on how people feel about other investments, wether [sic] they be stocks, bonds, real estate or industrial commodities – and how they feel about the broader economic environment. "Gold is a place where people go when they are scared of other assets," says Uri Landesman, president of the hedge fund Platinum Partners.
I'd even push back on the portability point somewhat -- below a certain level of value, the portability argument seems valid, but as any devotee of the fake game show Gold Case knows, "gold is heavy." The point is, if a real apocalypse happens -- the kind where law and order break down and cats and dogs start living together -- having a giant cache of gold won't do the owner much good. It's still pretty heavy and, to get all Marxist, has very little "use-value."
Indeed, if you think about it, for gold to be a smart large-scale investment, you need a kinda sorta apocalyptic sweet spot. On the one hand, there has to be sufficient levels of discord and inflation fears for a non-interest-bearing asset to look attractive. On the other hand, there has to be sufficient levels of stability such that the gold can still be protected and used as a medium of exchange and store of value.
And looking at the last five years, one can see when exactly that sweet spot appeared to be met.
So it looks like the immediate post-2008 years were the one time when it really made sense to invest in gold. There was just enough economic uncertainty and wildly exaggerated fears of inflation that it seemed worth it!
The thing is, gold bugs tend to hold that precious metal for way too long … whereas sensible investors find interest-bearing assets that, over the long run, vastly outperform gold.
Still, as talk of U.S. government default re-enters the lexicon, I'll tip my cap to the gold-buggers who, in October, might experience a brief uptick in their portfolio. But no matter what Glenn Beck tells you, remember -- for large caches of gold to be useful, the apocalypse can't go too far.
Back in June the Economist blogged about the Chinese Communist Party's new ideological document and what it means for China's future:
Over the past couple of months, officials around the country have been summoned to briefings about a Communist Party circular known as “Document Number Nine”. Its full contents have not been made public, but by all accounts it paints a grim picture of what the party sees as the threat posed by liberal ways of thinking. The message conveyed at these meetings has been a chilling one: stick to the party line and denounce any dissent.
The strident tone of this document, which is also called “A briefing on the current situation in the ideological realm”, has caused anxiety among liberal intellectuals, and confusion about the agenda of China’s new leader, Xi Jinping. On the economic front, signs remain strong that he wants to speed up the pace of reform.Caixin, a Beijing-based news portal, said on June 24th that a blueprint for this was “finally taking shape” and hinted that it would be unveiled at a meeting of the Party’s central committee in the autumn. It said history would “remember well those who lead China forward on its path to reform”. On the political front, however, the signs are pointing in the opposite direction.
Buried a bit further down in the post, however, there was this:
The message of Document Number Nine can be divined from official accounts of the secret briefings given to officials. Many of these use similar language, which it is safe to assume reflects the wording of the circular. In Yueyang city in the central province of Hunan, for example, officials at such a meeting reached a consensus that because the situation at home and abroad was “complicated and changeable”, struggles in the ideological realm had therefore become “complicated, fierce and acute” (see here, in Chinese). The officials identified several threats, including calls for “Western constitutional democracy” and universal values (as Analects reported here); promotion of “civil society”; support for “neo-liberalism” (an attempt, the officials said, to change China’s “basic economic system”); and endorsement of “Western news values” (an attempt, they said, to loosen the party’s control over the news media and publishing). Such calls, the officials agreed, were “extremely malicious”.
It's the "neoliberalism" attack that intrigues me - because it kinda cuts against the rhetoric/actions that China's new leadership has been talking/taking for most of 2013.
Today the New York Times' Chris Buckley follows up on Document Number Nine... and the report contains similar paradoxes:
Communist Party cadres have filled meeting halls around China to hear a somber, secretive warning issued by senior leaders. Power could escape their grip, they have been told, unless the party eradicates seven subversive currents coursing through Chinese society.
These seven perils were enumerated in a memo, referred to as Document No. 9, that bears the unmistakable imprimatur of Xi Jinping, China’s new top leader. The first was “Western constitutional democracy”; others included promoting “universal values” of human rights, Western-inspired notions of media independence and civic participation, ardently pro-market “neo-liberalism,” and “nihilist” criticisms of the party’s traumatic past.
Even as Mr. Xi has sought to prepare some reforms to expose China’s economy to stronger market forces, he has undertaken a “mass line” campaign to enforce party authority that goes beyond the party’s periodic calls for discipline. The internal warnings to cadres show that Mr. Xi’s confident public face has been accompanied by fears that the party is vulnerable to an economic slowdown, public anger about corruption and challenges from liberals impatient for political change....
[L]eftists, feeling emboldened, could create trouble for Mr. Xi’s government, some analysts said. Mr. Xi has indicated that he wants a party meeting in the fall to endorse policies that would give market competition and private businesses a bigger role in the economy — and Marxist stalwarts in the party are deeply wary of such proposals.
Here's the thing -- it seems that China has hit the limits of its current growth model, and therefore needs to pursue reforms in order to boost long-term growth, which would help sustain the political legitimacy of the Chinese Communist Party. As that last paragraph suggests, however, an attack on neoliberalism makes it kinda harder to do that. So a short-term effort to boost ideological consistency and legitimacy would seem to be coming at the expense of longer-term strategies to sustain political legitimacy.
So after reading Buckley's story, I wondered on Twitter how Xi was going to reconcile a critique of neoliberalism while pushing... er.... neoliberal-friendly reforms onto China's economy. Buckley was kind enough to respond:
@dandrezner I'm not sure that he knows, and that's one of the big conundrums of Chinese politics just now.
— Chris Buckley ??? (@ChuBailiang) August 20, 2013
I'd really like China-watchers to weigh in here, because I don't like knowing the answer.
The New York Times' Andrew Kramer has a front-pager today on Vladimir Putin's crazy idea to boost the Russian economy that just might work:
A business owner in Russia has a better chance of ending up in the penal colony system once known as the gulag than a common burglar does.
More than 110,000 people are serving time for what Russia calls “economic crimes,” out of a population of about three million self-employed people and owners of small and medium-size businesses. An additional 2,500 are in jails awaiting trial for this class of crimes that includes fraud, but can also include embezzlement, counterfeiting and tax evasion.
But with the Russian economy languishing, President Vladimir V. Putin has devised a plan for turning things around: offer amnesty to some of the imprisoned business people.
“This can be understood in the Russian context,” Boris Titov, Mr. Putin’s ombudsman for entrepreneurs’ rights, said of what is, even by the standards of the global recession, a highly unusual stimulus effort.
The amnesty is needed, he said, because the government had “overreacted” to the threat of organized crime and the inequities of privatization and over-prosecuted entrepreneurs during Mr. Putin’s first 12 years in power as president and prime minister.
Russia’s economy does need help. In the first quarter, growth fell to a rate of 1.6 percent because oil prices are level. And in that economic climate, few Russians seem willing to risk opening a new business that might create jobs and tax revenue for the government (emphasis added).
Gosh, you think? Why oh why would jailed Russian entrepreneurs be at all risk-averse in embracing Putin's New Economic Policy?
The amazing thing is that, if Putin was able to successfully crack down on the police cracking down on entrepreneurs for profit, there likely would be a revival of entrepreneurial activity. Here's one of the stories in Kramer's piece about an arrested entrepreneur:
Ruslan V. Tyelkov, whose short arc from businessman to inmate illustrates both the entrepreneurial spirit that still simmers in Russia and the risks. Mr. Tyelkov, a strapping 32-year-old from Moscow, invested nearly his last ruble to open a wholesale upholstery business that could hardly have gone wrong in Russia: selling leopard-print fabrics.
In 2010, Mr. Tyelkov spent the equivalent of $31,000 for 25,000 yards of Chinese-made leopard-print fabric suitable for chairs and sofas. “It’s very popular here, not only for furniture but cloths, wallpaper, sheets, shoes, bags, everything.”
With no warning, the police arrived at his warehouses and removed every roll on six flatbed trucks, handing it over to a competitor, ostensibly for storage, though it was later sold. Then they arrested Mr. Tyelkov, who spent a year in pretrial detention.
The crime? The police said they suspected copyright infringement of the leopard design. “It was funny at first,” recalled Mr. Tyelkov of his initial meeting with the police. “I asked, ‘Who owns the copyright, a leopard?’ ”
Mr. Titov’s later investigation confirmed the police had colluded with a competitor to seize the merchandise under the pretext of a criminal case, so it could be sold for a profit.
While his business was ruined, Mr. Tyelkov said he did manage to apply his skills to the small challenges of life in jail. He rose to become the informal leader of the cell he shared with a killer, a militant and several drug addicts.
One business owner, the founder of a chain of computer stores, ran his legal operation for nine years from prison, Mr. Titov said, much as some drug kingpins do.
I have no doubt that, if left alone by the policy, Mr. Tyelkov will survive and thrive.
And it's stories like these that help to explain why Ayn Rand valorized entrepreneurs so much. Putin's Russia strongly echoes the environment Rand grew up in. And in this kind of rent-seeking society, there really is something pretty damn heroic about an entrepreneur trying to make a profit without seeking the succor of the state.
Your humble blogger has been fascinated by how and whether the financial sector has faced any kind of constraints in its lobbying efforts after, you know, almost plunging the global economy into a second Great Depression. Dodd-Frank and Basel III suggested there were some limits on Big Finance in the wake of the crisis. Still, I've also seen a lot of commentators point out that with each passing year, the financial sector has regained more of its political influence. They have successfully stalled on the implementation of Dodd-Frank, Basel III, and so forth.
I bring this all up because of two stories today that suggest that maybe this narrative isn't so simple. The first, from Dealbook's Peter Eavis, is that the banks' very profitability is undercutting their political argument to be left alone:
The nation’s six largest banks reported $23 billion in profits in the second quarter, but they could end up victims of their own success.
In recent weeks, the Treasury Department, senior regulators and members of Congress have stepped up efforts intended to make the largest banks safer. The banks have warned that more regulation could undermine their ability to compete and curtail the amount of money they have to lend, but the strong earnings that came out over the last week could undercut their argument.
The most pressing concern for banks is a relatively tough new rule that regulators proposed last week that could force banks to build up more capital, the financial buffer they maintain to absorb losses. But the banks did not demonstrate any difficulty in meeting the proposed rules, and the banks now appear to have fewer allies in Washington than at any time since the financial crisis.
Meanwhile, the Financial Times' Vanessa Houlder also reports that the OECD is moving to crack down on corporate tax avoidance:
Plans for a global crackdown on tax arbitrage marking “a turning point in the history of international co-operation on taxation” were unveiled on Friday at the meeting of G20 finance ministers in Moscow.… Pascal Saint-Amans, the top tax official at the OECD, said the initiative would force up tax rates for multinationals that organise their affairs so they paid little tax. He said: “They know the golden age of ‘we don’t pay taxes anywhere’ is over.”
The effort to reshape the international tax rules was a chance to avert “global tax chaos”, according to the OECD, which said a failure to act could result in governments taking unilateral action. Countries outside the OECD such as India and China will be invited to take part in the revamp of the rules on an equal footing, in what experts said might be the last opportunity for the OECD to exert sufficient influence on the international tax system to reach a global accord.
The plan sets out more than a dozen proposals to block gaps between national tax systems and tackle practices that artificially separate taxable income from the activity that generates it. It includes proposals to tackle abuses of tax treaties, to prevent tax avoidance by shifting intangibles between group companies and to neutralise the impact of “hybrid” structures used to minimise billions of dollars of tax.
While the OECD initiative seems targeted more at tech companies like Apple, Google, and Amazon, I think it's safe to presume that Big Finance would be affected.
Now, a closer look at these stories suggests that the populists in the crowd will be disappointed again. As Eavis observes:
[S]ome analysts remain skeptical that the Fed and the Treasury would really lend their weight to the sort of aggressive measures some lawmakers are contemplating. The recent comments may be an attempt to gain some political benefit from looking tough on the banks. And the remarks may be aimed at reducing any momentum that the more draconian pieces of bank legislation are gaining in the Senate.
“I wonder how much of this is a serious policy change and how much is positioning by the administration to take on a more populist mode going into 2014,” Nolan McCarty, a professor of politics and public affairs at Princeton University, said. “It’s a little bit surprising that, three years after Dodd-Frank and five years after the financial crisis, people are concerned not enough has been done.”
Similarly, as someone who worked on OECD tax initiatives a long time ago in another life, I'm dubious that those efforts will reach fruition in the manner.
So, in the end, I suspect that there will be lots of compromises -- which means that there will be more regulation of Too Big to Fail institutions, but nothing that undercuts Basel III or drives a stake into their existence. This will be followed by lots of populist anguish about the power of these corporate lobbies.
Still, stories like these are useful. They point out that contrary to the simple regulatory capture argument that's so gosh-darn popular among academics and pundits, these corporations still face very strong political headwinds. And, paradoxically, the more profitable these firms become, the less likely they'll be able to effectively lobby Congress.
For years, I've read lament after lament that China's economic model, far from being the New New Thing, is badly broken, leading to all sorts of distortions and imbalances in the world. Only when the Chinese reform that model, the argument ran, would the global economy manage to right itself.
We're about to see that hypothesis put to the test.
The Wall Street Journal notes that China's slowdown is rippling through the global economy:
As the numbers pile up showing China's sizzling growth cooling down, industries world-wide—from German paper-cutter makers to Indonesian palm-oil exporters—are confronting an altered landscape of winners and losers.
The ones that benefited the most from China's rise are now being hurt. Others, aiming at China's 1.3 billion consumers, are faring better.
Growth in China, the world's second-biggest economy after the U.S., has been slowing since 2007's peak, but that slowdown has accelerated recently.
China's second-quarter gross domestic product released early Monday showed the economy expanded 7.5% from the year earlier, slower than the 7.7% growth in the first quarter.
That matches the government's full-year growth target of 7.5%, a rate that would make this year the slowest since 1990. Some economists figure China will grow even slower than that.
I'm gonna assume it's slower than that, because, to be honest, the difference between 7.5 percent and 7.7 percent ain't that big of a deal.
What's hugely ironic about this is that the current Chinese leadership appears to be doing, well, exactly what the international community has been asking it to do for years -- a point Bettina Wassener and Chris Buckley pointed out in the New York Times.
To a large degree, China’s recent cooling has been engineered by the authorities in Beijing, who are trying to steer the economy from an increasingly outdated growth model toward expansion that is more productive and sustainable.
While this slowdown has been happening for more than two years, a flood of comments from policy makers in recent months has made it increasingly clear that the new leadership that took the helm in March is serious about tolerating significantly slower growth for the foreseeable future in return for the longer-term gains of a more balanced economy.…
For years, China has relied on cheap credit, heavy manufacturing, infrastructure investment and exports as key economic drivers — a combination that produced double-digit annual growth rates for much of the past 30 years.
Increasingly, however, this growth model is running out of momentum. China’s population is aging and its labor force is shrinking, meaning that labor productivity has to be raised to make up for the shortfall. Rising wages and a stronger renminbi have eroded China’s competitiveness and are undermining its status as the blue-collar factory floor of the world.
This leads to two big questions that I would like to ask smarter China-watchers than I. First, does the current Chinese leadership actually have a plan? As Wassener and Buckley note:
Much uncertainty remains, however, as to the timing, pace and exact nature of the changes that Beijing wants to achieve: The policy pronouncements so far have been broad in nature, and little more detail is likely to be forthcoming until a meeting of the Communist Party Central Committee this autumn.
I think one can point to signs that Xi and Li are serious -- but I'm not sure one can point to their blueprint on getting from an unsustainable to a sustainable path.
The second question is whether the Chinese leadership will be competent enough to execute this plan. Last month's credit crunch does not necessarily offer that much comfort. As Simon Rabinovitch noted a few weeks ago:
[T]he central bank did a poor job of communicating its policy. It did not warn banks of the coming squeeze and was slow to explain what it was trying to achieve. In an interview with Reuters, Jiang Jianqing, chairman of Industrial and Commercial Bank of China, the country’s biggest bank, made revealing comments about how his institution was in the dark at the height of the panic. “Those few days, even for us, we were genuinely a bit tense,” he said.
Huang Haizhou, an executive with China International Capital Corp, a top investment bank, was even more direct. “The central bank has to increase its transparency,” he said at a public forum.
By triggering a cash crunch, the central bank had hoped to warn banks that markets are not predictable. But what it has done instead is show that financial policy in China is even less reliable.
The critics of the current Chinese economic model aren't wrong. The system needs reform. But the current model worked for quite some time for some very powerful actors, so this change is unlikely to be smooth.
Developing … in some very uncertain ways.
When we last left off on this blog, the central banker of the world's largest economy was sending some odd signals to the marketplace. Despite a sluggish global economy with inflation nary to be found, despite a national economy with plenty of spare capacity, Federal Reserve chairman Benjamin Bernanke was talking about tapering off of quantitative easing. At a time when China has its own problems and Europe can't agree on much of anything, this is a curious decision.
In his New York Times column today, Paul Krugman tries to figure out Bernanke's thinking:
One answer might be that the Fed has quietly come to agree with critics who argue that its easy-money policies are having damaging side-effects, say by increasing the risk of bubbles. But I hope that’s not true, since whatever damage low rates may do is trivial compared with the damage higher rates, and the resulting rise in unemployment, would inflict.
In any case, my guess is that what’s really happening is a bit different: Fed officials are, consciously or not, responding to political pressure. After all, ever since the Fed began its policy of aggressive monetary stimulus, it has faced angry accusations from the right that it is “debasing” the dollar and setting the stage for high inflation — accusations that haven’t been retracted even though the dollar has remained strong and inflation has remained low. It’s hard to avoid the suspicion that Fed officials, worn down by the constant attacks, have been looking for a reason to slacken their efforts, and have seized on slightly better economic news as an excuse.
And maybe they’ll get away with it; maybe the economic recovery will strengthen and all will be well. But rising interest rates make that happy outcome less likely. And now that everyone knows that the Fed is eager to slacken off, it will be hard to get interest rates back down to where they were.
Fed speculation is a fun game perfect for blogging, so can I add my two cents here? First, I do doubt Krugman's reasoning. The cross-national evidence is pretty overwhelming that Bernanke's embrace of quantitative easing was the right call, and it wouldn't take much effort for the Fed to make that point. Furthermore, Bernanke is not going to get reappointed, which means he's in endgame strategy mode right now. And finally, departing officials tend to be more blunt and caustic with critics rather than accommodating (see: Tim Geithner's congressional testimony for most of 2012).
I think there are two possibilities going on here. The first, simpler hypothesis is that Bernanke did a lousy job of communicating the Fed's intentions last week. Let's call this the Hilsenrath Hypothesis, named after the well-sourced-in-the-Fed Wall Street Journal reporter who can blow over CNBC bloviators with a single huff and puff. After markets reacted, Fed officials started trying to clarify things to Hilsenrath. Which leads to stories like today's in the WSJ:
One problem the Fed now faces is that in signaling its plans for the so-called quantitative-easing program, Mr. Bernanke might have led investors to believe the central bank is going to rein in all of its easy-money policies sooner or more aggressively than it actually expects.
The Fed isn't just buying bonds; it also has long held short-term interest rates close to zero, and has said since December it will keep its benchmark federal-funds rate there until the jobless rate falls to at least 6.5%. Mr. Bernanke likens the two levers to driving a car: When it reduces its bond purchases, that will be like lightening the pressure on the accelerator; when it starts raising rates, it will be akin to tapping the brake.
Many investors appear to have missed Mr. Bernanke's signals that the Fed might wait longer than expected before raising short-term rates. He said on Wednesday that the 6.5% unemployment rate threshold might be too high and that the Fed might decide to keep rates low for long after the rate drops below that level, especially if inflation remains low.
Other Fed officials seem to be on board with him. According to projections released after the meeting, only four Fed officials saw short-term interest rates rising before 2015, while 15 saw rates remaining near zero until 2015 or 2016.
In theory, that should reassure investors that borrowing costs are going to stay relatively low for years. But futures markets indicated investors now think the Fed is going to move rates up sooner, not later.
There is one other possibility, however, which the title of the post gives away. Let's call this possibility the Basel Belief. The Bank for International Settlements is the international regime for central bankers and regulators. Bernanke is a member in good standing of this central banker's club. As it turns out, last week the BIS issued their annual report. Here's how it opened:
Originally forged as a description of central bank actions to prevent financial collapse, the phrase “whatever it takes” has become a rallying cry for central banks to continue their extraordinary actions. But we are past the height of the crisis, and the goal of policy has changed – to return still-sluggish economies to strong and sustainable growth. Can central banks now really do “whatever it takes” to achieve that goal? As each day goes by, it seems less and less likely. Central banks cannot repair the balance sheets of households and financial institutions. Central banks cannot ensure the sustainability of fiscal finances. And, most of all, central banks cannot enact the structural economic and financial reforms needed to return economies to the real growth paths authorities and their publics both want and expect.
What central bank accommodation has done during the recovery is to borrow time – time for balance sheet repair, time for fiscal consolidation, and time for reforms to restore productivity growth. But the time has not been well used, as continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system. After all, cheap money makes it easier to borrow than to save, easier to spend than to tax, easier to remain the same than to change.
Yes, in some countries the household sector has made headway with the gruelling task of deleveraging. Some financial institutions are better capitalised. Some fiscal authorities have begun painful but essential consolidation. And yes, much of the difficult work of financial reform has been completed. But overall, progress has been slow, halting and uneven across countries. Households and firms continue to hope that if they wait, asset values and revenues will rise and their balance sheets improve. Governments hope that if they wait, the economy will grow, driving down the ratio of debt to GDP. And politicians hope that if they wait,
incomes and profits will start to grow again, making the reform of labour and product markets less urgent. But waiting will not make things any easier, particularly as public support and patience erode.
Alas, central banks cannot do more without compounding the risks they have already created. Instead, they must re-emphasise their traditional focus – albeit expanded to include financial stability – and thereby encourage needed adjustments rather than retard them with near-zero interest rates and purchases of ever larger quantities of government securities. And they must urge authorities to speed up reforms in labour and product markets, reforms that will enhance productivity and encourage employment growth rather than provide the false comfort that it will be easier later.
Shorter BIS: we are tired of bailing out political ineptitude, and the time for this moral hazard to stop is now.
This is a doubling down of last year's BIS annual report, which pretty much conveyed the same message. And it seems like Bernanke has heard that message and is trying to signal to political actors that they should get their act together.
While this would explain Bernanke's behavior.... it really makes no sense whatsoever. It doesn't take a deep dive to see that the United States has gone the furthest in private-sector deleveraging, and has made rapid progress in taming its public budget deficits. Furthermore, if the weird British spellings weren't a big giveaway, this New York Times story by Jack Ewing and James Kanter makes it clear that the BIS's ire is primarily targeted at Europe, not the United States.
So of these two hypotheses, count me as buying the Hilsenrath Hypothesis. But if I'm being perfectly honest, I'm saying that primarily because it's the most rational explanation. Enough crazy s**t has happened in macroeconomic policy over the past few years that I have to allow for the possibility that maybe some weird form of central banker groupthink has affected Bernanke.
What do you think?
Hey, remember how, after the 2008 financial crisis, a lot of Really Smart People said that the United States had reached the end of influence or a post-American world? How the accumulated ills of the U.S. economy were leading to a decline in American hegemony, or even the end of power itself? How the BRICS were the new new thing?
I bring this up because, five years after the financial crisis rally heated up, we confront this New York Times front-pager by Nathaniel Popper:
Despite a partial recovery in the markets on Friday, tumbling stock, bond and commodity prices around the world over the past month are demonstrating just how reliant the global economy has become on the monetary policies of the Federal Reserve.
In the weeks since the Fed’s chairman, Ben S. Bernanke, first indicated that the central bank might start to pare back its support for the economy, markets in Asia, Europe and Latin America have fallen even more sharply than those in the United States, threatening economic growth in many countries.
While leading market measures in the United States have declined 4 percent over the last month, an index of the world’s stock markets has slumped more than 6 percent.
“The Fed isn’t just the U.S.'s central bank. It’s the world’s central bank,” said Mark Frey, the chief strategist at the Cambridge Mercantile Group....
The selling picked up in markets around the world on Thursday, a day after Mr. Bernanke’s latest comments on the Fed’s plan to wind down the stimulus. While the reason for the shift by the Fed is good — a strengthening of the recovery in the United States — investors are nervous that the global economy may not be ready.
The heavy selling was a sharp reversal after years when low interest rates in the United States encouraged investors to put their money into foreign countries. For investors in once-attractive foreign markets, the fear was that those markets may be on even less firm economic footing than the United States’, and consequently less able to absorb the decline in lending that comes along with rising interest rates.
“When the U.S. embarks upon policies that are appropriate for its own domestic circumstances, it can impose policies on the rest of the world that aren’t necessarily appropriate to them,” said Darren Williams, the senior European economist at AllianceBernstein in London.
Surely, however, that rising economic superpower called "China" is ready to save the day, right? Wait, what's this?
Thursday was a very bad day for China’s economy, the world’s second-largest and a crucial pillar of the global economy, with credit markets freezing up in an unnerving parallel to the first days of the U.S. financial collapse. The question of how bad depends on whom you talk to, how much faith you have in Chinese leaders and, unfortunately, several factors that are largely unknowable. But we do know two things. First, Chinese leaders appear to be causing this problem deliberately, likely to try to avert a much worse problem. And, second, if this continues and even it works, it could see China’s economy finally cool after years of breakneck growth, with serious repercussions for the rest of us.
Read the whole thing - as well as this Bloomberg story -- to understand why China is acting the way it is.
So who's your hegemon now, huh? WHO'S YOUR HEGEMON???!!!
If Americans reading this are beginning to feel jingoistic, however, let me point out that if you think this is all good news, you're nuts. From an economic perspective, it's much better to see all these economies growing robustly. Since they're not, Ben Bernanke's decision to start talking about tapering off quantitative easing seems rather blinkered. This is for a few simple reasons:
1) As noted above, all of the other potential growth engines in the global economy are either contracting or screeching to a halt;
2) The fiscal headwind of U.S. fiscal policy hasn't been devastating, but it is likely a net drag on the economy. Oh, and inflation? That's nowhere to be seen. The U.S. economy is doing well in comparison to the other developed nations, but it's still not doing all that well. Now is not the time to engage in restrictive monetary policy (or terribly restrictive fiscal policy either).
3) This week Bernanke has been spelling out what the Fed will be doing in 2014 and beyond. Which would be peachy if Bernanke was going to be chairing the Fed then -- except that every indication is that he won't be. So why his word should carry such impact on post-2013 actions is a bit mystifying.
So the good news is that reports of declining U.S. influence have been greatly exaggerated. The bad news is that it's not obvious to me that the U.S. economic leadership is exercising that power responsibly.
Am I missing anything?
Hey, remember when Standard & Poor's downgraded U.S. sovereign debt back in 2011? Remember how your humble blogger thought it was based on really piss-poor political analysis before he fretted about the stickiness of perceptions about the United States before, six months later, he decided that the underlying fundamentals of the United States were strong?
I bring all of this up because yesterday, S&P upgraded its outlook on U.S. debt:
We see tentative improvements on two fronts. On the political side, Republicans and Democrats did reach a deal to smooth the year-end-2012 "fiscal cliff", and this deal did result in some fiscal tightening beyond that envisaged in BCA11 [2011 Budget Control Act], by allowing previous tax cuts to expire on high-income earners. The BCA11 also has engendered a fiscal adjustment, albeit in a blunt manner. Although we expect some political posturing to coincide with raising the government's debt ceiling, which now appears likely to occur near the Sept. 30 fiscal year-end, we assume with our outlook revision that the debate will not result in a sudden unplanned contraction in current spending--which could be disruptive--let alone debt service.
Aside from tax hikes and expenditure cuts, stronger-than-expected private-sector contributions to economic growth, combined with increased remittances to the government by the government-sponsored enterprises Fannie Mae and Freddie Mac (reflecting some recovery in the housing market), have led the Congressional Budget Office (CBO), last month, to revise down its estimates for future government deficits. Combining CBO's projections with our own somewhat more cautious economic forecast and our expectations for the state-and-local sector, and adding non-deficit contributions to government borrowing requirements (such as student loans) leads us to expect the U.S. general government deficit plus non-deficit borrowing requirements to fall to about 6% of GDP this year (down from 7%, in 2012) and to just less than 4% in 2015. We now see net general government debt as a share of GDP staying broadly stable for the next few years at around 84%, which, if it occurs, would allow policymakers some additional time to take steps to address pent-up age-related spending pressures.
The stable outlook indicates our appraisal that some of the downside risks to our 'AA+' rating on the U.S. have receded to the point that the likelihood that we will lower the rating in the near term is less than one in three. We do not see material risks to our favorable view of the flexibility and efficacy of U.S. monetary policy. We believe the U.S. economic performance will match or exceed its peers' in the coming years. We forecast that the external position of the U.S. on a flow basis will not deteriorate.
Huzzah!! Now that S&P is more bullish on the United States' debt picture, capital will rain from the skies and everything will be back to norm -- what, what's this?
Stocks were barely changed and closed mixed on Monday as the benchmark stock indexes swung between slight gains and losses throughout the day following Friday's jobs-report-fueled rally.
The listless trading came despite an upgrade on the outlook for U.S. government debt by Standard & Poor's Ratings Services and a 5% jump in Japan's Nikkei 225 index..
The Dow Jones industrial average fell 9.53 points, or 0.1%, to 15,238.59 and the Standard & Poor's 500 index dropped 0.57 point to 1,642.81. The Nasdaq composite index gained 4.55, or 0.1%, to 3,473.77.
Well, that's the stock market. Surely the bond mark -- wait, what's this?
The sell-off in government bonds has gone completely global as concerns over Federal Reserve tapering of monetary stimulus infect the market.
Everywhere this morning, bond yields are up huge as investors dump sovereign debt.
In the United States, the 10-year yield is up 6 basis points to 2.26%, its highest level in over a year.
I disagreed with S&P last time, and I agree with it this time, but the thing about this news that makes me the happiest is that markets are pretty much ignoring what Standard & Poor's is saying about U.S. sovereign debt.
Which is as it should be. The rating agencies have displayed almost zero talent for prospective forecasting. Their pre-2008 performance was … not good, and their attempt to wade into political analysis has been on the primitive side. It appears that markets are pricing in political changes far more quickly than the rating agencies. And, post-2008, I have to think that a world where rating agencies exercise less influence over sovereign governments is a pretty good thing.
I've spent a rather alarming portion of this week wading into intellectual pissing matches, so I'm loath to respond to Michael Kinsley's response to last week's brouhaha over austerity policies. But one paragraph does merit some pushback. After noting the backlash to his last column, Kinsley writes the following:
There are two possible explanations. First, it might be that I am not just wrong (in saying that the national debt remains a serious problem and we’d be well advised to worry about it) but just so spectacularly and obviously wrong that there is no point in further discussion. Or second, to bring up the national debt at all in such discussions has become politically incorrect. To disagree is not just wrong but offensive. Such views do exist. Racism for example. I just didn’t realize that the national debt was one of them.
Kinsley assumes that it must be the second explanation, and then goes on from there.
I can't speak for anyone else who pushed back against Kinsley's column from last week. Speaking for myself, however, I blogged about it because Kinsley was "spectacularly and obviously wrong." I say this because almost everything I wrote in my response to Kinsley I knew at age 18 after taking Economics 101 in college.
To explain, let me focus on Kinsley's motivation for thinking that the austerians have a point:
Austerians believe, sincerely, that their path is the quicker one to prosperity in the longer run. This doesn’t mean that they have forgotten the lessons of Keynes and the Great Depression. It means that they remember the lessons of Paul Volcker and the Great Stagflation of the late 1970s. “Stimulus” is strong medicine—an addictive drug—and you don’t give the patient more than you absolutely have to.
This is wrong for three reasons, one pedantic and two substantive. First, to be pedantic, the austerity debate is about the wisdom of using expansionary fiscal policy -- i.e., running a significant federal budget deficit -- to alleviate downturns. Paul Volcker was the chairman of the Federal Reserve and thereby responsible for setting monetary policy. He had nothing to do with fiscal policy. This is a distinction that I learned in my first few lectures on macroeconomics. So either Kinsley phrased this badly or he's confused about what this debate is about.
The substantive errors can be explained more easily once you look at this chart of the budget deficit as a percentage of GDP:
So, looking at the above, you find Kinsley's two substantive errors. First, during the period that Kinsley seems to find so relevant -- the late 70s -- you discover that the budget deficit as a percentage of GDP was shrinking and not growing. So, to repeat a theme, I'm not sure where Kinsley is getting this notion that expansionary fiscal policy is responsible for the high inflation of the 1970s [Maybe Kinsley would argue that stagflation was an aftereffect of the spending spike that followed the 1973-1975 recession?! --ed. OK, except a glance at that chart shows that compared to the 1980s, the 1970s was a period of fiscal probity. Oh, and as I said before, there was that whole expansionary monetary policy/commodity price shock thing happening as well. Which I learned about from my Econ 101 textbook oh so many moons ago.]
Second, contra Kinsley (and Charles Lane while we're at it), stimulus is not an addictive medicine. The above graph shows budget deficits expanding during recessions and then shrinking again as the economy recovers.
Look, this isn't rocket science -- Kinsley made an argument about austerity that got a lot of basic economic facts about the 1970s and the current era very, very wrong. Dare I say, spectacularly and obviously wrong.
So there's really no point in further discussion.
Paul Krugman is a very smart and very annoying person. Over the past few years he's been hammering away at political and economic advocates for austerity policies with unmitigated glee and derision. He does so with a brio and condescension that some people can find off-putting -- but that doesn't mean that he's wrong.
After pummeling "austerians" for much of the essay, Krugman then endeavors to explain why so many policymakers and pundits still favor such policies:
The turn to austerity was very real, and quite large.
On the face of it, this was a very strange turn for policy to take. Standard textbook economics says that slashing government spending reduces overall demand, which leads in turn to reduced output and employment. This may be a desirable thing if the economy is overheating and inflation is rising; alternatively, the adverse effects of reduced government spending can be offset. Central banks (the Fed, the European Central Bank, or their counterparts elsewhere) can cut interest rates, inducing more private spending. However, neither of these conditions applied in early 2010, or for that matter apply now. The major advanced economies were and are deeply depressed, with no hint of inflationary pressure. Meanwhile, short-term interest rates, which are more or less under the central bank’s control, are near zero, leaving little room for monetary policy to offset reduced government spending. So Economics 101 would seem to say that all the austerity we’ve seen is very premature, that it should wait until the economy is stronger.
The question, then, is why economic leaders were so ready to throw the textbook out the window.…
Everyone loves a morality play. “For the wages of sin is death” is a much more satisfying message than “Shit happens.” We all want events to have meaning.
When applied to macroeconomics, this urge to find moral meaning creates in all of us a predisposition toward believing stories that attribute the pain of a slump to the excesses of the boom that precedes it—and, perhaps, also makes it natural to see the pain as necessary, part of an inevitable cleansing process. When Andrew Mellon told Herbert Hoover to let the Depression run its course, so as to “purge the rottenness” from the system, he was offering advice that, however bad it was as economics, resonated psychologically with many people (and still does).
By contrast, Keynesian economics rests fundamentally on the proposition that macroeconomics isn't a morality play—that depressions are essentially a technical malfunction.
Now this sounds a little far-fetched -- I mean, it's not as if pundits and policymakers can be that economically illiterate, right?
And then, as if Krugman planned it all along, along comes Michael Kinsley in the New Republic -- responding to a different Krugman essay that makes similar points -- with an essay titled "Paul Krugman's Misguided Moral Crusade Against Austerity." I think one of the points Kinsley is trying to make is that the policy divide between austerians and anti-austerians in Washington isn't as great as Krugman portrays. That's likely correct in Washington. During debates this year, even austerity "advocates" like John Boehner have made noises about not wanting to turn off the fiscal tap too soon, and even austerity "critics" like Barack Obama have talked about the need for fiscal rectitude. So yes, even austerity's critics sound austerity-curious at times.
Still, the guts of Kinsley's essay are … problematic. Some highlights:
It’s easier to describe what the anti-austerians believe than the austerians themselves. Anti-austerians believe that governments around the world need to stop worrying about their debts for a while and continue pouring money into the economy until the threat of recession or worse is well and truly over. Austerians want the opposite. But what is the opposite? Is President Barack Obama, for example, an austerian? To Republicans and conservatives, no: He pushed through a stimulus package of almost a trillion dollars early in his first term, and remains a symbol of “big spending.” To liberals and Democrats, yes: They feel we need a second and much larger stimulus and Obama has let us all down.…
Austerians believe, sincerely, that their path is the quicker one to prosperity in the longer run. This doesn’t mean that they have forgotten the lessons of Keynes and the Great Depression. It means that they remember the lessons of Paul Volcker and the Great Stagflation of the late 1970s. “Stimulus” is strong medicine—an addictive drug—and you don’t give the patient more than you absolutely have to.…
Krugman also is on to something when he talks about paying a price for past sins. I don’t think suffering is good, but I do believe that we have to pay a price for past sins, and the longer we put it off, the higher the price will be. And future sufferers are not necessarily different people than the past and present sinners. That’s too easy. Sure let’s raise taxes on the rich. But that’s not going to solve the problem. The problem is the great, deluded middle class—subsidized by government and coddled by politicians. In other words, they are you and me. If you make less than $250,000 a year, Obama has assured us, you are officially entitled to feel put-upon and resentful. And to be immune from further imposition.
Austerians don’t get off on other people’s suffering. They, for the most part, honestly believe that theirs is the quickest way through the suffering. They may be right or they may be wrong. When Krugman says he’s only worried about “premature” fiscal discipline, it becomes largely a question of emphasis anyway. But the austerians deserve credit: They at least are talking about the spinach, while the Krugmanites are only talking about dessert. [Emphasis added.]
OK, so, a few things:
1) No Republican or conservative, anywhere in the United States, will claim that Barack Obama is an austerian. I'm just gonna assume that this is a typo and move on. [Editor's note: The typo has been cleared up on the New Republic's website, and the block quote above has been corrected.]
2) Stagflation in the 1970s was caused primarily by an inward shift of the aggregate supply curve due to a surge in commodity prices, particularly energy. Some central banks responded with accommodating monetary policies that accelerated inflation even further. Fiscal policy was an innocent bystander to this whole shebang. So I honestly don't know what the hell Kinsley is talking about.
More importantly, the current macroeconomic climate is really, really different from the 1970s. Inflation was a Big Bad Problem during that decade. It is not a problem right now. If inflation were spiking, then a genuine debate could be had on macroeconomic policy options. But that's not the case.
3) In his final paragraphs, Kinsley has managed to epitomize the exact critique that Krugman has served up.
The irony of this whole thing is that the Congressional Budget Office's recent figures put the lie to Kinsey's hidden assumption that the federal budget deficit is getting bigger and bigger. Right now it's shrinking at the fastest rate in postwar economic history.
The CBO also warns that the deficit will start to balloon up again due to entitlement spending, which suggests that Kinsley has half a point about thinking through entitlement reform. The thing is, that's a structural problem, not a business cycle problem. Kinsley et al. are acting as if the current fiscal climate demands immediate budgetary actions. And it doesn't -- it really, really doesn't.
Look, I think Paul Krugman has a few policy blind spots. His method of argumentation alienates as many people as it attracts. But he's not wrong when he's talking about austerity. In his response, Michael Kinsley has managed to embody the conventional wisdom in Washington -- and in doing so, embody every policy caricature of Paul Krugman's worldview.
Am I missing anything?
Well, this sounds like very bad news for the global financial system:
A plan to rescue the tiny European country of Cyprus, assembled overnight in Brussels, has left financial regulators, German politicians, panicked Cypriot leaders and a disgruntled Kremlin with a bailout package that has outraged virtually all the parties.
In the end, a bailout deal that was supposed to calm a financial crisis in an economically insignificant Mediterranean nation spread it wider. Word of the plan unnerved markets across Europe, raised fears of bank instability in Spain and Italy and sent pensioners into the streets of the island’s capital, Nicosia, in protest.
As markets tumbled and the Cypriot Parliament fell into turmoil, salvos of blame were hurled back and forth across the Continent.
Officials scrambled to explain what went wrong and how best to control the damage of what Philip Whyte, a senior research fellow at the Center for European Reform, called a “completely irrational decision” to make bank depositors liable for part of the bailout. The deal flopped so badly that finance ministers who came up with it shortly before dawn on Saturday were on the phone to each other Monday night talking about ways to revise it.
Now, on the one hand, you would be hard-pressed to find anyone who will defend the Cypriot deal as it was announced on Saturday -- but it's pretty easy to find critics of the proposed deal across the political spectrum. So this seems like yet another data point confirming the truly mind-boggling stupidity of European governments and regulators. It's particularly galling that they did this during a time when global capital markets are still fragile from the 2008 financial crisis.
Oh, except, wait a minute, it turns out that those markets aren't as fragile as the perception suggests. If you burrow into the McKinsey Global Institute's latest report on global asset markets, it turns out that, excepting Europe, the rest of global finance has experienced a decent recovery from the 2008 crash. According to MGI:
With the pullback in cross-border lending, foreign direct investment from the world’s multinational companies and sovereign investors has increased to roughly 40 percent of global capital flows. This may bring greater stability, since foreign direct investment has proved to be the least volatile type of capital flow, despite a drop in 2012.
Of course, this was written before the Cypriot stupidity, so now markets are really roiled, right? Well... here's Business Insider's Joe Weisenthal's take early this a.m.:
Markets are down a bit in Europe although not dramatically so yet.
US futures were flat, and Asia was actually up nicely, with Japan gaining 2%.
That seems like a thoroughly appropriate reaction. And over at the New York Times, Andrew Ross Sorkin explains why that's the rational and appropriate reaction:
While the bailout of Cyprus is a fascinating case study and raises interesting theoretical questions about moral hazard for policy wonks and talking heads, here is the reality: It is largely irrelevant to the global economy. Cyprus is tiny; its economy is smaller than Vermont’s. And the bailout is worth a paltry $13 billion, the equivalent of pocket lint for those in the bailout game.
Even the larger issue about bailing out a country by taking money from depositors — which quickly created outrage around the world — seems overblown....
[I]n truth, the smart money knows that the bailout of Cyprus says very little about future actions.
“I would assume that anyone in Spain, Portugal or elsewhere who knows about the taxation of Cypriot depositors also would know that the Cypriot banking system is a very different animal than anywhere else in the euro zone,” Erik Nielsen, chief economist at UniCredit, wrote in a note to clients.
Mr. O’Neill of Goldman also acknowledged: “I am sure it will not set a precedent.”
Cyprus is unique. Besides being tiny, its banking system looks different from those in most other countries. Much of the big money deposited in its banks is from foreign investors, including Russians who have long been suspected of money laundering. Those investors had fair warning that Cypriot banks were troubled. The issue has been simmering for six months. But those investors left their money in the bank, in part because they were gambling that the banks would be bailed out at no cost to them. If the current plan is approved, depositors will have lost that bet.
Now this is a perfectly rational analysis. What's significant is that it seems like markets are making the same calculation. When financial markets are fragile, when there's a fear of financial contagion, they don't make the rational calculation -- they freak out. That hasn't happened with Cyprus.
I know I'm at the risk of pulling a Donald Luskin here, but what's happening in Cyprus right now primarily affects Cypriots, with a small concern about regional effects. It doesn't look like it's triggering the same kind of concerns of either the Lehman collapse or the Greek sovereign debt crisis. And anytime the abject stupidity of European financial statecraft can be confined to Europe, that's a very, very good thing indeed for the global financial system.
Am I missing anything?
One of the lasting effects of the 2008 financial crisis was the belief that the distribution of economic power had radically shifted. China rising, West fading, yadda, yadda, yadda. A minor key in this argument has been the notion that a new and important measure of economic power is the size of a country's official reserves. This has led to the occasional panicked article that "China is buying gold!!" or "Russia is hoarding gold!!" or "Germany is moving gold!!" as a first step towards pushing the dollar out as the world's reserve currency.
Which is just so much horses**t.
Here are three facts to remember whenever you read any story about a BRIC economy hoarding gold:
1) Buying gold would have been extremely savvy in 2008. Now it's just silly. The price of gold peaked at over $1900 in September 2011 -- and despite massive amounts of quantitative easing and numerous reports about central bank hoarding, it's fallen by $300 since and trending downward.
2) The BRIC economies did not have a lot of gold to begin with. As Bloomberg notes, "Russia’s total cache of about 958 tons is only the eighth largest [in the world]."
1. The United States (8,134 tons)
2. Germany (3,391 tons)
3. The International Monetary Fund (2,814 tons)
4. Italy (2,451 tons)
5. France (2,435 tons)
So, to sum up: To believe that gold holdings really matter in the global political economy, you have to be willing to assert that Italy is a great power in global finance. I, for one, am not going there.
Let's face it, Americans do not understand the current state of either macroeconomic policy or foreign policy terribly well. According to Bloomberg, only six percent of Americans know that the federal budget deficit is actually shrinking. According to Gallup, just a bare majority of Americans believe that the United States military remains "number one in the world militarily." In a world of these kind of epic media fails, where significant numbers of GOP legislators seem "more concerned about 2% inflation than 8% employment," it's important to to have recognized experts try to clear the air.
Nobel Prize-winning economist and unusually-pithy-writer-for-an-economist Robert Solow has an op-ed in today's New York Times to offer a primer on the implications of U.S. debt. Here, in brief, are the "six facts about the debt that many Americans may not be aware of," in Solow's words. Let me number them here:
1) Roughly half of outstanding debt owed to the public, now $11.7 trillion, is owned by foreigners. This part of the debt is a direct burden on ourselves and future generations....
2) The Treasury owes dollars, America’s own currency (unlike Greece or Italy, whose debt is denominated in euros)...
3) One way to effectively repudiate our debt is to encourage inflation...
4) Treasury bonds owned by Americans are different from debt owed to foreigners. Debt owed to American households, businesses and banks is not a direct burden on the future....
5) The real burden of domestically owned Treasury debt is that it soaks up savings that might go into useful private investment.
6) But in bad times like now, Treasury bonds are not squeezing finance for investment out of the market. On the contrary, debt-financed government spending adds to the demand for privately produced goods and services, and the bonds provide a home for the excess savings. When employment returns to normal, we can return to debt reduction.
Some foreign pollicy experts think that Solow is being too sunny. Take Council on Foreign Relations president Richard Haass:
With respect, I think Solow is actually being too pesssimistic, and Haass is being way too pessimistic.
The problem is that, contra Solow, I suspect Americans are keenly aware of his points 1-5. The United States owes a lot of money to China, but I'd wager that any poll of U.S. citizens would reveal that the public thinks we owe even more to China than we actually do. Similarly, much of the policy rhetoric coming from Washington focuses on fears of incipient inflation that have yet to pan out.
It's Solow's last point that is the one Americans need to hear more: in an era of slack demand, bulging coporate cash coffers, and recovering personal savings rates, it's actually pretty stupid to have U.S. government spending and employment contract so quickly. I fear, however, that excessive concern about Solow's first, third, fourth and fifth points will swamp out the rest of his op-ed.
As for Haass, I'm not exactly sure what "rising rates" he's talking about, as just about any chart you can throw up shows historically low borrowing rates for the United States government. Indeed, the U.S. Treasury is exploiting this fact by locking in U.S. long-term debt at these rates. As for foreign governments pressuring the United States, the fear of foreign financial statecraft has been somewhat hyped by the foreign policy community. And by "somewhat hyped," I mean "wildly, massively overblown."
The bias in foreign policy circles and DC punditry is to bemoan staggering levels of U.S. debt. This bias does percolate down into the perceptions of ordinary Americans, which leads to wild misperceptions about the actual state of the U.S. economy and U.S. economic power. I'd like to see a lot more op-eds by Solow et al. that puncture these myths more effectively.
Am I missing anything?
A little more than a year ago I blogged that global policymakers had reached a "focal point" moment on the merits of austerity as a macroeconomic policy during a global recession. Namely, central bank authorities had concluded that the policy doesn't really work well at all. If true, this was a big deal. One could argue that from the May 2010 Toronto G-20 summit to the end of 2011 was a period where the austerity policies were widely touted and occasionally implemented. If this was the wrong policy, and there was a shift, that's kind of a big deal.
So where are we now on this?
On the public commentary side, I'd say we're approaching near-consensus on the failures of austerity for large economies. The passing of time has allowed for a comparative look at the data, and the results are not pretty for austertity enthusiasts. Martin Wolf sums up the indictment rather neatly, riffing off of a paper by Paul De Grauve and Yuemei Li:
[T]he chief determinant of the reduction in spreads over German Bunds since the second quarter of 2012, when OMT [the ECB pledge to open up its monetary taps] was announced, was the initial spread. In brief, "the decline in the spreads was strongest in the countries where the fear factor had been the strongest."
What role did the fundamentals play? After all, nobody doubts that some countries, notably Greece, had and have a dreadful fiscal position. One such fundamental is the change in the ratio of debt to gross domestic product. The paper makes three important observations. First, the ratio of debt to GDP increased in all countries even after the ECB announcement. Second, the change in this ratio turned out to be a poor predictor of declines in spreads. Finally, the spreads determined the austerity borne by countries.
On the policy output side, there's been a demonstrable but partial shift. In the past year, the European Central Bank, Federal Reserve, and Bank of Japan have rejected austerity policies in favor of greater levels of quantitative easing. Furthermore, contrary to the outright hostility developing countries directed at quantitative easing in the fall of 2010, the reaction to the past half-year of quantitative easing has been far more muted. When the latest G-20 communique said:
Monetary policy should be directed toward domestic price stability and continuing to support economic recovery according to the respective mandates. We commit to monitor and minimize the negative spillovers on other countries of policies implemented for domestic purposes.
That was code for "hey, G-7 central banks, you gotta do what you gotta do. We get that." Which is demonstrably different from yelling "currency wars", a meme that seems not to have caught fire this time around.
Top central bank authorities have also been willing to speak truth to power -- in this case, GOP members of Congress. John Cassidy recounts Ben Bernanke's testimony from yesterday:
Departing from his statutory duty of reporting to the Senate Banking Committee on the Fed’s monetary policy, Bernanke devoted much of his testimony to fiscal policy, warning his congressional class that letting the sequester go ahead would endanger the economic recovery and do little or nothing to reduce the country’s debt burden.
"Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant," Bernanke told his students, who included a number of right-wing Republican diehards, such as Senator Bob Corker, of Tennessee, and Patrick Toomey, of Pennsylvania. "Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run."
Translated from Fed-speak, that meant that congressional Republicans have got things upside down. Bernanke has warned before about the dangers of excessive short-term spending cuts. But this was his most blunt assertion yet that Mitch McConnell, John Boehner, et al. should change course. "To address both the near- and longer-term issues, the Congress and the Administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run," Bernanke said. "Such an approach could lessen the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the federal budget."
So does this mean some additional policy shifts? Alas, probably not. The consensus against austerity seems pretty strong on the monetary policy side of the equation. On the fiscal policy dimension, however, austerity remains the de facto policy for a lot of economies. This includes the United States, which is conventionally depicted as not having embraced austerity. The New York Times' Binyamin Appelbaum outlines the current fiscal austerity in his story today:
The federal government, the nation’s largest consumer and investor, is cutting back at a pace exceeded in the last half-century only by the military demobilizations after the Vietnam War and the cold war.
And the turn toward austerity is set to accelerate on Friday if the mandatory federal spending cuts known as sequestration start to take effect as scheduled. Those cuts would join an earlier round of deficit reduction measures passed in 2011 and the wind-down of wars in Iraq and Afghanistan that already have reduced the federal government’s contribution to the nation’s gross domestic product by almost 7 percent in the last two years.
The cuts may be felt more deeply because state and local governments — which expanded rapidly during earlier rounds of federal reductions in the 1970s and the 1990s, offsetting much of the impact — have also been cutting back.
Federal, state and local governments now employ 500,000 fewer workers than they did on the eve of the recession in 2007, the longest and deepest decline in total government employment since the aftermath of World War II.
Total government spending continues to increase, but those broader figures include benefit programs like Social Security. Government purchases and investments expand the nation’s economy, just as private sector transactions do, while benefit programs move money from one group of people to another without directly expanding economic activity.
The reason for this split does not require rocket science. Monetary policy is a tool of politrically insulated central bankers. Fiscal policy is a tool for elected politicians. The public might dislike specific budget cuts, but damn if they don't love austerity in theory.
So, in retrospect, I think early 2012 was a focal point -- but only for central bankers and commentators. As Cassidy notes, there remain elected politicians who are super-keen on austerity:
Corker, a former builder who is a long-time critic of Bernanke’s expansionary policies, called him "the biggest dove since World War Two." Toomey, a former head of the conservative lobbying group Club for Growth, questioned whether the sequester would have any real impact on the economy. Bernanke shrugged off the criticisms, calmly and methodically laying out the realities of the situation.
For the past few days I've been getting emails asking whether I'm gonna comment on one of the most offensive and brutally effective campaign ads I have ever seen:
It's brutal because... well, let's face it, that Romney tic was always the most cringe-worthy aspect of the campaign. Anything negative that Romney did, contrasted with that song, would be powerful.
It's ridiculously offensive, however, because it baldly asserts that doing business with Mexico, China or Switzerland is un-American. Other idiocies like the Olympic-uniform controversy feed into the public perception that having the other countries make stuff is an abomination of the first degree.
So, does it matter for policy? Well.... no.
Mario Cuomo once said "You campaign in poetry. You govern in prose." Now, Mario Cuomo was clearly the world's worst poetry connoisseur. Still, to update his observation for our current needs, we can say, "You campaign as a mercantilist; you govern as a free-trader." The reason that Romney has seemed so discombobulated by the Bain attacks is that he's been China-bashing since Day One ofhis campaign, so it's tough to then
flip-flop pivot to a free trade stance. As for Obama, Matthew Yglesias noted the following last week:
[A]ll indications are that Barack Obama also doesn't think Bain was doing anything wrong. As president he's made no moves to make it illegal for companies to shift production work abroad and has publicly associated himself with a wide range of American firms—from GE to Apple and beyond—who've done just that to varying extents. And we all remember what happened to Obama's promise to renegotiate NAFTA after taking office, right?
Or, David Brooks today:
Over the years of his presidency, Obama has not been a critic of globalization. There’s no real evidence that, when he’s off the campaign trail, he has any problem with outsourcing and offshoring. He has lavishly praised people like Steve Jobs who were prominent practitioners. He has hired people like Jeffrey Immelt, the chief executive of General Electric, whose company embodies the upsides of globalization. His economic advisers have generally touted the benefits of globalization even as they worked to help those who are hurt by its downsides.
But, politically, this aggressive tactic has worked.
Brooks' colleague Nate Silver might quibble a bit with the "politically working" point, but that's a small quibble. Americans loooooooove mercantilism, so this kind of rhetoric makes tactical sense during a campaign. As stomach-churning as I find this kind of ad, I must reluctantly agree with Yglesias and Brooks that it doesn't matter all that much for governing. Even this Washington Post story that talks about Obama's "rethinking" of free trade doesn't really deliver the goods on significant policy shifts. And it appears that even the Chinese government recognize campaign bluster for what it is.
So -- to repeat a theme -- I don't think the mercantilist campaign rhetoric will amount to much.
Still, as someone who thinks offshore outsourcing is an unobjectionable practice, this is going to be a nauseating campaign.
If one myth has been slain by the financial crisis and the response to it, it's the idea that central banks ought to be independent and unaccountable politically.
The idea of central bank independence was that it would guarantee good monetary policy. During the Great Moderation it certainly seemed that way. But now it's no longer the case...
[The] point is that the choice between inflation and unemployment is a political, not a technical choice. What's "better"? To screw debtors or creditors? To make millions unemployed or to "debase the currency"? Those are very important questions. More important, they're questions that cannot be solved by economics. They can be informed by them, but at the end of the day what you prefer is going to come down to your own moral value system. In other words, it's a political choice. And the way we make political choices in modern countries is through the democratic process, not through unelected, unaccountable technocrats....
The bottom line is that the argument of supercompetence of central bankers is dead and once that's gone you need to revert those powers back to the political process (emphasis in original).
Now, this is a pretty powerful argument. One would be hard-pressed to say that Jean-Claude Trichet or Alan Greenspan or Ben Bernanke have covered themselves in glory during the past five years or so. Why not return central banking to the politicians?
Well.... before I answer, I want to object to Gobry's framing of the issue in two ways. First, he sets up a too-simple dichotomy between "independence" and "political control." The devil is in the details here. Political scientists have done a lot of research into how legislatures exert influence over supposedly "independent" institutions like courts and regulatory agencies, and this logic applies to central banks as well. Or, to put it another way, I suspect that Ben Bernanke would be pumping more money into the economy were it not for a fear of Congressional blowback. Furthermore, "political control" is unclear here -- which politicians have control? Would central bankers be directly elected? Appointed by the legislature? Appointed by the executive subject to recall? And so forth.
Second, the notion that central banking decisions are strictly political seems as wrong as characterizing them as strictly technical. It is overly cynical to believe that either technocrats or politicians gin up any old theory to justify the policy ends they seek. As with Supreme Court disputes, there are genuine disagreements in economics on the theory side. At this very moment, different central bankers disagree over the best way to reduce unemployment in part because of different economic theories. Expertise is kinda important in these moments.
OK, these contestations aside, I still have a basic problem with Gobry's argument. For Gobry's process to work better, voters have to punish politicians for poor monetary policy and reward them for wise and prudent monetary policies. I see little evidence that voters would have the necessary knowledge and attention span to do this. Instead, they would likely vote on other considerations, or vote based on short-term considerations such as the unemployment rate and GDP growth without considering whether short-term pump-priming is occurring or long-term sustainable growth. Furthermore, politicians would rig the game just a bit. Political scientists have extensively discussed the existence of "political business cycles" due to fiscal policy. I have every confidence that political control over monetary policy would simply extend the phenomenon to that policy lever as well.
The fact that politicians still control the fiscal lever is what leads me to think that central banking should still be independent. A diversification of political controls over the economy seems like the best minimax strategy over the long run. Thinking back to how U.S. politicians would have handled the last 20 years of central banking, I suspect that they simply would have exacerbated the boom-bust dot-com and housing bubbles. It's not clear at all that the added democratic gain outweighs the loss in policy competence.
That said, Gobry makes a powerful argument, and I'd like to hear from readers. Has independent central banking jumped the shark? What do you think?
While I was on the road last week, I see that Greek elections managed to accomplish two things:
1) A requirement for yet more Greek elections; and
Sooo ... what happens then? The Financial Times has a useful article that asks the appropriate big questions while providing some useful information. Particularly interesting is the emerging belief that the eurozone now has erected the necessary firewalls to prevent contagion from Greece to the rest of the southern Med and Ireland:
[W]ith a new, permanent €500bn rescue fund backed by the strength of an international treaty with multiple tools to buy sovereign bonds on the open market and inject capital into eurozone banks, some officials believe the contagion could be contained -- much as it was after Athens finally defaulted on private bondholders last month.
"Two years ago a Greek exit would have been catastrophic on the scale of Lehman Brothers,” says a senior EU official involved in discussions about Greece’s future. “Even a year ago, it would have been extremely risky in terms of contagion and chain reaction in the banking system. Two years on, we’re better prepared."
The new eurozone firewall -- now backed with additional resources for the IMF -- is not the only reason some officials are becoming increasingly sanguine about losing Greece. Spain and Italy, they say, have taken huge steps to put their economic houses in order, enabling them to bounce back quickly if credit markets suddenly dry up and their banks wobble.
Still, uncertainty over how Europe’s banks would be affected has continued to be the primary concern.
Paul Krugman is somewhat more pessimistic. Sketching out the possible endgame, he posits that Spanish and Italian banks would experience massive capital flight, triggering the key decision faced by Germany:
4a. Germany has a choice. Accept huge indirect public claims on Italy and Spain, plus a drastic revision of strategy -- basically, to give Spain in particular any hope you need both guarantees on its debt to hold borrowing costs down and a higher eurozone inflation target to make relative price adjustment possible; or:
4b. End of the euro.
And we’re talking about months, not years, for this to play out.
Krugman has been predicting Greece's exit from the euro for some time now, but in this case I do think he's correct about the choice posed by Germany -- as yet more signals accrue about Merkel's declining political strength.
Now, actually, I suspect that Greece stays in the eurozone for longer than anyone suspects. That said, based on my two empirical observations during the past two years -- namely, eurogoggles and the Merkel Algorithm. Here is how I would game out the "Grexit" scenario:
1. Greece's departure is announced at the same time as an EU summit announces a boost to its new rescue fund and modest pro-growth German policies. Markets initially react to this news favorably.
2. Within 48 hours, negative news about the Spanish and Italian economies, combined with a second wave of stories revealing that the rescue fund isn't as big as anyone thought it was, rattles financial markets and triggers the behavior described by Krugman.
3. The ECB does nothing, calling on
MerkelEuropean political leaders to take "decisive action."
4. After a week or two of agnonizing non-action, Germany announces half-measures that end the immediate panic gut set up Spain for more stagnation and a new crisis in 2013.
Am I missing anything?
Your humble blogger is currently knee-deep in a pedagogical project on the foundations of economic prosperity. You can imagine my delight, then, that Daron Acemoglu and James Robinson have a new book coming out on that very topic: Why Nations Fail: The Origins of Power, Prosperity, and Poverty. There's an excerpt in the Montreal Review -- let's see how it opens, shall we?
To understand what these institutions are and what they do, take another society divided by a border. South and North Korea. The people of South Korea have living standards similar to those of Portugal and Spain. To the north, in the so-called Democratic People's Republic of Korea, or North Korea, living standards are akin to those of a sub-Saharan African country, about one tenth of average living standards in South Korea. The health of North Koreans is in an even worse state; the average North Korean can expect to live ten years less than their cousins to the south of the 38th parallel.
These striking differences are not ancient. In fact they did not exist prior to the end of the Second World War. But after 1945 the different governments in the north and the south adopted very different ways of organizing their economies....
It should be no surprise that the economic fortunes of South and North Korea diverged sharply. Kim Il-Sung's command economy soon proved to be a disaster. Detailed statistics are not available from North Korea, which is a secretive state to say the least. Nonetheless, available evidence confirms what we know from the all too often recurring famines: not only did industrial production fail to take off but North Korea in fact experienced a collapse in agricultural productivity. Lack of private property meant that few had incentives to invest or exert effort to increase or even maintain productivity. The stifling repressive regime was inimical to innovation and adoption of new technologies. But Kim Il-Sung, his son and successor, the "dear leader" Kim Jong-Il, and their cronies had no intention to reform the system, or to introduce private property, markets, private contracts, and economic and political freedoms. North Korea continues to stagnate economically, and there is no sign that anything will be different under the new "dear leader" Kim Jong-un.
Meanwhile in the south economic institutions encouraged investment and trade. South Korean politicians invested in education, achieving high rates of literacy and schooling. South Korean companies were quick to take advantage of the relatively educated population, the policies encouraging investment and industrialization, the export markets, and the transfer of technology. South Korea became one of East Asia's `Miracle Economies,' one of the most rapidly growing nations in the world. By the late 1990s, in just about half a century, South Korean growth and North Korean stagnation led to a tenfold gap between the two halves of this once-united country---imagine what a difference a couple centuries could make. The economic disaster of North Korea, which not only prevented growth but led to the starvation of millions, when placed against the South Korean economic success, is striking: neither culture nor geography nor ignorance can explain the divergent paths of North and South Korea....
The contrast of South and North Korea illustrates a general principle: inclusive economic institutions foster economic activity, productivity growth and economic prosperity, while extractive economic institutions generally fail to do so. Property rights are central, since only those who have secure property rights will be willing to invest and increase productivity. A farmer, for example, who expects his output to be stolen, expropriated or entirely taxed away would have little incentive to work, let alone any incentive to undertake investments and innovations. But extractive economic institutions do exactly that and fail to uphold property rights of workers, farmers, traders and businessmen.
It will not shock you, my dear readers, to learn that I agree with Acemoglu and Robinson. Indeed, as Ezra Klein showed with the following chart, the divergent paths of North and South Korea represents ironclad evidence about the power of instituions to determine prosperity:
Well, that's pretty damn persuasive, isn't it? It seems pretty friggin' obvious which institutions work and which ones don't!
Actually, to be more accurate, it seems pretty friggin' obvious now. Here's another chart that extends that graph back another two decades:
Things look sightly different in this chart. That massive divergence is still there, but what's stunning is that for the 25 years before that, the DPRK and ROK looked exactly the same in terms of per capital income. Indeed, as Nicholas Eberstadt notes:
Around the time of Mao Zedong's death (1976), North Korea was more educated, more productive and (by the measure of international trade per capita) much more open than China. Around that same time, in fact, per capita output in North Korea and South Korea may have been quite similar. Today, North Korea has the awful distinction of being the only literate and urbanized society in human history to suffer mass famine in peacetime.
My point here is not to defend Kim Il Sung or suggest that the DPRK's economic institutions are underrated. Rather, my point is that as data analysts, we're all prisoners of time. Had Acemoglu and Robinson written Why Nations Fail in the mid-1970s, it would have either made a different argument or it would have had a much tougher case to make about the merits of inclusive vs. extractive institutions (during the 1970s, commodity extracting states were looking pretty good).
Keep these charts in mind whenever anyone confidently asserts the obvious superiority of a particular model of political economy. Because, I assure you, there was a point in time when such superiority was far from obvious. And there might be another such point in the future.
Rick Santorum made some headlines over the weekend about calling President Obama a "snob" because POTUS ostensibly wants all Americans to get a four-year college degree. Here's the clip:
Now, most commentators are focusing on the "snob" comment or the broader thrust of Santorum's jeremiad against higher education or whether this will play in Michigan. I want to focus on the idiocy contained in the first part of Santorum's comment. This is important, because ostensibly one of Santorum's policy strengths is that he knows and likes manufacturing.
In the opening parts of the clip, Santorum says as follows:
I know what it means to have those manufacturing jobs at that entry level to get you in there, and it gives you the opportunity to accumulate more skills over time and rise, so you can provide a better standard of living for your family. And those opportunities are for working men and women -- not all folks are gifted in the same way. Some people have incredible gifts with their hands.
What's disturbing about this bit is that Santorum's ideas about manufacturing employment are so outdated. For an example, take a good, long look at Adam Davisdon's excellent essay in The Atlantic about how American manufacturing looks today. He zeroes in on two workers -- Maddie and Luke. Maddie is exactly the kind of worker Santorum wants to talk about -- a low-level worker with aspirations to move up. But read this part:
The last time I visited the factory, Maddie was training a new worker. Teaching her to operate the machine took just under two minutes. Maddie then spent about 25 minutes showing her the various instructions Standard engineers have prepared to make certain that the machine operator doesn’t need to use her own judgment. “Always check your sheets,” Maddie says.
By the end of the day, the trainee will be as proficient at the laser welder as Maddie. This is why all assembly workers have roughly the same pay grade—known as Level 1—and are seen by management as largely interchangeable and fairly easy to replace. A Level 1 worker makes about $13 an hour, which is a little more than the average wage in this part of the country. The next category, Level 2, is defined by Standard as a worker who knows the machines well enough to set up the equipment and adjust it when things go wrong. The skilled machinists like Luke are Level 2s, and make about 50 percent more than Maddie does.
For Maddie to achieve her dreams—to own her own home, to take her family on vacation to the coast, to have enough saved up so her children can go to college—she’d need to become one of the advanced Level 2s. A decade ago, a smart, hard-working Level 1 might have persuaded management to provide on-the-job training in Level-2 skills. But these days, the gap between a Level 1 and a 2 is so wide that it doesn’t make financial sense for Standard to spend years training someone who might not be able to pick up the skills or might take that training to a competing factory.
It feels cruel to point out all the Level-2 concepts Maddie doesn’t know, although Maddie is quite open about these shortcomings. She doesn’t know the computer-programming language that runs the machines she operates; in fact, she was surprised to learn they are run by a specialized computer language. She doesn’t know trigonometry or calculus, and she’s never studied the properties of cutting tools or metals. She doesn’t know how to maintain a tolerance of 0.25 microns, or what tolerance means in this context, or what a micron is (emphasis added).
It should be noted that Luke didn't get a four-year college degree either -- he went to community college. But that's actually consistent with what Obama has been saying on this issue. I'm not sure it's consistent with Santorum's worldview. Indeed, his notion that career advancement in manufacturing is possible simply through the sweat and skill of a person's brow is badly, badly antiquated. Which is something he would know if he, um... studied the issue a bit more.
UPDATE: I see Santorum's run of not-understanding-a-lot-of-economics continues.
In my experience, pundits tend to be risk-averse in calling out a very rich person on their economic or financial analyses. There's a couple of intuitive logics at work here:
1) Most pundits don't know much about economics, and so are leery of entering those waters;
2) The really rich person likely became really rich because they demonstrated a shrewd understanding of the markets -- therefore, who is the low-six-figure-or-less-earning pundit to challenge such high-yielding wisdom;
3) Most pundits refuse to admit that they don't understand something that reads like gobbledgook, because they're afraid this makes them look like an idiot.
Well, your humble blogger has never been afraid of looking like an idiot... which brings me to PIMCO's Bill Gross. I'll occasionally read his monthly newsletter when a link to it pops up in my Twitter feed. Every time, I'm amazed at the florid, rambling, not-really-related-to-his-main-point way he opens these little essays. Sometimes I find the analysis afterwards useful, sometimes I find it eerily similar to what someone says after spending too much time with Tom Friedman. I gather he's had better years as an analyst than he did in 2011, but everyone has down years and bad predictions.
Here's the thing, though -- I can't understand a word of his latest Financial Times column: Here's how it opens:
Isaac Newton may have conceptualised the effects of gravity when that mythical apple fell on his head, but could he have imagined Neil Armstrong’s hop-skip-and-jumping on the moon, or the trapping of light inside a black hole? Probably not. Likewise, the deceased economic maestro of the 21st century – Hyman Minsky – probably couldn’t have conceived how his monetary theories could be altered by zero-based money.
Things get a little clearer towards the end of the op-ed... but not much. His February 2012 newsletter appears to be an expanded version of this op-ed (plus the usual wacky opening), so let's go there to see what he's trying to say:
[W]hen rational or irrational fear persuades an investor to be more concerned about the return of her money than on her money then liquidity can be trapped in a mattress, a bank account or a five basis point Treasury bill. But that commonsensical observation is well known to Fed policymakers, economic historians and certainly citizens on Main Street.
What perhaps is not so often recognized is that liquidity can be trapped by the “price” of credit, in addition to its “risk.” Capitalism depends on risk-taking in several forms. Developers, homeowners, entrepreneurs of all shapes and sizes epitomize the riskiness of business building via equity and credit risk extension. But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight. Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns. Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains. This nominal or even real interest rate “margin” is why prior cyclical periods of curve flatness or even inversion have been successfully followed by economic expansions. Intermediate and long rates – even though flat and equal to a short-term policy rate – have had room to fall, and credit therefore has not been trapped by “price.”
Even if nodding in agreement, an observer might immediately comment that today’s yield curve is anything but flat and that might be true. Most short to intermediate Treasury yields, however, are dangerously close to the zero-bound which imply little if any room to fall: no margin, no air underneath those bond yields and therefore limited, if any, price appreciation. What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount. Duration risk and flatness at the zero-bound, to make the simple point, can freeze and trap liquidity by convincing investors to hold cash as opposed to extend credit (emplases in original).
And... sorry, I still don't get it. I get why zero interest rates are bad for bondholders like PIMCO. I get that flat yield curves + high amounts of economic uncertainty = cash hoarding. What I don't get is that:
A) Gross himself acknowledges that the yield curve ain't flat;
B) Low interest rates allow for private-sector deleveraging, which is a prelude to stimulating market demand;
C) Low interest rates prevent today's government binge from being even more expensive than it would be in normal times (by keeping financing costs down);
D) If uncertainty is decreasing -- and that appears to be the case with the U.S. economy -- then low interest rates should spur greater entrepreneurial investments.
So, at the risk of threatening my status in the International Brotherhood of Serious Global Political Econmy Bloggers That Talk Seriously About Economics, I hereby ask my commenters to explain Bill Gross' concerns to me. Because I don't get it -- and I'm beginning to wonder if I'm not the only one.
The term "inflection point" has become one of those overused bits of meaningless jargon in political discourse. I'm rather more fond of the notion of a "focal point" -- that is to say, an event or cluster of events in which everyone that cares about a particular problem focuses on the same set of stylized facts -- after which, they conclude that, gee, maybe the status quo set of policies ain't working so well and there should be a new status quo.
The fall of 2008 was one such focal point, during which there was remarkable consensus that a Keynesian boost in public spending was the only way to avert another Great Depression. At the fiirst G-20 leaders summit in Washington, there was consensus on expansionary fiscal policy. Oh, sure, there were grumblings about "crass Keynesianism," but even Germany reluctantly went along.
The Greek sovereign debt crisis was another such focal point. Greek profligacy seemed to be a synecdoche for excessive government borrowing and lax fiscal discipline. With the global economy seemingly still in the doldrums, a lot of Europrean governments climbed on the "expansionary austerity" bandwagon. By the Toronto G-20 summit in June 2010, the consensus had switched from Keynesian stimulus to fiscal rectitude. Oh, sure there were mutterings about "short-term austerity makes no macroeconomic sense whatsoever in a slack economy" but even Barack Obama started talking about slashing government spending.
Are we at another focal point? Consider the following:
1) According to the New York Times' Stephen Castle, European leaders now seem to recognize that austerity on its own ain't working:
Bowing to mounting evidence that austerity alone cannot solve the debt crisis, European leaders are expected to conclude this week that what the debt-laden, sclerotic countries of the Continent need are a dose of economic growth.
A draft of the European Union summit meeting communiqué calls for ‘‘growth-friendly consolidation and job-friendly growth,’’ an indication that European leaders have come to realize that austerity measures, like those being put in countries like Greece and Italy, risk stoking a recession and plunging fragile economies into a downward spiral.
2) The data is starting to come in on governments that have embraced austerity whole-heartedly, and it's pretty grim. Cue Paul Krugman on Great Britain:
Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.
Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.
And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.
3) Even commentators who would be tempermentally sympathetic with austerity are starting to
bash Germany question whether it's a solution. Consider Walter Russell Mead:
It takes some truly talented screw ups to come up with a worse plan for Greece than the one the Greeks have developed for themselves, but the Germans have risen to occasion in fine form....
Deep reform is needed if Greece is to stay in the euro, and so far the Greek political establishment — firmly backed by public opinion — is digging in its heels. Much whining, much talk, many promises and precious little action seems to be the favored Greek approach to the crisis. On the other hand, the austerity policies the Germans favor are hopelessly biased in favor of German banking interests and are aimed more at the preservation of the reputations of German politicians than at helping Greece.
The German political establishment seems willing to destroy Europe to avoid telling German voters the truth about how stupid it has been.
[UPDATE: For exhibit B of this trend, see this Niall Ferguson interview with Henry Blodget. My favorite part of the interview is this quotation: "I think the reason that I was off on that was that I hadn't actually thought hard enough about my own work.... My considered and changed view is that the U.S. can carry a higher debt to GDP ratio than I think I had in mind 2 or 3 years ago."]
4) U.S. 4th quarter data reveals that, consistent with GOP criticisms, the government has been the real drag on the U.S. economy. Not quite consistent with GOP criticisms: the reason why the government is dragging down the U.S. economy. Cue Mark Thoma:
[P]remature austerity -- cutting spending before the economy is ready for it -- is taking a toll on the recovery. The fall in government spending reduced fourth-quarter growth by 0.93 percent; if government spending had remained constant, GDP growth would have been 3.7 percent, rather than 2.8 percent.
This is the opposite of what the government should be doing to support the recovery. We need a temporary increase in government spending to increase demand and employment through, for example, building infrastructure. That would help to get us out of the deep hole we are in. Instead, the government seems to be trying to make it harder to escape.
We do need to address our long-run budget problems once the economy is healthy enough to withstand the tax increases and program cuts that will be required. But the idea of "expansionary" austerity has failed. Austerity in the short-term simply makes it harder for the economy to recover and delays the day when you can finally address budget issues without harming the economy. The lesson is that government needs to support the recovery, not oppose it through a false promise that contraction of one sector in the economy will be expansionary.
5) Central banks are acting more gung-ho on expansionary monetary policy. The unspoken quid pro quo in Europe seems to the that the ECB will expand its balance sheet and turn on the monetary taps in return for some kind of fiscal compact. The U.S. Federal Reserve announced a zero-interest rate policy for the next three years. Even China is showing (halting) signs that its reverted back to monetary easing.
Given that the United States has been the country to move the slowest on austerity, and given that the United States is doing the best job among the OECD economies (an admittedly low bar) of restoring confidence among investors and paying down non-governmental debt, have we reached another focal point?
One could argue that Krugman and Thoma are just biased in favor of Keynesianism, that Greece and the other Club Med countries haven't really embraced austerity, that the Euromess is dragging down British economic growth, and that the long-term numbers on developed country debt are really very scary. There are some large grains of truth in many of those statements.
It doesn't necessarily matter, however. Greece was not a genuine harbinger of the fiscal problems of large markets -- but it was a useful hook for austerity advocates to spread their gospel. What matters now is not whether these perceptions about the failure of austerity are 100% accurate, but whether they are accurate enough to become the new conventional wisdom.
What do you think?
Let's face it, there's a general anxiety about the future of America. There's Tom Friedman's column today, which my doctors have now forbade me from critiquing in order to keep my blood pressure down. Books suggesting the United States is kowtowing to China are forthcoming. The Economist recently observed on the highlights of a sobering survey of Harvard Business School graduates, which contained the following:
Fully 71% of the businesspeople polled expected America’s competitiveness to decline over the next three years. (National competitiveness is a slippery concept: countries do not compete in the same way that firms do. But the businessfolk in question answered some clearer questions, too.) Some 45% said that American firms will find it harder to compete in the global economy. A startling 64% said that American firms will find it harder to pay high wages and benefits.
Intriguingly, the Harvard alumni were gloomy about where America is headed, rather than how it is now. Some 57% felt that today the business environment in America is somewhat or much better than the global average; only 15% said it was worse. But when asked to compare its prospects with those of other industrialised economies, only 9% felt that America was pulling ahead; some 21% said it was falling behind. A striking 66% expected America to lose ground to Brazil, India and China; only 8% thought it would pull away from them.
This would seem to jibe with popular laments about why Apple can't make its products domestically. There are a lot of reasons, but a significant one is the lack of necessary skills for higher-end manufacturing. This is in no small part because American students shy away from the training necessary to do these kind of jobs even if they originally think they want to be engineers. Why? Because American college students don't like doing homework.
So, America is doomed, right?
To be honest, this sounds like a lot of pious baloney. As Michael Beckley points out in a new article in International Security, "The United States is not in decline; in fact, it is now wealthier, more innovative, and more militarily powerful compared to China than it was in 1991." The whole article is worth a read, and a good cautionary tale on the dangers of overestimating the ease of national catch-up:
The widespread misperception that China is catching up to the United States stems from a number of analytical flaws, the most common of which is the tendency to draw conclusions about the U.S.-China power balance from data that compare China only to its former self. For example, many studies note that the growth rates of China’s per capita income, value added in hightechnology industries, and military spending exceed those of the United States and then conclude that China is catching up. This focus on growth rates, however, obscures China’s decline relative to the United States in all of these categories. China’s growth rates are high because its starting point was low. China is rising, but it is not catching up.
What about the future? One could point to the last few months of modestly encouraging economic data, but that's ephemeral. Rather, there are three macrotrends that are worth observing now before (I suspect) they come up in the State of the Union:
1) The United States is successfully deleveraging. As the McKinsey Global Institute notes, the United States is actually doing a relatively good job of slimming down total debt -- i.e., consumer, investor and public debt combined. Sure, public debt has exploded, but as MGI points out, that really is the proper way of doing things after a financial bubble:
The deleveraging processes in Sweden and Finland in the 1990s offer relevant lessons today. Both endured credit bubbles and collapses, followed by recession, debt reduction, and eventually a return to robust economic growth. Their experiences and other historical examples show two distinct phases of deleveraging. In the first phase, lasting several years, households, corporations, and financial institutions reduce debt significantly. While this happens, economic growth is negative or minimal and government debt rises. In the second phase of deleveraging, GDP growth rebounds and then government debt is gradually reduced over many years....
As of January 2012, the United States is most closely following the Nordic path towards deleveraging. Debt in the financial sector has fallen back to levels last seen in 2000, before the credit bubble, and the ratio of corporate debt relative to GDP has also fallen. US households have made more progress in debt reduction than other countries, and may have roughly two more years before returning to sustainable levels of debt.
Indeed, the deleveraging is impressive enough for even Paul Krugman to start sounding optimistic:
the economy is depressed, in large part, because of the housing bust, which immediately suggests the possibility of a virtuous circle: an improving economy leads to a surge in home purchases, which leads to more construction, which strengthens the economy further, and so on. And if you squint hard at recent data, it looks as if something like that may be starting: home sales are up, unemployment claims are down, and builders’ confidence is rising.
Furthermore, the chances for a virtuous circle have been rising, because we’ve made significant progress on the debt front.
2) Manufacturing is on the mend. Another positive trend, contra the Harvard Business School and the GOP presidential candidates, is in manufacturing. Some analysts have already predicted a revival in that sector, and now the data appears to be backing up that prediction. The Financial Times' Ed Crooks notes:
Plenty of economists and business leaders believe that US manufacturing is entering an upturn that is not just a bounce-back after the recession, but a sign of a longer-term structural improvement. Manufacturing employment has grown faster in the US since the recession than in any other leading developed economy, according to official figures. Productivity growth, subdued wages, the steady decline in the dollar since 2002 and rapid pay inflation in emerging economies have combined to make the US a more attractive location.
“Over the past decade, the US has had some huge gains in productivity, and we have seen unit labour costs actually falling,” says Chad Moutray, chief economist at the National Association of Manufacturers. “A lot of our members tell us that it sometimes is cheaper to produce in the US, especially because labour costs are lower.”
Now, whether this boom in manufacturing will lead to a corresponding boom in manufacturing employment is much more debatable. Still, as The Atlantic's Adam Davidson concludes: "the still-unfolding story of manufacturing’s transformation is, in many respects, that of our economic age. It’s a story with much good news for the nation as a whole. But it’s also one that is decidedly less inclusive than the story of the 20th century."
Growth in shale oil and gas supplies will make the US virtually self-sufficient in energy by 2030, according to a BP report published on Wednesday.
In a development with enormous geopolitical implications, the country's dependence on oil imports from potentially volatile countries in the Middle East and elsewhere would disappear, BP said, although Britain and western Europe would still need Gulf supplies.
BP's latest energy outlook forecasts a growth in unconventional energy sources, "including US shale oil and gas, Canadian oil sands and Brazilian deepwater, plus a gradual decline in demand, that would see [North America] become almost totally energy self-sufficient" in two decades.
BP's chief executive, Bob Dudley, said: "Our report challenges some long-held beliefs. Significant changes in US supply-and-demand prospects, for example, highlight the likelihood that import dependence in what is today's largest energy importer will decline substantially."
The report said the volume of oil imports in the US would fall below 1990s levels, largely due to rising domestic shale oil production and ethanol replacing crude. The US would also become a net exporter of natural gas.
Note that this will take a while, and doesn't mean that the U.S. will be energy independent. Still, it's quite a trend. Or, rather, trends.
Since the Second World War, the pattern in the global political economy has been for the United States to adjust to systemic shocks better than any potential challenger country. A lot of very smart people have predicted that this time was different -- the United States wouldn't be able to do it again. These trends suggest that maybe, just maybe, that might be wrong.
Am I missing anything?
Your humble blogger is near the capital of
Waterworld Pennsylvania at the moment and all conferenced out. Regular blogging will resume after some sleep.
In the meanwhile, however, please check out FP's latest Deep Dive on the future of currencies. I have a contribution on the dollar's future as the world's reserve currency. It's depressing to note that the thing I like best about it is it's title -- which, of course, someone else at FP created.
I was pretty dismissive of Standard & Poor's debt downgrade last month. Re-reading that post, I stand by my political analysis of events going forward. Furthermore, the recovery of U.S. equity markets, the sharp reduction of yields on U.S. debt, and the failure of the other ratings agencies to follow suit are further data points suggesting that the S&P decision was flawed.
There's reality and perceptions of reality, however. On that latter front, after a recent expedition to Washington, I've concluded that regardless of whether S&P was right, they've won the argument in terms of perception. The summer debt debacle is, in many ways, the political equivalent of Hurricane Katrina. Perceptions of the Bush administration never recovered from that event, even though one could plausibly argue that the policy outputs of Bush's second term were better than the first term. Neverthelesss, Katrina was an inflection point that has caused a number of actors to reassess their perceptions about the political and policy competency of the White House and Congress.
Something similar seems to have happened with the debt deal. Politico's Ben White relays the dramatic effect on consumer confidence:
The Conference Board this week reported the biggest monthly decline in consumer confidence since the height of the financial crisis in 2008, its consumer confidence index falling from a reading of 59.2 to 44.5, the lowest in two years....
“The debt ceiling negotiation is an extremely significant event that is profoundly and sharply reshaping views of the economy and the federal government,” Republican pollster Bill McInturff wrote in a presentation of survey work he has done recently that suggests the debt ceiling debate has led to a significant shift in public opinion.
The partisan struggle over raising the debt went on for weeks before Obama finally announced on the night of Aug. 1 that a deal had been reached that resolves the issue for now. But while Washington has moved on to its next drama — the deliberations of the so-called supercommittee agreed to in the deal — its psychological impact has resonated widely.
McInturff said the result has been “a scary erosion in confidence” in both the economy and the government “at a time when this steep drop in confidence can be least afforded. … The perception of how Washington handled the debt ceiling negotiation led to an immediate collapse of confidence in government and all the major players, including President Obama and Republicans in Congress.”
A recent Washington Post poll found that 33 percent of Americans have confidence in Obama to make good decisions on the economy and just 18 percent have confidence in Congressional Republicans to do so.
These are especially dangerous readings when Federal Reserve Chairman Ben Bernanke has essentially said it is up to politicians to help boost the economy now that the Fed has fired nearly all its monetary policy bullets.
Speaking of Bernanke, he had this to say at Jackson Hole last week:
[P]erhaps most challenging, the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses. Although details would have to be negotiated, fiscal policymakers could consider developing a more effective process that sets clear and transparent budget goals, together with budget mechanisms to establish the credibility of those goals.
Ten days before Bernanke's speech, FP's Josh Rogin reported that Secretary of State Hillary Clinton had acknowledged the global ramifications of the debt fracas, telling a forum at National Defense University:
I happened to be in Hong Kong a few weeks ago, and I said confidently that we were going to resolve this; we were not going to default; we would make some kind of political compromise.
But I have to tell you, it does cast a pall over our ability to project the kind of security interests that are in America’s interest. This is not about the Defense Department or the State Department or USAID. This is about the United States of America. And we need to have a responsible conversation about how we are going to prepare ourselves for the future
Clinton's statements were confirmed by officials I talked to while down in DC.
So, can this perception be changed? Here, I'm bearish in the short-term. These kind of perceptions can be self-fulfilling. Economic growth is a remarkable political palliative, but growth looks anemic for a good long while. The Obama administration can try to change the narrative, but that's almost as difficult as Inception -- for the same reasons:
As Reinhart and Rogoff have observed, the economic aftereffects of debt crises are long-lasting. From here on out, the political effects of such crises will be on full display.
As someone who studies global political economy, this is fascinating. As a U.S. citizen, this is utterly depressing.
Chinese overlords alien visitors robot masters zombie hegemons post-apocalyptic historians:
Greetings. My goal in this message is to explain to you why the most powerful country in the world committed financial seppuku in the summer of 2011 AD*.
To set the stage: by now you know that the U.S. Congress was obligated to increase the debt ceiling in order for the United States government to continue to function normally. President Obama, Democrats in Congress, and most of the Republican leadership recognized the gravity of the situation. The GOP leadership, however, wanted to use the debt cekiling vote as leverage to get President Obama to commit to significant deficit reduction. After much haggling over "grand bargains," there was a recognition that no such deal could be passed. As a backup, leaders from both parties reluctantly advocated a bill that hiked the ceiling and put off questions about long-term deficit reduction to the future.
The problem was, a political faction emerged that some called "debt kamikazes." These were politicians and interest group leaders -- all Republicans -- who genuinely believed that nothing of consequence would happen if the debt ceiling wasn't raised. There were a few others who did believe it and were nevertheless copacetic with that outcome -- I'll get to that group later.
Sounds absurd to your futuristic ears, you say? Consider my evidence. The Daily Beast's John Avlon detailed the position of the 2012 GOP presidential candidates:
There were also interest group coalitions called "Tea Party" organizations that pressured their members of Congress not to raise the debt ceiling. As CNN's Shannon Travis chonicled, these organizations believed that the effects of more government spending were far more disastrous than defaulting on the debt:
Similarly, Red State blogger Erick Erickson wrote an open letter to the House GOP that boiled down to "do not believe the doom and gloom."
Now, future historians, you might argue that neither Tea Party activists nor presidential candidates (Bachmann excepted) were in Congress and therefore did not matter. However, what's important to understand is that these views were prevalent inside the House GOP caucus as well. The Washington Post's David A. Fahrenthold provided a detailed description of the members of the House of Representatives who thought a default wouldn't be such a big deal. Rep. Mo Brooks (R-AL) offered the most extreme example of House GOP thinking:
Lest you think the view that a default was not such a big deal was limited to backbenchers, Outside the Beltway's Steven Taylor found House Budget Chairman Paul Ryan telling CNBC that a "technical default" of a few days wouldn't be a big deal:
Now, at this point, I'm sure you, future post-apocalyptic historians, must be scratching your
third eye heads, thinking the following:
Why, why did these human beings maintain these beliefs in the face of massive evidence to the contrary? Why did these people continue to insist that default wasn't that big a deal when Federal Reserve Chairman Benjamin Bernanke (a Republican first appointed by Republican president George W. Bush) insisted that there would be a "huge financial calamity" if the debt ceiling wasn't raised? Why did their belief persist when Moody's, Standard & Poor's, and Fitch Ratings all explicitly and repeatedly warned of serious and expensive debt downgrades if the ceiling wasn't raised? Why did they stick to their guns despite news reports detailing the link between the rating of federal government debt and the debt of states and municipalities? Why did they stand firm despite the consensus of the Republican Governors Association and the Democrat Governors Association that a failure to raise the debnt cailing would be "catastrophic"? Why did they refuse to yield despite bipartisan analysis explaining the very, very bad consequences of no agreement, and nonpartisan analysis explaining the horrific foreign policy consequences of American default? Why did they not understand that even a technical default would cost hundreds of billions of dollars**, thereby making their stated goal of debt reduction even harder?
Most mysteriously, why did these people throw their steering wheel out the window despite witnessing the effect of the 2008 Lehman Brothers collapse, which revealed the complex interconectedness of financial markets? Treasuries were far more integral to global capital markets than Lehman, but the debt kamikazes refused to recognize the possibility that a technical debt default would have unanticipated, complex, and disastrous consequences. Why?
I would like to be able to offer you a definitive answer, I really would, but I can't. The implications listed in the previous paraqgraph seemed pretty friggin' obvious to a lot contemporaneous observers at the time. As near as I can determine, there are four partial explanations for why the debt kamikazes persisted in their belief that nothing serious would happen: One explanation, which I've detailed here, is that the debt kamikazes refused to budge because refusing to budge had yielded great political rewards in the past.
Another explanation is that the debt kamikazes convinced themselves that no possible alternative was worse than the federal government accumulating more debt. They looked at countries like Greece and Portugal and decided that the U.S. was only one more Obama administration away from such strictures.
A third explanation was the general erosion of trust in economic experts during this period. To be fair to the debt kamikazes, many of the prominent policymakers who warned about calamities if the debt ceiling wasn't raised had pooh-poohed the effects of the housing bubble in 2005, or the collapse of that bubble in 2007.
The final explanation goes back to those people who acknowledged that a default might be a big deal, but were nevertheless OK with the outcome. These debt kamikazes had undergone a fundamental identity change. That is to say, despite all their protestations to the contrary, they were no longer loyal Americans. They were loyal to Republicans first and Republicans only. Erick Erickson made this logic pretty clear in his open letter to Congress:
As Outside the Beltway's Doug Mataconis explained in response:
That's the best set of answers I can give you. I'm sure, future post-aopocalytpic historians, that you have devised new and sophisticated methodologies to unearth the mysteries of the past. I hope you can solve this historical puzzle -- because me and my contemporaries are thoroughly flummoxed.
I wish you the best of luck, and once again, apologies for the whole collapse-of-Western-civilization-thing that happened in 2011. Our bad.
*To translate into your time scale, 15 B.B. (Before Lord Beiber, Praised Be His Hairness)
** 100 billion U.S. dollars = 15 BieberBucks
For the past two years, staunch monetarists and economic conservatives have warned about the evils of massive deficit spending and quantitative easing. They have argued that such policy measures are inevitably inflationary and will debase the currency and raise nominal interest rates. By and large, supporters of Keynesian policies have responded by loudly pointing to the data on core U.S. inflation and the dollar's performance as falsifying the conservative argument. And, by and large, they have a point. If inflationary concerns really were prominent, the dollar should have depreciated in value an awful lot, and nominal interest rates should have soared. Neither of these things have happened. Point for Keynesians.
Right now, however, markets are providing a pretty powerful data point for Tea Party supporters who argue that hitting the debt ceiling is not the end of the world. Last week Moody's issued the following warning:
Moody's Investors Service said today that if there is no progress on increasing the statutory debt limit in coming weeks, it expects to place the US government's rating under review for possible downgrade, due to the very small but rising risk of a short-lived default. If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction. A credible agreement on substantial deficit reduction would support a continued stable outlook; lack of such an agreement could prompt Moody's to change its outlook to negative on the Aaa rating.
Although Moody's fully expected political wrangling prior to an increase in the statutory debt limit, the degree of entrenchment into conflicting positions has exceeded expectations. The heightened polarization over the debt limit has increased the odds of a short-lived default. If this situation remains unchanged in coming weeks, Moody's will place the rating under review.
Make fun of the ratings agencies all you like, but this was front-page news last week. One would think that markets would be pricing in the possibility of institutional investors diversifying away from dollar-denominated debt, a collapse in the dollar, skyrocketing interest rates, a drastic reduction in nominal GDP, dogs and cats living together, and so forth. Or, as Tim Geithner put it, "catastrophic economic and market consequences."
And yet.... last week, the yield on 10 year Treasuries fell below three percent. Maybe markets are underestimating the likelihood that a debt ceiling deal won't happen, maybe they are underestimating the damage caused by hitting the debt ceiling, or maybe they think the Chinese will continue to buy dollar-denominated debt no matter what happens on the debt ceiling (though read this). Or... maybe the Tea Party activists have a point.
So, my question to readers, investors, and experts on the global political economy -- why aren't markets freaking out more about the rising probability of hitting the debt ceiling?
In my last post I mentioned how China was encountering resistance to its rising power. Now, via Kindred Winecoff, I see a whole mess of reportage about China's mounting internal difficulties. In no particular order:
1) Nouriel Roubini has focused his Dr. Doom-O-Vision on the Middle Kingdom, and doesn't like what he sees:
China’s economy is overheating now, but, over time, its current overinvestment will prove deflationary both domestically and globally. Once increasing fixed investment becomes impossible – most likely after 2013 – China is poised for a sharp slowdown. Instead of focusing on securing a soft landing today, Chinese policymakers should be worrying about the brick wall that economic growth may hit in the second half of the quinquennium....
[N]o country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.
Commercial and high-end residential investment has been excessive, automobile capacity has outstripped even the recent surge in sales, and overcapacity in steel, cement, and other manufacturing sectors is increasing further. In the short run, the investment boom will fuel inflation, owing to the highly resource-intensive character of growth. But overcapacity will lead inevitably to serious deflationary pressures, starting with the manufacturing and real-estate sectors.
Eventually, most likely after 2013, China will suffer a hard landing. All historical episodes of excessive investment – including East Asia in the 1990’s – have ended with a financial crisis and/or a long period of slow growth. To avoid this fate, China needs to save less, reduce fixed investment, cut net exports as a share of GDP, and boost the share of consumption.
The trouble is that the reasons the Chinese save so much and consume so little are structural. It will take two decades of reforms to change the incentive to overinvest.
Now, Roubini is enough of a persistent doomsayer that it would be easy to discount this argument -- if it wasn't for the fact that this jibes with the opinion of other China economy-watchers. This coming-bust prophesizing comes on top of arguments made by Barry Eichengreen, Donghyun Park and Kwanho Shin that as China hits middle-income status, it will hit a "middle income trap" of slower growth. (One interesting question is whether, as China encounters rampant inflation, its eventual decision to let the RMB appreciate will help ease some of these pressures).
2) Meanwhile, China's political leadership appears to be engaged in a full-fledged freakout over the Arab revolutions and any whisper of a similar phenomenon happening in China. Rising food prices are leading to price controls and an anxious government monitoring if/when more expensive staple goods lead to political unrest. That said, Chinese authorities seem to be on top of the whole crushing dissent thing:
According to Chinese Human Rights Defenders, an NGO, by April 4th some 30 people had been detained and faced criminal charges relating to the so-called “jasmine revolution”—an inchoate internet campaign to emulate in China recent upheavals in the Middle East and north Africa. Human Rights Watch, another NGO, reports that a further 100-200 people have suffered repressive measures, from police summonses to house arrest. This has been accompanied by tighter censorship of the internet, the ousting of some liberal newspaper editors, and new curbs on foreign reporters in China, some of whom have been roughed up....
Even more worrying, however, is the increasing resort to informal detentions, punishments and disappearances. These are outside the law, offering the victim no protection at all. The government now dismisses the idea that one function of the law is to defend people against the arbitrary exercise of state power. On March 3rd a Chinese foreign-ministry spokeswoman told foreign journalists: “Don’t use the law as a shield.” Some people, she said, want to make trouble in China and “for people with these kinds of motives, I think no law can protect them.”
3) As for China's assessment of its external security situation, the State Council released its 2010 White Paper on defense last month. As this East Asia Forum summary suggests, there's a slight change in tone from the 2008 white paper:
The introductory assessment of the ‘security situation’ section notes that the ‘international balance of power is changing,’ that ‘international strategic competition centring on international order, comprehensive national strength and geopolitics has intensified,’ and that ‘international military competition remains fierce.’ Despite this sense of turbulence, and as was the case in 2008, the 2010 paper assesses that ‘the Asia Pacific security situation is generally stable.’ But the additional observation in the 2008 paper, namely, ‘that China’s security situation has improved steadily’ does not appear in 2010. One possible reason is that the 2010 paper reports that ‘suspicion about China, interference and countering moves against China from the outside are on the increase.’
In light of all these developments, yesterday's Economist editorial should come as no surprise:
The view from Beijing, thus, is different to the view from abroad. Whereas the outside world regards China’s rulers as all-powerful, the rulers themselves detect threats at every turn. The roots of this repression lie not in the leaders’ overweening confidence but in their nervousness. Their response to threats is to threaten others.
Now, as someone who's pointed out these problems on occasion on this blog, you might think I'm pleased as punch about these developments. Nope. First, from an economic standpoint, a recessionary China eliminates a vital engine of global economic growth. Second, as I wrote back in January:
Exaggerating Chinese power has consequences. Inside the Beltway, attitudes about American hegemony have shifted from complacency to panic. Fearful politicians representing scared voters have an incentive to scapegoat or lash out against a rising power -- to the detriment of all. Hysteria about Chinese power also provokes confusion and anger in China as Beijing is being asked to accept a burden it is not yet prepared to shoulder. China, after all, ranks 89th in the 2010 U.N. Human Development Index, just behind Turkmenistan and the Dominican Republic (the United States is fourth). Treating Beijing as more powerful than it is feeds Chinese bravado and insecurity at the same time. That is almost as dangerous a political cocktail as fear and panic.
Developing.... in very disturbing ways.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.