Author: Jonathan

Rotwang at TPM. The paper in question was co-authored by Dean Baker, Brad DeLong, and Paul Krugman.

It’s the Capitalism, Stupid

… My one-sentence summary of the paper is that the stock market can’t possibly be as good a long-run investment, relative to Social Security, as is commonly thrown about. At the time this was controversial. By ‘good’ I mean having a desirable mixture of low risk and decent return. As everyone should know, there is a trade-off between the two (risk & return, that is).

The average growth rate of the U.S. economy has been somewhere between three and four percent, after deducting inflation. Growth is a creature of growing labor supply, additions to the capital stock, and occasional hiccups (both positive and negative) from technological progress and who knows what else. In my view it is not well understood by economists. (I suspect I will not have to work hard to persuade you of that.) At any rate, in advanced industrial countries you would be foolish to expect sustained growth above five percent.

Even these numbers have an illusory component, since they do not account for depletion of the natural environment, the exhaustion of leisure time, and the sacrifice of other non-market amenities.

So it is idiotic to expect stocks to grow at double digit rates. In terms of ‘fundamentals,’ the value of stocks depends on the growth of profits from productive activity. Firms produce stuff that people want to buy. When you buy a stock you are buying an uncertain stream of future income. Some of this you may get in the form of cash dividends, otherwise you may reap capital gains. Alternatively, when you buy a bond you are buying a guaranteed share of a company’s profits, but the company’s survival is itself uncertain. Either way, you can’t expect double digit returns on average for any sustained period of time.

Everything else is buying or selling in expectation of a short-term run-up or drop, respectively, in price, otherwise known as speculation. Your gain will be somebody else’s loss, and vice versa. A huge accumulation of gains will end up as a big loss at some point. You can be lucky with a particular stock or with a particular portfolio for a particular period of time. You can be unlucky too.

…

Notable and Quotable, WSJ: From an address given by John Kenneth Galbraith at the London School of Economics in June 1999 called "The Unfinished Business of the Century":

We have far more people selling derivatives, index funds and mutual funds (as we call them) than there is intelligence for the task. I am cautious about prediction; I discovered years ago that my correct predictions are forgotten, the others meticulously remembered. But some things are definite; when you hear it being said that we have entered a new economy of permanent prosperity with prices of financial instruments reflecting that happy fact, you should take cover. This has been the standard justification of speculative excess for several centuries — for a good part of the millennium. My one-time Harvard colleague Joseph Schumpeter thought inevitable and even beneficial what he called "creative destruction" — the cyclical process by which the system eliminates the people and institutions which are mentally too vulnerable for useful economic service. Unfortunately the process has larger and less benign effects, including the possibility of painful recession or depression.

via Mark Thoma

Are the big banks out of the woods? Yves Smith is properly skeptical. RTWT.

Will Banks Start to Walk Their Talk? Don’t Hold Your Breath (Mark to Market Edition)

The new meme from big embattled banks, starting with Citigroup’s leaked Pandit memo yesterday and Bank of America CEO Ken Lewis’ declaration that the bank will be profitable in 2009, is that things will be OK and all this talk of nationalization is unwarranted.

I’ll reserve judgement till the fat lady sings. The record of financial crises suggests the housing market has lower to go (which is consistent with the notion that prices need to revert to historical norms relative to incomes and rents) and that unemployment is far from its peak (the Reinhart/Rogoff historical comparisions suggest US unemployment will reach 12%).

…

If the banks were really doing as well as their PR suggests, they would not need to use the to be launched public private garbage barge operation. Do you think there is a snowball’s chance in hell of that happening?

We are going straight down the Japan path: propping up banks rather than forcing them to recognize losses, and providing the same sort of accommodative accounting to boot. All it did for them was kick the can down the road a few years, at considerable cost to its society. But that’s what you get when the executive and regulators are unwilling to challenge the primacy of the banking class.

Brad Setser. Talk about falling off a cliff…

The fall in China’s exports caught up with the fall in China’s imports, at least for now

… After soaring for most of this decade — the pace of China’s export growth clearly turned up in 2002 or 2003 and then stayed at a very high pace — China’s exports are falling back to earth. The surge in China’s exports could prove to be as unsustainable as the rise in US (and some European) home prices. They might end up being mirror images … as Americans and Europeans could only import so much from China so long as they could borrow against rising home prices. …

via Calculated Risk

Paul Krugman. Let’s just jump to the conclusion.

Behind the Curve

… So here’s the picture that scares me: It’s September 2009, the unemployment rate has passed 9 percent, and despite the early round of stimulus spending it’s still headed up. Mr. Obama finally concedes that a bigger stimulus is needed.

But he can’t get his new plan through Congress because approval for his economic policies has plummeted, partly because his policies are seen to have failed, partly because job-creation policies are conflated in the public mind with deeply unpopular bank bailouts. And as a result, the recession rages on, unchecked.

O.K., that’s a warning, not a prediction. But economic policy is falling behind the curve, and there’s a real, growing danger that it will never catch up.

OK, let’s go back and pick up one more paragraph.

To see how bad the numbers are, consider this: The administration’s budget proposals, released less than two weeks ago, assumed an average unemployment rate of 8.1 percent for the whole of this year. In reality, unemployment hit that level in February — and it’s rising fast.

Yves Smith, blogging at Naked Capitalism, is one of the clearest online voices on economics. I’ll keep linking, but you really should add her to your econofeeds.

An Amazingly Disingenuous Piece by Alan Blinder on Bank Nationalization

Before I start shredding “Nationalize? Hey, Not So Fast,” by Alan Blinder in the New York Times, let us first go back to the basic problem,, nomenclature. Blinder does not specifically do so in this article, but opponents to nationalization often raise the image of enterprises being expropriated by the state, in other words, healthy (or at least viable) businesses being stolen.

We have the reverse here. Instead a transfer of wealth from the private sector to the state, we have the state (as in the taxpayer) propping up businesses and keeping management demonstrated to be incompetent, perhaps corrupt (let us not forget that overcompensation in phony good times is tantamount to looting, and liberal accounting appears to be awfully common) in place.

The normal remedy for failed businesses is to let them fail. But we don’t do that with banks. The big fear is depositor runs, and if that were to occur on any scale, it would indeed bring the entire system down.

Quite a few readers have said something along the lines of: “I’m opposed to nationalization, the banks should be put into receivership.” Hate to tell you, they are the same thing. …

“It’s the zero lower bound, stupid,” says Paul Krugman.

Paul Krugman.

Feelings of despair

There’s so much to like about where Obama is going — health care, transparency in government, ending the war in Iraq. And the stimulus bill is OK, though not big enough.

But on the question of fixing the banks, many of us are feeling a growing sense of despair.

Obama and Geithner say the right things. But Simon Johnson nails it:

How long can you say, “we are being bold” when in fact you are not?

Obama and Geithner say things like,

If you underestimate the problem; if you do too little, too late; if you don’t move aggressively enough; if you are not open and honest in trying to assess the true cost of this; then you will face a deeper, long lasting crisis.

But what they’re actually doing is underestimating the problem, doing too little too late, and not being open and honest in trying to assess the true cost. The actual plan seems to be to keep the banks semi-alive by implicitly guaranteeing their liabilities and dribbling in money as necessary, all the while proclaiming that they’re adequately capitalized — and hope that things turn up. It’s Japan all over again.

And the result will probably be a deeper, long-lasting crisis.

I didn’t get around to pointing to this post by Dean Baker on Wednesday. Just as well, since there’s a companion story on the AP wire (or I suppose these days its the AP tube) today.

The Banks’s Rigged Stress Test

Read it and weep. The NYT tells us that the baseline scenario for the stress tests is that the unemployment rates rises to 8.4 percent and home prices fall 14 percent. The worst case scenario is that unemployment rises to 8.9 percent and house prices fall 22 percent.

Okay, unemployment will almost certainly reach 8.0 percent and possibly 8.1 percent in February. It might cross 8.5 percent in March. The worst case scenario is that it hits 8.9 percent by the rest of the year?

Remember, this is the same crew that told us that there was no housing bubble. When it became clear that there were serious problems, they assured us that they would be contained in the subprime market. After Bears Stearn collapsed they told us that they didn’t see another Bear Stearns out there.

These stress tests indicate that our economic policy makers are still in a serious state of denial. Why isn’t the media ridiculing them and telling the public that the folks making economic policy still don’t understand the economy.

—Dean Baker

Cue the AP:

California’s unemployment rate jumped to 10.1 percent in January, the state’s first double-digit jobless reading in a quarter-century.

The jobless rate announced Friday by the state Employment Development Department represents an increase from the revised figure of 8.7 percent in December.

A year ago, California’s unemployment rate was 6.1 percent. Since then, steep declines in the construction, finance and retail industries have put thousands out of work.

The number of people without jobs in California soared to more than 1.8 million, up 754,000 over January 2008.

Got that? Worst case scenario, 8.9% by next December. California, 10.1% last month. Sure is lucky the banks don’t have any mortgages in California…

Thus Dean Baker.

Incredibly Bad Economic Piece on NPR

NPR helped a blackmail effort, as it was accurately described by MIT economist Simon Johnson, by telling us that we will have to pay huge amounts of money to rescue the banks. While it gave Johnson a brief chance to make his case, the piece concluded by telling listeners that “the problem is us,” that we had borrowed too much and therefore we have to pay the cost in the form of big taxpayer bailouts.

Okay, this is wrong, wrong, and wrong. First, the excessive borrowing wasn’t just shear frivolity, it was attributable to something that got very little notice from NPR at the time and unfortunately still gets very little notice from NPR: an $8 trillion housing bubble.

People borrowed against this bubble wealth because the experts that NPR and other media outlets present to the public all said that this run-up in house prices was real and would persist. Economists who warned about the housing bubble were almost completely excluded from NPR.

Because NPR and the media more generally led homeowners to believe that the run-up in house prices would persist, people acting in a way that was entirely reasonable given this view. If the price of their home had gone from $200,000 to $400,000, many homeowners opted to borrow some of this equity to take vacations, buy a car, pay for their children’s education or engage in other spending. They may also have stopped contributing to retirement accounts because their home was saving for them.

The problem was not “us,” the problem was the experts who run our economy were unable to see an $8 trillion housing bubble and the reporters who cover the economy largely refused to talk to any of the experts who could have pointed this out.

These reporters now want the taxpayers rather than the bankers, who profited from the bubble, to pay for this failure. This NPR piece is identified as being “Planet Money.” That may be appropriate because most listeners probably would not think it belongs on Planet Earth.

—Dean Baker

Matthew Yglesias.

If High Taxes Led to Growth, the Most-Taxed Countries on Earth Would Be the Richest; Which They Are

…

For the record, however, the most-taxed countries on Earth (i.e., the countries where revenue is the highest percent of GDP) are in order:

1. Denmark
2. Sweden
3. Belgium
4. France
5. Norway

In terms of per capita GDP these are, respectively, the 4th, 9th, 14th, 15th, and 3rd richest countries on earth while the United States is 17th. Of course in part that’s an exchange rate phenomenon and if you use PPP adjustments rather than market exchange rates, the U.S. looks better. On the other hand, if you peer into the future it seems to me that exchange rate comparisons are likely to make us look even worse in years to come. The high-tax five also do very well on things like the U.N. Human Development index.