Category: Economics

Jamie Galbraith says no.

No. The question is grossly misconceived. Right now and for the immediate future, the budget deficit is the only source of demand that can fuel a recovery. Our present problem is not that it is too big, but that it is too small. Far too small.

Via Devilstower, the change in the S&P 500 by year, sorted into buckets. If you’re looking for 1929 (I was), it’s in the –10% column.

More Signs of the End Times. Or Strange Days. Something.

The Curious Capitalist — Motion sickness quantified

Posted by Barbara Kiviat

You may have noticed that yesterday was a rough day for the market. And last week had gone so well, too. Shoot. This morning I was talking to some folks over at the electronic trading platform Liquidnet, and one of them pointed me to a Citigroup report that lends nice context to the recent volatility. Here’s a look at some different time periods and the number of days the S&P 500 has moved up or down more than 5% during the trading day:

1950-2000: 27 days
2000-2006: 7 days
Jan. 1-Sept. 30, 2008: 20 days
Since Oct. 1, 2008: 22 days

Historically, we’ve seen a 5% swing less than 1% of the time. Through September, we were running at about 10%. These days, we’re hitting the threshold more than half the time. Wear your seatbelts.

I’ve used Mark Thoma’s summary. Sounds good to me, but then I’ve got a fixed-rate mortgage and no long-term bond exposure.

Embracing inflation, by Kenneth Rogoff, guardian.co.uk/Project Syndicate

It is time for the world’s major central banks to acknowledge that a sudden burst of moderate inflation would be extremely helpful in unwinding today’s epic debt morass.

Yes, inflation is an unfair way of effectively writing down all non-indexed debts… Price inflation forces creditors to accept repayment in debased currency. … Unfortunately, the closer one examines the alternatives, including capital injections for banks and direct help for home mortgage holders, the clearer it becomes that inflation would be a help, not a hindrance.

Modern finance has succeeded in creating a default dynamic of such stupefying complexity that it defies standard approaches to debt workouts. Securitisation, structured finance and other innovations have so interwoven the financial system’s various players that it is essentially impossible to restructure one financial institution at a time. System-wide solutions are needed.

Moderate inflation in the short run — say, 6% for two years — would not clear the books. But it would significantly ameliorate the problems…

No one wants to relive the anti-inflation fights of the 1980s and 1990s. But right now, the global economy is teetering on the precipice of disaster. … Unless governments get ahead of the problem, we risk a severe worldwide downturn unlike anything we have seen since the 1930s.

The necessary policy actions involve aggressive macroeconomic stimulus. Fiscal policy should ideally focus on tax cuts and infrastructure spending. Central banks are already cutting interest rates left and right. Policy interest rates around the world are likely to head toward zero; the United States and Japan are already there. … Steps must also be taken to recapitalise and re-regulate the financial system. …

Most of the world’s largest banks are essentially insolvent, and depend on continuing government aid and loans to keep them afloat. … As the recession deepens,… bank balance sheets will be hammered further…

When one looks across the landscape of remaining problems, including the multi-trillion-dollar credit default swap market, it is clear that the hole in the financial system is too big to be filled entirely by taxpayer dollars. …

That brings us back to the inflation option. In addition to tempering debt problems, a short burst of moderate inflation would reduce the real (inflation-adjusted) value of residential real estate, making it easier for that market to stabilise. Absent significant inflation, nominal house prices probably need to fall another 15%… If inflation rises, nominal house prices don’t need to fall as much.

Of course, given the ongoing recession, it may not be so easy for central banks to achieve any inflation at all right now. Indeed, it seems like avoiding sustained deflation, or falling prices, is all they can manage.

Fortunately, creating inflation is not rocket science. All central banks need to do is to keep printing money to buy up government debt. The main risk is that inflation could overshoot, landing at 20% or 30% instead of 5–6%. Indeed, fear of overshooting paralysed the Bank of Japan for a decade. But… With good communication policy, inflation expectations can be contained, and inflation can be brought down as quickly as necessary.

It will take every tool in the box to fix today’s once-in-a-century financial crisis. Fear of inflation, when viewed in the context of a possible global depression, is like worrying about getting the measles when one is in danger of getting the plague.

Odd, isn’t it, how all these arcane terms are popping up in the major news outlets these days. I suppose that things like “credit default swaps” and “Baltic Dry Index” were out there around the periphery of my attention all this time, but suddenly they’re front and center and significant (well, maybe).

The Baltic Dry Index is a measure of international shipping costs. The name comes from its connection with the Baltic Exchange in London. Coincidentally, I’ve been listening to Alan Furst’s 2004 novel Dark Voyage, and there was a brief scene at the Baltic Exchange. So the next time the BDI appeared in the news, I took a closer look.

The scary part is a) the BDI has totally and dramatically collapsed, and is still going down, and b) it’s supposed to be an economic leading indicator. Here’s a graph from Investment Tools. Note the logarithmic scale; the red line is a 20-day average, the green is a 200-day average.

The BDI has a lot to do with the cost of tea (and everything else) from China, if not in China. And see also the end of the Wikipedia article for the implications for shipbuilders and shipping companies (hint: they’re going under).

Don’t worry, be happy.

A $1 Trillion Answer, by Joseph E. Stiglitz, Commentary, NY Times

What President-elect Barack Obama will need to do is horribly complicated but also very clear.

First, he must stop the economy from going deeper into recession. Then he needs to bring about a robust recovery, preferably in ways that support the long-term needs of the United States: by repairing our neglected public works, invigorating our technological leadership, making our society greener, fixing our health care problems, healing our social and economic divide, and restoring our social compact.

It will not be easy. President Bush’s legacy of debt and the opposition of those who benefit from the status quo present major obstacles.

There is an emerging consensus among economists that a big — very big — stimulus is needed, at least $600 billion to $1 trillion over two years. Mr. Obama’s announced goal of 2.5 million new jobs by 2011 is too modest. In the next two years, almost four million workers will enter the labor force — or would if there were jobs. Combined with the loss of employment this year, that means we should be striving to create more than five million jobs.

…

via Mark Thoma

It’s a long story; go read the whole thing.

Mankiw Promulgates Confusion on the Debt at the NYT

Greg Mankiw must know better than he indicates in his analysis of the debt in today’s NYT. He complains that efforts to use large-scale stimulus to boost the economy may put excessive burdens on our children.

So, in the stimulus story, we have handed our kids a more productive economy than in the no stimulus story. We also may have created an economy in which tax distortions are somewhat larger (although the plunge in stock values means that after-tax returns are likely to be far higher in the future even with higher tax rates, than they were in the pre-crash years), but any plausible measure of the distortions resulting from the additional tax burden will be dwarfed by the addition to GDP resulting from the stimulus. (If the tax distortions are equal to 25 percent of the tax collections, then they will be equal 0.0225 percent of GDP [25 percent of 0.09 percent]. The stimulus permanently raised output by 0.45 percent.)

In short, if we think about our kids, we should do the opposite of what Mankiw argued. We should support a big stimulus package that is focused on investments for the future. This is essential for sustaining the economy now and it will help our kids for decades to come.

—Dean Baker

Baker says spend — lots.

Dean Baker: Paper Wealth and the Economic Crisis

This backdrop should be kept in mind as Congress considers a stimulus package in the next two months. Congress can and should be considering very large sums for the stimulus package, possibly as much as $600 billion per year.

Spending of this magnitude is needed because that is the amount of demand that must be replaced. With consumption plunging, and housing, non-residential construction, exports and state and local government spending all headed downwards, a large dose of government spending is all that stands between us and long steep downturn. Ideally, this money will address real needs — repairing infrastructure, reducing energy use, extending health care coverage — but the key point is that we need spending, and lots of it.

Those who worry about the deficit and the resulting debt that will be created, and what we are passing on to our children, must think more carefully about sheets of paper. With the stock market plunging by 40 percent, it is now far cheaper for our children and grandchildren to buy the country’s capital stock. In other words, they can expect far better rates of return on money that they invest for retirement and other purposes as a result of the stock market’s plunge.

Similarly, the fall in house prices is great news for our kids. They will be able to get homes for 30 percent, 40 percent, in some areas even 50 percent less than would have been the case without the recent plunge in prices. They should be very happy.

Even the debt itself is not a net burden on our children. Someone must own the debt. In 50 or 60 years, most of us will be gone. The holders of the debt will be our children and grandchildren. While those with an ax to grind, such as cutting Social Security and Medicare, have tried to portray the government debt as redistributing income from future generations of workers to those currently alive and paying taxes, this is absurd on its face.

As a practical matter, our concern must be with the state of the economy. The only way that we can keep employment high, and maintain the infrastructure and investment needed to keep the economy prosperous in the future, is through massive amounts of deficit spending over the next two years.

The debt created by this spending will not be a burden to our children, rather by building a stronger economy we will have hugely benefited our children. The real crime to our children will be if we let misguided concerns about paper debt prevent us from taking the actions needed to pass on to them a healthy economy.

Krugman adds recapitalization and reregulation.

Krugman: What to Do

My guess is that the recapitalization will eventually have to get bigger and broader, and that there will eventually have to be more assertion of government control—in effect, it will come closer to a full temporary nationalization of a significant part of the financial system. Just to be clear, this isn’t a long-term goal, a matter of seizing the economy’s commanding heights: finance should be reprivatized as soon as it’s safe to do so, just as Sweden put banking back in the private sector after its big bailout in the early Nineties. But for now the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots. Nothing could be worse than failing to do what’s necessary out of fear that acting to save the financial system is somehow “socialist.”

The same goes for another line of approach to resolving the credit crunch: getting the Federal Reserve, temporarily, into the business of lending directly to the nonfinancial sector. The Federal Reserve’s willingness to buy commercial paper is a major step in this direction, but more will probably be necessary.
…
Even if the rescue of the financial system starts to bring credit markets back to life, we’ll still face a global slump that’s gathering momentum. What should be done about that? The answer, almost surely, is good old Keynesian fiscal stimulus.

Now, the United States tried a fiscal stimulus in early 2008; both the Bush administration and congressional Democrats touted it as a plan to “jump-start” the economy. The actual results were, however, disappointing, for two reasons. First, the stimulus was too small, accounting for only about 1 percent of GDP. The next one should be much bigger, say, as much as 4 percent of GDP. Second, most of the money in the first package took the form of tax rebates, many of which were saved rather than spent. The next plan should focus on sustaining and expanding government spending—sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.

The usual objection to public spending as a form of economic stimulus is that it takes too long to get going—that by the time the boost to demand arrives, the slump is over. That doesn’t seem to be a major worry now, however: it’s very hard to see any quick economic recovery, unless some unexpected new bubble arises to replace the housing bubble. (A headline in the satirical newspaper The Onion captured the problem perfectly: “Recession-Plagued Nation Demands New Bubble to Invest In.”) As long as public spending is pushed along with reasonable speed, it should arrive in plenty of time to help—and it has two great advantages over tax breaks. On one side, the money would actually be spent; on the other, something of value (e.g., bridges that don’t fall down) would be created.

Some readers may object that providing a fiscal stimulus through public works spending is what Japan did in the 1990s—and it is. Even in Japan, however, public spending probably prevented a weak economy from plunging into an actual depression. There are, moreover, reasons to believe that stimulus through public spending would work better in the United States, if done promptly, than it did in Japan. For one thing, we aren’t yet stuck in the trap of deflationary expectations that Japan fell into after years of insufficiently forceful policies. And Japan waited far too long to recapitalize its banking system, a mistake we hopefully won’t repeat.
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And once the recovery effort is well underway, it will be time to turn to prophylactic measures: reforming the system so that the crisis doesn’t happen again.

The Downside of Falling Mortgage Rates

I’m scared by the latest uptick in mortgage financing. Mortgage rates fell sharply yesterday, which is good news for people with good credit. But it might also be good news for people with bad credit — and very bad news for the US taxpayer.

Go read Business Week’s excellent investigation of subprime lenders who are now originating FHA-guaranteed loans, and you’ll see what I’m talking about. The only obstacle standing between these lenders and massive government-guaranteed riches, until now, was that mortgage spreads were still high, and that therefore mortgage rates weren’t following risk-free rates south. If that’s now changing, the US taxpayer might be funding — and, worse, guaranteeing — a brand-new subprime bubble.

More on falling rates — mostly cheerleading — in the LA TImes and the Sacramento Bee.

Paul Krugman: Lest We Forget

Some people say that the current crisis is unprecedented, but the truth is that there were plenty of precedents, some of them of very recent vintage. Yet these precedents were ignored. And the story of how “we” failed to see this coming has a clear policy implication — namely, that financial market reform should be pressed quickly, that it shouldn’t wait until the crisis is resolved.

About those precedents: Why did so many observers dismiss the obvious signs of a housing bubble, even though the 1990s dot-com bubble was fresh in our memories?

Why did so many people insist that our financial system was “resilient,” as Alan Greenspan put it, when in 1998 the collapse of a single hedge fund, Long-Term Capital Management, temporarily paralyzed credit markets around the world?

…

For once the economy is on the road to recovery, the wheeler-dealers will be making easy money again — and will lobby hard against anyone who tries to limit their bottom lines. Moreover, the success of recovery efforts will come to seem preordained, even though it wasn’t, and the urgency of action will be lost.

We have a smaller-scale “lest we forget” moment from NPR this morning:

SUV sales seemed doomed by high gas prices. But as prices at the pump drop, customers are returning to the big vehicles that — just a few months ago — they wouldn’t look at.

A fascinating investigative report from the LA Times. There were millions to be wrung out of a failing subprime mortgage lender by its executives.

As mortgages went bad, executives cashed out

While Irvine subprime lender New Century was failing, key executives continually changed their stock trading plans and often sold within days of colleagues’ trades, a Times investigation shows.

The subprime lending industry was starting to buckle under the weight of bad loans in November 2006, when executives at Irvine-based New Century Financial Corp. held a conference call to release their latest earnings.

Loan volume was down and defaults were up, the earnings report showed, and in recent weeks at least five stock analysts had downgraded the company’s shares. Moreover, four executives had sold nearly $20 million in stock in the last four months, six times as much as they had sold over the previous 12 months.

“It’s just part of their personal financial diversification plan,” Chief Executive Brad A. Morrice said in response to the question during the Nov. 2 earnings call.

Thus Dean Baker.

The Bear Is Cool: Overcoming Fears of Falling Stock Prices
…
The economic data are indeed grim, but the plunge in stock prices need not be a major cause of concern to the bulk of us who have little or no stock. The basic story is that the stock market is paper wealth, just like bonds, dollar bills or other financial assets. The strength of the economy depends on its ability to produce goods and services, not sheets of paper.

    Even though the stock market has fallen by close to 50 percent, the economy still has the same capacity to produce computers and planes, to provide health care and education, and to develop new software and drugs. The economy is every bit as productive after the market collapse as it was before the collapse.

    The plunge in stock prices destroyed paper wealth (lots of it). This is bad news for the relatively small group of people who had considerable stock wealth. However, for the bulk of the population, who own little or no stock, even including mutual funds in retirement accounts, the decline need not be cause for concern, since it has little direct impact on the economy.

    While there is a popular myth about firms selling stock to finance new investment, in reality the stock market has rarely been an important source of investment capital. Therefore, there is little reason to expect that the plunge in stock prices will have a substantial direct impact on investment or the economy.

    There can be a substantial indirect impact of the plunge on the economy. People consume based in part on their stock wealth. Close to $10 trillion of stock wealth has been destroyed in the last year. This implies a falloff in annual consumption on the order of $300 to $400 billion. Unless this demand is replaced, it will amplify the drop in consumption resulting from the collapse of the housing bubble.
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    Unfortunately, the Bush administration refuses to take the economy’s plight seriously, but a large stimulus package will be the first agenda item of the new administration when it takes office in January. If President Obama commits the government to spending another $500 billion a year, or more if necessary, it can offset the loss in demand created by the fall in stock prices and the collapse of the housing bubble.

    Of course there will be other damage created by the loss of this stock wealth. Most importantly, the plunge in stock prices has left many public and private pension funds severely under-funded. The federal government can temporarily allow for somewhat more liberal accounting standards in the case of private funds and provide limited support for state and local governments trying to keep their funds solvent. We can ensure that retirees will receive the pensions they were promised.

    There will be other people who will be hit by the loss of stock wealth, including tens of millions of workers with defined contribution retirement funds. This is unfortunate and points to the problem of the defined contribution pension system. Workers are forced to bear risk to an extent they probably did not recognize and almost certainly did not want.

    One of the many items on the national agenda should be the repair of the private pension system so that all workers have access to a secure form of retirement savings. The plunge in value of retirement accounts should be a painful lesson to tens of millions of hard-working people that they should never trust Wall Street or the politicians it owns.

    However, the most immediate story of the market crash is that it is a redistribution of wealth that goes overwhelmingly in the direction of the less wealthy. The plunge has destroyed claims to the nation’s wealth by the very wealthy in the same way that destroying $10 trillion in counterfeit bills held by mostly by the wealthy would destroy their wealth.

    The key point going forward is to use government spending to ensure that demand remains strong. That way, the rest of the country need not suffer along with the formerly wealthy.

No kidding.

Felix Salmon: Stocks: Recession Bites

Stock markets are a great way for a society to determine where best to allocate its capital. But once in a while we get a reminder that they’re best suited for long-term capital you don’t really need. Because when the recession really bites and you lose your job and you’re forced to fall back on your nest egg, that’s a particularly gruesome time to be forced to liquidate your portfolio.

Dean Baker, of course.

The Post Promotes Nonsense on Deflation

The Washington Post warned us of the evils of deflation in a front page story. The Post … told readers that:

‘Everyone is having these huge sales, and consumers know if they wait longer, the chances of them not having a good selection is fairly small and the chances are that the prices will be lower,’ said Charles McMillion, an economist who runs MBG Information Services. ‘So why buy today? This is exactly why economists are always scared to death of deflation.’

Okay, so let’s parse this one. If prices are falling, why should we buy items today when we can get them for a lower price next month? That’s a real good question.

Has anyone bought a computer in the last two decades? I have run across a few people who have. According to the Commerce Department, computer prices have been falling at the rate of more than 30 percent a year over most of the last two decades. If people felt that it made more sense to wait for prices to drop, we should expect the computer market to have been very weak. That isn’t quite consistent with the explosion in computer sales over this period.
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Now, there is a real sense in which falling prices do pose a problem, but that it primarily with houses, which do not even appear in the inflation indexes. Falling house prices reduce the wealth of homeowners and can put those with a mortgage underwater. This is a huge problem, but it is not the deflation story highlighted by the Post.

It is true that economies that are experiencing economic weakness are more likely to see deflation than other economies. But this confuses cause and effect. The deflation is a symptom, not a cause.

There is one final point worth noting about this issue. The “deflation” highlighted in this article is primarily the result of a plunge in commodity prices. This plunge reversed a sharp uptick in the price of oil and other commodities over the last two years. It is not clear that commodity prices will continue to fall. In fact, it is entirely possible that prices will quickly reverse course and rise sharply from current lows. This would quickly eliminate the Post’s concerns about deflation.

—Dean Baker

Felix Salmon.

Nothing’s unthinkable in this market, not even the idea that you can tie two rocks together and hope that they float.

More likely nationalization of Citi, this weekend, says Salmon.

Update: John Quiggin is pessimistic about Citi (and he’s not so sure about Switzerland).

End of the beginning?

The failure of Citigroup, which looks increasingly likely to happen in the near future, would mark the end of the beginning of the financial crisis. Until now, the prevailing view has been that the crisis and recession will pass in a year or so, after which things will go back, more or less, to the way they were, with a few less financial institutions, and a bit more regulation. A Citigroup failure would put paid to that idea.

Citi is not only too big to fail, it’s too big to rescue with any of the half-measures that have been tried so far. Only outright nationalization is feasible, and that will probably require joint action by a number of governments; Citigroup’s global operations are too big for the US to handle alone. After that, the kinds of tinkering discussed at the G20 last week will be irrelevant. It’s now unsurprising to read (on CNBC!) predictions that all US financial institutions will be nationalized within a year. That’s probably an overstatement: as long as the economy doesn’t really crash, there are plenty of small banks and credit unions that will survive, but few of the big names will be among them.