Friday, July 8, 2011

Weekend links

1--Contraction, Still Contractionary, Paul Krugman, New York Times

Excerpt: A new paper from the IMF (pdf) puts another nail in the coffin of the doctrine of expansionary austerity. It basically shows that results purporting to show economic expansion following spending cuts and/or tax increases were based on a statistical illusion: an expanding economy can often lead to rising revenue and/or falling spending (e.g. because safety-net spending falls or because the government cuts back in an attempt to cool off inflationary pressures). And as a result, what the Alesina-Ardagna results capture is muddle by reverse causation.

The paper corrects this by using the historical record to identify true examples of deliberate austerity — and it turns out that they are contractionary. The multiplier is less than one, but that may reflect the fact that these austerity programs did not take place in the face of a zero lower bound, so they were partly offset by monetary expansion....

If we were discussing a politically neutral subject, the evidence here would long since have been considered definitive: expansionary austerity is a doctrine that failed. But since we’re in the political realm, of course, such a convenient doctrine can’t be abandoned. On the contrary, it now seems to be the official doctrine of both the GOP and the White House.

2--On the "cannibalization of capitalism", Pragmatic Capitalism

Excerpt: ...While it is important to value wealth and those who can protect it, I think we need to better educate ourselves about the various forms of wealth protection that are available. This doesn’t mean that Wall Street is necessarily all evil. It just means that Wall Street as a proportion of the total US economy has become disproportionately important in the minds of most Americans and the fees and revenues generated by these firms have allowed them to attract the very best and brightest minds. What we need is a Wall Street that adds real value and is leaner and meaner. I think the financial crisis was the markets attempt to impose this self correcting mechanism on this industry, but the government and the Fed clearly had no interest in allowing that to happen. And so here we are back where we started with a crisis wasted and little resolved….

There’s an obvious cannibalization of capitalism that is occurring here and it is an incredibly serious risk to the US economy and our way of life. We have allowed the power to concentrate itself in one largely unproductive industry which we refuse to allow fail. That is the antithesis of the democratic and capitalist world that has made America so great. While better regulation can help to some degree, the only real sustainable fix is via education and better understanding of the financial world in which we live so that the average American can reduce their dependence on Wall Street.

3--U.S. Earnings May See Smallest Gain in 2 Years, Bloomberg

Excerpt: U.S. corporations are set to report the slowest earnings gain since the recession ended as companies from Ford Motor Co. (F) to McDonald’s Corp. (MCD) struggled with rising oil and commodity prices and a slowdown in consumer confidence that may continue to hamper spending this year.

Earnings per share for all Standard & Poor’s 500 Index companies rose 13 percent in the second quarter, according to analysts’ estimates compiled by Bloomberg. Profits gained 18 percent in the first quarter after jumping 37 percent in 2010.

“We aren’t going to see the dramatic increase we’ve seen in some quarters,” said John Carey, who helps manage $260 billion for Pioneer Investment Management Inc. in Boston. “Consumer spending got hammered a bit because of higher oil prices and we have also seen a drop in consumer confidence, which maybe hurt numbers.”

4--The mother of all tail risks, The Economist

Excerpt: A US technical default would convulse markets. Nothing else is certain...If a deal cannot be reached before August 2nd the Treasury says it will be forced to default. It has not specified on what: it could choose to stop paying pensioners and soldiers before it stopped paying interest on its debt. But outright default cannot be entirely ruled out. What happens if the world’s most trustworthy borrower reneges on its debt?...

There is a profound muddle about what a default would entail. Firms usually get a few weeks’ grace to make a payment. Sovereigns typically do not so default would probably be declared the day the Treasury missed a payment.....

Domestic banks would not have to classify their sizeable holdings of Treasuries as non-performing if they thought the default short-lived. But they would suffer nonetheless. Currently Treasuries represent roughly 30% of the collateral that financial institutions such as investment banks use to borrow in the $4 trillion repurchase (“repo”) market. They represent another 4-5% of the $1 trillion in collateral used in the derivatives market. A default could trigger demands by lenders like money-market funds for more or different collateral.

Matthew Zames of JPMorgan Chase, writing on behalf of the securities industry in April, gave warning that this could “lead to deleveraging and a sharp drop in lending”. Money-market funds themselves hold another $338 billion of Treasuries. In the event of a default at least one would probably “break the buck” (ie, fail to give the principal back to investors), threatening “a broader run on money funds”, Mr Zames said.....

5--News of the World Scandal: “The Murdochs Have Lost Control of Events” (Updated) Naked Capitalism

Excerpt: For those of us on the wrong side of the pond, it’s hard to appreciate the significance of the News of the World scandal. A 2009 investigation of this News Corp tabloid for interceptions of messages to royal aides led to a private investigator and a News of the World employee being convicted and sentenced to prison. The current scandal centers on the paper hacking into the voice mailboxes of over 2000 individuals. Sources allege the victims include Prime Minister David Cameron and Chancellor of the Exchequer (Treasury secretary) George Osborne.

But the event that galvanized opinion, as most readers know now, was the hacking into the phone and deleting messages of a girl who was abducted and murdered in 2002, Milly Dowler. The removal of the messages allowed the voicemailbox, which had been full, to take more messages, all for the purpose of getting more juicy messages from her desperate friends and relatives, at the ghoulish cost of giving them the false hope that she had deleted them and was therefore still alive.

And Dowler may not be the only case of this sordid conduct. As the Independent reported yesterday:

The Labour MP Tom Watson claimed last week that the NOTW hacked the phones of the parents of Holly Wells and Jessica Chapman, the children murdered at Soham in 2002....

From Bob Garfield at the Guardian:

The extraordinary thing from this vantage is to see the Great Transatlantic Paradox dissolve before our eyes. To wit: in the US, because his properties are such loud and shrill voices of rightwing politics, Murdoch has long been demonised as a press baron in the worst sense. In the Hearst sense, the Pulitzer sense, the Charles Foster Kane sense. Yet, he isn’t that at all, in these parts. In the US, he inflames zealots but has no measurable influence on anyone else, least of all institutions of power. He may well have the house organ of the Republican party, but by no means is the tail wagging the elephant.

In the UK, though, where prime ministers and MPs of both parties, the press and even the police have cowered under his influence for more than 30 years, he was – until this week – demonised hardly at all. He was the Teflon Oligarch. Only now, amid universal sympathy for the family of a murdered child, have the hitherto craven and cowed coalesced to fight back. Only now is Murdoch being held accountable for decades of ethical bankruptcy, including not mere wiretapping and bribery, but three political generations of influence-peddling and who knows what?

6--What Obama Wants, Paul Krugman, New York Times

Excerpt: On Thursday, President Obama met with Republicans to discuss a debt deal. We don’t know exactly what was proposed, but news reports ... suggested that Mr. Obama is offering huge spending cuts, possibly including cuts to Social Security and an end to Medicare’s status as a program available in full to all Americans, regardless of income.

Obviously, the details matter a lot, but progressives, and Democrats in general, are understandably very worried. Should they be? In a word, yes....

But let’s be frank. It’s getting harder and harder to trust Mr. Obama’s motives in the budget fight, given the way his economic rhetoric has veered to the right. In fact, if all you did was listen to his speeches, you might conclude that he basically shares the G.O.P.’s diagnosis of what ails our economy and what should be done to fix it. And maybe that’s not a false impression; maybe it’s the simple truth. ...

Anyway, I don’t believe that it’s all political calculation. Watching Mr. Obama and listening to his recent statements, it’s hard not to get the impression that he is now turning for advice to people who really believe that the deficit, not unemployment, is the top issue facing America..., and who also believe that the great bulk of deficit reduction should come from spending cuts. It’s worth noting that even Republicans weren’t suggesting cuts to Social Security; this is something Mr. Obama and those he listens to apparently want for its own sake.

Which raises the big question: If a debt deal does emerge, and it overwhelmingly reflects conservative priorities and ideology, should Democrats in Congress vote for it?

Mr. Obama’s people will no doubt argue that their fellow party members should trust him, that whatever deal emerges was the best he could get. But it’s hard to see why a president who has gone out of his way to echo Republican rhetoric and endorse false conservative views deserves that kind of trust.

7--"They are unanimous in their hate for me—and I welcome their hatred", FDR economist's view

Excerpt: Via the blog at the NYRB and FDR, a reminder for Obama:

For nearly four years you have had an Administration which instead of twirling its thumbs has rolled up its sleeves. We will keep our sleeves rolled up. We had to struggle with the old enemies of peace—business and financial monopoly, speculation, reckless banking, class antagonism, sectionalism, war profiteering. They had begun to consider the Government of the United States as a mere appendage to their own affairs. We know now that Government by organized money is just as dangerous as Government by organized mob. Never before in all our history have these forces been so united against one candidate as they stand today. They are unanimous in their hate for me—and I welcome their hatred. I should like to have it said of my first Administration that in it the forces of selfishness and of lust for power met their match. I should like to have it said of my second Administration that in it these forces met their master.

8--Proposal: Central clearing for repos, Repowatch

Excerpt: Central clearing for repurchase transactions could prevent the kind of runs on the repo market that triggered the financial crisis in 2007-2008, writes Jeff Penney, senior advisor to McKinsey & Company, managing member of financial services consulting firm High Line Advisors, and former Merrill Lynch executive. (much more on shadow banking)

9--Household Debt Is at Heart of Weak U.S. Economy: Business Class, Bloomberg

Excerpt: The household balance sheet is in worse condition than at any other point in history since the Great Depression. From 2001 to 2007, debt for U.S. households increased to $14 trillion from $7 trillion, and the ratio of household debt to gross domestic product was higher in 2007 than at any time since 1929 (and we know how that turned out).

The rise in home values during the boom disguised the over-levered household sector; the subsequent decline in house prices revealed just how bad the debt binge was. Mortgage defaults and foreclosures reached levels that were unprecedented in the past 30 years, as far back as the data go.

Weakness in household balance sheets has hammered the economy. Atif Mian of the University of California, Berkeley, and I have shown that the recession began as early as the end of 2006 in areas of the country with elevated levels of household debt. Further, employment, auto sales, and residential patterns in these highly levered areas remained mired in a severe recessionary environment through the first quarter of 2011. California, Arizona, Nevada, and Florida account for 30 percent of the employment losses during the downturn, even though they accounted for only 20 percent of jobs before the recession....

When highly indebted households experience a shock to their credit availability that necessitates deleveraging, their decline in consumption and efforts to pay back debt push interest rates down. In a well-functioning flexible-price economy, interest rates would decline to the point where households with healthy balance sheets would be induced to increase their consumption, thereby making up for the reduced purchases of the over-levered households.

But what happens if real interest rates need to fall dramatically -- even go negative -- to boost the economy? The existence of currency prevents the nominal interest rate from going below zero, which effectively limits real interest rates from getting low enough unless the economy experiences substantial inflation. So even though interest rates for financially healthy individuals are historically low, they need to get even lower to induce those consumers to buy a car or remodel their kitchen. In such an environment, the economy will be stuck in an equilibrium where household demand for goods and services is depressed by a real interest rate that isn't sufficiently low.

Many economists use this framework to justify fiscal stimulus, but they may be missing the point. In both the data and the theory, the critical problem is the high level of debt in the household sector. So why doesn’t macroeconomic policy directly combat this problem?...

There are historical precedents. After the panic of 1819, when cotton price declines decimated the net worth of farmers, state legislatures intervened with debt moratoria. In 1933, the U.S. Congress abrogated gold clause provisions in corporate debt contracts, dramatically reducing principal obligations by companies. So what is different today?

Which brings us to the practical: a successful principal writedown program must be targeted at households whose consumption behavior would be materially changed. Unfortunately, such a program is difficult to design. What is more likely to happen is that all underwater homeowners would line up for relief. This would lead to government expenditures far larger than most taxpayers would accept.

Solving the household debt problem won't be easy. But recognition is the first step toward a solution. If policy makers would acknowledge the drag on the economy from excessive household debt, a fix may present itself. I’m certainly open to suggestions. Just don't forget to bring data to support your proposal.

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