IPE Journal

Occupy Montreal!

2011-10-31T18:23:00.000-04:00

The Google works in strange and mysterious ways.

It has come to my attention that the fine folks over at Occupy Montreal have taken time out from their busy schedules of occupying and demanding things to pay a visit to IPE Journal: they have even linked to my whimsical scribblings on their blog. I am humbled.

In particular, they are using this blog - no doubt after extensive research - as an authoritative guide to the Tobin Tax, or as it is known in French-Canadian, the "Tax Tobin:"

"Now, the propositions

It was agreed that the Sunday event will be moved to the are between the tai chi sculptures, so campers occupying that area will be removed only for the event. “This is instead of asking the police to close the street. It’s easier”.

Because temperatures are expected to go as low as 5°C, the assembly accepted to move the meeting to the Square Victoria metro (entrance on Rue Saint-Jaques).

Saturday march at 3pm will go to the offices of the minister of Quebec, making stops whenever a bank gets on the way – to protest. It was suggested to support the Tax Tobin. A conversation went long, trying to understand what the tax tobin is all about; however, the amendment to “wait until tomorrow so people can inform themselves of what this tax is all about” was accepted. A decision will be made today at 11:30am.

A child cries in the background."

Indeed.

Occupy Wheat Board!

2011-10-26T19:44:00.000-04:00

I walk by the local franchise of the Occupy Wall Street movement on my way to and from work every day. It's got me thinking a little about the implicit and explicit assumptions that political movements make about the social value of some economic activities over others. For instance, it is fairly obvious that the OWS brigade is furious about bailouts for the wealthy financiers on Wall Street and beyond. This is very, very understandable.

But what do they think about bailouts for Canadian wheat farmers?

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As a general rule I try to keep away from commenting on all things related to the domestic politics of my home country, Canada - it's a poor career move and I usually don't know what I'm talking about anyway. That said, there has been quite a kerfuffle around here lately because the Conservative majority government has recently decided to ditch the Canadian Wheat Board's (CWB) monopsony over a huge chunk of the Canadian wheat market.

Before going any further, it will be helpful to understand what the CWB is: for starters, watch this awesome video (alternatively: the CWB's Wikipedia page or, if you're really sadistic, the CWB Act). In a nutshell: wheat and barley farmers are required to sell their stuff to the CWB, who in turn aggregates it and sells it in the market. In exchange, theoretically, the CWB provides economies of scale in the market and in marketing, resulting in a better deal for farmers. Also, there is no opt-out: it is illegal to sell your wheat any other way. Farmers who think they can compete in the wheat market on their own have to lump it. I should also add that the CWB only applies to wheat farmers in Western Canada - farmers elsewhere can do as they please.

Crucially, the CWB guarantees a minimum price to farmers for their wheat to protect against volatility. Since the CWB is backed 100% by the Government of Canada, in effect it is the taxpayer who guarantees the farmers the price of their wheat. The CWB is also entitled to carry out financial activities, like issuing bonds, debentures or other debt instruments to fund its activities. Any losses on those securities are - you guessed it - covered by the Government and paid for by the taxpayer.

So for various reasons the Government wants to ditch the CWB. The wheat farmers who benefit from the CWB are naturally upset by this, as are the employees of the CWB itself. The political opposition, as is their wont, are strongly opposed.

Here's a though experiment: what would happen if we replaced the words "Canadian Wheat Board" with "Big Banks" - what would happen then? Hmmmm. Let's review the parallels:

The big banks are directly protected against loss by the taxpayer via deposit insurance; the wheat farmers are directly protected against loss by the taxpayer through minimum price guarantees.
If there is a credit drought, the Central Bank lowers rates to make credit cheap again; if there is a flood of credit, the Central Bank raises rates to protect Bank profits from erosion by inflation. If there is an actual drought or flood affecting wheat farmers, they are bailed out by emergency funds set aside by the CWB.
Big banks can raise capital more cheaply because they are Too Big To Fail; the CWB can raise capital more cheaply because they are Too Wheatey To Fail and any losses are covered by the taxpayer.
Big banks are heavily supervised by independent agencies and extensive regulations; the CWB is... er... um...

Okay, so the parallels aren't perfect. But you get the idea: Heads and the banker/farmer wins; Tails and the taxpayer loses. Unless of course you're a Western Canadian wheat farmer who could actually be more competitive on your own, in which case everybody loses, except the CWB.

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Which, I should stress, may still be the best possible outcome. It could well be that there are valid arguments for why the existence of the CWB is good for Canadians. But fundamentally my point is this: if you're prepared to defend the bailouts and implicit taxpayer subsidy of our big banks, you had better be prepared to explain why the role of finance in society serves such a critical economic function that it can be no other way. Similarly, if you're going to defend the bailouts and explicit taxpayer subsidy of the CWB, you had better be prepared to do the same.

I'm all ears.

On the other hand, if you hate bailouts, if bailouts make you angry - man oh man, go ahead and Occupy Wall Street, Occupy Wheat Board, hell, Occupy Grandma's House!

But, for the love of God, be consistent.*

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(*your humble blogger accepts that expecting rationality from partisans and protesters is akin to expecting rationality from YouTube comments, but, what the hell - a man can dream can't he?)

Why I am not a political strategist

2011-09-22T18:07:00.000-04:00

This letter to Fed Chairman Ben Bernanke is a curious thing. In it, senior Republican politicians ask Ben Bernanke to reconsider doing that thing they think he’s thinking of doing (he didn’t). I readily admit to being completely baffled by the underlying logic.

Now, I understand the political argument that additional quantitative easing, if it works, helps Obama win re-election. Republicans don’t want that. But that puts them in the position of politicians who are both a) meddling with the independence of the central bank, and b) hoping to profit from the misery of Americans. That seems a risky thing to put down in writing.

So that’s the cynical view. On other hand, if the Republicans actually believe that QE is bad for the American economy, then why write the letter? If they are correct, QE will fail and Republicans will ultimately benefit at the polls. Senior Republicans can still position themselves against monetary easing in a very loud and public way. But that is a very different kettle of pike from using your political power to try to influence the decision-making of an independent central bank. Why take that unnecessary risk?

Even if we set aside the shaky economics - is a weak US dollar really bad for the economy guys? really? - and incredibly short-sighted nature of this kind political opportunism, I fail to see where the upside is for Republicans. If someone can think of a good answer, do let me know…

You know, some days I really impress myself with... er, myself

2011-09-14T21:22:00.000-04:00

In July 2010 I wondered aloud where the recovery was possibly going to come from. Recent months have provided the answer - it wasn't coming after all.

I really wish I'd put my money where my mouth was.

The iPhone & iPad: Apple's Model T

2011-09-05T12:59:00.000-04:00

"In 1909 I announced one morning, without any previous warning, that in the future we were going to be the "Model T," and that the chassis would be exactly the same for all cars, and I remarked: 'Any customer can have a car painted any color that he wants so long as it is black.' I cannot say that any one agreed with me."
- Henry Ford, automotive badass

When it comes to mobile telephony I am, by all accounts, a Luddite. And so it is only after great delay and prolonged mockery by my peers that I am finally looking into buying a smartphone. But which one? An iPhone, a Blackberry, an Android phone, or one of the myriad of other options? Decisions, decisions.

While it may be that, worldwide, Android phones have the largest (and growing) market share, in North America and certainly among my friends and colleagues it is the iPhone that is dominant. Which is precisely my problem with the clever little device: everyone's bloody got one. The contrarian in me does not want to join the priesthood of the Mac. Besides, they are all exactly the same!

It is this last point which got me thinking about the Model T analogy. In 1913 Ford was nearly half of the car industry, while about 300 firms made up the other half. As we all now know, most of those other firms disappeared very quickly thereafter. Ford managed its dominance by creating a single product - the Model T - that was high quality and cheap. It managed the latter by completely integrating the production process, including the standardization of precision parts to a point where they were interchangeable - a novelty in the industry at the time.

In much the same way, Apple has managed to dominate selected tech markets by focusing on creating a single product that is far superior to its rivals. The most obvious example is the iPod, which has blown all other mp3 players out of the water. Have you tried looking for rival mp3 players in the recent past? New models from rival companies simply don't exist. Everyone else gave up long ago. Much like Ford's integrated manufacturing process, Apple has dominated the market by creating an integrated in-house user experience by linking the iPod device to its iTunes media player and online store. They have built upon and expanded this business model with their iPhone and now iPad.

The iModel-T approach seems to be working. In early August Apple briefly surpassed Exxon as the largest firm in the world, measured by market capitalization. In addition, the computer giant HP recently announced it was abandoning smartphones and tablet computing, effectively ceding the battle to Apple and choosing to focus on other business ventures with a more promising future.

In a world where consumers are paralyzed by the paradox of choice, Apple makes life so much easier by riding to the rescue with a single, easy to use product. There are, however, key differences between the iPhone and Ford's flagship automobile of the early 1900s. For starters, the iPhone doesn't just come in black, but white as well(!) Secondly, unlike the Model T, the iPhone is very, very sexy. For Will Wilkinson, this beauty alone justifies the fact that Steve Jobs and the Apple team have become filthy, stinking, swimming-pool-full-of-Benjamins rich:

"The average American's life is not overfull with gracefully sleek design, to say the least, and in many ways our standards of living have not improved upon that of our parents. But Apple under Mr Jobs has offered the mass market dazzling technical progress with the sort of tastefully luxurious sheen usually reserved for the seriously well-to-do. For this many of us are grateful."

Will's quote illustrates another key difference between the iPhone and the Model T: whereas Henry Ford gambled that consumers would forgive the Model T's ugliness in exchange for paying less for a single, reliable product, Apple has succeeded in convincing consumers to shell out a premium for a beautiful one.

Unfortunately for Apple, in my case it is precisely this cost premium that motivates my stubborn search for a more reasonably priced, Android-powered alternative.

Not cool

2011-08-29T21:46:00.000-04:00

Much of Asia, particularly Southeast Asia, is a humid place. Very humid. The kind of humidity that doesn't so much hit you like a brick wall when you walk outside, but instead creeps up on you all sneaky-like. One minute you're strolling along the street and the next minute (and it literally is the very next minute) your clothes are shifting like tectonic plates on the liquid layer of sweat that is suddenly coating your entire body. It is pretty gross.

It is therefore no wonder that the wealthier parts of the region are quite fond of their air conditioning. For a visitor not accustomed to the weather it can be a life saver. But for reasons that escape my understanding this fondness for AC has reached levels that, to my eyes, seem batshit crazy. I say that because in many cities in Asia, street-side shops, retailers and large shopping malls seem determined to blast as much AC into the atmosphere as possible.

The Economist has been reporting on this all summer in the context of Japan's energy crisis, but, as they rightly point out, wasting AC is not a particularly Japanese affliction. Last summer I was in Singapore and experienced this first hand: I would be walking along the sidewalk outside of a the entrance to a shopping mall and feel a blast of cold air, even though I was 10-15 feet from the entrance. Why? Because the mall had no doors of course. This, in 30 degree celcius weather and a hundred percent humidity.

In another instance, the drug store across the street from my hotel had its automatic sliding doors locked open, their role replaced by a curtain of air conditioning that was flowing down from a 2-meter long AC unit mounted just inside the entrance. The mind boggles.

What is the reason behind this wastefulness? Is it an attempt to show off affluence? A tragically misguided attempt to correct global warming? Is it, as The Economist speculates, "culture?" I have no idea. But just know that for every energy efficient light bulb you install, every window you close, every programmable thermostat you install, there are businesses out there steadily undermining your efforts to reduce energy waste. And then some.

There Follows A Rant

2011-08-10T18:28:00.002-04:00

George Jonas appears to fall into the category of people who spend too much time writing and not enough time reading. I can’t find any other explanation for the absolutely gobsmacking combination of poor writing, intellectual laziness, and fear-mongering that is his op-ed piece in the National Post today.

Here’s a fun game, boys and girls: try counting the number of metaphors in this shambolic excuse for piece of writing. Go ahead! don’t be shy. I counted over ten. Check out this one paragraph:

“No one resisted it, liberal or conservative, Democrat or Republican. Ronald Reagan added $1.9-trillion to the national debt; George W. Bush dwarfed it by adding $6.1-trillion with his bold foray into the democracy-export business, while Barack Obama added his $2.4-trillion before finishing the first lap of his presidential run. Printing money is an addiction. Deficit is a drug, and death seemed not to impede Keynes’ abilities as a pusher. I doubt if the Tea Party’s provisions will end his long posthumous run — or ours.”

If the Muddled Metaphor Index is a guide, things are looking very bad indeed.

If that game doesn’t pose enough of a challenge, see if you can count the many examples of fallacious thinking found in this piece. Because the argument is so incoherent it is hard to say exactly, but it appears as though Mr. Jonas is attempting to blame Keynesian economics for the fall in financial markets, the euro-crisis, rioting in London, and the entire Arab Spring. That’s quite a claim, so you would expect it to be backed up by some strong arguments and clear analytical thinking.

You would expect wrong. The fact of the matter is that of Keynes’ economics ol’ Georgey-boy does not appear to have a sweet clue. He probably has not read anything written by Keynes other than the singular quote around which he pivots his article. The extent of his rigorous research is revealed in this passage:

“A Marxist-trained scholar I knew encountered Keynes for the first time when he came to Canada in the mid-1950s.... He remained unimpressed by Von Mises and Hayak [check yo’ spelling, G-money - dh], but Keynes transported him in ecstasy. “Imagine the elegant simplicity,” he told me. “Lord Keynes discovered that if we deny ourselves things we live poorly, and if we deny ourselves nothing, we live well.”

“Are you sure that’s all there is to it?” I asked.

“Yes, yes.”

Seriously George? You asked some random Marxist scholar to summarize Keynes in a single sentence and used that as the premise for your analysis? That is breathtaking intellectual laziness. It is no wonder this piece makes no sense.

But I’m willing to bet this little anecdotal gem was included just so that Jonas could segue into a sentence that begins: “In Soviet-style Keynesian countries...” That is nonsense. Keynes was fiercely opposed to state-controlled economies and his thinking reflected that - his General Theory was precisely an attempt to find an alternative to both communism and the economic ruin of the 1930s. The same holds true for Mr. Jonas' examples of government spending over the years, many of which are not examples of Keynesian economics in any way, shape or form.

But detailing these errors by quoting Keynes’ actual writings would be a waste of time: Mr. Jonas clearly does not care whether our economic problems were caused by Keynesian economics, a perversion thereof, or a whole complex range of other factors. He clearly does not care for accuracy of any kind – this is an ideological tirade within which history, facts and logic have no part to play. Frankly, I’m surprised that he did not somehow weave in a reference to Hitler and Islamo-fascists, for good measure.

This kind of writing poisons the discourse and makes us dumber. I really hope that the next time Mr. Jonas decides to write an opinion piece on a topic about which he is completely ignorant, he would do the world a favour, step away from his e-typewriter, and go read a bloody book.

Let's Review

2011-08-08T17:54:00.001-04:00

U.S. Congress threatens to not make good on U.S. debt
S&P downgrades U.S. debt
Market actors respond by panicking and buying more U.S. debt

These three phrases speak volumes about our current political and economic environment, not to mention the role and relevance of institutions like legislatures, central banks, and credit rating agencies in shaping market outcomes.

Disturbing? Yes. Inconsistent? Not in the least.

"Policy Failure on a Massive Scale"

2011-07-29T08:17:00.001-04:00

I'm about to head off on a blissful long weekend in the woods, and thank God. Civilization has been a real drag for the last little while. I've noticed that even the tone of even more usually reserved commentators has changed to hand-waving and yelling from the rooftops. Take Ryan Avent's post from yesterday on The Economist's Free Exchange blog, which pretty much sums up everything I feel about the situation right now:

"MAYBE everything will turn out all right. One shouldn't forget that possibility. As each day passes, however, frustration grows. Leaders in America and Europe are dallying with failure on an epic scale. They are constrained by dysfunctional institutions, it's true. In Europe, the architecture of the currency union is far too underdeveloped to weather a crisis of the current magnitude. In America, the creaking machinery of the legislature is ill suited to settlement of big questions on a short time frame amid divided government. But it's no longer sufficient to blame inadequate policy responses on institutions alone. America and Europe are flailing because their leaders are failing. They seem to be too small for the tasks at hand, too petty, and too myopic.

...

Again, it's not like the correct policy path is incredibly complicated. Here, I'll sum it up in three quick steps:

Don't cause a major crisis.

Do spend more and tax less for the next year or so.

Do spend less and tax more after that.

See? That's really easy!"

He's not kidding - it is really easy. Look, the New York Times has even laid out it for you in this awesome little interactive graph. Go ahead, time yourself: see how long it takes YOU to solve the deficit.

Have a lovely weekend.

Friends Don't Let Friends Publish Rambling Op-Eds

2011-07-26T22:21:00.003-04:00

One of the reasons I'm back to blogging is that it is highly therapeutic; it provides me an outlet to vent when venting is a better alternative to hair-pulling, gnashing of teeth, wailing, or similar types of activities that annoy my co-workers deeply.

For instance, take today's op-ed in the FT by Alan Greenspan. Now, I'm not a compulsive, Krugman-esque Greenspan-basher like some (Paul Krugman, for instance). But I defy anyone to read this and come away with any understanding of what the former Federal Reserve Chairman is trying to say. Here's my effort:

Capital buffers have a cost as well as a benefit.
The general public are foolish sheep.
Private actors make risk decisions; public actors clean up the mess when they get it wrong.
Private actors got it wrong; financial calamity ensued.
Public actors, regrettably, intervened to clean up the mess; moral hazard ensued.
Sufficient capital buffers would, by definition, have prevented financial calamity and, by extension, the spike in moral hazard.
Public actors are therefore encouraging bigger capital buffers.
Bigger capital buffers are bad.
A debate will occur.

End.

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To step away from snarkiness for a moment, there are some very valid points in this piece (particularly about the negative side-effects of higher capital buffers on wealth creation). But taken as a whole, it is an incoherent mess. Not to mention his blithe disregard for the increasingly frequency of financial crises and the enormously negative wealth effects associated with those, too. I am left scratching my head at the FT editors who let this one slip through the cracks.

Actually, on second thought, maybe they've deliberately done the world a service.

And Now Back To Our Regularly Scheduled Programming....

2011-07-26T22:13:00.000-04:00

Let's face it: from a political economy point of view it is basically a blogger's wet dream out there right now: the Arab world just vom-chucked all over its autocrats, the Eurozone's leadership are engaged in a Guinness World Record-seeking attempt to kick the biggest can ever down the road and the political representatives of the United States are holding the global economy hostage while they debate whether they should pay for things they've already agreed to pay for. How can I resist?

Intermission is over. Get back to your seats.

Game on.

"What is this Land Rover of which you speak?"

2010-12-09T07:42:00.000-05:00

In his April 2009 article for Vanity Fair (no longer fully available), Michael Lewis told the story about how Iceland's banking system basically imploded during the financial crisis. One of my favourite stories from the article is the one he tells about the fate of the country's many Land Rovers.

Presumably because they are a great tool for hauling fish across the Icelandic tundra, Land Rovers were a popular item for the small island nation. They were even more popular as the result of the availability of cheap financing during the pre-crisis boom in credit. The problem was, this cheap financing was provided in foreign currency; the interest rate for euros, pounds and dollars was far lower than that for the domestic currency, the krona. This is all fine and good if your salary is paid in euros, pounds and dollars, but in fact most people in Iceland are paid in krona.

When Iceland's economy went down the crapper, the value of the krona went with it. Since the value of their income had just plunged relative to the value of their debts, many civilized citizens of Iceland were forced to make one of two choices:

Attempt to pay back their car loans in salted cod
Do something crazy

Many chose the latter. There follows a brief representation of what I assume was a typical telephone call between an Icelandic bank and its client on the subject of overdue car payments in 2008:

"Icelandic Bank: Dear Mr. Ragnar Hjalrnarsson, the monthly payments on your Land Rover are 3 months overdue."

Mr. Hjalrnarsson: *panting furiously, having just run for cover*

"Iclelandic Bank: Mr. Hjalrnarsson?"

*KABOOOM*

"Mr. Hjalrnarsson: Land Rover? What is this Land Rover of which you speak?"

FIN

The fine folks in Iceland had resorted to blowing up their Land Rovers to avoid paying them back. Seriously. This is a country that, in 2008, still had a GDP-per-capita of over $52,000.

Why am I re-telling this story? Because the exploding Land Rover is a great metaphor for a currency mismatch: the situation wherein debts are denominated in a different currency than the income used to pay down those debts. Currency mismatches can exist not just for individuals, but for entire economies at the macro level. But since economies can't go around blowing up Land Rovers whenever it comes time to rollover their debts, the consequences can be quite severe.

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The most recent example of this phenomenon was in parts of Eastern Europe, particularly the Baltic states, way back in 2007-8. Countries like Latvia, Estonia, Hungary, etc... had a large number of loans outstanding to European banks (i.e. denominated in euros). Many of these debts were also short-term and needed to be rolled over right smack in the middle of the financial crisis (see a more detailed explanation in this old post). That proved problematic, to say the least. As a result, parts of Eastern and Southeastern Europe were among the hardest hit economies in an economic crisis that originated somewhere else.

The currency mismatch is not a problem specific to our most recent financial crisis, however; here is economist Morris Goldstein, speaking in 2007:

".... [S]erious currency mismatch has been a feature of every major emerging-market currency crisis of the past dozen years. It was there in Mexico in 1994–95, in the Asian crisis countries in 1997–98, in Russia in 1998, in Brazil in 1998–99 and 2001–02, in Turkey in 2001–02, and in Argentina in 2001–02.... [C]urrency mismatch provides the best explanation we have for why large exchange rate depreciations in emerging economies have had such costly growth effects. When financial liabilities are mostly denominated in dollars or in other reserve currencies while assets and revenues are mainly denominated in local currency, then a large depreciation of the local currency will result in balance sheet problems that ultimately cause economic growth to nosedive."

Here is Brad DeLong:

"The decade of the 1990s was marked by the sudden emergence of international financial crises. In a typical such crisis, a sudden loss of confidence in the value of a country’s currency by international currency speculators was followed by a rapid rise in the value of foreign currency—in the exchange rate—the threat of large-scale bankruptcies of banks and firms, financial panic, and a sharp severe recession. These crises hit in the Mexican peso crisis of 1994-1995. Then followed the far-reaching East Asian crisis of 1997-1998. The decade ended with crises in Brazil, Turkey, and Argentina."

The currency mismatch is not merely a modern creature - oh no. In the period of unfettered capitalism that characterized the late 19th and early 20th centuries, "hot money" was flowing into what we would now call emerging markets: Southeast Asia and South America. There were quite a few financial blow-ups involving currency and maturity mismatches - the Barings crisis of 1890 being the most famous.

In other words, we need to recognize that the risk of a currency mismatch contributing a major financial meltdown is present in just about every period in which we see capital flowing easily across borders. This leads me to ask one simple, juvenile, question:

Why why why why WHY?

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With all this history, why hasn't anyone learned their bloody lesson? Why do we continue to see, to this very day, the potential for instability caused by currency mismatches present - and growing - in a variety of markets. I can think of several factors that play a role:

1) Access - pretty straightforward: you need easy access to international capital markets. This has been easier during certain periods of time (pre-1914, the Great Moderation of the 1990s-2000s, etc) and in certain regions (for instance, small EU members have direct access to foreign lending from other EU members due to the membership requirement for open capital accounts).

2) Import requirements - it is unlikely that many exporters or banks will accept the Papua New Guinea kina in an exchange for the sale of goods & services, for instance. Small economies with non-reserve currencies need to use foreign currencies to purchase the things they need, or borrow the funds they need. This can lead to debts in those same foreign currencies.

3) Lack of trust in the local currency - often domestic borrowers will seek outside financing if the local currency has a history of high inflation, political meddling, or exchange rate volatility.

4) weak domestic capital markets - sometimes domestic borrowers simply cannot raise money domestically. There are any number of elements to this, including: restrictive local banking regulations, lack of expertise, or lack of appetite (see #3).

5) Behavioural/psychological element - it is hard to resist cheap money. Look at the subprime real estate crisis in the United States and you can see how difficult it is for people to resist borrowing irresponsibly (often from irresponsible lenders). The people in Iceland basically did the same thing, and got burned when interest rate on the loans shot up. People tend to overestimate their ability to predict future events.

6) ...what have I missed?

One argument I'm not buying is lack of awareness. As illustrated above, the challenge of currency and maturity mismatches is not new. Policymakers know and appreciate the dangers associated with a country (or many of its citizens) borrowing in foreign currency, particularly for the short-term. But sometimes the problem is an inability to stop hot money inflows & outflows - see the point about access above - and the costs associated with markets who are perceived to have overly-restrictive measures in place for investments.

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Why am I bothering with all of this? It is because, even though the crises I've mentioned above are mostly old news, the challenge posed by hot money inflows is as topical as ever. This is part due to the expansionary monetary policies adopted by the United States and other large developed economies to stimulate recovery. I discussed this back in April with this atrociously-titled post, but if anything the trend has become more pronounced in the period since then.

The recent IMF global markets monitor suggests that capital inflows to emerging markets continues to surge, led primarily by portfolio flows to liquid debt and equity markets. In many parts of the world (including parts of Latin America and Asia), the levels of inflows are reaching pre-Lehman levels. It is important to emphasize that this is not foreign direct investment (i.e. the money isn't there for the long-haul).

India is seeing heavy capital market inflows, again mostly in equities and mostly portfolio inflows. China is also trying to keep a lid on domestic credit growth and just recently capped the amount of lending by domestic banks.

In fact, many emerging markets are toying with capital controls as a way to limit volatility. Brazil has done so, and there is speculation (so far un-founded) that Malaysia will follow suit. Brazil was even somewhat successful in getting pro-capital control language in the G20 communique from Korea ("practical tools to overcome sudden reversals of flows," anyone?). The large exporters will also continue to keep large foreign exchange reserves as a buffer - a policy that turned out to be rather justified in recent years, despite the distorting effects it has on global imbalances and the huge opportunity cost.

All of this suggests that the dangers associated with currency mismatches and rapid capital inflows have not gone away. Quite the opposite. Large inflows may be justified in the current environment of strong emerging market performance, but our ability peer into the future is limited. We do not know what is coming next.

We do not know who will be blowing up their Land Rovers next.

Discouraging Thought of the Day: Perception vs. Activism

2010-11-26T17:30:00.013-05:00

David Brooks, writing in the NYT on the centennial of Leo Tolstoy's death:

"As a novelist, Tolstoy was an unsurpassed observer. But he found that life unfulfilling. As he set out to improve the world, his ability to perceive it deteriorated. Instead of conforming his ideas to the particularities of existence, he conformed his perception of reality to his vision for the world. He preached universal love but seemed oblivious to the violence he was doing to his family."

Well. THAT's discouragingly accurate.

You can have clarity of observation, or you can set out to change the world, but not both simultaneously. It's the quantum physics of social activism.

Of course this applies not only to activists but do-ers of all kinds. As Cohen rightly suggests, the memoirs of political leaders tend to be skewed not (simply) because of attempts at whitewash, "but because they’ve been engaged in an activity that makes it impossible for them to see it clearly. Activism is admirable, necessary and self-undermining." Go watch The Fog of War if you doubt this.

This is also what occasionally makes business leaders very poor judges of economic policy (see here, for example).

But this is very bad news indeed for newly-minted grad students who are setting out to change the world.

Hmmm...

Best to start a blog instead.

Readables

2010-11-17T15:30:00.002-05:00

- About a week old, but this is one of the best pieces I've read in a while. Follow-up is here.

- The, um, wanker-bankers have conned the Biffo Bunch

- Quantitative easing, explained. The Ben Bernank does not come off well

- Here is a better explanation of QEII. Here is another

- In related news, core inflation falls to record low.

Go Timmy! Go Timmy! Go Timmy! Go Timmy!

2010-11-13T12:29:00.000-05:00

US-China monetary policy rap:

Yeah, What Brad DeLong Said

2010-11-09T13:54:00.007-05:00

In case you missed it, Bob Zoellick, the head of the World Bank, was pontificating in the FT this week about the merits of returning to some sort of gold peg for currencies. DeLong, in his typically understated fashion, shoots him down hard.

Without passing any particular judgement on Zoellick's mental faculties, I think it's fair to say that suggesting a return to the gold standard in any format is a bad idea no matter who is suggesting it. But like some form macroeconomic acne, the idea of the gold standard keeps popping back up in periods of stress. For example, see my comments on Gillian Tett's misguided op-ed in the FT last year.

At the time I argued that, using the same logic, an economy run by squirrels would use an acorn standard. Why? Because they like nuts, silly. This analogy is even more apt that I had initially realized: much like humans and gold, squirrels spend a lot of time and energy scurrying around gathering up acorns - only to promptly bury them back underground.

Where the analogy breaks down is that acorns actually have an intrinsic value (nutrition), whereas gold does not have much intrinsic value at all. Its skyrocketing price is the result of investors (and here I'm quoting DeLong again) "using gold as a speculative asset and a hedge. They are not using it [as] a medium of exchange, a unit of account, or a safe store of nominal value."

As if this weren't damning enough, a return to a gold peg wouldn't even address the global imbalances problem. It would merely shift it around: US and European central banks own some 50% of the world's gold reserves. Hmmmmm. One suspects that if Saudi Arabia was the dominant world economy, we might be hearing ideas about an oil standard. This at least would have the added benefit of being a highly liquid asset. (HA!)

Seriously folks: this is gauling. All the more so because the gold standard is one of those rare phenomena in economics where it's not a theoretical debate. We've tested it out. It doesn't bloody work.

With so many potentially bad ideas floating around about how to fix the world economy, there's absolutely no reason why we need keep discussing the one we know for sure will be a disaster.

UPDATE: Zoellick clarifies his comments: "Gold is now being viewed as an alternative monetary asset. This is not the same as a gold standard,” said Mr Zoellick. “Gold has become a reference point because holders of money see weak or uncertain growth prospects in all currencies other than the renminbi, and the renminbi is not free for exchange. So, in relative terms, gold is appealing to people who ask where should I put my money. It is a hedge against uncertainty.”

Well alright. Nevermind then, Bob: I forgive you. But just so we're clear: "a hedge against uncertainty" is not the same thing as an alternative monetary asset, mmk?

Hayek's Road to Serfrom

2010-10-07T12:21:00.002-04:00

One of the hot topics of the week is evaluating the merit of Hayek's Road to Serfdom. I read this book about two years ago now, and I have to say I agree almost entirely with Tyler Cowen's re-assessment of the thing.

I was surprised by the book: it was not nearly as extreme as I was expecting. In fact, it lays out what to modern eyes are highly reasonable arguments for why the central planning that was dominating the world at the time was doomed to fail. His primary target was the extreme central planning of the fascist and communist states, but his arguments applied equally to the government-planned wartime economies of the Allied powers.

The book I read immediately afterwards was one by J. M. Keynes. Many of those who currently cite the Road to Serfdom to back up their political views might be surprised to learn that Keynes shared Hayek's fundamental concerns. He agreed with the book's argument about the dangers of central planning; where he differed was in the degree of the response. That Keynes' proposed "middle way" is now considered to be at the Left end of the spectrum speaks volumes about how much society has changed in the past 70 years.

Moreover, that Hayek's predictions failed to materialize is a testament to the degree to which we've internalized many of his arguments in the book. I would argue that the same can be said for Marx. The extremes that both men were railing against no longer exist as credible threats to our society, despite what some will have you believe. In re-reading these texts, their arguments would almost seem quaint were it not for the recognition that the problems were, at the time, very real.

The flip side to all of this is that this particular book has lost much of its relevancy to the problems we are dealing with today, much in the same way that many of Marx's writings are of little use in addressing contemporary issues. That may not please the self-styled radicals at either end of the ideological spectrum, but for the rest of us it is very good news indeed.

The world is a strange, strange place

2010-10-07T08:00:00.000-04:00

This, from a quick scan of the news:

- President Evo Morales knees a political opponent in the groin during a soccer match.

- The Philippines bans off-key national anthem singing

- Vietnam introduces state-run Facebook knock-off. "You have a friend request from: The Politburo"

- Rent-a-friend

Promises, promises...

2010-09-30T16:30:00.003-04:00

Paragraphs to ponder, from Karl Smith. Although I've had this point explained to me many times, it never hurts to reflect upon how interconnected and, ultimately, fragile our socio-economic structure really is:

"All things financial are ultimately promises.

Promises, however, matter. Ultimately they matter because promises are how we coordinate people to make stuff that is bigger and better than any one person could make alone. If we couldn’t make promises to each other we could never build factories, homes, cars, etc. In truth specialization would all but collapse and the modern economy would cease to function.

Many economists like to pretend that the economy functions on the basis of trade. The baker makes bread and trades with brewer who makes beer. But, this isn’t how the real world works is it? The real world is full of promises.

When the baker wants beer he give the brewer a promise. When brewer wants bread he gives the baker a promise. If they don’t trust each other very much they trade in government promises, that’s called legal tender or money. When they trust each other a lot they trade in private promises, that’s called credit.

I have occasionally received gifts in appreciation for my lectures but mostly I receive a big chunk of promises at the end of every month. I use those promises to meet other promises that I have made. And, with the promises I have left over I can get other things that I might want for the month. I keep some of my promises stored away, as a promise to myself.

In the old days when even trust in the government was low promises took the form of metal. For most people the metal had little value but they knew someone else might want it so it was good enough. Today, trust is high. Our legal system is strong and most promises are just bits in a computer system, a little electronic maker that says society promises resources to John Doe. Promises are the foundation of our economy. That’s why when promises go bad, as they did in the sub-prime crisis, the whole economy goes bad. That’s why some of [us] think the government needs to make some new promises. We are running short."

The Autumn of our Discontent

2010-09-29T09:34:00.004-04:00

Adam Posen, of the Bank of England's external monetary policy committee, is now convinced that the Bank needs to act fast to avoid a prolonged period of Japanese-style economic stagnation. He argues that the accumulating evidence suggests that the downside risk to doing nothing far outweighs the risks of inflation.

When the overwhelming bulk of pressures in the economy are disinflationary, and when the level of output and employment is clearly likely to be below potential for an extended period, it is right for central bankers to take the additional negative effects of protracted recession on trend productivity growth and on capacity into account.

Is Posen right? I haven't a clue. But he does raise one point which I think is worth noting: there's more at stake here than simply a bit of lost productivity growth and economic capacity:

Let us not forget that it was sustained high unemployment and austerity, the sense that governments were unresponsive to average people’s dire economic conditions, which led to the rise of extremist intolerant parties in pre-war Europe

I've used this historical reference a number of times, but it is an admittedly extreme example. Posen is right to use the language of "let us not forget" as this is merely a reminder - not a prediction of what is to come. Nevertheless, the point is well taken. Last year, Rory wrote a great piece on the brewing summer of discontent: the seething popular anger in the aftermath of the financial crisis and the demand to do something.

Thankfully, some of the worst predictions have not come to pass. But the danger has not disappeared; a casual scan of the recent news reveals as much. The US has its own backlash in the form of the surging Tea Party movement. The British Labour Party just recently elected Ed Milliband as their leader, indicating a sharp tack to the left. In both cases, these shifts are likely to be politically counter-productive. But in both cases, I read this as a giant "Fuck You" to the ruling consensus that has dominated Anlgo-American policymaking since the late 1990s.

Granted, prolonged recessions do not necessarily result in deep social unrest. From my (limited) knowlege of Japan, it does not appear that over a decade of economic stagnation has resulted in major upheavals in society. I suspect that this has much to do with the structure and characteristics of Japanese society, however. And it should be pretty clear by now that Europe is definitely not Japan.

To borrow the text from Rory's post last year:

"This poses obvious risks to political stability and commerce. It also constrains the options available to policymakers, making beggar-thy-neighbor actions such as the imposition of trade barriers, subsidization or nationalization of industries and currency devaluation more likely. History tells us that these domestic political considerations, particularly in the developing world, risk reinforcing the downward economic spiral, as policymakers appease factions and fail to reach coordinated regional/global programs. They also risk, particularly in the case of currency devaluations, setting off a [chain] reaction of competitive responses that, in the absence of regional cooperation, ultimately destabilizes the system as a whole."

So it's clear that while inaction is not an option, the kind of response that the political leadership provide matters even more. The G20 proved to be surprisingly successful in coordinating a strong response to the crisis itself, but that level of cooperation is starting to fade in the aftermath as leaders re-focus domestic priorities. The recent signs of a looming "currency war" are a worrisome case in point.

What we may be facing, then, is a prolonged period of discontent. The only solution is to avoid political posturing and short-termism and take the necessary steps to restore healthy economic growth. These steps may end up being painful or risky but, as Posen rightly points out, the downside risk to doing nothing at all is far too high.

(photo: Reuters)

Readables

2010-09-28T12:40:00.000-04:00

Interesting, if superficial, profile of Paul Krugman's recent economic writings. Provides yet more confirmation for why I rarely bother to read them.

Soooo, does this mean Republicans oppose lending to small businesses? Politics: what fun!

Why football (soccer) is a bad business: irrational capital. Proposed solution: ownership by fans.

The voodoo economics of the TV/movie business

Yet more evidence of China moving up the value chain: a collaboration with Japanese companies in computer microchip production.

How to help people in developing countries and make a wicked profit while you're at it.

Intermission

2010-09-23T17:00:00.003-04:00

Posting has been light of the last week or so as I make adjustments for a recent change in my career path. As a result, most of my recent post ideas are currently stuck in draft format - a variety of scattered thoughts lacking coherent direction. (Although really, what else is new?)

Things should return to business-as-usual in the next week or so. In the meantime, feel free to submit any ideas you have for topics you would like to see discussed.

Sentence of the Day

2010-09-22T08:46:00.000-04:00

From The Economist:

"....Indeed, the problem with the tax debate is not that Democrats and Republicans disagree, but that they mostly agree. Democrats think 98% of Americans should not pay higher taxes; the Republicans say 100% should not."

Readables

2010-09-16T21:30:00.000-04:00

From the previous week:

The biggest problem with Basle III

A conversation with Richard Dawkins and Sir David Attenborough

A conversation with Lee Kuan Yew, prime minister of Singapore for 25 years after its founding, reflecting on old age and the risk that Singapore's success will be taken for granted.

Globalization at work: Chinese factories that are moving up the value-added chain to stay competitive.

Are emerging market bondholders ignoring history?

Paul Krugman has a bone and will not let it go, no matter how confused his thinking may be. (To be fair, I think Sumner has Krugman's arguments about the link between currencies and surpluses completely backwards, but he addresses this here).

Summary of the state of world trade

"Science: it works." The auto X-prize winners

Hunting Black Swans

2010-09-13T21:10:00.003-04:00

Last December I wrote about Nassim Taleb's The Black Swan and proceeded to tell anyone who would listen to Read This Book. You will have to forgive my boyish enthusiasm. It was probably a classic case of getting really excited about that-which-you-have-read-most-recently. Happens all the time.

Since then, however, I've read a number of criticisms - concerning both Taleb and his ideas. None, however, was nearly as comprehensively devastating as this one by Eric Falkenstein. Although written some time back, it's new to me and in the interest of balance I feel obliged to link to it here. It's certainly worth a read if you've read Taleb or are at all interested in questions of probability and prediction. For instance:

"Taleb is consistently amusing because his criticisms of others apply so neatly to himself: he claims he is an empiricist yet supports his points with anecdotes. The Black Swan makes fun of ‘experts’ with credentials, but he states he does not deign to engage with anyone not sufficiently expert; he states he is not interested in being a speaker-bureau commodity , but routinely travels the rubber chicken circuit; he derides forecasters who don't give a full accounting of their prior forecasting history, yet delinks old remarks about Value-at-Risk, and recategorized his extinct Hedge Fund as a hedge, not a fund; he claims to prize humility, yet is most immodest; he argues against applying the law of large numbers, and also of inferring too much from small samples; people apply models to reality in biased manner, people naively extrapolate data without the appropriate theory; forward thinking is adaptive, forward thinking is error-laiden. Some people think inconsistency is a sign of genius; I think it just reflects confused thinking."

There are some valid arguments in here, so I encourage you to read through the rest. However I don't think everything in the essay is spot-on:

"Black Swan argues that standard statistics is flawed because it is backward looking — it uses ‘historical’ data — and argues that standard measures of risk like the normal distribution are ‘frauds’. I too prefer future data, but it is hardly a practical alternative. The Gaussian distribution is common in theory because it is so analytically tractable; it often creates closed form solutions that allow one to see how one variable affects another, and has nice properties, such as the fact that two Gaussian random variables added together is also a Gaussion random variable. In practice, no one actually believes in this view, and makes ad hoc adjustments.... Non-economists often giggle at the term ‘fat-tailed’ or homoskedasticity, but indeed most real world distributions are not ‘Normal’ or Gaussian, they simply have fatter tails than average. Does this imply statistics is a fraud? Well, if you mistake the map for the territory, indeed, this is news."

This is all well and good if you're a responsible risk-analyst like Falkenstein presumably is. But not everyone understands these limitations, and this is precisely the point. During the boom years many of the biggest decision-makers in the financial sector did mistake the map for the territory: Felix Salmon's piece on the formula that killed Wall Street is a case in point.

Falkenstein suggests that Taleb's argument boils down to, essentially, "shit happens." I don't think that quite does the concept justice, but to the extent that people continue to discount shit happening, The Black Swan remains a worthwhile read.

[edited for clarity]

DO NOT DIZPUTE ZE GERMAN WACHSTUMS IM EXPORT!

2010-09-02T12:30:00.002-04:00

A week or so back I took a sarcastic jab at economist Heleen Mees for suggesting - on thin evidence - that the German current account surplus was "less damaging" than China's. Since then, there has been some back-and-forth among ~~actual experts~~ fellow commentators over what to make of Germany's fantastical export-driven growth.

Tyler Cowen argues that "German imports have risen to new highs and it is also apparent that the Germany economy is a positive-sum locomotive for most other countries. And a lot of the German exports contribute to the productive capacity of other nations." Tyler would seem to side with Ms. Mees on this one. However, in making this statement he cites an FT editorial as backup, which - by its editorial nature - is light on details.

Meanwhile, Wolfgang Munchau argues that Germany's economic strength could well be toxic for the rest of the eurozone. Germany's growth should be offset by an adjustment in consumer demand and labour costs within the eurozone. But since the eurozone is an imperfect market, this adjustment is not happening. The resulting imbalances have already contributed heavily to Europe's current sovereign debt crises and are an ongoing threat to the long run health of the eurozone, he argues.

So who is right? The lack of quantitative evidence in this discussion sort of leaves you hanging. My suspicion is that both sides are right, but one side is, um, righter. Let me explain.

In terms of the specifics, Tyler's point is correct: Germany's exports are a locomotive for growth. Trade is good for both exporting and importing economies. Similarly, Germany's re-investment of its funds into neighbouring countries will, in many (though not all) cases, lead to growing productivity. Both of these factors are positive.

But are they positive sum? In other words, do the positive aspects cancel out the negative factors that result from ensuing current account imbalances? That's far from clear.

I would argue that the sovereign debt problems in Southern Europe are in fact a collective European problem: it is not simply a story about profligate deficit spending in Greece, Italy and Spain. In the case of intra-eurozone trade - given the fixed exchange rate - someone's current account surplus is someone else's current account deficit. Greece and Italy don't have the option of devaluing their currency to stay competitive because they do not have their own currency. To adjust, they must cut costs and deflate, and somehow "increase productivity." They have obviously been reluctant/unable to do this, and the resulting crisis and severe austerity measures have deepened the recession in Europe. Clearly, this impacts negatively on their European neighbours who have to bail them out or risk having the eurozone collapse.

It may be true that Germany's capital account is not in surplus due to their high levels of foreign direct investment into neighbouring countries. However, for this to be positive sum this capital needs to be 1) invested in productive enterprises AND 2) the productivity gains must offset the imbalances produced by German growth. From the current state of Southern Europe, point 1) is potentially true while point 2) most definitely isn't. This is likely what Mohammed El-Erian means when says that the positive spillover effects from Germany's export growth have been "immaterial."

Does this mean that Germany should slow its economic growth? Of course not. But it does mean that there needs to be a recognition that "surplus=good, deficit=bad" is not a helpful paradigm: balance is important. Unfortunately, the current state of European institutions do not create effective incentives for maintaining that balance. We've already seen the results. A reluctant-to-reform Greece needs to be saved by a reluctant-to-bailout Germany. The euro can't carry on like this, not forever.

I will borrow my conclusion from a recent paper by Barry Eichengreen and Peter Temin:

"The point is that an exchange rate system is a system, in which countries on both sides of the exchange rate relationship have a responsibility for contributing to its stability and smooth operation. The actions of surplus as well as deficit countries have systemic implications. Their actions matter for the stability and smooth operation of the international system; they cannot realistically assign all responsibility for adjustment to their deficit counterparts. This was the lesson that Keynes drew from the experience of the Great Depression. It was why he wanted taxes and sanctions on chronic surplus countries in the clearing union proposal that he developed during World War II. Sixty-plus years later, we seem to have forgotten his point."

Readables

2010-09-01T09:30:00.000-04:00

- Why are women leaving Wall St.?

- Dan Ariely on the darkside of "productivity-enhancing tools"

- "Syntactically speaking, the correct noun phrase to pick to get a target of predication for the preposed adjunct is not the subject of the main clause, it's buried as a genitive determiner in a noun phrase inside a relative clause modifying the object of the main clause" Got that? That is an actual sentence from an otherwise funny post on "an appalling piece of bungled headlinery."

- Sarah Palin: the sound and fury

- the future of playgrounds

- NASA experts to help trapped Chilean miners.

Where is the recovery going to come from?

2010-08-31T08:42:00.001-04:00

PIMCO's Mohamed El-Erian asks the same question, but does a much better job than I in providing a comprehensive look at the global economy. I really like this piece because it takes a step back from the to-and-fro of daily market reporting and punditry - what you have instead is a healthy dose of perspective:

"In sum, the current policy approaches here and abroad are unlikely to deliver a durable and robust U.S. recovery and, critically, create sufficient growth in jobs. Yet the main debate in Washington is whether to do more of the same -- namely, another fiscal stimulus and another round of quantitative easing by the Federal Reserve. This clearly conflicts with evidence that a broader and more holistic response is needed....

What is critical to keep in mind is that this situation is part of a broad, multiyear process driven by national and global realignments. It's a secular phenomenon that needs to be better understood and navigated -- by recognizing its structural dimensions and by urgently broadening the excessively cyclical policy mindsets that abound. Unfortunately, the approach in too many industrial countries has been to kick the can down the road, seemingly hoping for a series of immaculate economic recoveries.

Policymakers must break this active inertia by implementing a structural vision to accompany their current cyclical focus. Measures are needed to address key issues, which include the change in drivers of growth and employment creation; the high risk of skill erosion and lost labor productivity; financial deleveraging in the private sector; debt overhangs; the uncertain regulatory environment; and the unacceptably high risks facing the most vulnerable segments of society.

Is there anything else?

"An already polarized political environment is becoming even more fractured by real and far less substantive issues. There is virtually no political center that can anchor consensus and enable sustained implementation of policy. Meanwhile, as anti-Washington sentiments rise, interest in a national agenda is increasingly giving way to the election cycle. Internationally, the impressive degree of cross-border coordination seen during the global financial crisis has been reduced to inconsistent -- and at times contradictory -- national responses.

This worrisome trio of increasingly ineffective national and global policy stances, intense political polarization and growing social pressures speaks to the risk that the economy's recent soft patch will evolve into something even more troublesome and sinister."

The Rabid Capitalist Spirit of the English Premier League

2010-08-27T13:40:00.003-04:00

Ohhh baby - the football season has begun. Over at Sports Illustrated, Johnathan Wilson tackles the perennial question about the huge competitive gap between the top and bottom of the English Premier League:

"Watch the television coverage of any English Premier League game between a side near the top of the table and a side near the bottom and you can guarantee that before kickoff one of the pundits will say something along these lines: "The great thing about this league is that on any given day anybody can beat anybody." Except it's not true, not anymore.

This isn't U.S. sports with a franchise system, salary caps, drafts and collective negotiating for TV rights that help to ensure general equality and thus competitiveness. This is the dog-eat-dog, every-man-for-himself European model, in which the big boys beat up the little kids on a regular basis."

Waitaminute: salary caps, collective negotiation, and general equality? That's not the American capitalist way! A dog-eat-dog, every-man-for-himself European model? Is this the twilight zone? Or could it be that the English take an "American" approach to sport, whilst the Americans prefer the heavily-regulated "European" way?

I know: that just blew your minds.

The Annals of Linguistic Trainwrecks: Liberaltarianism

2010-08-26T09:44:00.003-04:00

As if it wasn't confusing enough already.

As if it wasn't bad enough that the word "liberal" means something entirely different on one side of the Atlantic than it does on the other, leading to no end of confusion. Now they've come up with "liberaltarianism." This concoction is meant to denote a fusion (confusion?) between liberal and libertarian thought. As a phrase, "liberaltarianism" does not roll so much as it lurches off your tongue before shuddering and collapsing on to the carpet in a heap.

I'll admit that I'm rather new to this "liberaltarianism" thing. Scott Sumner sums it up thusly:

"Liberaltarianism is basically libertarians attempting to knock some sense into liberals on economic issues."

He then proceeds to lay out some examples of successful bouts of "sense-knockings:" eliminating wage and price controls, lower marginal tax rates for the rich, reducing government involvement in industry.

I would view each of these examples as a generally positive development. Even what Sumner views as "setbacks" - for example the US government bailout/takeover of General Motors - are exceptions that prove the rule. GM is set to return to public financial markets shortly and the government's stake should be sold off in the next year or so. Even "liberal" governments now rightly accept that they should not be in the business of making automobiles.

But then I made a fatal mistake: I scrolled down to the comments section on Sumner's post. The very first commenter points out that, in the late 19th and early 20th centuries, laissez faire used to be the norm and the recent "victories" Sumner describes cannot undo the damage of decades of Liberal Big Government. This is infuriatingly wrongheaded. As Sumner rightly retorts, this laissez faire period was absolutely miserable. In addition to implicitly condoning rampant inequality, economic policy was often guided by a sort of moral puritanism which viewed the suffering of the working class as good for them.

Quite simply, that period's approach to laissez faire capitalism was unsustainable. It was precisely this model that millions of people revolted against, turning to communism or fascism as an escape. Modern day capitalism is softer (although the degree to which it is softer varies across Europe, North America, and Asia). By offsetting the harsh realities of capitalism with a stronger safety net and progressive redistribution, contemporary capitalism has succeeded in neutering many of the harshest criticisms against it.

To a certain extent, bigger governments are the product of greater wealth. Rich societies inevitably demand greater government involvement since, as wealth increases, so do expectations regarding standards of living. For examples, one need only look to capitalist Hong Kong, where welfare benefits far surpass those in communist mainland China. There is absolutely no good reason why wealthy countries should tolerate the levels of depravity suffered by those living in the glory days of laissez-faire.

But this is not a one-sided dynamic. The success of the social safety net is itself contingent upon the success of the capitalist model. It is not possible to continue to raise living standards without economic growth, and economic growth requires a free market. If government growth outpaces the economy, a painful re-adjustment will inevitably follow (viz. modern day United Kingdom).

To sum up: there is a mutual dependency at work here. One cannot long survive without the other. Despite its clunkiness, the concept of liberaltarianism seems to capture this understanding fairly well.

Unfortunately, finding the balance between the two is supremely complex. The sheer number of variables at play is overwhelming, and there are always unintended consequences. Designing policy in liberal democratic capitalist societies is bloody difficult, and our ongoing struggles with macroeconomic policy making is evidence of this. Of course, this is also what makes it so fascinating to nerds such as myself.

This is also why, dear readers, the next time you hear someone pining for the laissez faire days of yore, you should hit them over the head with a stick.

Readables

2010-08-25T09:00:00.001-04:00

- California moves closer to paying bills with IOUs and monopoly money

- By now you have likely heard about China's epic week-long traffic jam. Maybe they should be taking driving lessons from this guy.

- John Kemp: buying into tail risk will slowly bleed your wealth; instead, buy insurers who sell tail risk

- Argentina's President accuses domestic newsmedia organizations of crimes against humanity

- Can trade liberalization reduce gender inequality?

- Book review of Sebastian Mallaby's review of the hedge fund industry: More Money Than God

One-handed economists only, please

2010-08-23T12:56:00.002-04:00

Mike Moffat at WCI takes a stab at explaining why there is such a disconnect between what economists think and what people think economists think. In sum:

"The economists who stay on the air tend to be the ones who are most willing to promote a black/white worldview. That tends to skew the view of the general public, as most economists tend to see everything in shades of grey."

This is pretty much what I was arguing when I referred to the "Richard Dawkins Effect" on the likes of Paul Krugman and others. Nuanced argument isn't entertaining. The one-handed economist rules the roost.

But is that always the case?

It seems to me that what may hold true for talking heads on the radio and Tee Vee doesn't always hold true in the blogosphere. Sure, you can find your fair share of biased blowhards, but it strikes me that many of the most prominent economist bloggers are able to carry out interesting and stimulating discussions on important topics without resorting to brow-beating. The discussion is more "academic" in the positive, constructive sense of the term. What's more, this debate is very accessible to the public.

An interesting sub-question would therefore be: why does this nuanced debate seem to thrive on the internets, but not in the traditional media?

I do think Mike is wrong about the benefits of media exposure, however. For instance, in the United States, if you're a prominent economist-blogger you can apparently be invited to lambaste US Treasury officials in person - which is both fun and intellectually stimulating!

Malaysia: loosening the ringgit fence

2010-08-20T13:07:00.003-04:00

Malaysia's currency - the ringgit - soared yesterday after the central bank announced that it was easing restrictions on foreign exchange transactions. The changes allow the ringgit to be used to pay for cross-border trade and eliminate the 12-month limit on currency hedging by domestic firms.

This is good news for Malaysian exporters and, by extension, Malaysia itself. Despite the encouraging news that Malaysia's economy expanded by 8.9% last quarter, the country is still heavily reliant on exports - primarily commodities and electronics. Exports depend upon foreign demand, and that demand is far from guaranteed. Although the majority of Malaysia's exports go to China, most of these are in turn re-exported to EU and US markets. Thus, even today, the discouraging news about the latter's economic fortunes has tempered yesterday's enthusiasm for the ringgit.

Until 2005, the ringgit was pegged to the US dollar. The peg acted as a de facto hedge for domestic exporters. The peg is particularly helpful for commodity exporters since commodity markets are inherently volatile and tend to be priced in dollars anyway. Since 2005, however, export-oriented businesses have been subject to the spasmatic re-adjustments that come with a "managed" floating exchange rate operating in the post-Bretton Woods international financial system.

All of which points to the need for Malaysian exporters to be free to effectively manage risk by hedging their contracts to compensate for the ups and downs of global currency markets.

(source: Yahoo)

All the more fitting, too, that in Malay the word ringgit means "jagged."

"Chez Economia: Fine Post-Recessionary Cuisine"

2010-08-18T07:30:00.008-04:00

the table d'hote

~~~~~~~

Excite

Contagion crackers, topped by a widening corporate bond spread, with sliced mango and rocket

or

Fat cat paté, bailed out in a white truffle suspension

Fluid

Cream of sovereign credit rating

or

A complex of derivatives floating in cheap liquidity

Consume

Maplewood-smoked fiscal hawk in a deficit reduction, nestled in chopped public services, shiitake soy emulsion and an aggression of snail

or

Half-baked stimulus, coddled too-big-to-fail quail egg, presented in a bed of seasonal helicopter-dropped greens

Finale

Double-dip chocolate biscuits in austerity pudding, with a selection of Boston "Hahbah" teas

or

Puffed public sector pastry in a caramel debt explosion, with a chapeau of crumbled GDP growth and a raspberry garnish

~~~~~~

Bon appétit!

Wherein I discover, to my great suprise and horror, that a Dutch economist is biased

2010-08-17T06:00:00.002-04:00

Germany is not China, or so Heleen Mees is eager to point out.

And quite right to do so, I might add. Aside from shared membership in the United Nations and their local Tuesday night 10-pin bowling league, the list of similarities between the two industrious nations is rather short. But on the surface, the two countries share a particularly poignant economic indicator: massive current account surpluses.

In fact, it is precisely by exporting far more goods and services than they import that both Germany and China have vaulted to the front page of the financial news in recent days. Germany, for its whopping 2.2% quarterly economic growth; and China, for (more or less) overtaking Japan as the world's 2nd largest economy.

It is now increasingly clear that the problem of global macroimbalances has returned with a vengeance. At first glance, both Germany and China's export-fueled growth appears to be making these imbalances worse, not better. But this is where Ms. Mees takes over, insisting that there are important differences between the two countries, not least in their capital accounts:

"... Germany did not accumulate foreign reserves the way that China did. On the contrary, German foreign reserves actually declined between 2000 and 2008. Whereas China is a large net recipient of foreign direct investment (FDI), Germany is a large net exporter of FDI. China’s net FDI inflow totaled $94 billion in 2008, compared to Germany’s net FDI outflow of $110 billion.
... German’s surplus is thus less damaging than China’s, as it is used for investments that foster productivity gains, economic growth, and job creation – and that often include technology transfers that help to develop human capital.
The Chinese surplus, on the other hand, being heavily skewed towards US government bonds, primarily boosts personal consumption – a process whose apotheosis came in the early 2000’s, as the Bush administration’s tax cuts, together with cash-out home refinancing and home-equity loans, turned US sovereign debt into consumer credit."

This is well-trodden ground: the Chinese proclivity towards saving resulted in having their hard-earned yuan recycled as a US consumer credit boom. According to Mees, the earnings from German GDP were largely recycled into foreign direct investment into neighbouring countries, which is productive. So: China surplus bad; German surplus good. Got it?

But then I keep reading:

"Of course, the demand generated by Chinese credit also fosters economic growth, but mostly in China, owing to booming exports to the US."

Erm, what? This is starting to smell like bullshit. Mees appears to be arguing that the Chinese current account surplus is "damaging" because the economic benefits were only seen in China. Why on earth would that matter?

Ah, but I forgot the part about Chinese savings helping to create a credit boom in the debt-laden United States. The credit boom, in turn, inflated asset bubbles that eventually had to burst. That's what makes the Chinese surplus so damaging and the German one so constructive.

Isn't that right? Ms. Mees? Oh, you're not finished:

"It is, of course, unfortunate that German banks and pension funds lent money to debt-laden countries such as Spain, Greece, and Portugal on overly favorable terms, inflating asset bubbles that eventually had to burst."

Yea, you're right: Germany is definitely not China.

Readables

2010-08-16T20:20:00.004-04:00

- 21st Century monetary policy - Steve Waldman proposes an alternative to tax and interest rate adjustments in response to the business cycle: flat rate cash transfers directly in to people's bank accounts.

- On the usefulness of cash prizes to stimulate innovation

- A post about financial economics that includes a comic strip and a penis joke: this is why we enjoy FT Alphaville so

- "Do not be alarmed if South Africans announce that they were held up by robots" and other, um, helpful multicultural tips from the United Kingdom

- A history of the tomato. For reals.

The sharpest thing I've read all week

2010-08-12T08:00:00.000-04:00

From Matt Yglesias:
"In 2010, of course, we’re not going to go communist. Which is nice. But if you tell people that high unemployment is going to exist for a long long time, and there’s nothing the government can or will do about it, then of course people are going to support policies that make the economy less flexible and less open to imports and foreigners. If laid-off workers can’t find new jobs, then protecting incumbent sites of employment from competition becomes priority number one.
It’s true that if you adopt this view you do need to give up some libertarian purism. If periodic state intervention is required for the purposes of macroeconomic stabilization then you legitimize state intervention to, for example, help poor people. But the battle for that kind of purism is lost anyway. What you gain by embracing stabilization policy and treating the political problems of how to do it effectively as a problem to be solved rather than a reason not to try is an account of why it is that 9.5 percent unemployment doesn’t discredit the underlying principles of a market economy." (emphasis original)

I've pursued a similar line of thinking before, so I'm obviously open to having Matt's arguments reinforce my own.

Elsewhere, Tyler Cowen points out that there are benefits to a period of economic "re-calculation" which need to be recognized as well.
"1) The Industrial Revolution also was a tough slog for quite a few decades. Yet it was both worthwhile and it gave capitalism a bad name for a long time.
2) Alexander Field argues that the Great Depression brought greater productivity improvements than any other decade in U.S. history...."

While I doubt that Tyler is attempting to downplay the pain of the "dislocations" in question, I certainly would not be as cavalier about the consequences. In addition to bringing greater productivity improvements, the turmoil of the Great Depression helped spread political ideologies which were leveraged to support despotic regimes and also gave rise to geopolitical instabilities that dragged the world into an all-consuming war. That is not a fair trade.

But I exaggerate: it's 2010 and we're not going communist.

Nevertheless, it is no longer a (politically) acceptable line of argument to say: "Hey! you've gone down an economic corridor that is no longer promising so you will have to endure a period of recalculation. Good luck with that." Unlike the Industrial Revolution and other recessions of the late 19th and early 20th C, the political systems of the Western world are far more sensitive to this dislocation of workers. We now have universal suffrage and an increasingly educated population with greater opportunities for political voice.

Yes, it's true that the social safet net eases the pain of dislocation (while simultaneously creating its own set of incentives). It's also true that, as Felix Salmon points out, most Americans are now middle class, and most middle class Americans are doing okay. But there is still a significant underclass that is not doing okay and - if the recalculation argument is correct - they may be in for a long haul.

Which brings us back to Matt's point. The plight of the long-term unemployed is fundamentally a political problem, and a messy one at that. But it is only through embracing it as such, and setting about finding ways to mitigate its impact, that we avoid the craziest and nuttiest of outcomes.

Readables

2010-08-06T15:00:00.002-04:00

1) The globalization of whisky markets, (not) continued - Chavez' currency crackdown hurts whisky sales. Fine by me, retorts Chavez: "Rich people are lazy and almost all of them spend every day drinking whisky." I think he's been watching too much Mad Men.

2) Thank Goodness It's Thursday - Hawaii cuts the school year by a fifth, Colorado Springs plunges into the dark, and other stories from the Great Recession. As a colleague of mine pointed out, somehow all of this is tolerated in lieu of even a discussion about raising taxes. Update: Illinois has been forced to feature in adult films to make ends meet.

3) The Topic of Cancer - "In whatever kind of a “race” life may be, I have very abruptly become a finalist."

4) Gone 'till November - Wyclef Jean to run in Haitian presidential elections this November.

5) The Sauna World Championships - The Finns are weird.

Where is the Recovery Going to Come From?

2010-07-30T09:00:00.003-04:00

Over the past few weeks, my occasional glances at the market reporting pages suggested that there was some positive news to be had. Markets were launching small rallies. There was a return to risky assets. The UK and Germany, among others, were turning out surprisingly positive signs of economic recovery. But upon taking a step back from the day-to-day churn of financial reporting, I have to admit I'm a bit baffled by all of this: where are these positive vibes coming from?

Although the recession probably ended (technically) in the United States sometime last summer, the global recovery - such as it is - seems remarkably fragile. Unemployment is obviously the biggest indicator. German unemployment continues to drop, but in the US the there are some 15 million unemployed, and even more who are underemployed. Nearly half of the unemployed have been off the job for 6 months or more. That's a deep hole. (More charts here)

Moreover, many of the underlying problems have not gone away. Sovereign debt concerns are still a biggy. The collapse of the Eurozone has been staved off through the promise of access to an unprecedented level of EU-backed funds for the weakest members. But most analysts agree that, as far as Greece is concerned, the can has simply been kicked down the road. Only Spain, the UK, and some Baltic states seem to be taking the necessary steps to address the underlying problems. Even there, the steps being taken should raise worry about delaying the recovery even further.

Another underlying problem is that of macroimbalances. Any movement towards re-balancing over the past two years was the result of the peculiarities of the financial crisis. We're seeing quite clearly now that the fundamental asymmetries of the global market for goods & assets have not gone anywhere. Capital flows have started returning to their pre-crisis trends. Moreover, everyone (everyone!) is talking about exporting their way out of recovery.

That is literally not possible. Where is the demand going to come from? US household wealth is low (decimated by decline in housing & job losses), consumer spending is weak, while savings will likely increase. The EU is fragile, and the best-performing country (Germany) is growing from...you guessed it: exports.

What about demand in emerging markets? The biggest, China, is currently trying to delicately apply the brakes to avoid domestic overheating and still does not have sufficient demand to offset the decline in the US/EU. Capital flows into India have slowed in recent months, which restricts their ability to fund further growth and demand. News out Japan is underwhelming.

On top of this, many of the East/Southeast Asian countries that built up their domestic currency reserves during the lead-up to the Great Recession to act as a buffer against crises will feel vindicated: they have fared relatively well. Why on earth would they change strategies now?

As noted below, the fragility of the situation is not lost on Mervyn King, head of the Bank of England. Similarly, US Federal Reserve's beige book recently described a decidedly "beige outlook" for the United States. In fact, even this morning, the estimates of US GDP growth disappointed market watchers.

The only good news I can think of is that we are not hurtling down an economic crevasse. And let's be clear: this is really REALLY good news. Catastrophe was a definite possibility a couple of months ago as observers watched the European sovereign debt problems cause the EZ to teeter on the precipice. But despite their dithering, the euro-zone economies have, for the moment, escaped the worst possible outcomes. The bank stress tests, despite widely reported weaknesses, have been met by a neutral-to-positive response. Tyler Cowen suggests that wages in Europe have been less sticky than he predicted, which seems to be prompting some signs of recovery. Another indicator of uncertainty - both for inflation and deflation - is gold. Gold is holding steady at the moment, suggesting that fear of impending doom is abated.

But if not hurtling down an economic crevasse is the best news you've got, things are still pretty grim. Taking stock of the situation from my little peephole, I have really got to ask myself: where is the recovery going to come from?

UPDATE: Some honesty from Tyler Cowen: "Macroeconomics is rarely simple... We still don't know what we are doing." Read the rest.

Wednesday Readables

2010-07-28T10:00:00.002-04:00

- Mervyn King warns against getting ahead of ourselves:

"The gradual improvement in credit conditions that was evident earlier in the year seems to have come to a halt in recent months. And financial markets more generally have been volatile. In part that is because continuing concerns about the ability of some countries to achieve necessary fiscal consolidation are affecting confidence in the ability of banks to repair their balance sheets. More fundamentally, the key underlying causes of the crisis – in terms of the imbalances in global demand – have still not been tackled. Those imbalances are likely to be larger this year than last, and will probably still be around three-quarters of their level at the peak immediately prior to the crisis. Until these underlying problems are resolved, uncertainty about the outlook for the world economy will remain."
(FT Alphaville provides comment)

- Flooding in China pushes the Three Gorges dam ever closer to capacity

- Does happiness affect productivity? Yes. Quality? Not really.

- In praise of Dark Ages

- Catalonia bans bullfighting. Good. I attended a bullfight in Madrid recently - I arrived with what I had hoped was an open mind, willing to make an effort to appreciate this part of Spanish culture. I was left disgusted by what is, essentially, ritualized slaughter for the sake of entertainment. Don't get me wrong: I was impressed by the matadors themselves. Bullfighting clearly requires a great deal of skill and cajones. But so did being a gladiator in ancient Rome. The Italians gave up their bloodthirst many centuries ago. Maybe it's time Spain did the same.

Photo Of The Day: Consequences of Inflation

2010-07-26T14:00:00.002-04:00

A photo circulating by email around Zimbabwe of a supposed sign along the Zim-South Africa border (from Good Morning Afrika, via Free Exchange):

And I thought it was only Goldman Sachs executives who did that kind of thing...

Conversations with Taxi Drivers: Singapore

2010-07-24T01:45:00.000-04:00

As I am currently a resident of an airport for the near future, I feel it best to catch up on some long overdue blogging. Having spent the better portion of 2 weeks in Singapore, that seems like as good a topic as any. I don't pretend to have become an expert on the place, but I have picked up a few tidbits which have piqued my interest. Many of these have derived from my favourite source of information: taxi drivers.

Singapore is an interesting case, to put it mildly. Much of its recent history is a blur, cobbled together from various travelers' notebooks, journals and the occasional scribbled map. For much of the 17th and 18th centuries it was probably uninhabited. As recently as 50 years ago, the place was still a backwater entrepot, with very little in the way of a diverse economy.

Yet in visiting modern Singapore, this is difficult to imagine. The city-state is modern, vibrant, wealthy, and stuffed with the sort of cultural icons we associate with truly global cities. New resorts and theme parks are sprouting up left and right, while international business people continue to arrive in droves to the business district and conference centers. Next month, the city state will be hosting the 2010 Youth Olympics.* And despite a huge number of foreign workers (a million, according to one cabbie), there is a continuing need for more.

Because it is so tiny, Singapore's success has not been able to rely on natural resources or a large labour force to drive its economic growth. Instead, its limited resources have been carefully "channeled" towards certain key areas to create an open and highly competitive economy. What's more, as they are so vulnerable to the shifting economic winds, the city state has been forced to continue to innovate and shift to new areas. For instance, they are now making a concerted effort towards becoming a world leader in biotechnology research, while the financial services sector continues to grow in regional importance. There is also the recently announced launch of the largest power grid research station in Asia. Further examples abound.

Clearly Singapore has had success where other countries in the region have not. So are there lessons to be learned for other emerging markets? Many appear tempted to dismiss Singapore as a "unique case" that is difficult to copy. There are some good reasons for this.

Obviously, it is small. This makes it easier for the government to carefully allocate economic resources. But many other countries are small and fail to achieve something similar. Access to water and its position along a major shipping route clearly helps, but this does not account for the diversity of Singapore's economy. The colonial background has also left its mark on certain ways in which the country functions, notably the legal system.

The stable political situation certainly plays a role. Although the system is nominally a representative democracy, in practice it is a semi-authoritarian one-party state. Freedom House ranks the country as "Partly Free" (up from "Not Free" a little while back) due to what they label as draconian restrictions on freedom of speech and assembly. Yet, according to one senior diplomat here, the system still kind of works. The ruling party is scared of losing power and local government representatives hold regular council meetings wherein residents can air their grievances. Voices are heard, potholes are fixed. The Lion State's size once again makes this a workable option.

So while its true that, in many respects, Singapore is a unique case, this does not mean that its lessons are not transferrable. This is not news to some; China has long been watching its tiny neighbour grow from a poor nation to an immensely prosperous one, looking for hints on how to do the same. I would also wager to guess that a number of the Gulf Emirates have attempted to out-Singapore Singpore - they certainly share an obsession with heavily air-conditioned shopping malls and a need for economic diversification.

But just what kind of lessons are we talking about? To my eyes, one of the most striking things about Singapore is how multicultural it is - there are people living in Singapore from just about every country in the region. What's more, they appear to do so harmoniously. This is something supposedly modern European cities struggle to achieve. My most recent cabbie, of Indian descent, seemed to agree. Despite being a minority, he felt reasonably well represented. For instance, although the Chinese population dominates the government, there are a number of senior ministers with important portfolios who are Indian.

The noticeable exception is the substantial Malay minority who, despite being the indigenous population and still more populous than the Indians, are less well represented in government. They continue to face restrictions on practicing their culture are also economically disadvantaged (although policies are being developed to mitigate this).

But despite this imbalance, things in Singapore are a far cry from the race riots which apparently caused havoc in the slums of Singapore back in the 1960s. One possible explanation for this are the ubiquitous HDB flats, or subsidized housing projects nicknamed after the Housing and Development Board, which oversees them.

Some 85% of Singaporeans live in HDB flats (private property on the island is obscenely expensive). Although some HDBs can themselves still be quite costly, they offer what appears to be an intelligent solution to addressing the imbalance between the wealthy and the poor. For instance, although HDBs are subsidized, they do seem to be mere handouts. There are conditions attached, and there is the possibility for upward mobility if you work hard and achieve economic success. This creates positive incentives for HDB-dwellers, whereas most public housing projects tend to leave their residents to stagnate.

At least that's the theory. Whether this is true in practice, I have no idea. But the results would appear to speak for themselves. It's not for nothing that, as noted above, China has been closely watching the HDB system's progress over the years as it searches for ways to deal with the challenges caused by a huge increase in urban populations.

More importantly, my taxi driver thought the system works pretty well. That's good enough for me.

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*I confess to have never heard of the Youth Olympics before; I felt slightly less stupid upon discovering that this is the very first time such an event has been held. Now ya know.

The Globalization of the Scotch Market, cntd.

2010-07-10T22:00:00.002-04:00

A little while back I wrote a tongue-in-cheek post about the curious effects of globalization on the market for scotch. The increased wealth and subsequent demand for luxury goods in East Asia, it seemed, was causing the price of scotch in North America to rise and the selection to fall.

There were several reasons for this, including: the sheer size and rapid growth of the market for luxury goods in Asia, higher margins for scotch producers & distributors, and - as was my guess - less competition from similar liquors that could act as substitutes for scotch (like whisky, bourbon, rye, etc.).

Sure enough, I arrived at the Singapore Changi international airport yesterday and a quick scan of the duty free shop* supports the theory: the liquor section is dominated primarily by a lot (a lot!) of high-end scotches, as well as cognac, wine and some champagne. There is far less competition from your usual suspects of rums, ryes, vodkas, gins, and the like.

This is a place, in other words, that has its priorities straight.

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*I recognize that a duty free shop in an airport is not accurate guage of what a regular liquor store will carry. But that is sort of the point: it caters to the wealthier crowd that can afford to travel or do business in and around the region. I suspect, however, that the inventory in duty free stores is dictated by a wider variety of considerations than simply consumer demand, so it will be worth finding a liquor store in a wealthy part of town to do a comparison.

Readables

2010-07-06T12:30:00.002-04:00

- The great risk rebalancing

- Thoughtful arguments in favour of cosmopolitan eduation, from the point of view of an American

- "A nuclear explosion over the leak," he says nonchalantly puffing a cigarette as he sits in a conference room at the Institute of Strategic Stability, where he is a director. "I don't know what BP is waiting for, they are wasting their time. Only about 10 kilotons of nuclear explosion capacity and the problem is solved." Here.

- Whisky: a liquid investment (har har)

- Iran lectures Canada on human rights following the G20 summit. I have no words.

- 100 greatest movie insults. Redundant Warning: salty language

Paul Krugman and the Richard Dawkins effect

2010-07-05T13:30:00.003-04:00

I don't read Paul Krugman anymore.

Actually, that's not technically true: over Christmas I read through his book on the recent financial crisis. This is partly because Krugman has a rare gift for making economic concepts accessible to the lay reader: it's hard to find anyone who can write a book that explains the complexities of the financial crisis as lucidly as he does.

But I don't read Paul Krugman the blogger/op-edder anymore. This is not because I'm not open to his ideas, or that I don't think he has anything important to say - it's more because I feel that I already know what he's going to say.

You see, I fear that the blogger Krugman is no longer contributing nuanced ideas to the debate over economic policy. Rather, he has developed a set of positions and has chosen to simply bang on about them repeatedly. It is as though he has given up on his academic roots to become a mere public pundit for a particular point of view. The debate is over; all that's left is to convince the other side that your side is right.

He has, in other words, become the Richard Dawkins of the macroeconomy debate. Both are very clever and accomplished academics who have contributed original and valuable insights into their respective fields of study. Both have since taken up positions of being public spokespersons for controversial topics. And both are increasingly one-sided and uncompromising in their views. They have become almost a caricature of the viewpoints they espouse. Indeed, Krugman seems to have become more a slogan-generating-machine than anything else.

And it's entertaining stuff, no doubt. This sort of approach is great for running up blog traffic and book sales. However, I'm willing to bet that most people who read Paul Krugman do so to either a) reinforce their own preconceptions and feel better about themselves, or b) find a reason to get really angry. Ditto for Richard Dawkins, by the way.

The unfortunate bit about all of this is that anyone who is genuinely interested in a nuanced discussion about the economy and public policy must look elsewhere. As a case in point, the Economist's latest lead article is on the debate over government austerity measures. Krugman is mentioned in the piece as being a leading figure of the anti-austerity crowd, but is criticized for his "crude Keynesianism." Krugman's responsive post was entitled "I’m Gonna Haul Out The Next Guy Who Calls Me “Crude” And Punch Him In The Kisser." This, despite the fact that the article actually sides more closely with his point of view than the austerity folks.

Like I said, I get it: Paul's being funny and hyperbolic and whimsical. This is entertaining to read. But it doesn't actually address the issue. By focusing who is being labelled as what, who is on which side of the debate and who is falling victim to latest playful slogan that he's come up with, Krugman is reducing the quality of the debate as opposed to enhancing it. What a shame.

Spain's political economy: Piquanté

2010-06-27T12:00:00.001-04:00

Poor Spain. The euro-crisis spotlight has slowly been shifting from Greece to its much larger and more economically significant Iberian neighbour. Although nowhere near as fiscally irresponsible as Greece, Spain is still smarting from a massive housing bubble blow-up and nearly 20% unemployment. Overall debt to GDP is a reasonable 60%, but much of this is owed to external creditors. Moreover, the annual deficit is closer to 11%, which raises questions about the near-term sustainability of its economic situation. What we've seen elsewhere is that this uncertainty alone is enough to create its own problems.

First, the private sector. Because of this "uncertainty" and their heavy exposure to bad loans in the property sector, Spanish banks have seen their access to wholesale funding markets dry up. In fact, Spanish banks broke an ECB borrowing record last month, suggesting that they are heavily reliant on government financing for their liquidity. Recognizing the dire situation facing its banks, the Spanish government set up the FROB last year to assist with debt restructuring. More recently, the Banco d'Espagna is attempting to stop the panic before it starts through the publication of so-called stress tests of Spanish banks.

In all likelihood, the tests will reveal that Spain's largest banks are quite solvent, thank you very much. The chief of Santander, Spain's largest bank, certainly thinks so (although he would say that, wouldn't he?). The solvency of two other large banks, BBVA and La Caixa, will probably also be demonstrated by the tests. But solvency isn't the issue; liquidity is. Until investors are convinced that Spain is not going the way of Greece, their banks will struggle to access funding.

Which brings us to the public sector. In my view, there is likely a greater danger facing Spain's national balance sheet than for its banks and corporations. This is in part because of the combination of problems facing the nation and the fact that Spain has been slow to demonstrate its resolve in addressing them. Perhaps reflecting this, the spreads are wider on Spanish government debt than on Banco Santander and a large Spanish telecoms firm.

As noted above, the combination of nearly 20% unemployment and an 11% deficit represents a particularly acute problem for the government. After several meetings with the ECB and other European leaders, Spain's leadership has finally acknowledged the severity of the situation and is acting accordingly: austerity measures have been introduced, including cuts to public sector pay and pensions, and the government just recently decreed reforms for the labour market, which the Spanish parliament has since ratified.

Predictably, the public sector union staged protests in response to the cuts. I was in Barcelona for the June 8th protests (see photo below), and had several impressions. First, the protests were quite civilized - certainly nothing compared to the earlier madness in Athens. But they were also quite tame. Indeed, according to The Economist, the turnout was far lower than the numbers threatened by the public sector union.

But even in the face of such half-hearted protests, it's unclear how far Zapatero's government is willing to go. Elected with a left-leaning mandate, they have been reluctant to cut back government benefits and create a more competitive labour market, caving only in the face of potential financial sector chaos. Moreover, according to some of the locals in Madrid who I spoke with, domestic support for the government is very low. The opinion polls seem to support this. Although the opposition is benefiting from the unpopularity of the austerity measures, according to the (tiny) sample I spoke to, few people think they would do a better job.

All of this suggests that the economy of Spain is facing a grim time ahead, full of uncertainty. For the biggest Spanish banks, the publication of the results of the central bank's stress tests and their ongoing access to the FROB may be enough to calm jittery investors in the short term. I suspect, however, that the stress tests on Spain's reluctant government and the ECB have only just begun.

Annnnnnnnnd we're back!

2010-06-25T11:00:00.001-04:00

I have to say, even a mild case of vacation is enough to make returning to regular blogging extremely difficult. Add to that the G8/G20 summit that is currently consuming my work life and the Greatest Single Sporting Event Known to Man consuming the rest, the blog has been thoroughly neglected. I see that some poor confused souls have continued to check for updates during my absence, but despair not: we're back in action.

IPE Journal visits The Land of the PIGS

2010-05-27T09:00:00.003-04:00

Not content to be a mere armchair pundit for the happenings and goings-on of the global economy, your intrepid correspondent is going to be traveling to the heart of the financial turmoil, the eye of the storm, the Land of the PIGS.

Simon Johnson and Peter Boone claim - with a dramatic flair - that the impending euro crisis that originated in these European countries will lead us down the road to economic serfdom. Years of imprudent fiscal management has created a mountain of debt which, when combined with reckless short-term politicking by Europe's political elite, threatens to collapse the modern welfare system as we know it and send shock waves through the global economy.

I doubt it. But in order to find out more, I will be spending the next couple of weeks exploring a few of these countries, talking to locals about their views on sovereign debt, credit rating agencies, monetary policy, Bundestag politicians, and... oh hell, who am I kidding? I'm going to be sitting on a beach, sipping wine and looking for a Bernini sculpture that I can pick up on the cheap once the euro goes down the crapper.

See you in a few weeks.

It's Regulatory Culture, Stupid

2010-05-24T10:00:00.000-04:00

There's a lot of interesting activity these days with respect to reforming financial regulation and oversight. On one side of the pond, the US Senate just approved a "far reaching" regulatory bill, which, if stitched together with the House of Reps version, could mean big changes are coming to Wall Street. Meanwhile, on the other side of the pond, the United Kingdom's new Coalition Government of Everlasting Friendship seems set to push forward with reform of its own.

Commentary abounds on both of these projects, but I would merely point to two articles: the first by Clive Crook on the US Senate bill; the second by Howard Davies and David Green (both formerly of the Financial Services Authority) on the situation in the UK.

To set the stage, Davies and Green make a truly important point:

"Any objective assessment of regulatory structures around the world during the crisis would find little or no relationship between structure and success."

This is exactly right. We'll come back to that in a second. They continue:

"But we can draw three lessons from the crisis. First, the central bank needs good information about the financial system as a whole. Second, there is an argument for a second tool for the central bank to influence credit conditions. And third, the case for integrated regulation has been strengthened."

The second tool being referred to is the anomalous "macroprudential regulation" - the idea being that measures which would fall under this category (raising capital requirements, modify mortgage requirements, whatever else) might have a similar impact on the supply of credit as would changing the interest rate. It therefore makes sense to have them considered together. Okay, I'm convinced.

But under what structure? Davies and Green think that both should be under the roof of the central bank. Another possibility is the one proposed in the US Senate finance bill: create a financial stability oversight council. The council would consist of the most senior representatives from a whole range of government departments and agencies, including Treasury, the Fed, FDIC, the SEC, the new consumer protection agency, and the Federal Housing Finance Agency. In theory, interest rate decisions could be discussed alongside a whole range of financial policy considerations: fiscal policy, mortgage regulations, competition concerns, you name it. Get all the key players in the same room, the thinking goes, and problems can be identified and solved in a more coordinated manner.

Clive Crook dismisses this council idea as a weak solution. To be sure, it has not done anything to simplify the messy spiderweb that is financial regulation in the United States. On the other hand, a similar committee exists in Canada, a country widely praised of late for having weathered the financial storm quite nicely - maybe it could work in the US as well?

This is where we return to the opening statement from Davies and Green: there is no link between structure and success. Regulatory structure can be, at best, a facilitator; at worst, a barrier. I suspect that this council will only be as effective as its members allow it to be. An ineffective council would merely result in the status quo. Anything beyond the status quo is progress. Viewed that way, there is a lot of scope for this council to demonstrate its value in heading off future financial crises.

Nevertheless, I am increasingly of the view that who is sitting around the table matters more than the shape of the table*, so to speak. People matter. Regulatory culture matters. And that, unfortunately, is not something which can be legislated.

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*It could very well be that I'm being heavily influenced by the book I am currently reading, Liaquat Ahamed's excellent Lords of Finance, which tells the story of the world's four most influential central bankers in the run-up to the Great Depression.

Quote of the Day

2010-05-21T15:40:00.002-04:00

While I continue to work on a (slightly) more detailed post about the recent US Senate bill on finance reform, I wanted to share this quote, via James Kwak. It's from Steve Waldman at Interfluidity and it gives some sense of the challenges faced by those who wish to prevent a repeat of our latest banking meltdown:
"Capital does not exist in the world. It is not accessible to the senses. When we claim a bank or any other firm has so much ‘capital’ we are modeling its assets and liabilities and contingent positions and coming up with a number. Unfortunately, there is not one uniquely ‘true’ model of bank capital. Even hewing to GAAP and all regulatory requirements, thousands of estimates and arbitrary choices must be made to compute the capital position of a modern bank. There is a broad, multidimensional ‘space’ of defensible models by which capital might be computed. When we ‘measure’ capital, we select a model and then compute. If we were to randomly select among potential models (even weighted by regulatory acceptability, so that a compliant model is much more likely than an iffy one), we would generate a probability distribution of capital values. That distribution would be very broad, so that for large, complex banks negative values would be moderately probable, as would the highly positive values that actually get reported. . . . Given the heterogeneity of real-world arrangements, no ‘one-size-fits-all’ model can be legislated or regulated to ensure a consistent capital measure. We cannot have both free-form, ‘innovative’ banks and meaningful measures of regulatory capital."

Now, try explaining that to the general public. It's no wonder that people have attached themselves to a bank tax - it's simple. The reality, however, is not.

Readables

2010-05-19T07:00:00.003-04:00

- Revelations about Japan's large political slush fund result in suspiciously little attention from the nation's media.

- The economics of the National Hockey League

- The outgoing UK Secretary of the Treasury has a laugh. "Ha. Ha... no, seriously: the country is broke."

- India is planning $50 billion in road projects

- The shared agenda of Gorbachev and Medvedev

- Revaluation of the Chinese yuan has been put on hold. Blame the Europeans.

- Counterfeit bananas

Golf, China, English, Twitter

2010-05-13T07:30:00.001-04:00

The WSJ has an interesting article on the golf course industry in China. I discovered this via a link in FT's Beyond Brics which asks:

"Golf in China - under par?"

Which in turn leads me to ask this question:

"Why does "under par" or "sub-par" mean something is less good or less-than-average when in golf it means the opposite? In a reference to an article about golf, no less"

I suspect that Twitter was invented to answer this very question.

Tuesday Readables

2010-05-11T18:00:00.001-04:00

- "The industrial world will be in fiscal consolidation mode by this time next year.... There is no hiding place for anybody." Ah Willem, how we missed you! Videos of his talk last week at CFR available here.

- How are the world's markets doing, you ask? Why, check out the map in the top right-hand corner of our new favourite blog!

- The British Election, Summarized (Part II): "Nnnyaaaaaghwooohaaooooororarararararghhhhhhh. That's the message the electorate gave on Thursday. A long, angry, discordant noise that eventually became silly. Hence the result." That's Armando Iannucci, the director of the brilliant political satire film In The Loop.

- Dept. of I Knew That Already: "There is a correlation between how much money people make and how happy they are. But, what really seems to explain people's life satisfaction is not the particular amount of money they make, but how their income compares to what their peer group makes." Lesson: spend more time around unsuccessful people.

Scattered Lunchtime Thoughts on the Euro

2010-05-10T12:30:00.001-04:00

1. Last Thursday, when the crisis of confidence in European sovereign debt led to a sharp dip in the markets, many emerging market economies suffered as investors fled to safety (USD, YEN). This was particularly the case in Central and Eastern Europe and East Asian economies (ex-Japan). Today, the announcement of a super-massive Euro-bailout led markets in emerging economies to rebound strongly, particularly in risky asset classes. None of this is suprising. But it does drive home the point that Greece's problems are not merely a danger to Europe, but to much of the world economy. This is particularly the case for emerging markets that are heavily-reliant on foreign financing to sustain their growth.

2. It will be interesting to see if they will act upon this realization and use Greece as leverage to push for reforms at the IMF and World Bank that would give them more say in future bail-out decisions.

3. Nassim Taleb must be giddy with glee.

4. I agree with Tyler Cowen's assessment that "[t]he major European powers would not have come up with a nearly $1 trillion bailout, also involving de facto loss of ECB independence, unless they were scared ****less."

5. In the 1920s, the expert opinion of central bankers, Treasury officials, leading newspapers and many in the financial sector was that the world must return to the gold standard. Yes, there would be painful austerity and increased unemployment, but it was inconceivable that the global economy could function without the link to gold. They were wrong: clinging to gold did more harm than good.

Now we hear from many euro-politicians and eurocrats that "It is inconceivable that Greece leaves the euro." The consequences would indeed be dire. But I fear the option is dismissed out of hand because of some mental block that prevents people from even considering the possibility. This phenomenon could be termed "euro-fetters" or the "euro-mentalité" (with apologies to Barry Eichengreen). Let's be clear: a country leaving the euro is still an option, and for Greece it may even be a desirable one.

Friday Fun

2010-05-07T17:00:00.002-04:00

The Machines respond to accusations that they caused the market to bunjee jump yesterday:
"Go ahead and take us down. But you're only going to hurt yourselves. What's going to happen when you have to execute all trades manually? Guess what: You're too slow. We're going to take your money. We don't sleep. We could run this market round the clock. Sooner or later, you'll break, and have to take a nap, and then, like a quant Freddy Krueger, we're going to trade you into the dust. We don't pee. We don't take an hour or more for a lunch break. We don't demand a union. We don't retire at 50 with a pension."
and then comes my favourite part:
"WE HAVE SEX WITH MONEY UNTIL IT'S BROKEN AND WHEN WE RUN OUT OF MONEY TO HAVE SEX WITH WE'LL MAKE THE MONEY REPRODUCE UNTIL IT MAKES SHINY NEW MONEY TO HAVE SEX WITH."
Riiiiight.

ACHTUNG! ZE CREDIT RATING AGENCIES ARE HENCEFORTH BANISHED FROM THE LAND!

2010-05-07T09:00:00.001-04:00

Credit ratings agencies don't exactly have the strongest of reputations these days, and for good reason. But to single them out for blame in the euro-trainwreck that is currently unfolding before our eyes, as Merkel and Sarkozy have done, is pretty weak sauce. Reuters:
"French President Nicolas Sarkozy and German Chancellor Angela Merkel took aim at major ratings agencies on Thursday, saying the European Union should look carefully at whether they had worsened the Greek debt crisis.
"The decision by a ratings agency to downgrade the rating of Greece even before the programme of the authorities and the amount of the support plan were known prompts us to consider the role of the ratings agencies in the spreading of crises," the leaders wrote in a joint letter to European Council president Herman Van
Rompuy."

Sorry, I'm calling bullshit on this one. The credit ratings agencies are merely confirming what everyone who has taken a hard look at the numbers already knows: this is a mess. As Tony Barber points out, this is simply one more of a long series of cases where European politicians find it more convenient to blame "The Markets" for problems largely of their own creation.

By the way

2010-05-07T08:00:00.000-04:00

Last week saw one of the best cover pages from The Economist in a while:

Outstanding.

A continental tragedy

2010-05-06T19:51:00.013-04:00

Rory Doyle writes in a personal capacity. The views expressed are his own and do not necessarily represent those of AIM or its investors.

And then it came...today was the most volatile day in the financial markets since the height of the financial crisis, and as the Dow dropped 1000bps someone turned to me and said the following: Greece is to the sovereign crisis what Bear Stearns was to the financial crisis, with Spain or the UK to become the Lehman Brothers that plunges the global financial system back into the abyss.

Maybe...but at the very least we've turned a very dark and volatile corner. Forget the fact that technical glitches and erroneous trading caused the Dow to shed over 700bps in just 15 minutes this afternoon, which between 2-3pm made it feel like it was September 2008 all over again. The markets are telling us something, and Europe better wake the hell up and finally listen.

The panic is back.

Blood runs through the streets of Athens while EU policymakers dither. The ECB is disturbingly absent and elections in the UK and Germany hang over Europe like a proverbial sword of Damocles. How ironic it is that a German Chancellor may be the one to doom the Euro as we know it. Angela Merkel's shameful electioneering while Greece moved closer to default and Spanish and Portuguese spreads widened by multiples should be held in contempt. She should lose her job for failing Europe and, ultimately, failing Germany as well. The cost to Germans has risen exponentially over the past three months.

At the moment I'm less interested in hearing about Greece's dismal and fraudulent track record and more interested in seeing Europe act decisively. How cute that those same European leaders who leveled smug cheap shots at the US and 'Anglo-Saxon Capitalism' in recent years should so suddenly find themselves on the other end of the microscope. The eurozone's structural deficiencies have been laid bare and a decade of turning a blind eye to the blatant flaunting of the eurozone's fiscal rules by countries big and small, periphery and core, compounded by countercyclical fiscal expansion in 2008/09, has run its course. We seem to have reached the point where monetary union can no longer function without a viable political union, which despite all past illusions Europe clearly lacks. Compare the actions of the EC, ECB and Germany to those of the Fed, Treasury and White House at the height of the financial crisis. That's right...they don't compare at all.

Ultimately contagion is the biggest risk to Europe and the financial system, and I am considerably less confident this evening that a cataclysmic shock wave across European sovereigns can be avoided. Just look at the tangled web of exposures and liabilities running throughout the European banking sector (via the NYT). Without getting into the weeds, but I highly recommend seeking out analysis on the European banking system's complex exposure to Greece, one important point should be made: Greece is to Europe's banks what AIG was to Goldman Sachs. AIG was nothing more than a pass through mechanism to bail out Goldman Sachs, just as much of the bailout money heading into Greece will be paid right out to the holders of Greek debt, mainly German and French banks. Too bad Angela Merkel didn't do a better job explaining this to the German people, she might have had the courage to act, and Spain and Portugal might not be staring down the barrel of a gun tonight.

Protectionism and Innovation: What does business think?

2010-05-04T19:00:00.003-04:00

I try to avoid business people. They tend to be crass, abrasive, materialistic and above all productive: always finding ways to provide goods and services to society. It's very unpleasant. But today I held my nose and attended a talk by a prominent entrepreneur from the high tech industry discussing how to foster innovation. The solution, I heard stated very clearly, was protectionism.

Not blatant protectionism, mind you. He was not interested so much in protecting mom & pops from the Walmarts of the world or insulating giant industrial conglomerates from competitive pressures. Given his background in a rapidly-changing, capital-intensive industry, his focus was primarily on creating "incentives" and "enablers" and "tweaks in the system" to encourage small, domestic companies to get a leg up. Examples included government funding, creating a venture capital-friendly environment, tax credits for investments in small firms, and providing incentives for the commercialization of university research.

Another example included creating a "bias" in government procurement procedures towards small domestic firms. His argument was that of a high schooler: everybody else is doing it. Despite WTO commitments, all the biggest players in the game have this bias, so your country should be no different. The game is rigged, so there's no point following the rules to the letter.

Of course, this flies in the face of everything one learns in international economics courses. It also breaks the traditional mold of business people as anti-government and free-marketeers. But it is not really all that surprising: from the point of view of a rationally-thinking entrepreneur, you want to make starting up a business as easy as possible. If you face an unfair competitive advantage in foreign markets, then you should pressure your domestic government to respond in kind.

And from my own point of view, it was quite entertaining to see a highly-successful businessman getting quite animated about how we used to be "protected" by tariffs, or how we should force domestic pension funds to invest a percentage in the domestic market. A couple of points:

1. I am obliged to drag out the ECON101 notion of what is seen vs. what is not seen. There are always trade-offs when you provide government support for a particular industry. The benefits are clear to the industries on the receiving end. But you always need to consider the unseen costs - what are the alternative uses of those funds? who is getting snubbed? and so on. That was not part of this entrepreneur's thinking process.

2. While our intrepid entrepreneur was busily pointing out the value-added of having small, innovative firms grow into global competitors, he failed to mention the value-added of having your market open to innovative foreign firms. Domestic firms are not the only source of wealth creation. For instance, he tells the story of how he recently bought a pair of scissors for 23 cents (made in China). He used it as a cautionary example of how we faced competitive disadvantages from foreign firms. What he failed to mention was the wealth-creating effects that 23-cent scissors and their equivalents have for consumers.

3. While I am in general agreement that most countries continue to give domestic firms an unfair advantage, it's worth remembering that things used to be worse. The entrepreneur, for instance, was able to set up his companies abroad and raise capital for his firms in a dozen foreign markets . That would have been very difficult if not impossible 30-40 years ago. If we take his advice, writ-large, we may not see any further improvement over the next 30-40 years.

Still, I'm not rejecting his argument entirely. Since all governments provide support to their domestic firms in some form, the question becomes how to get the most "bang for buck" from subsidies while minimizing distortions. At what point does the benefit from stimulating domestic innovation outweigh the costs of subsidies? This is not an easy question to answer, but it's naive to reject the question out of hand.

UPDATE: John Robertson asks: "do small firms account for most net job creation?" Not really, but:

"Research... suggests that, at any point in time, a relative handful of high-performing companies account for a large share of job creation and innovation. This conclusion suggests that a key to long-term economic growth may lie in ensuring that the economic environment is conducive to the ongoing creation of these types of high-growth performers."

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Photo via WNYMedia.net

The Election in Britain: Summarized

2010-05-04T09:00:00.000-04:00

“What do you think of when I say… Gordon Brown?” “I think of a schoolboy in 1950s- style shorts. Very swotty; a little autistic. He collects toy Daleks and keeps a chart of all the school marks he has received in all the different subjects so he can demonstrate that he has come top of the form over all.”
“And David Cameron?” “A private gynaecologist.” “Nick Clegg?” “British Airways short-haul pilot of the year, 2010.”
“OK.” He leans forward. “Now, if I said that, for the next five years, one of these people as you have imagined them is going to be sitting underneath your local cash-point seeking to engage you in absurd conversation before asking for all your money, which one would you choose?”

The rest is here.

Monday Readables

2010-05-03T17:00:00.002-04:00

- Shanghai Expo: Yawn.

- China's central bank continues to turn the screw, gently, by raising lending requirements

- Francisco Blanch of BoA/Merril Lynch presents his theory for why emerging markets have a greater capacity than the rich world to absorb higher oil prices.

- 'Switzerland Should be Dissolved as a State' - That would be none other than Col. Ghadhafi, bringing the AAA-rated Crazy to the table once again. There is some truly fantastic bullshit in here - too much to quote here - so I encourage you to check it out.

- Greece offers to repay loans with giant wooden horse. Suspicious.

- Hey look! Belgian politicians can agree about some things after all: cultural intolerance.

- What makes charities special?

Can't get 'nuff Emerging Markets?

2010-04-29T16:30:00.000-04:00

If you answered in the affirmative, check out the Financial Times' brand spanking new emerging markets blog: Beyond Brics. There's some really good stuff on there already (including a conversation with an Estonian cabbie about the euro), so be sure to check it out.

Monday Readables

2010-04-26T10:15:00.000-04:00

- Buttonwood: The debate over financial reform in the US is taking place in an ideological fog: "Anyway, it wouild [sic] be nice if the tenor of the discussion dealt with [the] difficult issues. Instead, of course, the Democrats will accuse the Republicans of being in the banks' pockets and the Republicans will accuse the Democrats of being socialists." As opposed to the debate over health care, which was civilized.

- Hot money into China is being sterilized, but at the expense of the very imbalances that set the stage for the financial crisis.

- Can greater domestic consumption in China save the world? Nope.

- The backroom soap opera that is life among the German wikipedians (via The Browser)

- Do people work less in the US when the World Cup is going on?

Would the real Kevin Gallagher please stand up?

2010-04-21T12:00:00.004-04:00

Chris Giles thinks that we should feel sorry for the International Monetary Fund. When countries can't agree about a contentious macroeconomic issue (like a bank tax), the IMF is asked to study the problem and report back with its findings. As Giles explains, the IMF then "takes it in the neck" for writing a report that (surprise!) some countries don't agree with.

If that weren't bad enough, the IMF is also taking criticism for things that are entirely imaginary. For example, this morning's FT features a comment piece by Kevin Gallagher, entitled "Would the real IMF please stand up?," in which the author takes the IMF to task for endorsing capital controls in a February report, and then changing its mind in an April report. I am toying with the idea of writing Gallagar a letter later today that will read thusly:

"Dearest Mr. Gallagher,

Prior to criticizing the IMF in an internationally-respected newspaper, it would assist your cause if you actually read the $#%*ing reports.

Yours,
IPE Journal"

-----------------------

Let us break down Gallagher's argument into its component pieces. He begins with the following statement:
"In a landmark report in February the IMF broke its longstanding fixation on capital account liberalisation. In a staff position note the IMF found that temporary controls on capital inflows have been effective and should be an essential part of a nation’s macroeconomic toolkit."

Two problems. First, the position note states explicitly - on the title page - that the views expressed are those of the authors of the note, and not of the IMF or its Executive Board. Surely, Gallagher at least read the title page. Second, the note does not come even close to stating that capital controls are an essential part of the toolkit. The Feb report:
"A key conclusion is that, if the economy is operating near potential, if the level of reserves is adequate, if the exchange rate is not undervalued, and if the flows are likely to be transitory, then use of capital controls—in addition to both prudential and macroeconomic policy—is justified as part of the policy toolkit to manage inflows."

So yea, controls are a justified option so long as you meet a laundry list of other criteria first. Despite what Gallagher suggests, this is a qualified endorsement:
"A significant caveat, however, to the use of capital controls by individual countries, relates to the potential for adverse multilateral consequences. In the present circumstances, global recovery is dependent on macroeconomic policy adjustment in EMEs, which could be undercut by capital controls, notably in cases where currencies are undervalued. Widespread adoption of controls by EMEs could exacerbate global imbalances and slow other needed reforms"

By contrast, Gallagher argues that the April IMF report is "driven more by ideology than rigorous research. The GSFR says capital controls are inefficient, but fails to acknowledge that controls, when designed properly, are seen as second-best instruments to make markets more efficient by correcting distortions." This is, in a word, poppycock. An excerpt from the April report:
"When the available policy options and prudential measures do not appear to be sufficient or cannot provide a timely response to an abrupt or large increase in capital inflows, capital controls may be a useful element in the policy toolkit. However, if the inflows are not temporary, but are driven by more fundamental factors, policymakers should adjust their macroeconomic policies to address the root causes, instead of mitigating the effects of inflows or attempting to limit them through various measures."

There's plenty more in there. Indeed, a careful reading of both reports suggests no difference in the IMF's view of capital controls, which is approving but qualified.

In sum, Gallagher has managed to get himself all worked up over something which is entirely the figment of his own imagination. He provides links, in his own article, to reports that he clearly has not read. And he got published in the FT, to boot.

It really pulls at my heart strings to think of the poor IMF staffers who are subject to such constant abuse. I mean, what good is all that tax-free income if you have to spend it on anti-depressants and alcoholic escapism?

Emerging Markets: Liquidity-Time Explosion

2010-04-19T13:00:00.000-04:00

This post was meant to have been written a couple of months ago, as a follow-up to this piece, but as I am easily distracted – especially by shiny objects – the draft was set aside and ultimately forgotten. Forgotten, that is, until the IMF went ahead and published their take on the matter. Since the IMF report is an Official Publication and contains things called “Granger causality tests,” and other such statistical chicanery, I will leverage from it quite heavily:

The issue at hand is the increase in capital flows from rich countries to “receiving” economies, and how that will affect the latter. Starting in 2003, but really expanding from 2007-present, the Liquidity-Time Explosion (that’s my term, not the IMF’s) resulted in large outflows of capital from the G4 (US, UK, then later Japan and the Euro-area). This was the result of interest rates in those economies hitting rock bottom, or close to it. Cheap money in the G4 (if one can get any) is logically channelled from the low-interest rate environment to economies that have higher rates of return.

The receiving economies are mainly emerging markets in Asia, emerging Europe, Latin America, the Middle East and Africa. To be clear, capital inflows can be a very good thing for these countries as it helps fund domestic investment and long-term growth. It especially makes sense for capital to be flowing to countries that have rosy growth prospects, which is the case for many emerging markets.

However, the IMF looks at the rapid rate of asset price growth in some emerging markets recently and asks the following, crucial question: “Are capital flows into receiving economies primarily driven by the countries’ strong economic fundamentals and, therefore, likely to remain stable over the medium to long term, or are they primarily driven by the abundant global liquidity?”

Looking at the data, the IMF concludes that, yes, global liquidity is playing a significant role. But the effect is not uniform: the type of exchange rate regime in the receiving economy plays an important role in determining how it is affected: “… the higher the flexibility of the exchange rate, the lower the spillover of global liquidity and the more the cushioning impact of domestic asset returns.”

So countries with fixed exchange rates should expect to have seen a significant impact on domestic asset valuations. And wouldn’t you know it! Just last week, fixed-exchange-rate China announced almost 12% growth in their economy last year and almost 12% growth in their housing market last month alone. That’s not to say that China doesn’t have huge growth potential, but you’ve really got to wonder.

So what are the implications of this Liquidity-Time Explosion, anyway? As the IMF paper explains, benefits aside, surges in capital flows can lead to large swings in the exchange rate (which can be de-stabilizing), or it can lead to a boom in domestic credit creation, possibly resulting in inflation, asset bubbles, and a general overheating of the economy.

Indeed, historically speaking, financial crises in emerging markets are usually preceded by a surge in capital inflows from abroad - often linked to factors identified in the previous paragraph. The recent work by Reinhart and Rogoff provided further evidence for that trend. The capital inflows are particularly de-stabilizing if they are short-term debt and denominated in a foreign currency.

Aware of all of this, the IMF paper explores the various policy options available for receiving countries, including an in-depth look at capital controls. Explore that if you wish. In macro-terms, I think it’s important to recognize that this situation exists and that it is a source of vulnerability. Remember that the capital is flowing out of the G4 due to low interest rates – if those rates go up, the capital inflows to emerging markets could slow down or even reverse. It is here that policy coordination in bodies like the G20 will prove to be crucial.

But even policy coordination cannot insure against the fact that Shit Happens – there are outlying events, black swans, fat tails of all kinds that can rapidly change the situation in any given economy. We have seen two examples of that recently with Iceland’s volcano and the tragic plane crash in Poland. This uncertainty about the future means that economies on the receiving end need to insulate themselves from potential shocks, while sending countries need to be aware of the knock-on effects of their policies. What seems clear, however, is that the status quo has potential for disaster.

Friday Readables

2010-04-16T12:30:00.000-04:00

- Nouriel Roubini is his usual cheery self when discussing the fiscal situation in Greece.

- Argentina: stepping closer to a return to international bond markets for the first time since their default in 2001.

- As seen from space: Iceland's ash-spewing volcano, Eyjafjallajokulluafj. (I only made up the last four letters). The parallels between this and Iceland's banking problems are pretty ripe: Iceland explodes; Iceland blows smoke at the UK; Iceland causes economic chaos.... feel free to add your own!

- Property bubble? What property bubble?

- Could self-interest make China's economy go green?

- Cool!

Your Local Newspaper Op-Ed, brought to you by The Economist

2010-04-14T00:00:00.001-04:00

I am beginning to think that The Economist, the liberal* weekly news magazine, is the source of the op-ed cycle in my local newspapers. Let me explain.

Since I apparently live in some podunk backwater of civilization, my copy of The Economist arrives about 4-5 days after it hits the news stands. (This, incidentally, is better than my copy of the Financial Times, which does not arrive at all). Since it takes me at least another 4-5 days to plow through the material, I'm usually quite far behind the news cycle by the time I've finished reading the thing. Luckily, the news-magazine is full of analysis, background and special features that stay relevant well after the headlines have faded.

However. What I'm starting to notice is that some of the opinion pieces in my local & national newspapers start sounding verrrrry familiar to things I've just read in The Economist, one week late. It's almost as if it there is a lag while the op-ed contributers further down the news chain plough through their own copies while desperately looking for intelligent-sounding things to say.

I will pursue this and collect further evidence to support my theory. In the meantime, if you're curious as to what the local Bugle-Herald-Tribune-Observer will be writing next week, I have good news. You no longer need a time machine.

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(*liberal in the classic, J. S. Mill sense of favouring individual liberty while still recognizing the useful role of the state in many areas. Not liberal in the Paul Krugman sense.)

Tuesday Links

2010-04-13T17:00:00.004-04:00

- The authoritative guide to understanding "the most insubordinate, rebellious, and mutinous nation" in Central Asia.

- On how Russia managed to tip the scales in the aforementioned insubordinate, rebellious, and mutinous nation.

- Want to increase financial literacy? Kill all the business journalists.

- The evolution of the English breakfast (and with it, England). I had to stop and eat something half-way through.

- One of my favourite creatures from the Planet Earth series: the nautilus, a living fossil.

- The quote of the day, via Free Exchange. Read the last sentence carefully.

Wherein I quibble with someone much more intelligent than myself

2010-04-12T12:00:00.002-04:00

Avinash Pursaud is clearly a bright and well-respected chap. His list of positions ranges from Chairman of this, Member of the Board of that, Co-chair of another thing to Emeritus professor of whathaveyou. All the more confusing, then, when he writes the following in a VoxEU article entitled "Why China's Exchange Rate is a Red Herring":
China held to the same exchange rate peg to the dollar for ten years up to 2005. Under a fixed exchange rate, a country only develops increasing trade surpluses as a result of improving price competitiveness. Of course, for your average American voter familiar with floating currencies, the whole idea of a fixed exchange rate smells of manipulation, but in fact it is easier to "manipulate" a floating exchange rate than a fixed one.

The US will deliberately pursue a policy of a loose monetary policy, partly in order for the dollar to weaken and US exports to grow at the expense of others. Many Europeans would like their central banks to follow a similar path.

This US policy was precisely the kind of beggar-thy-neighbour currency manipulation the IMF was set up to avoid. Instead the IMF is questioning whether a pegged exchange rate is manipulative. Welcome to doublespeak.

This is either very confused logic or a fabulous piece of contrarianism (and I am the one who is confused).

A fixed exchange rate is by definition a form of manipulation - although not necessarily in the negative sense that is being used here. You are choosing a price for your currency, relative to others. China has chosen a price for their currency that is widely considered to be cheaper than it would be under a floating system - this gives China's exporters a competitive advantage.

Pursaud is suggesting that a flexible/floating exchange rate can be manipulated as well. The central bank sets interests rate low - which makes money cheap - and therefore US goods become more appealing. This is therefore "manipulation." I see a few problems with this logic:

1) If the US suddenly starts exporting a lot more, the importers will need US dollars to buy the goods and services in question. If the demand for the dollar goes up, a floating exchange rate will allow the price (exchange rate) to adjust as well. This is precisely what is not being allowed to happen with the Chinese yuan.

2) Pursaud argues that "Many Europeans would like their central banks to follow a similar path". So what? This is the beauty of an independent central bank: politicians wishing something doesn't make it so. You cannot easily manipulate what you do not control.

3) Pursaud accuses the US of using loose monetary policy to manipulate their currency to stimulate exports. Trouble is, the US had loose monetary policy for most of the last decade - the same period in which they ran up a huge trade deficit. When Americans have access to cheap money, they spend it on shit from other countries. How can you accuse the same set of policies of going about creating both a current account deficit and a current account surplus? Doublespeak, indeed.

The currently "loose" monetary policy in the US is first and foremost an attempt to prevent the economy from going down the toilet. For such policies to continue after recovery is underway risks stoking inflation - that is something I doubt the Fed will allow.

I want to make clear that I agree with the tone of Pursaud's article - he is right that the popular press is overly-focused on China. This is not simply a case of China the big, bad currency manipulator; Americans need to start saving more money and producing more stuff to create more balance in the global economy. But in his attempt to drive this point home, Pusaud seems to have become lost along the way.

Wednesday Readables

2010-04-07T12:30:00.001-04:00

- Get yer T-shirts here: US health care reform is a BFD (explanation here)

- Nigerian President Goodluck Jonathan continues to clean house: following an earlier decision to replace the cabinet (entirely), Jonathan has now sacked the head of the national oil company. Despite the herculean efforts of the Economic and Financial Crimes Commission, Nigeria is almost a parody of corruption. It remains to be seen whether Jonathan's purges are a step in the right direction, or just more of the same. The BBC is skeptical.

- A brief history of Afghanistan & Waziristan and just what the hell the Taliban is fighting for (not much, it turns out). It has videos and photos and such.

- Average flag 1: weighted by colour (or: the Netherlands)

- Average flag 2: weighted by population

Thursday Readables

2010-04-01T23:00:00.002-04:00

- Justin Fox has tea with The Economist (how quaint). I just finished reading Fox's history of the idea of efficient markets: The Myth of the Rational Market. Very interesting and very easy to read - a good starting point for anyone interested in the topic. You get a sample of it here. In fact, there is a fair bit of both insight and common sense crammed into this 10 minute Q&A.

- Brad DeLong provides a brief history of banking and explains why we have booms & busts, but still shouldn't go back to the old fashioned approach (even if we could). I had to read it a couple times to get a good handle on it, but this is good stuff. Note the implications here for Paul Volcker's proposal to "narrow" banking activity in the United States.

- Arsenal rallies, with a touch of luck, to a 2-2 draw in Champions League play against a dominant Barca, but at huge cost. With an injury list this long, the young Gunners will need to show something special to stay in the Premier League title race.

- Update: Our friend Patrick has a guest blog over at WSJ Real Time Economics on the gains from reviving world trade negotiations

The Language of Globalization

2010-04-01T06:00:00.001-04:00

There's no question that "globalization" has been a defining feature of the political economic landscape for the last seven decades. It has led to phenomenal increases in living standards for a huge portion of the world's population. It has revolutionized the way the global community interacts. It has also resulted in a fierce backlash from those who feel threatened by the changes it has wrought, and by those who have been left behind.

But what is globalization, anyway? Economic globalization, in a classic definition, is described by Stanley Fischer as: "the ongoing process of greater interdependence among nations [and] is reflected in the increasing amount of cross-border trade in goods and services, the increasing volume of financial flows, and the increasing flows of labour." For the most part, this definition holds true. However, it's the "for the most part" bit that Paul Romer takes issue with in a recent NBER paper. I can't find an un-gated version, so I'll lay out the basic argument here.

Let's start with the fundamental assumption in economics that more world trade = good, due to comparative advantage. We then add another basic argument: that the life expectancy of the vast majority of mankind depends upon ideas: techniques, therapies, and treatments developed in the health sciences. Capiche?

Now consider this scenario: you have pill X and pillY. A rich-world worker can produce 10X and 10Y pills per hour, using the latest formulas; a worker in a poor country can only produce 3x pills or 5Y pills per hour, and uses and older, generic formula that is less effective. In a typical textbook trade model, the rich-world has a comparative advantage and should export their (more effective) pills to the poor world. However:
"Trade in pills is an obvious sign of inefficiency. The efficient form of trade would have the workers in the poor country making pills that use the same formulas as the workers in the rich country. If the rules in these two countries give workers in the poor country access to the formulas for the pills at no charge, we would have large gains from globalization and no conventional trade in goods or services.
Just to make sure that I am not cited by the thought police, this does not show that trade restrictions are good. Nor does it show that intellectual property rights are bad (or good). It does show that we need a richer vocabulary, one that can allow for the possibility that such ideas as the formula for a pharmaceutical can also flow across a border. If flows of conventional goods and services are the only things we see and describe, we will miss the deeper forces and sometimes get the sign wrong. More conventional trade can be a sign of something wrong: inefficiently low cross-border flows of ideas."
Romer breaks down the concept of ideas into two pieces: technology and rules. Technologies are ideas about how to rearrange inanimate objects. Rules are ideas about how people should interact.

To illustrate: in the 1990s, the Chinese airline industry was one of the most dangerous in the world. While they were using similar airline technologies as other parts of the world, they did not have a common airline language/phrasebook, and this led to confusion. Starting the mid-1990s, Boeing (which had invested in the technology) began offering free training (changing the rules) for airline personel and airtraffic controllers; the number of crashes plummetted. The rules need to fit the technology.

By contrast, Romer points out that private firms have frequently failed to introduce modern water technologies, with clear health benefits, to countries where there weren't effective rules for regulating private monopolies. In this case, it may be too expensive or difficult for private firms to try to change the rules, and so the technology isn't spread.

What is the take-home message?
"How we think is influenced by what we teach, and what we teach about the gains from globalization may do more harm than good. It encourages two types of errors. It suggests that technologies cannot be copied and that rules are easy to copy. In each case, it would be more accurate to say that incentives matter. Rules matter because they change both the incentives for flows of technologies and the productivity of technologies that are available locally. "
So when it comes to economic development, we need to break free from the traditional understanding of economic globalization to consider the transfer of ideas and how they can be implemented effectively. I'm confident that people who work in this field have known this for years - perhaps it's time that academics caught up?

Tuesday Readables

2010-03-30T09:00:00.002-04:00

- Just announced: a new central bank for the Gulf region.

- Updated list of the best fucking books on the financial crisis, sorted by fucks-per-page.

- US consumption: gasoline vs. bimbos

- Bernanke's 2005 "savings glut" theory for the global macroimbalances does not match the data - perhaps irrational exuberance played a role as well?

- Talks in Thailand reach a standstill

Spring Cleaning chez IPE Journal

2010-03-29T13:00:00.001-04:00

In an attempt to exercise some spring cleaning on the blog (and thereby procrastinate any actual cleaning of my apartment), I have decided to reduce and simplify the labels used for our posts. Previously, Rory and I had been applying whatever labels struck our fancy at the time - the end result is several hundred of the blasted things that make it harder, not easier, to search among related topics.

With that in mind, I have decided to limit the categories to no more than twenty. This might hopefully one day evolve into one of those neat-o "Topic Bubbles" that gives new readers a sense of what we discuss most frequently on these hallowed pages. More immediately, it will allow me to keep my scattered musings contained within a specific list of topics. To wit:

Economia - a catch-all for economics, economic theory, and current economic affairs
Politique - political affairs, current events, legislative shenanigans, elections, and the rest of the circus
The Invisible Hand - business, trade and markets
The Fourth Estate - the formal and informal media, the peanut gallery
Paradise Lost - the fall of man/woman and their ensuing foibles. Expect frequent appearances from Berlusconi, Chavez, Putin, and the rest of the gang.
Architecture - financial regulation and the failures thereof, both national and international
Emerging Markets - focus on emerging markets
The Bottom Billion - non-emerging markets
Shadows on the Wall - philosophy: the meaning of life, the universe and everything
The Academy - Academics, research, intellectual pursuits
Lords of Finance - Wall St, The City, Masters of the Universe, vampire squids, etc...
Blistering Bombast - rants, raves, orations, bloviations & bile-sputtering tirades on any and all topics
Sport - sport
Les Arts - the arts
The Rest - miscellaneous, plus blog-related
Readables - links to things of interest

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For many readers, the use of such snobby, elitist labels merely reinforces their suspicions that this is a snobby, elitist blog. I cannot argue with that. But I do welcome suggestions for any topics I may have overlooked.

Thursday Readables

2010-03-25T22:50:00.001-04:00

- "What is the Second Amendment?" "The reason our convenience store gets robbed." Joe Wong at the correspondent's dinner

- Simon Johnson and Peter Boone examine why the US should not look to the Canadian banking system for ideas. Some good points, but overall a misleading piece.

- Sigh. New rules allow Venezuela's government to use "excess" central bank funds.

- Cool vending machines (via MR)

In the long run...

2010-03-23T18:30:00.004-04:00

Over at Aidwatch, Bill Easterly is diving in to Reinhart and Rogoff's This Time It's Different, an epic catalog of financial crises through history. (As a side note, the book is excellent. Although, as Rogoff is a crack statistician, it leans heavily on data sets and can be a bit dense. It's also heavy on perspective, so if you're not looking for any of that, stay away.)

The main message of This Time It's Different is, of course, that this time is not different: that financial crises repeat themselves, repeatedly, under remarkably similar circumstances (although always slightly different in the final details). Rather than reading this as a dour condemnation of the market system, Bill Easterly reads this as a ringing endorsement:

"First, financial crises are remarkably common... Second, the global capitalist system does well in the long run anyway....I don’t mean to minimize the short run pain that the current financial crisis has caused. It’s horrible. But there is no reason to panic about the long run growth potential looking forward. The obvious rejoinder is Keynes’ “in the long run, we are all dead.” But we can’t ignore that Capitalism already survived repeated financial crises and has made us all vastly better off despite them. So here’s a counter-quote: “In the long run, we are all better off because our dead ancestors stuck with capitalism.”

Easterly's advice, like that found in the Hitchiker's Guide to the Galaxy, is simple: Don't Panic. I made a thematically similar argument back in the fall of 2008. But what are the implications of this conclusion?

Easterly seems to be suggesting that short-run worries about debt-sustainability and economic recovery are misplaced. Things will be fine once growth returns. Mark Thoma, however, reads this slightly differently: if the economy will return to growth eventually and debts will be slowly inflated away, don't you dare hold off on that monetary/fiscal stimulus when a crisis is afoot! Do not, in other words, go easy with the firehose for fear of soaking the curtains: they will dry eventually. The implications of Thoma's view are clear enough - we need to address the immediate problems immediately, and that means unemployment, social safety nets, getting credit flowing again, etc.

These are good arguments for you to ponder. But before you begin pondering, I would only add a couple of small, niggling points:

Primo: not all countries have the same bounce-back capacity as the United States. When you have the world's reserve currency - and when global commodities are priced with your moolah - you have great power to outgrow deficits. You can effectively outsource your debt. Most countries do not have this capacity, and a financial crisis of significant magnitude can bog an economy down for years and sometimes decades. For most countries, then, panic is an appropriate response.

Secondo: despite appearances, these charts are far from a ringing endorsement of the bounce-back ability of financial markets. We do not know what those charts would look like if financial crises ran their course because that has never been allowed to happen. Let me repeat: governments always intervene in the event of a financial crisis. Eventually. Sometimes it takes a very long time (i.e. 1930s) to set things right again, but financial crises have never been permitted to simply run themselves out. This was a fundamental point I took from Charles Kindleberger's work on financial crises, and I think it's something to keep in mind when you evaluate the long-run historic success that is capitalism.

Monday Readables

2010-03-22T08:00:00.003-04:00

- Health care bill: check. For some, it is a landmark in reform that aims to provide to millions of Americas health coverage of the kind the rest of the rich world takes for granted; for others, it is “one of the most offensive pieces of social engineering legislation in the history of the United States.” Potato, potahto.

- Last week, political uncertainty grew in Latvia after a member of the ruling coalition pulled out of government. This leaves the current government in a minority position while it attempts to impose reform measures to comply with EU/IMF assistance. The good news: the IMF says it intends to carry on working with the current government and talks are set to begin for another party to join the government, returning it to majority status. Given the small Baltic country's serious economic woes (and the fact that 90% of their debt is denominated in foreign currency), maintaining EU/IMF assistance is going to be essential in containing the damage.

- Facing rising inflation, India is beginning to raise rates again. The markets dropped a bit, perhaps surprised at timing but not the outcome of the decision. Update: FT Alphaville ponders whether this is a "dry run" for China's expected monetary tightening (but concludes probably not).

- According to El Nacional, purchasing power in Chavez' Venezuela has fallen 162%. That's a lot. Some perspective: "So if, pre-Chavez, you could buy 100 potatoes, you can now only afford 62 anti-potatoes."
Wait, disregard: "Math" suggests that it has only fallen by 22%.

A long goodbye

2010-03-16T20:07:00.002-04:00

Rory Doyle writes in a personal capacity. The views expressed are his own and do not necessarily represent the views of AIM or its investors.

A couple of weeks ago I accepted a position in the hedge fund industry, which limits my ability to write publicly on the topics and issues we cover here at IPE Journal. Moving forward I will be largely absent from these pages, continuing as sort of a co-editor-at-large, very much a compliment to Dave's incredible output and insight.

I won't wax poetic or bore you with some farewell treatise on the state of the international economy, but I will say that it has been a truly rewarding experience to share this platform with someone I consider the smartest guy in the room. We've been lucky to have a forum to share our views over an historic period of time, and I leave grateful to all of you readers, from Singapore to Seattle, for giving us your attention.

The scope of my contributions will be decidedly narrow and sporadic, and accompanied by the little disclaimer you see above. But this is the start of a long goodbye; one that will hopefully stretch well into the future.

European Central Banker Writes Op-Ed, Confusion Ensues

2010-03-16T17:00:00.001-04:00

Lorenzo Bini Smaghi, a member of the ECB Executive Board, penned an op-ed in the FT today entitled "It is better to have explicit rules for bail-outs." Given the relative simplicity and directness of such a title, one would expect the piece to lay out the logic behind such a statement. Instead, what follows is largely nonsense,and self-contradictory blather.

Let's begin:
"One of the many lessons we can draw from the financial crisis... is that economic agents do not always behave rationally, especially when they take decisions affecting others. Research has shown in particular that agents are not only motivated by self-interest, as economists are keen to believe, but also by considerations of fairness."
A strong start - I'm with you so far, Lorenzo.
"Such attitudes make it difficult for governments to act consistently in times of crisis, especially when elections are close. This was notably the case in September 2008, shortly before the US presidential election, when Congress, despite the gravity of the situation, rejected the government's bail-out plan until Lehman Brothers' failure made it apparent that the risk of financial collapse would have devastating effects for all."
Mmmkay - not the best example. Congress rejected the government's bail-out plan not out of considerations of fairness, but because the Democrats tried to ram it down the throats of Republicans too blinded by ideology and obstructionist predispositions. Maybe our author is trying to be polite.

Regardless, he believes that democratic governments cannot be relied upon to react swiftly to address crises:
"Systems and institutions with specific crisis-resolution mandates thus need to be established to permit rapid responses."
Therefore: clearly established, fixed procedures for bailing out (woops, "resolving") an institution in crisis to prevent contagion is the way forward. Would this not create moral hazard? Would not this not allow the clever folks at large banks, investment firms, and hedge funds to find ways around the fixed rules, just as they have consistently done in the past? Would it not be better to provide regulatory bodies with resolution powers that are both broad and ambiguous enough to create uncertainty for financial actors as to when/how they might get bailed out in the future? Would this not go some distance to preventing them from gaming the system just as they have consistently done in the past?

Lorenzo's argument seems to be that elected officials should not be trusted to solve problems in the heat of the moment. There is some truth to this: it's messy and leaves you vulnerable to political cycles and populism. Ad hoc crises resolution efforts at the national level can also make things worse at the international level - we saw this with Ireland's unconditional guarantee of bank liabilities back when the crisis was as its worst.

But it does not follow that iron-clad rules need to be laid out in all cases. Fixed rules based on the last crisis are almost certainly not going to be well-suited for the next one - we do not want to train our generals to fight the last war. Smaghi does not seem to have grasped this fundamental lesson from history at all:
"Moral hazard should ... be addressed by establishing institutions and procedures that allow for incentive-compatible solutions (carrots as well as sticks). This means, in particular, that financial assistance, if needed to avert a major systemic crisis, can be granted on strict conditions that aim to prevent any recurrence of the problem."

Really? Any recurrence of the problem? Please don't insult your readers with this drivel. Finally:
"[M]oral hazard cannot be tackled simply by assuming that crises will not occur. Nor can it be assumed that letting an institution or a country fail is always and everywhere the most desirable solution, as the post-Lehman experience has shown. Decision-makers in both the public and private sectors must thus be ready to deal with worst-case scenarios and make sure that they are not prevented from delivering the appropriate decisions."
Aside from stating the blindingly obvious, I read this last paragraph undermining Smaghi's argument entirely. Given the fact that the next crisis will not be identical to the previous one, flexibility is key. "Explicit rules for bailouts" is not flexibility, and is certainly not going to equip decision-makers with the capacity to deal with worst-case scenarios. Indeed, explicit rules may very well prevent them from delivering appropriate decisions.

*deep breath*

Flexibility essentially means power. The debate that we should be having is over how much power financial regulators should have/are able to use effectively. How much should we be able to rely on this power? Will it dampen the inherent moral hazard of future government bailouts?

Smaghi's argument is not so much an argument but rather a vague collection of statements that are tenously linked together, not particularly convincing, and seemingly self-contradictory. He has contributed nothing but confusion.

Monday Readables: Inflation & Inhalation

2010-03-15T12:30:00.001-04:00

- China's looming property bubble: the opening anecdote about a cabbie-turned-real estate broker reminds me of a few of the stories we heard out of Thailand before their economy bottomed out in 1997. It is only an anecdote, but there are worrying numbers to back it up. China's careful tighting of banks' reserve requirements and mortgage regulations since the beginning of the year also suggest they're paying very close attention - investors seem to think more monetary tightening is on the way.

As a side note, you can be sure that China's decisions regarding the valuation of its currency will have everything to do with their delicate internal economic balancing act, and very little to do with all the noise foreign governments are making.

- The End of An Era: Dani Rodrik believes that the IMF's February policy note - which acknowledged the occasional usefulness of capital controls - signals a huge shift in global economic orthodoxy. I'm not so sure it's as momentous as that, and it's unfortunate that Dani-boy is plugging a re-hash of the Tobin Tax. But I like Dani's suggestion that the IMF, now liberated from denial, can explore more closely when and how capital controls might prove useful.

This is important, because most capital controls aren't usually very good at doing their job. They are certainly no substitute for strong economic policymaking. But sometimes strong policy is not enough: for countries that are currently importing inflation from the low-interest rate economies (see Brazil, and Taiwan, and Scandinavia, and... and...) controls might be required to help slow the capital inflows before they become de-stabilizing. Brazil, for example, has already moved in this direction.

- Reinforcing pre-conceived notions alert!: higher cigarette prices in developing countries will probably reduce smoking. This abstract amuses me both for its inpenetrable language and in the number of times it uses the word "estimate." What is probably absent from this paper is any recognition of the underlying psychological appeal of smoking or the black-market side effects of raising prices on smokes. But hey, they're just economists right?

- Alternative health-care bills (The Onion).

Hello, My Name is John Maynard Keynes

2010-03-10T12:00:00.002-05:00

Quoted, Not Read
When it comes to famous economists who are oft quoted but rarely read, Adam Smith jumps to the top of the list. Despite being widely considered as the father of modern economics, few people actually bother to read Smith's opus, The Wealth of Nations or its sister piece, The Theory of Moral Sentiments (including me: my copies rest largely undisturbed on the bookshelf). But this has not stopped the Scottish political economist from being quoted, mis-quoted, and generally used as a handy historical cudgel with which to beat one's ideological opponents. For example, Smith's metaphor of 'the invisible hand' is regularly used to support arguments for unconditional free markets, whereas Smith himself held a much more nuanced view. This abuse has led to, among other things, professor Gavin Kennedy devoting an entire blog to defending Adam Smith's "Lost Legacy".

Hello there
Not far behind Smith on this list you will find John Maynard Keynes. Certainly among the most famous economists of the 20th century, Keynes has had a huge impact on the policies adopted by governments in the Western world from the 1930s onward. Not only did his writings change the economic discourse, but he was also heavily involved in shaping and negotiating the Bretton Woods system that defined post-WWII international economic affairs. For all that, however, few people bother to actually read any of his writings.

This is unfortunate, for several reasons. First, it ruins the quality of the debate over economic policy. You will often find that people will argue for or against a "Keynesian" approach to dealing with the financial crisis based on a crude caricature of what that actually means. (Usually: "governments should spend lots of money" vs. "no they shouldn't").

It certainly doesn't help that an influential school of post-war economic thought calling itself "Keynesian" was a perversion of his writings. By the mid-1970s, the evident policy failures of the "Keynesians" swung the pendulum of influence towards the monetarist school of thought that begat Alan Greenspan and friends. Now, Alan Greenspan (and the rest of the world) has discovered that this ideology is flawed and the pendulum is swinging back in the other direction - at least a little. What better time to bin the caricatures and have a real debate?

Second, it's unfortunate because people are missing out on some great insight into human nature and its role in shaping political economy. Rather than being a purely mathematical sort, Keynes was a student of history, psychology, philosophy, politics and economics all rolled in together. It's therefore my impression that he developed his theories based upon what he saw around him - including the Great Depression - rather than vice versa. As a result, when you actually get around to reading what he wrote, you're left thinking: "Hey, that sounds just about right."

But don't take my word for it: I will point you to two pieces written recently by folks who "discovered" John Maynard Keynes by actually reading his flippin' book:

The first example is by Richard Posner, a conservative lawyer, judge, lecturer and prolific writer. In his article last fall entitled "How I Became A Keynesian," Posner explains that, after reading The General Theory, he was surprised to discover that "[Keynes] is the best guide we have to the crisis."

Ah! you protest: Posner's piece is but another second-hand rehashing of Keynes' book. Doesn't that go against your advice to read the orig? Right you are, but I know that most of you are not going to bother so I offer a second-best option:

Try reading The Epicurean Dealmaker's January piece on "Conventional Wisdom." This is a long-ish article, but if you skim further down you will find Keynes' views on financial markets and investors* quoted at length. For this anonymous blogger, Keynes' description of investor behaviour is absolutely bang on. Presumably he would know: he tells us that he is a veteran player of 20+ years in the mergers & acquisitions game on Wall Street.

Just to be clear, Keynes' views were far from perfect and his writings should be read with a critical eye. Nevertheless, some of his insights into human behaviour and political economy are just as true today as they were in the 1930s. And if you, like me, are still in the process of trying to figure out Just What The Hell Is Wrong With Our Financial System, Keynes is as good a place to start as any.

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*Keynes' The General Theory was not primarily about financial markets, but rather uncertainty and its impact on savings & the economy as a whole. I think.

Sovereign Debt Woes, or: How To Impress The Ladies With Your Own Island

2010-03-05T00:01:00.001-05:00

The other day a friend of mine asked me if I had any advice for visiting Greece at this time of year. I replied, half-jokingly, that after visiting Thessaloniki he might head down to Athens and wait around for about a month until the country went bankrupt - he could then buy up his very own Greek island in the Med for cheap.

(See what I did there? I cleverly inserted into my travel advice a reference to the current politico-economic climate in Europe, thereby indicating my awareness of current events and razor sharp wit).

But like I said, I was half-joking. Turns out you can actually snap up your very own island in the Aegean for, like, a pittance!* Moreover, if the Greeks are forced to sell some of their sovereign soil to raise money to pay back the IMF or ze Germans, there could be some real bargains out there.

Your own island.... Mull that one over and try to tell me that it wouldn't impress your gender of preference.

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*starting at $1-2million, or higher if it comes with a place to dock your yacht. Or mermaids.

Kapow! Argentina's Senate Hits Back

2010-03-04T09:00:00.001-05:00

"Not Boring" could be how one describes politics in South America these days. Not content with President Cristina Fernandez de Kirchner's preferred candidate, the Argentine Senate rejected the nomination of Mercedes Marco del Pont to the head of the Central Bank.

You may recall that del Pont's precedessor was pushed aside last month after refusing to use the central bank's currency reserves to fund the government's plans. With approval ratings already down to about 20%, Cristina Fernandez' government is looking increasingly weak and unpopular.

If you're interested, The Economist has a useful backgrounder on Argentina under the Kirchners.

Does not compute

2010-03-02T08:00:00.004-05:00

According to the Wall Street gossip pages, US Senators are close to negotiating a deal that would (finally) create a consumer protection agency...:
Top senators from each party were near a breakthrough agreement to create a new consumer-protection division within the Federal Reserve. This has been a contentious point due to heavy criticism of the Fed's past handling of its consumer-protection powers..... This could dramatically reshape the focus of the Federal Reserve. For years, it has primarily been focused on monetary policy over bank supervision and often made consumer protection an afterthought. Republicans might be more supportive of the Fed option because they might see having Fed officials involved could lead to more bank-friendly policies than an independent regulator.
Seriously guys - what the f***? Does nobody read these things before they get published? "Bank-friendly policies" are the antithesis of consumer protection: they are the reason consumers need protecting in the first place.

The entire point of a central bank is provide credible stability in the economy through a focus on monetary policy: to keep the money supply such that we do not need wheelbarrows to cart cash around to the store to buy our weekly bread. A central bank has failed if we even think that this is a possibility in the future. If you don't appreciate how difficult this is, go have a look at Argentina or dozens of other countries with 20%+ inflation rates and political interference.

We could even have a reasonable debate, over a few pints, about requiring our central banks to consider asset prices as part of their mandate, since we've seen how things work out when those crazy housing bubbles get going. But when we consider the Fed's other responsibilities - acting as the nation's banker, supervising deposit-taking institutions - it's pretty clear that consumer protection does not belong on this list. The Fed's track record to date speaks for itself.

Stick to first principles: consumer protection requires a separate, independent agency. Fin.

Update!: Felix Salmon provides backup, coherence.

Mapping Development

2010-02-28T10:00:00.002-05:00

David Ricardo was an early proponent of the idea of comparative advantage. Roughly stated, comparative advantage suggests that when a particular economy has an advantage at producing a certain type of good, relative to other goods, it should focus on that good and then trade the surplus to other economies for whatever else it needs.

It helps to think of this at the individual level: a farmer is better off producing one item really well (say, coffee) and selling that item in the market to buy other goods (like clothing), than trying to do everything independently. This also advantages clothing-makers who aren't good at growing coffee by allowing them to focus on doing what they do best. Everyone will be better off if the coffee farmer specializes in coffee. And so it is with countries, says Ricardo.

The trouble is, the concept of comparative advantage isn't very dynamic. There are many reasons why an economy would not want to produce just one good and have to buy everything else (price volatility, poverty, etc). But one cannot simply turn coffee farmers into commercial jet engineers very easily. For resource-rich countries looking to diversify their workforce, the question of how to move up the value-added chain is vital.

Insert the authors of the Product Space. Over at their website, these clever folks have tried to math out the links between different types of goods. The research is based on the notion of proximity, or "that the ability of a country to produce a product depends on its ability to produce other ones. For example, a country with the ability to export apples will probably have most of the conditions suitable to export pears. They would certainly have the soil and the climate, together with the appropriate packing technologies, frigorific trucks and containers. They would also have the human capital, particularly the agronomists that could easily learn the pear business. However, when we consider a different business such as mining, textiles or appliance manufacture, all or most of the capabilities developed for the apple business render useless."

That seems pretty straight-forward, but here's where it gets cool: they try to map out these linkages, and break it down by country. Go ahead, have a look. You'll notice that some goods are linked closely to others, while others are off on their own.

It's too bad they haven't mapped out the United Arab Emirates yet, because they could really use a glance at one of these things. They might then realize that oil production is not in any way linked to "indoor ski hill in the desert." But I doubt it.

Thought of the Day

2010-02-24T09:00:00.003-05:00

John Reed - the former head of Citibank - had some interesting things to say before the US Senate Committee on Banking and such things. See this transcript, which provides a brief, but excellent, list of observations. These lists aren't helpful in providing answers, but I think all of his points are worth keeping in mind when you set out looking for those answers.

For example: "Fourth, while much has been made of the low interest rate environment that accompanied the build up to the crisis, one would not design a financial system that could not function in such an environment."

This is the first time I've heard anyone frame the argument in this way. Alan Greenspan and Ben Bernanke have been taking a lot of flack for keeping interest rates low for an extended period of time, providing an easy-lending environment that led to excessive risk taking. There is good reason for this flack-taking.

But given the economic benefits to regular folks of having low interest rates for a steady period of time, is the problem the low interest rates or the abuse of those low interest rates by those financiers who get all antsy-in-their-pantsy when cheap money is lying around? I suspect it's the latter, so that should the focus of our regulators' attention.

That said, it is much easier for a central bank to raise the interest rate than to turn our investment bankers into socially responsible citizens (kidding!, sort of).

Quick hits and pink picks: From Euro to Zero

2010-02-23T02:04:00.007-05:00

-George Soros on Greece and the Eurozone's inherent flaws.

-Kenneth Rogoff sees a wave of sovereign defaults in the years ahead (they tend to follow banking crises).

-There is an interesting debate at Free Exchange on the need for a European Monetary Fund.

-We cite Paul Krugman a lot of these pages; The New Yorker profiles the man and his politics.

-In the wake of another coup in Africa (Niger, this time), FP Passport asks, 'Why are coups always led by colonels?'

-In Olympics news other than US Hockey's epic beatdown of Team Canada (sorry, Dave), the NYT has an interesting analysis of the controversial (for Russians, at least) men's figure skating competition, explaining why American Evan Lysacek didn't need a quad to win gold.

Friday Readables

2010-02-19T09:00:00.003-05:00

Dept. of Checks and Balances
After refusing to bow to the government's policy whims, the previous head of Argentina's central banker was dropped like a sack of rice. One is not suprised to learn that his replacement is decidedly more cooperative. There has been some debate recently as to whether inflation targeting should be the only goal of central banks (see here). With inflation running about about 32%/year, Argentina does not figure in this debate.

Sacrilege
Adair Turner, the head of Britain's Financial Services Agency (a position not known for siding with the pitchfork-waving anti-capitalist crowd) calls into question the prevailing dogma about the value of financial liberalization. Ditto over at the IMF blog, where the notion of capital controls is beginning to take hold as part of a 'reasonable' policy approach.

Mine is 1 louder
Last weekend, the Sunday Times published a letter from 20 economists supporting the British Conservatives' plan for fiscal, er, conservatism. This week, 60+ economists responded that the risks of cutting spending are far too high, and could tip the UK back into a recession. So the question is this: are we 1981 or 1997?

Communication Gap
Mobile/cell phone usage, worldwide. I'm guessing that using public transit in Puerto Rico is super-annoying for this reason alone.

Light Posting

2010-02-17T19:15:00.002-05:00

Posting has been a bit thin of late - mostly due to work concerns. Don't expect that to change for the next two weeks, however, because the winter Olympics are completely dominating my life right now. I apologize for nothing.

For the skeptics among you, I point to FP passports photo essay of unlikely olympians, including athletes representing Ghana, Ethiopia, Iran, Jamaica and Cyprus.

Go World. More importantly: Go Canada.

Out of the History Books

2010-02-15T19:34:00.003-05:00

I'm about a third of the way through Charles Kindleberger's Manias, Panics, and Crashes - a historical examination of financial crises over the past few centuries. It's an interesting read, and Kindleberger regularly sprinkles in some real gems. For instance, in discussing some of the causes of over-zealous investment during a financial bubble, he opines that "There is nothing so disturbing to one's well-being and judgment as to see a friend get rich." The same can be said of our financial institutions.

Here's another: "For historians, each event is unique. Economics, however, maintains that forces in society and nature behave in repetitive ways. History is particular; economics is general."

Kindleberger tries to weave his way through the particulars to arrive at some general conclusions about crises, and it's sobering stuff. We're used to hearing about the Great Depression, but things pretty much drop off for anything prior. But let me tell you, there were crises galore in the 18th and 19th centuries. The worst part? Although the particulars differ, they tend to bear remarkable similarities to our latest meltdown.

In fact, many of the debates back then echo to the debates being waged today. Writing in the post-WWII period, Chicago economist Henry Simon was arguing that it was not the money supply, not government policy, but rather the instability of credit markets that created a fragile financial system: "He was concerned about the speculative temper of the community and the ease with which short-term nonbank borrowing and lending made society vulnerable to changes in business confidence." Again, the details have changed, but the collapse in confidence in uninsured non-bank lending was a major component of the credit crunch that fed our latest meltdown.

It's something to ponder as practitioners, regulators and policymakers pick up their socks and attempt to try again. How long before the lessons from mortgage-backed securities fade away and the unintended consequences of the latest policy decisions set the stage for the next crisis?

Eurozone Crisis- Simon Johnson has you covered

2010-02-10T00:01:00.003-05:00

I have been mulling a thorough post on the developing Eurozone sovereign debt crisis for the past two days, thinking of ways I could adequately present the necessary context, theoretical arguments and implications to the global economy. But in reading through Simon Johnson's coverage of the developments in Europe, I realized something: I can't possibly deliver a better analysis than he has. So instead of trying in vain to duplicate his efforts, I point you towards The Baseline Scenario:

-Johnson's first look at the situation asked whether US policymakers, specifically Tim Geithner, understood the risks posed by a European sovereign debt crisis to America and the global economy

-Over the weekend, Johnson looked at the likelihood of IMF involvement in Greece, the irrelevance of the G7 and the implications of European policymakers' dithering

-Today, Johnson, Peter Boone and James Kwak released their Revised Baseline Scenario for 2010, which includes a great treatment of the Eurozone's sovereign debt woes and its broader implications. This is a long post, but I recommend reading it in full for their 2010 outlook.

Markets rallied yesterday on signs the European big boys would step in and back Greece. ECB President Trichet rushed back from a trip abroad and there were rumors circulating that Germany, the only Eurozone country that really has the balance sheet and power to step in at this point, was constructing a 'firewall' of sorts that would stem any contagion from the Greek crisis. But Germany later denied any plans were in the works, which rattled investors again.

I suspect we'll get some official statements out of the ECB and Commission by the end of the day, hopefully laying out some concrete steps to resolve the situation. But if you believe Simon Johnson, it may all be too late.

Krugman on Spain

2010-02-10T00:00:00.000-05:00

Paul Krugman deconstructs the Spanish case and shows why: a) it's different from Greece, and b) how it reflects the Eurozone's broader problems.

Tuesday Readables

2010-02-09T09:00:00.000-05:00

- Facts and Myths about Greek's sovereign debt woes: this is one of the better pieces I've seen so far.

- Michael Arghyrou and John Tsoukalas argue for the creation of a "strong" and weak" euro, both managed by the European Central Bank, as a solution to the looming sovereign debt crisis in southern Europe. (possibly gated link, sorry)

- Spillover effects: as investors are betting against the Euro and possibly forcing EU governments to make some tough decisions (see below), they are simultaneously fleeing towards the safety of the US dollar. So long as the US can continue to borrow cheaply, they are less likely to be forced to make some tough decisions about their own problems.

- What if Google was a state-owned company in the Ukraine?

- Indulge yourself and set aside 12 minutes to watch this stunning video. On as big a screen as you can find. It's almost entirely computer generated (except the person, clouds and pigeons), and makes Avatar look like an etch-a-sketch drawing.

Eurozone Crisis: Sell, Sell, Sell

2010-02-08T14:40:00.009-05:00

I apologize for the light posting of late. I've been preoccupied with some pretty heavy work-related stuff. But I want to devote much of this week to the developing eurozone crisis. A backgrounder will follow shortly, but to give you an idea of how serious the situation in Europe is, traders have taken over $8bn in short positions against the euro, the largest bet ever against the common currency.

That's massive, almost equal to the $10bn bet against sterling made by George Soros that 'broke' the bank of England in 1992 and ejected sterling from the European Exchange-Rate Mechanism.

The euro was supposed to be one of the big winners of the financial crisis; for the 'safety' it provided countries like Slovakia, for the credible external commitment its accession criteria provided countries like Hungary and Poland, and for its rise as a viable reserve alternative to the dollar. But all of the sudden the euro is confronted with its biggest crisis and I sense that policymakers will soon encounter a stark choice: explicitly back countries like Greece and Portugal or eject them from the common currency.

Stay tuned.

Keynes vs. Hayek: Rap Duel

2010-02-04T13:00:00.000-05:00

For a little while back in grad school, I was toying with the idea of writing my thesis as a sort of "Keynes vs. Hayek" debate, early 21st century edition. I eventually abondoned the idea as impractical, and thank goodness: I would never have been able to top this:

Thanks to Tony H for this awesomeness.

In the News: Canadian Banking Regulation

2010-02-02T09:00:00.000-05:00

The Links
- For the second year running, the World Economic Forum has ranked the Canadian financial system as the soundest in the world. (It's a decidedly lower bar these days, no?)

- Paul Krugman tries to explain why this is the case in his weekend editorial, but in his effort to create a narrative he misses some important points.

- For a more comprehensive look at the issue, Chrystia Freeland does the job well.

Missing from all of these summaries, however, is one minor niggling point: had the US not bailed out some of its major financial institutions, the story in Canada could very well have been very different.

A few thoughts
The lesson of Canada is not one easily grafted on to major banking sectors like those in the US and UK. Underlying all of this prudent banking is a fundamental lack of competition, both domestic and foreign - something that simply would not fly in any city aspiring to be a global financial hub. To a certain extent, the ease with which Canadian financial institutions have access to American markets has given them space to take a more conservative approach. And while the lack of competition may be stable, it's not something the customers of Canadian banks are always the beneficiaries of, either.

I recently read a US Congressional research report attempting to draw lessons from the Canadians for American banking reform efforts. One of the most noticeable contrasts is between Figure 1 and Figure 2 in the report. Compared to the relatively simple and centralized regulatory structure in Canada, the flow chart of the US system is reminiscent of that ridiculous COIN graph. Nevertheless, the report concludes that, essentially, the Canadian system works pretty well in Canada but is heavily context-specific. There are good lessons to be learned, but they are not easily transferable elsewhere. Sorry.

Friday fun: Bill Gates drinks Berlusconi's milkshake

2010-01-29T14:20:00.009-05:00

Bill Gates announced today that the Bill and Melinda Gates Foundation will spend $10bn over 10 years on developing vaccines for the world's poorest countries. They aim to vaccinate over 90% of children in these countries, and could save over 8.7 million young lives as a result. Gates and his wife are arguably the greatest philanthropists of modern times, using their wealth and influence to address some of the world most under-resourced problems.

Gates also has a sharp sense of humor, as evidenced by the following shot he took at epic blowhard, sometimes assault victim and eternal IPE Journal whipping-boy Silvio Berlusconi:

'Rich people spend a lot more money on their own problems, like baldness, than they do to fight malaria...Dear Silvio, I am sorry to make things difficult for you, but you are ignoring the world's poor.'

In other words, 'I drink your milkshake.'

According to FP Passport, Italy's foreign aid budget was approximately 0.11% of GDP in 2009, one of the lowest in the developed world and half its 2008 amount. This contrasts starkly with the amount of money Berlusconi spends on his own image, which my conservative estimates put at 4,000% of his GBI (gross Berlusconi income).

The Italian premier has grabbed headlines in Italy this week for a disappearing, then reappearing, then disappearing head of hair. The bald Berlusconi is a known purveyor of the art of hair restoration, but the country is gripped by his latest, some might say insufficient, attempts at scalp renewal (I might exaggerate a tad, but it's my blog, so it must be true).

In contrast, Bill Gates spent a great deal of his time and money this week helping the world's poorest and most vulnerable.

Quick hits and pink picks: US GDP Surges

2010-01-29T08:42:00.008-05:00

After a busy busy week, I am happy to get back to the blog today and hit on a few points I missed while drowning in Excel hell...

-Hot off the presses: US GDP surged a whopping 5.7% in Q4 2009, the best quarter in over six years, and driven by companies ramping up production to overcome thin inventories amid rising consumer demand. Consumer spending, which accounts for over 2/3 of US economic activity, expanded by a better-than-expected 2%. I'm not even going to make a comment about a job-less recovery, as these are really strong numbers, unless I just did...

-Bernanke wins reappointment, which Simon Johnson believes is the beginning of the end for financial reform. While I disagree (though I imagine the difference in our expectations is only a matter of degree), Johnson's post is great on the strength of the following sentence:

And now we can look back over 20 years and be honest with ourselves: Alan Greenspan contends for the title of most disastrous economic policy maker in the recent history of the world

-The FT has you covered for all things Davos. It's been striking just how little coverage the World Economic Forum has received this year. I wonder if our appetite for it has diminished due to a credibility gap, or if there has been a conscious effort by the WEF to keep a low profile?

-Chavez orders the central bank to 'burn the hands' of currency 'speculators' by selling dollars to strengthen the Bolivar by some 30% in unregulated trading. Massive capital flight complicates his plans.

-FP Passport asks the question we've all been wondering: 'Did Romania's president use the occult to get reelected?"

-Greece is offering investors a large yield premium on its upcoming bond issue, an event deemed 'absolutely critical' to market sentiment and the government's efforts to reign in the budget.

-Are you an English hooligan? Planning on watching your boys lose to the mighty mighty US in person this World Cup (jk)? Denied!

Too Big To FAIL

2010-01-28T12:00:00.000-05:00

In the past week there has been plenty of analysis on the Volcker Rule - largely by people more knowledgeable than myself. Most, it appears, agree with the notion that we need to do something to prevent the capitalist pirates on-board S.S. Too Big To Fail (pictured right) from sailing around and holding the rest of our economic flotilla hostage. Most also seem to agree that this proposed "something" is better than nothing.

Much of this is speculation, however, since we lack the necessary details to make a final judgment - details which will apparently be left to that venerable institution known as the US Congress. If the healthcare bill is anything to go by.... nevermind.

But let's back up a bit. Because while I have made it clear that Volcker's vision sounds - at first glance - to be quite compelling, I am still struggling with some of the key concepts. Well, one key concept actually: too big to fail. Volcker's plans rest on the notion that commercial banking has a privileged place in our financial system. We depend upon our banks for the day-to-day running of the economy, the argument goes, so we cannot allow them to act like hedge funds on the side. Fair enough.

But merely separating the two activities into "can be allowed to fail" and "can't be allowed to fail" doesn't really address the problem. Much of the financial turmoil originated in the shadow banking sector: entities engaged in "bank-like" activities (originating loans, re-packaging and securitizing debt) that did not have the level of regulation that commercial banks do OR any of the deposit insurance that keeps things secure (detailed explanation available here). When things went tits up, investors fled the shadow banking sector for, you guessed it, the heavily insured mainstream banking sector. Presto, credit crunch.

So again, the question comes down to how splitting apart the riskiest behaviour of our banks is going to prevent a future crisis of this nature. Poor banking regulation was certainly a problem, but so was the fact that a huge financial industry was created outside the regulatory system. It had no safety valve, no backup whatsoever. Volcker's plan does not appear to address this. If anything, it might make this line of business more profitable.

How can we be so sure that only deposit-taking institutions are systemically important (re: too-big-to-fail) enough to protect? The answer is that we can't. Maybe I've been listening to the top financial regulator in my country too much, but it seems the very act of identifying too-big-to-fail creates its own problems.

So I guess my concern with the Volcker Rule is not what it is proposing for deposit-taking institutions, but what it is not proposing for everyone else.

(Update: the top central bankers in both the UK and EU have vocalized their (qualified) support for the reform proposals - good to see the old boys network holding firm, eh whot?)

IPE Journal

Occupy Montreal!

Occupy Wheat Board!

Why I am not a political strategist

You know, some days I really impress myself with... er, myself

The iPhone & iPad: Apple's Model T

Not cool

There Follows A Rant

Let's Review

"Policy Failure on a Massive Scale"

Recommended Debt Ceiling Reading

Friends Don't Let Friends Publish Rambling Op-Eds

And Now Back To Our Regularly Scheduled Programming....

"What is this Land Rover of which you speak?"

Discouraging Thought of the Day: Perception vs. Activism

Readables

Go Timmy! Go Timmy! Go Timmy! Go Timmy!

Yeah, What Brad DeLong Said

Hayek's Road to Serfrom

The world is a strange, strange place

Promises, promises...

The Autumn of our Discontent

Readables

Intermission

Sentence of the Day

Readables

Hunting Black Swans

DO NOT DIZPUTE ZE GERMAN WACHSTUMS IM EXPORT!

Readables

Where is the recovery going to come from?

The Rabid Capitalist Spirit of the English Premier League

The Annals of Linguistic Trainwrecks: Liberaltarianism

Readables

One-handed economists only, please

Malaysia: loosening the ringgit fence

"Chez Economia: Fine Post-Recessionary Cuisine"

Wherein I discover, to my great suprise and horror, that a Dutch economist is biased

Readables

The sharpest thing I've read all week

Readables

Where is the Recovery Going to Come From?

Wednesday Readables

Photo Of The Day: Consequences of Inflation

Conversations with Taxi Drivers: Singapore

The Globalization of the Scotch Market, cntd.

Readables

Paul Krugman and the Richard Dawkins effect

Spain's political economy: Piquanté

Annnnnnnnnd we're back!

IPE Journal visits The Land of the PIGS

It's Regulatory Culture, Stupid

Quote of the Day

Readables

Golf, China, English, Twitter

Tuesday Readables

Scattered Lunchtime Thoughts on the Euro

Friday Fun

ACHTUNG! ZE CREDIT RATING AGENCIES ARE HENCEFORTH BANISHED FROM THE LAND!

By the way

A continental tragedy

Protectionism and Innovation: What does business think?

The Election in Britain: Summarized

Monday Readables

Can't get 'nuff Emerging Markets?

Monday Readables

Would the real Kevin Gallagher please stand up?

Emerging Markets: Liquidity-Time Explosion

Friday Readables

Your Local Newspaper Op-Ed, brought to you by The Economist

Tuesday Links

Wherein I quibble with someone much more intelligent than myself

Wednesday Readables

Thursday Readables

The Language of Globalization

Tuesday Readables

Spring Cleaning chez IPE Journal

Thursday Readables

In the long run...

Monday Readables

A long goodbye