A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Thursday, December 31, 2009

Wray says anxious Fed need not fret about moon creature attack

Fed Offers New CD; Chairman Bernanke is still confused
By L. Randall Wray
Wednesday, December 30, 2009

As reported in the NYT yesterday, the Fed has decided to offer banks an interest-paying CD. So far, so good. However, the argument offered by the Fed to justify this "innovation" is that it needs to start mopping up reserves in order to prevent inflation:

The Federal Reserve on Monday proposed allowing banks to park their reserves at the central bank, a move aimed at weaning the economy off extraordinary infusions of cash and curbing inflation. The Fed would create the equivalent of a certificate of deposit that pays interest to banks for keeping some of their reserves — which are currently estimated at more than $1 trillion — for up to one year. That would help offset some of the $2.2 trillion the central bank has fanned out into the economy during the financial crisis. It also would allow the Fed to quickly entice banks to take more money out of circulation in case inflation emerged as a serious threat in the near future. The proposal was the latest sign the Fed is intensifying its efforts to scale back the vast amounts of money it pumped into the economy at the height of the crisis.

This blog has published a number of pieces explaining why there is no need to worry about the trillions of dollars of reserves and cash created by the Fed to deal with the run to liquidity set-off by this crisis (see here and here). As and when banks decide they do not want to hold reserves, they will retire their loans at the discount window and will begin to purchase higher-earning assets. As this pushes up asset prices (reducing interest rates), the Fed will begin to unwind its balance sheet—selling the assets it purchased during the crisis. Retiring discount window loans plus purchases of assets from the Fed will eliminate undesired reserve holdings. It is all automatic and nothing to worry about or to plan for. And it will not set off a round of inflation. The old "money multiplier" view according to which excess reserves cause banks to lend, which induces spending, which causes inflation, was abandoned by all serious monetary theorists long ago. Chairman Bernanke ought to abandon it, too.

However, there is nothing wrong with offering longer-maturity CDs to replace overnight reserve deposits held by banks at the Fed. Banks are content to hold deposits at the Fed—safe assets that earn a little interest. They are hoping to play the yield curve to get some positive earnings in order to rebuild capital. If they can issue liabilities at an even lower interest rate so that earnings on deposits at the Fed cover interest and other costs of financing their positions in assets, this strategy might work. That is what they did in the early 1990s, allowing banks that were insolvent to work their way back to profitability. The Fed could even lend to banks at 25 basis points (0.25% interest) so that they could buy the CDs, then pay them, say, 100 or 200 basis points (1% or 2% interest) on their longer maturity CDs. The net interest earned could tide them over until it becomes appropriate for them to resume lending to households and firms.

Finally, note that these new CDs are equivalent to Treasuries: government debt that pays interest. However, no one has castigated the Fed for proposing to bankrupt our grandchildren by running up debt. Apparently, this is because economists and policymakers recognize that the Fed is just substituting one kind of liability (reserves) for another kind of liability (CDs). But that is exactly what a sale of a Treasury bond does: it substitutes one government liability (Fed reserves) for another government liability (Treasury bonds). Operationally, it all amounts to the same thing. Once this is recognized, the Treasury can stop issuing debt, we can all stop worrying about our grandchildren, and our nation can get on with ramping up fiscal policy to get out of this economic crisis.

Wednesday, December 30, 2009

Robert Pollin on Industrial Policy, Innovation and the Way Out

Robert Pollin correctly points to the efficacy of industrial policy and the extremely efficient means of generating innovation by guaranteeing a market, by advance procurement guarantees. This is also an intro to you for Real News Network. Go there. Subscribe. Good stuff.


JAY: We've talked in previous interviews about stimulus and how it affects the economy.


POLLIN: Well, it is an important debate, because of course given the current severe recession, people look back to the '30s and what got us out of the Depression. And it's very clear that for the whole decade of the 1930s we had a lot of social programs aimed to stimulate the economy—the Work Projects Administration, Civilian Conservation [Corps] board, etc.—and they conducted those through the '30s, and they didn't really get us out of the Depression. And then World War II hits, and we go from 13 percent to 2 percent of employment within a year. So the story is war is the answer to depressions.

JAY: And then part of the right-wing critique is, the other piece of that story is: and government stimulus to create jobs is not.

POLLIN: And government stimulus on anything other than war is not. Now, that's not the crux of the matter. The real crux of the matter is that it was government deficit spending, borrowing money and spending, injecting that into the economy, that got us out of the 1930s depression, and the war was the only thing that had the political support to raise the level of deficit spending necessary to overcome the Depression.


if you actually add up military spending versus domestic spending, comparing, dollar for dollar, $1 million on the military versus $1 million in education or clean energy, military spending is actually a bad job stimulus. Education, clean energy, health care, those are much more effective as a job stimulus. The only issue is politically whether we can move enough money into those areas to become effective sources of new job creation.

JAY: So how do you know that?

POLLIN: Okay, this is recent research that I've done based on US statistics from the Department of Commerce. Using the input-output model from the Department of Commerce, what we basically find is as follows, that if you spend $1 million on the military, you create 12 jobs; if you spend $1 million on clean energy, you create 17 jobs; if you spend $1 million on health care, you create 20 jobs; if you spend $1 million on education, you create 29 jobs.

JAY: So why? Get into the actual nitty-gritty.


POLLIN: Okay. So there's basically two factors going on here. Number one is how much money you spend domestically versus how much you spend abroad. Obviously, military spending has a high proportion of spending abroad, and that's not going to create jobs in the US. These other areas that I mentioned—education, health care, clean energy—are much more focused on the domestic economy.

JAY: But isn't most of "abroad" still American weapons produced here, food supplies in little packages produced here?

POLLIN: Yeah, there is, but still, when you're sending checks, for example, to soldiers abroad or you're building Camp Victory in Iraq, that's work that's being done in Iraq, and there's a lot of money doing that.


Or Operation Enduring Freedom in Afghanistan, whatever we might think about it in political terms, as an economic phenomenon it's happening in Afghanistan and Pakistan. So in terms of job creation, that's sucking money out of the US, where you can be creating jobs here. And the second factor is what we economists call "labor intensity", which is the relative amount, when you spend $1 million, the relative amount that goes to hiring people versus spending on machine, on land, on transportation, on energy. And so investing in education, investing in health care, and investing in building a new, clean-energy economy entail much more use of people and rely less on these other costs.

JAY: How does the—and I don't know if you call it a ripple effect, but, you know, I've heard it talked about in domestic economy, if you spend this dollar, you get more of a ripple than military dollar.

POLLIN: Yeah. Exactly.

JAY: It's not just the foreign factor. What else is it?

POLLIN: There are two kinds of ripples. So number one, if we're going to, say, hire people to be in a school or if we're going to retrofit a building, we first of all have to hire people, other people in the school, not just teachers: we have to hire people in the front office; we have to hire people serving lunch; we have to hire bus drivers. Then that's one set. We also have to buy new books. So that provides employment for people working for the book publishers. Then there's people that—all those people that newly have jobs also have money in their pockets, and they spend it. And in their communities that stimulates markets and stimulates activity in their communities. So those are the ripple effects. And those ripple effects are very important, and they're bigger the more concentrated you are in the domestic economy, communities, versus having the money go out.

JAY: Now, part of the issue of war, especially these days, it's not about—they're not selling it based on the economic stimulus; they're selling it on the national security threat, terrorism.

POLLIN: Right, right. Sure.

JAY: So in terms of the decision people have to make, it's not just an economic decision here.

POLLIN: No, of course not, it's not an economic decision. Yet in the debate around the Pentagon budget, for example, the job issues became central. And, in fact, the rhetoric was: we can't possibly cut his weapons program because it's so important for jobs. Now, okay, we did cut—.

JAY: Which goes to this idea of why they produced parts for an airplane in 50 states, so everybody's got something in it.

POLLIN: Yeah, yeah, yeah, yeah. Just a coincidence. No, of course it's because we can create jobs in all these states. And that's true: if you spend $1 million, $1 billion, $100 billion on anything, if anybody spends it, you will create jobs. The question, the real relevant metric, is how many jobs relatively, from one activity versus another. And militarism is a bad source of job creation. These other areas are much stronger as sources of job creation.

JAY: Yeah, you've seen this in the fight over the F-22. The ads from the manufacturer were all about jobs. It wasn't that we need this plane to fight wars; it was all about employment.

POLLIN: That's right. So the F-22 got cut, but the F-34 [sic] was strengthened. There is no change in the overall budget. And my own senators—I mean Kerry, Senator Kerry, supposedly liberal senator from Massachusetts, voted for the—he cut the F-22, expanded the F-34. Why? Because he said we need the jobs in Massachusetts. What we really need are jobs in more effective ways. If you put the money into the educational system, into building a clean-energy economy, we'd have more jobs.

JAY: So it goes back to your first point. When you have the rationale of fighting terrorism, and you have the kind of great moral support for war, then you can get your economic benefits justified through that way. But you can't get, now, the political support for straightforward infrastructure spending.

POLLIN: Right. I mean, the point is—politically, the military story is we need this to fight terrorism, and it's great for jobs. We can debate whether it's great for fighting terrorism. I can tell you flat out that it's not great for jobs. It's bad for jobs relative to other ways of spending the same amount of money.

JAY: Well, so in the next segment of our interview, let's talk about this argument that widescale, large militarization has been one of the driving forces of this successful American economy, both in terms of innovation and on other fronts. So please join us for the next segment of our interview with Bob Pollin.

Tuesday, December 29, 2009

Transcript:: 338 Year End Rant

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On Friday, Demand Side looks back at the year that wasn't, in our annual review of stories that did not happen but were widely reported or assumed.  Today we inaugurate another annual event.  The look ahead, featuring the morose and hopeless rant.

First, lets start with some observations from a couple of Nobel economists, Joseph Stiglitz and Paul Krugman.  First from AP, on December 15.
CNBC (AP) 12.15.09

Nobel Prize-winning economist Joseph Stiglitz warned there's a "significant" chance the U.S. economy will contract in the second half of next year, and urged the government to prepare a second stimulus package to spur job creation.

"The likelihood of this slowdown is very, very high," Stiglitz told reporters in Singapore. "There is a significant chance that the number will be in the negative range."

Stiglitz, a professor at Columbia University, called on Washington to make more funds available to state governments who face a drop in tax revenue.

The U.S. economy, the world's largest, must grow at least 3 percent to create enough jobs for new entrants into the labor force, he said.

The unemployment rate fell to 10 percent in November from 10.2 percent in October.

"If you don't prepare now, and the economy turns out to be as weak as I think it's likely to be, then you'll be in a very difficult position," he said.

The economy grew at a 2.8 percent rate in July through September, after a record four straight quarters of contraction.

Next, from one of last Sunday's talk shows, Paul Krugman.


The Rant

We are in a world of trouble, my friends. 

Of the total population, perhaps 20 percent are aware of what is going on at any meaningful level.  The rest of us are distracted by football, beer, personal vices, ignorance, depression and fear, youth, old age, family, health, or self-centered confusions and distractions of one kind or another.

Of this 20 percent, perhaps three-quarters have pre-cooked explanations based on religion, political slant, personal history, bad or no education, or childhood traumas.

Of the remaining five percent of the total, at least half have occupations or positions which would be adversely affected by a progressive resolution of the mess.  And half of the remainder are marginalized for their political views or were not able to purchase the education that would have put them in their appropriate positions. 

Of the remaining, say, one and one-quarter percent, most are too busy or too frazzled or too broken or too insecure to make a difference in local settings.

Sorry, it is up to the broken and the busy and the frazzled and the insecure to turn this thing around.

Then there is the problem of the unchanging blather from the Right.

We would have put up another dozen idiots of the week, but it is too discouraging.

When we began the podcast in the fall of 2007, we rushed to air from fear that we would be only one voice in a chorus calling down the Supply Side nonsense.  Decades of stagnation in the middle class had been justified by the assurance that the way to stable growth was to make sure the rich could get richer and entrepreneurs could prosper by favorable tax treatment and cutting the legs out from under the public sector. 

When the collapse came in housing, then in the financial sector, we were sure the entire gamut of policies favoring the corporate greed would be thrown out and a new, enlightened age of education, infrastructure, climate change action and the rest would flow naturally into the policy plan.

Nothing at all like that has happened.  The Obama campaign seemed to be the course of reform and renovation, but it stalled as soon as it got into office, not all because of corruption.  The so-called liberal wing of economics, aside from a very few like Stiglitz and James K. Galbraith, seem as stuck in schemes that did not work as the conservatives.  In particular, we see faith in stimulus packages absent the willingness to eliminate the collapse of states and municipalities as a self-contradiction.  Anything that fails to generate big new private investment will fail.  And big, new private investment will never come back in the consumer goods sector for two reasons.  One, the consumer will not be coming out from under his debt any time soon.  Two, there is already plenty of capacity in consumer goods production facilities, not all of it in the U.S., so there is little need to invest in new capacity even if consumers could spend.

Nothing is so stupid as "We cannot afford ..."  We have a quarter of the economy standing idle and we need to put it to work.  We have the pecuniary needs of one profligate sector, the banking sector, standing in the way.  This is worse than nonsense, it is diabolical.  If we do not put it to work, we will not be able to provide for ourselves in the future.  Like a farmer who cannot get grain because the bank needs it.  Absent the planting and irrigating and harvesting, nobody is going to get nothing.

We've made enough to-do about the relative sizes of the federal debt and private household debt and private business.  Those who are constrained, businesses and households, have by far the biggest debt, and somehow it is the federal debt that is going to drag us down.

So, at the end of the day, we have not done thing one about fixing what brought on the mess or mitigated the shock to any great degree on actual Americans.  Instead we've run more chips up to the casino so the high rollers can continue to make their bets, and maybe they'll let us park their cars.

The heroes of the low-tax high-growth strategy used to be the Irish and before them the Japanese.

The fundamental opinion that the private sector produces wealth, while the public sector hangs on like a predatory parasite ought to have been reversed.

We have garages full of crap and houses too big for two people, but the economy is on the rocks.  Everything that is working has a government support.  Education, infrastructure, public security and safety, public health such as it is, are the muscle and bone upon which the veneer of private profit pretense attempts to take credit.

It is hard to see the private investment that is so robust, or at least more robust than the highways, bridges, water works, state and municipal organization, educational systems and structures and the intellectual capital inherent in them.  To me it seems that the productive investment is entirely on the public side, while the private investment that is still paying off is extracting one hundred percent of its value and more in purchase price.

We have come to the conclusion that there will be no voluntary sharing of the burden of debt, that the banks and the owners of the securities, the creditors, will not agree to write down the debt or to take any of the burden on themselves, and expect the productive real economy to bear the entire burden.  In the absence of an inflation that would float the real economy off these debt rocks, it is necessary to address the problem at its structural level.

As we come up to the New Year, we are going to celebrate with the following hard look at what needs to be done.

As you are aware, we at Demand Side do not believe the tepid growth -- originally announced at 3.5 percent, now down to 2.2 percent -- of the third quarter constitutes an end to the Great Recession.  It is nothing more than the activity around huge government deficits, the automatic and discretionary stabilizers.  There is no recovery in investment or in employment.  The business cycle is broken. 

The economy is sinking productive end first while the bankers who devised the course and failed at captaincy are still playing in the casino.  Perhaps they realize, perhaps not, that the economy has hit an iceberg.  It could well be that the intoxication of greed has let them think that the resumption of their own cash flows is evidence that the worst is over.

The growth evident in Q3 is composed entirely of federal deficit spending.  Statistically, 300 percent of the growth is composed of federal borrowing.

We are not going to debate too long the question of whether the economy is in recovery.  Suffice it to say that Demand Side is not as alone as it may have appeared.  Notables such as the redoubtable Martin Feldstein and the dark-minded David Rosenberg are in our little lifeboat.  Equally confirming is the absence of victory dances among those who made the call.  And the fact that recovery has slipped from the lead into paragraph five of news copy.

The issue is the debt.  We have to come to grips with the fact that there will be no voluntary sharing of the burden.  Though two hands built the monument to greed, the authorities have so far assigned the duty to one to tend to its collapse.  That has to change.  Not only for reasons of justice and equity, but because it is not practical.  It is not workable.  The economy cannot recover unless its machinery is balanced.  It remains to be seen how long profits can be supported by downsizing before this is realized. 

Without another financial crisis, however, it seems unlikely the big banks will be vulnerable enough to wholesale destruction.  The Commercial Real Estate crash is apparently concentrated in smaller banks, but the issues and the fundamentals and the optics could be confused enough to make it the entry point.

Continued Depression-level numbers in labor and housing markets cannot but inculcate more difficulties, if not crises. 

And again, it is not simply a political calculation, me being from the Left and the banks being from the Right.  It is an economic calculation.  This is where the debt is stored.  These are the financial landlords, supported by a few in government, who would make perpetual share-croppers of the rest of the economy.  That means not only working the fields on their behalf, but being obliged to buy supplies and seed at their stores.

So.  How will it work out?  We cannot see from here.  It will not be pretty.  Let's hope it is fair and just and workable.  And get ready.

Monday, December 28, 2009

Wall Street is Back, says Robert Reich, but the rest of the economy has sunk

Robert Reich puts his finger on the folly of the bail out the big banks strategy pursued by the Treasury and Fed. It didn't work. It didn't lead to a better economy, only a more indebted government. It didn't chasten the banks. It didn't even rationalize their holdings so they would be in more stable shape as we go forward.

No. It only benefited entrenched interests.

But now that it is clear it didn't work, there is no good reason not to let the bond-holders and creditors begin to take their medicine. They were getting paid for risk, let them experience what risk is. It will reduce debt, generate solvent banks, and get us at least right side up as we try to get the economy out of the hole it is in.
2009: The Year Wall Street Bounced Back and Main Street Got Shafted
Robert Reich
December 27, 2009

In September 2008, as the worst of the financial crisis engulfed Wall Street, George W. Bush issued a warning: "This sucker could go down." Around the same time, as Congress hashed out a bailout bill, New Hampshire Sen. Judd Gregg, the leading Republican negotiator of the bill, warned that "if we do not do this, the trauma, the chaos and the disruption to everyday Americans' lives will be overwhelming, and that's a price we can't afford to risk paying."

In less than a year, Wall Street was back. The five largest remaining banks are today larger, their executives and traders richer, their strategies of placing large bets with other people's money no less bold than before the meltdown. The possibility of new regulations emanating from Congress has barely inhibited the Street's exuberance.

But if Wall Street is back on top, the everyday lives of large numbers of Americans continue to be subject to overwhelming trauma, chaos and disruption.

It is commonplace among policymakers to fervently and sincerely believe that Wall Street's financial health is not only a precondition for a prosperous real economy but that when the former thrives, the latter will necessarily follow. Few fictions of modern economic life are more assiduously defended than the central importance of the Street to the well-being of the rest of us, as has been proved in 2009.

Inhabitants of the real economy are dependent on the financial economy to borrow money. But their overwhelming reliance on Wall Street is a relatively recent phenomenon. Back when middle-class Americans earned enough to be able to save more of their incomes, they borrowed from one another, largely through local and regional banks. Small businesses also did.

It's easy to understand economic policymakers being seduced by the great flows of wealth created among Wall Streeters, from whom they invariably seek advice. One of the basic assumptions of capitalism is that anyone paid huge sums of money must be very smart.

But if 2009 has proved anything, it's that the bailout of Wall Street didn't trickle down to Main Street. Mortgage delinquencies continue to rise. Small businesses can't get credit. And people everywhere, it seems, are worried about losing their jobs. Wall Street is the only place where money is flowing and pay is escalating. Top executives and traders on the Street will soon be splitting about $25 billion in bonuses (despite Goldman Sachs' decision, made with an eye toward public relations, to defer bonuses for its 30 top players).

The real locus of the problem was never the financial economy to begin with, and the bailout of Wall Street was a sideshow. The real problem was on Main Street, in the real economy. Before the crash, much of America had fallen deeply into unsustainable debt because it had no other way to maintain its standard of living. That's because for so many years almost all the gains of economic growth had been going to a relatively small number of people at the top.

President Obama and his economic team have been telling Americans we'll have to save more in future years, spend less and borrow less from the rest of the world, especially from China. This is necessary and inevitable, they say, in order to "rebalance" global financial flows. China has saved too much and consumed too little, while we have done the reverse.

In truth, most Americans did not spend too much in recent years, relative to the increasing size of the overall American economy. They spent too much only in relation to their declining portion of its gains. Had their portion kept up -- had the people at the top of corporate America, Wall Street banks and hedge funds not taken a disproportionate share -- most Americans would not have felt the necessity to borrow so much.

The year 2009 will be remembered as the year when Main Street got hit hard. Don't expect 2010 to be much better -- that is, if you live in the real economy. The administration is telling Americans that jobs will return next year, and we'll be in a recovery. I hope they're right. But I doubt it. Too many Americans have lost their jobs, incomes, homes and savings. That means most of us won't have the purchasing power to buy nearly all the goods and services the economy is capable of producing. And without enough demand, the economy can't get out of the doldrums.

As long as income and wealth keep concentrating at the top, and the great divide between America's have-mores and have-lesses continues to widen, the Great Recession won't end -- at least not in the real economy.

Paragraphs and the Week's Links

Banks Bundled Bad Debt, Bet Against It and Won
By Gretchen Morgenson and Louise Story
New York Times
December 24, 2009

Goldman was not the only firm that peddled ... complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.


One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.

Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.

And some links:

Master of Disaster, John Dugan, Comptroller of Currency, from Chris Whalen at The Big Picture
John Dugan: Architect of “Too Big to Fail” Banks from Barry Ritholtz, also at The Big Picture
The Lost Science of Political Economy from Michael Hudson at Economic Perspectives from Kansas City
Sustaining Recovery:  Medium-Term Prospects and Policies for the U.S. from Dimitri B. Papadimitriou, Greg Hannsgen, and Gennaro Zezza at the Levy Institute

Sunday, December 27, 2009

American political ideal is subversion in China

The economic viability of a nation is connected to its political viabiity. This is through the law of incentives. Where political freedom and human rights exist, the possibility of personal advancement by simple and honest means exists. China is patently a dictatorial society. Its economic success is built in large part by enforcing low wages and serving as the outsourcing center for assembly and manufacturing. To us, there is no stability in such a scheme. Here is the straightforward evidence that liberalization of the society is not the way the authorities are going. We should expect the worst.
Repression in China
Daniel Little
Friday, December 25, 2009

The Chinese government signaled a major escalation in its policy of repressing dissidents with this week's conviction of dissident intellectual Liu Xiaobo on charges of subversion (New York Times link).  Liu's eleven-year sentence on charges of subversion sends a chilling message to all Chinese citizens who might consider peaceful dissent about controversial issues.  Other dissidents have been punished in the past year, including environmental protesters, advocates for parents of children killed in the Sichuan earthquake, and internet activists.  But Liu is one of the first prominent activists to be charged with subversion.  Liu is a major advocate of Charter 08, and his conviction and sentencing represent a serious blow to the cause of political liberalization in China.  Regrettably, the regime of citizen rights of expression, association, and dissent has not yet been established in China.

What is Charter 08?  It is a citizen-based appeal for the creation of a secure system of laws and rights in China, and has been signed by several thousand Chinese citizens (New York Review of Books translation).  The central principles articulated in the Charter include:

  • Freedom
  • Human rights
  • Equality
  • Republicanism
  • Democracy
  • Constitutional rule
The specific points included in the Charter include:
  1. A New Constitution
  2. Separation of Powers
  3. Legislative Democracy
  4. An Independent Judiciary
  5. Public Control of Public Servants
  6. Guarantee of Human Rights
  7. Election of Public Officials
  8. Rural-Urban Equality
  9. Freedom to Form Groups
  10. Freedom to Assemble
  11. Freedom of Expression
  12. Freedom of Religion
  13. Civic Education
  14. Protection of Private Property
  15. Financial and Tax Reform
  16. Social Security
  17. Protection of the Environment
  18. A Federated Republic
  19. Truth in Reconciliation
What is involved in advocating for "legality" and "individual rights" for China's future? Most basically, rights have to do with protection against repression and violence. These include freedom of association, freedom of action, freedom of expression, freedom of thought, and the right to security of property.  History makes it clear that these rights are actually fundamental to a decent society -- and that this is true for China's future as well. Moreover, each of these rights is a reply to the threat of violence and coercion.

Take the rights of expression and association.  When a group of people share an interest -- let's say, an interest in struggling against a company that is dumping toxic chemicals into a nearby river -- they can only actualize their collective interests if they are able to express their views and to call upon others to come together in voluntary associations to work against this environmental behavior. The situation in China today is harshly inconsistent with this ideal: citizens have to be extremely cautious about public expression of protest, and they are vulnerable to violent attack if they organize to pressure companies or local government to change their behavior.

The use of private security companies on behalf of companies, land developers, and other powerful interests in China is reasonably well documented. And these companies are largely unconstrained by legal institutions in their use of violence and gangs of thugs to intimidate and attack farmers, workers, or city dwellers. It's worth visiting some of the web sites that document some of this violence -- for example, this report about thugs attacking homeowners in Chaoyang. Similar reports can be unearthed in the context of rural conflicts over land development and conflicts between factory owners and migrant workers.

So this brings us to "legality." What is the most important feature of the rule of law? It is to preserve the simple, fundamental rights of citizens: rights of personal security, rights of property, rights of expression. What does it say to other people with grievances when private security guards are able to beat innocent demonstrators with impunity? What it says is simple -- the state will tolerate the use of force against you by powerful agents in society. And what this expresses is repression.

It is also true that the state itself is often the author of repression against its own citizens for actions that would be entirely legitimate within almost any definition of core individual right: blogging, speaking, attempting to organize migrant poor people. When the state uses its power to arrest and imprison people who speak, write, and organize -- it is profoundly contradicting the core rights that every citizen needs to have.

It should also be said that these legal rights cannot be separated from the idea of democracy. Democracy most fundamentally requires that people be able to advocate for the social policies that they prefer. Social outcomes should be the result of a process that permits all citizens to organize and express their interests and preferences -- that is the basic axiom of democracy. What this democratic value rules out is the idea that the state has a superior game plan -- one that cannot brook interference by the citizens -- and that it is legitimate for the state to repress and intimidate the citizens in their efforts to influence the state's choices. A legally, constitutionally entrenched set of individual civil and political rights takes the final authority of deciding the future direction of society out of the hands of the state.

Give the Chinese people democratic rights and they can make some real progress on China's social ills -- unsafe working conditions, abuse of peasants, confiscation of homeowners' property, the creation of new environmental disasters. Deprive them of democratic rights, and the power of the state and powerful private interests can create continuing social horrors -- famine, permanent exploitation of workers, environmental catastrophes, development projects that displace millions of people, and so on. The authoritarian state and the thugocracy of powerful private interests combine to repress the people.

(Here is a very interesting audio interview with Perry Link on the NYRB website about the context of Charter 08. Also of interest is a piece by Daniel Drezner (post) on Charter 08 on the ForeignPolicy blog.  See also this very extensive analysis of the Charter by Rebecca MacKinnon at Rconversation.)

Saturday, December 26, 2009

Transcript: 337 Mish and the China Syndrome

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We're celebrating the holiday week at Demand Side by borrowing, plagarizing and paraphrasing from the work of others.  Tuesday it was Hyman Minsky in Plain English.  Today it is Michael "Mish" Shedlock on China, largely borrowed from Mish's Global Economic Trend Analysis blog.

We should note that we do not agree with Mish on about half of things, particularly his sensitivity to the federal deficit and numbness to the private debt.  But here he does us all a favor by mining data and news for indications of what might actually be happening in China.  Demand Side has long distrusted the China miracle.  At a minimum, China's success comes with a deep failure of its environment.  Here is

China Faces Crash Scenario

Problems in China continue to mount. Money supply is growing rampantly out of control, property prices are in a bubble, exports are weak, commodity speculation is pervasive, and GDP growth is more of a mirage than real.

Money Supply is growing at a record nearly 30 percent. 

As we've been discussing on Demand Side recently, money is created by the boom, not by the authorities.  But Mish and the Chinese are not aware.

China’s banking regulator plans to slow new lending to between 7 trillion yuan and 8 trillion yuan next year, a person familiar with the matter said this week. China is trying to ensure that there is enough credit to support an economic recovery without increased risks of bad loans and asset bubbles.

“We believe slower credit growth in 2010 will be key to avoid a boom-bust scenario in the economy,” Wang Tao, a Beijing-based economist for UBS AG, said in a report.

Good luck.

The government “plans to control property prices by accelerating property investment and increasing supply,” economists Lu Ting and T.J. Bond said in an e-mailed note today. That contrasts with efforts in 2006 to cool prices by controlling investment, the economists said.

Sounds like controlling a runaway train by building tracks over a cliff.  Mish agrees.

China Is Overbuilding Already

Note the insanity. China want to control prices by building more. It already has completely empty shopping centers, condos, and even a completely empty city.

China Has Trouble Maintaining Demand Growth

In spite of obvious speculation and overheating in the housing sector, China Faces Difficulties in Maintaining Demand Growth.

China, the world’s third-largest economy, faces “increased difficulties” in maintaining growth in domestic consumption, the nation’s top economic planning agency said.

A recovery in external demand is “difficult,” the National Development and Reform Commission said on its Web site today, citing Vice Chairman Du Ying. The nation’s economic recovery “is not yet solid,” the agency known as NDRC said.

China will maintain a “moderately” loose monetary-policy stance and “proactive” fiscal policies in 2010 as its economic recovery isn’t solid yet, the official Xinhua News Agency said Dec. 7, citing a statement by the annual central economic work conference.

The country still faces a “very challenging” international environment and “the domestic problems it is confronted with are also complicated,” Du said in the statement today. “The potential risks in the fiscal and financial sectors can’t be underestimated,” Du said.

Economic growth in China, which is spending $586 billion on a stimulus package, accelerated to 8.9 percent in the third quarter after slipping to 6.1 percent in the first. The government is targeting 8 percent growth for the full year.

And here they fall back to the illusion that monetary policy is controlling the money supply.

Moderately Loose Monetary Policy?!

What would a "loose" policy look like? Regardless, when Vice Chairman Du Ying says the "recovery is not solid" and the environment is "very challenging" you can take his word for it. Actually you can look at money supply growth and empty cities and conclude the same thing.

Bear in mind that China calculates GDP a peculiar way, as soon as the money is allocated. Much of that GDP growth is a mirage. Moreover, much if not most of what isn't a mirage, is nothing more than property malinvestment and other speculation.

Premier Wen Jiabao said Nov. 28 that property speculation must be suppressed, and the government on Dec. 9 reinstated a sales tax on homes sold within five years of purchase after reducing the period to two years in January. That change is superficial and will have minimal impact, said Lu Qiling, an analyst at Shanghai Uwin Real Estate Information Services Co.

“It’s only a token measure,” Lu said. “It won’t change the upward trend in housing prices.”

“The government is clearly in a dilemma,” Luk said. “It wants to address the surging property prices and concerns on bubble-bursting, yet it dares not take drastic measures for fear of hitting the market too hard.”

The nation’s real estate and stock markets are a “bubble” that will burst when inflation accelerates in 2011, former Morgan Stanley chief Asian economist Andy Xie said in an interview in Hong Kong today.

“China’s asset markets are a Ponzi scheme,” said Xie, now a Shanghai-based independent economist. “Property is heading for one huge bust that will take a year and a half to unfold.”

The Shanghai Property Index, which tracks 33 developers listed in the city, has more than doubled this year, compared with a 75 percent gain for China’s benchmark Shanghai Composite Index.

        Copper Stockpiles Soar

Copper stockpiles held in duty-free warehouses in China, the top user, may be re-exported after surging to as much as 350,000 tons from almost none at the start of the year.

Pig farmers and other speculators may have amassed more than 50,000 metric tons, Jeremy Goldwyn, who oversees business development in Asia for London-based Sucden, wrote in an e- mailed report after a visit to China. That’s about half the level of inventories tallied by the Shanghai Futures Exchange, which stood last week at a two-year high of 97,396 tons.

Sucden’s estimate underscores the difficulty analysts face in gauging metals demand in China amid increased speculation by retail investors, whose holdings remain outside the reporting framework undertaken by exchanges. Private investors in China also had as much as 20,000 tons of nickel, Goldwyn wrote.

According to one observer who was just in China, “It’s pervasive; people are piling this stuff up in their backyards.”

Chinese Banks Hide Transactions Off Balance Sheet.

Dec. 18 (Bloomberg) Chinese banks’ capital strength is probably more “strained” than it appears as lenders use more off-balance sheet transactions to make room for loan growth, Fitch Ratings said.

The increasing amount of unreported transactions, including repackaging loans into wealth management products to sell to investors, and the outright sale of loans to other financial institutions, represent a “growing pool of hidden credit risk,” Fitch said in an annual review of Chinese banks.

Hiding assets off the balance sheet is one of the things that wrecked Citigroup. The Citi kept accumulating assets thinking there was plenty of time left at the ball.

Former Citigroup CEO Chuck Prince: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing".

Well, the music stopped abruptly about one month later and Citigroup was stuck with $1 trillion in off balance sheet garbage. Chuck Prince turned into a pumpkin and was tossed out the door.

Exactly how much of that garbage is left and what it is worth is hard to tell, other than by judging the action in Citigroup share price (which is not pretty to say the least).

Don't confuse unsound lending and pervasive speculation in China with inflation in the US. Remember that commodity prices are set at the margin, and in this case the margin include pig farmers.

If you are looking for inflation, the place to find it is in China, not the US.

Scylla or Charybdis?

China is in a Scylla or Charybdis scenario. If China continues to inflate it will overheat. If it doesn't, unemployment and unrest will soar, and the economy will implode. Either way, there is no winning solution.

Peak oil and environmental pollution compound China's problem immensely. China is simply on an unsustainable path for many reasons.

Whither the savings in the "savings rate?"

The excerpts below from a NYT article display how people's actual savings is threatened by the zero interest rate policy of the Fed (a back-door bailout as explained elsewhere on Demand Side). The savings rate that is going up is the difference between income and spending. This is debt service, not actual savings. Meanwhile people who depend on their savings to generate income are not so lucky. Actual savings is being eroded by the need to dip into it to pay for current expenses.

Ben Bernanke is not a bad man. It's just that he should be employed directly in some bank's accounting arm rather than as the manager of the financial system. It is the public interest that has to be paramount, not that of the financial institutions.
At Tiny Rates, Saving Money Costs Investors
By Stephanie Strom
New York Times
December 25, 2009


Experts say risk-averse investors are effectively financing a second bailout of financial institutions, many of which have also raised fees and interest rates on credit cards.

“What the average citizen doesn’t explicitly understand is that a significant part of the government’s plan to repair the financial system and the economy is to pay savers nothing and allow damaged financial institutions to earn a nice, guaranteed spread,” said William H. Gross, co-chief investment officer of the Pacific Investment Management Company, or Pimco. “It’s capitalism, I guess, but it’s not to be applauded.”

Mr. Gross said he read his monthly portfolio statement twice because he could not believe that the line “Yield on cash” was 0.01 percent. At that rate, he said, it would take him 6,932 years to double his money.

Many think the Federal Reserve is fueling a stock market bubble by keeping rates so low that investors decide to bet on stocks instead. Mr. Parks of Better Investing moved more money into the stock market early this year, when C.D.’s he held began maturing and he could not nearly recover the income they had generated by rolling them over.

He began investing some of the money in blue chip stocks with a dividend yield of at least 3 percent and even managed to find an oil-and-gas limited partnership that offered 8 percent.

Mr. Parks said, however, that he would not pursue that strategy as more of his C.D.’s matured. “What worked in the first quarter of this year isn’t as relevant, because the market has come up so much,” he said.

No one is advising a venture into higher-risk investments. Katie Nixon, chief investment officer for the northeast region at Northern Trust, said that, in general, “no one should be taking risks with their pillow money.”

“What people are paying for is safety and security,” she said, “and that’s probably just right.”

People who rely on income from such investments for support, however, are being forced to consider new options.

Eileen Lurie, 75, is taking out a reverse mortgage to help offset the decline in returns on her investments tied to interest rates. Reverse mortgages have a checkered reputation, but Ms. Lurie said her bank was going out of its way to explain the product to her.

“These banks don’t want to be held responsible for thousands of seniors standing in bread lines,” she said.

Such mortgages allow people who are 62 and older to convert equity in their homes into cash tax-free and without any impact on Social Security or Medicare payments. The loans are repaid after death.

“If your assets aren’t appreciating and aren’t producing any income, you’re getting eaten up in this interest rate environment,” said Peter Strauss, a lawyer who advises the elderly. “A reverse mortgage is one way of making a very large asset produce income.”

Eve Wilmore, 93, has watched returns on her C.D.’s drop to between 1 percent and 2 percent from about 5 percent a year or so ago. Yet the Social Security Administration recently raised her Medicare Part B premium based on those higher rates she had been earning. “I’m being hit from both sides,” Mrs. Wilmore said. “There’s some way I can apply for a reconsideration, and I’m going to fight it. I have to.”

She said she was reluctant to redeploy her money into higher-risk investments. “I don’t know what my medical bills will be from here on in, and so I want to keep the money where I can get to it easily if I need it,” she said.

Peter Gomori, who taught a course on money and investing for Dorot, a nonprofit that offers services for the elderly, did not advise his students on investment strategies but said that if he had, he would probably have told them to sit tight.

“I know interest rates are very low for Treasury securities and bank products, but that isn’t going to be forever,” he said.

But investment professionals doubt rates will rise any time soon — or to any level close to those before the crash.

“What the futures market is telling me,” Mr. Gross said, “is that in April 2011, these savers that are currently earning nothing will be earning 1.25 percent.”

Friday, December 25, 2009

Edward Harrison says policy must move from timely, targeted and temporary to real

The automatic and discretionary fiscal stabilizers are what is keeping the Great Depression at bay, in the Demand Side view. Here Edward Harrison marks his own transition from believing "at bay" is good enough and into investment-led reconstruction of the economy.

Moving away from stimulus happy talk to focus on malinvestment
from Credit Writedowns - Finance, Economics, and Markets by Edward Harrison

Moving away from stimulus happy talk to focus on malinvestment is a post from: Credit Writedowns

For the period leading up to the panic last year, I had been warning of a rather severe recession. My view at the time was that what was needed was a realignment of America’s industrial organization away from finance and housing where serious overinvestment meant many firms would fail and asset prices would fall.This turned out to be an accurate view.

However, when Lehman Brothers collapsed in a heap, it was clear to me that we faced a stark choice. One choice was a deflationary spiral and the associated economic dead weight loss of a non-equilibrating global economy in Depression. The other choice was a soft depression cushioned by fiscal (and monetary stimulus). About a year ago I wrote an ode to Keynesian economics called Confessions of an Austrian economist in which I said that I choose fiscal stimulus to cushion the downturn and prevent a depressionary spiral.

The thinking was this: if government buoys the economy, the effects of deleveraging and the bankruptcy of large systemic players need not create a deflationary spiral that leads to a deadweight loss, social unrest or the usurping of democracy by populist autocrats.

But, I am going to move away from the happy talk about fiscal stimulus and re-focus on malinvestment (I have never really talked much about monetary stimulus as a solution). I am sure many of you saw this coming when I wrote “Stop the Madness now!” last month and I have been signaling my realignment with posts like “A few thoughts about the limitations of government.”

The reason is simple: in theory, fiscal stimulus can cushion the downturn and hasten real recovery by preventing a spiral into a non-equilibrating economic state. However, in practice, stimulus has been used as an excuse to maintain the status quo, prop up zombie companies and forestall the inevitable. This only lengthens the downturn, misallocating even more resources to less efficient uses. And all of the worries I had about social unrest, populism, and protectionism are coming true nonetheless.

To be honest, I always knew that the fiscal stimulus game was fraught with risk. Politicians will always use public money in part for their own devices. However, perhaps I was naive enough to believe this time would be different. Cognizant of the risks of the policy response detailed in my stimulus post, I wrote a post detailing what economist Ludwig von Mises said about stimulus years ago. Here is what he said about the actual efficacy of stimulus as opposed to its theoretical application.
It has often been suggested to “stimulate”economic activity and to “prime the pump” by recourse to a new extension of credit which would allow the depression to be ended and bring about a recovery or at least a return to normal conditions; the advocates of this method forget, however, that even though it might overcome the difficulties of the moment, it will certainly produce a worse situation in a not too distant future.

What you should take away from this quote is exactly what I said earlier: Rather than use the period of fiscal stimulus to promote private-sector deleveraging and saving and to purge malinvestment, politicians will simply use this period as a way to continue business as usual, making the problem even bigger down the line.

Is this not what we have just seen with the too-big-to-fail bank bailouts? Is this not what we witnessed with the Chrysler and GM bailouts? Has my advocacy of fiscal stimulus not been proved wrong? It seems that Mises’ estimation of the likely consequences of stimulus are spot on.

What about monetary policy? Well, in a depression where the constraint is overinvestment, leverage, and debt, the question is not a monetary one. As Marshall recently suggested, it appears Fed Chairman Bernanke doesn’t understand the basic economics of central banking. Throwing more money into the system will not make credit-worthy borrowers borrow more. Nor will it necessarily induce banks to lend when they fear that many of their prospective borrowers are not credit-worthy.

By lowering interest rates and expanding the money supply, central banks are not inducing more lending; they are trashing cash. You are not promoting saving with 0% rates; you are looking to re-create the asset-based status quo ante. And when there are insufficient lending opportunities, banks are either forced to sit on billions of cash earning nothing or try other ways of making money (proprietary trading, investment in Treasuries, maybe even lending to non-credit worthy borrowers). Moreover, investors are earning next to nothing as well. How many people have looked at their money market fund statements with the 0.00% interest staring them in the face and decided to switch into bond, equity or commodity funds? It’s was called liquidity seeking return – a major reason the stock market has been buoyed.

So, in future, you will see a lot less chatter about stimulus and the desire to avoid a downturn and a lot more chatter about malinvestment and the need to address the inevitable realignment of investment and resource allocation.

Wednesday, December 23, 2009

Responses to Paul Krugman re Michael Hudson and Paul Samuelson

Two responses to Paul Krugman's critique of Michael Hudson's 1970 piece published yesterday. Krugman has a much more positive view.
Krugman Gets it Wrong
By L. Randall Wray
Saturday, December 19, 2009

In his column in yesterday's NYT, Professor Paul Krugman rose to the defense of Paul Samuelson. He argued that Michael Hudson's piece, originally published in 1970, not only misunderstood Samuelson's theories but also wrongly asserted that he was not deserving of a Nobel. Krugman's main argument was that Samuelson's version of "Keynesian" economics offered a solution to depressions that pre-existing "institutionalist" theory did not have:
"Actually, there was a time when many people thought that institutional economics, which was very much focused on historical context, the complexity of human behavior, and all that, would be the wave of the future. So why didn’t that happen?

Why did the model-builders, led by Samuelson, take over instead?

The answer, in a word, was the Great Depression."Faced with the Depression, institutional economics turned out to have very little to offer, except to say that it was a complex phenomenon with deep historical roots, and surely there was no easy answer. Meanwhile, model-oriented economists turned quickly to Keynes — who was very much a builder of little models. And what they said was, "This is a failure of effective demand. You can cure it by pushing this button." The fiscal expansion of World War II, although not intended as a Keynesian policy, proved them right. So Samuelson-type economics didn't win because of its power to cloud men's minds. It won because in the greatest economic crisis in history, it had something useful to say".

This claim is bizarre, to say the least. First, Roosevelt's New Deal was in place before Keynes published his General Theory, and it was mostly formulated by the American institutional economists that Krugman claims to have been clueless. (There certainly were clueless economists—those following the neoclassical approach, traced to English "political economy".)

Second, it was Alvin Hansen, not Paul Samuelson, who brought Keynesian ideas to America. And Hansen retained the more radical ideas (such as the tendency to stagnation) that Samuelson dropped. Further, Hansen was—surprise, surprise—working within the institutionalist tradition (as documented by in a book by Perry Mehrling).

Third, many other institutionalists also adopted Keynesian ideas in their work—before Samuelson's simplistic mathematization swamped the discipline. For example, Dudley Dillard—a well-known institutionalist—wrote the first accessible interpretation of Keynes in 1948; Kenneth Boulding's 1950 Reconstruction of Economics served as the basis for four editions of his Principles book—on which a generation of American economists was trained (again, before Samuelson's text took over). It is in almost every respect superior to Samuelson's text. I encourage Professor Krugman to take a look.

Fourth, Hyman Minsky (who first trained with institutionalists at the University of Chicago—before it became a bastion of monetarist thought) took Samuelson's overly simplistic multiplier-accelerator approach and extended it with institutional ceilings and floors. He quickly grew tired of the constraints placed on theory by Samuelsonian mathematics and moved on to develop his Financial Instability Hypothesis (which Krugman has admitted he finds interesting, even if he does not fully comprehend it). I ask you, how many analysts have turned to Samuelson's work to try to understand the current crisis—versus the number of times Minsky's work has been invoked?

And fifth, Samuelson's "button" approach to dealing with the business cycle has been thoroughly discredited since the late 1960s—when he announced that we would never have another recession. In truth, as Minsky argued, it is not possible to "fine-tune" the economy because "stability is destabilizing". The simplistic "Keynesian" approach propagated by the likes of Samuelson leaves out the behavioral and institutional analysis that is necessary to deal with instability and crisis.

Sixth, as has been long recognized, Samuelson purposely threw Keynes out of his analysis as he developed the "Neoclassical Synthesis". The name dropping was intentional—Keynes was too radical for the cold warrior Samuelson. At best, what Samuelson presented was a highly bastardized version of Keynes—as Joan Robinson termed it, a Bastard Keynesian approach (we know the mother was neoclassical economics but we do not know who the father was).

Finally, and most telling of all, whose work is universally acknowledged as the most insightful analysis of the Great Depression? Might it be John Kenneth Galbraith's The Great Crash? I have never heard anyone refer to any work of Samuelson in that context.

So Professor Krugman has got it wrong.

And here from Michael Hudson

Michael Hudson Responds to Paul Krugman
Michael Hudson, Distinguished Visiting Professor, UMKC
December 19, 2009

I have recently republished my lecture notes on the history of theories of Trade Development and Foreign Debt. (Available from Amazon) In this book, I provide the basis for refuting Samuelson's factor-price equalization theorem, IMF-World Bank austerity programs, and the purchasing-parity theory of exchange rates.

These ideas were lapses back from earlier analysis, whose pedigree I trace. In view of their regressive character, I think that the question that needs to be asked is how the discipline was untracked and trivialized from its classical flowering? How did it become marginalized and trivialized, taking for granted the social structures and dynamics that should be the substance and focal point of its analysis? As John Williams quipped already in 1929 about the practical usefulness of international trade theory, "I have often felt like the man who stammered and finally learned to say 'Peter Piper picked a peck of pickled peppers' but found it hard to work into conversation." But now that such prattling has become the essence of conversation among economists, the important question is how universities, students and the rest of the world have come to accept it and even award prizes in it!

To answer this question, my book describes the "intellectual engineering" that has turned the economics discipline into a public relations exercise for the rentier classes criticized by the classical economists: landlords, bankers and monopolists. It was largely to counter criticisms of their unearned income and wealth, after all, that the post-classical reaction aimed to limit the conceptual "toolbox" of economists to become so unrealistic, narrow-minded and self-serving to the status quo. It has ended up as an intellectual ploy to distract attention away from the financial and property dynamics that are polarizing our world between debtors and creditors, property owners and renters, while steering politics from democracy to oligarchy.

Bad economic content starts with bad methodology. Ever since John Stuart Mill in the 1840s, economics has been described as a deductive discipline of axiomatic assumptions. Nobel Prizewinners from Paul Samuelson to Bill Vickery have described the criterion for economic excellence to be the consistency of its assumptions, not their realism.[2] Typical of this approach is Nobel Prizewinner Paul Samuelson's conclusion in his famous 1939 article on "The Gains from International Trade":

"In pointing out the consequences of a set of abstract assumptions, one need not be committed unduly as to the relation between reality and these assumptions."[3]

This attitude did not deter him from drawing policy conclusions affecting the material world in which real people live. These conclusions are diametrically opposed to the empirically successful protectionism by which Britain, the United States and Germany rose to industrial supremacy.

Typical of this now widespread attitude is the textbook Microeconomics by William Vickery, winner of the 1997 Nobel Economics Prize:

"Economic theory proper, indeed, is nothing more than a system of logical relations between certain sets of assumptions and the conclusions derived from them... The validity of a theory proper does not depend on the correspondence or lack of it between the assumptions of the theory or its conclusions and observations in the real world. A theory as an internally consistent system is valid if the conclusions follow logically from its premises, and the fact that neither the premises nor theconclusions correspond to reality may show that the theory is not very useful, but does not invalidate it. In any pure theory, all propositions are essentially tautological, in the sense that the results are implicit in the assumptions made."[4]

Such disdain for empirical verification is not found in the physical sciences. Its popularity in the social sciences is sponsored by vested interests. There is always self-interest behind methodological madness. That is because success requires heavy subsidies from special interests, who benefit from an erroneous, misleading or deceptive economic logic. Why promote unrealistic abstractions, after all, if not to distract attention from reforms aimed at creating rules that oblige people actually to earn their income rather than simply extracting it from the rest of the economy?


[1] John H. Williams, Postwar Monetary Plans and Other Essays, 3rd ed. (New York: 1947), pp. 134f.

[2] I have surveyed the methodology in "The Use and Abuse of Mathematical Economics," Journal of Economic Studies 27 (2000):292-315. I earlier criticized its application to international economic theorizing in Trade, Development and Foreign Debt (1992; new ed. ISLET, 2009), especially chapter 11.

[3] Paul Samuelson "The Gains from International Trade," Canadian Journal of Economics and Political Science, Vol.  5 (1939), p. 205.

[4] William Vickery, Microeconomics (New York: 1964), p. 5.

Tuesday, December 22, 2009

On Paul Samuelson, nice guy, deadly to reality-based economics

We observed the passing of Paul Samuelson with some nostalgia for a time when we found his text illuminating and inspiring.  It was our back window into Keynes and only later did we appreciate how poorly it served in translating the fundamental discoveries and insights of previous economics into the post-war policy environment.   Here is a piece from 1970 which we wish we had read in 1970. (tomorrow we print two  rebuttals of a Paul Krugman critique of this piece, one from Hudson and one from  or you can get it ahead of time at
Elegant Theories That Didn't Work
from Economic Perspectives from Kansas City
The Problem with Paul Samuelson
By Michael Hudson
"First Published on counterpunch.org"
"The following article was written in 1970 after Samuelson received the award"

Paul Samuelson, America’s best known economist, died on Sunday. He was awarded the Nobel prize for economics, (founded one year earlier by a Swedish bank in 1970 “in honor of Alfred Nobel”). That award elicited this trenchant critique, published by Michael Hudson in Commonweal, December 18, 1970. The essay was titled “Does economics deserve a Nobel prize? (And by the way, does Samuelson deserve one?)”

It is bad enough that the field of psychology has for so long been a non-social science, viewing the motive forces of personality as deriving from internal psychic experiences rather than from man's interaction with his social setting. Similarly in the field of economics: since its “utilitarian” revolution about a century ago, this discipline has also abandoned its analysis of the objective world and its political, economic productive relations in favor of more introverted, utilitarian and welfare-oriented norms. Moral speculations concerning mathematical psychics have come to displace the once-social science of political economy.

To a large extent the discipline’s revolt against British classical political economy was a reaction against Marxism, which represented the logical culmination of classical Ricardian economics and its paramount emphasis on the conditions of production. Following the counter-revolution, the motive force of economic behavior came to be viewed as stemming from man's wants rather than from his productive capacities, organization of production, and the social relations that followed therefrom. By the postwar period the anti-classical revolution (curiously termed neo-classical by its participants) had carried the day. Its major textbook of indoctrination was Paul Samuelson's Economics.

Today, virtually all established economists are products of this anti-classical revolution, which I myself am tempted to call a revolution against economic analysis per se. The established practitioners of economics are uniformly negligent of the social preconditions and consequences of man's economic activity. In this lies their shortcoming, as well as that of the newly-instituted Economics Prize granted by the Swedish Academy: at least for the next decade it must perforce remain a prize for non-economics, or at best superfluous economics. Should it therefore be given at all?

This is only the second year in which the Economics prize has been awarded, and the first time it has been granted to a single individual -- Paul Samuelson -- described in the words of a jubilant New York Times editorial as “the world’s greatest pure economic theorist.” And yet the body of doctrine that Samuelson espouses is one of the major reasons why economics students enrolled in the nation's colleges have been declining in number. For they are, I am glad to say, appalled at the irrelevant nature of the discipline as it is now taught, impatient with its inability to describe the problems which plague the world in which they live, and increasingly resentful of its explaining away the most apparent problems which first attracted them to the subject.

The trouble with the Nobel Award is not so much its choice of man (although I shall have more to say later as to the implications of the choice of Samuelson), but its designation of economics as a scientific field worthy of receiving a Nobel prize at all. In the prize committee’s words, Mr. Samuelson received the award for the “scientific work through which he has developed static and dynamic economic theory and actively contributed to raising the level of analysis in economic science. . . .”

What is the nature of this science? Can it be “scientific” to promulgate theories that do not describe economic reality as it unfolds in its historical context, and which lead to economic imbalance when applied? Is economics really an applied science at all? Of course it is implemented in practice, but with a noteworthy lack of success in recent years on the part of all the major economic schools, from the post-Keynesians to the monetarists.

In Mr. Samuelson’s case, for example, the trade policy that follows from his theoretical doctrines is laissez faire. That this doctrine has been adopted by most of the western world is obvious. That it has benefited the developed nations is also apparent. However, its usefulness to less developed countries is doubtful, for underlying it is a permanent justification of the status quo: let things alone and everything will (tend to) come to “equilibrium.” Unfortunately, this concept of equilibrium is probably the most perverse idea plaguing economics today, and it is just this concept that Mr. Samuelson has done so much to popularize. For it is all too often overlooked that when someone falls fiat on his face he is “in equilibrium” just as much as when he is standing upright. Poverty as well as wealth represents an equilibrium position. Everything that exists represents, however fleetingly, some equilibrium -- that is, some balance or product -- of forces.

Nowhere is the sterility of this equilibrium preconception more apparent than in Mr. Samuelson's famous factor-price equalization theorem, which states that the natural tendency of the international economy is for wages and profits among nations to converge over time. As an empirical historical generality this obviously is invalid. International wage levels and living standards are diverging, not converging, so that the rich creditor nations are becoming richer while poor debtor countries are becoming poorer -- at an accelerating pace, to boot. Capital transfers (international investment and “aid”) have, if anything, aggravated the problem, largely because they have tended to buttress the structural defects that impede progress in the poorer countries: obsolete systems of land tenure, inadequate educational and labor-training institutions, pre-capitalist aristocratic social structures, and so forth. Unfortunately, it is just such political-economic factors that have been overlooked by Mr. Samuelson’s theorizing (as they have been overlooked by the mainstream of academic economists since political economy gave way to “economics” a century ago).

In this respect Mr. Samuelson's theories can be described as beautiful watch parts which, when assembled, make a watch that doesn’t tell the time accurately. The individual parts are perfect, but their interaction is somehow not. The parts of this watch are the constituents of neoclassical theory that add up to an inapplicable whole. They are a kit of conceptual tools ideally designed to correct a world that doesn’t exist.

The problem is one of scope. Mr. Samuelson’s three volumes of economic papers represent a myriad of applications of internally consistent (or what economists call “elegant”) theories, but to what avail? The theories are static, the world dynamic.

Ultimately, the problem resolves to a basic difference between economics and the natural sciences. In the latter, the preconception of an ultimate symmetry in nature has led to many revolutionary breakthroughs, from the Copernican revolution in astronomy to the theory of the atom and its sub-particles, and including the laws of thermodynamics, the periodic table of the elements, and unified field theory. Economic activity is not characterized by a similar underlying symmetry. It is more unbalanced. Independent variables or exogenous shocks do not set in motion just-offsetting counter-movements, as they would have to in order to bring about a meaningful new equilibrium. If they did, there would be no economic growth at all in the world economy, no difference between U.S. per capita productive powers and living standards and those of Paraguay.

Mr. Samuelson, however, is representative of the academic mainstream today in imagining that economic forces tend to equalize productive powers and personal incomes throughout the world except when impeded by the disequilibrating “impurities” of government policy. Empirical observation has long indicated that the historical evolution of “free” market forces has increasingly favored the richer nations (those fortunate enough to have benefited from an economic head start) and correspondingly retarded the development of the laggard countries. It is precisely the existence of political and institutional “impurities” such as foreign aid programs, deliberate government employment policies, and related political actions that have tended to counteract the "natural" course of economic history, by trying to maintain some international equitability of economic development and to help compensate for the economic dispersion caused by the disequilibrating “natural” economy.

This decade will see a revolution that will overthrow these untenable theories. Such revolutions in economic thought are not infrequent. Indeed, virtually all of the leading economic postulates and “tools of the trade” have been developed in the context of political-economic debates accompanying turning points in economic history. Thus, for every theory put forth there has been a counter-theory.

To a major extent these debates have concerned international trade and payments. David Hume with the quantity theory of money, for instance, along with Adam Smith and his “invisible hand” of self-interest, opposed the mercantilist monetary and international financial theories that had been used to defend England’s commercial restrictions in the eighteenth century. During England’s Corn Law debates some years later, Malthus opposed Ricardo on value and rent theory and its implications for the theory of comparative advantage in international trade. Later, the American protectionists of the 19th century opposed the Ricardians, urging that engineering coefficients and productivity theory become the nexus of economic thought rather than the theory of exchange, value and distribution. Still later, the Austrian School and Alfred Marshall emerged to oppose classical political economy (particularly. Marx) from yet another vantage point, making consumption and utility the nexus of their theorizing.

In the 1920s, Keynes opposed Bertil Ohlin and Jacques Rueff (among others) as to the existence of structural limits to the ability of the traditional price and income adjustment mechanisms to maintain “equilibrium,” or even economic and social stability. The setting of this debate was the German reparations problem. Today, a parallel debate is raging between the Structuralist School ­ which flourishes mainly in Latin America and opposes austerity programs as a viable plan for economic improvement of their countries, and the monetarist and post-Keynesian schools defending the IMF's austerity programs of balance-of-payments adjustment. Finally, in yet another debate, Milton Friedman and his monetarist school are opposing what is left of the Keynesians (including Paul Samuelson) over whether monetary aggregates or interest rates and fiscal policy are the decisive factors in economic activity.

In none of these debates do (or did) members of one school accept the theories or even the underlying assumptions and postulates of the other. In this respect the history of economic thought has not resembled that of physics, medicine, or other natural sciences, in which a discovery is fairly rapidly and universally acknowledged to be a contribution of new objective knowledge, and in which political repercussions and its associated national self-interest are almost entirely absent. In economics alone the irony is posed that two contradictory theories may both qualify for prizeworthy preeminence, and that the prize may please one group of nations and displease another on theoretical grounds.

Thus, if the Nobel prize could be awarded posthumously, both Ricardo and Malthus, Marx and Marshall would no doubt qualify, just as both Paul Samuelson and Milton Friedman were leading contenders for the 1970 prize. [Friedman got his Nobel in 1976.] Who, on the other hand, can imagine the recipient of the physics or chemistry prize holding a view not almost universally shared by his colleagues? (Within the profession, of course, there may exist different schools of thought. But they do not usually dispute the recognized positive contribution of their profession’s Nobel prizewinner.) Who could review the history of these prizes and pick out a great number of recipients whose contributions proved to be false trails or stumbling blocks to theoretical progress rather than (in their day) breakthroughs?

The Swedish Royal Academy has therefore involved itself in a number of inconsistencies in choosing Mr. Samuelson to receive the 1970 Economics Prize. For one thing, last year’s prize was awarded to two mathematical economists (Jan Tinbergen of Holland and Ragnar Frisch of Norway) for their translation of other men's economic theories into mathematical language, and in their statistical testing of existing economic theory. This year’s prize, by contrast, was awarded to a man whose theoretical contribution is essentially untestable by the very nature of its “pure” assumptions, which are far too static ever to have the world stop its dynamic evolution so that they may be “tested.” (This prompted one of my colleagues to suggest that the next Economics Prize be awarded to anyone capable of empirically testing any of Mr. Samuelson’s theorems.)

And precisely because economic “science” seems to be more akin to “political science” than to natural science, the Economics Prize seems closer to the Peace Prize than to the prize in chemistry. Deliberately or not, it represents the Royal Swedish Academy’s endorsement or recognition of the political influence of some economist in helping to defend some (presumptively) laudable government policy. Could the prize therefore be given just as readily to a U.S. president, central banker or some other non-academician as to a “pure” theorist (if such exists)? Could it just as well be granted to David Rockefeller for taking the lead in lowering the prime rate, or President Nixon for his acknowledged role in guiding the world’s largest economy, or to Arthur Burns as chairman of the Federal Reserve Board? If the issue is ultimately one of government policy, the answer would seem to be affirmative.

Or is popularity perhaps to become the major criterion for winning the prize? This year’s award must have been granted at least partially in recognition of Mr. Samuelson’s Economics textbook, which has sold over two million copies since 1947 and thereby influenced the minds of a whole generation of -- let us say it, for it is certainly not all Mr. Samuelson’s fault -- old fogeys. The book’s orientation itself has impelled students away from further study of the subject rather than attracting them to it. And yet if popularity and success in the marketplace of economic fads (among those who have chosen to remain in the discipline rather than seeking richer intellectual pastures elsewhere) is to become a consideration, then the prize committee has done an injustice to Jacqueline Susann in not awarding her this year’s literary prize.

To summarize, reality and relevance rather than “purity” and elegance are the burning issues in economics today, political implications rather than antiquarian geometrics. The fault therefore lies not with Mr. Samuelson but with his discipline. Until it is agreed what economics is, or should be, it is as fruitless to award a prize for “good economics” as to award an engineer who designed a marvelous machine that either could not be built or whose purpose was unexplained. The prize must thus fall to those still lost in the ivory corridors of the past, reinforcing general equilibrium economics just as it is being pressed out of favor by those striving to restore the discipline to its long-lost pedestal of political economy.

*At the time I wrote this critique I was teaching international trade theory at the Graduate Faculty of the New School for Social Research at the time. Subsequently, I criticized Mr. Samuelson’s methodology in “The Use and Abuse of Mathematical Economics,” Journal of Economic Studies 27 (2000):292-315. Most important of all is Mr. Samuelson’s factor-price equalization theorem. I finally have republished my Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy.

Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, mh@michael-hudson.com

Minsky in Plain English

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plagarizing, paraphrasing and semi-quoting

in the chapter on institutional dynamics from Stabilizing an Unstable Economy, 1986, pp 278 and following

Flexibility of finance and its responsiveness to business are needed for a dynamic capitalism. This cannot exist without the banking process. But banking and finance are highly disruptive forces in our economy.

The destabilizing aspects of banking should not be surprising. After all, bankers are specialists in providing short-term financing and the banker sells his services by teaching customers how to use bank facilities. Bankers cannot make a living unless business, government and households borrow. Banks are merchants of debt.

There is currently a game that is played between the authorities and profit-seeking banks. In this game, the authorities -- the central banks -- impose interest rates and reserve regulations and operate in money markets to produce what they consider to be the right amount of money. The banks invent and innovate in order to circumvent the authorities. The authorities may constrain the rate of growth of the reserve base, but the banking and financial structure determines the efficacy of reserves.

This is an unfair game. The entrepreneurs of the banking community have much more at stake than the bureaucrats of the central banks. For forty years, the authorities have been repeatedly "surprised" by changes in the way financial markets operate. Profit-seeking bankers inevitably win. But in winning the game, the banking community destabilizes the economy. The true losers are the newly unemployed and those hurt by inflation.

It is the self-interest of the butcher and the baker that leads to the provision of meat and bread. This is a dictum propounded by Adam Smith. It has evolved into the proposition that the pursuit of self-interest leads to market equilibrium. But it is in the self-interest of bankers to make loans, to spread the use of their services. At the same time it is in the self-interest of investors to use bankers' services as long as the price of capital assets exceeds the supply price of investment goods.

That is, if you can build an asset whose price is higher than the cost of building it, investors will make as many as possible.

Whereas in commodity production the process of supply generates incomes equal to the market value of supply, in financial markets with responsive banking the demand for finance generates the offsetting supply of finance. On top of this, excess supply of finance will push up the price of capital assets relative to the supply price of investment output, and this will increase the demand for investment and therefore finance.

In a world with capitalist finance it is simply not true that the pursuit by each unit of its own self-interest will lead an economy to equilibrium. The self-interest of bankers, levered investors, and investment producers can lead the economy to inflationary expansions and unemployment-creating contractions. Supply and demand analysis -- in which market processes lead to an equilibrium -- does not explain the behavior of a capitalist economy. The financial processes endogenously create destabilizing forces. Financial fragility, which is a prerequisite for financial instability, is fundamentally a result of internal market processes.

Control of these destabilizing forces is attempted through the regime of regulation by the authorities, by chartering restrictions, and by central bank determination of the volume and effectiveness of bank reserves. The dominant economic theory of the moment, however, discredits regulatory arrangements because they are seen to reflect primitive superstitions and ignorance. This current view holds that the authorities are trying to regulate and control phenomena that do not exist in nature -- booms, inflations, crunches, recessions and depressions. These kinds of instability are, it is said, due to the very efforts to contain and offset them.

Institutions such as the Federal Reserve were introduced in an effort to control and contain disorderly conditions in banking and financial markets These institutions have now become slaves to an economic theory that denies the existence of such conditions. This theory holds that the authorities should focus on the money supply and try to achieve a constant rate of growth of this construct. [Minsky is writing in the early 1980s, at the time of the Volcker Monetarist experiment.] The authorities, in fact, accept these blinders, and now ignore the financial relations by which monetary phenomena affect activity.

These money-supply blinders conceal from view the ways in which portfolio transformations occur and how they affect the stability of the economy. The erosion of bank equity bases, the growth of liability management banking, and the greater use of covert liabilities are virtually ignored until financial markets break down. Only then does the Federal Reserve's original reason for being come into play. The Fed, acting as a lender of last resort, pumps reserves into the banking system and refinances banks in order to prevent a breakdown of the financing system.

In this role as lender of last resort, the authorities increase the reserve base of banks and validate the threatened financial usages. Many financial institutions, in addition to those that are in immediate danger of failing, retrench and become conservative to improve their own financial posture. In a capitalist economy with Big Government, automatic and discretionary fiscal stabilizers lead to a large deficit that sustains profits and employment. It is these deficits and the lender-of-last-resort interventions that abort the the downward spiral so common in earlier history.

The lender-of-last-resort actions combine with the huge government deficits to increase the reserve base and holdings of government debt by the banking system. This exercise shores up financing ability for a future business expansion. Because the interventions lead to a quick halt to the downturn, [obviously written before the current situation] financial disturbances ... no longer lead to sustained price decreases. Quite the opposite, the actions taken to prevent a debt deflation and a depression set a groundwork for a burst of expansion followed by inflation.

Expansions breed new financial instruments and new ways of financing activity. Defects of the new ways and the new institutions are typically revealed only when the crunch comes. The authorities intervene to prevent localized weakness from leading to a broad decline in asset values; an intervention usually taking the form of the Federal Reserve accepting new types of instruments into its portfolio or acquiescing in refinancing arrangements for new institutions and markets. By this intervention, since it validates the new ways, the central bank sets the stage for a broader acceptance and use of the new financial instruments in subsequent expansions.

If the disrupting effects of banking are to be constrained, the authorities must drop their blinders and accept the need to guide and control the evolution of financial usages and practices. In a world of businessmen and financial intermediaries who aggressively seek profit, innovators will always win the game with regulators. The authorities cannot prevent changes in the structure of portfolios from occurring. What they can do is keep the asset to equity ratio of banks within bounds by setting equity absorption ratios for various types of assets. If the authorities constrain banks and are aware of the activities of fringe banks and other financial institutions, they are in a better position to attenuate the disruptive expansionary tendencies of our economy.

Bankers supervise borrowers and holders of lines of credit. Once a line of credit is opened, the banker has a continuing concern about the affairs of the borrower and about business and financial developments that can affect the customer's viability. Given his behavior as a lender, a bank as a borrower naturally accepts supervision from its actual or potential lenders. But depositor surveillance has disappeared, a victim of deposit insurance and the merger technique of dealing with distressed banks. Bank examination by the insuring or chartering agency is now a substitute for depositor surveillance. Thus the insuring authority should have power to constrain and control business practices of its policy holders. If the deposits were uninsured, depositors would walk away from banks with low equity ratios and suspect assets. As substitutes for this depositor surveillance, the regulating and insuring authorities must be able to constrain bank asset to equity ratios and asset structures.

Commercial bank reserves mainly result from the ownership of government securities by the Federal Reserve. The government security/open market technique of supplying reserves to the banking system is not the only way reserves can be furnished. Prior to the Great Depression, a major part of reserves that were not based on gold were based on borrowings by banks at the discount window. The resurrection of the discount window as a normal source of bank reserves is a way of tightening Federal Reserve control over commercial banks. If commercial banks normally borrow at the Federal Reserve discount window, they will necessarily accept and be responsive to guidance by the Federal Reserve.

As long as bank reserves are mainly the result of open-market purchases of government securities, the giant banks are virtually immune to Federal Reserve pressures. If normal functioning required banks to borrow at the discount window, then the capital adequacy and asset structure of banks would be under Federal Reserve supervision. This would then diminish the destabilizing influences in our economy that result from too rapid an expansion of bank financing of business and asset holdings.