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, September 30, 2010

Transcript: 406 Carbon as the Core of Recovery

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Last week we did part one, this week it's


Wait, wait, wait. It's part two of carbon as the core of an economic reconstruction of the U.S.


Okay, okay, Here we have Joe Mason, professor of banking at Lousiana State University


Coming out waving as many red flags as he can at the pollitically naive, we might expect Professor Mason has some weak arguments. We would be correct.

The oil and gas industry as a generator of jobs is wrong in so many ways, and Mason's pat explanation is transparently false. If it were true that all fiscal policy were equal, you could create as many jobs by giving AIG $180 billion to pass through to its banking counterparties as you could by hiring people for the CCC with the same $180 billion. We know, in fact, that $180 for AIG passed through to the banks did save a few jobs, but the bonuses were tremendous. We might imagine that six million jobs at $8.50 per hour complete with benefits could be created with the same money.

It is wrong to view oil and gas as a jobs industry, when it is a resource extraction industry. Value added is not the core of the big profits available to resource extraction. Empirically derived estimates show the number of jobs per dollar of activity in oil production and distribution to be lower than for any other industry. To have an economist make the claim that it is only makes economists look foolish. Even defense spending, another low-jobs, high cost industry that gets credit for more than it delivers, is much more effective.

The jobs in energy are efficiency, green construction, carbon-minimizing infrastructure, retrofitting. Characterizing tax loopholes for the oil and gas industry as economic stimulus is not intellectually coherent, and is probably disingenuous. Joe Mason, water carrier for oil and gas, Idiot of the Week.

But there was more. Arnold Schwarzenegger, the governator, of all people, went off on Big Oil last week as they dump their massive money into the political climate of the state of California in the form of Proposition 23.

Again with the claim that oil and gas is somehow going to produce jobs. It is just not so. We'll see what money and modern mind manipulation can do. If it can convince Californians that the road to prosperity is through more carbon pollution, it can do anything.


Arnold Scwharzenegger. Noting again, as with everything on Demand Side, remarks may be heavily edited.


These are skirmishes on the fringes of the issue of oil and gas and the future of the American economy. The critical battle is on the issue of a higher oil price and a move to a low-carbon economy. As Joseph Stiglitz pointed out last week on Demand Side, a higher oil price can position economies for the future by creating the context for new investment and comparative advantage. If an enlightened policy such as the Cantwell-Collins CLEAR Act were the law of the land, gradually higher prices and mandated reductions in emissions could go hand in hand with certainty. The same law would generate a funding base for new investment directly by the government or a quasi-government body in infrastructure and clean energy. At the same time, because the majority of revenues would be rebated directly to individuals on a per-capita basis, it would be a progressive tax and a way for households to capture directly in cash money the fruits of conservation.

We're going to let that be our discussion of the matter. But even a higher oil price and reorganization and reconstruction of the economy on the basis of carbon reduction is not the core of the matter from an economic perspective. We want to end today with an extended excerpt from Manfred Max-Neef, a Chilean economist, without further comment.


We are simply, dramatically stupid. We act systematically against the evidences we have. We know everything that should not be done. There’s nobody that doesn’t know that. Particularly the big politicians know exactly what should not be done. Yet they do it. After what happened since October 2008, I mean, elementally, you would think what? That now they’re going to change. I mean, they see that the model is not working. The model is even poisonous, you know? Dramatically poisonous. And what is the result, and what happened in the last meeting of the European Union? They are more fundamentalist now than before. So, the only thing you know that you can be sure of, that the next crisis is coming, and it will be twice as much as this one. And for that one, there won’t be enough money anymore. So that will be it. And that is the consequence of systematical human stupidity.

First of all, we need cultured economists again, who know the history, where they come from, how the ideas originated, who did what, and so on and so on; second, an economics now that understands itself very clearly as a subsystem of a larger system that is finite, the biosphere, hence economic growth as an impossibility; and third, a system that understands that it cannot function without the seriousness of ecosystems. And economists know nothing about ecosystems. They don’t know nothing about thermodynamics, you know, nothing about biodiversity or anything. I mean, they are totally ignorant in that respect. And I don’t see what harm it would do, you know, to an economist to know that if the beasts would disappear, he would disappear as well, because there wouldn’t be food anymore. But he doesn’t know that, you know, that we depend absolutely from nature. But for these economists we have, nature is a subsystem of the economy. I mean, it’s absolutely crazy.

And then, in addition, you know, bring consumption closer to production. I live in the south of Chile, in the deep south. And that area is a fantastic area, you know, in milk products and what have you. Top. Technologically, like the maximum, you know? I was, a few months ago, in a hotel, and there in the south, for breakfast, and there are these little butter things, you know? I get one, and it’s butter from New Zealand. I mean, if that isn’t crazy, you know? And why? Because economists don’t know how to calculate really costs, you know? To bring butter from 20,000 kilometers to a place where you make the best butter, under the argument that it was cheaper, is a colossal stupidity, because they don’t take into consideration what is the impact of 20,000 kilometers of transfer? What is the impact on the environment of that transportation, you know, and all those things? And in addition, I mean, it’s cheaper because it’s subsidized. So it’s clearly a case in which the prices never tell the truth. It’s all tricks, you know? And those tricks do colossal harms. And if you bring consumption closer to production, you will eat better, you will have better food, you know, and everything. You will know where it comes from. You may even know the person who produces it. You humanize this thing, you know? But the way the economists practice today is totally dehumanized.

There are some important scientists that already are saying, I believe. I have not reached that point yet. But some believe, you know, and state that it’s definite: we are finished. We are finished. In a few more decades, I mean, there will be no humanity anymore. I don’t think we have reached that point of it, but I believe that we are pretty close to it. I’ll say that we already crossed one of the three rivers. And if you look at it and what is happening everywhere, I mean, it’s quite frightening how the amount of catastrophes are increasing all over the place, you know, in all manifestations—storms, earthquakes, you know, volcanoes erupting. I mean, the amount of events is growing dramatically. I mean, it’s really frightening. And we continue with the same.

The principles, you know, of an economics which should be are based in five postulates and one fundamental value principle. One, the economy is to serve the people and not the people to serve the economy. Two, development is about people and not about objects. Three, growth is not the same as development, and development does not necessarily require growth. Four, no economy is possible in the absence of ecosystem services. Five, the economy is a subsystem of a larger finite system, the biosphere, hence permanent growth is impossible. And the fundamental value to sustain a new economy should be that no economic interest, under no circumstance, can be above the reverence of life.

Nothing can be more important than life. And I say life, not human beings, because, for me, the center is the miracle of life in all its manifestations. But if there is an economic interest, I mean, you forget about life, not only of other living beings, but even of human beings. If you go through that list, one after the other, what we have today is exactly the opposite.

Growth is a quantitative accumulation. Development is the liberation of creative possibilities. Every living system in nature grows up to a certain point and stops growing. You are not growing anymore, nor he nor me. But we continue developing ourselves. Otherwise we wouldn’t be dialoguing here now. So development has no limits. Growth has limits. And that is a very big thing, you know, that economists and politicians don’t understand. They are obsessed with the fetish of economic growth.

Many studies have been done. I’m the author of a famous hypothesis, the threshold hypothesis, which says that in every society there is a period in which economic growth, conventionally understood or no, brings about an improvement of the quality of life. But only up to a point, the threshold point, beyond which, if there is more growth, quality of life begins to decline. And that is the situation in which we are now.

I mean, your country is the most dramatic example that you can find. I have gone as far as saying—and this is a chapter of a book of mine that is published next month in England, the title of which is Economics Unmasked. There is a chapter called "The United States, an Underdeveloping Nation," which is a new category. We have developed, underdeveloped and developing. Now you have underdeveloping. And your country is an example, in which the one percent of the Americans, you know, are doing better and better and better, and the 99 percent is going down, in all sorts of manifestations. People living in their cars now and sleeping in their cars, you know, parked in front of the house that used to be their house—thousands of people. Millions of people, you know, have lost everything. But the speculators that brought about the whole mess, oh, they are fantastically well off. No problem. No problem.

I don’t know how to turn it around. I mean, it will turn around itself, you know, in catastrophic manners. I mean, I don’t understand how there isn’t—millions of people can all of a sudden go out in the streets in the United States and begin destroying things, I don’t know. That may perfectly happen. You know, the situation is absolutely dramatic. Absolutely dramatic. And it is supposed to be the most powerful country in the world, you know, and so on. And even in those conditions, they continue with those stupid wars, you know, and spend more, more, more millions and trillions. Thirteen trillion dollars for the speculators; not one cent for the people who lost their homes! I mean, what kind of logic is that?

Friday, September 24, 2010

Transcript: 405 Summers out, Recession over, Fed still at sea

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Today on the podcast, personnel changes at the White House, the NBER calls an end to the recession, and then carbon prices, the engine of economic recovery question mark, with Joseph Stiglitz and Johan Rockstrom.


Larry Summers is leaving as point man on the economy in the White House and returning to Harvard. This may signal a change in economic tack, and will likely be welcomed on the Left. On the Right, House Minority leader John Boehner has already called for Summers' firing. Many progressive economists feel that following Summers' advice not only led into stagnation, but wasted a good crisis. His Timely, Targeted and Temporary mantra ginned up the ineffective Bush stimulus. His carefully parsed advice and analysis was always, critics say, a day late and a dollar short. Will things change? The political winds are turning and the possibilities for progressive action are much more limited today than they were two years ago. We've been asked who we would prefer as his replacement. Joseph Stiglitz was Bill Clinton's chair of the Council of Economic Advisers, James K. Galbraith was staff director of the Joint Economic Committee. Either of these men would be what the country needs economically. Politically, it is not going to happen. I would suggest a progressive business person, there are many, I'm sure. It would take away one of the complaints from business and at the same time grant some status not likely in an academic.

But what does Robert Scheer, journalist and author of The Great American Stick-Up: How Reagan Republicans and Clinton Democrats Enriched Wall Street While Mugging Main Street


Summers' departure is certainly to be welcome. My book is largely about the follies of Lawrence Summers, beginning in the Clinton administration, when he pushed through the Commodity Futures Modernization Act, which opened the floodgates to all of these toxic derivatives that he, as much as anyone in the country, bears responsibility for the economic debacle. And then Obama brought him back. And I think what he has done is basically throw money at Wall Street, continue the Bush policy, and get nothing in return, particularly in the way of relief for homeowners—you know, mortgage foreclosure, a moratorium on foreclosures. And so, I think this is really good news. And, you know, I hope he’s not replaced with someone worse, but it’s hard to imagine someone worse.

the New York Times today, Barack Obama, President Obama yesterday, referred to this guy as "brilliant." And I don’t know how many times you have to fail before you’re considered to be something less than brilliant. And this guy has been a disaster at every position he has held. He was the Treasury Secretary under Clinton who presided over the radical deregulation of that administration, fulfilling the fantasy of the Reagan Revolution. The Republicans couldn’t pull it off. Summers and Robert Rubin, his mentor, did pull it off. And it’s been—this is the basic root cause of this meltdown. Then he goes to Harvard, where he was a disaster as president, divisive, mysogynist, demeaning of women and so forth.

And meanwhile, he’s being paid not only close to $600,000 by Harvard, but then he goes and consults on Wall Street. He was paid $4 million by D.E. Shaw, a hedge fund, and you’ll notice the Obama administration has not reined in hedge funds at all. And he received almost another $4 million in speaking fees. He got $135,000 from Goldman Sachs for one short speech. He got that much from Citigroup for two speeches. You know, so this guy, while he was advising Obama, he was raking it in, eight million bucks, while he’s an adviser to the candidate.

And then, for reasons that Obama will someday have to explain, he’s brought in as the key guy. It’s not Geithner. Geithner is a water carrier and was very much a subordinate in the Clinton administration to both Summers and Rubin. And they bring in Summers, and what he did is, again, follow that strategy, reassure Wall Street, don’t spook the markets, give them what they want, submit to their blackmail, and make them whole. And they continued the Bush policy with a vengeance, throwing money at Wall Street. The Fed now holds $2 trillion worth of toxic assets taken off the books of the banks. The banks still hold a massive amount. And every time the housing market looks like it might get better, they dump this stuff. The Fed announced yesterday that the economy is not getting better. They’re very troubled.

So what is the legacy? You know, it’s like Vietnam. Vietnam, as David Halberstam once wrote, was brought to us by the best and brightest, people who presumably have the best education and, you know, are sincere and smart and so forth. And the economic meltdown reminds one of that and Vietnam. I mean, if this is what brilliance means, let’s have a sort of ordinary common sense for a while. And common sense will tell you, help the homeowners now. You’ve done enough for the banks. Get something back from the banks. Make them, you know, readjust those mortgages. Don’t have it be voluntary. Empower the bankruptcy courts to help the people who are struggling, the 40 to 50 million people who are already underwater on their mortgages, but everybody else. And if you don’t do that, you’re not going to fix this economy. And I don’t care whether he brings in a businessman or a labor leader or brings in Stiglitz or makes Paul Krugman his adviser, whoever he brings in has got to tell him that, or we’re not going to see progress.

Another positive personnel move was the addition of Elizabeth Warren to organize the Consumer Protection Bureau for financial products. Many have characterized her as a fierce watchdog for consumer interests. Our take is that the bureau will analyze and standardize financial products and thus introduce market competition, along with safety. This setting up of the office and its processes is thus a vital period.

Last week the economic news centered on the likelihood of an extension of the Bush tax cuts. The president has proposed making permanent the tax cuts for everyone earning less than $250,000. Senate Republicans threaten to block such a move unless it brings along those in the higher income brackets.


We half agree with Mitch McConnell on this. That the economy is in the middle of recession. Unfortunately for both Mitch and Demand Side, the National Bureau of Economic Research, which is the official arbiter of recessions, called the official end to the 2007 recession as June of 2009. Neither credit markets, employment, housing, investment, nor consumer sentiment have recovered, nor has the economy returned to the levels of production of 2007, but there is enough light in the tunnel for the NBER, which said, in part:

In determining that a trough occurred in June 2009, the committee did not conclude that economic conditions since that month have been favorable or that the economy has returned to operating at normal capacity. Rather, the committee determined only that the recession ended and a recovery began in that month. A recession is a period of falling economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. The trough marks the end of the declining phase and the start of the rising phase of the business cycle. Economic activity is typically below normal in the early stages of an expansion, and it sometimes remains so well into the expansion.

Demand Side does not see a normal business cycle in any form. In our view, the business cycle remains broken.

Calculated Risk commented:

The committee decided that any future downturn of the economy would be a new recession and not a continuation of the recession that began in December 2007. The basis for this decision was the length and strength of the recovery to date.
This is somewhat subjective - and I thought they'd wait longer because the committee usually waits until some of the key indicators have returned to pre-recession levels. This time no indicator has reached the pre-recession level, and some are still very low (like personal income less transfer payments).

If the recession ended in June 2009, it may well be that a new recession began in May 2010. Hard to see how a protracted period of going nowhere is anybody's definition of recovery.

Elsewhere, the Federal Reserve suggested it was preparing the ground for new actions to return inflation to its... well, let's quote:

Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability.

The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.

As we've covered here previously, the inflation of financial assets by the Fed has not stemmed the fall in housing, nor stimulated any real investment activity. Pumping more money into the financial sector may be inflating the value of financial assets and possibly creating bubbles there, without touching the real economy.

So, deflation is the risk. Well, yes. Is the Fed going to touch the deflation that is the risk with its low-interest rate policies? No. That debt deflation awaits write-downs and real action. The stagnant price level will continue as long as there is no investment and all economic actors are racing to the bottom.

Monetary policy is not working. Has not worked and will not work.

Investment needs the prospect of profit. Profit needs relatively certain demand. Improving profit by cheaper hiring or equipment or financing effectively short-cirdcuits the demand loop. The demand -- again relatively certain -- for consumer products does not exist, so demand for investment goods which are financed over a period of time does not exist even more and is not forthcoming. Thus monetary policy focused on financial assets labors under the delusion. Absent demand, investment goods will not come on line, so the policy is a failed policy and there will be no recovery.


Now let's move on to part one of our treatment of carbon as the potential center of a rebirth of the economy. Today we offer short treatments by economist Joseph Stiglitz and then environmental observer Johan Rockstrom. Here is Joseph Stiglitz speaking last month in Australia



That was Johan Rockstrom, giving some context. The context of a planet poised for catastrophe while its navigators argue among themselves in the wheelhouse about how to get more acceleration. We need a change of course, not more acceleration. Thanks today to Democracy Now and Amy Goodman for today's contribution from Robert Sears and to the TED talks for Johan Rockstrom.

Thursday, September 16, 2010

Transcript: 404 The Four Major Forecasting Errors

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Today on the podcast, we have a full boat, Hyman Minsky, presidential economics, the four main errors of economic forecasters and --- yes -- Idiot of the Week.

The last portion today is an extended excerpt from the Obama press conference from last week as it regards the economy, to give you a notion of what the political terrain looks like. And we -- like Robert Shiller -- are wondering why we don't reduce unemployment by hiring people. We offer a program from Hyman Minsky, proposing an economic stability policy based on employment rather than interest rates and corporate tax cuts. But first ... you may remember last January we spoke with the chief economist of the regional forecasting council and recommended he go with our bouncing along the bottom with chance of downside crises forecast -- the forecast we've had for a very long time -- but we could understand if he needed to keep closer to the consensus for personal professional reasons. Turns out he chose the latter, and in April issued an appropriately guarded but inappropriately optimistic forecast along with a call for higher inflation. He had to walk that back in July, which he did with aplomb, but he should have gone with the Demand Side stock. In any event, we are inspired to write a memo outlining the four basic forecasting errors that cloud the current outlook for the non-Keynesian, non-Demand Side economist. Which includes virtually all, and excludes only those who have been right.


  1. Assuming consensus is a good indicator
  2. Assuming the Fed controls the money supply
  3. Assuming a natural return to equilibrium
  4. Assuming a return of the consumer economy.

On the first he went so far as to statistically distribute and analyze the predictions of forecasters as if they were independent data points. Any empirical examination will show economists' forecasts more than a few quarters out to be highly inaccurate. Witness the major failure to predict the GFC and before that the recession brought on by the housing bubble and bust. Since most forecasters share the same Neoclassical errors, there should be no surprise that they correlate much better to each other than they do to actual outcomes. This is nearly explicit in a statement you often hear that forecasts are subject to a high degree of uncertainty.

On the second, the error of thinking the Fed controls the money supply is admittedly nearly ubiquitous, in spite of some detailed work done by no less conservative economists than Edmund Phelps and Finn Kydland. We've made this point before, but it bears repeating. The money supply expands and contracts to fit the boom and bust. That means innovation and intermediation on the way up and deleveraging and disintermediation on the way down. These processes are the V in MV equals PQ. When economists say we are sure to have inflation because the Fed is creating money, they are wrong. The Fed can make base money, but it cannot make the banks lend, nor people borrow, nor the rest of the story.

As John Kenneth Galbraith once noted, nothing has survived contradictory evidence so well as the belief in the efficacy of monetary policy. The Fed has been able to stall the economy quite effectively at times by increasing interest rates and the cost of doing business, but in terms of starting it, not so much. This follows directly from the mistaken belief that the Fed controls the money supply and the money supply will expand in proportion to the Fed's printing.

The third mistake is also endemic to Neoclassical economists. That is the widespread belief that there is a natural stabilizing mechanism of one kind or another. Sometimes it is postulated through the labor markets, more recently you hear that corporate profits will stimulate investment. As we noted before, these profits were generated by cutting costs -- efficiencies they are called. This means jobs and this is downward pressure on the economy as a whole, even as it pushes up company bottom lines. No matter the speculation on labor right-sizing its wage demands, no market function exists that brings economies into the mythical equilibrium naturally.

So-called automatic stabilizers do exist, but these are the policies and programs of social insurance -- unemployment and social security -- of the New Deal that kick in automatically. They are not anything inherent to capitalism, but an adjustment to capitalism. These put a floor under demand, and often by increasing government deficits. Discretionary -- as opposed to automatic -- stabilizers are those things like public works or jobs programs that are passed during the crisis. They are no less functions of public policy action, they are just not embedded in law prior to the need for them. These are the base under demand, and in the current crisis, these are the reasons the depression has not been as deep as that of the 1930s, where they were invented in the New Deal. Federal revenue sharing today with states and local governments would be an extremely effective stabilizer. But it difficult to institute politically for the opposition of the savage stupidity generated by panicking self-interest.

Fourth, and last on this list of major forecasting errors, is the nearly universal assumption on both Left and Right that any recovery will come through the private consumer economy. This ignores the huge private debt that crushes spending power, but also the general absence of productive investment opportunities in consumer products. A glut of capacity exists. And right in the middle is the housing situation. Housing has led every recovery since the Second World War. Housing was nurtured by growth-oriented economists since the great Leon Keyserling, for its ability to produce both jobs and household assets. Now there is a tremendous overhang of inventory and the housing asset is now a financial liability.

Were demand to be shifted to public goods, such as infrastructure, energy and social services, ample opportunity for private investors would be forthcoming. It is investment that produces growth in both the short and long terms. It is the prospect of profit that stimulates investment. It is more or less certain demand for products that produces the prospect of profit. This is the reason for advertising, to control demand for the goods one wants to produce. But even with modern mind control, the consumer is not a source of stable, certain demand, because he is tapped out.

The government can be.

And before we leave this, we have to note again, that economics is being put to the service of the status quo, and the status quo is unsustainable, not least in its utilization of the environment. We are at a tipping point with regard to the planet's climate. This tragic fact is ignored in the economic debate when it ought to be at the center. Next week, we'll look at energy and carbon as a route out of the economic mess. Today, lets just recognize that reorganizing and retooling and reconstructing transportation, housing and energy will pay off in real terms, and we will be crippled in all dimensions until we can see this.

Now, on the subject also to be covered later in the excerpt from the president's press conference, we have Michelle Gerard of RBS



Stop, Stop Stop. 97 percent of small businesses are not impacted. Of the three percent that are, some are in the Fortune 100, not so small, but these are S corporations. Beyond this, when people say small business creates the most new jobs, they are primarily talking about new businesses which succeed. That is, the Whole Foods which go from one store to one thousand and explode into big business. These companies are not going to worry about less than five percent on the top marginal income tax. Another group comes from lawyers and doctors and other high-priced professionals who are small businesses covering a group of professionals.

Is this a headwind? We illustrated the effect of tax cuts on the rich as a means of stimulating the economy a few weeks ago using the multiplier. It turns out that high-roller tax cuts have a multiplier below .6, as empirically derived. This means for every one dollar of benefit, they produce sixty cents of economic action. This is a loss of 40 cents.

And finally, if there were any sound economic theory behind this, you can be sure it would be trotted out right now. Instead we get the weather report, headwinds, or logical fallacies: because it works for the middle class, it has to work for the rich. No, it doesn't. This is not class warfare. It is legitimate economics.

Michelle Gerard


Idiot of the Week.

Robert Shiller recommended a couple of weeks ago an employment program to stabilize the economy. Figuring $30 billion per one million jobs. At that rate, for the cost of one AIG bailout, we could have three percent unemployment. But Hyman Minsky was far ahead. Still, of course, following the great John Maynard Keynes and the masters of the New Deal, but far ahead of today.

While current economic stability planning and policy has been ceded to the Fed, with its short-term interest rate, and to inducements to corporations, Minsky saw twenty-five years ago that a better approach than interest rates was employment.


Stabilizing an Unstable Economy, p. 343

An Employment Strategy

Although stabilization policy operates upon profits, the humane objective of stabilization policy is to achieve a close approximation to full employment. The guarantee of particular jobs is not an aim of policy; just as with profits, the aggregate -- not the particular -- is the objective.

The current strategy seeks to achieve full employment by way of subsidizing demand. The instruments are financing conditions, fiscal inducements to invest, government contracts, transfer payments and taxes. This policy strategy now leads to chronic inflation and periodic investment booms that culminate in financial crises and serious instability. The policy problem is to develop a strategy for full employment that does not lead to instability, inflation and unemployment.

The main instrument of such a policy is the creation of an infinitely elastic demand for labor at a floor or minimum wage that does not depend upon long-and short-run profit expectations of business. Since only government can divorce the offering of employment from the profitability of hiring workers, the infinitely elastic demand for labor must be created by government.

A government employment policy strategy should be designed to yield outputs that advance well-being, even though the outputs may not be readily marketable. Because the employment programs are to be permanent, operating at a base level during good times and expanding during recession, the tasks to be performed will require continuous review and development.

There are four labor-market aspects to an employment strategy:
  1. The development of public, private and in-between institutions that furnish jobs at a noninflationary base wage.
  2. The modification of the structure of transfer payments.
  3. The removal of barriers to labor force participation
  4. The introduction of measures that constrain money wages and labor costs.

The four aspects of the employment strategy are linked. If the massive transfer-payment apparatus is to be dismantled, then alternative sources of income must be guaranteed for the current and potential recipients of such payments. If barriers to labor-force participation are removed, then jobs have to be available for those who are now free to enter the labor market. Constraints upon money wages and labor costs are corollaries of the commitment to maintain full employment.

Now and finally, an extended excerpt from last week's presidential news conference. Already the ice seems to be breaking as a result of this no doubt political initiative. But here, without further introduction:


Friday, September 10, 2010

Joseph Stiglitz is still waiting for a fix to the housing market

Fixing America’s Broken Housing Market

Joseph E. Stiglitz

Project Syndicate


NEW YORK – A sure sign of a dysfunctional market economy is the persistence of unemployment. In the United States today, one out of six workers who would like a full-time job can’t find one. It is an economy with huge unmet needs and yet vast idle resources.

The housing market is another US anomaly: there are hundreds of thousands of homeless people (more than 1.5 million Americans spent at least one night in a shelter in 2009), while hundreds of thousands of houses sit vacant.

Indeed, the foreclosure rate is increasing. Two million Americans lost their homes in 2008, and 2.8 million more in 2009, but the numbers are expected to be even higher in 2010. Our financial markets performed dismally – well-performing, “rational” markets do not lend to people who cannot or will not repay – and yet those running these markets were rewarded as if they were financial geniuses.

None of this is news. What is news is the Obama administration’s reluctant and belated recognition that its efforts to get the housing and mortgage markets working again have largely failed. Curiously, there is a growing consensus on both the left and the right that the government will have to continue propping up the housing market for the foreseeable future. This stance is perplexing and possibly dangerous.

It is perplexing because in conventional analyses of which activities should be in the public domain, running the national mortgage market is never mentioned. Mastering the specific information related to assessing creditworthiness and monitoring the performance of loans is precisely the kind of thing at which the private sector is supposed to excel.

It is, however, an understandable position: both US political parties supported policies that encouraged excessive investment in housing and excessive leverage, while free-market ideology dissuaded regulators from intervening to stop reckless lending. If the government were to walk away now, real-estate prices would fall even further, banks would come under even greater financial stress, and the economy’s short-run prospects would become bleaker.

But that is precisely why a government-managed mortgage market is dangerous. Distorted interest rates, official guarantees, and tax subsidies encourage continued investment in real estate, when what the economy needs is investment in, say, technology and clean energy.

Moreover, continuing investment in real estate makes it all the more difficult to wean the economy off its real-estate addiction, and the real-estate market off its addiction to government support. Supporting further real-estate investment would make the sector’s value even more dependent on government policies, ensuring that future policymakers face greater political pressure from interests groups like real-estate developers and bonds holders.

Current US policy is befuddled, to say the least. The Federal Reserve Board is no longer the lender of last resort, but the lender of first resort. Credit risk in the mortgage market is being assumed by the government, and market risk by the Fed. No one should be surprised at what has now happened: the private market has essentially disappeared.

The government has announced that these measures, which work (if they do work) by lowering interest rates, are temporary. But that means that when intervention comes to an end, interest rates will rise – and any holder of mortgage-backed bonds would experience a capital loss – potentially a large one.

No private party would buy such an asset. By contrast, the Fed doesn’t have to recognize the loss; while free-market advocates might talk about the virtues of market pricing and “price discovery,” the Fed can pretend that nothing has happened.

With the government assuming credit risk, mortgages become as safe as government bonds of comparable maturity. Hence, the Fed’s intervention in the housing market is really an intervention in the government bond market; the purported “switch” from buying mortgages to buying government bonds is of little significance. The Fed is engaged in the difficult task of trying to set not just the short-term interest rate, but longer-term rates as well.

Resuscitating the housing market is all the more difficult for two reasons. First, the banks that used to do conventional mortgage lending are in bad financial shape. Second, the securitization model is badly broken and not likely to be replaced anytime soon. Unfortunately, neither the Obama administration nor the Fed seems willing to face these realities.

Securitization – putting large numbers of mortgages together to be sold to pension funds and investors around the world – worked only because there were rating agencies that were trusted to ensure that mortgage loans were given to people who would repay them. Today, no one will or should trust the rating agencies, or the investment banks that purveyed flawed products (sometimes designing them to lose money).

In short, government policies to support the housing market not only have failed to fix the problem, but are prolonging the deleveraging process and creating the conditions for Japanese-style malaise. Avoiding this dismal “new normal” will be difficult, but there are alternative policies with far better prospects of returning the US and the global economy to prosperity.

Corporations have learned how to take bad news in stride, write down losses, and move on, but our governments have not. For one out of four US mortgages, the debt exceeds the home’s value. Evictions merely create more homeless people and more vacant homes. What is needed is a quick write-down of the value of the mortgages. Banks will have to recognize the losses and, if necessary, find the additional capital to meet reserve requirements.

This, of course, will be painful for banks, but their pain will be nothing in comparison to the suffering they have inflicted on people throughout the rest of the global economy.

Thursday, September 9, 2010

James K. Galbraith asks, “What can be done now?”


Galbraith: Thoughts on a Plan B

In July 2008, in a memorandum for the Obama campaign team and later published in Challenge,  I wrote as follows:

If the above analysis is correct, the political capital of the new presidency risks being depleted, quite quickly, in a series of short-term stimulus efforts that will do little more than buoy the economy for a few months each. Since they will not lead to a revival of private credit, every one of those efforts will ultimately be seen as “too little, too late” and therefore as ending in failure.

Painful though it is to repeat those words, the question remains: what can be done now?

1. First of all, do not rely on the Federal Reserve. Quantitative easing is eyewash – a fantasy solution.  And the zero interest policy is also not expansionary.  These policies relieve banks of bad assets, provide them with cheap funds, and make them seem profitable in spite of the fact that they are doing nothing constructive.  They do not increase lending to the public and therefore have no effect on spending.  Further, the zero interest rate policy reduces total spending, since it cuts interest incomes and therefore spending from interest income.

Eventually the short-term interest rate should be raised, and banks “jawboned” to raise the interest rates they pay on deposits and CDs.  This is an expansionary policy under appropriate conditions:it squeezes bank profits and encourages them to take more business risk. As in 1994, banks that are truly solvent will seek to keep their earnings up by making commercial and industrial loans – the legitimate risk-taking that powers the private economy.

2.  As for the banks that are not truly solvent, who needs them? They are a burden, kept alive by the raw exercise of political power.  It is past time for clean audits, for definitive market valuation of toxic assets, and for the downsizing of bloated banks, under new top managers – paid appropriately less than the current crop. Meanwhile we need full investigation and prosecution of the vast swindles in the mortgage markets.

3.  Restructure household debts.  Restoring financial health to households will be a long, slow process, but it must start.  Let’s have a new bankruptcy reform ending the indentured servitude imposed under Bush, and also enact the right of judges to cram down mortgage payments in bankruptcy.  Let’s enact right-to-rent for foreclosed homeowners, and direct Fannie Mae and Freddie Mac to reset and restructure mortgage payments aggressively.

4.  Let people retire!  Full employment is the right goal but job losses have been so severe that practically we are not going to get there by any known measures. So we need to choose who gets the first crack. The right thing is to allow older workers who wish to exit the labor force to do so, opening jobs for younger people. Enact a three-year window during which workers aged 62 and older could retire on full Social Security.  Enact Medicare at 55, allowing workers with health problems but sufficient resources otherwise to escape into a comfortable retirement.

5.  Help the States.  So far, help for states in the stimulus program has only offset the job cuts imposed by falling revenues and balanced-budget requirements. There must now be fiscal assistance to end, finally, the budget crisis of states and localities.  Federalizing Medicaid may be the most effective and practical way to achieve this. The alternative is open-ended general revenue sharing: on the condition that states neither raise nor lower their tax rates, the federal government should supply the funds required to close their budget gaps and to maintain public services at baseline levels, for the duration of the crisis.

And if deficit hysteria could be overcome, the following steps should also be taken:

6.  Tax relief for workers.  The American Recovery and Reinvestment Act (ARRA) offset payroll taxes through the income tax.  This policy should be extended, expanded, or even altogether replaced by a full payroll tax holiday, granting all working families an increase in after-tax incomes of over eight percent up to the limit of the FICA. To keep the Social Security Trust Fund whole, let the federal government credit it for the taxes — and add the revenues of the estate tax for good measure.  The policy of tax relief for workers should remain in place until unemployment falls below six percent, at which time it can be gradually phased out. Tax relief for the wealthy is a failed strategy that should end now; a higher personal tax rate will induce companies to retain and invest their earnings, as they used to do.

7.  Jobs Programs.  Taking a leaf from the New Deal, let the federal government establish a new Conservation Corps, a Neighborhood Corps to protect, maintain and revitalize (or as necessary demolish) distressed housing, and a Home Care corps to provide services to the elderly in their own homes.   Other suggestions welcome.

8.  Strategic Investments: Energy and Climate Change.  The illusion of stimulus was that the economy would “return to normal” with a little “fiscal boost.”  The reality is that having exhausted (however imperfectly) the 1940s agenda of middle-class housing, the 1950s highways agenda, the 1960s health-care agenda and the 1990s information-technology bubble, the economy needs a new strategic direction.  The clear and pressing priorities are energy and climate change. To address these challenges is a grand task, requiring decades of research, careful planning and many investments, if we are to pass on a livable planet and a decent living standard.  Institutionally it will require new lending agencies to assure that the funds needed are available over the long term. And the work can provide jobs for millions, for many years.

Wednesday, September 8, 2010

Transcript: 403 Obama Plan: More infrastructure, more recovery juice needed

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The failure of economic policy in America and in Iraq. We look at liberal analysis of what went wrong and what to do about it from Robert Reich and Paul Krugman with regard to the U.S. On Iraq, we cast back to George Marshall and the Marshall plan, with a nod to George McGovern and the McGovern plan. And we’ll throw in an idiot of the week.

We begin with an anticipation of the president’s announcement today, borrowed from Eric Tymoigne at New Perspectives from Kansas City..

The White House released the following statement regarding its new recovery plan: "The President today laid out a bold vision for renewing and expanding our transportation infrastructure – in a plan that combines a long-term vision for the future with new investments. A significant portion of the new investments would be front-loaded in the first year."

This front load is worth $50 billion…a lot of money…but an insignificant amount compared to the size of what is needed. It is not a bold vision it is a very timid vision. Don't believe me? Ask the American Society of Civil Engineers. In its 2009 Infrastructure Report Card, it gave a D average to US infrastructures and recommended $2.2 trillion of dollars of spending over the next 5 years. And that is just to bring current infrastructures back to good condition; trillions more are needed to respond to growing needs.

Money is not a problem for the federal government, all this could be started tomorrow like we have done to finance wars, bail outs the financial sector and other wasteful items. We did it before, when the country had a truly bold vision and was much less wealthy, and we could do it again. Besides current infrastructures, we need to start to use our underused resources (especially labor) to address the future needs of our aging population and our environmental problems: education, infrastructure, social networks, technology, energy, food production, and many others sectors need help.

That from Eric Tymoigne

We reported more than two years ago on the blue ribbon commission on surface transportation suggesting a $250 billion per year program for twenty years to be financed by a gradually increasing tax on gasoline. This is not only the scope of the infrastructure need, it is exactly the kind of investment -- yes the “I’ word -- that would regenerate real employment.  Financing it with taxes on gasoline was particularly apt.  There is no better toll booth for the nation's transportation infrastructure than the gas pump.  This would give an immediately apparent means for repaying the investment, and so could be financed off the operating budget -- on a capital budget -- with bonds whose service would come directly from these dedicated tax revenues.  This is real investment.

For conventional liberal perspective on this, we turn to the opinion pages of the New York Times. September 3 you had pillars on each side of page A19 -- one column from Paul Krugman and the other from Robert Reich.

Reich begins on point under the head “How to End the Great Recession.”

This promises to be the worst Labor Day in the memory of most Americans....
The national economy isn’t escaping the gravitational pull of the Great Recession. None of hte standard booster rockets are working: near-zero short-term interest rates from the Fed, almost record-low borrowing costs in the bond market, a giant stimulus package and tax credits for small businesses that hire the long-term unemployed have all failed to do enough.

Thyt’s because the real problem has to do with the structure of the economy, not the business cycle. No booster rocket can work unless consumers are able, at some point, to keep the economy moving on their own. But consumers no longer have the purchasing power to buy the goods and services they produce as workers; for some time now, their means haven’t kept upwith what the growing economy could and should have been able to provide them.

Riech then continues with various proposals and programs to improve the spending power of the consumer. Notably absent is reducing the mortgage debt by writedowns, which should be the first step.

Krugman’s column is entitled “The Real Story.”

... President Obama is scheduled to propose new measures to boost the economy. I hope they’re bold and substantive, since the Republicans will oppose him regardless -- if he came out for motherhood, the GOP would declare motherhood un-American. So he should put them on the spot for standing in the way of real action.

But let’s put politics aside and talk about what we’ve actually learned about economic policy over the past 20 months. When Mr. Obama first proposed $800 billiion in fiscal stimulus, there were two groups of critics. Both argued that unemployment would stay high -- but for very different reasons.

One group -- the group that got almost all the attention -- declared that the stimulus was much too large, and would lead to disaster. If you were, say, reading the Wall Street Journal’s opinion pages in early 2009, you would have repeatedly been informed that the Obama plan would lead to skyrocketing interest rates and soaring inflation.

The other group, which included [Krugman] warned that the plan was much too small given the economic forecasts then available. As he pointed out in February 2009, the CBO was predicting a $2.9 trillion hole in the economy over the next two years; an $8oo billion program, partly consisting of tax cuts that would have happened anyway, just wasn’t up to the task of filling that hole.

Krugman then goes on to correctly define who was right and why.

The Demand Side objection to both these points of view is that it assumes that the consumer will someday come back as the engine of the economy. We will learn to produce things for the people of China or our own consumers will rebound.

We believe the consumer is not the engine of recovery, except as he or she consumes public goods.

To expect big new investment in consumer goods industries is an expectation that the consumer will climb out from under his debt with such strength and vitality that he will fill the existing and dormant industrial capacity and come back for more. Not a likely outcome.

What else went wrong? Monetary policy is being treated as if it works, in spite of no new private sector investment.  And the Fed is treated as if it knows what it is doing. They are serving the banking interests they are supposed to be regulating. As far as effectiveness, in particular, looking forward to QE II, we offer the following exchange between Kathleen Hayes of Bloomberg and Allen Sinai of Decision Economics.


If that is the mechanism quantitative easing is going to use, it is no wonder it is not working. 

The end of the combat mission in Iraq was announced last week in what is already one of the least-remembered addresses from the Oval Office by any U.S. president. It completed a pledge made in the campaign by Barack Obama and consummated the agreed withdrawal negotiated by former president George W. Bush. But the situation in Iraq is far from settled.

Much has been made of the nearly fifty thousand American service personnel still in Iraq and the context of corruption and instability of the domestic political situation in which they operate. Probably as important to the average Iraqi on the ground is the stone age condition of the country’s infrastructure.

In 1990, Iraq boasted infrastructure and living conditions among the best in the Middle East. After the devastation of the first Gulf War and the damage inflicted by the subsequent invasion by the U.S. to oust Saddam Hussein, the conditions are radically worse. This in spite of more than fifty billion in reconstruction aid provided by the U.S. and allies specifically to rebuild the country.

Demand Side views the rebuilding effort as an object lesson in how not to win a peace. We have the example of how to do it right in the Marshall Plan instituted to rebuild Europe after the Second World War. In spite of protestations to the contrary by historical revisionists -- including Alan Greenspan -- the Marshall Plan effectively won the war by winning the political peace.

Officially titled the European Recovery Program, the ERP was conducted between 1947 and 1951. Its purpose was to rebuild and create the economic foundation for the countries of Europe. Named for Secretary of State George Marshall, three times TIME’s Man of the Year, the plan modernized European industrial and business practices, reduced artificial trade barriers and instilled a sense of hope and self-reliance. It relied on the political and business leaders of the countries themselves to come up with the plans, mandated integration and coordination of plans, and insisted on strict standards. In executing the Marshall Plan the nations of Europe experienced the fastest growth in their history and at the same time wove the fabric of a working peacetime economy from the devastation of war.

We could have done something broadly similar in Iraq by empowering the Kurds, Sunni’s and Shia factions to develop their own plans and programs and requiring them to come up with legitimate rebuilding activities. We could have evaluated those plans and reconciled them with reality, funded them, and mandated strict performance standards.

Instead the U.S. embarked on one of the most corrupt and incompetent operations in living memory. More than ten billion in Defense Department support is unaccounted for. Reports of truckloads of hundred dollar bills being offloaded into trucks were too numerous to be false. Big U.S. industrial corporations like Halliburton got massive no-bid contracts and produced these many years later nothing workable. Rolling brownouts are the rule. Sewer and water systems are inadeuquate to even minimum standards.

An Iraq program which required integration and cooperation by the disparate factions, targeted to modernizing and preparing the economy for the future -- as was the Marshall Plan -- and utilizing the indigenous intellectual, business and political capacity would have woven the fabric of a working society. Instead, to the barbaric American, political stability still means a government in control of an effective military and police apparatus. That definition of political stability has not been met, but even if it were, it would not produce political stability. A functioning society is composed of interdependent working parts. Business, utilities, civil service and political functions working together. The idea that we could somehow build projects FOR them while enriching our domestic corporations and an army of mercenary civil engineers and heavy equipment operators is just nonsense.

That said, it is highly likely that the inputs for rebuilding would have been purchased from the U.S., from established companies and would have resulted in long-term relationships. The Marshall Plan was beneficial in this way. Failure has been a boon to nobody.

Instead, seven years later, the Special Inspector General for Iraq said, in part

Special Inspector General for Iraq Reconstruction
Stuart Bowen

The seven-year Iraq stabilization and reconstruction program — the largest ever undertaken by the United States — began without a sufficiently established management structure capable of executing the unprecedented effort. In mid-2003, the U.S. government undertook a massive reconstruction mission—much larger than planned and now exceeding $53 billion—with an ad hoc management system. Some projects met contract specifications, but the many unacceptable outcomes stemmed chiefly from the lack of a clear, continuing, and coherent management structure (as opposed to a paucity of resources or poor leadership).

Hard experience has shown that the United States did not have the financial, personnel, information technology, or contracting systems in place necessary to execute what became the most extensive and most expensive SRO in history. It is thus not surprising that the Iraq program failed to achieve its goals.

At the outset, there was no established plan and no existing and well-resourced office to manage the effort. Eventually, the Iraq reconstruction program devolved along with the security situation. Decisions were driven by circumstances, and the unstable security environment impeded progress on all fronts, preventing success. Notwithstanding these painful realities, some of which were perhaps unavoidable, a well-developed SRO plan and a sufficiently robust interagency management office could have implemented program adjustments that might have averted the waste of hundreds of millions of taxpayer dollars.

Thus, the inspector general admits failure, but casts it as an inadequacy of central command and control. It was, rather, an inadequacy of approach.

Is this all hindsight? No. The McGovern Plan produced shortly after victory proposed just such a way of going about it. Had that plan been implemented, the Iraqi society would not have collapsed. The health care system would not have lost its human capital. The United States would not be leaving in disgrace, even as Republicans and Democrats vie for credit.

We at Demand Side wrote pretty much what we are talking about now.

Somebody will fill the void -- the Chinese, the Iranians -- we don’t know. The peace can still be won. Perhaps it can be us who wins it.

Sunday, September 5, 2010

Steve Keen: “Back to the Future” in the U.S. economy

Back to the Future

Published in September 5th, 2010

by Steve Keen in Debtwatch

Things are looking grim indeed for the US economy. Unemployment is out of control—especially if you consider the U-6 (16.7%, up 0.2% in the last month) and Shadowstats (22%, up 0.3%) measures, which are far more realistic than the effectively public relations U-3 number that passes for the “official” unemployment rate (9.6%, up 0.1%).

The US is in a Depression, and the sooner it acknowledges that—rather than continuing to pretend otherwise—the better. Government action has attenuated the rate of decline, but not reversed it: a huge fiscal and monetary stimulus has put the economy in limbo rather than restarting growth, and the Fed’s conventional monetary policy arsenal is all but depleted.

This prompted MIT professor of economics Ricardo Cabellero to suggest a more radical approach to monetary easing, in a piece re-published last Wednesday in Business Spectator (reproduced from Vox). Conventional “Quantitative Easing” involves the Treasury selling bonds to the Fed, and then using the money to fund expenditure—so public debt increases, and it has to be serviced. We thus swap a private debt problem for a public one, and the boost to spending is reversed when the bonds are subsequently retired. Instead, Caballero proposes

a fiscal expansion (e.g. a temporary and large cut of sales taxes) that does not raise public debt in equal amount. This can be done with a “helicopter drop” targeted at the Treasury. That is, a monetary gift from the Fed to the Treasury. (Ricardo Caballero)

The government would thus spend without adding to debt, with the objective of causing inflation by having “more dollars chasing goods and services”. This is preferable to the deflationary trap that has afflicted Japan for two decades, and now is increasingly likely in the US. So on the face of it, Cabellero’s plan appears sound: inflation will reduce the real value of financial assets, shift wealth from older to younger generations, and stimulate both supply and demand by making it more attractive to spend and invest than to leave dollars languishing, and losing real value, in the bank.

However, though this is indeed the right time to consider radical solutions, Cabellero’s proposal would do only half the required job. Focusing on the good bit, one reason we got into this predicament in the first place was because private sector, debt-based money swamped public sector, fiat money. Ultimately we need to return to the public-private money balance we had in the 1950s and early 1960s.

But if getting “Back to the Future” was all we needed to do, then our problems would already be over, because Ben’s Helicopter Drop of late 2008 has got us there already: the ratio of M0 to M2 is now almost 0.25, far higher than the 1960 level of 0.14, while the ratio to M3 is back where it was then (using Shadowstats data, which I can’t publish here since it’s proprietary).

So why aren’t we “Back To The Future” already? Why isn’t the economy booming once more, and why is inflation giving way to deflation?

Because, though the money supply is back to where it was in 1960, the debt to money ratio is utterly different. Even after Ben’s Helicopter Drop, the debt to base money ratio is almost twice what it was in 1960, and over 3 times what it was back in the Golden Days of the 1950s.

This points out the blind spot in the thinking of even progressive Neoclassicals like Cabellero, who are willing to consider unconventional policies: they don’t understand how money is created in our credit-driven economy. Because of that, they don’t appreciate how much of that credit has financed a glorified Ponzi Scheme rather than investment, nor do they comprehend the impact that private sector deleveraging is having on aggregate demand.

I’ve covered the first topic ad nauseam in my post “The Roving Cavaliers of Credit”, so I won’t repeat myself here. Instead I’ll focus on the obvious message from the above chart: if the government simply pumps its money into the system without restraining the financial system from financing speculation on asset markets, the best we can hope for is a repeat of this crisis, on an even larger scale, some years down the track. To see that, all we have to do is look at what happened back in the 1980s.

The Debt to M0 ratio, which had risen sixfold since the 1950s, went into sudden reverse as the economy imploded when the Savings and Loans fiasco ended. The growth of debt collapsed, and the State tried to rescue the financial sector from its follies by fiscal policy and boosting the money supply. That rescue ultimately succeeded when the recession of the 1990s finally ended, but since finance was emboldened rather than reformed, it simply financed two further fiascos: the DotCom madness and then the Subprime scam.

The reason why the 1990s rescue isn’t working this time stands out more clearly when you look at the changes in debt and M0 in raw dollar terms (the scale of the change in M0 is 1/5th that for the change in debt in next two graphs). In the 1990s crisis, the rate of growth of private debt slowed by 2/3rds, but it didn’t actually fall; and a quadrupling of the rate of growth of M0 (starting half a year after debt growth slowed down) was enough, after several years, to let the Wall Street party resume.

This time, the change in debt has turned solidly negative—having growth at up to $4 trillion p.a., it is now shrinking at over $2 trillion. Ben’s far larger quantitative easing (when compared to Alan’s back in 1990-94) simply hasn’t been enough to fight a private sector that is now seriously deleveraging.

QE2 could nonetheless work, if Cabellero’s plan was executed with gusto. But if all we do is effect a monetary rescue, and yet leave the finance sector untouched, then it will reborn once again as an even bigger Ponzi Scheme.

Do we really want to go through all that again?

Saturday, September 4, 2010

Relay 402A Joseph Stiglitz on the Great Financial Crisis

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Here is Joseph Stiglitz speaking to the Australian National University on the causes and conditions for the global financial crisis and taking questions on a variety of subjects.

Wednesday, September 1, 2010

Transcript: 402 Confusion in Jackson Hole


Today on the podcast, confusion from Jackson Hole, but also some slow movement toward realism. We feature Bill White and Carmen Reinhart. From another time and place and level of understanding we share a clip of this Saturday's relay of Joseph Stiglitz speaking in Australia.

The markets took heart when Baffled Ben Bernnake promised to do something if things got worse. This demonstrates the childlike simplicity combined with the superficiality of the political and financial establishment. What Ben will do was not important. The fact that he has a beard and a powerful position was much more significant.

What would Ben do? The buzz was more quantitative easing. That is, buying securities. If they buy Treasuries, that will be monetizing the debt. If they buy other forms of securities, it would be outside their purview, but that hasn't stopped them before. And why bother with Treasuries, when they are loaning money at zero to the banks who buy them to collect the spread. That is, we are already monetizing the debt and paying the banks for the privilege.

Paul Krugman and others have called for a way of finessing the darned zero bound, which prevents monetary policy from working. Not unlike complaining that the runway cannot be made low enough. It is not preventing the crashing of the airplane. Better to give a little juice to the engine than to pretend we can dig fast enough.


The Jackson Hole Symposium of central bankers displayed three years on that these people have no idea of what they're doing. The market response to Bernanke's speech displays that the markets have no idea that the Fed has no idea of what it's doing.

How can it be that the phrase "Bernanke and the Fed will do whatever it takes" has any punch left? In this case it is deflation. Bernanke will do whatever is necessary to avert deflation. In the fall of 2007 it was to avert a recession. Bernanke will do whatever it takes to avert a recession. They got blindsided by a financial crisis. They did whatever they could to avert a financial meltdown. Neither recession, financial meltdown, nor deflation were averted. I use the past tense purposely. Asset price deflation is in full swing.

House prices dropping to 60 percent of their previous high and commercial real estate prices following. There may be some noise from commodity markets, where cost-push and speculation creates volatility that are picked up by the broad CPI and PPI. But consumer price deflation is sure to follow asset price deflation, as all business activity comes to be focused on producing consumer goods even while consumer demand is shrinking by virtue of unemployment and heavier debt loads. To restate that. In a healthy, growing economy, there are both investment goods and consumer goods being produced, and the workforce is divided between the two, with those in investment goods typically garnering higher wages. In a stagnating, shrinking economy, there is only the consumer goods sector, with business and labor watching their wealth shrink and racing each other to the bottom in terms of prices.

Bill White, formerly of the Bank for International Settlements and now at the OECD and Carmen Reinhart spoke outside the meeting hall at Jackson Hole shortly after Reinhart presented her research on the historical record of the decade before and the decade after financial crises. We panned the recent book by Reinhart co-authored with Ken Rogoff, which purported to find a tipping point at 90 percent of GDP where government debt begot a declining economy. That didn't hold empirical or theoretical water. Here, however, Reinhart has come up with something in the lead-off presentation at the central bankers' symposium.

She has identified the tremendous build-up of debt leading to a crisis and the constriction of economies by this debt after the crisis as the salient feature of crises. She could have just read Steve Keen's blog, but at least she came up with the information, if still lagging on the theory. Keen used exactly the evidence of this debt build-up to predict the financial crisis. It got him a Revere Prize, but not yet standing in the coterie of PHUDS, Ph.Ds who run the economic establishment for their own purposes.

But we are too cynical. Here is Bill White, chief discussant of the Reinhart paper, speaking to Bloomberg.


and here is Carmen Reinhart herself.


Now as we said the one person who has been out in front is Steve Keen. He employed his appreciation of rising debt levels to predict the GFC. Reinhart is coming along with the empirical details, but everyone is still behind the curve in theory except Keen.

His observations on Bernanke's speech are up on his web site. They begin

Bernanke’s recent Jackson Hole speech didn’t contain even one reference to the key force driving the American economy right now: private sector deleveraging (here’s the previous year’s speech for comparison’s sake). The reason the US economy is not recovering from this crisis is because all sectors of American society took on too much debt during the false boom of the last two decades, and they are now busily getting themselves out of debt any way they can.

Debt reduction is now the real story of the American economy, just as real story behind the apparent free lunch of the last two decades was rising debt. The secret that has completely eluded Bernanke is that aggregate demand is the sum of GDP plus the change in debt. So when debt is rising demand exceeds what it could be on the basis of earned incomes alone, and when debt is falling the opposite happens.


All these characters in Jackson Hole would gain a great deal of clarity if they understood another thing that Minsky and Keen and others are trying to tell them. The money supply is endogenous. The Fed does not control the money supply. It will shrink in a falling economy and expand in an expanding economy as a function of internal dynamics. Bankers will create money for a boom. They will destroy money in a bust. Intermediation, innovation, disintermediation and deleveraging.


So just as the recession was already in progress when Bernanke promised to do whatever it took to avoide it, so the deflation is already in progress even as Bernanke -- or his apologists -- promise to do whatever it takes to avoid it.

But do low Fed interest rates CAUSE deflation. This suggestion was raised by Minnesota Fed President Narayana Kocherlakota and immediately attacked by Paul Krugman and his liberal fellow travellers as ludicrous. While we do not follow Kocherlakota's line of reasoning which has to do with long-term expectations, we do, again, wonder why making new investment cheaper than existing investment goods by way of low interest rates does not erode the value of existing investment that may compete.

At the risk fo losing our left-leaning listeners, we'd like to point out that Paul Krugman is not in the direct lineage of Keynesian financial theory. That line runs through Hyman Minsky and Steve Keen, both of whom -- yes -- view the money supply as endogenous and the interest rate in a much different light.

Krugman's obsession with the zero bound, that monetary policy is frustrated because interest rates canot go below zero sounds to us like claiming that if only the runway were lower, the planes would not crash. In fact, in anything resembling a pragmatic world, you need more juice in the aircraft and less focus on excavation of interest rates by unconventional means. It seems as likely to us that the exercise of keeping interest rates low for the banks will only further reduce the value of existing assets. If new investment goods can be produced more cheaply that existing goods, it will drive the prices of existing assets to the new level, stimulate further distressed sales and contribute to debt deflation.

So, taking it up thirty thousand feet.

The brain trust in power during the run-up to the housing bust is still in power. The financial crisis occurred and the brain trust bailed out banking to the tune, "Save banking and we will save the real economy." The real economy was not saved, but bankers continue to get bailed out, because the same brain trust is still in power.

The division and dissension at the Fed is not evidence of anything except confusion. They operated in unanimity under Greenspan when they were doing equally badly. Now at least there is some appreciation that things are not going according to plan.

As the central bankers back away from the rubble and for reasons of maintaining professional capital maintain something along the lines of what they have always said, we should ourselves look to the only alternatives for stability, growth and financial reconstruction.

Economic stability based not on interest rates but on mandated full employment, which we will get to in an upcoming podcast by reviewing the plan put forward by Hyman Minsky. Economic growth must be based on investment in public goods, infrastructure and energy projects, that can be funded by positive interest rate "recovery bonds." Financial reconstruction has to be based on reconstructing the finances of households, not big banks. It needs to begin with writing down debt, converting debt to equity, and fully funding education so as not to generate debt in the normal activity of a healthy economy.


Now, in a peek at the return of the Saturday Demand Side Relay, here is a segment from the speech by Joseph Stiglitz to the Australian National University earlier in August.

Look for the rest of that on Saturday's Relay.