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Friday, October 31, 2008

Infrastructure Spending vs. Tax Rebates

With all due respect to Mankiw's "Let States decide" what kind of stimulus they get (which seems to me would be a political nightmare for numerous Governors, many of which may be new to office by the time the stimulus passes), there is good reason to favor direct spending such as via infrastructure a la a "New" New Deal as opposed to further tax rebates.

Firstly, there is significant evidence that consumers and firms are saving good chunks of their income due to the uncertainty of the market. In so far as that money is hoarded or used to pay off bad or old debt, then a rebate will do little to stimulate new investment and consumption. In so far that it is thrust into the financial sector via the purchase of bonds or stock etc., there is good chance that the money would be 'tied up' with the rest of the money that banks refuse to lend. It is true that lending is loosening, but it is still a problem.

No, the only way to guarantee an actual stimulus in this climate is through direct spending. Cut out the financial intermediaries and eliminate the potential for leakages and directly pump money into new investment projects - investment projects that sadly have been crowded out over the course of a number of decades due to the massive expense for the sake of "national defense" (or offense, as the case may be).

McCain's "Spending Freeze"

Not so much.

Wednesday, October 29, 2008

Another step closer to a liquidity trap - for nothing

Today the Fed acted to cut the Fed Funds rate to 1%. As I've expressed in the past, at best, this will likely be ineffectual.

I agree with economist Bernard Baumohl who said:

"The latest Fed move is not going to hasten the economic recovery by a single day or accelerate the cleansing of bank balance sheets, what is needed more than anything else at this stage is simply patience."

I agree with him that the problem lies not with the cost of obtaining a loan (the demand side), but with the inability / unwillingness of banks to lend (the supply side) in this time of great debt and uncertainty.

Thursday, October 23, 2008

A Sign of the Times

...and the shift in economic priorities - one that maybe occurs once in a generation.

Wednesday, October 15, 2008

Tuesday, October 14, 2008

Warnings from the Ignored Father of Macroeconomics

Some people, including economists are bemoaning the fact that the warnings about our 'excessive' economy were not heeded. They point to recent predictions made by Roubini and others years ago. But these warnings extend not just from 6 months prior, or 2 years ago - they go all the way back to an all-but-pushed-aside economist (nowadays at least): John Maynard Keynes, from Chapter 12 of his "General Theory":

"Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is “to beat the gun”, as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.... As the organisation of investment markets improves, the risk of the predominance of speculation does, however, increase.... Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.... These tendencies are a scarcely avoidable outcome of our having successfully organised “liquid” investment markets."

Here's to hoping his warnings are never forgotten (or ignored) again.

Saturday, October 11, 2008

"We are All Minskyans now": Support of Partial Nationalization of Financial Markets

The Fed Chair and Treasury Secretary and a number of rich nations have all agreed yesterday on a course of action which would essentially, at least partially, nationalize the banking / financial system worldwide.

I support this measure as an unfortunate necessity of our times. I've come to the conclusion after much thinking and much observation that the only way the government can attempt to end this crisis is to reduce the massive uncertainty in our banking and financial institutions. Having only one or two major / rich nations do this would be problematic as it would facilitate the flow of financial capital out of those troubled countries that failed to nationalize and toward those that did. No, to be beneficial globally, it has to be a global agreement. And it looks like that is what it will be.

Just throwing money at banks is more harmful than good as I mention in previous posts - again to reiterate, reduced interest is beneficial for those that want to consume or invest or borrow money for further lending (banks), but is hardly beneficial to banks and financial intermediaries that want to borrow when the banks they want to lend from have no incentive to do so, and that is where the real problem is. The problem isn't on the borrowing side of the equation, it's on the lending side.

By buying stock in failing banks etc., we assure other banks and customers etc. that that institution has the backing, support, and partial ownership by the government. This expectation alone immediately boosts the banks credit worthiness and reduces the uncertainty that if I as a bank lend to that institution, it could very likely fail. The idea is that interbank lending will eventually increase back to normal, and eventually the money will end up on main street where it belongs.

In order for this to work, massive amounts of stock will have to be bought. 700 Billion will not be enough to stop the global crisis. The entire system has to be normalized, and that will require a lot of nationalization.

Will this mean the end of capitalist financial markets? Not entirely, but it will mean the end of next-to-no-holds-bars financial markets. it will mean a true oversight by big government, and by the Central banks of the world. It will mean Hyman Minsky's predictions will have come true.

It's the end of an era. And the beginning of a new one.

Friday, October 10, 2008

Indiana Goes Obama

Indiana is now in the blue for the first time ever over at

Panic is the Incorrect Term

'A panic is a "situation in which people do things that contradict rationality," says Paolo Pasquariello, a professor at the University of Michigan's Ross School of Business.'

I disagree. There is nothing irrational about taking your money out of stocks and financial instruments in general in a situation of intense market uncertainty. The argument that the "real" economy isn't that bad, so why make such rash decisions is ridiculous given the fact that the "real" economy, more and more since the financial credit explosion of the 1970s to today, is the financial sector. IE, the financial sector is inextricably linked to the traditional real economy.

People aren't in a "panic." They are worried. They see rising uncertainty and a financial sector in shambles. Panic implies people making impulsive decisions when things aren't that bad. Economists and pundits should take a lesson from history. The last time we had a major "financially caused" recession was the Great Depression. Most all the recent past recessions have been due to bubbles in physical assets (which is what this started out as but got infinitely worse because of the securitization of those assets - which is a financial problem), shocks to input prices, etc. I don't personally think this will likely be a depression, but this will be one hell of a recession - there's nothing irrational about preparing for it.

Finally an Austrian post I can (partly) Agree With

Thorsten Polliet makes the solid case, that I agree with that, at a minimum, the Fed's rate cuts will do nothing to ease the current crisis conditions. Effectively there is a coordination failure in the credit money system that has created a vertical "wall" of money supply, whereby no reduction in r can stimulate the transfer of that money to those that need it. IE, no matter the money demand for investment spending, the supply can't get there.

And I think Thorsten is correct that this could be a net negative effect in that the lower interest rates mean that those that can obtain financing are urged to make ever riskier decisions regarding what to do with their cheaply lent money. Low-interest rates are bubble creating.

I disagree with his assessment that it is all the government's fault, or that somehow fiat money is the core trouble-maker. Government was a contributor certainly, but markets themselves need to take a hard look in the mirror.

Thursday, October 9, 2008

Present / Future Credit Mix under Financial Uncertainty and Endogenous Money

So, I have been working my brain trying to conceptualize how credit and financial mis-coordination can be integrated with Keynes' liquidity preference and post-Keynesian concepts of credit and money endogeneity.

This where I'm at so far. It may make no sense at all... but I guess everyone with an econ background should be at least trying to figure out what's going on! The first picture is my basic setup, the second is an example of potential dangerous attempted monetary expansion under conditions of endogeneity, liquidity preference and credit, and high levels of uncertainty whereby credit money suppliers / savers are unwilling / unable to lend for present spending

Wednesday, October 8, 2008

More evidence that debt from credit is at heart of crisis

Minsky theory predicts this.

People have negative borrowing-on-credit growth for the first time in a LONG time. This means people are taking more of their money and putting it against their debt - especially given that revolving credit card debt growth is negative. This is exactly what we would expect. So the Fed can pump all the money it wants into the economy. New spending will not happen until consumers and investors pay for the debt created by their past consumption and investment. When people pay this debt it goes right back to the banks --- where the money is tied up in the first place!

To quote post-Keynesian structuralism (like a crystal ball....):

Furthermore, Goodhart (1993) suggests that with the growth of wholesale

money markets and liability management, the distinction between situations of

illiquidity and conditions of insolvency has been erased in such a way that the

central bank’s role as lender of last resort involves a serious risk of loss. He also

warns that, in today’s more competitive conditions, a central bank would find it

increasingly hard to persuade banks to join in and share the burden of potential

loss from the rescue of an insolvent bank. He concludes, ‘this could lead to

serious problem for central banks. They may not have sufficient funds of their

own … to accept the potential losses involved in a future rescue exercise’

(Goodhart, 1993, p. 421). Here, the expression of liquidity preference for the

central bank operates through the amount of funds made available to banks. For

the central bank, the decision to place funds with the ‘risk-insolvent’ bank

involves the creation of new debts (i.e. change in the size of its portfolio). When

liquidity preference rises, the central bank is less willing to face a potentially

large insolvency problem, and there is no alternative but the partial or total

intervention of the government.

Credit-money is endogenous folks. The Fed can set the rate, but it's ultimately up to people and banks whether or not to lend. And reducing interest rates is not the way to do it - not when there are so many outstanding debts and in the midst of economic malaise.

World is Making a Big Mistake

Interest rate cuts around the world is not just a useless solution - it's dangerous, as I posit in my previous post.   Apparently I'm not alone in this concern. 

The stock market apparently has reservations as well. 

UPDATE:  Apparently, the average Joe doesn't have confidence in "normal" monetary policy tools either, nor even fiscal policy.  

They like the "give it time" idea.   Or maybe they don't like it, but they accept it.  

I would add, "give it time, BUT keep using non-traditional tools to try to loosen credit markets."   

Real Liquidity Trap

The Fed just announced a 1/2 point interest rate cut to try to stimulate the economy and provide funds for investment.  This to me may be more harmful than helpful.  As economists like Paul Krugman have pointed out, we are close to a Keynesian liquidity trap - where nominal interest rates approach zero meaning that with each successive cut, the effect of monetary policy on the economy approaches zero.  

But the real problem is one of coordination failure cause by bad debt and lack of confidence in our financial system.  That is what is causing the crisis.  Throwing more money at the problem and driving real interest rates further down has the effect of causing a REAL liquidity trap, which is increasing the incentive to hoard.  In times of financial crisis, people take money out of risky assets and want to put it in less risky ones.  But the real yields on these assets become lower and may become negative as the Fed cuts rates.  This increases the incentive to take money out of the system, to hoard it, to keep cash on hand, and to use it to pay down past spending (debt accumulated from past credit).   So, is this really the best policy to stimulate our economy and provide liquidity?  It seems it could have the opposite effect!

What are our options?  Maybe direct government outlays?  Direct spending?  But then doesn't that just exacerbate our real long term problems with spending more money than we have?  Maybe we have to feel this pain for a while.  

It's Called "Social Security," not "Social Gamble"

The best argument against privatizing social security finally, sadly, has real-world roots.  It's amazing though that some people STILL are talking about privatizing social security via financial investment markets.  

Tuesday, October 7, 2008

Big Booms, Prolonged Recessions - Credit the Culprit?

I've been thinking about how booms and busts and the  increased variability in money demand post-1970 might be inter-related.  

It makes sense given that credit card debt and Foreign capital inflows are not included in our money stock.   It's an observational fact that credit card useage and the US's debt obligations to countries like China has grown rapidly over the past 30 years.   That fact alone can explain why our tech bubbles and our housing bubbles and the resulting "pops" have served to increase the volatility of our business cycles.

Theoretically, a person can hold their permanent income in four forms: money, financial assets, physical assets, and credit (imbued with human capital - potential for future earnings and consumption smoothing).

First, there is something to be said for a strictly Keynesian explanation as not all financial assets are equal, and classical economists like Friedman ignore non-probabilistic uncertainty in their models.  

But, what is missing from strictly classical and a strictly Keynesian models is the "credit" part. As mentioned in a previous post(s), this is not however lost on heterodox economists like Hyman Minsky.  

If you combine Keynesian liquidity preferences with Minsky cycles you get the following:

To start off let's assume (rightly) that the US becomes more "spend-happy," and is now more willing to spend on credit and to borrow from foreign entites for consumption and investment.

This has the effect of reducing money demand because more purchases are willing to be financed with debt as opposed to cash or deposits.  The lower interest rate helped add to the frenzy of investment already occuring.  But then...

1. An de-stabilizing even occurs (housing bubble bursts, etc)
2. Uncertainty (as separate from probabilistic risk) rises
3. Demand to hold money rises and liquidity is constrained
4. Interest rates rise and consumption and Investment fall

You are now left with a choice:  Where do you put your money?
-Not in your physical assets because the uncertainty of their return has risen
-Not in your financial assets certainly for similar reasons
-Not as cold hard money because in the United States, over the last couple decades, our savings rate has declined as we have become more consumerist and have been more willing to borrow from our future expectations, and from abroad to finance our capital investments.   In fact, our savings rate over the last few years has been aroudn 0, and sometimes negative.   It makes more sense to pay off this debt - the negative savings we did via credit -  in order to avoid interest payments, as opposed to just stuffing money in a mattress or keeping cash on hand.  

What this means is that in times of crisis (like this one), people may be taking money out of banks and financial instruments to try to pay down their bad debt that they racked up - the very debt that got them into their current dire straights.  The problem is that while paying down private debt is theoretically similar to the positive effect that paying off gov't debt, private debts fail easier and are corrupted by un-market friendly practices ironically set up by the free market ("fixed" rates that can be variable within 2 weeks notice, huge late fees, misleading balloon payments/interest, etc).   Not to mention a lot our private debt has been securitized into things so complex we can't even know the value of!   All this means that perhaps aggregate hoarding and keeping cash-on-hand is inevitable for a time.  

Even when the debts can be paid, some public debt is a good thing (eduction spending, infrastructure), but some of this private debt is likley just excess or debt taken on due to "herd" behavior.  

How did the debt get them there:  by providing an incentive to consume and invest beyond one's means.  By providing an incentive for self-fulfilling prophecy of a Minsky cycle, whereby individuals and firms expect future incomes to be great enough to pay for current spending and this "rush to greed" fulfills that expectation for a time until "reality" sets in and the market crashes.  

Friday, October 3, 2008

Dow Jones FALLS as Bailout Passes

Just as the last majority vote was cast to necessitate the passage of the bailout, and as CSPAN anchors were saying the Dow was on the rise, the Dow started (despite the anchor's incorrect and embarassing words) falling!  

But why?

(I learned a new concept!)

Concept makes obvious sense just never really gave it much thought before.  

Thursday, October 2, 2008

Matt Tully should take an econ course

Regarding IN Governor Mitch Daniel's plane trips for government purposes:

Shouldn't his campaign pay for at least the portion of the trip that was campaign-related?

The answer is yes"

That is ridiculous, and it shows the lack of economic understanding (that apparently many Indy Star commenters do have).  If the Governor takes a trip for governmental business reasons, the trip itself is sunk for that purpose.  It would be ridiculous to make State personnel pay for plane trips or "part" of trips ... what does that even mean?  You want to start dividing miles into personal and governmental miles?

Do we make regular State personnel pay for going to see a movie by reducing their travel compensation after their business is concluded on a business trip?  No we just assume they get their business done and THEN they do whatever private matters they might need/want to do on their own dime.  I don't see how this situation is any different.