Tuesday, December 30, 2008

As I was just saying ...

The only redeeming feature of Big Brother is his salvational incompetence.

The historical-institutional processes that drive the evolution of the state are quite likely to result in an all-absorbing Leviathan.  This is because the main actors competing for the control of the government and thus of the apparatus of the state are  recruited by political processes that select for people with a hunger for power, ruthlessness,  a belief that the ends justify the means and an unquestioned faith that the common good (as seen by the aspiring politico) always takes precedence over individual rights and liberties.   We have to hobble this would-be Leviathan if  we value what is left of our rights and liberties.

Not Drunk (Enough) With Power

Normally I find myself in pretty close agreement with Paul Krugman, and I even think his Keynesianism is thoughtful and in the current circumstances practical (though his condescension towards the Austrians is a vice), but he has this big government FDR fixation that goes along with it that drives me nuts.  A recent column begins with:

Times have changed. In 1996, President Bill Clinton, under siege from the right, declared that "the era of big government is over." But President-elect Barack Obama, riding a wave of revulsion over what conservatism has wrought, has said that he wants to "make government cool again."

Before Mr. Obama can make government cool, however, he has to make it good. Indeed, he has to be a goo-goo.

Goo-goo, in case you're wondering, is a century-old term for "good government" types, reformers opposed to corruption and patronage. Franklin Roosevelt was a goo-goo extraordinaire. He simultaneously made government much bigger and much cleaner. Mr. Obama needs to do the same thing. ...

I'm all for better government.  And I agree that government could theoretically get both bigger and better at the same time, depending on who is running it.  But someone as smart as Krugman is being disingenuous in writing a column like that without even mentioning that bigger government works like a ratchet -- once you make it bigger, it is impossible to shrink it again.  Combine this simple insight with the realization that FDR or Obama or whoever your patron saint of the day might be will not be around forever, and you have a powerful argument for doing everything you can to minimize the size of the government over time. 

Cleaner government is always needed, and perhaps bigger government is needed in a crisis, but big clean government inevitably gets dragged through the mud and ends up as a big dirty pig.

Tuesday, December 23, 2008

Clever, maybe

Alistair Milne has an interesting comment over on the forum attached to Martin Wolf's column at the FT.  He wants to encourage the central banks to pursue a specific type of quantitative easing that will work better than the flavor Japan pursued.  The basic idea of quantitative easing is straightforward -- the central bank goes out and buys government securities from banks and private individuals and pays for these with freshly created reserves.  Theoretically, the banks should lend these new reserves to businesses, and the amount of money in circulation should increase, counteracting any deflationary tendency.  In the case of Japan, the problem was that the banks didn't lend the money out.  Alistair's solution:

Quantitative easing will be much more effective if the central bank uses its balance sheet to buy not government bonds but better quality illiquid and undervalued structured and mortgage-backed securities. This eases bank funding constraints and so directly expands the stock of credit. Moreover, as the economy recovers, credit spreads will fall and so the central bank can make a profit.

Quantitative easing will be more powerful still if the central bank takes pure credit spread exposures, using interest rate swaps to remove its exposure to fluctuations in nominal interest rates.

At first blush this makes great sense, and was the basic idea behind TARP -- buy up the iliquid securities so that bank balance sheets are cleaner and more liquid, which should reduce the amount of cash they need in reserve and encourage them to lend to businesses as well as ecourage businesses and investors to once again trust that the lenders are solvent.

Unfortunately this does nothing to answer the question of what you should pay for these things.  If the Fed or the BOE starts to directly target credit spreads by buying "better quality iliquid and undervalued" paper, it must be able to figure out what paper actually fits this description and what it's worth.  But if it were so obvious that these securities were undervalued, there would be private investors willing to buy them.  What makes him so sure that the Fed is so much smarter?  He goes on to argue that the Fed, being the creator of money, can meet and margin call, and so cannot be squeezed out of any trade.  True enough.  But is that why people aren't buying this paper?  Frankly I doubt it. 

All this talk about undervalued MBS takes for granted that the real problem is liquidity, and not solvency.  Probably some of this paper is undervalued.  I wouldn't doubt that.  A lot more of it is worth zero though.  If the Fed buys this worthless paper it is just continuing to subsidize an overly large financial sector.  That may keep credit spreads for real businesses low and (might) keep loans flowing, but it does nothing to fix address the most fundamental imbalance -- the financial sector needs to shrink relative to the size of the overall economy.

Monday, December 22, 2008

Jim Hamilton is a godsend

Certain academic economist are really proving their worth to the greater financial community in this crisis, and high up on the list of contributors is Jim Hamilton of Econbrowser.  Follow the link to the clearest description I think I've ever seen of what the Fed normally does, what it's doing now, what it might do in the future, and why you should give a shit.

Sunday, December 21, 2008

Well boo-fucking-hoo

What pathos one has when reading the punchline of this FT article about how the Fed will now lend to Hedge Funds so that they can buy up credit-card securitizations:

The loans will be secured only against the securities and not the borrower. However, the Fed will lend slightly less than the value of the securities pledged as collateral. The Treasury has committed $20bn to cover potential losses.

Since the credit crisis erupted, hedge funds have complained that they cannot get the leverage they need to arbitrage away excessive spreads and meet high hurdle rates of return.
 
I'm literally aghast here.  You mean hedge funds weren't able to meet their high hurdle rates?  That will simply have to be fixed.  I mean, if these guys don't get free money guaranteed by the Fed, then nobody can get free guaranteed lunch, I mean money.  If the sharks don't eat, the whole ecosystem will collapse by god!  This whole bailout has become just a blatant farce with every pig in town feeding at the trough.  It's like we're literally imitating Japan on purpose.

It's so sad to watch America get looted.  I hope there's still enough great things about this country that it one day comes back.

The Greatness of Ponzi

I read somewhere that towards the end of his life, Deleuze was working on a book about "The Greatness of Marx". He jumped out of a window before he finished it, and I don't exactly know in what sense he meant this, but my own fairly recent re-appraisal of Marx (I continue to mercilessly flog Kolakowski's book as the best thing ever written about Marx) has made me realize that a thinker can come at something deep and fundamental -- but from the wrong angle, or in a confused way that obscures the important novelty of the concept.

So this morning I'm eating my bagel and reflecting that someone should write a similar book about Ponzi. The structure of a Ponzi scheme is one of the greatest inventions of all time. In a nutshell it is just a faster version of the concept of trust -- we get together and cooperate today for some mutual benefit tomorrow. As long as the trust continues and expands, a Ponzi scheme is the surest and fastest route to progress. You can get rich along with everyone else.

I already hear some objections to my fevered praise of Ponzi. What, you might acidly ask, about when the trust breaks down and more people are leaving the system than coming in? That's a fair objection. But I never said that Ponzi's scheme didn't have flaws. All I was pointing out was that those flaws were the same as the flaws of our society. It's instructive to realize that some things we recognize as flat out Ponzi schemes can go on for 30 years. To call that unstable, or a scam, is to twist those words far beyond their usual definitions.

In fact, our society is modeled on a Ponzi scheme, and if trust in it were to break down, the results would be as spectacularly bad as Ponzi or Madoff or any of the other situations we recognize as "scams". You could argue that the US political system has gotten to a point where any attempt to shrink the government would cause the whole works to collapse. We already see how the government gets bigger and bigger every year, taking on more and more obligations both for the future and for the control of the present. Ask yourself for a moment what might happen to healthcare and social security and the housing market and ... if the government were to stop expanding in those areas, and even begin to contract. Caught a whiff of chaos ¿no?

And it's not just the government. Our entire productive apparatus (I am now extending this beyond just our financial "system") is based on the idea of a continual and continually expanding progress. If the trading of current consumption for future consumption down the road, if a system that depends inherently on the savings and investment leading to surplus leading to more savings and investment and ... if this concept of progress is not in essence isomorphic to a Ponzi scheme ... well ... then ... I'll have to re-think the title of my book about Ponzi.

Interfluidity has said it better than I could hope to, though he foolishly fails to mention Ponzi by name:

We, collectively, have not figured out a means of addressing an incompatibility between the incentives by which we encourage production and the means by which we distribute it. Human effort is driven by positional as much as material incentives: We measure ourselves against one another. Two centuries ago, a person could be rich with no running water, electricity, or internet person. But wealth was still wealth, and people worked just as hard to be rich then as now. But since wealth is positional, people's desire for wealth may far exceed their intention or ability to consume. When great wealth is earned by contributing to production, this leads to a surplus, which seems like a good thing, but creates the "problem" of excess capacity. The obvious solution is to redistribute claims on production, so that those with unmet wants make use of the excess. But doing so reduces the differences in station that inspire Herculean efforts to produce, and provokes conflicts over who gets what.

The macroeconomic stories of this decade have all been about squaring this circle: Rather than redistributing claims outright, we adopted the fiction of trading present goods for future claims. The ambitious grew wealthy by accumulating claims on the future of the less ambitious, in exchange for which the less ambitious (and sometimes very distant) consumed present production, and demanded more. Entrepreneurs could measure their position against their fellows by the quantity of their claims. Others could consume in proportion to their ability to manufacture claims that entrepreneurs would accept, that is, they could consume what they could borrow. But high quality claims on future wealth are in reality very scarce. An economic system that depends upon ever expanding claims on the future in order to provide current incentives to produce can not be stable. Once the "wealthy" learn that many of their claims are worthless, the system falls apart. The less-wealthy have no means of consuming, as new claims are shunned. Owners of capital gain nothing but bear costs for maintaining productive infrastructure. "Excess capacity" appears.

Friday, December 19, 2008

The challenge of macro

I find that I'm spending a lot of time these days trying to reconnect financial concepts with real world macro-economic concepts. There's a feeling that I'm trying to break through some sort of veil of analogy in order to see what it actually means when people make proposals to "get credit flowing again" and "stimulate the economy" and whatnot. I'm hardly alone in the effort of course, and a post from interfluidity goes in this same direction:

Think about that: "overcapacity in almost all industries". Perhaps we exist in a more enlightened world than I ever imagined. I've always thought that human want for material goods was basically unlimited. Apparently not! We have enough, not just here in the once gluttonous U.S. of A., but everywhere. All of the nearly seven billion humans of planet Earth have no use for anything more than they already have. Subsistence farmers in Africa prefer to live as they do, because it plays charmingly in National Geographic. If you offered them 10 million Yuan and a shopping trip, they'd shyly refuse.

The world does not now, and never has had, a general problem with "overcapacity". It might be sensible to talk about overcapacity with respect to a particular good or service in a particular setting. Maybe five Starbucks Cafes really are too many for one city block. But as a macroeconomic phenomenon, overcapacity is bullshit. Capacity can be misaligned — there might be too many sock factories for too few shoe factories. But there can be no general overcapacity, only underutilization.

This is an important thought, but only partially true. It leaves out an irreducible psychological element. The human desire for cheap plastic shit is limitless, but it is not constant. People and societies really do go through periods of over and under confidence, over and under desire.

Win some

I don't see why they don't just give me a Nobel Prize right now and get it over with. Or at least a column with the New York Times:

The Madoff Economy, by Paul Krugman, Commentary, NY Times: The revelation that Bernard Madoff — brilliant investor (or so almost everyone thought), philanthropist, pillar of the community — was a phony has shocked the world, and understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.

Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?

Monday, December 15, 2008

China's big rebalancing act

Interesting comment from Michael Pettis today in the FT:
The second way is for trade-surplus countries to engineer sharp increases in domestic consumption, most likely though massive fiscal expansion, that match the decline in US household consumption and so reduce the overcapacity problem. The problem with this solution is that the scale of the adjustment is beyond the capacity of most countries. A decline in US consumption equal to 5 per cent of US GDP, for example (which is a low estimate), would require an increase in Chinese consumption equal to 17 per cent of Chinese GDP – or a nearly 40 per cent growth in consumption. This is clearly unlikely.
This is an important point. China stimulating domestic demand to compensate for the US going on a diet is all well and good, but we cannot expect it to work miracles. China is growing in importance in the world economy, but it still constitutes a tiny fraction of world GDP.

Sunday, December 14, 2008

Fractional Reserve Banking is an Inherently Unstable System

There, I said it. File me away with the unibombers, the conspiracy theorists, and the gold bugs.

But the fact of the matter is that the whole system is really a sort of Ponzi scheme where you pay the people who want their money back with what you get from the people who are coming in. This works great until more people are going than are coming, a la Madoff. It makes you wonder if something fundamental will change once we pass through the steepest part of the global demographic phase transition.

This thought is inspired by a reading some commentary from Robert Bruner who recently wrote a book about the panic of 1907. I haven't read the book yet, but the commentary is probably sufficient to judge the conclusions he reaches. The basic idea is pretty simple. Fractional reserve banking is inherently unstable. Banks have a mismatch in the duration of their liabilities (I can get my deposits back any day of the week) and their assets (especially when they have made loans against that tried and true, but particularly iliquid, asset class -- real estate). Normally not everyone wants their money back at the same time, so this is fine. In a panic, even a solvent bank can be unable to pay its depositors.

The solution to this problem, as far as Bruner is concerned, is also pretty straightforward. You need some entity that backstops the banks, and convinces depositors not to pull their money out of solvent banks. You accomplish this by someone having enough cash in reserve to give the first group of depositors all their money back, so those after them realize that it's unneccesary even to ask for it. Simple enough. It's a con game really. Or a prisoner's dilemma, if you prefer. The success of fractional reserve banking as a business model depends on confidence and trust.

So how do you instill or recover that trust when for some reason people begin to lose it? In 1907 J.P. Morgan restored trust. Personally. I find it both sad and amazing that this could have worked. Sad, because it shows you how dominant a position this man had. In his commentary Bruner poses the question of whether there was a money trust (analogous to the oil trust and the cotton trust, etc ...) at the turn of the century. Poses it as if this were a question. I think the fact that any single man could restore trust in an entire system more or less tells you empirically that he had monopoly power. On the other hand it's kinda amazing that one man commanded such respect and was so competent that he could save an entire system. Imagine anyone trying to do this today. Are you going to put your trust in Geore W. Bush? Bill Gates? The suits from Goldman Sachs?

Bruner is clearly in awe of Morgan, and who wouldn't be? On the other hand, he obviously thinks that this was the last time any person could singlehandedly save the financial system. Today the problem is too big even for Warren Buffett, and requires a central bank instead a central financier (though wouldn't you rather have "Buffett Bucks" than dollars at this point?). A central bank is a perfectly sensible solution to the problem. Who can best restore confidence? The government. Where do all monopolies ultimately migrate to? The government. How do we solve problems of collective action? It's the government, stupid.

It's also the kiss of fucking death.

You haven't actually solved the problem with this, youv'e just pushed it up a level. Because there's no guarantee that we will always have confidence in our govenment. If we think it is run by a bunch of lying kleptocrats and their buddies, legitimized by dozens of pseudo-scientific technocrats who have had their heads in the sand for as long as we can remember, if perhaps we think the government and the people in it might, just maybe, be looking out more for themselves than for us -- well ... let's just say it may not be a foolproof firewall between us and the armageddon of zero-sum-ness.

Is anbody seeing a pattern here? Is it any wonder that this crisis happened when it did? I don't even trust my own shadow anymore, much less Ben Bernanke, Dr. Evil and mini-me over at the TARP. For all I know these guys are going to bomb the credit default swaps market because they heard somebody say that's where the weapons of mass destruction are. We'll have paper everywhere like confetti after the war.

In addition to creating the mother of all free-rider problems, pushing the question up a level and letting the government be the final backstop for the financial system means that the final instability of is now no longer solely financial, but cultural and political. Would you like to see what this slippery slope looks like when you've slid, repeatedly to the bottom of it?

Steve Hsu (hap tip Efrain)

... is another physics type who is interested in markets, though it seems that he is actually a physicist still, so I don't know how much solidarity he'd muster for us dropouts. At any rate, he also has a blog that mashes up all sorts of intellectual endeavour. Today's missive is about Keynes' brand of economics:
As someone with a mathematical bent I was not initially drawn to Keynes' brand of economics -- my interests were in areas of modern finance like option pricing theory, volatility, stochastic models. But like Keynes I have seen a bubble up close -- first in Silicon Valley, and now, from a greater distance, the current credit crisis. What seemed to be reasonable rough approximations: efficient markets, no arbitrage conditions, stochastic processes, etc., are now revealed as terribly naive and dangerous. And so over time my views have come to resemble those described below. (See my talk on the financial crisis, and this Venn diagram.)
The views described below are a piece that is floating around the intertubes this morning from the NYT magazine -- Keynes biographer basically says that Keynes came up with the idea of the black swan and not that self-aggrandizing Taleb bozo.
Keynes created an economics whose starting point was that not all future events could be reduced to measurable risk. There was a residue of genuine uncertainty, and this made disaster an ever-present possibility, not a once-in-a-lifetime “shock.” Investment was more an act of faith than a scientific calculation of probabilities. And in this fact lay the possibility of huge systemic mistakes.

The basic question Keynes asked was: How do rational people behave under conditions of uncertainty? The answer he gave was profound and extends far beyond economics. People fall back on “conventions,” which give them the assurance that they are doing the right thing. The chief of these are the assumptions that the future will be like the past (witness all the financial models that assumed housing prices wouldn’t fall) and that current prices correctly sum up “future prospects.” Above all, we run with the crowd. A master of aphorism, Keynes wrote that a “sound banker” is one who, “when he is ruined, is ruined in a conventional and orthodox way.”
This is all great and I am in complete agreement. Markets are traded by monkeys. The future is hard to predict. In the absence of information (and even sometimes in its presence) we look to our neighbor to figure out what to do. The possibility of feedback under such circumstance is obvious.

But what is new in all this? Anybody who has worked in markets for any length of time already knew that the emperor had no clothes. Disrobing Alan Greenspan and his flawed ideology is not an intellectual challenge. These guys were like the flat earth club -- fine if your in the mood to argue a bit and get into the philosophical details of what the word "proof" might mean, but a boring distraction when it comes to shipping cheap plastic shit from Long Doc to Long Beach.

What is challenging is figuring out if there are patterns to the "irrationality" of markets, and if these patterns are stable enough to be studied and related to other systems we can study in the same way that classical economics is related to physical systems that tend toward equilibrium. The sad things is that I'm sure there are economists out there studying this stuff. Only physicists (not Hsu of course) think that physics is the only science just because it happens to be the simplest one (excepting perhaps mathematics). Why don't these guys get a voice? Why is orthodoxy such a stunningly powerful force in academia?

I guess I think that the really disturbing thing is not that the emperor has no clothes, but the fact that so many people are surprised by this.

Saturday, December 13, 2008

The Amero

Ecuador defaulted on its debt today. Or maybe yesterday, I don't know. For those existentialists out there this is another example that makes you question the very raison d'ĂȘtre of fiat money. From the FT:

Alberto Bernal, Head of emerging market macroeconomic Strategy at Bulltick Capital Markets, said the move was a prelude to a decision to exit dollarisation.

”Dollarisation is popular in Ecuador. Yet president Correa does not believe in dollarisation, and he needs further tools to pump the economy, because he will never receive the support of the private sector to generate employment,” Mr Bernal said. ”We think that a 60 per cent to 70 per cent devaluation is likely to take place at some point in the near future, unless oil prices recover fast.”

Ecuador abandoned the sucre for the dollar in 2000 after the collapse of its banking sector, which effectively leaves Mr Correa with no monetary policy of his own.

This passage makes one realize what the fundamental error is -- the government shouldn't have any monetary policy of its own. In fact, if there's one thing that the government should never ever be allowed to have, it's a monetary policy. If there's one thing you should never let the government do, it's control the supply of money. It always has and always will end in tears. Allowing the government to print money gives it an extraordinary control over society that is never apparent until it's too late.

Friday, December 5, 2008

Our Founding Fathers

I always find it interesting to see how, over the course of time, ideas get distorted into rigid ideological parodies of themselves. It is probably an inevitable consequence of mass adoption (witness religious doctrine in general). One of the cases that particularly fascinates me is how remarkably prescient Adam Smith the man was, given how remarkably awful many of the self-labeled "free market" types are who almost certainly never read a word he wrote.

Today's quote is a propos of this reflection, and the Fed's new plan to make us all rich again by forcing us to buy overpriced houses.

I can only think of Adam Smith’s warning:

The proposal of any new law or regulation which comes from [businessmen], ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.

One of the stranger revelations of the last few years for me has been that Adam Smith and Karl Marx could almost be thought of as being on the same team. Naturally, Marx spawned an equally absurd school of misinterpretation, though in his case, you might throw a chunk of the blame at his own doorstep.

Thursday, December 4, 2008

Turning Chinese

PREFACE: Scattered thoughts on money from more than a year ago, with a small contemporary addendum at the end.


The more you read, the more you realize that despite enormous amounts of noise and hand-wringing about what we should do, the bigger question is what China is going to do. Exactly like the US in 1929, China is really the linch-pin of the global economy right now. If they fall into protectionism and purposefully try to devalue their currency, we are all likely to go down together -- trade will grind to a halt, and the dollar will skyrocket and then implode, a chart we are all very familiar with right now.

Brad Sester has the best explanation of this stuff, though the Martin Wolf editorial he cites is a close second and a good summary.
China can try to support its own growth by taking a larger share of a shrinking pie, but that hardly helps the world. The G-20 isn’t just meant to bring countries together to discuss the global economy. It also needs to encourage countries to take into account the global implications of their economic policy choices. If China – which has by far the best balance of payments position of any major economy – feels like it has to direct its government policy toward maintaining export market share, efforts to rebalance the world economy will be set back.
Let me try to explain more clearly why China is so important to the current global system.

Recently, I've been thinking a lot about the charts you can find here from Steve Keen (warning: those with heart conditions are advised not to read his blog). In particular there is one that I feel like you simply have to explain, which is the one at the top of this post. So, they send us this chart, and we're supposed to shit ourselves with fear? What's the matter with a little debt? If the system is closed, one man's debt overhang is another's surplus, so where's the problem?

As far as I can make out, the argument about the unsustainability of debt in real terms is quite subtle. First, let's simplify the question and assume that we are on the gold standard or some other system where the amount of money is fixed. Further assume that the system is rolling along more or less close to equilibrium -- that is, that everyone is working and making stuff, and is swapping it for other stuff that everyone else is working and making. It helps to think of capitalism (and science and everythig else for that matter) as an animal behavior pattern. Money is just the index of all the swapping going on, just a way of counting it.

Here you can see the first way that money could get you into trouble. Because, you need different amounts of it to facilitate different structures of swapping. For example, if the economy consisted of two large centralized and vertically integrated agents (China and the US let's say) then all the specialization necessary for production could be swapped internally, without the need for money except at the last step of the interchange between the two agents. So the US could make all kinds of sophiticated goods like blue jeans and rock'n'roll, and at the last minute, we could swap these goods for cheap plastic shit that the Chinese had made. Here you only need enough money to count the value of the final swap, not the value of all the swapping necessary for the specialized production, because you are assuming that this production is organized along the lines of barter or command-and-control or something. In other words, you only need enough money for the swapping of the net value added by the US and by China, which at equilibirum would be equal.

If, however, instead of two vertically integrated agents, your economy consists of millions of tiny producers that need to swap with one another to make one sophiticated good, you are going to need more money to facilitate all of those transactions. You are going to need gross money, rather than net money, so to speak. I think this is basically the essence of the velocity of money. Now you can see how reducing the supply of money suddenly could get you into trouble all by itself, even if nothing changes (or in fact precisely because nothing changes) in the real economy. If I'm used to converting my production into money and swapping that money for the things I need, and there is a sudden scarcity of money, then we will have a calamity. The lubrication has all gone out of the system, and to continue to produce the same amount as before, it needs to be reorganized so that more of the swapping occurs internally to the production. This sort of reorganization is possible, but it can't happen overnight; in the meantime you have a crisis that appears economic but in reality is more an information crisis than anything else. Perhaps if we let Google run our economy we would need less money.

Anyhow, getting back to the debt question. Let's throw this whole system into motion. After all, in a static equilibrium, why would you ever have anything more than the very short-term debt necessary to finance trade receivables? If at all times, everyone were only consuming the amount they were producing, debt wouldn't exist. So, to state the obvious, debt is an inherently time-indexed structure.

UPDATE 090620:

The thing that throws the whole works out of equilibrium is the fact that not everyone is consuming just as much as they are producing. In fact, part of the specialization of modern economies is that some people are busy investing now (and investment is a form of consumption) in order to produce stuff later. And each year, the scale of this investment tends to increase. We live in a capitalist economy, which is not the same thing as a free market economy, in part because it requires large concentrations of capital that are otherwise alien to a perfect market. Once you introduce the idea of large capital projects that need to be financed, you inherently need someone saving and someone investing. While a system like this certainly can reach an equilibrium, isn't it obvious that it must be a dynamic one? And isn't it obvious that this is unlikely to be as stable an equilibrium as one in which each producer and consumer is essentially self sufficient?

I continue to chug through Minsky, and my update here is coming mostly from that line of thinking. He makes the very interesting observation that capitalism is inherently unstable precisely because it is not capable of incorporating large capital projects in a stable way. I'm sure I'll write some more about this later, but his basic idea is straightforward -- stability breeds instability as the initiators of large projects and their lenders over-extend themselves. His ideas put the actual functioning of money and finance back into economic theory (don't even ask why they left it out to begin with, it's a long story). The dismissal, until just recently, of all his ideas is part of what made it so difficult and heretical feeling to think about all of this stuff last year.

Monday, December 1, 2008

Double entendre


There are two ways to look at a chart like this. You can either wonder what the Japanese market would look like if they invested more like Americans, or what the American market would look like if they invested more like the Japanese. God help us if the second came to pass.

Mixed company

Normally I don't have much use for our collectively clueless superego -- the UN. But occasionally they agree with me, and a recent update to their economic report warns that the current strength in the dollar may be temporary. They also point out that the world is a closed system, and that we can't all stimulate at the same time. What would make more sense is if the US cut back on consumer spending and Japan and China took up the slack by buying things from us. Is the solution really to yet again encourage Americans to go out and do their patriotic duty and shop? From the report:

Continuing, he said the current tendency in macroeconomic policy was not all in the right direction, particularly in the surplus countries where there had been a tightening of monetary and fiscal policies, particularly in Germany and Japan, making it more difficult for the United States to lower its external deficits by export growth. The United States would also need to adopt some contractionary policies to slow down its deficit. Another way to compensate without a major recession in the world economy was for the surplus countries to make more expansionary adjustments in their economies. The more expansionary fiscal policies of some Asian countries seemed to be insufficient to compensate for the possible deflationary effects of an adjustment in the United States.
The report called, therefore, for a coordinated strategy that would think about how to adjust global imbalances while avoiding recessionary tendencies in the global economy, he said. International policy coordination could take place outside of the mediation of the International Monetary Fund, provided that the Fund pushed ahead with its reforms and enhanced representation of the votes and voices of its members.

Obviously the second stanza here is why nobody listens to the UN. I too think that thinking about the problem is a good idea, but they don't publish a news release about that.