Tuesday, September 29, 2009

Thursday, September 24, 2009

A Wolf Amongst Sheep

Calling Wen Jiabao: Martingale currency strategy misguided.

That would be equivalent to official holdings by the US government of $6,000bn (€4,000bn, £3,670bn) all denominated in the currencies of other countries. It is little wonder such a huge exposure makes the Chinese government nervous. But nobody asked the Chinese to do this. On the contrary, US policymakers have consistently (and wisely) advised them to do the opposite. Having made what I believe was a huge mistake, the Chinese government cannot expect anybody to save them from its consequences.

And this is particularly good; I had never thought to look at it this way.

It is important to understand how distorted China's economy now is: in 2007, personal consumption was just 35 per cent of GDP. Meanwhile, China was investing 11 per cent of GDP in low-yielding foreign assets, via its current account surplus. Remember how poor hundreds of millions of Chinese still are. Then consider that the net transfer of resources abroad was equal to a third of personal consumption.

Honestly, the more you think about it, the more you realize that Steve Keen's idea of a debt jubilee is the most sensible solution (minute 6:20). Housingdefaultswap.com on grand scale. Maybe the Jews were onto something with that sabbatical thing. We can keep making all the stuff we're making (there need be no falloff in production) if we just admit that some of the benefits of this are going to be redistributed in a way nobody anticipated when they followed the incentives laid out for them. This is true in the US, and true in China as well. The only fundamental problem with the world economy is that the Chinese have excess capacity in Teddy Bear production and shortage of capacity in clean air, while we have excess capacity in housing and a shortage of capacity in air filtering technology. That may take some time to cure, but doesn't seem insurmountable to me (which and so by the way, where's our green tech bubble when we need it).

On another note, I'm a little worried that I find myself agreeing with some obscure Australian economist being interviewed on some pirate internet news channel over a bad Skype connection to the backdrop of an office that looks like it was recently raided (again) by some nefarious government agency. Things is definitely gettin' weird.

Anyhow, this all gets into the obvious problem that if the government did have a debt jubilee it would change the incentives for the future. How do you get people to go out and work really hard and invent new stuff and provide new services and just generally fuck up their time with shit to do, when they know that even if they do (or don't do) shit the table will be reset in 7 years?

Well, I think the answer is you just make debt illegal to begin with. I suppose this was the Islamic improvement on the Jewish financial regulation. Following this train of thought, it's clear that the Christians went overboard with the whole turning the other cheek thing -- Jesus was a commie. What we need is naked, ruthless, unfettered, equity-only supercapitalism. And a religion to go with it.

Anarcho-theism to the rescue!

Not to be difficult, but ...

Today   20090924

Stock market up, household net worth up, confidence in spite of falling wages and rising unemployment up, debt-fueled consumption up, and voila! It's 2006 again. Or, look no further than yesterday's comment from Lennar CEO Scott Shipley: "The sense that now is the time to buy is starting to gain momentum as potential qualified purchasers are getting confirmation from news reports and the overall stock market that prices are at or near lows." 

Take an image of Federal Reserve Chairman Ben Bernanke silently wiping a single tear of joy from his cheek as that comment scrolled across his Bloomberg terminal.

Yesteryear  19300924

Observers believe little liquidation of investment holdings has taken place in Sept.; market break is attributed to bull pools becoming discouraged and selling out stocks they were sponsoring. While business pessimism has returned in past 10 days, there doesn't seem to be reason behind it other than the market decline.

Reflexivity famously goes in both directions.

Monday, September 21, 2009

Begging for a question

Does anyone see a pattern here?

Credit where credit is due: I was delighted when Lawrence Summers, the administration's ranking economist, lashed out at the campaign the U.S. Chamber of Commerce, in cooperation with financial-industry lobbyists, is running against the proposed creation of an agency to protect consumers against financial abuses, such as loans whose terms they don't understand. The chamber's ads, declared Mr. Summers, are "the financial-regulatory equivalent of the death-panel ads that are being run with respect to health care."

Wednesday, September 16, 2009

Aimee McPherson

This one sounds like a real live wire.

In 1913 she embarked upon a preaching career in Canada and the USA. In June 1915 she began evangelizing and holding tent revivals, first by traveling up and down the eastern United States, then going to other parts of the country.

Her revivals were often standing room only. One of these was held in a boxing ring, with the meeting before and after the match, throughout which she walked about with a sign reading "knock out the Devil."

McPherson had practiced speaking in tongues but rarely emphasized it.

Collections were taken at every meeting, often with the admonishment, "no coins, please."

She began broadcasting on radio in the early 1920s. McPherson was the first woman to preach a radio sermon and with the opening of Foursquare Gospel-owned KFSG (now KTLK AM 1150) on February 6, 1924 she also became the first woman granted a broadcast license by the Federal Radio Commission.

KFSG … received a stern warning, because the station either used too much power, drifted off its assigned frequency or changed frequencies without permission. These violations of the radio regulations caused interference around Los Angeles to those trying to hear other local stations. … There must have been some warning from the Department of Commerce that KFSG could lose its license if the station continued breaking the rules … In response to these warnings from the radio regulators, at some point, … McPherson fired off an angry telegram … to Herbert Hoover. … The telegram … reportedly said:

PLEASE ORDER YOUR MINIONS OF SATAN TO LEAVE MY STATION ALONE. YOU CANNOT EXPECT THE ALMIGHTY TO ABIDE BY YOUR WAVELENGTH NONSENSE.

Monday, September 14, 2009

The Frustration Builds


I can't tell whether this is a picture of the effects of a serotonin re-uptake inhibitor called "monetary policy", or whether it's a snapshot of the concentration of something else that builds up when you are depressed. Is it cure or symptom? And is the disease depression, or just the after-effects of an earlier manic episode?

All I know is that it does not feel good.

Sunday, September 13, 2009

Question of the Day

If the whole universe is a computer, are we looking at the hardware or the software?

Friday, September 11, 2009

Engineers of Freedom

Yves didn't think much of this Luigi Zingales article, but I actually think she's off base, and I wrote as much in the comments. Being more generous, her basic objection seemed to be that being pro market competition didn't always mean being anti-regulation. I agree with that sentiment; you can't measure the competitiveness of a market solely by the number of rules governing it (though it's not a bad place to start). A careful reading of the article though, reveals that Zingales agree with that too. I know he's from U. Chicago, but let's give him a chance. For example, he talks about the inefficiency of the old regulated banking system from an economic perspective, but it's success from the perspective of keeping the banking system fragmented.

The real effect of Gramm-Leach-Bliley was political, not directly economic. Under the old regime, commercial banks, investment banks, and insurance companies had different agendas, and so their lobbying efforts tended to offset one another. But after the restrictions were lifted, the interests of all the major players in the financial industry became aligned, giving the industry disproportionate power in shaping the political agenda. The concentration of the banking industry only added to this power.

Those are not the words of a man who believes always and everywhere in fewer rules. But let's not belabor the point. The normally perceptive Yves screwed the pooch on this one, but the article is very much worth reading. Here are a few excerpts along with some context to whet your appetite.

First, why is the US more pro market than anywhere else?

American capitalism also developed at a time when government involvement in the economy was quite weak. At the beginning of the 20th century, when modern American capitalism was taking shape, U.S. government spending was only 6.8% of gross domestic product. After World War II, when modern capitalism really took shape in Western European countries, government spending in those countries was, on average, 30% of GDP. Until World War I, the United States had a tiny federal government compared to national governments in other countries. This was due in part to the fact that the U.S. faced no significant military threat to its existence, which allowed the government to spend a relatively small proportion of its budget on the military. The federalist nature of the American regime also did its part to limit the size of the national government.

The centrality of government to the economic system elsewhere has a pretty predictable effect:

In most of the world, the best way to make money is not to come up with brilliant ideas and work hard at implementing them, but to cultivate a government connection. Such cronyism is bound to shape public attitudes about a country's economic system. When asked in a recent study to name the most important determinants of financial success, Italian managers put "knowledge of influential people" in first place (80% considered it "important" or "very important"). "Competence and experience" ranked fifth, behind characteristics such as "loyalty and obedience."

Even the backlash against the concentration of power can end up reinforcing it:

In countries with prominent and influential Marxist parties, pro-market and pro-business forces were compelled to merge to fight the common enemy. If one faces the prospect of nationalization (i.e., the control of resources by a small political elite), even relationship capitalism (which involves control of those resources by a small business elite) becomes an appealing alternative.

The basic mechanism behind the instability of free markets in a democratic system where elections cost money is also pretty clear:

True capitalism lacks a strong lobby. That assertion might appear strange in light of the billions of dollars firms spend lobbying Congress in America, but that is exactly the point. Most lobbying seeks to tilt the playing field in one direction or another, not to level it. Most lobbying is pro-business, in the sense that it promotes the interests of existing businesses, not pro-market in the sense of fostering truly free and open competition. Open competition forces established firms to prove their competence again and again; strong successful market players therefore often use their muscle to restrict such competition, and to strengthen their positions. As a result, serious tensions emerge between a pro-market agenda and a pro-business one, though American capitalism has always managed this tension far better than most.

While the US is probably still more free market than rip-off nations everywhere, it is an exorbitant privilege that can be revoked:

Although the United States has the great advantage of having started from a superior model of capitalism and having developed an ideology to support it, our system is still vulnerable to these pressures — and not only in a crisis. Even the most persuasive and resilient ideology cannot long outlive the conditions and reasoning that generated it. American capitalism needs vocal defenders who understand the threats it faces — and who can make its case to the public. But in the last 30 years, as the threat of global communism has waned and disappeared, capitalism's defenders have grown fewer, while the temptations of corporatism have grown greater. This has helped set the stage for the crisis we now face — and left us less able to discern how we might recover from it.

So finally we have a choice of where we want to go. Towards the free market, or towards a sort of capitalism, or corporatism, or, dare we say it, a national socialism for the rich?

We thus stand at a crossroads for American capitalism. One path would channel popular rage into political support for some genuinely pro-market reforms, even if they do not serve the interests of large financial firms. By appealing to the best of the populist tradition, we can introduce limits to the power of the financial industry — or any business, for that matter — and restore those fundamental principles that give an ethical dimension to capitalism: freedom, meritocracy, a direct link between reward and effort, and a sense of responsibility that ensures that those who reap the gains also bear the losses. This would mean abandoning the notion that any firm is too big to fail, and putting rules in place that keep large financial firms from manipulating government connections to the detriment of markets. It would mean adopting a pro-market, rather than pro-business, approach to the economy.

The alternative path is to soothe the popular rage with measures like limits on executive bonuses while shoring up the position of the largest financial players, making them dependent on government and making the larger economy dependent on them. Such measures play to the crowd in the moment, but threaten the financial system and the public standing of American capitalism in the long run. They also reinforce the very practices that caused the crisis. This is the path to big-business capitalism: a path that blurs the distinction between pro-market and pro-business policies, and so imperils the unique faith the American people have long displayed in the legitimacy of democratic capitalism.



Wednesday, September 9, 2009

Il Impuestazo

The first famiglia of Argentina has spoken again.

Multinational electronics manufacturers have launched a lobbying push to halt a bill in Argentina's Senate that would double the value-added tax on cellphones, televisions and cameras.

The so-called impuestazo, or big tax, would double to 21% the value-added tax on most electronics goods not produced in the Tierra del Fuego special economic zone.

Mrs. Kirchner says the tax would mean "fewer dollars that leave the country to pay for imports and more jobs for all Argentines."

¿"Fewer dollars leaving the country"? These guys can't even make their own currency, much less a modern cell phone. I Understand the logic of wanting to build your own industry, and I supported K and co. when the issue was the tax hike on agricultural exports. I even agree that steps to diversify beyond agriculture are absolutely warranted, though more for political than economic reasons. But Argentina is never going to be a global competitor in cell phone and TV production. It just isn't. So a tax like this is entirely a subsidy for a few businessmen to produce shoddy sub-standard computers in the ass end of the world (no coincidence that K used to be governor of the province of Santa Cruz). And the tax is paid for directly by every Argentine who buys a computer, and indirectly, because this means that fewer people will buy computers and the country will slide ever further in the direction of Chavez-landia -- a backwater in the modern digital economy.

This is such a blatantly asinine economic policy that I almost have to wonder whether it wasn't sponsored by the campo, in an effort to keep the country barefoot and pregnant, so to speak, and forever chained to the same agricultural export model it has always had. I mean, there's no way that cell phone production will ever become a big industry with the same political pull, so subsidizing that group is harmless from the perspective of the big ag exporters.

Why can't these two ever come up with a progressive policy that actually makes sense? For example, why not raise the tax on imports of farm equipment, and stimulate an industry that makes some freaking sense given the realities of the country. If I were Argentina I'd try to compete with Catepillar and John Deere before I took on Nokia.

Redistributing wealth is an admirable motive, as long as you don't do it by making everyone poor at once.

Tuesday, September 8, 2009

Don't Make Me Break My Foot Off In Your Ass

I've basically quit reading the Economist because while they always have one eye sticking out, the rest of their head is constantly buried in the sand.  Witness the glittering gem-like logic of this reasoning:

Yet there was a common ingredient in most failures: an over-reliance on wholesale borrowing. As the Western banking system has expanded over the past two decades its assets have grown to about 2.5 times its deposits, forcing firms to seek other types of finance. Bear Stearns and Northern Rock, largely reliant on short-term borrowing, faced the modern version of a "run" when their counterparties refused to roll over debts. Most other banks suffered some loss of confidence, forcing them to turn to funding from the state.

Unsurprisingly, regulators think that forcing banks to find more secure funding, along with more capital, will make the system safer. The Basel club of bank supervisors is considering new liquidity rules, as are many national regulators. New Zealand has already drawn up concrete rules (see article). It is not clear how far this can go. There can be no return to an idealised past where only a dollar deposited in a bank would be loaned out. To force banks to rely only on deposits would require a big shrinkage of their balance-sheets, with devastating economic implications.

So ... the basic model is obviously unstable, and recently resulted in a thunderous crash heard round the world, but it would be dangerous to move towards a safer system?  I see.  Jolly good old chap.  Another gin and a stiff upper lip and we can follow Chuck Prince's advice and keep dancing.  Ponzi was a small time schmuck by comparison.

Now that Big Finance has been nursed back to rude health by suckling at the teat of Big Government, nobody sees to mention anymore that this unstable funding is still real money.  Arguably, that money should never have been printed up (inflation is always and everywhere a monetary phenomenon, it just manifests itself sometimes as price inflation and sometimes as asset inflation).  But now that it exists, it has to go somewhere.  The issue at hand is whether you force the unstable wholesale money that is liable to panicked flight back into the old FDIC regulated deposit system that we set up after the last snafu.  If you force the holders of that money to either genuinely put it at risk (without an implicit government backstop) or to put it in the safety of a regulated banking system and accept lower returns, then you can make the systemic parts of the system less liable to runs at the same time as you allow the non-systemic portions to fail if that's what they deserve. 

Deleveraging is real, both for the banks and for consumers, but the problem is compounded by this half guarantee.  If you encouraged the creation of new banks that could absorb the wholesale money as normal deposits, rather than trying to prop up the old banks by re-guaranteeing their slippery funding, you could have less aggregate deleveraging at the system level because you would have cleaner and more transparent balance sheets that could safely tolerate higher leverage.  Naturally, this is politically impossible, and is exactly the opposite of what we're doing.  The economic implications of banks in general relying on deposits is much less devastating than if the banks that currently monopolize the system are forced to go back to relying on deposits and we allow them to keep their monopoly.  In other words, the current banks have convinced us that they are the only possible banks.  There was a moment in March when some smart people were talking about starting over with the banking system (Buiter and his good bank solution was one of the best ideas in my mind) but then the government got its con job mojo working and foreclosed on any possibility of change.  They consider this to be "success".  And it's pretty clear who succeeded.


Now that's fucking interesting

Some crafty Swiss physicists have managed to measure just how accurate our paranoid conspiracy theories really are. It's a heavy duty paper, but the basic idea is that the local dispersion of control (how many different people own a stock) and the global concentration of control (what fraction of the stock market is controlled by what fraction of the populace) are independent variables. A couple of charts illustrate this admirably. This one shows the definition of the terms:


And the next one shows the punchline, namely where the US falls. Only Japan has a more globally concentrated ownership structure, a fact obscured by the local dispersion of American ownership.


You may now freak out with full empirical justification.

Friday, September 4, 2009

Thus Spoke Zarathustra (again)

CP recently commented that conversations with your humble blogger induce a feeling of vertigo. I believe this to have been a compliment, of sorts, but regardless of the intention, the anecdote is useful as a point of departure. Because lately I have been noticing that one of my most cherished analytic tricks is to take a thought, somehow figure out a way to reflect it back on itself so as to induce a feedback loop, and then move quickly to a safe distance to see if anything interesting happens. The feedback loop as intuition pump. Not, now that I think of it, dissimilar to Kevin Kelly's anecdote in Out of Control about asking scientists what color they thought a chameleon would be when looking in the mirror (a pretty good book so far, by the way -- the guy is not just on the bus, he's spent some time driving it)

I used to think that feedback loops were kind of silly, and I was aggressively uninterested in the whole meta-meta postmodern hall of mirrors. I still am. The problem with the way those ideas were presented was that the feedback was never thought of as creative. It was always just the same structure over and over again -- base, meta-level, base meta-level, again and again, with some counter that incremented every time you went around the loop. That's not feedback, that's tedious repetition. The secret of real feedback is that it's creative and unpredictable. It's unlimited, even though it doesn't necessarily move off uniformly in one direction. Interesting feedback doesn't repeat because there's no beginning or end to the circle. Or at least, if it repeats, it is the act of repeating that is primary, and not the thing repeated; the form that is repeated doesn't pre-exist the repetition, and in fact, the only reason you know that it is the "same" form is because you can get it to repeat again (and again ad infinitum).

Once you understand how creative feedback can be, infinity and self-reflection (the reflection that makes a self) become much more interesting ideas. Vertigo may even have been up there with sex as the first drug. And all of this means that Nietzsche's idea of the Eternal Return comes back with a vengeance.

Hedging Gaia

Indulge me as I take a stab at an idea that has been wandering around in my head, lost in the desert for some time now.

There are all kinds of patterns in market prices data, on all kinds of scales. How do we think about those patterns? We know that they are not random fluctuations around a mean value -- the market is not a classic random walk binomial distribution. It has fat tails and black swans. Or maybe it's got a fractal time structure like Mandelbrot claims. At any rate, we have yet to come up with a good statistical description of most market time series data. This is what confounds risk management, fools the physicists, and ends in the ritual sacrifice of Vikram Pandit and other former high priests of VaR.

So what kind of statistical beast is the market then? Well, let's think about how it gets built up. The first markets (conceptually, but also historically to some extent) are just instantaneous spot markets. Think of the medieval fair. Pigs and salt and harlots. Supply and demand meet casually in the street, talk shop over a tall cool glass of mead. These markets aren't very random at all. They pretty quickly find their way to equilibrium, and then they mostly stay there. These markets also do experience fluctuations, but these aren't random either. The price of strawberries goes up when they are out of season. If you want more grain at harvest time, it will cost you dearly. The fluctuations are largely as predictable as the seasons from which they derive. The only thing that shakes them loose from these patterns is a change in one of the two terms, typically the supply one -- a drought, a plague, a war, etc ...

But fluctuations that everyone can predict in advance are clearly not sustainable in a market system. Chinese pig farmers will hoard aluminum and washing machines when they are cheap and sell them when they are expensive. This damps out the natural cycle. In addition, other clever monkeys will invent futures markets and other derivatives that institutionalize these mechanisms and make them much more powerful and systematic. Under these conditions (iff storable surplus production, speculative capital accumulation, and information propagation, as far as I can see) markets become forward looking. Eventually, the idea is that this would lead to conditions of perfect arbitrage and perfect equilibrium. I believe there's even a famous theorem about how instruments that allow the market to be more forward looking serve, mathematically speaking, to "complete" it, and, at the limit (you need not just futures, but futures on futures, etc ...) to guarantee that is machine for producing perfect equilibrium. Lacking this perfection in practice, the tiny remaining fluctuations around equilibrium would presumably be distributed along a bell curve.

If the market did produce perfect equilibrium, and the world were completely predictable, then everything that could happen would already be reflected in the market, and it would never change. All the predictable variations of the world, all the seasonal patterns, etc ... would be incorporated in one fixed and unchanging price in advance. It would be a sort of perfect crystal ball that told us in advance of all sorts of thing that we might think improbable a priori, but that are still predictable. The question of what kind of patterns we find in this market would then be identical to asking what kind of patterns we don't find in the world. "How random is the stock market" would become "how random is the part of the world we don't know about"? And this is in fact exactly what the efficient markets hypothesis guys have in mind when they say that the market reflects all the known information at a given time. It's a strange sort of equilibrium, as the price of securities would continue to jump around as new shit came to light, but it's a sort of equilibrium nevertheless, in that there is no force within the system that would cause its state to evolve.

Well, but so then we can wonder just how random is the part of the world we don't know about. Do we believe that the distribution of unknown outcomes for our world falls along a bell curve? That seems remarkably unlikely. The world is truly Random. It's not little random-walk model random, which is actually just domesticated randomness with its tiny predictable variations. For true Randomness, not even statistics works. Everything is sui generis. Or not even, because even that would be a form of pattern. True randomness would be utterly patternless, if such a thing can be conceived ...

And this, ultimately is my point. The market is the closest thing we have to a true random number generator, just not in the sense it is usually claimed.

--------

Okay, so that was originally ultimately my point, but after a few days of thinking about it I now have a new and improved point that supercedes that original ultimate point and you certainly wouldn't want to miss that, now would you? My new and improved point picks up where the last one left off -- the market is truly Random. It's as random, to quote a great philosopher of yesteryear, as the unknown unknowns of our world. And yet the market fluctuations that track this deep randomness are not merely reflections of it; the market is not a passive, objective observer of the world, but actually a part of it (and what isn't these days?). When the market incorporates a new fact, it not only has to change the price of securities to reflect this new information, but it has to incorporate the new real reactions people have to the fact that this information is now available. In other words, the new information has an impact not only on the market, but also on the world. But this means that the market's original incorporation of the predictable aspects of the world was actually wrong (though in an unpredictable way -- the known unknowns were, by hypothesis, already incorporated in the market, albeit probabalistically). And what's worse, if people were earlier using the market to make real decisions (which the market of course incorporated, and which was of course a good idea, because the market is always right honorable) those decisions have now been obsoleted.

The upshot is that the market can't be random. It can't be as Random as the world (because we can predict some of that world, and the market incorporates those predictions, as well as the real actions taken to make those predictions come true). It can't even be as RRandom as the things we don't know about the world, because the things we don't know about the world change the things we do know about the world, when, in fact, this new shit comes to light. So the market has to be RRRandom or Random2 or maybe even RandomRandom -- the randomness of the market feeds back on itself like infinity, so it's hard to know whether twice as Random is more Random than half as Random.

Having reached this level of randomness, you should clearly spend the rest of the day slumped on the couch with your feet propped up on a copy of Gesammelte Abhandlungen mathematischen und philosophischen inhalts and a cold compress over your eyes. Drink exotic cocktails through a Twizzler, and, whatever you do, do not trade any more stocks -- you'll just make things worse.

How many times are we going to have this same crisis?

Numbered amongst those who should be entirely ignored when they complain about the national debt are:
  1. People who voted for the Bush tax cuts and refuse to let them expire now
  2. People who supported the Iraq war
  3. People who thought that the same amount of debt was fine when it was on the books of Goldman Sachs and Citibank, and who simultaneously supported the financial bailout
  4. People opposing healthcare reform
  5. Centrist reach-across-the-aisle Democrats who blame this on the crazy Republican party, rather than putting aside their pansy-ass reelection scheming, grabbing some sack, and fucking doing something about the situation.
Conversely, except for this last point, Brad DeLong can be taken seriously when it comes to speaking about the dangers of government debt:

If global investors lose confidence in governments tomorrow, then we have a huge crisis--and they are right to lose confidence. If global investors do not lose confidence, then we are fine--and those crying "the sky is falling" are wrong and will lose money--as long as we don't let fear of a loss of confidence panic us into prematurely cutting the government deficits that are maintaining demand.

The right policy, therefore, is (a) big deficits now, and (b) big automatic tax increases enacted now to take effect in the future if we then fail to grow our way out of the debt.

But are we smart enough to enact such policies? Certainly not with today's Republican Party.

Ken Rogoff:

From Financial Crisis to Debt Crisis?: Everyone from the Queen of England to laid-off Detroit autoworkers wants to know why more experts did not see the financial crisis coming. It is an awkward question. How can policymakers be so certain that financial catastrophe won't soon recur when they seemed to have no idea that such a crisis would happen in the first place? The answer is not very reassuring. Essentially, there is still a risk that the financial crisis is simply hibernating as it slowly morphs into a government debt crisis.

This is definitely the crux of the issue.  If we lose confidence in the government, it can do nothing for us, and we can expect a hyperinflationary depression.  If we don't lose confidence in the government, it can be an amazing tool for muddling us through this mess.


Tuesday, September 1, 2009

The Road to Smurfdom

One of the first things you notice about American capitalism is that there are a bunch of really large firms.  How many?  Well, to make serious progress on this question, I can think of a couple of numbers that I'm too lazy to go try and find right now:
  1. A history of S&P 500 profits as a percentage of GDP
  2. An analogous history of large company profits as a share of GDP for other countries, an for the Euro area as a unit
  3. A history of the concentration of profits broken down by individual industry.
The history of the concentration of capital may not be at our fingertips, but one thing we know for sure is that right now, bigger is better.  In fact, the impetus for this note comes from two stories to that effect that I came across this morning.  The WSJ says that bigger firms are finding the current environment easier because their competitors are struggling for access to credit:

Panera Bread, a St. Louis-based national chain of more than 1,400 cafes, is a rare winner in its industry. With more than $100 million in cash and no debt, it is demanding, and getting, cut-rate leases from landlords. Panera's occupancy costs have come down 10% to 20% since last year. It is hiring and expanding into spaces formerly occupied by Blockbusters and Bennigan's.

"For us, this is the best of times," says Ron Shaich, its chief executive. "Cash is king and this is a buyer's market."

Business is tougher for Panera franchisees. They can still borrow -- but at a price. Mike Hamra, who owns 47 Panera restaurants in the Boston and Chicago areas, says he is paying a full percentage point more on his loans than he paid last fall. "Banks are not throwing money at us," Mr. Hamra says.

while bigger banks are trouncing their smaller rivals because of cheap government money:

Big lenders are currently enjoying an advantage in their "cost of funds" -- the raw material of a bank, which is in the business of borrowing cheaply and lending at a higher rate. The handful of banks with more than $10 billion in assets were paying 1.18% to borrow money in the second quarter, the FDIC said in data issued Thursday. By contrast, banks with $100 million and $1 billion in assets were paying 1.97%, a big difference in a business where tenths of a percentage point translates into millions of dollars in profits.

Meanwhile, the Economist does it's best to miss the point (and I'm openly dubious of this GDP share figure -- of course the production of big industrial companies fell as a percentage of GDP since 1974, the US ceased to be an industrial country):

Great names such as Pan Am had disappeared. Others had survived only by dint of huge bloodletting: IBM sacked 122,000 people, a quarter of its workforce, between 1990 and 1995. Everyone agreed that the future lay with entrepreneurial start-ups such as Yahoo!—which in late 1998 had the same market capitalisation with 637 employees as Boeing with 230,000. The share of GDP produced by big industrial companies fell by half between 1974 and 1998, from 36% to 17%.

Today the balance of advantage may be shifting again. To a degree, the financial crisis is responsible. It has devastated the venture-capital market, the lifeblood of many young firms. Governments have been rescuing companies they consider too big to fail, such as Citigroup and General Motors. Recession is squeezing out smaller and less well-connected firms. But there are other reasons too, which are giving big companies a self-confidence they have not displayed for decades.

In any case, as a result of the financial crisis, we are currently seeing a fairly dramatic increase in the concentration of economic power.  Suggestive ¿no?  So, you're telling me that one driving force behind the concentration of economic power is entirely financial, and has nothing to do with economies of scale of efficiencies of production?  I would argue that this is not a special case, but a moment where we can see a dramatic illustration of a glacial everyday force in our supposedly free markets; our financial system, broadly construed has always been the primary driver behind economic concentration.  The ability to leverage, together with privileged access to markets and bank credit, are constant small advantages that accrue to size in normal times, but that pay huge dividends in extraordinary circumstances.  But of course, there's no way to separate these two times because crises are an inherent part of capitalism.  Extraordinary times are utterly commonplace, and capitalism (as opposed to markets) only works by breaking down.

Looking over the history of the last year, it's clear that a number of financial firms looked at this dynamic and quite sensibly adopted the idea of too-big-to-fail as a business model.  Sometimes you hear people complain that our supersized financial firms are the product of regulatory failure, or excess Chinese savings or whatever.  In my mind this is no different than the argument that corporate influence in politics is the product of corruption or corporate greed or, again, whatever.  Both diagnoses mistake symptoms for causes.  Both lack a systematic perspective on the forces at work. 

Corporations, be they financial firms or car manufacturers or Wal-Mart, seek profits.  You make profits, over a long period of time, by sustaining some sort of advantage over the competition.  You make profits, that is, by staying out of the free market.  This is the dirty open secret of capitalism that somehow got erased from our macroeconomic theory and policy debate -- corporations abhor the free market, and the opposite of a market economy is less socialism than capitalism.  So the natural working of a capitalist economy moves it further and further away from the free market equilibrium ideal as businesses develop and refine models that protect them from the competition by any means necessary.  In the case of financial firms, the only sustainable way to stay ahead of the competition was to capture the government and its unique ability to extend credit.  So that's what the successful firms did.  It was systematic and inevitable.  A simple evolutionary process.

I think that idea is less controversial now that we've seen a collapse of the financially less well connected.  What I hear less about is the way this adaptation amongst the highest level of the food chain had a trickle down effect on everyone beneath.  Concentration spreads like a virus, as Galbraith aptly pointed out in his Countervailing Power essay.  If suppliers concentrate, it prompts a concentration in buyers.  If retailers concentrate, manufacturers will do the same to maintain their profit margins.  And if your competitors with better access to leverage start buying up the industry, you too better get yourself a pet banker and get your deal on before you're done for. 

The implicit government guarantee of excessive leverage forces a concentration of economic power across the spectrum.  And it also forces a concentration of power in the biggest business in the country.  You know the one I mean.  The 'protection' business.  The goodfellas with the greenbacks get their game on, and you start to see what competitive advantage really means.  In the end, the capitalist axiomatic is just a way of backing slowly into totalitarian socialism.  Fascism has real economies of scale.