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.

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.

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.

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.

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.