*New* Post–Various Items
Now that I have at least a temporary fully functioning blog to use, I can post several items that have come across my desk over the past few days. D&S subscriber and WordPress-pro Shaun S. has kindly offered to help us migrate once again to a permanent WordPress blog located on our own server, so I hope that will be up and running very soon. Here are those item, in no particular order:
(1) Another interesting paper by Jayati Ghosh (the earlier one I posted from was on food security and derivatives), this time on a surge of private capital flows into emerging markets, aka speculative “carry trade”:
Once again, emerging markets have become the (often unwilling) “beneficiaries” of a surge in private capital flows. Once again, this is not really being used within most receiving economies, since they continue to add to their external reserves. And once again, this is creating additional and often complicated problems of macroeconomic management, with conflicts between different domestic goals.
Some of this renewed capital inflow relates to the perceptions of private investors about better long term economic growth prospects in countries like China, India, Brazil and so on. But much of this is simply what is known as the “carry-trade”, which is essentially the attempt to benefit from different rates of return on assets in different currencies.
This is not a new tendency–for example, in the late 1990s, the Japanese yen carry trade (which was based on interest rate arbitrage) caused significant exchange rate movements that affected its trade partners adversely. Todays basic source of the carry trade is the US economy. This results from the very loose monetary policy that was part of the stimulus package, with low interest rates, easy credit policies and “quantitative easing” (which is the current euphemism for deficit financing in the form of money creation). These have all provided a significant increase in access to funds at very low nominal interest rates that are actually negative in real terms, because they are well below expected inflation.
As a result, the big players in international capital markets–banks, mutual funds, hedge funds and the like–have renewed risk appetite and are making forays into emerging markets (mostly through portfolio flows) as well as into commodity markets (mostly in the futures markets). In the past one year there has been a near doubling of net private capital flows into emerging markets.
Read the rest of the article.
(2) Ezra Klein interviews Jamie Galbraith on the deficit: “The danger posed by the deficit ‘is zero’”. Hat-tip to Aslam K.:
EK: You think the danger posed by the long-term deficit is overstated by most economists and economic commentators.
JG: No, I think the danger is zero. It’s not overstated. It’s completely misstated.
EK: Why?
JG: What is the nature of the danger? The only possible answer is that this larger deficit would cause a rise in the interest rate. Well, if the markets thought that was a serious risk, the rate on 20-year treasury bonds wouldn’t be 4 percent and change now. If the markets thought that the interest rate would be forced up by funding difficulties 10 year from now, it would show up in the 20-year rate. That rate has actually been coming down in the wake of the European crisis.
So there are two possibilities here. One is the theory is wrong. The other is that the market isn’t rational. And if the market isn’t rational, there’s no point in designing policy to accommodate the markets because you can’t accommodate an irrational entity.
EK: Then why are the bulk of your colleagues so worried about this?
JG: Let’s push a bit deeper on the CBO forecasts. They publish a baseline set of projections. One of those projections holds the economy will return to a normal high-employment level with low inflation over the next 10 years. If true, that would be wonderful news. Go down a few lines and they also have the short-term interest rate going up to 5 percent. It’s that short-term interest rate combined with that low inflation rate that allows them to generate, quite mechanically, these enormous future deficit forecasts. And those forecasts are driven partially by the assumption that health-care costs will rise forever at a faster rate than everything else and by interest payments on the debt will hit 20 or 25 percent of GDP.
At this point, the whole thing is completely incoherent. You cannot write checks to 20 percent to anybody without that money entering the economy and increasing employment and inflation. And if it does that, then debt-to-GDP has to be lower, because inflation figures into how much debt we have. These numbers need to come together in a coherent story, and the CBO’s forecast does not give us a coherent story. So everything that is said that is based on the CBO’s baseline is, strictly speaking, nonsense.
EK: But couldn’t there be a space between the CBO being totally correct and the debt not being a problem? It seems certain, for instance, that health-care costs will continue to rise faster than other sectors of the economy.
JG: No, it’s not reasonable. Share of health-care cost would rise as part of total GDP and the inflation would rise to be nearer to what the rate of health-care inflation is. And if health care does get that expensive, and we’re paying 30 percent of GDP while everyone else is paying 12 percent, we could buy Paris and all the doctors and just move our elderly there.
EK: But putting inflation aside, the gap between spending and revenues won’t have other ill effects?
JG: Is there any terrible consequence because we haven’t prefunded the defense budget? No. There’s only one budget and one borrowing authority and all that matters is what that authority pays. Say I’m the federal government and I wish to pay you, Ezra Klein, a billion dollars to build an aircraft carrier. I put money in your bank account for that. Did the Federal Reserve look into that? Did the IRS sign off on it? Government does not need money to spend just as a bowling alley does not run out of points.
What people worry about is that the federal government won’t be able to sell bonds. But there can never be a problem for the federal government selling bonds. It goes the other way. The government’s spending creates the bank’s demand for bonds, because they want a higher return on the money that the government is putting into the economy. My father said this process is so simple that the mind recoils from it.
EK: What are the policy implications of this view?
JG: It says that we should be focusing on real problems and not fake ones. We have serious problems. Unemployment is at 10 percent. if we got busy and worked out things for the unemployed to do, we’d be much better off. And we can certainly afford it. We have an impending energy crisis and a climate crisis. We could spend a generation fixing those problems in a way that would rebuild our country, too. On the tax side, what you want to do is reverse the burden on working people. Since the beginning of the crisis, I’ve supported a payroll tax holiday so everyone gets an increase in their after-tax earnings so they can pay down their mortgages, which would be a good thing. You also want to encourage rich people to recycle their money, which is why I support the estate tax, which has accounted for an enormous number of our great universities and nonprofits and philanthropic organizations. That’s one difference between us and Europe.
EK: That does it for my questions, I think.
JG: I have one more answer, though! Since the 1790s, how often has the federal government not run a deficit? Six short periods, all leading to recession. Why? Because the government needs to run a deficit, it’s the only way to inject financial resources into the economy. If you’re not running a deficit, it’s draining the pockets of the private sector. I was at a meeting in Cambridge last month where the managing director of the IMF said he was against deficits but in favor of saving, but they’re exactly the same thing! A government deficit means more money in private pockets.
The way people suggest they can cut spending without cutting activity is completely fallacious. This is appalling in Europe right now. The Greeks are being asked to cut 10 percent from spending in a few years. And the assumption is that this won’t affect GDP. But of course it will! It will cut at least 10 percent! And so they won’t have the tax collections to fund the new lower level of spending. Spain was forced to make the same announcement yesterday. So the Eurozone is going down the tubes.
On the other hand, look at Japan. They’ve had enormous deficits ever since the crash in 1988. What’s been the interest rate on government bonds ever since? It’s zero! They’ve had no problem funding themselves. The best asset to own in Japan is cash, because the price level is falling. It gets you 4 percent return. The idea that funding difficulties are driven by deficits is an argument backed by a very powerful metaphor, but not much in the way of fact, theory or current experience.
Read the original interview. Also see Marty Wolfson’s article on myths of the deficit in the current issue of D&S.
(3) More, and more recent, from Jamie Galbraith–from a written statement to the Senate Judiciary Committee: “I write to you from a disgraced profession.”:
Chairman Specter, Ranking Member Graham, Members of the Subcommittee, as a former member of the congressional staff it is a pleasure to submit this statement for your record.
I write to you from a disgraced profession. Economic theory, as widely taught since the 1980s, failed miserably to understand the forces behind the financial crisis. Concepts including “rational expectations,” “market discipline,”efficient markets hypothesis” led economists to argue that speculation would stabilize prices, that sellers would act to protect their reputations, that caveat emptor could be relied on, and that widespread fraud therefore could not occur. Not all economists believed this—but most did.
Read the full statement, available at the Real World Economics Review, aka the Post-Autistic Economics Review.
(4) Also from the Real World Economics Review, aka the Post-Autistic Economics Review (whose new name they adopted at least 27 years after we’d been calling our textboos the “Real World” series, ahem, but we love them anyway): The Revere Award for Economics is awarded to Steve Keen (contributor to D&S‘s Economic Crisis Reader), Nouriel Roubini, and Dean Baker, who wrote about the housing bubble in a D&S article back in January of 2005. Kudos!
(5) Hat-tip to D&S collective member and Bentley University economist AND senior lecturer Herr Prof. Bryan Snyder for pointing us to this astroturf website, purporting to be worried about too big to fail, but in fact trying to block financial (re-)regulation. As reported at Talking Points Memo among other sites, the site duped MIT economist Simon Johnson (here responding at his blog Baseline Scenario) and former labor secretary Robert Reich, who referred to the website as engaging in “swiftboating” of reform.
That’s all for now.
—CS
One Response to “*New* Post–Various Items”
David Dzidzikashvili says:
May 25, 2010 at 8:16 pm
The Dow being up 61.2 percent during the past year tells us how effective the Federal Reserve has been at supporting markets, not how successful the recovery has been. The patient (economy) is still on life support. Take that away and we are completely screwed. When interest rates start to go up the true health of the economy will be uncovered. We need to develop better indicators not the same old formulas that are subject to government manipulation. But this won’t be happen until the government will have no other choice. This can lead to Economic Collapse Phase 3 (we are already in Phase 2).
What are the logical outcomes? Unfortunately the outcomes, even the best case scenario looks pretty bad. Take just all facts, hard statistical and economic data, and start looking at the trends, formulas and factors such as unemployment rates, foreclosures, US economic productivity & output, etc…
From what I can see right now, and just relying on data – the first 6 months of 2010 (January through June 2010), Americans continue to live in the “unreality”…the period between July and October is when the financial fireworks will begin. It will become impossible for he government to hide unpleasant economic data & news and the reality check will cause economic tsunami. The Fed will act unilaterally for its own survival irrespective of any political implications… Great Depression will start to look like a church picnic. Whoever has a stable job now, at this moment, might not enjoy the stability in the 3rd and 4th quarters of 2010. In this case, it’s logical to say that the FDIC will collapse during the second half of 2010. Additionally, to make things even worse, I think there is a more than 75% probability that bond market will crash, especially municipal, sometime towards the final months of 2010. These events should have taken already place in the last months of 2009, but they were delayed, only due to the government’s cash injection and bailouts. The bailouts did not address the root of the problem and in general the systemic issues have been overlooked at, because the government does not want to talk about negative events, in the world of politics, the politicians tend stress their attention on positive developments for PR needs and purposes. But ignorance will have extremely negative consequences… Add to that more than $10 Trillion US debt and record deficits… Logical question – what will happen after this?
After this, the US government will ONLY have TWO options, bad option and even worse one. You judge which is bad and which is even worse.
Option one: Inflate Dollar, devalue it. This is a pretty bad option, since inflation has never proven to be a viable solution. What will happen to the savings of millions of middle class Americans, who’ve worked all their lives to save money and retire, what will happen to 401Ks, social security? All gone…and done.
Option two: Default! Yes, the US government basically filing national Chapter 7 bankruptcy for USA and telling Chinese and other creditors – Sorry, we’re SOL, we’re bankrupt, the debt is unrealistically high and we’re defaulting on all our financial obligations. This will send irrecoverable shockwave through world markets and this will be the end of Capitalism as we know it (technically we’ve already done it). But this will give a fresh start to the United States, a new currency system will be created and new social/economic/political system will be in place, a mix of socialism-more regulations-some free market (under many regulations)-and raise of Mercantilist economic policies. We need to rebuild manufacturing and re-start whole American polit-economic system (after we hit Reset button). This is not a good option either, but in these scenarios there will never be a truly viable solution.