Economy | - Part 30

On Deep Dysfunction and the U.S. Economy

The more I hear about “secular stagnation”, the more it sounds like the U.S. and global economy are like some massive software project that had fundamental design flaws that prevented it from ever functioning properly, yet all the managers want to do is get it fixed (and they’ll try just about anything short of a complete redesign).

Of course, fundamental design flaws in big software projects almost always end up leading to redesigning the thing from the ground up after everything else has failed, but, aside from a few Austrian economists who continue to preach to the choir, you never hear a peep about rethinking the overall design of the U.S. or global economy.

In another example of “real life meets Onion satire” to produce some terrifying implications (i.e., this 2008 classic Recession-Plagued Nation Demands New Bubble To Invest In), we read in this New York Times story that former Treasury Department Chief Larry Summers is still thinking about our “secular stagnation” predicament.

Want a thriving labor market? Blow a bubble.

That’s one implication of a theory about the contemporary American economy developed by Lawrence H. Summers, the former Treasury secretary and prominent public intellectual.

The theory is a frightening one, implying deep dysfunction in the way the American government treats the economy. It is a trendy one, all the talk among policy makers and those at think tanks. And Mr. Summers expanded on it at a forum on full employment hosted on Wednesday by the Center on Budget and Policy Priorities.

The big idea is that — absent extraordinary intervention in the economy through fiscal policy, monetary policy or both — growth and employment will prove lackluster.

What’s a government to do? Well, the Fed could keep its easy monetary policy indefinitely and watch the bubbles form, like the dot-com bubble of the late 1990s or the housing bubble of the mid-2000s. But, Mr. Summers pointed out, bubbles burst, with hugely destructive consequences.

“A strategy that relies on interest rates significantly below growth rates for long periods of time virtually guarantees the emergence of substantial bubbles and dangerous build-ups in leverage,” Mr. Summers wrote recently. “The idea that regulation can allow the growth benefits of easy credit to come without the costs is a chimera.”.

Despite Summers urging, that’s about all we’ve got – Fed sponsored bubbles – and that situation doesn’t look as though it will improve after this fall’s mid-term elections.

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The “Nice Phase of Minsky’s Cycle”

It’s kind of ironic to think of all the time and money that went into all those high frequency trading computers (i.e., the hardware design and the software development that must have both been cutting edge) that have been the subject of much debate at 60 Minutes and CNBC over the last few days, that is, when you think of them in relation to the U.S. economy.

Yes, that computer hardware and software added to the nation’s economic output as did all the talk on TV, but it’s all part of the recent epidemic of unhealthy growth that constitutes the current “recovery” as NYSE margin debt seems to make new all-time highs with every passing week and analysts hail the return of higher levels of borrowing by consumers.

In this Business Spectator report, Steve Keen reminds us why we “can’t escape Minsky” and why reality is different than perception.

It might be felt that Minsky is irrelevant, now that the economy has begun its recovery from this crisis. But in fact this period — in the immediate aftermath to a crisis, when the economy is growing once more, and debt levels are only just starting to rise — is precisely the point from which Minsky developed his explanation of economic cycles.

Minsky’s message is for the whole financial cycle, not just the moment when it turns nasty. At the moment, we’re in the nice phase of Minsky’s cycle, when it pays to lever. Leverage is clearly on the rise, as Figure 1 indicates.

The acronym “DCED” stands for debt contribution to effective demand and measures the annual change in private debt divided by GDP.

There are a couple more charts that are both pretty interesting and some commentary about why the last “Minsky cycle” started in the early 1990s rather than a decade ago.

You can see this in the chart above where overall debt-to-GDP really didn’t dip much in the early-2000s because the American consumer quickly picked up where corporate American left off reckless-borrowing-and-spending-wise.

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The Deep State

Here’s a pretty unsettling look at the status quo in both Washington and corporate board rooms from someone who has seen it all from the inside, Mike Lofgren, a former GOP congressional staff member with the House and Senate Budget Committees, who talked with Bill Moyers below and filed this report on the subject.

One highlight from early on in the discussion:

It’s kind of a natural evolution when so much money and political control is at stake in the most powerful country in the world … a hybrid of corporate America and the national security state … everyone knows about Wall Street and its depredation, everyone knows how corporate America acts. They’re both about the same thing. They’re both about money, sucking as much money out of the country as they can, and they’re about control – corporate control and political control

It’s the red thread that runs through the history of the last three decades. It’s how we had deregulation, financialization of the economy, the Wall Street bust, the erosion of our civil liberties, and perpetual war.

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Why the Fed May Again Fail

We might be hearing a little less talk from the Federal Reserve about how much “slack” there is in the economy (Fedspeak for the “output gap”, or the difference between real and potential growth) after a new report by Commerzbank as detailed in this Bloomberg story.

The Federal Reserve, Bank of England and European Central Bank have started using the level of spare capacity in their economies as a way to foretell when they will start reversing easy monetary policies. The more capacity, the bigger the output gap between actual and potential economic growth and the longer officials can keep interest rates low because price pressures will be sluggish.

Bloomberg“While this sounds plausible, past experience suggests that central banks tend to hike rates too slowly, with corresponding risks for price inflation,” Christoph Balz and Bernd Weidensteiner, economists at Commerzbank AG in Frankfurt, said in a March 21 report.

The problem is that output gaps are hard to estimate and better done in hindsight. To demonstrate that, the Commerzbank economists looked at what the Fed would have estimated for the output gap in the early 1970s, given the data they had available from the prior three decades.

The initial impression was of an output gap of minus 1 percent for 1974, which would have encouraged the U.S. central bank to be “moderately expansionary,” said the report.

In reality, the economy was later shown to have been slightly over-stretched in 1974. Repeating the exercise for 1983, the output gap the Fed would have calculated at the time was minus 1 percent, versus the minus 4 percent it proved to be.

“A more restrictive policy would have been appropriate in 1974, but in 1983 a more expansionary policy was required,” said Commerzbank. “This demonstrates the uncertainty when monetary policy conclusions are drawn from the current data set.”

With the Fed’s new lines of communication aimed at damping expectations of rate hikes, the risk is the Fed “will again probably raise rates too late and too cautiously,” said the economists. This time the “greater danger” may be that loose monetary policy fans inflation in asset prices.

This idea that, it doesn’t matter how economic growth arrived at a particular level (e.g., in 2007 after the biggest credit bubble since the 1930s) and that you should somehow gauge future economic growth against past growth (regardless of how artificial it was) – this is one one of the stupidest things that economists have ever come up with.

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Shiller on Bubbles and Busts

Rounding out today’s troika of stories on rapidly inflating financial bubbles (that in some parts of the world, for example the U.K., are seen as genuine progress for the economy) comes this Wall Street Journal interview with Nobel Laureate Robert Shiller who talks about the recent history and future of bubbles and busts.

Shiller minces no words in blaming his own (economics) profession, calling it “unnatural” when asked how to explain what we’ve seen in financial markets over the last few decades.

It’s pretty hard to argue with that assessment and it’s laughable to think that some dismal scientists still believe in such folly as “efficient market theory”, “rationale actors”, and the value of economists’ vaunted “models” today given the perverse incentives that are provided on Wall Street and condoned by the Federal Reserve where, once, it was believed that investment banks are “self-regulating”.

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