Tag Archives: paul krugman

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Paying For Our Past Sins

Michael Kinsley’s argument for immediate austerity is about “paying for our past sins”:

Krugman also is on to something when he talks about paying a price for past sins. I don’t think suffering is good, but I do believe that we have to pay a price for past sins, and the longer we put it off, the higher the price will be. And future sufferers are not necessarily different people than the past and present sinners. That’s too easy. Sure let’s raise taxes on the rich. But that’s not going to solve the problem. The problem is the great, deluded middle class—subsidized by government and coddled by politicians. In other words, they are you and me. If you make less than $250,000 a year, Obama has assured us, you are officially entitled to feel put-upon and resentful. And to be immune from further imposition.

Austerians don’t get off on other people’s suffering. They, for the most part, honestly believe that theirs is the quickest way through the suffering. They may be right or they may be wrong. When Krugman says he’s only worried about “premature” fiscal discipline, it becomes largely a question of emphasis anyway. But the austerians deserve credit: They at least are talking about the spinach, while the Krugmanites are only talking about dessert.

To Kinsley, austerity is the necessary spinach. I don’t really understand this. In the United States a crisis in shadow finance spread into the banking industry leading to a default cascade throughout the financial system, which resulted in a wider crisis throughout the economy, and ever since 2008 even after the banking sector was propped-up, unemployment throughout the wider economy has been rife, economic output has fallen far below its long-term trend line, and bank deposits are soaring as the weak economy has damaged confidence and convinced possessors of money to save and not spend or invest.

So many activities in the boom — from home speculation, to NINJA loans, to subprime securitisation, and ultimately the 40-year cycle of total credit growth that led to the Minsky Moment in 2008 — proved unsustainable. But a huge cost has already been paid for those unsustainable activities in the form of the initial crash, and depressed growth, and unemployment, etc. The structure of production has been irrevocably changed by the bust. But are the people suffering the unemployment, the depressed real wage growth, etc, the people who created the total debt growth? No, of course not. Any connection is arbitrary — the people creating the credit default swaps and structured securitised products (ABS, MBS, etc) and NINJA loans that triggered the banking crises in many cases have kept their jobs and been promoted. Certainly, some bankers like Dick Fuld who were involved in creating the crisis lost their jobs, but while people who had nothing whatever to do with the banking crisis have lost their jobs or worse have never even got a job.

So who does Kinsley want to consume the spinach? The people who take the hit to their purchasing power in an austerity program aren’t the ones who caused the financial crisis. Perhaps financial regulators and central bankers were to some degree responsible, but the overwhelming majority of people dependent on government income had nothing whatever to do with financial regulation. Though certainly one side-effect of the crisis has been falling tax revenues, which has meant bigger deficits. But structural deficits are actually relatively low, and nominal deficits are rapidly falling. And the actual interest rate cost of servicing the deficits are at record lows and with current soaring savings levels, unlikely to start rising anytime soon. So any appearance of a deficit problem is a side-effect of a depressed economy. Ultimately, austerity will reduce the government’s use of resources — capital, and labour. And what is the problem with the economy at the moment? Slack resources in capital and labour to such an extent that interest rates are at record lows and unemployment is very high. Kinsley’s “spinach” has nothing whatever to do with the problem. In the long run, once the economy is at full-employment and businesses are booming, and interest rates have risen some austerity will be helpful, not least to take the edge off the boom. But why now? Immediate austerity is iatrogenic medicine — misidentifying the problem, and prescribing a cure that harms the patient.

In my view a bust after an economic boom may be to some degree be unavoidable as an artefact of human psychology. Ultimately, we should remember that a credit-driven boom isn’t a sign of overproduction of goods and services, or a society living beyond its means. After all, the demand for goods and services really existed, and the capacity for the production and use of goods and services really existed. Humans are excitable animals, prone to strange twinges  of spirit both in mania and depression. The business cycle delivers the dessert and the spinach in recurrent cycles. Actions have consequences, and the actions leading into the slump have had huge consequences. But what about our present sins? Having the government force more spinach onto a society already suffering from massive unemployment of people, resources and capital is a strange and cruel prescription. We have already had our spinach in the crash of 2008 and the following slump. Huge numbers of people are unemployed, or have dropped out of the labour force, or have not had the chance to enter the labour force. That is the spinach. If the economy was a man, spinach would be coming out of his ears. Michael Kinsley and his intellectual cousins want to offset spinach with more spinach. Yet the economy has much the same or higher pre-slump capacity for ice cream, and pizza and milkshakes and marshmallows. In the long run, society will rediscover its taste for economic growth, for income growth, and all the slack resources will be used up to produce things that people actually want and need. Yet that does not help the unemployed who have eaten plateful after plateful of spinach as a consequence of actions for which they were mostly not responsible. What could help the unemployed? Job creation and putting slack resources to use.

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The New Swedish Model?

Swedish-flag-credit-Matti-Matilla

The advocates of “austerity now!” are talking about Sweden.

Last year Fraser Nelson wrote in The Spectator:

When Europe’s finance ministers meet for a group photo, it’s easy to spot the rebel — Anders Borg has a ponytail and earring. What actually marks him out, though, is how he responded to the crash. While most countries in Europe borrowed massively, Borg did not. Since becoming Sweden’s finance minister, his mission has been to pare back government. His ‘stimulus’ was a permanent tax cut. To critics, this was fiscal lunacy — the so-called ‘punk tax cutting’ agenda. Borg, on the other hand, thought lunacy meant repeating the economics of the 1970s and expecting a different result.

Three years on, it’s pretty clear who was right. ‘Look at Spain, Portugal or the UK, whose governments were arguing for large temporary stimulus,’ he says. ‘Well, we can see that very little of the stimulus went to the economy. But they are stuck with the debt.’ Tax-cutting Sweden, by contrast, had the fastest growth in Europe last year, when it also celebrated the abolition of its deficit. The recovery started just in time for the 2010 Swedish election, in which the Conservatives were re-elected for the first time in history.

So, how is the Swedish economy doing?

Well, the good thing about assessing the Swedish economy is that Sweden remains monetarily sovereign, meaning that its economy is not dependent upon the monetary policy of a foreign agency like the ECB. This means that it can be fairly assessed side-by-side with other Western monetary sovereigns like Britain, America and Japan.

The thing that austerians are so excited about is that Sweden currently has low debt and is running balanced budgets:

sweden-government-debt-to-gdp

But that hasn’t meant that unemployment has been low. In fact, right now it’s worse than American, British and Japanese unemployment:

sweden-unemployment-rate

And while Sweden’s low debt and balanced budgets may have resulted in low rates, its rates are not significantly lower than Britain and America, and are higher than Japan who carry the highest debt load of all:

sweden-government-bond-yield

But to be fair real GDP growth in Sweden since the crisis has been relatively decent — although notably still below its pre-2008 trend — beating the other three countries who all performed poorly:

fredgraph

I think that Sweden is benefiting less from its actions during the slump and more from its actions during the boom.

In my view, Sweden’s focus on bringing down deficits in the years from 2004 until the crisis in 2008 was very responsible and prudent. Sweden had no wasteful expansionary spending in the mid 2000s on things like occupying Iraq. It was not enacting expensive legislation like No Child Left Behind, Medicare D and unfunded tax cuts that bloated government budgets.

Coming into the crisis with a low debt-to-GDP ratio is very healthy because it gives the government additional fiscal space to cut taxes, and spend money on infrastructure, public goods and tax rebates to bring down the unemployment rate, which is the one aspect of the Swedish macroeconomy with significant room for improvement. An unemployment rate approaching 9% is undeniably unhealthy, and it is disappointing that the Swedish treasury with so much wiggle room is not doing more to assist the private sector in bringing down unemployment. And even though Sweden has had more growth than other Western countries, it has still not caught up with its pre-2008 growth trend.

Sweden’s unemployment woe illustrates that Sweden is not a paradigm of the supposed virtues of austerity in all seasons. Austerity in the slump just frees up resources while the economy is already suffering from a high degree of slack in resources — capital (high savings, low interest rates) and labour (high unemployment). Sweden illustrates this just as much as other Western nations.

The lesson we should take from Sweden is that a countercylical spending policy — less spending in the boom, more spending in the slump — is preferable.

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Reinhart & Rogoff’s Scary Red Line

One frustrating fact regarding Reinhart & Rogoff’s controversial paper Growth in a Time of Debt — which incidentally was never peer reviewed, even in spite of its publication in the American Economic Review — is that the arbitrary threshold for diminished growth of “above 90%” seems to have no relation whatever with recent events in the United States.

When the financial crisis happened in 2008, and the United States was plunged into deep recession the public debt was actually moderate — higher than the level that Bush inherited in 2000, but less than the level Bill Clinton inherited in 1992. After the crisis, the deficit soared, but as soon as the deficit rose above Reinhart and Rogoff’s red line real growth actually picked up again.

scaryredline

This very much suggests that in this case the soaring debt was a reaction to recession. Lowered growth preceded soaring public debt, not vice verse.

This is a result supported by econometric analysis. Arindrajit Dube finds a much stronger association in Reinhart and Rogoff’s data between a high debt-to-GDP ratio and weak growth in the past three years than between a high debt-to-GDP ratio and weak growth in the following three years, strongly implying that America’s experience of weak growth preceding soaring public debt is the norm not the exception:

dube_rr_2_v2

Reinhart and Rogoff claim that their empirical study never made any claims about causality, although their 2011 editorial for Bloomberg reads as an exposition for the virtues of austerity:

As public debt in advanced countries reaches levels not seen since the end of World War II, there is considerable debate about the urgency of taming deficits with the aim of stabilizing and ultimately reducing debt as a percentage of gross domestic product.

Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP. Nevertheless, many prominent public intellectuals continue to argue that debt phobia is wildly overblown. Countries such as the U.S., Japan and the U.K. aren’t like Greece, nor does the market treat them as such.

Reinhart and Rogoff’s interpretation, then, is clearly that the debt trajectory itself – as opposed to underlying factors driving the debt trajectory — that is the risk, which is a claim unsupported by their own and other research. But the problem is larger than this.

Other empirical work on debt has focused on a broader range of debt while still following Reinhart and Rogoff in attempting to draw arbitrary danger lines on graphs. Cechetti (2011) attempts to factor in household debt (drawing a danger line at 85% of GDP) and corporate debt (90% of GDP) as well as government debt (85%), implying a cumulative danger line of 260% in total credit market debt:

TCMDOredline

Total debt seems to have been a more appropriate metric than public debt, because it was in the danger zone when the crisis hit, and after the crisis hit total debt began gradually deleveraging after forty years of steady rises as a percentage of GDP, implying a deep and mechanistic connection. But there is still a lot of room between the crossing of the red line, and the beginning of the deleveraging phase. The red line itself doesn’t tell us anything about the phenomenon of 2008, or the period preceding 1929, where a similar phenomenon occurred, other than implying in a nonspecific way that the rising debt load was becoming unsustainable.

Drawing an arbitrary line on a graph implies that negative effects associated with excessive debt are a linear phenomenon; cross the line, and bad things are more likely to occur. This is an unsophisticated approach. The bursting of debt bubbles is a nonlinear and dynamic process that occurs when credit dries up, and leverage collapses. This specific effect is not tied to any specific nominal debt level, but instead to an unpredictable mixture of market participants’ expectations about the economy, profit taking, default rates, the actions of the central bank, input costs (e.g. energy), geopolitics, etc.

Steve Keen’s modification of Goodwin’s models may be an important step toward a clearer and more mechanistic understanding of the credit cycle and how an economy can be driven into a Minsky Moment.  One of the keys to modelling Minsky’s notion of a credit-driven euphoria giving way to credit contraction, asset price falls and despair is the notion of credit acceleration, the speed at which growth in credit grows. While total credit growth acceleration is clearly a signal of an impending Minsky Moment and debt deflation, drawing scary red thresholds is a fundamentally fruitless exercise, especially in sole regard to government debt levels which do not appear to drive an economy into a Minsky Moment followed by deleveraging and weakened growth and employment.

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Why the Gold Crash? The Failure of Inflation to Take Off

One of the key features of the post-2008 gold boom was the notion that inflation was soon about to take off due to Bernanke’s money printing.

But so far — by the most-complete inflation measure, MIT’s Billion Prices Project — it hasn’t:

AnnualInflation

To me, this signifies that the deflationary forces in the economy have so far far outweighed the inflationary ones (specifically, tripling the monetary base), to such an extent that the Fed is struggling to even meet its 2% inflation target, much less trigger the kind of Weimar or Zimbabwe-style hyperinflation that some gold enthusiasts have projected.

The failure of inflation to take off (and thus lower real interest rates) is probably the greatest reason why gold’s price stagnated from 2011 and why gold has gone into liquidation the last week. With inflation low, investors became more cautious about holding gold. With the price stagnant, the huge gains that characterised gold’s rise from 1999 dried up, leaving more and more long-term investors and particularly institutional investors leaving the gold game to hunt elsewhere for yield.

I myself am an inflation agnostic, with deflationista tendencies. While I tend to lean toward the notion of deeply-depressed Japan-style price levels during a deleveraging trap, price levels are also a nonlinear phenomenon and could both accelerate or decelerate based on irrational psychological factors as much as the level of the money supply, or the total debt level, or the level of deleveraging. And high inflation could certainly take off as a result of an exogenous shock like a war, or series of natural disasters. But certainly, betting the farm on a trade tied to very high inflation expectations when the underlying trend is largely deflationary was a very bad idea, and those who did like John Paulson are being punished pretty brutally.

The extent to which this may continue is uncertain.Gold today fell beneath its 200-week moving average for the first time since 2001. How investors, and particularly institutional investors react to this is uncertain, but I tend to expect the pendulum to swing very far toward liquidation. After all, in 2011 most Americans named gold the safest investment, and now that psychological bubble is bursting. That means that for every goldbug buying the dip, many more may panic and sell their gold. This could easily turn to a rout, and gold may fall as low as the cost of production ($900), or even lower (especially considering gold’s high stock-to-flow ratio). Gold is a speculation in that it produces no return other than price rises. The last time gold got stuck in a rut, it was stuck there for almost 20 years.

However, my case for physical gold as a small part of a diverse portfolio to act as a hedge against systemic and counterparty risks (default cascades, Corzine-style vaporisation, etc) still stands, and lower prices are only good news in that regard. The financial system retains very many of its pre-2008 fragilities as the deregulated megabanks acting on margin continue to speculate in ways that systematise risk through balance sheet interconnectivity. Another financial crisis may initially lower the price of gold on margin calls, but in the long run may result in renewed inflows into gold and a price trend reversal. Gold is very much a barometer of distrust in the financial, governmental and corporate establishment, and as middle class incomes continue to stagnate and income inequality continues to soar there remain grave questions over these establishments’ abilities to foster systemic prosperity.

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On Stockman & Liquidation

David Stockman’s New York Times Op-Ed has ruffled a lot of feathers. Paul Krugman dislikes it, saying Stockman sounds like a cranky old man, and criticising Stockman for throwing out a load of meaningless numbers that sound kind of scary, but are less scary in context. Krugman is right on both counts, but what Krugman overlooks is Stockman’s excellent criticism of crony capitalism, financialisation, systemic rot and Wall Street corruption of Washington, something Stockman has seen from the inside as part of the Reagan administration.

The important part:

Essentially there was a cleansing run on the wholesale funding market in the canyons of Wall Street going on. It would have worked its will, just like JP Morgan allowed it to happen in 1907 when we did not have the Fed getting in the way. Because they stopped it in its tracks after the AIG bailout and then all the alphabet soup of different lines that the Fed threw out, and then the enactment of TARP, the last two investment banks standing were rescued, Goldman and Morgan Stanley, and they should not have been.

As a result of being rescued and having the cleansing liquidation of rotten balance sheets stopped, within a few weeks and certainly months they were back to the same old games, such that Goldman Sachs got $10 billion dollars for the fiscal year that started three months later after that check went out, which was October 2008. For the fiscal 2009 year, Goldman Sachs generated what I call a $29 billion surplus – $13 billion of net income after tax, and on top of that $16 billion of salaries and bonuses, 95% of it which was bonuses.

Therefore, the idea that they were on death’s door does not stack up. Even if they had been, it would not make any difference to the health of the financial system. These firms are supposed to come and go, and if people make really bad bets, if they have a trillion dollar balance sheet with six, seven, eight hundred billion dollars worth of hot-money short-term funding, then they ought to take their just reward, because it would create lessons, it would create discipline. So all the new firms that would have been formed out of the remnants of Goldman Sachs where everybody lost their stock values – which for most of these partners is tens of millions, hundreds of millions – when they formed a new firm, I doubt whether they would have gone back to the old game. What happened was the Fed stopped everything in its tracks, kept Goldman Sachs intact, the reckless Goldman Sachs and the reckless Morgan Stanley, everyone quickly recovered their stock value and the game continues. This is one of the evils that comes from this kind of deep intervention in the capital and money markets.

There are plenty of other writers who have pointed to this problem of propping up casino finance, including myself. But very few of them are doing so on the pages of the New York Times. So while it’s rather disappointing to see Stockman railing against deficits when the evidence shows capital and labour markets are still very slack even with large deficits, and while it’s rather disappointing to see him making technically-incorrect claims about the United States being “bankrupt” — sovereign lenders controlling their own currency cannot go bankrupt — we should not throw the baby out with the bathwater. Stockman is a cranky old man — but when it comes to drawing attention to real-world problems with crony capitalism, he’s doing a fine job.

Many will say that just letting the banks liquidate was not an option. I tend to disagree — depositors could have been protected, and a new part-nationalised banking system could perhaps have been built and capitalised just as quickly as the old dinosaurs were bailed out — but even if we assume liquidation to be impossible there are plenty of other options to bring the financial sector to heel. It is extremely disappointing to see the Obama administration fail to go after the banks in any meaningful way. The administration could have tried to break up the TBTF megabanks, reimpose Glass-Steagall, impose the Volcker Rule, fire failed management. Perhaps even try to impose the Chicago Plan. Without Fed liquidity, the US banking sector is toast, so almost any reform is possible.

Instead the banks took their bailouts without any discipline, and guess what? We’ve had even more systemic corruption, carrying on in the same pre-2008 mould — the London Whale, Ina Drew, Kweku Adoboli, the theft of segregated deposits by MF Global, even while financial sector stocks have soared. Central banks have reinflated the markets, but with the same people who created the last bust still in charge, it looks much more like a reinflated bubble than a road to lasting prosperity. Papering over the cracks…

The result of that is soaring corporate profits while employment and wages remain depressed. Feast for Wall Street, famine for Main Street. Obama may deploy plenty of populist rhetoric, but outcomes speak for themselves:

fredgraph (19)

Stockman has actually gone further in the past, criticising the toothlessness of Dodd-Frank in dealing with the problem of Too Big To Fail, and even endorsing a return to Glass-Steagall and the banning of corporate campaign donations. This 30-minute video is really worth watching:

 

In the long run, I think it will become patently clear that throwing liquidity at the financial system won’t solve anything other than immediate liquidity concerns. The rot was too deep. The financial sector needed real reform in 2008. It still needs it today.

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When All Else Fails, Housing Bubble

Last month I asked:

So what’s Osborne’s plan to generate growth?

Today we seem to have an answer.

As Anatole Kaletsky sarcastically put it:

That’s right — aside from an underfunded infrastructure pledge, a duty cut on beer and cigarettes, and a tiny and delayed corporation tax and national insurance decrease, George Osborne’s plan is to throw money at housing and hope for the best. 

Sounds markedly similar to the American strategy following 2001 when Greenspan “created a housing bubble to replace the NASDAQ bubble”, and we all know how that ended.

I’d tend to argue that the opposite is a much better idea. Instead of propping up the housing market, Cameron and Osborne should deregulate construction and planning (getting planning permission can be a long, costly task in the UK, and planning restrictions are estimated to add up to £40,000 to house prices) so that housing prices fall (if not absolutely at least priced in median wages) and Generation Y can start getting on the housing ladder.

As Faisal Islam put it:

But alas no. Instead of using the ultra-low interest rate environment and idle resources to invest in a quality business infrastructure  — high speed broadband, roads, railways, energy — and lower unemployment, Osborne has chosen to throw his stock in with the malinvestment-loving property speculators.

Unfortunately, pumping up credit bubbles can win elections (as we saw with Bush in 2004), so this may have improved the Tory electoral chances for 2015. But in the long run, we will see this as a dire move.

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Of Krugman & Minsky

Paul Krugman just did something mind-bending.

KrugMan-625x416

In a recent column, he cited Minsky ostensibly to defend Alan Greenspan’s loose monetary policies:

Business Insider reports on a Bloomberg TV interview with hedge fund legend Stan Druckenmiller that helped crystallize in my mind what, exactly, I find so appalling about people who say that we must tighten monetary policy to avoid bubbles — even in the face of high unemployment and low inflation.

Druckenmiller blames Alan Greenspan’s loose-money policies for the whole disaster; that’s a highly dubious proposition, in fact rejected by all the serious studies I’ve seen. (Remember, the ECB was much less expansionary, but Europe had just as big a housing bubble; I vote for Minsky’s notion that financial systems run amok when people forget about risk, not because central bankers are a bit too liberal)

Krugman correctly identifies the mechanism here — prior to 2008, people forgot about risk. But why did people forget about risk, if not for the Greenspan put? Central bankers were perfectly happy to take credit for the prolonged growth and stability while the good times lasted.

Greenspan put the pedal to the metal each time the US hit a recession and flooded markets with liquidity. He was prepared to create bubbles to replace old bubbles, just as Krugman’s friend Paul McCulley once put it. Bernanke called it the Great Moderation; that through monetary policy, the Fed had effectively smoothed the business cycle to the extent that the old days of boom and bust were gone. It was boom and boom and boom.

So, people forgot about risk. Macroeconomic stability bred complacency. And the longer the perceived good times last, the more fragile the economy becomes, as more and more risky behaviour becomes the norm.

Stability is destabilising. The Great Moderation was intimately connected to markets becoming forgetful of risk. And bubbles formed. Not just housing, not just stocks. The truly unsustainable bubble underlying all the others was debt. This is the Federal Funds rate — rate cuts were Greenspan’s main tool — versus total debt as a percentage of GDP:

fredgraph (18)

More damningly, as Matthew C. Klein notes, the outgrowth in debt very clearly coincided with an outgrowth in risk taking:

To any competent central banker, it should have been obvious that the debt load was becoming unsustainable and that dropping interest rates while the debt load soared was irresponsible and dangerous. Unfortunately Greenspan didn’t see it. And now, we’re in the long, slow deleveraging part of the business cycle. We’re in a depression.

In endorsing Minsky’s view, Krugman is coming closer to the truth. But he is still one crucial step away. If stability is destabilising, we must embrace the business cycle. Smaller cyclical booms, and smaller cyclical busts. Not boom, boom, boom and then a grand mal seizure.

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Currency Wars Are Trade Wars

Paul Krugman is all for currency wars, but not trade wars:

First of all, what people think they know about past currency wars isn’t actually true. Everyone uses some combination phrase like “protectionism and competitive devaluation” to describe the supposed vicious circle of the 1930s, but as Barry Eichengreen has pointed out many times, these really don’t go together. If country A and country B engage in a tit-for-tat of tariffs, the end result is restricted trade; if they each try to push their currency down, the end result is at worst to leave everyone back where they started.

And in reality the stuff that’s now being called “currency wars” is almost surely a net plus for the world economy. In the 1930s this was because countries threw off their golden fetters — they left the gold standard and this freed them to pursue expansionary monetary policies. Today that’s not the issue; but what Japan, the US, and the UK are doing is in fact trying to pursue expansionary monetary policy, with currency depreciation as a byproduct.

There is a serious intellectual error here, typical of much of the recent discussion of this issue. A currency war is by definition a low-level form of a trade war because currencies are internationally traded commodities. The intent (and there is much circumstantial evidence to suggest that Japan at least is acting with mercantilist intent, but that is another story for another day) is not relevant — currency depreciation is currency depreciation and still has the same effects on creditors and trade partners, whatever the claimed intent.

Krugman cites Barry Eichengreen as evidence that competitive devaluation does not necessarily mean a trade war, but Eichengreen does not address the issue of a trade war directly, much less denying the possibility of one.  Indeed, while broadly supportive of competitive devaluation Eichengreen notes that the process was “disorderly and disruptive”.

And the risks of disorder and disruption are still very real today.

As Mark Thoma noted in 2010:

While the positive effects a currency war produced in the 1930s are unlikely to reappear, there is a chance of large negative effects such as a simultaneous trade war or the breakdown of the international monetary system, so let’s hope a currency war can be avoided.

The mechanism here is very simple. Some countries — those with a lower domestic rate of inflation, like Japan — have a natural advantage in a currency war against countries with a higher domestic rate of inflation like Brazil and China. If one side runs out of leverage to debase their currency because of heightened domestic inflation, their next recourse is to resort to direction trade measures like quotas and tariffs.

And actually, the United States and China in particular have been engaging in a low-level trade and currency war for a long time.

As I noted last year:

China and Russia and Brazil have all recently expressed deep unease at America’s can-kicking and money-printing mentality. This is partly because American money printing has exported inflation to the world, as a result of the dollar’s role as the global reserve currency, and partly because these states already own a lot of American debt, and do not want to be paid off in hugely-debased money.

Since I made that statement, there has been a great lot of debasement without any great spiral of damaging trade measures. But with the world locked into ever greater monetary and trade interdependency, and with fiery trade rhetoric continuing to spew forth from the BRIC nations, who by-and-large seem to continue to believe that American money-printing is damaging their interests, and who in the past two years have put together a new global reserve currency framework, it would be deeply complacent to believe that the risks of a severe trade war have gone away.

(Unfortunately, Krugman and Eichengreen both seem to discount the reality that Okun’s law has broken down, and that monetary expansion today is supporting crony industries, and exacerbating income inequality, but those are another story for another day)

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Of Wages and Robots

There is a popular meme going around, popularised by the likes of Tyler Cowen, Paul Krugman and Noah Smith that suggests that recent falls in worker compensation as a percentage of GDP is mostly due to the so-called “rise of the robots”:

For most of modern history, two-thirds of the income of most rich nations has gone to pay salaries and wages for people who work, while one-third has gone to pay dividends, capital gains, interest, rent, etc. to the people who own capital. This two-thirds/one-third division was so stable that people began to believe it would last forever. But in the past ten years, something has changed. Labor’s share of income has steadily declined, falling by several percentage points since 2000. It now sits at around 60% or lower. The fall of labor income, and the rise of capital income, has contributed to America’s growing inequality.

…

In past times, technological change always augmented the abilities of human beings. A worker with a machine saw was much more productive than a worker with a hand saw. The fears of “Luddites,” who tried to prevent the spread of technology out of fear of losing their jobs, proved unfounded. But that was then, and this is now. Recent technological advances in the area of computers and automation have begun to do some higher cognitive tasks – think of robots building cars, stocking groceries, doing your taxes.

Once human cognition is replaced, what else have we got? For the ultimate extreme example, imagine a robot that costs $5 to manufacture and can do everything you do, only better. You would be as obsolete as a horse.

Now, humans will never be completely replaced, like horses were. Horses have no property rights or reproductive rights, nor the intelligence to enter into contracts. There will always be something for humans to do for money. But it is quite possible that workers’ share of what society produces will continue to go down and down, as our economy becomes more and more capital-intensive.

So, does the rise of the robots really explain the stagnation of wages?

This is the picture for American workers, representing wages and salaries as a percentage of GDP:

WASCURGDP

It is certainly true that wages have fallen as a percentage of economic activity (and that corporate profits as a percentage of economic activity have risen — a favourite topic of mine).

But there are two variables to wages as a percentage of GDP. Nominal wages have actually risen, and continued to rise on a moderately steep trajectory:

WASCUR_Max_630_378

And average wages continue to climb nominally, too. What has actually happened to the wages-to-GDP ratio, is not that America’s wage bill has really fallen, but that wages have just not risen as fast as other sectors of GDP (rents, interest payments, capital gains, dividends, etc). It is not as if wages are collapsing as robots and automation (as well as other factors like job migration to the Far East) ravage the American workforce.

It is more accurate to say that there has been an outgrowth in economic activity that is not yielding wages beginning around the turn of the millennium, and coinciding with the new post-Gramm-Leach-Bliley landscape of mass financialisation and the derivatives and shadow banking megabubbles, as well the multi-trillion dollar military-industrial complex spending spree that coincided with the advent of the War on Terror. Perhaps, if we want to look at why the overwhelming majority of the new economic activity is not trickling down into wages, we should look less at robots, and more at the financial and regulatory landscape where Wall Street megabanks pay million-dollar fines for billion-dollar crimes? Perhaps we should look at a monetary policy that dumps new money solely into the financial sector and which has been shown empirically to enrich the richest few far faster than everyone else?

But let’s focus specifically on jobs. The problem with the view that this is mostly a technology shock is summed up beautifully in this tweet I received from Saifedean Ammous:

The Luddite notion that technology might render humans obsolete is as old as the wheel. And again and again, humans have found new ways to employ themselves in spite of the new technology making old professions obsolete. Agriculture was once the overwhelming mainstay of US employment. It is no more:

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This did not lead to a permanent depression and permanent and massive unemployment. True, it led to a difficult transition period, the Great Depression in the 1930s (similar in many ways, as Joe Stiglitz has pointed out, to the present day). But eventually (after a long and difficult depression) humans retrained and re-employed themselves in new avenues.

It is certainly possible that we are in a similar transition period today — manufacturing has largely been shipped overseas, and service jobs are being eliminated by improvements in efficiency and greater automation. Indeed, it may prove to be an even more difficult transition than that of the 1930s. Employment remains far below its pre-crisis peak:

EMRATIO_Max_630_378

But that doesn’t mean that human beings (and their labour) are being rendered obsolete — they just need to find new employment niches in the economic landscape. As an early example, millions of people have begun to make a living online — creating content, writing code, building platforms, endorsing and advertising products, etc. As the information universe continues to grow and develop, such employment and business opportunities will probably continue to flower — just as new work opportunities (thankfully) replaced mass agriculture. Humans still have a vast array of useful attributes that cannot be automated — creativity, lateral thinking & innovation, interpersonal communication, opinions, emotions, and so on. Noah Smith’s example of a robot that “can do everything you can do” won’t exist in the foreseeable future (let alone at a cost of $5) — and any society that could master the level of technology necessary to produce such a thing would probably not need to work (at least in the sense we use the word today) at all. Until then, luckily, finding new niches is something that humans have proven very, very good at.

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Taleb on Overstabilisation

It’s nice to know that Taleb is preaching more or less the same gospel that I am.

Via the NYT:

Stabilization, of course, has long been the economic playbook of the United States government; it has kept interest rates low, shored up banks, purchased bad debts and printed money. But the effect is akin to treating metastatic cancer with painkillers. It has not only let deeper problems fester, but also aggravated inequality. Bankers have continued to get rich using taxpayer dollars as both fuel and backstop. And printing money tends to disproportionately benefit a certain class. The rise in asset prices made the superrich even richer, while the median family income has dropped.

Overstabilization also corrects problems that ought not to be corrected and renders the economy more fragile; and in a fragile economy, even small errors can lead to crises and plunge the entire system into chaos. That’s what happened in 2008. More than four years after that financial crisis began, nothing has been done to address its root causes.

Our goal instead should be an antifragile system — one in which mistakes don’t ricochet throughout the economy, but can instead be used to fuel growth. The key elements to such a system are decentralization of decision making and ensuring that all economic and political actors have some “skin in the game.”

Two of the biggest policy mistakes of the past decade resulted from centralized decision making. First, the Iraq war, in addition to its tragic outcomes, cost between 40 and 100 times the original estimates. The second was the 2008 crisis, which I believe resulted from an all-too-powerful Federal Reserve providing cheap money to stifle economic volatility; this, in turn, led to the accumulation of hidden risks in the economic system, which cascaded into a major blowup.

Just as we didn’t forecast these two mistakes and their impact, we’ll miss the next ones unless we confront our error-prone system. Fortunately, the solution can be bipartisan, pleasing both those who decry a large federal government and those who distrust the market.

First, in a decentralized system, errors are by nature smaller. Switzerland is one of the world’s wealthiest and most stable countries. It is also highly decentralized — with 26 cantons that are self-governing and make most of their own budgetary decisions. The absence of a central monopoly on taxation makes them compete for tax and bureaucratic efficiency. And if the Jura canton goes bankrupt, it will not destabilize the entire Swiss economy.

In decentralized systems, problems can be solved early and when they are small; stakeholders are also generally more willing to pay to solve local challenges (like fixing a bridge), which often affect them in a direct way. And when there are terrible failures in economic management — a bankrupt county, a state ill-prepared for its pension obligations — these do not necessarily bring the national economy to its knees. In fact, states and municipalities will learn from the mistakes of others, ultimately making the economy stronger.

It’s a myth that centralization and size bring “efficiency.” Centralized states are deficit-prone precisely because they tend to be gamed by lobbyists and large corporations, which increase their size in order to get the protection of bailouts. No large company should ever be bailed out; it creates a moral hazard.

Consider the difference between Silicon Valley entrepreneurs, who are taught to “fail early and often,” and large corporations that leech off governments and demand bailouts when they’re in trouble on the pretext that they are too big to fail. Entrepreneurs don’t ask for bailouts, and their failures do not destabilize the economy as a whole.

Second, there must be skin in the game across the board, so that nobody can inflict harm on others without first harming himself. Bankers got rich — and are still rich — from transferring risk to taxpayers (and we still haven’t seen clawbacks of executive pay at companies that were bailed out). Likewise, Washington bureaucrats haven’t been exposed to punishment for their errors, whereas officials at the municipal level often have to face the wrath of voters (and neighbors) who are affected by their mistakes.

If we want our economy not to be merely resilient, but to flourish, we must strive for antifragility. It is the difference between something that breaks severely after a policy error, and something that thrives from such mistakes. Since we cannot stop making mistakes and prediction errors, let us make sure their impact is limited and localized, and can in the long term help ensure our prosperity and growth.