Paul Krugman just did something mind-bending.
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:
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.
In an increasingly globalised economy, we need more global data measurement.
The Economist presents a new attempt to measure global GDP. The sub-bars are showing each region’s contribution to global GDP growth, rather than their internal growth rate:
Globally, there was a big and swift return to strong GDP growth, built on the backs of emerging countries and particularly the BRICs. Since early 2010, rather than getting stronger and stronger, global growth has actually become weaker and weaker.
This is quite a departure from certain narratives popular today that suggest that growth has gotten stronger and stronger since the end of the recession, that we are almost out of the woods, and that we are on the cusp of a new era of spectacular growth.
And in a world of globalised trade, globalised lending, and global supply chains the notion that any nation can really be shielded from the ongoing effects of declining global growth seems extremely over-optimistic.
Yet another reason to be highly cautious of the increasingly popular idea that now is the time to turn bullish on American equities.
They don’t agree:
Question 1 — Agree
Economists in Sapienza and Zingales’ study resolutely agreed that it is hard to predict stock prices. A majority of the public agreed with the statement, but not so resolutely. Stock prices are the culmination of transactions between humans, and human behaviour is hard to predict because it is often irrational and informed by cognitive fallacies.
Question 2 — Agree, with a bitter taste in my mouth.
Economists were vastly more bullish on the stimulus’ effect on unemployment than the general public. And the data is actually quite unkind toward the economists’ view — the real unemployment path was far worse than the path projected by those in the Obama administration who promoted the stimulus. However, this is more of a symptom of the stimulus’ designers underestimating the depth of the economic contraction that the financial crisis caused. There is no doubt that the stimulus created jobs and lowered the unemployment rate in the immediate term. Whether the jobs created were really useful and beneficial — and to what extent the stimulus was a malinvestment of capital — is another question entirely, and one which can only be answered in the long run.
Question 3 — Agree
Economists overwhelmingly agreed that market factors are the chief cause behind variation in petrol prices. The public agreed, but to a lesser extent. Presumably, the dissenting public and dissenting economists see government intervention as a more significant force? Certainly, the present global oil market is a precarious pyramid of supply chains balanced on the back of the petrodollar empire. But the market reflects these factors. When governments start a war, that is reflected in the oil price. That’s a force that the market responds to. If a central planner was directly setting the oil price (rather than merely influencing it) — as is the case in communist countries — that would be a price determined by non-market forces.
Question 4 — Uncertain
Economists were broadly certain that a carbon tax is less costly than mileage standards. I think this is far too general a question. Without nuts-and-bolts policy proposals, it is not really possible to assess which would be more costly.
Question 5 — Uncertain, leaning toward Disagree.
This was the only question where economists and the public were largely agreeable — and economists were largely split. As I stated above, the “success” of the stimulus package can only really be assessed in the longer run, and even then there are difficulties with measurement. Generally, I suspect very much that the various interventions in 2008 onward have preserved and supported economically unsustainable and inefficient sectors and industries that ought to have been liquidated and rebuilt (especially the financial industry, but also other sectors, e.g. Detroit). Had the government in 2008 followed the liquidationary trend in the market, the slump would have been much deeper, unemployment would have risen much higher, but the eventual rebound may have been much quicker and stronger.
Question 6 — Agree
This is where economists and the public disagree the most. It is the point on which the public was the most bullish, and economists almost unanimously bearish. Economists in general seem to believe that what they define as free trade is best, even when it destroys domestic supply chains and drastically decreases manufacturing employment. To economists, this means that the American government should not discriminate against foreign products but buy for the best product and the best price. This ignores some important externalities. Buying American certainly supports American jobs, because money goes to American companies, and toward American salaries. This might foster inefficient and otherwise-unsustainable industries, but if the American public chooses to favour American products for their government, that is their right. And a strong domestic manufacturing base is no bad thing, either.
The black swan is probably the most widely misunderstood philosophical term of this century. I tend to find it being thrown around to refer to anything surprising and negative. But that’s not how Taleb defined it.
Taleb defined it very simply as any high impact surprise event. Of course, the definition of surprise is relative to the observer. To the lunatics at the NYT who push bilge about continuing American primacy, a meteoric decline in America’s standing (probably emerging from some of the fragilities I have identified in the global economic fabric) would be a black swan. It would also be a black swan to the sorry swathes of individuals who believe what they hear in the mainstream media, and from the lips of politicians (both Romney and Obama have recently paid lip service to the idea that America is far from decline). Such an event would not really be a black swan to me; I believe America and her allies will at best be a solid second in the global pecking order — behind the ASEAN group — by 2025, simply because ASEAN make a giant swathe of what we consume (and not vice verse), and producers have a historical tendency to assert authority over consumers.
But black swans are not just events. They can also be non-events. To Harold Camping and his messianic followers who confidently predicted the apocalypse on the 21st of May 2011 (and every other true-believing false prophet) the non-event was a black swan. Surprising (to them at least) and high impact, because it surely changed the entire trajectory of their lives. (Camping still lives on Earth, rather than in Heaven as he supposedly expected).
To true-believing environmentalists who warn of Malthusian catastrophe (i.e. crises triggered by overpopulation or resource depletion), history is studded with these black swan non-events.
From the Economist:
Forecasters of scarcity and doom are not only invariably wrong, they think that being wrong proves them right.
In 1798 Thomas Robert Malthus inaugurated a grand tradition of environmentalism with his best-selling pamphlet on population. Malthus argued with impeccable logic but distinctly peccable premises that since population tended to increase geometrically (1,2,4,8 ) and food supply to increase arithmetically (1,2,3,4 ), the starvation of Great Britain was inevitable and imminent. Almost everybody thought he was right. He was wrong.
In 1865 an influential book by Stanley Jevons argued with equally good logic and equally flawed premises that Britain would run out of coal in a few short years’ time. In 1914, the United States Bureau of Mines predicted that American oil reserves would last ten years. In 1939 and again in 1951, the Department of the Interior said American oil would last 13 years. Wrong, wrong, wrong and wrong.
Predictions of ecological doom, including recent ones, have such a terrible track record that people should take them with pinches of salt instead of lapping them up with relish. For reasons of their own, pressure groups, journalists and fame-seekers will no doubt continue to peddle ecological catastrophes at an undiminishing speed. These people, oddly, appear to think that having been invariably wrong in the past makes them more likely to be right in the future. The rest of us might do better to recall, when warned of the next doomsday, what ever became of the last one.
Critics will note that Malthusians only have to be right once to provoke dire consequences; deaths, famines, plagues. Of course, that is the same logic that has led governments to spend trillions, and trample the constitutional rights of millions of people in fighting amateurish jihadis, when in reality more Americans — yes including the deaths from 9/11 — are crushed to death by furniture than are killed by Islamic terrorism.
But it is true, the scope of the threat posed by Malthusian catastrophe is probably an order of magnitude greater than by jihadis with beards in caves. And of course, groups like the Club of Rome and individuals like Paul Ehrlich will keep spewing out projections of imminent catastrophe.
So what were the real threats to humanity following Malthus’ predictions? Was it overpopulation? Nope. Imperial warfare killed far, far more than any famine or resource crisis in the 20th Century. To the overwhelming majority of the population, World War I — both in its origins (the assassination of an obscure archduke), its scope, its death toll, and its final ramifications (i.e. the Treaty of Versailles, the rise of Nazism and World War II) was the great black swan event, the great killer, the great menace.
Black swan events defined the 20th Century; the black swan non-events of Malthus did not. The true story of the early 20th Century was the decline of a heavily indebted, consumptive and overstretched imperial power (Britain), and the dangers to peace and international commerce as its productive and expansionistic rivals (especially Germany, but also America) rose and challenged her (in vastly different ways).
There are some real environmental concerns like the dangers posed by nuclear meltdowns, runaway global warming (although I believe a little global warming is probably a good thing, as it will keep us out of any prospective future ice age), tectonic activity, or an exotic solar event like an X-flare, but we have no clue what will hit us, when it will hit, and its branching tree of consequences. We don’t have a full view of the risks. In spite of what unsophisticated mathematician pseudo-scientists in the tradition of Galton and Quetelet may tell us, we cannot even model reality to the extent of being able to accurately foretell tomorrow’s weather.
But once again a heavily consumptive, indebted and overstretched imperial power (America) is coming to terms with the problem of decreasing power in the face of productive and expansionistic rivals (particularly China). That parallel tends to lead me to believe that imperialist warfare will be the greatest menace of the 21st Century, too. But that’s the problem with predicting the future: we simply don’t know what black swan events and non-events nature will deliver (although it would be wise not to place too much trust in politicians or the establishment media, who simply blow their own trumpet and hope for the best).
So what are we to do?
Well, I think it’s important that businesses, governments and individuals think about Malthusian concerns. Malthus’ incorrect theorising touched upon the most significant of human concerns. Quite simply, without food, water and energy we weak and fragile humans are imperilled. It’s important that governments (particularly of importer nations) devise strategies to cope with (for example) breakdowns in the international trade system. Individuals, families, businesses and communities should be aware of where their food, energy and water come from, and of alternatives in case the line of supply is cut. Keeping backups (e.g. solar panels, batteries, wind turbines, storable food and water) is a sensible precaution for all citizens. There will be shocks in the future, just as there have been in the past. We should be prepared for shocks, whatever they may be.
And we should learn to love such volatility. Nature will always deliver it. We evolved and developed with it. It is only in modernity that we have adopted systems procedures and methodologies to subdue volatility. And — as we are slowly learning via the disastrous consequences of every single failed experiment in central planning — volatility suppressed is like a coiled spring.
Paul Krugman — surely the most (deliberately) provocative economist in the world — thinks we need more inflation.
From Paul Krugman:
Inflation hawks, including Paul Volcker in today’s NYT, often invoke the supposed lessons of history, to the effect that inflation is always harmful and always gets out of control.
But that’s a selective reading of history, and it skips the most relevant examples.
Early on in this crisis, I began wondering why the US didn’t relapse into the Great Depression after World War II. And there’s a good case that this had something to do with it:
The big rise in prices during and after WWII arguably did a lot to eliminate the debt overhang, making it possible for the economy to enter a sustained, non-inflationary boom.
So his reasoning is that inflation is necessary for debt elimination. And when it comes to debt elimination, (for once) I agree with him. But should that be done through inflation?
Absolutely not. If a debtor cannot afford its debts, there are two paths to debt-elimination:
The second option — which is effectively what Krugman is advocating — is incredibly risky. From the perspective of the consumer, inflation coupled with stagnant wages would be painful — and the potential for a hyper-inflationary spiral is downright dangerous. A far better option is giving consumers more options to default on or renegotiate their debts, including mortgages.
But from the perspective of the US Treasury, inflation would be far worse still. Why? Money printing is increasingly seen as a sign that foreign creditors need to get out of the dollar, and into harder assets. This would result in many foreign-held dollars flooding back to America, worsening the inflationary spiral.
The private Federal Reserve has been quite careful in maintaining a veil of secrecy over the full extent of dollar saturation in foreign markets in order to hide the sheer volume of greenback devaluation and inflation they have created. If for some reason the reserves of dollars held overseas by investors and creditors were to come flooding back into the U.S., we would see a hyperinflationary spiral more destructive than any in recorded history.
Conversely, a straight-forward haircut would be painful in the short term, but would do far less than money printing to undermine the dollar in the medium term — and cause far less of a flood of dollars back into America. Creditors, particularly China, would be happier to see a short-term default stopping the printing presses and safeguarding the long-term purchasing power of the dollar than they would see the dollar constantly undermined.
So, in conclusion, default achieves debt elimination in a clean and relatively one-dimensional manner, while safeguarding the value of the currency. Inflating away the debt achieves the same thing in a more dangerous fashion, because it endangers the quality of the currency. The international ramifications of such a policy are unpredictable, especially given the fact that so much of America’s economic might is built on its ability to acquire resources and energy with dollars.
As Ernest Hemingway put it:
The first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.
No — we don’t need more inflation. We need to pay down our debts in a timely and honest fashion, and if we can’t do that we need to default.
Of course, there is another aspect to this:
Krugman thinks weak demand is eating the American economy, and that money printing and a little inflation will provide enough of a boost to juice the economy into a stronger position. But weak demand is not the problem. The biggest problem is imperial overstretch.
The most annoying thing about the establishment’s ongoing obsession with maintaining the status quo, and supporting and bailing out older and larger companies?
Dinosaurs don’t create jobs.
From the Economist:
Research funded by the Kauffman Foundation shows that between 1980 and 2005 all net new private-sector jobs in America were created by companies less than five years old. “Big firms destroy jobs to become more productive. Small firms need people to find opportunities to scale. That is why they create jobs,” says Carl Schramm, the foundation’s president.
And it doesn’t stop there.
In the US, small business (less than 500 employees) accounts for around half the GDP and more than half the employment. Regarding small business, the top job provider is those with fewer than 10 employees, and those with 10 or more but fewer than 20 employees comes in as the second, and those with 20 or more but fewer than 100 employees comes in as the third.