Asymptosis

Real Reasons Bankers Don’t Like Basel’s Rules: Clive Crook – Bloomberg. Why bankers’ whining about higher equity requirements is just that:

A much-cited paper by Stanford’s Anat Admati and colleagues — “Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Expensive” — should have ended this debate once and for all. It dismantles the banks’ position step by painstaking step.

The study makes the crucial distinction between the interests of bank managers, bank shareholders and the public at large. Managers are being disingenuous. They do have reasons, valid after a fashion, for opposing higher capital requirements, just not reasons they can admit. The one they emphasize — cost of funding and its effect on future lending — is fit for public use, but bogus.

What might their real reasons be? If banks sell more shares, it’s true that the return on equity will fall. If managers’ pay is tied to return on equity (as it often is), they will be worse off. Shareholders, on the other hand, shouldn’t mind, because the risk of their investment is reduced in proportion. Taxpayers, of course, would be better off — less likely to be stuck at some point with the cost of bailing out the bank.

The paper is here.

Cross-posted at Angry Bear.

I’ve gone on about this elsewhere, but thought I should bring it up front and center here.

While everyone hyperventilates about government debt, they don’t seem to be aware of the massively greater load of private debt, and its spectacular runup compared to government debt:

This from Steve Keen’s latest. (It’s not very long. There are lots of pictures. It makes every kind of sense. Read the whole thing.) The blue line is publicly held debt — not including money the government owes itself (on the consolidated budget) for Social Security and Medicare.*† The red line is debt of 1. households and nonprofits, 2. nonfinancial businesses, and 3. financial businesses.

Here’s how those sectors break out:

Again, you hear all sorts of hyperventilating from the morality-based school of economics about households/consumers going on a debt-financed spending binge, especially in the 00s. And that definitely happened. With the financial industry begging them to borrow — almost literally throwing money at them — and telling them authoritatively that it’s free because house prices always go up, it’s not surprising. Humans will be humans; who’s gonna turn down money when the powers that be — who presumably know a lot more about finance than a high-school-educated homeowner working at a lumber mill — say it’s free?

But that ignores the really massive runup: financial corporations’ debts. Starting at a little over 10% of GDP in 1970, they hit almost 80% by 2000, and when the crash hit they were over 120% of GDP  — a 10x, order-of-magnitude increase over 40 years.

The story explaining these pictures was told long ago — notably by Irving Fisher in 1933 (only after he had driven his Wall Street firm to ruin and lost everything, including his house, by clinging, Polyanna-like, to the kindergarten-ish Price-Is-Right! nostrums of classical economics). Minsky told it in cogent and convincing detail.

The basic story is very simple. It goes like this (in my words):

• Banks (and shadow banks) make money by lending. Bankers have every incentive to increase their loan books, even by extending questionable loans, because bankers don’t personally bear the eventual, down-the-road losses from loan defaults — they’ve gotten their money already.

• When banks run out of real, productive enterprises to lend to — enterprises that can pay back loans and interest from the production and sale of real goods that humans can consume — they start lending to speculators (gamblers) who are buying financial assets in hopes that their prices will rise.

• That lending — extra money being pumped into the system — does indeed drive up the price of financial assets, far beyond the value of the real assets that (according to most economists you listen to) supposedly underpin those financial assets’ value.

• Eventually people realize that the value of financial assets far exceeds the value of real assets — and far exceeds the capacity of the real economy to service the loans that drove up those financial asset prices. Prices of financial assets plummet, borrowers default because there just ain’t enough real income to service the loans, financial-asset prices plummet some more, all in a downward spiral — with all sorts of collateral damage to the real economy.

There’s your (economy-wide) Ponzi scheme. Households and nonfinancial businesses definitely participate (the financial industry makes it almost irresistible not to), but it’s driven by the financial industry, and a huge proportion of the takings go to players in the financial industry.

But as Keen points out, the powers that be almost completely ignore that simple story. He quotes one of Bernanke’s extraordinarily rare mentions of either Fisher or Minsky:

Fisher’s idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects… (Bernanke 2000, p. 24; emphasis added)

The rarity — inexplicable to me, at least — speaks even more loudly and eloquently than this blithely dismissive quotation does.

When really smart people like Ben Bernanke constantly ignore an elegant, simple, even obvious explanation that’s been lying on the ground, ready to pick up, for at least 75 years, you gotta figure they’ve got some incentive — whether they’re conscious of it or not. That’s what I talked about the other day.

Again, read Steve’s whole piece. And if you have any interest in economics and haven’t bought the new edition of his book yet, do.

* Please don’t try to dismiss this by pointing to the net present value of SS/Medicare liabilities extending into the infinite future. 1. Including those intra-government debts doesn’t change this picture much at all. 2. It’s a completely separate discussion, about whether we choose to provide those services out of current GDP over future years and decades. 3. If charges by health-care providers were rising at the same rate as inflation, even that future cost would not be a terrible burden. 4. Social Security is actuarily solid on a cash-flow basis for decades, and beyond the foreseeable future (75 years+) if we simply Scrap The Cap on the payroll tax, requiring high earners to pay their full share.

† I’m not clear whether he includes bonds held by the Fed — again, money the government owes itself, if you view Treasury and Fed as both being part of the government — which total a whopping $1.6 trillion or so, more than 10% of GDP, last I checked. I don’t actually know if Fed holdings are included in “debt held by the  public.” (You gotta wonder whether the Fed counts as “the public.”) Little help, so I don’t have to go Google it up myself?

Cross-posted at Angry Bear.

I’m stealing this headline directly from Sandwichman. He sez:

No it doesn’t. It almost never is. To pay back government debt, you have to run a budget surplus, and while there may be modest surpluses from time to time, they don’t add up to more than a minuscule fraction of all the accumulated debt. But don’t take it from me, look at the record.

Here’s a longer-term view, zoomed in on successive times slices so you can see the changes:

Do you notice our progenitors’ great-great-grandchildren (us) paying off our forebears’ debts? Yeah, neither did I. (It did happen once, and the result was economic catastrophe. Every depression in our nation’s history was preceded by a big decline in nominal Federal debt.)

Here’s the U.K.:

David Graeber, from Debt: The First 5,000 Years:

The reader will recall that the Bank of England was created when a consortium of forty London and Edinburgh merchants — mostly already creditors to the crown — offered King William III a £1.2 million loan to help finance his war against France.

To this day, this loan has never been paid back. It cannot be. If it ever were, the entire monetary system of Great Britain would cease to exist.

That was 317 years ago — in 1694.

Governments that issue their own money don’t have to pay off their debts. They actually can’t. In fact, they issue money — the money that’s necessary for a growing economy to operate — by deficit spending.

Private borrowers (and non-sovereign-currency states like Greece and Alabama) do have to pay off their debts (or default). That’s why the level of private debt, not sovereign debt, is the big management problem — a problem that neoclassical economics has not tackled, does not even have the theoretical apparatus to tackle.

Yes, of course: government debt and interest payments as a percentage of GDP are important issues. I’ll hand it back to Sandwichman:

The debt burden depends on the ratio of debt to GDP as well as the interest cost in servicing it. The way to reduce this burden is to have a combination of real economic growth, inflation and modest interest rates. If you want to show your solicitude for the well-being of future generations, demand macroeconomic policies that will boost demand and raise inflation a bit, consistent with continued low interest rates.

Today’s creditors will hate you. But your grandchildren will love you.

Update (thanks to Buffpilot at Angry Bear for finding holes): A more precise explanation of why a sovereign-currency issuer might “have” to pay back their debt: if they have committed to redeem their money for something else. For instance Argentina (dollar-denominated debt) and whole host of others who were on a gold standard, had promised to give gold in return for their money. If they can’t or won’t do so, that’s a default on their promise. The U.S. and the U.K. (among others) do not face that situation.

Cross-posted at Angry Bear.

Let’s start with the basics:

Increased inflation results in (in a sense, is) a wealth transfer from creditors to debtors.

Debtors get to pay off their loans in less-valuable dollars — dollars that can’t buy as much real-world stuff, stuff that humans can consume, that they value.

If you’re holding a hundred million dollars in bonds — you’ve lent out hundred million dollars — and bananas are going for a dollar apiece, an extra percent of inflation means that a year from now, you can only buy 99 million bananas. The people who borrowed the money from you get the other million bananas. If inflation stays up and the loan remains outstanding, they get another million bananas next year. You don’t.

You can start to see why creditors might be inflation-averse.

How big is this wealth-transfer effect? Here’s a quite conservative back-of-the-envelope calc.

Figure that there are somewhere north of $50 trillion dollars in private “credit market instruments” out there in the U.S. as of Q3 2011 ($120 trillion in total liabilities).

Do the math: 1% of $50 trillion is 500 billion dollars. One extra percent of inflation transfers that much wealth — buying power — from creditors to debtors. Every year.

This is probably an overstatement — many people/businesses are both creditors and debtors, so part of the transfer is from them to themselves. But still: let’s cut the number in half. An extra point of inflation transfers a quarter of a trillion dollars per year in buying power — real wealth — from creditors to debtors.

Because this effect impacts the huge existing stock of financial assets, 1. it is a permanent , and 2. its scale utterly dwarfs the relatively measly (and multidirectional) effects on flows — often second- or third-order effects — that (neoclassical) economists tend to go on about when discussing inflation. (“Money illusion,” “neutrality of money,” etc.)

And there are far fewer creditors than there are debtors. The effects of the transfer are concentrated on one side, diffused on the other. (See: Mancur Olson).

I’ll have a lot more to say about this in future posts, but keeping this short, I’ll bring it back to the the title of this post:

The Fed is run by creditors. And I’ve heard it said that financial incentives matter. The Fed governors have a huge incentive to keep inflation low, and ignore the other side of their dual mandate: employment.

We tend to talk in very big numbers these days, but a quarter of a trillion dollars a year seems like it’s still enough to get people’s attention.

Cross-posted at Angry Bear.

Let’s start with two basic facts:

• Governments in all thriving, prosperous countries tax/spend 25–50% of those countries’ GDP (averaging around 40%).

• Governments in non-prosperous countries — those that haven’t suffered a recent crash in the numerator/GDP — are all below that range.

There is not a single thriving, prosperous country that does not tax at these levels, or engage in massive quantities of redistribution. Not one.

For me, this raises the conundrum:

If policies eschewing such redistribution are so economically efficient — as claimed by libertarians/conservatives/Republicans/neoclassical economists — one would expect at least one country to have emerged that eschews those policies, and to see that country surge ahead of all the rest.

It hasn’t happened. Not once.

So it’s easy to jump to the post hoc ergo propter hoc conclusion:

Redistribution is necessary for a prosperous country to emerge and thrive. It is at least a necessary (though of course not necessarily sufficient) cause of that prosperity.

But of course you can argue the opposite causation:

Prosperity causes bigger government.

I see two possibilities there:

1. Government services are “normal goods” — as people get more prosperous, they want more of them. Giving people what they want is not a bad thing.

2. The growth of government is an emergent property of a prosperous economy, and is not actually an expression of, does not provide, what individuals want. It just happens because of the inherent dynamics of the system. (Dynamics that are easy to imagine but that I won’t describe here.)

#2 is, I think, the the argument that libertarians would make to explain the correlation between government size and prosperity.

I don’t know how to adjudicate in any definitive way between these two conclusions, or between [one of them] and the redistribution-”causes”-prosperity conclusion.

Given some correlation (necessary to even assert causation), the only way to convincingly demonstrate causation is to tell a coherent and convincing story about the process by which the causation happens. That’s what I did in my first Angry Bear post (well, you can judge for yourself how convincing it is).

Absent any definitive way to decide, for the time being I’m going to stick with the first-blush conclusion suggested by the correlation, and supported by my theories of causation:

Larger government and a significant dose of redistribution are necessary for a prosperous, modern country to emerge and thrive.

 Cross-posted at Angry Bear.

File under: “Every brilliant, original thought or formulation that you think you’ve come up with has probably been thought of before, and probably by a Nobel laureate.”

Nanute points us to:

15 Fatal Fallacies of Financial Fundamentalism. William Vickrey, 1996.

Here are the first three paragraphs. As they say in the trade, read the whole thing.

Much of the conventional economic wisdom prevailing in financial circles, largely subscribed to as a basis for governmental policy, and widely accepted by the media and the public, is based on incomplete analysis, contrafactual assumptions, and false analogy. For instance, encouragement to saving is advocated without attention to the fact that for most people encouraging saving is equivalent to discouraging consumption and reducing market demand, and a purchase by a consumer or a government is also income to vendors and suppliers, and government debt is also an asset. Equally fallacious are implications that what is possible or desirable for individuals one at a time will be equally possible or desirable for all who might wish to do so or for the economy as a whole.

And often analysis seems to be based on the assumption that future economic output is almost entirely determined by inexorable economic forces independently of government policy so that devoting more resources to one use inevitably detracts from availability for another. This might be justifiable in an economy at chock-full employment, or it might be validated in a sense by postulating that the Federal Reserve Board will pursue and succeed in a policy of holding unemployment strictly to a fixed “non-inflation-accelerating” or “natural” rate. But under current conditions such success is neither likely nor desirable.

Some of the fallacies that result from such modes of thought are as follows. Taken together their acceptance is leading to policies that at best are keeping us in the economic doldrums with overall unemployment rates stuck in the 5 to 6 percent range. This is bad enough merely in terms of the loss of 10 to 15 percent of our potential production, even if shared equitably, but when it translates into unemployment of 10, 20, and 40 percent among disadvantaged groups, the further damages in terms of poverty, family breakup, school truancy and dropout, illegitimacy, drug use, and crime become serious indeed. And should the implied policies be fully carried out in terms of a “balanced budget,” we could well be in for a serious depression.

I’ve been re-reading parts of James McPherson’s Battle Cry of Freedom (thanks Sis!), often billed as the best one-volume history of the Civil War era. While it goes into quite a bit more detail about orders of battle and such than I feel the need for — there’s too much about the war and less than I’d like about the war era — its early chapters do an excellent job of explaining the discord in preceding decades that led up to the conflict (Missouri Compromise, Kansas-Nebraska Act, all that).

But what caught my eye this time was the following passage about the first session of Congress after the southern states seceded (pp. 450-51). Emphasis mine for easy scanning.

The second session of the 37th Congess (1861–62) was one of the most productive in American history. Not only did the legislators revoloutionize the country’s tax and monetary structures and take several steps toward the abolition of slavery; they also enacted laws of far-reaching importance for the disposition of public lands, the future of higher education, and the building of transcontinental railroads. these achievement were all the mroe remarkable because they occurred in the midst of an all-consuming preoccupation with war. Yet it was the war — or rather the absence of southerners from Congress — that made possible the passage of these Hamiltonian-Whig-Republican measures for government promotion of sociaoeconomic development.

… Republicans easily overcame feeble Democratic and border-state opposition to pass a homestead act. …

For years Vermont’s Justin Morrill … had sponsored a bill to grant public lands to the states for the promotion of higher education in “agriculture and the mechanic arts.” … The success of the land-grant institutions was attested by the later development of first-class institutions in many states and world-famous universities at Ithaca, Urbana, Madison, Minneapolis, and Berkeley.

… transcontinental railroad … Freed of the southern incubus, Yankee legislators highballed forward … Lincoln signed the Pacific Railroad Act granting 6,400 acres of public land (later doubled) per mile and lending $16,000 per mile (for construction on the plains) and $48,000 per mile (in the mountains) of government bonds to corporations organized to build a railroad from Omaha to San Francisco Bay. …

… Most Americans in 1862 viewed government aid as an investment in national unity and economic growth that would benefit all groups in society.

By its legislation to finance the war, emancipate the slaves, and invest public land in future growth, the 37th Congress did more than any other in history to change the course of national life. As one scholar has aptly written, this Congress drafted “the blueprint for modern America.”

Do you think we could convince them to secede again?

Tax-to-GDP ratio and bond yields in OECD countries

Tax-to-GDP ratio and bond yields in OECD countries (excluding Greece)

In fact, governments that tax sufficiently to pay their bills have lower borrowing costs. Go figger.

More here: The welfare state is not to blame for the Euro crisis « We are all dead..

Ask and ye shall receive. Roger Chittum sent me this:

Estimated correlations between sons’ and parents’ incomes, 1950-2000

Higher correlations, of course, mean lower mobility.

Why do all these inflection points land at 1980 (or just before)?

While you’re there, don’t miss this incredible interactive graphic:

Mobility decreasing in recent decades | State of Working America.

By every measure I’ve been able to find, income mobility in America is much lower than in other prosperous (especially northern European) countries. (Follow Related Posts links below for details.)

But I’ve had trouble tracking down changes in those measures. Here’s one:

I’m finding it difficult to parse the date axis at the bottom (and I haven’t had time to go back to the original paper), but it looks to me like the blue line is generally flat until 1985, when it starts declining.

This measure is necessarily plagued by the life-cycle changes problem that these type of studies are heir to, but it’s another data point in the big picture. I’d love to see a similar chart of intergenerational mobility over time — or even better, multiple such charts for different countries/regions.

Off the Charts Blog | Center on Budget and Policy Priorities | Blog Archive | Income Mobility Can’t Explain Away Evidence of Increased Inequality.