Archive for October, 2012

Mitt Romney in the Big Banks’ Pocket? Pas Possible

October 25th, 2012 1 comment

Deep and Long: Private Debt and Financial Recessions

October 22nd, 2012 3 comments

While he (uncharacteristically) doesn’t explain or deploy it terribly well, Paul Krugman points to some very excellent research on the relationship between private debt levels and the depth and duration of (especially financial-crisis-driven) recessions. The Schularick/Taylor Vox EU article is here. The Jorda/Schularick/Taylor paper is here (PDF).

I think the work is excellent in large part because JS&T address one of my pet peeves: sample size and selection. Unlike Reinhardt and Rogoff, who make wild claims about government debt/GDP levels above 90% based on a mere handful of sample points (examples that mostly aren’t representative of our current or recent situation), and unlike the kind of single-country and short/single-period analyses that you see all the time, and totally unlike shameless cherry pickers such as John Taylor (who dares to call 1981 — unequivocally a Fed- and interest-rate-driven recession — a financial crisis) JS&T look at a long-term, representative, multi-country data set culled from:

o Fourteen advanced economies that at least in that sense are representative of the economies that at least I am interested in understanding (i.e., ours). “The share of global GDP accounted for by these countries was around 50% in the year 2000.”

o Over 140 years

o Using a very clear definition of “financial recession” (below).

They end up with a sample of 208 recessions in advanced economies over that period, 35 of which were financial recessions.

And then they look at multiple lag times (something that is far too often absent from time-series studies): with conditions X in year zero, how do economies perform 1, 2, 3, 4, and 5 years later? (I rather took this issue to the limit in comparing US and EU growth rates, here.)

Results? I’ll cut to the comment that I just left on Krugman’s blog, with graphics added and some links and editing for your reading pleasure

The Schudarick/Taylor Vox article is excellent, as is the Jorda/Schularick/Taylor paper underlying it.

But I don’t think you describe them well.

First, ST&J don’t use “use pre-crisis credit growth … to identify financial-crisis slumps.” They use Laeven and Valencia’s (PDF) definition of a “systemic banking crisis.” [Emphasis and bracketed additions are mine.]

…a country’s corporate and financial sectors experience a large number of defaults and financial institutions and corporations face great difficulties repaying contracts on time. As a result, non-performing loans increase sharply and all or most of the aggregate banking system capital is exhausted. This situation may be accompanied by depressed asset prices (such as equity and real estate prices) on the heels of run-ups before the crisis, sharp increases in real interest rates, and a slowdown or reversal in capital flows. In some cases, the crisis is triggered by depositor runs on banks [yes we saw some — Northern Rock — but largely a cause rather than an effect], though in most cases it is a general realization that systemically important financial institutions are in distress. [No names, just initials: Lehman Brothers. AIG.]”

Yes: they find “that such [financial] slumps are indeed characterized by slow recovery.”

But their focus and key finding relates to private debt levels prior to such crises, and how those debt levels relate the depth and duration of the ensuing recession. They conclude that:

1. Higher private debt levels (and runups) prior to recessions correlate with much deeper and longer recessions (slower recoveries), and

2. That effect is especially pronounced with financial recessions, (those associated with systemic banking crises).

A typical financial recession in an advanced country that begins with high private debt levels takes two years to hit -5% GDP growth, and continues for three more years without regaining its previous level.

We saw U.S. private debt skyrocket off the charts in the thirty years leading up to this financial crisis (except in the early 90s…), utterly dwarfing the runup in government debt:

Based on ST&J’s work, that runup and magnitude in private debt, preceding (and causing) the financial crisis (combined with standard and straightforward Fisher/Minsky theory), is all the explanation anyone needs for the deep downturn and slow recovery.

A grateful nod to my fellow contributors on this subject: While I find Jazzbumpa and Arthur’s arguments about private debt and growth compelling, I do not find the single-country (U.S.) evidence that they provide conclusively convincing (for the reasons outlined above, and here [also see comments there]). I am pleased to find that a far more comprehensive and more systematically analyzed data set seems to support their conclusions. JS&T don’t do 20-year lags, so it’s hard to know from them what the long-term growth effects are of excessive private-debt runups. But they certainly display a mechanism whereby such runups could damage long-term growth: by savaging that growth in rare but devastating financial recessions.

And it’s worth remembering who that devastation is visited upon: the middle class and the poor. The rich do just fine.

Recessions are nature’s (and neoclassicals’) way…of keeping the little guy down.

Cross-posted at Angry Bear.

“No, the shareholders don’t own the corporation”

October 21st, 2012 Comments off

The excellent Justin Fox makes the excellent point that I have made many times: that nobody in the ecosystem of publicly traded companies — including shareholders – is anything like a business owner.

And no, the shareholders don’t own the corporation — they own securities that give them a not very well-defined stake in its earnings, and the freedom to flee with no responsibility for the corporation’s liabilities if things go pear-shaped.

Justin’s post — and the discussion with Felix Salmon — is well worth reading. I also especially liked the paper by Lynn Stout that Justin links to: “Bad and Not-So-Bad Arguments For Shareholder Primacy.”

Restating Justin somewhat, the key difference affecting incentives, from my perspective: The difficulty of exit for real business owners, and the time required to achieve it, is huge. Having sold quite a few businesses myself, I can assure you that it requires months or years of hard work. There’s real risk to the business associated with the process (revealing company secrets to other players, freaking out employees, suppliers, and customers). And the expected results, when you start the process, are deucedly uncertain.

By contrast, shareholders can exit with a few mouse clicks.

Because they can’t just walk away with their “share” of the business, instantly and effortlessly converted into cash, business owners have every incentive to keep all the stakeholders in the business — suppliers, creditors, employees, managers, customers — happy and working together. In short, maintaining and building a “going [and growing] concern.” For shareholders, those incentives are diluted to the point of nonexistence.

The notion that the ecosystem of modern business bears any relationship to Adam Smith’s village of butchers and bakers is profoundly deluded.

Cross-posted at Angry Bear.

Amazon and Apple: The Myth of the Rational Market?

October 18th, 2012 4 comments

Can anybody explain this to me?

Price/Earnings 15.15 302.68

That’s a 20:1 ratio.

Yes, Amazon has a lower price to revenues ratio, by a 2:1 margin.

Price/Sales 4.06 2.06

And presumably at some point Amazon can turn the prices-versus-market-share dial away from gaining market share/maximizing revenue and toward price and profits. Say they manage a 1% across-the-board price increase with no decrease in their roughly $50 billion in 2011 sales. That would add about $500 million to their $643 million in 2011 after-tax profits — a 77% increase.

That’s a pretty nice jump, but can they do it more than once?

And: assuming Amazon’s stock price remains unchanged, their profits have to grow by 1900% to match Apple’s current PE ratio (which is also about what we’ve seen as a historical average ratio for U.S. equities in general).

Sure, we’ve been seeing 55-65% annual revenue growth from Amazon (excepting 2009), but at a steady 50% revenue growth rate it’s going to take them something like seven years to match Apple’s PE at the current Amazon share price, based on revenue growth alone. How confident does anyone feel in predicting that future?

Will Amazon have a trillion dollars in revenues seven years from now? Apple’s 2011 revenues were $108 billion…

Shortly after Amazon IPOed in the 90s I did the same kind of back-of-the-envelope calc, and realized that if they had $10 billion in sales — a 10x increase at the time — the stock price might be reasonable. It took them almost a decade get there — just to get to what would have been “reasonable” ten years earlier. This has been going on for a very long time.

Is this time different?

Full disclosure: I’m long Apple. And I do most of my shopping on Amazon. Many thanks to all those Amazon share purchasers who have subsidized my lavish lifestyle.

Cross-posted at Angry Bear.


Should Central Banks Burn All Their Government Bonds?

October 18th, 2012 3 comments

In June of 2008, Ron Paul made a radical proposal: the Fed should simply burn all the U.S. Treasuries it’s currently holding, reducing the government (U.S. Treasury) debt by $1.6 trillion, or about 10%. (Yes: bonds held by the Fed are counted as part of “Debt Held by the Public,” even though the government basically “owns” the Fed.)

Paul called this “bankruptcy,” but it’s actually pure MMT thinking, acknowledging that 1. the Fed and the Treasury are most reasonably viewed as a single consolidated entity (“the government”), and 2. that government debt is something of a side issue in the big monetary picture (bonds are a vehicle for interest-rate management by the Fed), compared to the matter of central importance: how much newly created money the government puts into the economy by deficit spending, or takes out with a surplus (destroying more money by taxing than it creates by spending).

This is pretty radical talk, for sure. (I wonder if Paul and Kucinich ever eat lunch together.) But now Gavyn Davies tells us in the Financial Times that such notions are at least floating about in some decidedly traditional circles (emphasis mine):

Two separate journalists (Robert Peston of the BBC and Simon Jenkins of The Guardian) said that Lord Turner’s “private view” is that some part of the Bank’s gilts holdings might be cancelled in order to boost the economy. Lord Turner distanced himself in public from this suggestion on Saturday. However, the notion will now be widely discussed. It is easy to see how the idea could appeal to a finance minister facing the need to tighten fiscal policy during a recession in order to bring down the public debt ratio. [that’s “Adair Turner, the Chairman of the UK Financial Services Agency, and reportedly a candidate to become the next Governor of the Bank of England.”]

Davies doesn’t like the idea (inflation worries), and apparently Lord Turner has his qualms as well. But the fact that these ideas are getting any consideration at all in the world of central banking is pretty radical in itself. Heck, the fact that Davies is even writing about it (and explaining it rather well, IMHO, with some caveats) speaks volumes. He has been, after all, a partner, Managing Director, Chief Economist, and Chairman of the Global Investment Research Department at Goldman, Sachs. Not your typical internet econocrank.

For those who follow these discussions, Davies’ two footnotes might be the most significant:

[1] Similar proposals have however been widely debated by economists in the past. This goes back at least as far as the works of Abba Lerner in the 1940s on “functional finance” and the role of fiat money. More recently, the Modern Monetary Theorists have reawakened Lerner’s ideas. See this explanation of MMT, and Paul Krugman’s rejection of the approach as being likely to lead to hyperinflation in the long run.

[2] Samuel Brittan makes the case that part of the budget deficit should be money financed in this column. Martin Wolf makes a similar case in this column. Both argue that money financing of deficits is preferable to “everlasting austerity and slump”.

Cross-posted at Angry Bear.

Why Unwinding QE Won’t Matter

October 17th, 2012 2 comments

Ashwin Parameswaran nails it once again. If you want to understand how the modern financial/monetary system actually works, run don’t walk to read this post.

His key insight:

Just as the East India Company could access cash on the back of their government bond holdings in the 18th century, any pension fund, insurer or bank can do the same today.

Let me translate that into my words:

If the CB unwinds QE by trading bonds for “money,” “sopping up” “cash” (those are all “so-called” quotes) from the private sector, the private bond-holders can just use those bonds as collateral to get (new) cash loans. Commercial and shadow banks will create (“counterfeit”) the new money under (explicit or implicit) license from the central bank, and deposit the money into the bondholders’ accounts.

Result: roughly the same amount of “cash” in the system.

In other words:

…the private sector can monetize the deficit as effectively as the central bank can.


…the reversal of QE, if and when it happens, will have no impact on economy-wide access to cash/purchasing power.

Update, 08:30 PST: This also serves to explain why QE may not have had as much effect as one might hope. The Fed gave bondholders cash in return for their bonds, so bondholders ended up with more cash but less collaterizable/monetizable/convertible-to-cash bonds. A wash?

Discuss. (But not until you’ve read Ashwin’s whole piece [at least once].)

Cross-posted at Angry Bear.

Adam Smith on Corporatism

October 16th, 2012 Comments off

As a many-times business owner, I noted a couple of years back that in the ecosystem of publicly traded companies, there is nobody who thinks, acts, has incentives like, or is really anything like a real business owner.

I’m pleased to find that Adam Smith agrees with me (emphasis mine):

The trade of a joint stock company is always managed by a court of directors. This court, indeed, is frequently subject, in many respects, to the control of a general court of proprietors. But the greater part of those proprietors seldom pretend to understand anything of the business of the company, and when the spirit of faction happens not to prevail among them, give themselves no trouble about it, but receive contentedly such half-yearly or yearly dividend as the directors think proper to make to them. This total exemption from trouble and from risk, beyond a limited sum, encourages many people to become adventurers in joint stock companies, who would, upon no account, hazard their fortunes in any private copartnery. Such companies, therefore, commonly draw to themselves much greater stocks than any private copartnery can boast of. The trading stock of the South Sea Company, at one time, amounted to upwards of thirty-three millions eight hundred thousand pounds.*65 The divided capital of the Bank of England amounts, at present, to ten millions seven hundred and eighty thousand pounds.*66 The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

This of course speaks to principle-agent conundrum that has been so widely studied and discussed, notably the pathological separation of ownership and control discussed in Berle and Means, The Modern Corporation and Private Property. (1932, revised edition 1967.)

But it’s nice to see Adam articulating it so nicely.

Modern corporatism is freakishly removed from, really bears no resemblance to, the fairy tale of “free-market” village butchers and bakers on which libertarians rest so much of their intellectual house of cards. (To quote my daughter’s high-school econ prof: “Econ schools should be teaching a lot more game theory and a lot less price theory.”)

It’s also worth noting that the Koch-brothers shop over at GMU and econlog, from whose “Library of Economics and Liberty” the above passage is copied, has never, in all those bloggers’ years of blogging, even mentioned this passage from their hero.

Cross-posted at Angry Bear.

“If you tax investment income what will people do? Stuff their money in the mattress?”

October 15th, 2012 Comments off

Richard Thaler asks exactly the right question. This from the latest IGM Forum poll of big-name economists, on the effects of taxing income from “capital.”

I’ve been over this multiple times before, but it’s nice to see the thinking validated by a real economist. If you’ve got money, there is no (practicable) alternative to “investing” it. (Those are irony quotes: referring to “buying financial assets,” as opposed to “buying/creating real [fixed] assets,” which is the technical meaning of “investing” in national-account-speak.)

Or actually — there is one alternative to “investing” your money: spending it.

Are the neoclassicals really going to argue that if we tax returns on financial assets at a higher rate — so “investors” have less after-tax income — they’re going to spend more? I don’t think I have to cite sources to prove that they consistently argue exactly the opposite.

But just for grins, let’s say they will spend more. That would be great! They’d increase the volume of private money circulation (P*T, or M*V, your choice) — boosting demand for real goods and services, stimulating production, and goosing GDP.

And if we’re lucky, they’ll use it for investment spending instead of consumption spending. They get to write off those real investment expenditures against their taxes, after all. Not true with consumption expenditures, much less purchases of financial assets.

In which case — this seems kind of obvious when you think about it — taxing “investment” income will increase investment (while reducing the federal deficit). What’s not to like?

See also David Cutler’s apt comment:

I prefer not to think of all capital as the same.

In particular my pet peeve, the rampant confution of financial “capital” with real capital.

Cross-posted at Angry Bear.


Did Global Warming “Stop” Sixteen Years Ago?

October 15th, 2012 Comments off

An acquaintance of mine who’s very statistically savvy (and quite conservative) posted the following link on Facebook today.

I replied as follows (I’ve replaced a link here with a clickable image):

As a statistics guy, you know way better than most how important sample size is. There was a 30-year plateau in the HADCRUT data, mid-40s to mid-70s. But the longer-term trend is obvious and apparent:

(This is one just data set, but you can view and compare many others at this link. They’re remarkably similar. Try the rolling-average smoothing to get a less noisy picture.) For me the really big sample relates to arctic ice. We don’t really know when the summer arctic ice cap was last as small as it is now, but we do know that the last time it melted completely was approximately three million years ago. To me, if that’s just sort of happening due to random climate variation, over mere decades, it’s looking like a quite spectacular statistical anomaly.

I added: if he’s been saying this for years, he’s been basing those statements on even smaller sample sizes.

Cross-posted at Angry Bear.

GDP, Prosperity, The Wealth Effect, and Marginal Propensity to Consume

October 15th, 2012 2 comments

Comes to mind: the one about the two British ladies who meet at the Ascot races.

“My dear,” says the first. “What a lovely hat. Where did you get it?”

“Oh darling,” says the second, looking somewhat pained, “don’t you know, we have our hats.”

It comes to mind as I ponder the rather grudging and tepid suggestions that you hear here and there these days — that excessive inequality might actually be a drag on economic growth and prosperity. There are some full-throated assertions of this belief out there, but in the mainstream economics community they are rare and in general quite decidedly mealy-mouthed. (No names, just initials: The Economist.)

The general failure to question the “more inequality is good for growth” mantra has deep roots, even among progressive economists. Viz, this from Paul Krugman back in December, 2008, when the highest inequality since The Great Depression was was in the process of delivering the first (at least potential) depression since…The Great Depression (bold mine):

There’s no obvious reason why consumer demand can’t be sustained by the spending of the upper class — $200 dinners and luxury hotels create jobs, the same way that fast food dinners and Motel 6s do. In fact, the prosperity of New York City in the last decade — largely supported off of super-salaried Wall Street types — is a demonstration that you can have an economy sustained by the big spending of the few rather than the modest spending of large numbers of people.

This seems to completely ignore marginal propensity to consume (MPC) — that poorer people spend a larger percentage of their income than rich people, so a more equal income distribution would result in higher money velocity, hence higher GDP. (I have seen no indication that Krugman’s opinion on this subject has changed since then.)

But I’d like to suggest that the problem runs deeper. Almost all the thinking about MPC seems to obsess about income, and greatly downplay the role of wealth, or net worth. The Wikipedia article on MPC, for instance, includes only one passing mention of wealth.

This failure to consider wealth is important because wealth inequality in this country (and worldwide) utterly dwarfs income inequality.

The Friedman/Modigliani rational-expectations lifecycle-hypothesis school does include wealth in their theories of marginal propensity to consume, but they assume that a great deal of people’s “wealth” actually consists of expected future income. This in turn assumes consumers’ excellent foresight decades into the future, and that people (at all income levels) are able or even likely to engage (accurately) in net-present-value calculations of their future incomes and expenditures.

There’s obviously a large literature on this subject that is ridiculously condensed above. But that aside: for thinking purposes I’d like to propose an admittedly simplified, opposite model that I have not seen discussed, in which current wealth (individual net worth) is the only determinant of (consumption) spending in a given period.

Imagine a world with eleven people in it, where we all have our wealth, and where net worth is broken out as follows.

Person 1: $1,000,000

Persons 2-11: $100,000 each

All spending comes from these stocks of wealth.

Now assume a very simple consumption function — a two-step “curve” — based on MPC (and marginal utility of consumption) thinking: propensity to consume for those holding more than $500,000 is 3% (because that satisfies their desires), while it’s 5% for those holding less than $500K.

Here’s how spending (Y, or GDP) plays out:

.05 x $100K x 10 = $50,000
+ .03 x $1 mil = $30,000
= $80,000

Now change the initial wealth setting: Persons 2-11 have $50,000 each, and Person 1 has $1.5 million.

.05 x $50K x 10 = $25,000
+ .03 x $1.5 mil = $45,000
= $70,000

By transferring half of the poorer people’s money to the richer person, we’ve cut GDP by $10,000, or 12.5%.

Then consider the change in shares of wealth from 2007-2010. Median net worth dropped by 40%, while the net worth of the top 10% went up.

Even if you accept the notion that predicted income constitutes a large portion of people’s perceived “wealth,” the implications are the same. If more of the national income (the $80K or $70K in spending) goes to the poorer people, they will have more wealth in future periods, with the salutary effects on GDP and prosperity shown above. (If they expect that distribution to continue, it will even impact their estimates of their own wealth in this period, increasing their current propensity to spend/consume.)

And this doesn’t even consider declining marginal utility of consumption (or only includes it in a display of circular logic) — that somebody with a $25,000 consumption budget gets more utility from a given (percentage or absolute) budget increase than one with a $50,000 consumption budget. So a small percentage shift in shares of wealth from the rich to the poor, or vice versa, results in quite large shifts in shares of our aggregate utility.

A supporting argument from the personal-anecdote-as-the-singular-of-“data” school of rhetoric: all this holds true for me. I put away a very nice chunk some years back, and am playing the fairly typical “will I run out first or die first?” game. (It’s hard to say which is worse. How many people spend their last dollar on the day they die?) I’ve often joked with my financial advisor that I have one Key Economic Indicator: how much money do I have? That’s what I think about when deciding whether to spend. People nearing or in retirement start paying a lot more attention to wealth than income. (Related but tangential: not surprisingly, as the future gets closer and more predictable, as the kids get up on their own feet, for instance, “the marginal propensity to consume (MPC) out of wealth increases with the age of the consumer.” PDF.) And we have an increasing number of people in or near retirement these days.

If this thinking holds any water — that the distribution/concentration of (perceived) wealth has an important impact on aggregate marginal propensity to consume — there’s a very solid and rather straightforward theoretical basis for the otherwise largely limp-wristed assertions that we’re starting to hear more glimmers of these days in the mainstream media, and in the more influential sectors of the econoblogosphere.

Equity and economic efficiency are not in conflict. Quite the contrary, in fact.

For those who prefer to look at pesky things like facts, the empirical data bears this out: at least in prosperous countries, greater wealth equality correlates with greater long-term prosperity.

For those who care to hear a personal account of how modest, widespread wealth dispersal can encourage innovation, entrepreneurship, and wealth-creation, see here.

Cross-posted at Angry Bear.