Global Depression or Persistent Stagflation?

Dr. Doom and Gloom lays out the downside global economic scenario. Worth reading and factoring into our economic posturing…[Comments bracketed in red].

Published in NY Magazine

Why Our Economy May Be Headed for a Decade of Depression

Eric Levitz May 22, 2020

The worst is yet to come?

In September 2006, Nouriel Roubini told the International Monetary Fund what it didn’t want to hear. Standing before an audience of economists at the organization’s headquarters, the New York University professor warned that the U.S. housing market would soon collapse — and, quite possibly, bring the global financial system down with it. Real-estate values had been propped up by unsustainably shady lending practices, Roubini explained. Once those prices came back to earth, millions of underwater homeowners would default on their mortgages, trillions of dollars worth of mortgage-backed securities would unravel, and hedge funds, investment banks, and lenders like Fannie Mae and Freddie Mac could sink into insolvency.

At the time, the global economy had just recorded its fastest half-decade of growth in 30 years. And Nouriel Roubini was just some obscure academic. Thus, in the IMF’s cozy confines, his remarks roused less alarm over America’s housing bubble than concern for the professor’s psychological well-being.

Of course, the ensuing two years turned Roubini’s prophecy into history, and the little-known scholar of emerging markets into a Wall Street celebrity.

A decade later, “Dr. Doom” is a bear once again. While many investors bet on a “V-shaped recovery,” Roubini is staking his reputation on an L-shaped depression. The economist (and host of a biweekly economic news broadcastdoes expect things to get better before they get worse: He foresees a slow, lackluster (i.e., “U-shaped”) economic rebound in the pandemic’s immediate aftermath. But he insists that this recovery will quickly collapse beneath the weight of the global economy’s accumulated debts. Specifically, Roubini argues that the massive private debts accrued during both the 2008 crash and COVID-19 crisis will durably depress consumption and weaken the short-lived recovery. Meanwhile, the aging of populations across the West will further undermine growth while increasing the fiscal burdens of states already saddled with hazardous debt loads. Although deficit spending is necessary in the present crisis, and will appear benign at the onset of recovery, it is laying the kindling for an inflationary conflagration by mid-decade. As the deepening geopolitical rift between the United States and China triggers a wave of deglobalization, negative supply shocks akin those of the 1970s are going to raise the cost of real resources, even as hyperexploited workers suffer perpetual wage and benefit declines. Prices will rise, but growth will peter out, since ordinary people will be forced to pare back their consumption more and more. Stagflation will beget depression. And through it all, humanity will be beset by unnatural disasters, from extreme weather events wrought by man-made climate change to pandemics induced by our disruption of natural ecosystems.

Roubini allows that, after a decade of misery, we may get around to developing a “more inclusive, cooperative, and stable international order.” But, he hastens to add, “any happy ending assumes that we find a way to survive” the hard times to come.

Intelligencer recently spoke with Roubini about our impending doom.

You predict that the coronavirus recession will be followed by a lackluster recovery and global depression. The financial markets ostensibly see a much brighter future. What are they missing and why?

Well, first of all, my prediction is not for 2020. It’s a prediction that these ten major forces will, by the middle of the coming decade, lead us into a “Greater Depression.” Markets, of course, have a shorter horizon. In the short run, I expect a U-shaped recovery while the markets seem to be pricing in a V-shape recovery.

Of course the markets are going higher because there’s a massive monetary stimulus, there’s a massive fiscal stimulus. People expect that the news about the contagion will improve, and that there’s going to be a vaccine at some point down the line. And there is an element “FOMO” [fear of missing out]; there are millions of new online accounts — unemployed people sitting at home doing day-trading — and they’re essentially playing the market based on pure sentiment. My view is that there’s going to be a meaningful correction once people realize this is going to be a U-shaped recovery. If you listen carefully to what Fed officials are saying — or even what JPMorgan and Goldman Sachs are saying — initially they were all in the V camp, but now they’re all saying, well, maybe it’s going to be more of a U. The consensus is moving in a different direction.

Your prediction of a weak recovery seems predicated on there being a persistent shortfall in consumer demand due to income lost during the pandemic. A bullish investor might counter that the Cares Act has left the bulk of laid-off workers with as much — if not more — income than they had been earning at their former jobs. Meanwhile, white-collar workers who’ve remained employed are typically earning as much as they used to, but spending far less. Together, this might augur a surge in post-pandemic spending that powers a V-shaped recovery. What does the bullish story get wrong?

Yes, there are unemployment benefits. And some unemployed people may be making more money than when they were working. But those unemployment benefits are going to run out in July. The consensus says the unemployment rate is headed to 25 percent. Maybe we get lucky. Maybe there’s an early recovery, and it only goes to 16 percent. Either way, tons of people are going to lose unemployment benefits in July. And if they’re rehired, it’s not going to be like before — formal employment, full benefits. You want to come back to work at my restaurant? Tough luck. I can hire you only on an hourly basis with no benefits and a low wage. That’s what every business is going to be offering. Meanwhile, many, many people are going to be without jobs of any kind. It took us ten years — between 2009 and 2019 — to create 22 million jobs. And we’ve lost 30 million jobs in two months. [This begins to show why employment is the wrong focus for the Information Age.]

So when unemployment benefits expire, lots of people aren’t going to have any income. Those who do get jobs are going to work under more miserable conditions than before. And people, even middle-income people, given the shock that has just occurred — which could happen again in the summer, could happen again in the winter — you are going to want more precautionary savings. You are going to cut back on discretionary spending. Your credit score is going to be worse. Are you going to go buy a home? Are you gonna buy a car? Are you going to dine out? In Germany and China, they already reopened all the stores a month ago. You look at any survey, the restaurants are totally empty. Almost nobody’s buying anything. Everybody’s worried and cautious. And this is in Germany, where unemployment is up by only one percent. Forty percent of Americans have less than $400 in liquid cash saved for an emergency. [This is a major policy failure that citizens of other countries do not share. Our tax policies have discouraged savings but encouraged borrowing.] You think they are going to spend?

Graphic: Financial Times
Graphic: Financial Times

You’re going to start having food riots soon enough. [I don’t see that happening, at least not in the US. People on state welfare support are going to need more of it and the welfare roles will rise.] Look at the luxury stores in New York. They’ve either boarded them up or emptied their shelves,  because they’re worried people are going to steal the Chanel bags. [Yes, because luxury goods are a form of currency. Luxury stores are also a focus of resentment.] The few stores that are open, like my Whole Foods, have security guards both inside and outside. We are one step away from food riots. There are lines three miles long at food banks. [This not a riot, it’s an overload on govt provided welfare.] That’s what’s happening in America. You’re telling me everything’s going to become normal in three months? That’s lunacy.

Your projection of a “Greater Depression” is premised on deglobalization sparking negative supply shocks. And that prediction of deglobalization is itself rooted in the notion that the U.S. and China are locked in a so-called Thucydides trap, in which the geopolitical tensions between a dominant and rising power will overwhelm mutual financial self-interest. But given the deep interconnections between the American and Chinese economies — and warm relations between much of the U.S. and Chinese financial elite — isn’t it possible that class solidarity will take precedence over Great Power rivalry? In other words, don’t the most powerful people in both countries understand they have a lot to lose financially and economically from decoupling? And if so, why shouldn’t we see the uptick in jingoistic rhetoric on both sides as mere posturing for a domestic audience?

First of all, my argument for why inflation will eventually come back is not just based on U.S.-China relations. I actually have 14 separate arguments for why this will happen. That said, everybody agrees that there is the beginning of a Cold War between the U.S. and China. I was in Beijing in November of 2015, with a delegation that met with Xi Jinping in the Great Hall of the People. And he spent the first 15 minutes of his remarks speaking, unprompted, about why the U.S. and China will not get caught in a Thucydides trap, and why there will actually be a peaceful rise of China.

Since then, Trump got elected. Now, we have a full-scale trade war, technology war, financial war, monetary war, technology, information, data, investment, pretty much anything across the board. Look at tech — there is complete decoupling. They just decided Huawei isn’t going to have any access to U.S. semiconductors and technology. We’re imposing total restrictions on the transfer of technology from the U.S. to China and China to the U.S. And if the United States argues that 5G or Huawei is a backdoor to the Chinese government, the tech war will become a trade war. Because tomorrow, every piece of consumer electronics, even your lowly coffee machine or microwave or toaster, is going to have a 5G chip. That’s what the internet of things is about. If the Chinese can listen to you through your smartphone, they can listen to you through your toaster. Once we declare that 5G is going to allow China to listen to our communication, we will also have to ban all household electronics made in China. So, the decoupling is happening. We’re going to have a “splinternet.” It’s only a matter of how much and how fast.

And there is going to be a cold war between the U.S. and China. Even the foreign policy Establishment — Democrats and Republicans — that had been in favor of better relations with China has become skeptical in the last few years. They say, “You know, we thought that China was going to become more open if we let them into the WTO. We thought they’d become less authoritarian.” Instead, under Xi Jinping, China has become more state capitalist, more authoritarian, and instead of biding its time and hiding its strength, like Deng Xiaoping wanted it to do, it’s flexing its geopolitical muscle. And the U.S., rightly or wrongly, feels threatened. I’m not making a normative statement. I’m just saying, as a matter of fact, we are in a Thucydides trap. The only debate is about whether there will be a cold war or a hot one. Historically, these things have led to a hot war in 12 out of 16 episodes in 2,000 years of history. So we’ll be lucky if we just get a cold war.

Some Trumpian nationalists and labor-aligned progressives might see an upside in your prediction that America is going to bring manufacturing back “onshore.” But you insist that ordinary Americans will suffer from the downsides of reshoring (higher consumer prices) without enjoying the ostensible benefits (more job opportunities and higher wages). In your telling, onshoring won’t actually bring back jobs, only accelerate automation. And then, again with automation, you insist that Americans will suffer from the downside (unemployment, lower wages from competition with robots) but enjoy none of the upside from the productivity gains that robotization will ostensibly produce. So, what do you say to someone who looks at your forecast and decides that you are indeed “Dr. Doom” — not a realist, as you claim to be, but a pessimist, who ignores the bright side of every subject?

When you reshore, you are moving production from regions of the world like China, and other parts of Asia, that have low labor costs, to parts of the world like the U.S. and Europe that have higher labor costs. That is a fact. How is the corporate sector going respond to that? It’s going to respond by replacing labor with robots, automation, and AI.

I was recently in South Korea. I met the head of Hyundai, the third-largest automaker in the world. He told me that tomorrow, they could convert their factories to run with all robots and no workers. Why don’t they do it? Because they have unions that are powerful. In Korea, you cannot fire these workers, they have lifetime employment. [There is a serious cost to raising labor rates in a world with price competition. Raising input costs means pricing power rules and most producers lack that pricing power. If Hyundai cars become more expensive, then Hyundai loses sales and Hyundai requires state subsidies paid for by Korean taxpayers. If Hyundai reduces costs, Hyundai workers face dimmer income prospects and more state welfare. The only way out of this conundrum is to share the economic costs across all stakeholders. That’s best done through equity rights than through state directives. This is especially true in the US under the corporate legal structure.]

But suppose you take production from a labor-intensive factory in China — in any industry — and move it into a brand-new factory in the United States. You don’t have any legacy workers, any entrenched union. You are going to design that factory to use as few workers as you can. Any new factory in the U.S. is going to be capital-intensive and labor-saving. It’s been happening for the last ten years and it’s going to happen more when we reshore. So reshoring means increasing production in the United States but not increasing employment. Yes, there will be productivity increases. And the profits of those firms that relocate production may be slightly higher than they were in China (though that isn’t certain since automation requires a lot of expensive capital investment).

But you’re not going to get many jobs. The factory of the future is going to be one person manning 1,000 robots and a second person cleaning the floor. And eventually the guy cleaning the floor is going to be replaced by a Roomba because a Roomba doesn’t ask for benefits or bathroom breaks or get sick and can work 24-7. [I’ve written many times in the past, what matters is who owns and controls the robots.]

The fundamental problem today is that people think there is a correlation between what’s good for Wall Street and what’s good for Main Street. [Yes, but conceptually we can close this conflict of interest by turning more of Main St. into entrepreneurial risk takers through the sharing of diversified equity risks.] That wasn’t even true during the global financial crisis when we were saying, “We’ve got to bail out Wall Street because if we don’t, Main Street is going to collapse.” How did Wall Street react to the crisis? They fired workers. And when they rehired them, they were all gig workers, contractors, freelancers, and so on. That’s what happened last time. This time is going to be more of the same. Thirty-five to 40 million people have already been fired. When they start slowly rehiring some of them (not all of them), those workers are going to get part-time jobs, without benefits, without high wages. That’s the only way for the corporates to survive. Because they’re so highly leveraged today, they’re going to need to cut costs, and the first cost you cut is labor. But of course, your labor cost is my consumption. So in an equilibrium where everyone’s slashing labor costs, households are going to have less income. [Again, this is why using wage labor as the dominant distributional mechanism for the success of capitalism is no longer viable. It only was during the industrial age.] And they’re going to save more to protect themselves from another coronavirus crisis. And so consumption is going to be weak. That’s why you get the U-shaped recovery.

There’s a conflict between workers and capital. [Only in the short-run.] For a decade, workers have been screwed. Now, they’re going to be screwed more. There’s a conflict between small business and large business.

Millions of these small businesses are going to go bankrupt. Half of the restaurants in New York are never going to reopen. How can they survive? They have such tiny margins. Who’s going to survive? The big chains. Retailers. Fast food. The small businesses are going to disappear in the post-coronavirus economy. So there is a fundamental conflict between Wall Street (big banks and big firms) and Main Street (workers and small businesses). And Wall Street is going to win. [We all win by participating in the financing and risk sharing of capitalism. We all need to be invested in Wall St., and finance – both ownership and control – must be transparent. Someday we will have blockchain smart contracts distribute corporate profits to shareholders in a transparent manner under the shareholders’ control, reducing the agency costs and conflicts of interest.]

Clearly, you’re bearish on the potential of existing governments intervening in that conflict on Main Street’s behalf. But if we made you dictator of the United States tomorrow, what policies would you enact to strengthen labor, and avert (or at least mitigate) the Greater Depression? 

The market, as currently ordered, is going to make capital stronger and labor weaker. So, to change this, you need to invest in your workers. [Yes, but that does not mean wage or labor supply controls – intervention on the cost side of production will only backfire.] Give them education, a social safety net — so if they lose their jobs to an economic or technological shock, they get job training, unemployment benefits, social welfare, health care for free. [These policies all lead to productive investment in human capital, but it is not enough. Workers need financial capital that generates diversified streams of income.]  Otherwise, the trends of the market are going to imply more income and wealth inequality. [The Fed has been no help here.] There’s a lot we can do to rebalance it. But I don’t think it’s going to happen anytime soon. If Bernie Sanders had become president, maybe we could’ve had policies of that sort. [No, Bernie is completely focused on intervening into labor markets. Workers look like they’re gaining in the short-run and lose big time in the long-run.] Of course, Bernie Sanders is to the right of the CDU party in Germany. I mean, Angela Merkel is to the left of Bernie Sanders. Boris Johnson is to the left of Bernie Sanders, in terms of social democratic politics. Only by U.S. standards does Bernie Sanders look like a Bolshevik.

In Germany, the unemployment rate has gone up by one percent. In the U.S., the unemployment rate has gone from 4 percent to 20 percent (correctly measured) in two months. We lost 30 million jobs. Germany lost 200,000. Why is that the case? You have different economic institutions. Workers sit on the boards of German companies. So you share the costs of the shock between the workers, the firms, and the government. [Yes, this is how it should be, but in US society and business, equity is the cleanest way to achieve this representation. Stakeholders should have board representation through their equity ownership claims.]

In 2009, you argued that if deficit spending to combat high unemployment continued indefinitely, “it will fuel persistent, large budget deficits and lead to inflation.” You were right on the first count obviously. And yet, a decade of fiscal expansion not only failed to produce high inflation, but was insufficient to reach the Fed’s 2 percent inflation goal. Is it fair to say that you underestimated America’s fiscal capacity back then? And if you overestimated the harms of America’s large public debts in the past, what makes you confident you aren’t doing so in the present?

First of all, in 2009, I was in favor of a bigger stimulus than the one that we got. I was not in favor of fiscal consolidation. There’s a huge difference between the global financial crisis and the coronavirus crisis because the former was a crisis of aggregate demand, given the housing bust. And so monetary policy alone was insufficient and you needed fiscal stimulus. And the fiscal stimulus that Obama passed was smaller than justified. So stimulus was the right response, at least for a while. And then you do consolidation.

What I have argued this time around is that in the short run, this is both a supply shock and a demand shock. And, of course, in the short run, if you want to avoid a depression, you need to do monetary and fiscal stimulus. What I’m saying is that once you run a budget deficit of not 3, not 5, not 8, but 15 or 20 percent of GDP — and you’re going to fully monetize it (because that’s what the Fed has been doing) — you still won’t have inflation in the short run, not this year or next year, because you have slack in goods markets, slack in labor markets, slack in commodities markets, etc. But there will be inflation in the post-coronavirus world. [We will have asset price inflation in the immediate and longer-term – this greatly aggravates inequality.] This is because we’re going to see two big negative supply shocks. For the last decade, prices have been constrained by two positive supply shocks — globalization and technology. Well, globalization is going to become deglobalization thanks to decoupling, protectionism, fragmentation, and so on. So that’s going to be a negative supply shock. And technology is not going to be the same as before. The 5G of Erickson and Nokia costs 30 percent more than the one of Huawei, and is 20 percent less productive. So to install non-Chinese 5G networks, we’re going to pay 50 percent more. So technology is going to gradually become a negative supply shock. So you have two major forces that had been exerting downward pressure on prices moving in the opposite direction, and you have a massive monetization of fiscal deficits. Remember the 1970s? You had two negative supply shocks — ’73 and ’79, the Yom Kippur War and the Iranian Revolution. What did you get? Stagflation.

Now, I’m not talking about hyperinflation — not Zimbabwe or Argentina. I’m not even talking about 10 percent inflation. It’s enough for inflation to go from one to 4 percent. Then, ten-year Treasury bonds — which today have interest rates close to zero percent — will need to have an inflation premium. So, think about a ten-year Treasury, five years from now, going from one percent to 5 percent, while inflation goes from near zero to 4 percent. And ask yourself, what’s going to happen to the real economy? Well, in the fourth quarter of 2018, when the Federal Reserve tried to raise rates above 2 percent, the market couldn’t take it. So we don’t need hyperinflation to have a disaster. [So we seesaw between heeling one way or the other –  inflationary or deflationary pressures with volatile financial policy. Sounds like a great policy scenario.]

In other words, you’re saying that because of structural weaknesses in the economy, even modest inflation would be crisis-inducing because key economic actors are dependent on near-zero interest rates?

For the last decade, debt-to-GDP ratios in the U.S. and globally have been rising. And debts were rising for corporations and households as well. But we survived this, because, while debt ratios were high, debt-servicing ratios were low, since we had zero percent policy rates and long rates close to zero — or, in Europe and Japan, negative. But the second the Fed started to hike rates, there was panic.

In December 2018, Jay Powell said, “You know what. I’m at 2.5 percent. I’m going to go to 3.25. And I’m going to continue running down my balance sheet.” And the market totally crashed. And then, literally on January 2, 2019, Powell comes back and says, “Sorry, I was kidding. I’m not going to do quantitative tightening. I’m not going to raise rates.” So the economy couldn’t take a Fed funds rate of 2.5 percent. In the strongest economy in the world. There is so much debt, if long-term rates go from zero to 3 percent, the economy is going to crash.

You’ve written a lot about negative supply shocks from deglobalization. Another potential source of such shocks is climate change. Many scientists believe that rising temperatures threaten the supply of our most precious commodities — food and water. How does climate figure into your analysis?

I am not an expert on global climate change. But one of the ten forces that I believe will bring a Greater Depression is man-made disasters. And global climate change, which is producing more extreme weather phenomena — on one side, hurricanes, typhoons, and floods; on the other side, fires, desertification, and agricultural collapse — is not a natural disaster. The science says these extreme events are becoming more frequent, are coming farther inland, and are doing more damage. And they are doing this now, not 30 years from now. 

So there is climate change. And its economic costs are becoming quite extreme. In Indonesia, they’ve decided to move the capital out of Jakarta to somewhere inland because they know that their capital is going to be fully flooded. In New York, there are plans to build a wall all around Manhattan at the cost of $120 billion. And then they said, “Oh no, that wall is going to be so ugly, it’s going to feel like we’re in a prison.” So they want to do something near the Verrazzano Bridge that’s going to cost another $120 billion. And it’s not even going to work.

The Paris Accord said 1.5 degrees. Then they say two. Now, every scientist says, “Look, this is a voluntary agreement, we’ll be lucky if we get three — and more likely, it will be four — degree Celsius increases by the end of the century.” How are we going to live in a world where temperatures are four degrees higher? And we’re not doing anything about it. The Paris Accord is just a joke. And it’s not just the U.S. and Trump. China’s not doing anything. The Europeans aren’t doing anything. It’s only talk.

And then there’s the pandemics. These are also man-made disasters. You’re destroying the ecosystems of animals. You are putting them into cages — the bats and pangolins and all the other wildlife — and they interact and create viruses and then spread to humans. First, we had HIV. Then we had SARS. Then MERS, then swine flu, then Zika, then Ebola, now this one. And there’s a connection between global climate change and pandemics. Suppose the permafrost in Siberia melts. There are probably viruses that have been in there since the Stone Age. We don’t know what kind of nasty stuff is going to get out. We don’t even know what’s coming. [Climate change and environmental degradation need to be managed, probably in a decentralized manner using market signals to change behavior. But a society needs resilience, slack, and insurance to manage the vagaries and risks of uncertain change. We’ve reduced our ability to adapt through misguided policies for about 50 years now, greatly increasing systemic risk. That’s what man-made disasters are made of.]

Bubblenomics

Some people will read this and say, “No inflation, no problem.” But that completely misses the point of asset price volatility and distortions of resource allocations. People complain about inequality, but then ignore these policies that aggravate inequality while making unequal outcomes rather arbitrary. In the meantime we live in a far more volatile and precarious world.

The Federal Reserve’s everything bubble

Desmond Lachman, May 19, 2020

Good economic policymaking resembles good medical practice. In much the same way as a skilled doctor’s effective prescription for a disease rests on an accurate diagnosis of the illness, so too a wise economic policymaker’s effective crisis policy response depends on a comprehensive understanding of the crisis’s underlying causes.

One has to regret Federal Reserve Chairman Jerome Powell’s seemingly partial diagnosis of our present daunting economic challenge, especially considering his key role in defusing the crisis. In Powell’s view, our economic predicament has nothing to do with the possibility that years of ultra-easy U.S. monetary policy might have contributed to the creation of worldwide asset and credit market bubbles. Rather, he seems to believe that our economic challenge is solely the result of the supply side shock delivered to the economy by the coronavirus pandemic. 

Following the bursting of the U.S. housing and credit market bubble in 2008, it took the U.S. economy some six years to regain its pre-crisis employment level. Dismissing any notion that the coronavirus pandemic might now be bursting asset and credit market bubbles of the Fed’s creation, Powell believes that this time around we could have a quicker economic recovery than we did following the 2008-2009 Great Recession. 

Indeed, Powell believes that the U.S. economy could fully recover by the end of 2021, notwithstanding the very much deeper economic recession that we are now experiencing than in 2008-2009. 

Despite Mr. Powell’s assertions to the contrary, over the past decade the Fed, along with the world’s other major central banks, created a global asset and credit market bubble. They did so by buying a staggering cumulative $10 trillion in low-risk government and private sector bonds with the aim of forcing investors to take on more risk and to stretch for yield. The net result of that policy was the creation of a global equity and housing market boom as well as the major distortion of world credit markets.

One indication of the world equity price bubble was the very high valuation to which the U.S. equity market reached before its large coronavirus-induced correction earlier this year. Measured by the cyclically adjusted price-earnings ratio, before the pandemic’s onset U.S. equity valuations reached lofty levels experienced only three times in the past hundred years. Meanwhile, numerous housing markets around the world, including those in several large U.S. cities, had price-to-income ratios that exceeded those reached at the 2006 peak of the earlier housing market bubble.

More troubling yet, the world’s major central banks have distorted global credit markets in a major way, as investors were encouraged to take on excessive risk. One indication of such credit market excess was the more than doubling in the risky U.S. leveraged-loan market to its present level of around $1.3 trillion. Other indications were the approximate doubling over the past decade of lending to the emerging market economies and the very low interest rates at which highly indebted countries like Italy were able to finance themselves. 

A key point to which Powell is choosing to turn a blind eye is the great likelihood that the very depth of the current economic recession, which is almost certain to be the worst experienced in the past 90 years, will burst asset price bubbles around the globe and make it all the more difficult for debtors to service their loans. This will be particularly the case for the travel, hospitality and entertainment sectors of the world economy that are bound to be particularly hard hit, at least until a COVID-19 vaccine is made widely available. If a wave of debt defaults and bankruptcies were to occur, we could see real stress in the world financial system. [The only option the Fed has at this point is to ramp up ZIRP and QE4ever as well as underwrite US Treasury borrowing.]

Another key point that Powell seems to overlook is the likelihood that the global economic recession could trigger both another round of the European sovereign debt crisis and yet one more major emerging market economic crisis. In this respect, it is hardly encouraging that the European economic recession shows every sign of being deeper than that in the United States and that Europe is still struggling to fashion a united fiscal response to the recession. Nor is it encouraging that capital is being withdrawn from the emerging market economies at a record pace and that a number of emerging market currencies already appear to be in free fall.     

To his credit, Powell responded both boldly and promptly to the initial phases of the current economic crisis. Hopefully, he stands ready to do more of the same at the first signs of real stress in the global financial system. If not, we can be sure that our full economic recovery will be delayed until well after the end of 2021. 

[Not sure how writing more trillion$ blank checks really is a solution.]

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.


The problem we see here is that the world’s economies, made up of the world’s citizens, have been dangerously pushed out on the risk curve. Meltdowns of inflated asset values are sure to occur and each one means we are less able to respond to excess risk and loss. The USA is in an envious position because its control of the world currency means all those dollars come back to the US economy to buy real assets, so those who own those assets (Americans) are far more fortunate than those who want to buy them. But this only means more economic and political volatility across the globe.

Mortgage Housing Follies

 

Some of us have been sounding this alarm for about 18 years, since the time the Greenspan Fed inflated the housing markets across the board by keeping interest rates too low. Since the inevitable crash in 2008, financial housing policy has doubled and tripled down on this folly to the point where in many areas of the country most homeowners live in houses they could never afford if they had to buy them again.

Recovery in any housing market requires housing prices to find fundamental value by shoring markets up at the margin, helping people who can’t afford their house, and never could, to sell to those who do have the necessary resources. And that doesn’t mean reflating private equity portfolios to become the new landlords of residential housing. Nor does it mean buying up mortgages at full value and then selling them at a deep discount to investors. Bad investments require taking losses and if necessary, going bankrupt.

Widespread housing and land ownership are the foundation of the middle class, and we’re quickly destroying it. We are experiencing Einstein’s definition of insanity.

The Bailout Miscalculation That Could Crash the Economy

When Donald Trump signed the $2 trillion CARES Act rescue on March 27, there was immediate praise across the political spectrum for section 4022, concerning homeowners in distress. Under the rule, anyone with a federally-backed mortgage could now receive instant relief.

Forbearance, the law said:

…shall be granted for up to 180 days, and shall be extended for an additional period of up to 180 days at the request of the borrower.

Essentially, anyone with a federally-backed mortgage was now eligible for a six-month break from home payments. Really it was a year, given that a 180-day extension could be granted “at the request of the borrower.”

It made sense. The burden of having to continue to make home payments during the coronavirus crisis would be crushing for the millions of people put out of work.

If anything, the measure didn’t go far enough, only covering homeowners with federally-backed (a.k.a. “agency”) mortgages. Still, six months or a year of relief from mortgage payments was arguably the most valuable up-front benefit of the entire bailout for ordinary people.

Unfortunately, this portion of the CARES Act was conceived so badly that it birthed a potentially disastrous new issue that could have severe systemic ramifications. “Whoever wrote this bill didn’t have the faintest fucking clue how mortgages work,” is how one financial analyst put it to me.

When homeowners take out mortgages, loans are bundled into pools and turned into securities, which are then sold off to investors, often big institutional players like pension funds.

Once loans are pooled and sold off as securities, the job of collecting home payments from actual people and delivering them to investors in mortgage bonds goes to companies called mortgage servicers. Many of these firms are not banks, and have familiar names like Quicken Loans or Freedom Mortgage.

The mortgage servicing business is relatively uncomplicated – companies are collecting money from one group of people and handing it to another, for a fee – but these infamously sleazy firms still regularly manage to screw it up.

“An industry that is just… not very good,” is the generous description of Richard Cordray, former head of the Consumer Financial Protection Bureau.

Because margins in the mortgage service business are relatively small, these firms try to automate as much as possible. Many use outdated computers and have threadbare staffing policies.

Essentially, they make their money collecting in good economic times from the less complicated homeowner accounts, taking electronic payments and paying little personal attention to loan-holders with issues.

They rely on lines of short-term financing from banks and tend to be cash-poor and almost incompetent by design. If you’ve ever tried to call your servicer (if you even know who it is) and failed to get someone on the phone, that’s no accident — unless you’re paying, these firms don’t much want to hear from you, and they certainly don’t want to pay extra to do it.

Last year, the Financial Stability Oversight Council (FSOC), which includes the heads of the Treasury, the Commodity Futures Trading Commission, the Fed, the aforementioned CFPB and others issued a report claiming mortgage service firms were a systemic threat, because they “rely heavily on short-term funding sources and generally have relatively limited resources to absorb financial shocks.”

For Cordray, who has a book out called Watchdog that chronicles his time heading the CFPB, the worry about mortgage servicers was serious.

“Nonbanks are very thinly capitalized,” he says. “They haven’t been very responsible in building up capital buffers.”

Enter the coronavirus. Even if homeowners themselves weren’t required to make payments under the CARES Act, servicers like Quicken and Freedom still had to keep paying the bondholders every month.

It might be reasonable to expect a big bank like Wells Fargo or JP Morgan Chase to front six months’ worth of principal and interest payments for millions of borrowers. But these cardboard fly-by-night servicer firms – overgrown collection agencies – don’t have that kind of cash.

How did the worst of these firms react to being told they suddenly had to cover up to a year of home payments? About as you’d expect, by trying to bully homeowners.

Soon after the passage of the CARES Act, reporters like Lisa Epstein at Capitol Forum and David Dayen at the American Prospect started hearing stories that servicers were trying to trick customers into skipping the forbearance program. As David wrote a few weeks ago:

I started hearing from borrowers that they were being told that they could apply for three months forbearance (a deferment of their loan payment), but would have to pay all three months back at the end of the period…

It soon came out that many servicers were telling homeowners that even if they thought they were getting a bailout break, they would still have to make it all up in one balloon payment at the end of the deferral period. This was a straight-out lie, but the motivation was obvious. “They’re trying to get people to pay any way they can,” is how Cordray puts it.

Dayen cited Amerihome Mortgage and Wells Fargo, but other names also started to be associated with the practice. Social media began to fill up with stories from people claiming firms like Mr. CooperBank of America and others were telling them they had to be prepared to make big balloon payments.

Same with the CFPB’s complaint database, which began to be filled with comments like the following, about a firm called NewRez LLC:

If you have 4 months of mortgage payments laying around at the end of the COVID-19 pandemic you will be fine if not good buy [sic] to your house. I understand its a business and they will make a lot of money with I’m sure a government bailout and lots of foreclosures from not helping any american home buyers…

Suddenly regulators and politicians alike were faced with a double-edged dilemma. On the one hand, the poorly-designed CARES Act placed servicers in genuine peril, an issue that left unfixed might break the mortgage markets – not a fun experience for America, as we learned in 2008.

The obvious solution was to use some of the apparently limitless funding ammunition in the Federal Reserve to help servicers maintain their responsibilities. The problem was the firms that needed such help the most were openly swindling homeowners. If there’s such a thing as regulatory blackmail, this was it.

Should the Fed open its war chest and create a “liquidity facility” to help mortgage servicers? If so, how could this be done in a way that didn’t put homeowners at more risk of being burned in some other way?

“This is the script of a heist flick, where homeowners get screwed in the end while servicers get the money,” says Carter Dougherty of Americans for Financial Reform. “If you combine money for servicers with strong consumer protections and a vigorous regulator, then the film could have a happy ending. But I’m not holding my breath.”

In early April, a group of Senators led by Virginia’s Mark Warner sent a letter that pleaded with Treasury Secretary Steven Mnuchin to use some of the $455 billion economic stabilization fund to solve the problem. The letter included a passage that essentially says, “We know these companies suck, but there’s no choice but to bail them out”:

While we understand that some nonbank lenders may have adopted practices that made them particularly susceptible to constraints on their liquidity during a severe downturn, imposing a broad liquidity shock to the entire servicing sector is not the way to go about reform…

The Senators put the problem in perspective, noting that as much as $100 billion in payments might be forborne under the CARES Act. This was a major hit to an industry that last year “had total net profits of less than $10 billion.”

The CARES Act was written in March with such speed that it became law before anyone even had a chance to catch, say, a $90 billion-sized hole in the bailout’s reasoning. Still, when the forbearances began and it started to look like the servicers might fail, there was talk among regulators and members of congress alike of letting failures happen, to teach the idiots a lesson.

But ultimately the Senators on the letter (including also Tim Kaine, Bob Menendez and Jerry Moran) decided this would ultimately be counterproductive, i.e. letting the economy collapse might be an unacceptably high price for the sending of a message to a handful of dirtbag companies.

“The focus now should not be on longer-term reform, but on ensuring that the crisis now unfolding does as little damage to the economy as possible,” is how the letter put it.

Although the letter essentially urged the creation of a new Fed bailout facility to contain the mortgage-servicer ick, that didn’t happen, even after mortgage servicers stepped up lobbying campaigns. In mid-April, a string of news stories appeared in which servicers warned reporters of snowballing market terror – as the New York Times put it, the “strain is expected to intensify” – that would only be solved with a bailout.

No dice. In a repeat of the often-halting, often illogical responses to mushrooming crises of 2008, the first pass at a solution came in the form of a move by the Federal Housing Finance Agency (FHFA), the overseer of Fannie and Freddie.

On April 21, FHFA announced they were coming to the rescue: servicers would no longer need to come up with six months of payments. From now on, it would only be four:

Today’s instruction establishes a four-month advance obligation limit for Fannie Mae scheduled servicing for loans and servicers which is consistent with the current policy at Freddie Mac.

Which was fine, except for one thing: from the standpoint of most of these woefully undercapitalized servicing firms, having to cover four months of payments is not a whole lot easier than covering six. “It still might as well be ten years for these guys,” is how one analyst put it.

Absent an intervention from the Fed, a bunch of these servicing firms will go bust. There will be chaos if even a few disappear. As we found out in 2008, homeowners facing servicer disruptions can immediately be confronted with all sorts of problems, from taxes going unpaid to payments vanishing to incorrect foreclosure proceedings taking place. Such problems can take years to resolve. Service issues helped seriously prolong the last crisis, as I wrote about in 2010.

Also, if your servicer disappears, someone still has to do the grunt work of managing your loan. To make sure your home payments are collected and moved to the right place, some entity will have to acquire what are known as the Mortgage Servicing Rights (MSRs) to your loan.

But MSRs have almost no value in a battered economy, which means it’s likely no big company like a bank will be interested in acquiring them in the event of mass failures, absent some kind of inducement. “They’re not going to want that grief,” is how one hill staffer puts it.

A third problem is that if some of these nonbank servicers go kablooey, a likely scenario would involve their businesses being swallowed up by big banks, perhaps with the aid of incentives tossed in from yet another bailout package.

This would again mirror 2008, in that a regulatory response would worsen the hyper-concentration problem and make big, systemically dangerous banks bigger and more dangerous, again.

As Dougherty says, the simplest solution would be opening a Fed facility to contain the servicer disaster, coupling aid with new measures designed to a) force servicers to keep more money on hand for a rainy day and b) stop screwing homeowners.

But the more likely scenario is just a bailout for now, with a vague promise to reform later. This would lead either to an over-generous rescue of some of our worst companies, or an industry wipeout followed by another power grab by Too Big To Fail banks.

The whole episode is a classic example of how governmental ignorance married to corporate irresponsibility can lead to systemic FUBAR, though we still don’t know how this particular version will play out. As Cordray puts it, it’s not easy to predict where failures in the mortgage servicer industry might lead.

“What’s easy to predict, though,” he says, “is that it will be a mess.”


Yeah, no kidding.

Virus Killing Off Mom and Pop…

…stores, that is. This article in the Atlantic sounds the real alarm for a free, self-reliant society. I suppose the alternative is for everyone to line up in a queue several million long to get those few jobs at Amazon and Google. An uncompetitive, ‘managed’ economy is one run by oligarchs and served by serfs.

Ultimately, this means a less competitive American economy. New companies and small businesses drive net job growth in the U.S. They generate more productivity growth than bigger and established businesses. The great small-business die-off will fuel industry consolidation, which will both depress wages for workers and increase prices for consumers. More inequality, more sclerosis, and a smaller GDP: These are some of the legacies the coronavirus pandemic is leaving.

The Small-Business Die-Off Is Here

theatlantic.com/ideas/archive/2020/05/bridge-post-pandemic-world-already-collapsing/611089/

Annie Lowrey Staff writer at The Atlantic, May 4, 2020

Outside of Boston, a marketing company is struggling to figure out how to cover its bills. In Indiana, a dance studio is waiting on three emergency-loan applications. In Baltimore, a deli is closed and desperate for help.

The government is engaged in an unprecedented effort to save such companies as pandemic-related shutdowns stretch into the spring. But Washington’s policies are too complicated, too small, and too slow for many firms: Across the United States, millions of small businesses are struggling, and millions are failing. The great small-business die-off is here, and it will change the landscape of American commerce, auguring slower growth and less innovation in the future.

Small businesses went into this recession more fragile than their larger cousins: Before the crisis hit, half of them had less than two weeks’ worth of cash on hand, making it impossible to cover rent, insurance, utilities, and payroll through any kind of sustained downturn. And the coronavirus downturn has indeed been shocking and sustained: Data from credit-card processors suggest that roughly 30 percent of small businesses have shut down during the pandemic. Transaction volumes, a decent-enough proxy for sales, show even bigger dips: Travel agencies are down 98 percent, photography studios 88 percent, day-care centers 75 percent, and advertising agencies 60 percent.

This deep freeze has posed a singular policy challenge: The government has never before been tasked with figuring out how to put a majority of the country’s businesses on life support. “We know how to support the financial system. It goes all the way back to Walter Bagehot,” Satyam Khanna, of the Institute for Corporate Governance and Finance at NYU’s School of Law, told me, referring to the 19th-century British thinker. “There’s a playbook to follow. What we don’t know how to do, or had no idea how to do, is provide direct support to your local coffee shop at scale.”

Congress and the Trump administration came up with a $350 billion plan to provide forgivable loans to small businesses, now amplified by a second tranche of $320 billion. The Small Business Administration’s Economic Injury Disaster Loan initiative provides small grants to small firms; its Paycheck Protection Program has small firms apply to retail banks and credit unions for loans of up to $10 million, intended for expenses such as rent, insurance, utilities, and wages. The PPP loans become grants, provided that employers retain their employees and spend 75 percent of the money on payroll.

Since it went live in early April, this rescue effort has been beset with implementation problems. Banks were unclear on what information to collect and were overwhelmed with applications. Small businesses had difficulty figuring out where to put in their paperwork, and what was available to them to begin with. Millions of massage therapists and cupcake makers and furniture companies were left adrift. A survey by the National Federation of Independent Business showed that four in five applicants to the two emergency programs were unsure whether they would receive help when the first tranche of money ran out.

Even successful applicants describe the process as a mess. Jackie LaVana owns a marketing firm in the Boston area. “It’s small but mighty,” she told me. “Me at my kitchen table,” plus a team of subcontractors who help her create online advertising campaigns. “I was having my best year ever” before the coronavirus pandemic, she said. But her company has since taken a 25 percent hit to revenue, if not higher.

LaVana watched the congressional rescue process closely and spent hours on text and email threads, talking with friends in the accounting and legal trades and with other small-business owners. Everyone had questions. What version of the program did they need? Who would even let them apply? Did they qualify? Would they meet the requirements? “It was complete confusion,” LaVana told me.

The Village Bank in Wayland, Massachusetts, where LaVana’s company has an account, initially said it could process her application, then told her it could not help her, because her company did not have a commercial loan. Other financial institutions told her that she needed an account with them to apply, or did not respond to her queries. She had finally managed to move forward with a small bank in western Massachusetts, before her own bank got back to her and said it would, in fact, be able to help.

The money would be enough to “keep the lights on,” she told me. One of the worst facets of the crisis, she feels, is that so many small businesses in her community are ailing together, and so many have not received help: “This is spiraling,” she said. “My ability to run my business allows my home day-care [provider] to get paid, and they’re also seeking a disaster loan. I want to support the businesses that sustain me, but I feel like I need support to do that.”

The problems with the relief package run far deeper than a flubbed rollout. For one, banks have been prioritizing applications from bigger clients; some have even developed “concierge treatment” options for wealthy firms. Even after some congressional fixes, the small-business plan, in that way, has helped big small businesses over small small businesses, and established small businesses over new small businesses, as the approval of loans to brand-name companies such as Shake Shack, Ruth’s Chris, the Los Angeles Lakers, Potbelly, and others has demonstrated. (Under public pressure, these companies have returned the funding.) Much of the help has gone to the companies that need it the least, among them firms with employee counts just under the SBA caps, franchises of major chains, and publicly traded firms, which are by definition able to raise money from investors. As structured by the federal government, “it was inherently regressive,” Khanna said.

Indeed, loans of $1 million or more soaked up half of the initial $350 billion allocated by Congress. Whiter, less populated states got more loan money per capita, with Vermont, North Dakota, and Minnesota overrepresented and Nevada, Florida, and California underrepresented. Researchers found no evidence that money went to the places and industries hit hardest, as measured by business closures and declines in hours worked. The accommodation- and food-services sector accounted for two in three jobs lost, but received just 9 percent of federal aid dollars.   

The program is generating inequality in other ways too. One of the businesses that has applied but not yet received aid belongs to Jessica Yang’s parents, who sell sandwiches and groceries at a deli in Baltimore. The shop has closed, unable to make a takeout-and-delivery model work with no notice: The deli had no online presence before the shutdown, and services such as DoorDash and Uber Eats charge such large commissions that it would “never break even on an order,” Yang told me. The SBA was its only hope. “I heard that we would hear back in three to five days,” she said. “My parents keep calling me and asking if I’d heard anything. Then we read in the news that the program reached its limit. I wonder if that has anything to do with it. Maybe there’s just no money to go around.”

Yang said that her parents’ ages and backgrounds complicated the application process: Her father is in his 60s; her mother is in her 50s and does not speak English fluently. “For first-generation Koreans, how are they getting accurate information?” Yang asked. “I don’t want people like my parents to miss out on these opportunities because the process of applying is complicated.”

They are, and it is. Although the government is not collecting or releasing data on the racial makeup of SBA-aid recipients—leaving think tanks and advocacy groups to fill in the gaps—the Center for Responsible Lending has estimated that 95 percent of black-owned businesses, 91 percent of Latino-owned businesses, 91 percent of businesses owned by Native Hawaiians or Pacific Islanders, and 75 percent of Asian-owned businesses have “close to no chance” of getting an emergency loan through a mainstream financial institution. Even with congressional tweaks, the program is amplifying existing racial disparities.

In other ways, the SBA programs are too little, too late. John Lettieri of the Economic Innovation Group, a Washington, D.C.–based research and advocacy organization, explained to me, “If you have a short-duration crisis that causes a lack of liquidity across small businesses, followed by a quick return to normal, PPP is going to help a lot of businesses. But does that sound like what we’re facing? Not to me.”

Among the issues that EIG and other advocates are pointing to: The program is not big enough, because businesses likely require an estimated $1 trillion in relief. The maximum loan size, at $10 million, is too small for many firms to cover payroll and other expenses. The program disadvantages companies with high overhead costs, such as businesses that need to pay rent in expensive cities. It requires employers to keep workers on the books, when many would financially benefit from being laid off and receiving enhanced unemployment-insurance payments. Finally, its timetable is far too short, given that formal shelter-in-place orders are expected to last for months, and the consumer economy is expected to remain weak for a year at minimum.

Facing mounting bills and absent revenue, many businesses are closing permanently, rather than drifting further and further into insolvency. “When responding to something like this, you’re not just dealing with dollars and cents. You’re dealing with toxic and pervasive fear and uncertainty,” Lettieri told me. “I can’t take for granted that Congress will extend this program, and that I’ll have a business worth running in three months. I’m going to burn through the cash I have in pocket, so why not cut losses now?” Surveys indicate that one in four small businesses does not expect to survive; an additional one-third are uncertain of their potential to withstand the cataclysm.

The short-term effects of this disaster are clear: When businesses liquidate, they lay off workers, who spend less in their local economies, making other businesses weaker, necessitating further layoffs. Business failures thus act as an accelerant in a downturn, making temporary damage permanent. This is a central reason why many economists do not expect a sharp, V-shaped rebound to the current recession, but a long, slow, U-shaped recovery.

But the decimation of American small businesses will inflict more insidious, long-lasting harm too. “We are seeing a complete wipeout of a cohort of entrepreneurs and young firms,” Lettieri said. “And there’s nothing coming up behind them.” The pandemic will mean the triumph of franchise chains over mom-and-pop shops, of C-suite executives over entrepreneurs working in their basements. It will mean town centers filled with banks and 24-hour pharmacies rather than bookstores and nail salons and takeout counters. It will also mean fewer start-ups competing with incumbents.

Ultimately, this means a less competitive American economy. New companies and small businesses drive net job growth in the U.S. They generate more productivity growth than bigger and established businesses. The great small-business die-off will fuel industry consolidation, which will both depress wages for workers and increase prices for consumers. More inequality, more sclerosis, and a smaller GDP: These are some of the legacies the coronavirus pandemic is leaving.

Viral (or Vile) Media

I start my morning reviewing the headlines of the major news media on RealClearPolitics to see if there is anything worth reading. Of course, RCP now juxtaposes the ying with the yang on every issue in order to drive engagement and traffic. Today I came across these two articles and was struck on how they captured the manufactured controversy over ending or maintaining virus lockdowns. Give them a read and see if you can perceive the difference.

How to reopen the economy with a reality-based approach

https://www.washingtonexaminer.com/opinion/how-to-reopen-the-economy-with-a-reality-based-approach

The first, published in the esteemed (sic) NYT, is written by a professor of pediatrics. I read it through, hoping to gain some insights. Sadly, incredibly obtuse, he makes assertions about epidemiology and public opinion and dismisses experts from the fields of psychiatry, politics, economics, and social behavior with a fairly baseless argument that only the medical experts know. We must follow their advice without question (okay, let’s ignore the fact that every medical projection has been off by a country mile). Then he adds that public opinion agrees. Okay, a public survey poll is an obvious contradiction of expertise: if 60% of the lemmings say we need to go over the cliff, the other 40% better follow?

He tried to obscure this error with a survey of economists. As a trained economist I happen to know the profession is one of the most risk-averse in academia (note the quoted economist who doesn’t want to be a restaurant guinea pig). Why? Because we are painfully aware of how much we don’t know (and make sure to maintain plausible deniability for those bad forecasts – Paul Krugman take note). There is no actionable intelligence in this opinion piece, as that’s what it is, unqualified opinion.

The second piece is published by the less esteemed (?) Washington Examiner (hmm, presenting a perfect opportunity to shoot the messenger and kill the message?), written by an MD and JD trained in economics. This writer offers a nuanced strategy with actionable intelligence for opening up parts of society while maintaining certain social behavior protocols to manage the risks. Okay, not bad.

My advice: trash the NYT piece and don’t take the WE piece as gospel, as that is not how it is intended, but give it careful consideration. There’s no equivalence here. Our media seems committed to misguiding at least half the country’s citizens. Ugh!

Donut Holes?

Watched a TED video by the woman who developed this idea of doughnut economics (see book). Seems to be all the rage among the save the planet crowd.

TED Talk Kate Raworth

Interesting, but I think she’s tilting at a straw man. This is a measurement problem, not a mechanistic problem. First, GDP is a very blunt instrument for measuring improvements to the human condition, but it’s the only yardstick the politicians and policymakers have and they are judged based on these metrics. Same with U6 and CPI and PPI and poverty, etc. We get GPD numbers every week of the year and our information channels repeat them as grade reports.

Second, Ms. Raworth uses the word growth as a proxy for measuring change and consuming energy resources. Not all growth or GDP measurement is expansion of goods and services. Recycling is a measure of growth; developing alternative sources of energy is a measure of growth. What we are truly dealing with is how to manage positive CHANGE. When we mismanage change, we get negative GDP growth rates. When we manage it productively, we get positive changes in GDP, among other measurements of life quality, like leisure time and cultural and technological innovation.

Economics is the fine art of managing change through exchange. So we need better measurements that include those subjective values that are not so easy to measure.
Everything else here is fantastic hyperbole, saving the planet and all that…dollars to donuts?

Social Behavior and the Coronavirus Pandemic

If you’re like me and follow the mainstream as well as social media, you’ve likely been inundated with information about the coronavirus pandemic, with many different data interpretations and conflicting claims based on these interpretations. The simple graphic below, called “flattening the curve,” seems to be the dominant visual for explaining the current public healthcare issues and provides a good starting point.

Flattening the curve.

The graph was created by disease specialists at the CDC and has been spread widely by medical professionals, government officials, and non-government agencies. It visually represents the logic behind the political response to the crisis and the strategy to slow the spread of the virus. This is critical to managing the capacity limitations of healthcare resources like hospitals, drug therapies, and healthcare personnel. However, it is a theoretical model based on exponential pandemic dynamics; it is not a graph of actual empirical data. It is meant to educate, not report.

Unfortunately, the graph has been adopted by public media as a projection of “likely” real-time scenarios under various assumptions, focusing completely on the rose-colored part of the graph. According to this worst-case scenario, without strict adherence to isolation protocols the coronavirus is projected to spread exponentially through the population, placing an impossible burden on healthcare resources. The problem is that the empirical data so far does not seem to be supporting this worst-case scenario.

Let’s not get derailed here: the virus outbreak is a serious public health threat and a deadly threat to the elderly and immune-compromised. Our policies should foremost target the security of these groups. In this respect, the model is valuable and instructive, but not so much for actual health outcomes to the majority of the population. From the macro point of view, we have little idea how many of those people infected will require medical intervention and how extensive that intervention might be. In other words, infection rates may not impact health care capacity as depicted here. We also have little feel for how high or low that spike might be, or the magnitude of the y-axis – is it thousands, millions, or billions? 20%, 50% or 90%? Many media interpretations of existing data choose a scale that looks like we’re shooting up to the top of that rosy peak when we are really barely past the initial stage way, way down near the floor of the x-axis (see next graph). The projections repeatedly fail to project for interventions and behavior changes.

Where are we?

Also, as we discover more and more people have contracted the virus yet show no serious symptoms, we are missing any projection of herd immunity. Immunity gradually reduces the ability of the virus to find new hosts within the existing population so it gradually dies out.

What is valuable about the meme is the implication for how the public should adapt social behavior now to reduce the transmission rate of the contagion. Physical or social distancing is at this time imperative. Essentially this is less about biology and more about social behavior informed by biology. It strikes me that most of our media information is overly focused on very uncertain medical data given credibility by concerned medical experts. The problem is that the experts are shrouded in uncertainty and thus must err on the side of extreme caution. In hindsight most of this speculation will likely turn out to be fictional. But the effect will be real, and this takes us back to social behavior.

Some reports opine that this coronavirus is just a bad flu. If one is looking at medical data, I would tend to agree. But looking at social behavior, I would obviously disagree. What is driving social behavior, which will be measured in political policies and economic results, relates to the nature of this pandemic, not the pathogen itself. The coronavirus strikes at the heart of our instinctual behavior in the face of existential threats.

The real problem we face is that 1) the threat is invisible, 2) seems to be highly transmissible and somewhat random, 3) offers no preventive therapy (vaccine) or 4) sure treatment options or cures. Thus, 5) we feel little sense of control over what might be a serious existential threat. What this combination of characteristics does is incite a strong psychological reaction to uncertainty, risk, and potential loss, leading to exaggerated reactions to very low probabilities.

We know from behavioral science that the survival instinct causes behavior to respond to these contextual parameters. Humans, like all sentient beings, are risk and loss averse. Loss pertains to the nature of the threat, such as will I lose my job, or my savings and pension, or the ultimate existential threat: will I get sick and die? Risk is a probability function of the uncertainty of that loss. As the threat level rises (reported death counts and mortality rates) people become more fearful. Then, as uncertainty blankets us like a fog, the anxiety level rises. This survival response is perfectly rational for any organism trying to stay alive.

The important thing to note is that when the probability of loss increases and the consequence becomes more serious, people tend to become risk-seeking. In other words, faced with a likely existential threat, people take more behavioral risks than would be rational in the absence of that threat. We see this in those apocalyptic movies, when widespread hysteria and panic leads to chaos and deadly conflict, where more people die from the chaos than from the threat.

Individual behavior is compounded by irrational social behavior. An example is the panic buying of paper products, where some people, pressed to explain their behavior, have only offered the justification that everybody else was hoarding paper, so they were too. This suggests that what may not be categorically much different than a bad flu medically has the potential to turn into a global social and economic crisis.

So why is this reaction to coronavirus different than the Asian bird flu, Ebola, SARS, MERS or H1N1? The coronavirus seems to have a much higher and faster transmission rate than these previous pathogens and thus it has spread world-wide much faster. This is likely because it is highly asymptomatic while it is contagious and spreading. It also may be far more benign. But we don’t know why it is asymptomatic in some people and severely life-threatening for others. This uncertainty and randomness heighten our fear of the threat.  

There is something else going on with the present pandemic that is aggravating the crisis. Because the virus has easily spread rather quickly, our global information media has gone into overdrive, especially social media. We know that social media is mostly driven by emotional reactions to uncertain facts, what we now call fake news. The sad reality is that the traditional print and broadcast media have also had to succumb to sensationalism and emotions in order to stay in business. Remember the editor’s dictum: If it bleeds, it leads. This presents the danger of reporting one random healthy young person who dies of COVID-19 complications instead of the thousands of others who contract the virus and seem unaffected. Our media, willingly or unwillingly, by focusing on infection and death counts taken out of context may be contributing to the social psychological effects driving this pandemic crisis. Worst-case scenarios painted by the medical experts and spread by the media are doing the same.

I suspect officials may sincerely believe projecting the worst-case scenario is necessary to “scare people straight” to get them to change behavior. But social behavior indicates that fear can become more viral than the virus, increasing the threats to social stability, safety, and security.

If one doubts this, imagine what would happen if a vaccine or cure were discovered tomorrow. Most of the world would return to normal the next day, not because the pathogen was eradicated any more than the seasonal flu, but because our fear would disappear.

When Perfect Doesn’t Exist

I wasn’t aware of Mr. Caddell’s 1983 memo, but it appears he was spot-on in reading the US politics of his day that explains much of the past 40-50 years and how we got to where we are today.

It’s interesting to note that for half the country’s voters, Donald Trump represents the fictional Mr. Smith who will clean up national political corruption (“drain the swamp”?). Obviously a very imperfect candidate, but it only goes to show that one does not even need to be liked to play the role. I doubt the Democrats can counter this in the nine short months to the next election.

I should note that half the story is not covered here, the half that explains why this era is different than past eras of political corruption. It has to do with how we have financed a governing behemoth run by very fallible human beings. Next post…

The Global Debt Bubble

I reprint this Bloomberg article in full because it lays out all the ways global policymakers have increased the risks of a global debt-driven correction, sometimes called a depression.

These policymakers have decided that since there is no shortage of global labor, there is little chance of cost-push inflation. But this ignores the very real effect of excess credit, which is the relative price changes reflected in real assets, such as land, real estate, and the control of Big Data. These assets are being more and more concentrated in fewer hands – it’s like a return to feudalism where a few lords owned all the productive assets and the laboring peasants were forced to work for subsistence living.

So, the real question is which comes first: a global financial collapse or a political revolution? Neither are smart risks for public policy and democratic governance.

My comments in bold red.

The Way Out for a World Economy Hooked On Debt? More Debt

By Enda Curran

December 1, 2019, 4:00 AM PST Updated on December 2, 2019, 12:12 AM PST

    • Cheap borrowing costs have sent global debt to another record
    • Options to revive economic growth require even more borrowing
    • Zombie companies in China. Crippling student bills in America. Sky-high mortgages in Australia. Another default scare in Argentina.

A decade of easy money has left the world with a record $250 trillion of government, corporate and household debt. That’s almost three times global economic output and equates to about $32,500 for every man, woman, and child on earth.

Global Debt

Much of that legacy stems from policymakers’ deliberate efforts to use borrowing to keep the global economy afloat in the wake of the financial crisis. Rock bottom interest rates in the years since has kept the burden manageable for most, allowing the debt mountain to keep growing.

Now, as policymakers grapple with the slowest growth since that era, a suite of options on how to revive their economies share a common denominator: yet more debt. From Green New Deals to Modern Monetary Theory, proponents of deficit spending argue central banks are exhausted and that massive fiscal spending is needed to yank companies and households out of their funk. [But we can’t ignore the fact that central banks are largely funding this deficit spending by buying bonds. If they can no longer expand their balance sheets, the private sector would have to buy this excess debt at much higher yields.]

Fiscal hawks argue such proposals will merely sow the seeds for more trouble. But the needle seems to be shifting on how much debt an economy can safely carry.

More than a decade after the financial crisis, the amount of combined global government, corporate and household debt has reached $250 trillion.

One solution proposed by policymakers? More debt pic.twitter.com/KVrv3CdlW1

[Debt growth is an exponential function – thus as we increase debt, we have to increase it at an ever greater rate just to keep the game going.]

Central bankers and policymakers from European Central Bank President Christine Lagarde to the International Monetary Fund have been urging governments to do more, arguing it’s a good time to borrow for projects that will reap economic dividends.

“Previous conventional wisdom about advanced economy speed limits regarding debt to GDP ratios may be changing,” said Mark Sobel, a former U.S. Treasury and International Monetary Fund official. “Given lower interest bills and markets’ pent-up demand for safe assets, major advanced economies may well be able to sustain higher debt loads.”

Rising expectations of fiscal stimulus measures across the globe have contributed to a pick-up in bond yields, spurred by signs of a bottoming in the world’s economic slowdown. Ten-year Treasury yields climbed back above 1.80% Monday, while their Japanese counterparts edged up closer to zero.

A constraint for policymakers, though, is the legacy of past spending as pockets of credit stress litter the globe.

At the sovereign level, Argentina’s newly elected government has promised to renegotiate a record $56 billion credit line with the IMF, stoking memories of the nation’s economic collapse and debt default in 2001. Turkey, South Africa, and others have also had scares.

Debt:GDP

[The trend of total debt/GDP tells us whether are deficit spending is paying off. When it gets too high, most of our GDP will need to service existing debt loads. The more likely scenario is widespread defaults that ricochet through the global economy.]

As for corporate debt, American companies alone account for around 70% of this year’s total corporate defaults even amid a record economic expansion. And in China, companies defaulting in the onshore market are likely to hit a record next year, according to S&P Global Ratings.

So-called zombie companies — firms that are unable to cover debt servicing costs from operating profits over an extended period and have muted growth prospects — have risen to around 6% of non-financial listed shares in advanced economies, a multi-decade high, according to the Bank for International Settlements. That hurts both healthier competitors and productivity.

As for households, Australia and South Korea rank among the most indebted.

The debt drag is hanging over the next generation of workers too. In the U.S., students now owe $1.5 trillion and are struggling to pay it off.

Even if debt is cheap, it can be tough to escape once the load gets too heavy. While solid economic growth is the easiest way out, that isn’t always forthcoming. Instead, policymakers have to navigate balances and tradeoffs between austerity, financial repression where savers subsidize borrowers, or default and debt forgiveness.

“The best is to grow out of it gradually and consistently, and it is the solution to many but not all episodes of current indebtedness,” said Mohamed El-Erian, chief economic adviser to Allianz SE.

Gunning for Growth

Policymakers are plowing on in the hope of such an outcome. [Hope for the best? In the meantime, elites’ ability to manage a crisis of their own making is more secure.]

To shore up the U.S. recovery, the Federal Reserve lowered interest rates three times this year even as a tax cut funded fiscal stimulus sends the nation’s deficit toward 5% of GDP. Japan is mulling fresh spending while monetary policy remains ultra easy. And in what’s described as Britain’s most consequential election in decades, both major parties have promised a return to public spending levels last seen in the 1970s.

China is holding the line for now as it tries to keep a lid on debt, with a drip-feed of liquidity injections rather than all-out monetary easing. On the fiscal front, it has cut taxes and brought forward bond sale quotas, rather than resort to the spending binges seen in past cycles.

What Bloomberg’s Economists Say…

“When a slump does come, as surely it will, monetary policy won’t have all the answers — fiscal policy will contribute, but with limitations.”

— Bloomberg Economics Chief Economist Tom Orlik

As global investors get accustomed to a world deep in the red, they have repriced risk — which some argue is only inflating a bubble. Around $12 trillion of bonds have negative yields.

Anne Richards, CEO of Fidelity International, says negative bond yields are now of systemic concern.

“With central bank rates at their lowest levels and U.S. Treasuries at their richest valuations in 100 years, we appear to be close to bubble territory, but we don’t know how or when this bubble will burst.”

The IMF in October said lower yields are spurring investors such as insurance companies and pension funds “to invest in riskier and less liquid securities,” as they seek higher returns.

“Debt is not a problem as long as it is sustainable,” said Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis SA in Hong Kong, who previously worked for the European Central Bank and Bank of Spain. “The issue is whether the massive generation of debt since the global financial crisis is going to turn out to be profitable.”


 

Okay, so we know that public debt never gets paid back, just rolled over with new debt. The question, as Ms. Herrero says, is whether this debt leverage is productive or not; does it make our lives better in material and non-material terms; will it help us tackle non-monetary challenges like climate change?

Credit constraints are those that penalize unproductive investments in favor of productive ones before we know which is which. The elimination of credit constraints means we are just throwing money at the wall to see what sticks, and whoever gets those credits is largely arbitrary. The whole strategy is driving global inequality, so the question again is which comes first: financial collapse or political revolution?

Oh yeah, Merry Christmas!

Electoral College Confusion

I print this from The Atlantic in full because I think it lays out a convincing but misguided case in the Electoral College debate. I’ve included my response to The Atlantic below.

Five Common Misconceptions About the Electoral College

November 29, 2019

Two of the nation’s last three presidents won the presidency in the Electoral College, even though they lost the popular vote nationwide. In 2000, Al Gore outpolled George W. Bush by more than 540,000 votes but lost in the Electoral College, 271–266. Sixteen years later, Hillary Clinton tallied almost 3 million more votes than Donald Trump but lost decisively in the Electoral College, 306–232. And, as a recent New York Timespoll suggested, the 2020 election could very well again deliver the presidency to the loser of the popular vote.

Despite this, defenders of the Electoral College argue that it was created to combat majority tyranny and support federalism, and that it continues to serve those purposes. For example, Representative Dan Crenshaw of Texas, responding to Representative Alexandria Ocasio-Cortez’s recent criticism of the Electoral College, tweeted that “we live in a republic, which means 51% of the population doesn’t get to boss around the other 49%,” and that the Electoral College “promotes more equal regional representationand protects the interests of sparsely populated states.”

But arguments like these are flawed, misunderstanding the pertinent history. Below, I identify five common mistakes made in arguing for the preservation of the Electoral College.

Mistake Number 1: Many supporters of the Electoral College assume that the debate about presidential selection at the Constitutional Convention, like the debate today, focused on whether the president should be chosen by the Electoral College or by a nationwide popular vote.

But as tempting as it is to read history in the light of contemporary concerns, the debate at the convention focused on a different issue: Should Congress choose the president? Both the Virginia Plan and the New Jersey Plan, the two primary alternatives at the Convention, proposed that Congress select the president. This was unsurprising because in most states at the time, the legislature chose the governor. On June 1, the convention voted 8–2 that Congress should elect the president, and the delegates would affirm that decision on three other occasions.

The frequency with which the delegates revisited the issue reveals not their confidence but their dissatisfaction. Most delegates wanted the executive to check legislative usurpations and block unjust or unwise laws, but they feared that dependence on the legislature for election—and possible reelection—would compromise the executive’s independence. Some delegates hoped to avoid this danger by limiting the president to a single term, but as Gouverneur Morris of Pennsylvania observed, this could deprive the nation of a highly qualified executive, eliminate the hope of continuation in office as a spur to good behavior, and encourage the executive to “make hay while the sun shines.” James Madison added that election by the legislature would “agitate and divide the legislature so much that the public interest would materially suffer” and might invite the intervention of foreign powers seeking to influence the choice.  

The difficulty lay in finding an alternative to legislative selection, and the delegates considered and rejected various possibilities, including popular election. Ultimately, perhaps in desperation, they referred the issue to the Committee on Unfinished Parts. On September 4, less than two weeks before the convention ended, the committee proposed the Electoral College. Its proposal mirrored the states’ distribution of power in Congress; each state had as many electoral votes as it had members of Congress. But because the electors dispersed after voting for the president, the Electoral College did not threaten the independence of the executive. With only minor adjustments—most notably, the House replaced the Senate as the body that would select the president if a majority of electors failed to agree on a candidate—the convention endorsed the proposal.

The point of all this is, the Electoral College did not emerge because of opposition to popular election of the president.

Mistake Number 2: Another common belief is that the convention rejected popular election of the president because the delegates feared majority tyranny. People make this claim as though to say that because the Framers were skittish of a national popular election, so should we be today.

But, once again, this interpretation of history is wrong. The convention did twice reject popular election of the president. But the delegates who rejected it did not object to popular elections per se—they had no problem with popular election of the House of Representatives or state legislatures. Rather, they were skeptical of a national popular election, primarily for reasons that are no longer relevant today.

First, they feared that people would lack the information to make an informed choice as to who might be an appropriate candidate for the presidency or who might be the best choice among candidates. Thus George Mason of Virginia claimed, “It would be as unnatural to refer the choice of a proper candidate for chief Magistrate to the people, as it would be to refer a trial of colours to a blind man.”

But his reason was that “the extent of the Country renders it impossible that the people can have the requisite capacity to judge of the respective pretensions of the Candidates.” In such circumstances, he thought, voters would naturally gravitate to candidates from their own state. Delegates who favored popular election replied that “the increasing intercourse among the people of the states would render important characters less and less unknown,” and that “continental characters will multiply as we more or more coalesce,” reducing state parochialism. Today, with mass communication and interminable campaigns, lack of information is no longer a problem.

Second, some southern delegates feared that popular election of the president would disadvantage their states. James Madison noted that, given less restrictive voting laws, “the right of suffrage was much more diffusive in the Northern than the Southern states,” which would give them an advantage in a popular election. Beyond that, a popular vote would not count the disenfranchised enslaved population, reducing southern influence.

The Electoral College solved both those problems, awarding electoral votes based on a state’s population, not its electorate, and importing the three-fifths compromise into presidential elections. The effects were immediate and dramatic—in 1800 John Adams would have defeated Thomas Jefferson had only free persons been counted in awarding electoral votes. Obviously, these concerns no longer apply, although popular election would encourage states to increase their influence by expanding their electorate, while the Electoral College offers no such incentive.

Third, some small-state delegates opposed popular election because they feared that larger states, with their greater voting power, would dominate. Yet these same delegates also objected to the Electoral College, insisting it too gave excessive power to the large states. Their concerns were addressed by stipulating that should no candidate receive a majority of the electoral vote, the selection would devolve on the House of Representatives, with each state casting a single vote.

What is striking about the convention’s debate on popular election of the president is that its opponents did not claim it would encourage majority tyranny. Doubtless the delegates were aware of the danger of such a tyranny—Madison first presented his famous discussion of “majority faction” at the convention—but no delegate objected to popular election on that basis, and Madison himself supported popular election of the president.

Mistake Number 3: Similarly, some defenders of the Electoral College have argued that the delegates who favored the Electoral College opposed popular election of the president.

Given the current debate on presidential selection, this might seem obvious, but the deliberations at the convention were much more fluid. James Wilson of Pennsylvania first proposed popular election of the president, but when his motion failed, he immediately raised the possibility of a mediated popular election: electors chosen by the people who would select the executive. All the other leading advocates of popular election—Morris, Madison, and Alexander Hamilton—also supported the Electoral College, primarily as an alternative to congressional selection. In defending the Electoral College, Madison and Hamilton emphasized its popular character. Madison in “Federalist No. 39” noted that “the President is indirectly derived from the choice of the people,” and Hamilton in “Federalist No. 68” concurred: “The sense of the people should operate in the choice of the person to whom so important a trust was to be confided,” and reelection should depend on “the people themselves.”

Mistake Number 4: Many people also believe that the Electoral College was designed to preserve federalism and states’ rights.

The Constitution was, in James Madison’s words, “in strictness neither a national nor a federal Constitution, but a composition of both.” It empowered state legislatures to determine how the presidential electors were to be chosen, and if the Electoral College failed to select a president, the House of Representatives would, with each state casting a single vote. However, the debates during the Constitutional Convention make clear that the Electoral College was not intended to protect the states or enhance the influence of state governments and state perspectives.

The convention delegates sought to safeguard the independence of the national executive from state governments. They overwhelmingly rejected proposals that the executive be selected by state legislatures or by state governors. They also rejected a proposal that the president be removable upon request by a majority of state legislatures and did not even consider the New Jersey Plan’s provision that the president “be recalled by Congress when requested by the majority of executive of the states.” This was hardly surprising. Most delegates were sharply critical of state legislatures and wanted to ensure that the president had the independence necessary to oppose their schemes. Madison summarized the prevailing sentiment: “The President is to act for the people, not the States.”

Although the Electoral College allowed state legislatures to determine how electors would be chosen, it was expected that once selected, the electors would operate independently of their state governments. The constitutional ban on senators serving as electors and the choice of the House to resolve deadlocks in the Electoral College ensured that those selected by (and perhaps influenced by) state legislatures would not play a role in selecting the president. Beyond that, the delegates expected that the electors’ deliberations would remain secret, that they would be free to choose the candidates they believed most qualified, and that their votes would be tabulated and transmitted to the president of the Senate without any indication as to who voted for which candidate, so that no political retribution could be exacted. The Constitution’s requirement that electors vote for two candidates, at least one of whom was not from their state, served to reduce state parochialism and encourage a national perspective.

In sum, the Electoral College was not designed to promote federalism—Martin Diamond, one of the most thoughtful proponents of the Electoral College, accurately described the design as “an anti-states-rights device, a way of keeping the election from state politicians and giving it to the people.” The core protections of federalism, today as in the past, are the vitality of state governments, the division of powers between nation and state, and representation in Congress along state lines. The replacement of the Electoral College by a nationwide popular vote would threaten none of these. Voting procedures would remain the same, the only difference being that votes would be tabulated nationwide rather than state by state.

Mistake Number 5: And finally, perhaps the most widely believed and, at the same time, most incorrect of the arguments for the Electoral College is that it has vindicated the hopes and expectations of its creators.

To begin with, to some extent those expectations were unclear. For example, after the Electoral College was proposed, some delegates claimed that in most elections—George Mason predicted “nineteen times in twenty”—no candidate would get a majority of the electoral votes, and so the House of Representatives would elect the president. This of course would compromise the independence of the executive, and both Madison and Hamilton unsuccessfully proposed that the House’s role be eliminated, with the candidate winning a plurality of the electoral vote becoming president. Other delegates expected that a majority of the electors would coalesce around a single candidate. In “Federalist No. 39,” Madison presumed that “the eventual election” would be made by the House, but this was mere speculation and quickly disproved.

Even when the delegates’ hopes and expectations were clear, constitutional amendments have altered the operation of the Electoral College. The Twelfth Amendment, adopted after the contested election of 1800, requires electors to specify for whom they are voting for president and vice president. The Twentieth Amendment, by shifting the date congressional terms begin to January 3, ensures that the newly elected House of Representatives, rather than the previous House, would elect the president if no candidate received an electoral-vote majority. And the Twenty-Third Amendment extends the right to vote in presidential elections to U.S. citizens residing in the District of Columbia, awarding the District three electoral votes, though the Electoral College continues to deny American citizens living in Puerto Rico and other U.S. territories any role in choosing the president.

Even more important have been changes in political practice. In “Federalist No. 64,” John Jay maintained that the Electoral College “will in general be composed of the most enlightened and respectable citizens,” and in “Federalist No. 68,” Alexander Hamilton described the electors as “most likely to possess the information and discernment” necessary to choose the chief executive. But by 1800 political parties had developed, and elector discretion was replaced by elector commitment to the parties’ candidates. Today many states do not even bother to list the electors’ names on the ballot. Interestingly, Hamilton and Madison as party leaders played a crucial role in this transformation.

The Constitution authorized state legislatures to determine how electors were to be selected, but by 1828 every state but South Carolina chose its electors by popular vote, and today all states do. Moreover, despite the initial expectation that electors would be chosen in districts, by 1836 party competition had promoted a winner-take-all allocation of electors in all the states. (Maine and Nebraska have since bucked that trend.) This in turn has affected presidential campaigns, as more and more candidates target their speeches, campaign appearances, and ads at “swing states” and largely ignore states they confidently expect to carry or to lose.

Meanwhile, the proliferation of primary elections, the nationalization of the choice of presidential candidates, the move toward candidate-based campaigns, and the reduced importance of state party organizations have fundamentally transformed presidential selection, without changing how votes are awarded under the Electoral College.

In “Federalist No. 68,” Alexander Hamilton contended that the Electoral College would frustrate “the desire in foreign powers to gain an improper ascendant in our councils.” It would also “afford a moral certainty that the office of President [would] seldom fall to the lot of any man who is not in an eminent degree endowed with the requisite qualifications.” In addition, it would keep from the office candidates with “talents for low intrigue, and the little arts of popularity.” In evaluating the Electoral College today, one must judge whether Hamilton’s hopes have been vindicated.


My response:

In his article, “Five Common Misconceptions About the Electoral College,” (The Atlantic, Nov. 29, 2019), Alan Tarr presents arguments against what he perceives to be the primary assumptions in support of the Electoral College system. These five “common misconceptions” are explained well but largely skirt the arguments applied to our current politics.

The Founders converged on the Electoral College in order to address the problems of the new United States of America, but in so doing they attempted to anticipate the dynamics of political conflict within a union of sovereign states representing a diverse and pluralistic population scattered across a large land mass. It is the logic of these dynamics that matters to today’s debate, not the original application to a scenario rooted in history.

Mr. Tarr dispels the comments of Rep. Crenshaw as a misunderstanding of history, but of course his words are perfectly accurate in describing the issue today. We do not adhere to a simple majoritarian system when choosing national leaders and the electoral system does help balance regional and demographic interests.

As far as the historical record is concerned, only five times in fifty-eight presidential elections has the EC tally not confirmed the national popular vote tally–that’s over a 90% rate of coincidence—and the fact that two of the aberrant cases have occurred in the past 20 years likely indicates something different and untoward about our current political divisions. An honest analysis of the 2016 election reveals that the EC corrected for a seriously skewed national popular vote.

In this light, Mr. Tarr’s evident “mistakes” are really mistakes of interpretation largely irrelevant to our current debate. But Mr. Tarr does make some assertions that are relevant and arguably flawed. He claims that with “mass communication…lack of information is no longer a problem.” One look at a major news aggregator such as RealClearPolitics or social media quickly dispels this misplaced confidence. As a political scientist, Mr. Tarr surely knows that the only true threat to democracy is systemically biased information, which is why media is the first target of despots and dictators. Fake news seems to be the byproduct of the information age.

The true political dilemma we face today is a large country divided politically according to population density: we have blue cities and inner suburbs vs. red exurbs and rural counties. Population density does suggest many diverging economic and policy interests and have so over the long history of our republic, but today’s divide is reinforced and amplified by party platforms and media interests. Democrats have targeted urban voters and Republicans have targeted non-urban voters. Both parties have focused on partisan identity politics.

Our major news media is largely located in urban areas, because that’s where their audiences are concentrated. The digital disruption of media means media has had to provoke, entertain, and serve the interests of their audiences as a matter of survival. Hence they have turned to infotainment and politics demanded by their audiences, which suggests a strong news bias towards urban politics. (The fact that most critiques of the EC are published by urban news organizations reveals this bias against our long-standing democratic institutions.)

Mr. Tarr then dismisses the most crucial implication of a national popular vote, which is not states’ rights, but the rights of the residents of those states over the direction of the union to which they belong. Due to the highly skewed geographic distribution of partisan voting, large concentrated populations would be favored by campaigns and policy platforms, because that’s where the winning votes would reside. These interests run counter to large swaths of the country outside of metro areas. How long before less populated states tired of taxation without representation? Thus, the true threat to the United States is the weakening and possible dissolution of the union. As political secession is not an anachronism in the world today, dismissing this threat as implausible would be the gamble of a fool.

The residents of small states do not dominate national elections, and likewise a few large urban states should also not dominate national elections. Neither can without joining broader coalitions. Without the EC that forced compromise would not be necessary for a few large states. And so it turns on swing states, but swing state voters should be applauded for their bipartisan fluidity, while states’ voters that are stuck in partisan identity should be encouraged to open their hearts and minds to the same spirit of bipartisanship. That’s democratic politics as it is meant to be managed.

And this gets back to what we believe were the hopes and expectations of our Constitutional Founders. It seems obvious from Washington to Lincoln to Roosevelt to Trump that the primary objective of our electoral system is a strong, coherent, stable United States in defense of its constitutional principles of liberty and justice. Stated in another way, our system of democracy is not designed to make voters happy—since roughly half the voters will be unhappy after every election—but to perpetuate the exceptional experiment of American democracy.

We are not France.

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