Money For Nothing?

TowerofPower

…there is now a nagging fear that credibility in central bankers is being lost. Investors, it seems, are losing confidence in the Fed.

You think? I believe the definition of insanity is to keep doing the same thing over and over and expecting a different result. It seems to me the Fed has sidelined itself and the future path of the economy will be determined by markets, and it won’t all be good. As Stockman says (see second article below), the global economy in many respects is at peak debt, thus the global private and public sectors are both struggling to de-leverage. The only borrowers are national governments and those speculating in asset markets.

Thus, the Fed’s efforts to boost inflation to 2% have been for naught and merely goosed asset markets and resource misallocation. For the global economy to re-balance from peak debt requires debts to be written down, something that occurs with bankruptcy accompanied by price deflation. Forestalling instead of managing these corrections only means a larger correction at some point in the future.

On another note, our experience is confirming the weakness of Friedman’s monetarism. Inflation is not purely a monetary phenomenon – more important, it is a behavioral one based on demographics and the perceived level of uncertainty and risk regarding the future of the economy and policy distortions.

Markets reflect the collective intelligence of humans; they’re not all stupid.

Why Wall Street’s Stimulus Junkies Weren’t Thrilled by the Fed’s Rate Decision

By Anthony Mirhaydari
It wasn’t supposed to be like this.

In a massively hyped Federal Reserve policy announcement Thursday — one that threatened to end the nearly seven-year experiment with interest rates near 0 percent and usher in the first rate hike since 2006 — Chair Janet Yellen and her cohorts gave Wall Street exactly what they wanted: No change, in line with futures market odds.

And yet stocks drifted lower, even as the action in the currency and commodities market was as expected, with the dollar falling hard and gold up 0.8 percent. Why?

Cutting to the quick: Investors, it seems, are losing confidence in the Fed.

While the Wall Street stimulus junkies should’ve been happy with the continuation of the status quo, there is now a nagging fear that credibility in central bankers is being lost — something that RBS’ Head of Macro Credit Research Alberto Gallo took to Twitter this afternoon to reiterate.

Moreover, the Summary of Economic Projections by Fed officials revealed that, at the median, policymakers now only expect a single rate hike by the end of 2015. The futures market is now pricing in a 49 percent chance of a hike at the December meeting (although Yellen noted that the October meeting was “live” and could result in a hike should markets and economic data improve).

But the kicker — the one that pushed large-cap stocks lower into the closing bell — was the appearance of a negative interest rate projection by a Fed policymaker on the newly released “dot plot.” Someone, it seems, expects federal funds policy rate to be in negative territory at the end of 2016. Four officials don’t expect any hikes this year at all.

Not only does this undermine confidence in the state of the economy, but it calls into question the efficacy of the Fed’s ultra-easy monetary policy stance that has been in place, to varying degrees, since 2008. Moving forward, it will be critical for the bulls to recover from Thursday’s intra-day selloff. The day’s action resulted in a very negative “shooting star” technical pattern that signals buying exhaustion and often precedes pullbacks.

In their statement, Federal Open Market Committee members fingered recent global economic weakness and financial market turbulence as giving reason to believe that inflation would take longer to return to their 2 percent target. So the new dot plot shows the median rate projection for the end of 2015 falling to 0.375 percent from 0.625 percent as of June; to 1.375 percent for 2016 vs. 1.625 percent before; and 2.625 percent for 2017 from 2.875 percent. The long-term neutral rate declined to 3.5 percent from 3.75 percent, signifying ongoing structural problems in the economy holding down its potential growth rate.

But a tree should be judged by the fruit it produces. In this case, median household incomes are stagnating despite all the Fed has already done, including three bond-buying programs and the “Operation Twist” maturity extension program. With corporate profits rolling over and global growth stagnating, people are wondering: Is this all the Fed and its central banking counterparts can do? Fresh threats, such as another possible debt ceiling showdown on Capitol Hill this autumn and an election in Greece, are approaching.

As for what comes next, Societe Generale Chief U.S. Economist Aneta Markowska suggests a replay of the late 2013 experience surrounding the beginning of the end of the QE3 bond-buying program: “Our scenario is reminiscent of 2013 when the ‘taper tantrum’ spooked the Fed in September, a government shutdown spooked the Committee in October, and the fog finally lifted by December when the taper was finally announced.”

If the Fed left rates unchanged, there were some new wrinkles in its statement. In explaining their decision, Fed officials elevated issues like global economic growth and the dollar’s valuation seemingly above its traditional mandate regarding labor market health. J.P. Morgan Chief U.S. Economist Michael Feroli believes investors shouldn’t read too much into the new factors being cited. In a paraphrase of the infamous rant by former Arizona Cardinals coach Dennis Green: Yellen is a dove. She is who we thought she was. And until higher inflation becomes a clear and present problem, this continual moving of the goalposts for Fed rate hikes — deferring until more data comes in — looks set to continue.

But that may no longer be enough to keep stocks happy.

——————-

Yellen-cheap-money

David Stockman is not a fan of the Fed. In fact he claims that the Fed is on a “jihad” against retirees and savers.

The former Reagan budget director and author of “The Great Deformation: The Corruption of Capitalism in America” visited Yahoo Finance ahead of the Fed announcement to discuss his predictions and the potential impact of today’s interest rate decision. “80 months of zero interest rates is downright crazy and it hasn’t helped the Main Street economy because we’re at peak debt,” he says.

Businesses in the U.S. are $12 trillion in debt. That’s $2 trillion more than before the crisis, but “all of it has gone into financial engineering—stock buybacks, mergers and acquisitions and so forth,” according to Stockman. “The jig is up; [the Fed] needs to get on with the business of allowing interest rates to find some normalized level.”

While Stockman believes that the Fed should absolutely raise rates today, he isn’t so sure that they will (Note: they did not). But even if they do, he says they’ll muddle the effect by saying “‘one and done’ or ‘we’re going to sit back and watch this thing unfold for the next two or three months.’”

This all fuels an inflationary bubble on Wall Street, according to Stockman. “This massive money printing we’ve had has never gotten out of the canyons of Wall Street. It’s sitting there as excess reserves.”

According to Stockman, the weakness of the U.S. economy has been due to a lack of investment over the past 15 years and inflated labor costs in America that can’t compete on a global scale. “Simply printing more money and keeping interest rates at zero do not help that problem.”

Zero interest policies, says Stockman, are leading to the global economic turmoil we are currently experiencing. “In the last 15 years China took its debt from $2 trillion to $28 trillion… it’s a house of cards with an enormous overcapacity and enormous speculation and gambling that is beginning to roll over,” he says. “It’s just the leading edge of a global deflation that I think is underway as a consequence of all this excess credit growth that we’ve had.”

If the Fed raises rates and doesn’t mince words there’s going to be a long-running market correction, says Stockman. If the Fed doesn’t raise rates there will be a short-term relief rally but eventually the markets will lose confidence in the central bank bubble and we’ll be in store for a “huge correction.”

The Economics of a Stagnating World

economics-cartoon

This article by Edmund Phelps in the upcoming issue of the NYROB is excellent for bringing the important underlying issues to the fore. The “good life,” as Aristotle describes it, is based on humanist values that often get lost in discussions about materialistic economics or even abstractions of moral justice. Thus, our policy challenges are not only about delivering the sustenance for life, but making life worth living.

Phelps correctly focuses on the humanist values of creativity and innovation for pursuing meaning in our lives. (I would suggest that equally important to meaning is the process of sharing that creativity through community, and Phelps would certainly agree.)

But how can we achieve a world of shared creative discovery?

Creativity is a function of imagination and taking risks into the unknown when it comes to acting on our imaginations. This is where the materialist concerns enter in. Human beings are rationally loss averse because survival is paramount to the individual, the community, and the species. As Phelps argues, our pursuit of material prosperity has reduced our economic lives to the pursuit of greater efficiency, rather than greater meaning. At the same time, as we pursue greater efficiency by the rationalization of production-principly by reducing labor costs-we’ve exposed large segments of our society to greater individual risks, while not managing them very well.

Phelps correctly attributes this to the demands of classical economic theory – and we operate on what we know. Thus, we need to pursue new paradigms to manage economic change that also foster inclusion into economic and political society. I’ve discussed several aspects of what a new paradigm might look like in previous blogs such as:

Why Ownership Matters

Power Laws I, II, III

Rethinking Inequality and Redistribution in a Free Society

Beyond Piketty’s Capital

What is wrong with the economies of the West—and with economics?

by Edmund Phelps, The New York Review of Books, August 13, 2015

It depends on whether we are talking about the good or the just.

Many of us in Western Europe and America feel that our economies are far from just, though our views on justice differ somewhat. One band of economists, led for decades by the British economist Anthony Atkinson, sees the West as being in another Gilded Age of inequality in income and wealth.1 Adopting Jeremy Bentham’s utilitarian view, they would redistribute income from those in high brackets to those farther down—until we reach the highest “sum of utilities.” It is a question, though, whether this doctrine captures intuitive views of what is just.

Philosophers over these same decades have been more interested in the work by the American philosopher John Rawls. His book A Theory of Justice argues for a fundamental shift away from Bentham: economic justice is about the distribution of “utilities,” for him a word usually denoting the satisfactions of consumption and leisure, not the sum of those utilities.2 It is about the terms on which each participant contributes to the fruit of the society’s economy. For Rawls, justice requires the state to use taxes and subsidies to pull up people with the lowest wages to the highest level possible. That way, the least advantaged get the largest possible portion of the gain from people’s cooperation in the economy.

A struggle persists between these views. The Benthamite view has morphed into the corporatist idea that a nation’s government ought to provide benefits, whether in the form of money or tax advantages, or free services, to interest groups—whether corporations, or unions, or consumers—that voice a need until more benefits would be deemed to cost too much. Meeting these claims of many different interests has left little in the public purse for low-wage workers.

The Rawlsian view has found little support among legislators, it is true. In the US, the Earned Income Tax Credit was passed in 1975. But it mainly supplements the income of low-wage mothers of young children. It does nothing for low-end workers as a whole and, to some extent, it actually reduces paychecks for low-paid work of childless women and single men. In Europe, a few countries spend much more than the US on job subsidies but statistical analyses have not found large effects on wages or unemployment.

With little or no effective policy initiative giving a lift to the less advantaged, the jarring market forces of the past four decades—mainly the slowdowns in productivity that have spread over the West and, of course, globalization, which has moved much low-wage manufacturing to Asia—have proceeded, unopposed, to drag down both employment and wage rates at the low end. The setback has cost the less advantaged not only a loss of income but also a loss of what economists call inclusion—access to jobs offering work and pay that provide self-respect. And inclusion was already lacking to begin with. In America, black urban teenagers have long been lacking in inclusion. In France there is a comparable lack of inclusion among North Africans. In much of Europe there has been little attempt to include the Roma.

This failing in the West’s economies is also a failing of economics. The classical idea of political economy has been to let wage rates sink to whatever level the market takes them, and then provide everyone with the “safety net” of a “negative income tax,” unemployment insurance, and free food, shelter, clothing, and medical care. This policy, even when humanely carried out, and it often is not, misses the point that, even if we confine our attention to the West since the Renaissance, many people have long felt the desire to do something with their lives besides consuming goods and having leisure. They desire to participate in a community in which they can interact and develop.

Our prevailing political economy is blind to the very concept of inclusion; it does not map out any remedy for the deficiency. A monograph of mine and a conference volume I edited are among the few book-length studies of ways to remedy failure to include people generally in an economy in which they will have satisfying work.3

Commentators are talking now about injustice of another sort. Workers in decent jobs view the economy as unjust if they or their children have virtually no chance of climbing to a higher rung in the socioeconomic ladder. And moving up appears harder now. Even in the Gilded Age, many of the moguls came up from the bottom. (The rungs were far apart, yet the ladder was climbed.) The feeling of injustice comes from a sense of unfair advantages: that those above are using their connections to stay there—or to ensure that their children can follow them. The bar to upward mobility is always the same: barriers to competition put up by the wealthy, the connected, corporations, professional associations, unions, and guilds.

But the truth is that no degree of Rawlsian action to pull up low-end wages and employment—or remove unfair advantages—could have spared the less advantaged from a major loss of inclusion since Rawls’s time. The forces of productivity slowdown and globalization have been too strong. Moreover, though the injustices in the West’s economies are egregious, they ought not to be seen as a major cause of the productivity slowdowns and globalization. (For one thing, a slowdown of productivity started in the US in the mid-1960s and the sharp loss of manufacturing jobs to poorer countries occurred much later—from the late 1970s to the early 1990s.) Deeper causes must be at work.

While people need a just economy for their self-respect and national pride—Rawls regarded justice as the first virtue of a society—justice is not everything that people need from their economy. They need an economy that is good as well as just. And for some decades, the Western economies have fallen short of any conception of a “good economy”—an economy offering a “good life,” or a life of “richness,” as some humanists call it.

The good life as it is popularly conceived typically involves acquiring mastery in one’s work, thus gaining for oneself better terms—or means to rewards, whether material, like wealth, or nonmaterial—an experience we may call “prospering.” As humanists and philosophers have conceived it, the good life involves using one’s imagination, exercising one’s creativity, taking fascinating journeys into the unknown, and acting on the world—an experience I call “flourishing.” These gains are gains in experience, not in material reward, though material gains may be a means to the nonmaterial ends. As the writer Kabir Sehgal put it, “Money is like blood. You need it to live but it isn’t the point of life.”4

How might such a good life prevail in a society? Historically, as my book Mass Flourishing argues,5 prospering and flourishing became prevalent in the nineteenth century when, in Europe and America, economies emerged with the dynamism to generate their own innovation. Responding to the challenges and opportunities of an ever-evolving economy, the more entrepreneurial participants were immersed in the experience of solving the new problems and overcoming the new hurdles posed in the process of innovation: these people were “prospering.” Sparked by the new spirit of dynamism, the more innovative participants were constantly trying to think of new ways to produce things or new things to produce: these people were “flourishing.”

What were the origins of this dynamism? It sprang from the development of a favorable culture. In nineteenth-century Britain and America, and later Germany and France, a culture of exploration, experimentation, and ultimately innovation grew out of the individualism of the Renaissance, the vitalism of the Baroque era, and the expressionism of the Romantic period. In view of the explosion in poetry, music, and art in the “creative” sector of the economy, it should not surprise us that imagination exploded in the rest of the economy too. In these years George Stephenson conceived the steam railway, John Deere the cast-steel plow that “broke the plains”; Isaac Singer developed and marketed a commercial sewing machine, Thomas Edison the phonograph, the Lumière brothers the cinema, and Florence Nightingale effected a reorganization of hospitals. Innovation was rampant—and very apparently in America, as observers testified. Abraham Lincoln, touring America in 1858, exclaimed that the country had “a great passion—a perfect rage—for the ‘new.’”6

What made innovating so powerful in these economies was that it was not limited to elites. It permeated society from the less advantaged parts of the population on up. People of ordinary background might be involved in innovations, large and small. Stephenson was illiterate, Deere a blacksmith, Singer a machinist, Edison of humble origins. People of ordinary ability could also have innovative ideas. As I wrote in Mass Flourishing, “Even people with few and modest talents…were given the experience of using their minds: to seize an opportunity, to solve a problem, and think of a new way or a new thing.”

The experience of working in these dynamic economies was evidently good for most people—far better than the previous economies were, at any rate. Diaries of the period contradict the old familiar tune that the rural life of mercantile times, with its routine and isolation, was preferred to modern life in businesses and cities.7

It may be that some other economies lacked (and still lack) the wages for large numbers of ordinary people to afford to pursue careers in which they could prosper or flourish; or they lacked enough jobs for large numbers of people to have those opportunities. High-enough wages, low-enough unemployment, and wide-enough access to engaging work are necessary for a “good-enough” economy—though far from sufficient. The material possibilities of the economy must be adequate for the nonmaterial possibilities to be widespread—the satisfactions of prospering and of flourishing through adventurous, creative, and even imaginative work.

Some economists maintain that nations do not need dynamism to be happy. The French and Italians seem to find it perfectly acceptable that their economies have been almost devoid of indigenous innovation for nearly two decades. They are content with an economy unable to do more than simply let global market forces—including advances in science at home and abroad—pull up the going level of wage rates and prop up the market rates of return on wealth. (In fact, little upward movement of real wages has been occurring of late in the advanced economies.) But from my perspective, such an economy is pitiful next to an economy with significant prospering and flourishing—let alone the economies of heady innovation in the West’s past. Oddly, this pitiful sort of economy is very much like the theoretical models of classical economics.

In the classical models I have been describing, no one is trying to think up something new (except perhaps new profitable investments) and no one is attempting to create it. There is no conception of human agency, only responses to wages, interest rates, and wealth. The economy is mechanical, robotic. The crops may be growing, but there is no personal growth. In the classical canon, Bentham, with his “sum of utilities,” portrays individuals like machines working to contribute their share to the general welfare. Joseph Schumpeter portrays “innovation” as produced by hard-driving entrepreneurs who make “obvious” applications of discoveries occurring outside the nation’s economy—as if the economy’s central participants possessed no imagination whatever.

Such classical models are basic to today’s standard economics. This economics, despite its sophistication in some respects, makes no room for economies in which people are imagining new products and using their creativity to build them. What is most fundamentally “wrong with economics” is that it takes such an economy to be the norm—to be “as good as it gets.” The cost is that elements of the Western economies are becoming products of this basically classical economics, which has little place for creativity and imagination.

Since around 1970, or earlier in some cases, most of the continental Western European economies have come to resemble more completely the mechanical model of standard economics. Most companies are highly efficient. Households, apart from the very low-paid or unemployed, have gone on saving, each year pushing up their wealth to higher levels, spectacular levels in Italy and France—far higher than in America, leaving aside the super-rich. And with the rise of household wealth contracting the supply of labor, workweeks and labor force participation have been shrinking.

One could argue that the continental economies are marching—D.H. Lawrence’s “everlasting slog” comes to mind—along a path of ever-increasing wealth like that derived mathematically by Frank Ramsey long ago. That study inspired John Maynard Keynes’s influential essay in which he praised the decline of work as liberating the human spirit.8 Keynes seemed to think that ordinary people are incapable of prospering or flourishing. Even now, many Europeans seem not to have grasped that, while comparatively rich in wealth and spare time, they are poor in the conditions for the good life: an economy conducive to flourishing and prospering. The causes of this decline are clear.

In most of Western Europe, economic dynamism is now at lows not seen, I would judge, since the advent of dynamism in the nineteenth century. Imagining and creating new products has almost disappeared from the continent—a continent that had been a major wellspring of new industries and new ways of living. Growth there has stopped, and econometric estimates of the rate of homegrown innovation are generally small. The near disappearance of imaginative and creative activity has reduced indigenous innovation, contracted investment activity, and depressed the demand for labor.

The bleak levels of both unemployment and job satisfaction in Europe are testimony to its dreary economies. Polls can produce simplistic responses to questions about complex feelings; but it should not be puzzling that a recent survey of household attitudes found that, in “happiness,” the median scores in Spain (54), France (51), Italy (48), and Greece (37) are all below those in the upper half of the nations labeled “emerging”—Mexico (79), Venezuela (74), Brazil (73), Argentina (66), Vietnam (64), Colombia (64), China (59), Indonesia (58), Chile (58), and Malaysia (56).9 As I wrote in a commentary on western continental Europe, “the economy is failing society.”10

The US economy is not much better. Two economists, Stanley Fischer and Assar Lindbeck, wrote of a “Great Productivity Slowdown,” which they saw as beginning in the late 1960s.11 The slowdown in the growth of capital and labor combined—what is called “total factor productivity”—is stark and, with the exception of the years of the Internet boom, between 1996 and 2004, it has not let up; it has only gotten slower since the 1960s. In my analysis, the slowdown is the source of the deep decline in wage growth, labor force participation, and, on some evidence, in job satisfaction. Markedly fewer lead the good life. (As in continental Europe, the slowing of productivity growth caused wage growth to slow, and many households kept adding to their wealth through savings, all of which has been dragging participation down. Yet America’s productivity slowdown started earlier, so the cumulative damage to participation has been greater than Europe’s to date.)

What is the mechanism of the slowdown in productivity? Many commentators and laymen suppose that the dramatic rise of innovation in Silicon Valley has displaced labor and slowed the rise of wages at the low end and the middle. We have all observed the disappearance of bookstores, record stores, and many other kinds of stores, as well as newsprint. But if innovation in the aggregate were up, it would be hard to explain why growth of aggregate total factor productivity is so unmistakably down. As Alvin Hansen said many decades ago, it is the “cessation of growth,” or, as he implied, the slowdown of aggregate innovation, “which is disastrous.”12

The plausible explanation of the syndrome in America—the productivity slowdown and the decline of job satisfaction, among other things—is a critical loss of indigenous innovation in the established industries like traditional manufacturing and services that was not nearly offset by the innovation that flowered in a few new industries—digital, media, and financial. In the vast heartland of America, the loss of dynamism is almost palpable—and not just in the oft-cited education and health care industries. Companies like Google and Facebook may offer jobs allowing or requiring imagination and creativity, but the whole of Silicon Valley accounts for only 3 percent of national income and a smaller percentage of national employment. Once European economies ran out of American innovations they could copy, the syndrome of low productivity growth hit them too—France and Italy in the late 1990s, Germany and Britain by 2005 or so. That most European economies appear to be in worse condition than the American in labor force participation and job satisfaction can be laid to America’s noticeable edge in innovation. That has kept America a step ahead.

What then caused this narrowing of innovation? No single explanation is persuasive. Yet two classes of explanations have the ring of truth. One points to suppression of innovation by vested interests. Their power has risen enormously in Western Europe and finally America over the postwar decades. Invoking corporatist notions of economic control and social contract originating in the corporazioni of ancient Rome, some professions, such as those in education and medicine, have instituted regulation and licensing to curb experimentation and change, thus dampening innovation.

Invoking the corporatist notion of solidarity, companies hurt by innovators—as GM was hurt by BMW and Toyota—have been able to obtain federal government bailouts to help them regain their positions. As a result, fleeting innovators—BMW and Toyota in my example—often lose money in their attempts. So would-be innovators will think twice before trying again to innovate in America’s automobile market.

Invoking the corporatist tenet of social protection, established corporations—their owners and stakeholders—and entire industries, using their lobbyists, have obtained regulations and patents that make it harder for new firms to gain entry into the market and to compete with incumbents. A result is that the outsiders have been stifled—though some entered new industries before those too could put up barriers. And some insiders, now protected from new entrants, feel it is safe to drop whatever defensive innovation they used to do. We can see dramatic examples of how these barriers protect insiders in the pharmaceutical and the medical device industries, where the FDA approvals process has blocked new entry and slowed innovation to a crawl. Insiders feel free to raise their markups, thus increasing profits and wealth inequality.

We can test this theory. Bureau of Labor Statistics data on the US nonfarm business sector show labor’s share of income falling from 66 percent at its twin peaks in the mid-1970s to 61 percent in the 1990s and around 58 percent more recently. OECD data on business sectors show a rise in capital’s share from 32.5 percent in 1971–1981 to 34.5 percent in 1995–1997 in the US and from 33.3 percent to 38.5 percent in the European Union.13

The second explanation points to a new repression of potential innovators by families and schools. As the corporatist values of control, solidarity, and protection are invoked to prohibit innovation, traditional values of conservatism and materialism are often invoked to inhibit a young person from undertaking an innovation. Schools are doing less to expose the young to the great books of adventure and personal development. Parents teach their children from infancy to be careful and stay close to the family. There is discussion now of the overprotected child: the need for a return to “free range” children who are allowed to explore, to try things and take chances.14 Parents urge their children upon graduating to take a secure job with high pay, not a job at a startup. Many universities are now teaching courses in “responsible investing” but nothing on venturesome investing.

How might Western nations gain—or regain—widespread prospering and flourishing? Taking concrete actions will not help much without fresh thinking: people must first grasp that standard economics is not a guide to flourishing—it is a tool only for efficiency. Widespread flourishing in a nation requires an economy energized by its own homegrown innovation from the grassroots on up. For such innovation a nation must possess the dynamism to imagine and create the new—economic freedoms are not sufficient. And dynamism needs to be nourished with strong human values.

Of the concrete steps that would help to widen flourishing, a reform of education stands out. The problem here is not a perceived mismatch between skills taught and skills in demand. (Experts have urged greater education in STEM subjects—science, technology, engineering, and mathematics—but when Europe created specialized universities in these subjects, no innovation was observed.) The problem is that young people are not taught to see the economy as a place where participants may imagine new things, where entrepreneurs may want to build them and investors may venture to back some of them. It is essential to educate young people to this image of the economy.

It will also be essential that high schools and colleges expose students to the human values expressed in the masterpieces of Western literature, so that young people will want to seek economies offering imaginative and creative careers. Education systems must put students in touch with the humanities in order to fuel the human desire to conceive the new and perchance to achieve innovations. This reorientation of general education will have to be supported by a similar reorientation of economic education.

We will all have to turn from the classical fixation on wealth accumulation and efficiency to a modern economics that places imagination and creativity at the center of economic life.

  1. An early work of Atkinson’s is Economics of Inequality (Oxford University Press, 1975); for a review of his most recent book, Inequality: What Can Be Done? (Harvard University Press, 2015), see Thomas Piketty, The New York Review, June 25, 2015. I was struck by a presentation by Atkinson, “The Social Marginal Valuation of Income,” at the conference celebrating the seventieth birthday of Sir James Mirrlees, Clare College, Cambridge, July 28, 2006. 
  2. A Theory of Justice (Harvard University Press, 1971). The book sees a society’s economy as central to the people, arguing that they are drawn together by their desire for mutual gains from collaborating in its economy. 
  3. Rewarding Work: How to Restore Participation and Self-Support to Free Enterprise (Harvard University Press, 1997) and Designing Inclusion: How to Raise Low-End Pay and Employment in Private Enterprise (Cambridge University Press, 2003). 
  4. Kabir Sehgal, Coined: The Rich Life of Money and How Its History Has Shaped Us (Grand Central, 2015). 
  5. Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge, and Change (Princeton University Press, 2013). 
  6. Abraham Lincoln, “Discoveries and Inventions,” Young Men’s Association, Bloomington, Illinois, April 6, 1858. 
  7. See Emma Griffin, Liberty’s Dawn: A People’s History of the Industrial Revolution (Yale University Press, 2013). Her current work, as yet unpublished, has reached farther into the nineteenth century, where some of the findings are equally or more striking. 
  8. See F.P. Ramsey, “A Mathematical Theory of Saving,” The Economic Journal (1928), and J. M. Keynes, “The Economic Possibilities for Our Grandchildren,” The Nation and the Athenaeum (1930, in two parts). 
  9. “People in Emerging Markets Catch Up to Advanced Economies in Life Satisfaction,” Pew Research Center, October 2014. (Performing better were the UK at 58, Germany at 60, and the US at 65.) 
  10. “Europe Is a Continent That Has Run Out of Ideas,” Financial Times, March 3, 2015. 
  11. See Assar Lindbeck, “The Recent Slowdown of Productivity Growth,” The Economic Journal, Vol. 93, No. 369 (March 1983), and Stanley Fischer, “Symposium on the Slowdown in Productivity Growth,” Journal of Economic Perspectives, Vol. 2, No. 4 (Fall 1988). Lindbeck begins, “The growth slowdown that began in the late 1960s or early 1970s is the most significant macroeconomic development of the last two decades.” 
  12. Alvin H. Hansen, “Economic Progress and Declining Population Growth,” The American Economic Review, Vol. 29, No. 1 (March 1939). 
  13. OECD, Economic Outlook, December 1998. 
  14. See Hanna Rosin, “The Overprotected Kid,” The Atlantic, April 2014, and Lenore Skenazy, Free-Range Kids: How to Raise Safe, Self-Reliant Children (Without Going Nuts with Worry), (Jossey-Bass, 2009). 

The Greek Tragedy Enters the 3rd Act

stock_market_bubbleDavid Stockman will be wrong until he’s right.

The only thing in this utterly broken “market” which is really priced-in is an unshakeable confidence that any disturbance to the upward march of asset prices will be quickly, decisively and reliably countermanded by central bank action.

It Is NOT Priced-In, Stupid!

by  • July 6, 2015

Among all the mindless blather served up by the talking heads of bubblevision is the recurrent claim that “its all priced-in”. That is, there is no danger of a serious market correction because anything which might imply trouble ahead—-such as weak domestic growth, stalling world trade or Grexit——is already embodied in stock market prices.

Yep, those soaring averages are already fully risk-adjusted!

So the “oxi” that came screaming unexpectedly out of Greece Sunday evening will undoubtedly be explained away before the NYSE closes on Monday. Nothing to see here, it will be argued. Today’s plunge is just another opportunity for those who get it to “buy-the-dip”.

And they might well be right in the very short-run. But this time the outbreak of volatility is different. This time the dip buyers will be carried out on their shields.

Here’s why. The whole priced-in meme presumes that nothing has really changed in the financial markets during the last three decades. The latter is still just the timeless machinery of capitalist price discovery at work. Traders and investors in their tens-of-thousands are purportedly diligently engaged in sifting, sorting, dissecting and discounting the massive, continuous flows of incoming information that bears on future corporate profits and the present value thereof.

That presumption is dead wrong. The age of Keynesian central banking has destroyed all the essential elements upon which vibrant, honest price discovery depends. These include short-sellers which insure disciplined two-way markets; carry costs which are high enough to discourage rampant leveraged speculation; money market uncertainty that is palpable enough to inhibit massive yield curve arbitrage; option costs which are burdensome enough to deny fast money gamblers access to cheap downside portfolio insurance; and flexible, mobilized interest rates which enable imbalances of supply and demand for investable funds to be decisively cleared.

Not one of these conditions any longer exists. The shorts are dead, money markets interest rates are pegged and frozen, downside puts are practically free and carry trade gambling is biblical in extent and magnitude.

So a vibrant market of atomized competition in the gathering and assessment of information relevant to the honest pricing of financial assets has been replaced by what amounts to caribou soccer. That is, the game that six-year old boys and girls play when the chase the soccer ball around the field in one concentrated, squealing pack.

The soccer ball in this instance, alas, is the central banks. Until Sunday the herd of speculators was in full rampage chasing the liquidity, word clouds and promises of free money and market “puts” with blind, unflinching confidence.

The only thing in this utterly broken “market” which was really priced-in, therefore, was an unshakeable confidence that any disturbance to the upward march of asset prices would be quickly, decisively and reliably countermanded by central bank action. But now an altogether different kind of disturbance has erupted. It is one that does not emanate from short-term “price action” of the market or an unexpected macroeconomic hiccup or lend itself to another central bank hat trick.

Instead, the Greferendum amounts to a giant fracture in the apparatus of state power on which the entire rotten regime of financialization is anchored. That is, falsified financial prices, massive, fraudulent monetization of the public debt and egregious and continuous bailouts of private speculator losses, mistakes and reckless gambling sprees.

What has transpired in a relative heartbeat is that one of the four central banks of the world that matter is suddenly on the ropes. In the hours and days ahead, the ECB will be battered by desperate actions emanating from Athens, as it struggles with a violent meltdown of its banking and payments system; and it will be simultaneously stymied and paralyzed by an outbreak of public confusion, contention and recrimination among the politicians and apparatchiks who run the machinery of the Eurozone and ECB superstate.

Yes, the Fed will reconfirm its hundreds of billions of dollar swap lines with the ECB, and the BOJ and the Peoples Printing Press of China will redouble their efforts to prop-up their own faltering stock markets and to contain the “contagion” emanating from the Eurozone.

But this time there is a decent chance that even the concerted central banks of the world will not be able to contain the panic. That’s because the blind confidence of the caribou soccer players will be sorely tested by the possibility that the ECB will be exposed as impotent in the face of a cascading crisis in the euro debt markets.

Here are the tells. If the Syriza government has any sense it will nationalize the Greek banking system immediately; replace the head of the Greek central bank with a pliant ally; refuse to heed any ECB call for collection of the dubious collateral that stands behind its $120 billion in ELA and other advances; and print ten euro notes until the plates on the Greek central bank’s printing presses literally melts-down.

If the Greeks seize their banking system and monetary machinery from their ECB suzerains in this manner—- out of desperate need to stop the asphyxiation of their economy—– those actions will trigger, in turn, pandemonium in the PIIGS bond markets. From there it would be only a short step to an existential crisis in Frankfurt and unprecedented, fractious conflict between Berlin, Paris, Rome and Madrid.

Either all of the Eurozone governments fall in line almost instantly in favor of a massive up-sizing of the ECBs bond buying campaign to stop the run on peripheral bond markets, or the Draghi “whatever it takes” miracle will be obliterated in a selling stampede that will expose the naked truth. Namely, that the whole thing since mid-2012 was a front-runners con job in which the ECB temporarily rented speculator balance sheets in order to prime the PIIGS bond buying pump, thereby luring the infinitely stupid and gullible managers of bank, insurance and mutual fund portfolios into loading up on the drastically over-valued public debt of the Eurozone’s fiscal cripples.

Needless to say, there is likely to emerge a flurry of leaks and trial balloons from the desperate precincts of Brussels, Berlin and Frankfurt. These will be designed to encourage the Greeks to leave their banking system hostage to “cooperation” with their paymasters, and to persuade traders that Draghi has been greenlighted to buy up the PIIGS debt hand-over-fist——-and to do so without regard to the pro-rata capital key under which the current program is straight-jacketed.

But that assumes that the Germans, Dutch and Finns capitulate to an open-ended and frenzied bond-buying campaign that would make the BOJ’s current madness look tame by comparison. Yet if they do, its only a matter of time before the euro goes into a terminal tail-spin. And if they don’t, collapsing euro debt prices will infect the entire global bond market in a tidal wave of contagion.

Either way, its not priced-in. That’s been the real stupid trade all along.

Ben the Blogger

BenBernankeReposted article by David Stockman responding to Ben Bernanke’s first blog. I hope Ben’s baseball commentary is more insightful.

Central Banking Refuted In One Blog—–Thanks Ben!

By David Stockman

Blogger Ben’s work is already done. In his very first substantive post as a civilian he gave away all the secrets of the monetary temple. The Bernank actually refuted the case for modern central banking in one blog.

In fact, he did it in one paragraph. This one.

A similarly confused criticism often heard is that the Fed is somehow distorting financial markets and investment decisions by keeping interest rates “artificially low.” Contrary to what sometimes seems to be alleged, the Fed cannot somehow withdraw and leave interest rates to be determined by “the markets.” The Fed’s actions determine the money supply and thus short-term interest rates; it has no choice but to set the short-term interest rate somewhere.

Not true, Ben.  Why not ask the author of the 1913 Federal Reserve Act and legendary financial statesman of the first third of the 20th century—–Carter Glass.

Read more

fed-rate-zero

God Bless the Child

Billie

Them that’s got shall have,
Them that’s not shall lose,
So the Bible said and it still is news.
Mama may have, Papa may have,
But God bless the child that’s got his own,
That’s got his own.

            – Billie Holiday, God Bless the Child

See post: Why Ownership Matters

The Making of Financial Policy

BHOBank

The following is excerpted from an article by Jay Cost:

How about Wall Street reform? Obama likes to pose as a people-versus-the-powerful crusader, but he staffed his administration with friends of the big banks. Unsurprisingly, that has enormously influenced policy.

David Skeel, a professor at the University of Pennsylvania Law School, writes about the framework “that would eventually become the Dodd-Frank legislation,” in particular the resolution rules that enables Treasury to intervene when too-big-to-fail institutions fall into distress.  He explains:

Both the resolution rules and the overall framework read as if they had been written by Timothy Geithner in consultation with the large banks he had worked with as head of the New York Fed. Geithner would get all of the powers that he and former Treasury Secretary Henry Paulson wished they had when they intervened with Bear Stearns, Lehman Brothers, and AIG. But the framework also did not overly ruffle the feathers of the largest financial institutions. There was no call to break them up…While systemically important status might subject the biggest institutions to greater oversight, it also would bring benefits in the marketplace. They could borrow money more cheaply than could smaller competitors, because lenders would assume they would be protected in the event of a collapse, as the creditors of Bear Stearns and AIG were.

The suspicion that the legislation might be a little too accommodating to the largest banks was further aroused by the discovery that David, Polk & Wardell, “a law firm that represents many banks and the financial industry’s lobbying group,” as the New York Times put it…had been deeply involved in the early drafting of the legislation. Treasury had worked from a draft first written by Davis Polk, and the legislation literally had the law firm’s name on it when Treasury submitted it to Congress, thanks to a computer watermark that Treasury had neglected to delete.

That’s not all. In Confidence Men, Ron Suskind reports that Obama instructed Geithner to develop a plan to break up Citi — as a warning to the other banks and a signal to the broader marketplace that the government was in charge, not the banks. But, per Suskind, Geithner disobeyed Obama, and never put together the plan. He suffered no consequences.

The best that can be said about this president and Wall Street is that, when it mattered most, he was a passive observer in his own administration. He allowed shills to write a bill enormously favorable to the biggest interests.

Crony Capitalism

Bailout City

For those interested in the economics of Piketty’s new book on Capitalism, there is a critical review in Barrons this week (link below). But I believe this addendum to the review by Gene Epstein included here is by far more politically relevant than Piketty’s questionable assumptions and interpretations of historical data. Today it’s all about cronyism and Piketty’s prescriptions just make the cronies that much more powerful and untouchable.

THE CORE PROBLEMS OF Thomas Piketty’s magnum opus, Capital in the Twenty-First Century, are covered in the review in Balancing the Books. One key point should be added. A work that radically indicts our current economic system is well worth writing. Capital in the Twenty-First Century is not that book.

That’s because Piketty makes no mention of crony capitalism—the unholy alliance between government and business—which badly distorts the economy and leads to unjust inequalities of wealth and income, because they are outcomes of an unjust process. While capitalism is a system of profit and loss, businesses under crony capitalism are shielded from losses; the 2008-09 bailouts of Chrysler and GM are notorious examples.

Hunter Lewis, author of the excellent Crony Capitalism in America: 2008-2012, also points out that Piketty’s charting of the ups and downs of income returns to the top 10% correlates with central-bank-induced bubbles. These bubbles, Lewis explains, constituted “an explosion of crony capitalism as some rich people exploited all the new money, both on Wall Street and through connections with the government in Washington.”

Piketty conjures up the naive image of capitalist businesses generating virtually risk-free income to their owners. Under crony capitalism, however, with government flooding the bond markets with low-risk IOUs, while expanding the list of businesses too big to fail, there is indeed greatly enhanced potential to turn capitalist winnings into steady streams of income for the cronies. And to the extent that Piketty is right to say that capitalist riches provide the wealthy with disproportionate power in politics, one obvious solution is to shrink government influence, thus reducing the capitalists to their classically humble role of having to sell us goods and services we choose to buy. But Piketty would march us in the opposite direction, expanding government’s reach.

The Three “C” Sins

Bailout City

Quoted from WSJ, Daniel Henninger, Capitalism’s Corruptions:

The plight of the world’s poor can be summed up in three truly ugly C-words: corruption, collusion and cronyism. All three may be kissing cousins but each in any language makes a mockery of both capitalism and justice.

Some 20 years ago economists began asking why so many countries, especially in Africa, never get better, even amid periods of global growth. An enormous body of economic literature now exists confirming that corruption keeps the poor down. A survey of this work for the International Monetary Fund concluded that countries get stuck in a “vicious circle of widespread corruption and low economic growth.”

Corruption suppresses growth because citizens in time recognize that honest work produces a lower return than spending one’s energies gaming the system. And, they’ve also found, the vicious circle worsens when real productivity falls alongside an inexorably expanding public sector.

Global poverty persists because corruption kills capitalism. History’s most recent exhibit is the Arab Spring, a product of economic exasperation, especially in Egypt. In time, corruption accelerates political instability, erodes democratic order if it exists, and someone from the outside has to clean up the mess. Think Syria or Mali.

Free enterprise and free markets are always taking the hit for man’s corruptions.

Are We Citizens Serious?

Lew2Jacob Lew

The definition of cronyism: Jack Lew.

Senator Chuck Grassley blasts incoming Treasury Secretary Jack Lew for cronyism and hypocrisy.

From the floor statement of Sen. Chuck Grassley (R., Iowa) regarding the nomination of Jack Lew as Treasury secretary, Feb. 27:

The problem we face with Mr. Lew’s nomination is that the Senate does not have answers to basic factual questions about Mr. Lew. How can we make an informed choice on his nomination? For example, when Mr. Lew worked at tax-exempt New York University, he was given a subsidized $1.4 million mortgage. Now, Mr. Lew claims that he cannot remember the interest rate he paid on his $1.4 million mortgage that tax-exempt New York University gave him. Does this pass the laugh test? . . .

When Mr. Lew was executive vice president of NYU, the school received kickbacks on student loans from Citigroup . Then, Mr. Lew went to work for Citigroup. When I asked Mr. Lew if he had any conversations with Citigroup about these kickbacks while he was at NYU, he once again “could not recall.” . . .

In the past, the President has railed against the “fat cats” on Wall Street. Today, the President nominates a man who took a bonus from a bailed-out financially insolvent bank. The President has constantly complained about the high cost of college tuition. While Mr. Lew was at NYU, the University increased tuition nearly 40 percent while he was getting paid more than NYU’s President. In the not so distant past, President Obama called the Ugland House “the biggest tax scam in the world.” Today he nominates a man who invested there. In fact, the President has repeatedly railed against the Cayman Islands and Cayman Islands investments. Mr. Lew is a serial Cayman Islands investor. On his watch, Citigroup invested money there, NYU invested money there, and he invested his own money there.

I believe it is essential to hold everyone to the same standard they set for others. For these reasons I will vote no on this nomination.

Zero-Sum Politics

I’ve reprinted an essay written by the satirist P.J. O’Rourke because it hits on a fundamental economic truth when it comes to the assumptions driving economic policy, and this blog is about economics, not partisan politics. Mr. O’Rourke reveals some economic fallacies that underlie the economic and political strategy the current administration is pursuing with redistributive tax and budget policies.

Zero-sum thinking not only fails as policy in a dynamic, changing world, it diminishes the very people it is hoping to lift up. Zero-sum economics is the stepchild of the dismal science in service to the naked pursuit of political power and exploitation, while positive-sum economics is the mother of shared prosperity and good will.

From the WSJ:

Dear Mr. President, Zero-Sum Doesn’t Add Up

Is life like a pizza, where if some people have too many slices, other people have to eat the pizza box?

By P.J. O’ROURKE

Given that hypocrisy is an important part of diplomacy, and diplomacy is necessary to foreign policy, allow me to congratulate you on winning a second term.

I wish I could also congratulate you on your conduct of international affairs. I do thank you for killing Osama bin Laden. It was a creditable action for which you deserve some of the credit you’ve been given. Of course the intelligence was gathered, and the mission was undertaken, by men and women who, although they answer to your command, answer to duty first. And it is difficult to imagine any president of the United States who, under the circumstances, wouldn’t have ordered the strike against bin Laden. Although there is Jimmy Carter. Thank you for not being Jimmy Carter.

But even though it violates the insincere amity that creates a period of calm following national elections, no thank you for the following, and it is only a partial list:

• Telling the Taliban to play by the rules or you’ll take your ball and go home;

• Leaving Iraq in a lurch (and in a hurry);

• Watching the EU go down the sink drain and into the Greece trap and wanting to take America along on the trip;

• Miscalculating human rights and strategic engagement in the Chinese arithmetic of your China policy;

• Being the personification of bad weather during the Arab Spring with your chilly response when you encountered its best aspects and your frozen inaction when you encountered its worst;

• Playing with Russian nesting dolls, opening hollow figurine after hollow figurine hoping to find one that doesn’t look like Vladimir Putin;

• Sitting and doing nothing like a couch potato watching a made-for-TV movie as the Castro and Chávez zombies continue their rampage;

• Hugging the door on your date with Israel;

• Putting the raw meat of incentives in your pants pocket when you go to scold the pit bulls of Iran and North Korea;

But the worst thing that you’ve done internationally is what you’ve done domestically. You sent a message to America in your re-election campaign. Therefore you sent a message to the world. The message is that we live in a zero-sum universe.

There is a fixed amount of good things. Life is a pizza. If some people have too many slices, other people have to eat the pizza box. You had no answer to Mitt Romney’s argument for more pizza parlors baking more pizzas. The solution to our problems, you said, is redistribution of the pizzas we’ve got—with low-cost, government-subsidized pepperoni somehow materializing as the result of higher taxes on pizza-parlor owners.

In this zero-sum universe there is only so much happiness. The idea is that if we wipe the smile off the faces of people with prosperous businesses and successful careers, that will make the rest of us grin.

There is only so much money. The people who have money are hogging it. The way for the rest of us to get money is to turn the hogs into bacon.

Mr. President, your entire campaign platform was redistribution. Take from the rich and give to the . . . Well, actually, you didn’t mention the poor. What you talked and talked about was the middle class, something most well-off Americans consider themselves to be members of. So your plan is to take from the more rich and the more or less rich and give to the less rich, more or less. It is as if Robin Hood stole treasure from the Sheriff of Nottingham and bestowed it on the Deputy Sheriff.

But never mind. The evil of zero-sum thinking and redistributive politics has nothing to do with which things are taken or to whom those things are given or what the sum of zero things is supposed to be. The evil lies in denying people the right, the means, and, indeed, the duty to make more things.

Or maybe you just find it easier to pursue a political policy of sneaking in America’s back door, swiping a laptop, going around to the front door, ringing the bell, and announcing, “Free computer equipment for all school children!”

However, domestic politics aren’t my first concern here. The question is whether you want to convince the international community that zero-sum is the American premise and redistribution is the logical conclusion.

I would argue that the world doesn’t need more encouragement to think in zero-sum terms or act in redistributive ways.

Western Europe has done such a good job redistributing its assets that the European Union now has a Spanish economy, a Swedish foreign policy, an Italian army, and Irish gigolos.

Redistributionist political ideologies, in decline since the fall of the Soviet bloc, are on the rise again. Will you help the neo-Marxists of Latin America redistribute stupidity to their continent?

The Janjaweed are trying to redistribute themselves in Darfur. The Serbs would like to do the same in Kosovo. The Chinese have already done it in Tibet. Al Qaeda offshoots are doing their best to redistribute violence to places that didn’t have enough.

And Russia and China would like the global balance of power to be redistributed. Since China has plenty of money to lend and Russia has plenty of oil to sell, your debt and energy policies should go a long way toward making the balance of power fairer for the Russians and Chinese.

While redistribution—or “plagiarism,” as we writers call it—is a bad idea, zero-sum is even worse. Zero-sum assumptions mean that a country that doesn’t pursue a policy of taking things from other countries is letting its citizens down. That’s pretty much the story of all recorded history, none of which needs to be repeated. It has taken mankind millennia to learn that trade is more profitable than pillage. And we don’t have to carry our plunder home in sacks and saddlebags when we’re willing to accept a certified check.

The Chinese don’t seem to understand this yet. They think trade is a one-way enterprise, the object of which is for China to have all the world’s money. They’ve got most of ours already. Mr. President, validating China’s economic notions isn’t a good thing.

A zero-sum faith in getting what’s wanted by taking it can extend to faith itself. In some places there is only one religion. If other people have a religion of their own they must be taking away from my religion. Give up that faith, infidels.

Speaking of infidel faiths, Mr. President, please consider the message of this Christmas week—a message of giving, not taking. And consider your prominent position as a messenger of peace on earth and goodwill toward men. When you embrace a belief in the zero-sum nature of what’s under the Christmas tree and propose to redistribute everything that’s in our Christmas stockings, you’re asking the world to go sit on the Grinch’s lap instead of Santa’s.

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