Economic History

Selected highlights of recent economic history:

• up to1930 -- Laissez-faire is the conventional wisdom in capitalist countries, supported by Say's Law, i.e.: "A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value."
  Shorter version of Say's Law: "supply creates its own demand".
• 1895 -- The chartalist theory was introduced by German statistician and economist G. F. Knapp.  Important contributions were made by Alfred Mitchell-Innes in 1913-1914. Chartalism experienced a revival under Keynes and Abba P. Lerner, and has a number of modern proponents.  Chartalism is a descriptive economic theory that details the procedures and consequences of using government-issued tokens as the unit of money, i.e., fiat money. The name derives from the Latin charta, in the sense of a token or ticket. The modern theoretical body of work on chartalism is known as Modern Monetary Theory (MMT).
• Great Depression -- Keynes emerges as preeminent economist noting need for government to step in when markets fail.  Full employment cannot be maintained via laissez-faire policies, but demand can be boosted via fiscal policy to stimulate the economy.
  Shorter version of Keynesianism:  "demand creates its own supply".
• 1940-1970 -- Keynesian economics reigns supreme in US and Europe. John Kenneth Galbraith is perhaps the leading Keynesian economist.
• 1940-1970 -- neo-Keynesian economics developed to integrate classical (pre-Keynes) economics with Keynesian economics.  Paul Samuelson is perhaps the leading neo-Keynesian economist, developing a neoclassical synthesis which still dominates mainstream economics.  His 1948 textbook became the standard.
• ~ 1945 -- early liberal forms of Keynesianism:
• 1943 -- Abba Lerner develops functional finance, a theory of purposeful financing to meet explicit goals, including full employment, no taxation designed solely to fund expenditure or finance investment, and low inflation.  Functional finance is based upon the effective demand principle and chartalism.
• 1947 --  Lorie Tarshis writes first introductory textbook that brought Keynesian thinking into American university classrooms. The work swiftly lost popularity after it was charged with excessive sympathy to communism by McCarthyist activists. 
• 1970-1980 -- Stagflation and lack of political will lead to loss of faith in fiscal policy.  Monetarist alternative promoted by Milton Friedman gains prominence
• 1980 -- Laissez-faire economics regains prominence in Republican circles under the guise of Supply-side Economics.  This fits well with Milton Friedman's Monetarism.
• 1990 -- New Keynesian economics develops as a successor to the dormant neo-Keynesianism and a response to the resurgent laissez-faire advocates.  This watered-down Keynesianism adds little that is new or interesting (in my opinion), but is popular with powerful centrist Democrats as it offers a practical alternative to the laissez-faire Republicans.
• 1975-present -- (most of this section is from Wikipedia) Post-Keynesian economics emerges as a school of economic thought with its origins in the works of John Maynard Keynes. Keynes's biographer Lord Skidelsky writes that the Post Keynesian school has remained closest to the spirit of Keynes's own work.
           Post-Keynesian economists are united in maintaining that Keynes's theory is seriously misrepresented by the two other principal Keynesian schools:  neo-Keynesian economics which was orthodox in the 1950s and 60s – and by New Keynesian economics, which together with various strands of neoclassical economics has been dominant in mainstream macroeconomics since the 1980s.
           The theoretical foundation of post-Keynesian economics is the principle of effective demand, that demand matters in the long as well as the short run, so that a competitive market economy has no natural or automatic tendency towards full employment.
           The positive contribution of post-Keynesian economics has extended beyond the theory of aggregate employment to theories of income distribution, growth, trade and development in which money demand plays a key role, whereas in neoclassical economics these are determined by the 'real' forces of technology, preferences and endowment. In the field of monetary theory, post-Keynesian economists were among the first to emphasize that the money supply responds to the demand for bank credit, so that the central bank can choose either the quantity of money or the interest rate but not both at the same time.
           This view has largely been incorporated into monetary policy, which now targets the interest rate as an instrument, rather than the quantity of money. In the field of finance, Hyman Minsky put forward a theory of financial crisis based on financial fragility, which has recently received renewed attention.
• 1994-present -- Modern Modern Theory (MMT) is a branch of Post-Keynesian economics and Functional Finance as well as the modern version of Chartalism.  Along with the features of Post-Keynesian economics mentioned above, MMT relies on the work of Wynne Godley who described the accounting-oriented sectoral financial balances which constrain the macro economy.  For example, government deficits generally correspond to private sector surpluses as a simple matter of accounting.
            As one would expect from the name, MMT describes the working of modern fiat currencies in considerable detail.  This provides stark contrasts and significant insights in comparison with conventional economic schools (New Keynesian and laissez-faire/neoclassical/monetarist) which are based upon gold standard monetary systems.
           MMT is somewhat unique among economic schools in that it has both liberal and conservative supporters.  While most in the MMT community are liberal and advocate liberal policies, MMT also has conservative advocates.  The descriptive aspects of modern fiat monetary systems stand alone and can be separated from any policy recommendations of MMT proponents.

Another good account of recent economic history is in this paper by David Colander - Functional Finance, New Classical Economics and Great Great Grandsons.

More detail is provided below, mainly from John Kenneth Galbraith...

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Here are some notes I took from John Kenneth Galbraith’s book via a commenter named "from Mexico" at the Naked Capitalism blog:

Say’s Law, not a thing of startling complexity, held that, from the proceeds of every sale of goods, there was paid out to someone somewhere in wages, salaries, interest, rent or profit (or there was taken from the man who absorbed a loss) the wherewithal to buy that item. As with one item, so with all. This being so, there could not be a shortage of purchasing power in the economy….

Until Keynes, Say’s Law had ruled in economics for more than a century. And the rule was no casual thing; to a remarkable degree acceptance of Say was the test by which reputable economists were distinguished from the crackpots. Until late in the ’30s no candidate for a Ph.D. at a major American university who spoke seriously of a shortage of purchasing power as a cause of depression could be passed. He was a man who saw only the surface of things, was unworthy of the company of scholars. Say’s Law stands as the most distinguished example of the stability of economic ideas, including when they are wrong….

This was the doctrine, perhaps more accurately the theology, that Keynes brought to an end…..

To suggest that there might be oversaving now no longer cost a man his degree or, necessarily, his promotion. That the proper remedy for oversaving was public spending financed by borrowing was henceforth a fit topic for discussion — although it continued to provoke bitter rebuke. The way was now open for public action.

[....]

The Keynesian adjustment to an excess of savings is through a reduction in aggregate demand. When demand falls, something must give, and what gives must be either prices or production. If prices can be held up by the market power of the corporation, it is production that must fall. When production falls, so will employment. With corporate market power, unemployment will thus become a highly distinctive feature of the Keynesian adjustment.

[….]

What had always been believed, as against Keynes and the Keynesians, was an inordinately powerful thing. For two hundred years Americans of the truest blood had displayed a penchant for paper money. For seventy years they had agitated for silver. Monetary experiment in the United States was thus in an ancient and politically most acceptable tradition. It also retained a large political constituency. A congressman or senator, returning to Oklahoma or Iowa after urging an issue of green-backs to enhance prices and advance social justice, could be a hero. No such tradition and no such constituency supported the idea of deficit financing, a deliberately, promiscuously unbalanced budget. A man returning to Iowa after advocating this in Washington might be thought dangerously insane.

Wise governments had always sought to balance their budgets. Failure to do so had always been proof of political inadequacy; things need not be any more complicated than that….

Roosevelt did not disagree; in his first post-convention radio speech he said the country must “stop the deficits,” adding that “Any Government, like any family, can for a year spend a little more than it earns. But you and I know that a continuation of that habit means the poorhouse.” 23

The beliefs so affirmed by the two Presidents were still powerful five years later — still a formidable barrier against the ideas of a distant English don. There was also explicit in Roosevelt’s position what has come to be called the fallacy of composition. This too was a staunch bar to the Keynesian ideas — and it remains influential to this day.

An engagingly plausible mode of thought, the fallacy of composition extends the economics of the family to that of the government. A family cannot indefinitely spend beyond its income. So neither can a government. A parent who borrows to live leaves debts, not a competence, to those who come after. A government that borrows does the same. Both are morally deficient.

The comparison between family and state, on second thought, is implausible…. [I]t should be observed that the wealth and solvency of a nation depend on what its national economy produces. If borrowing and spending enhance production, as the Keynesian ideas held, then such borrowing and spending enhance solvency. Only rarely do borrowing and spending enhance wealth for a family. It was an enduring complaint of Keynesians that their opposition did not understand what they were trying to do. It was equally the case that the Keynesians did not understand the depth of the tradition to which their opposition was subject or the power by which it was governed…..

The Great Depression showed the patent ineffectuality of monetary policy for rescuing the country from a slump — for breaking out of the underemployment equilibrium once this had been fully and firmly established. For this only fiscal policy would serve. Only fiscal policy ensured not just that money was available to be borrowed but that it would be borrowed and would be spent. This was the lesson of John Maynard Keynes...

By the early ’60s it had become the conventional wisdom of the New Economics that, at full employment, the revenues raised by the Federal government were too large in relation to expenditures. The result was “a fiscal drag” upon output, income and employment. To lessen this drag, a horizontal reduction in taxes was deemed necessary. By now, public sophistication allowed of such action; taxes could be reduced and the deficit increased for the deliberate and exclusive purpose of increasing the budget deficit and so improving economic performance. In 1964, such a reduction, amounting to $14 billion in revenues, was enacted. It was “the most overt and dramatic expression of the new approach to economic policy.”

Implicit in this action, however, was the need to reverse it should an excess of demand start pulling up prices. And this, as later history would amply establish, was far more difficult.

[….]

If taxes cannot be increased except under the force majeure of war and public expenditures cannot be decreased much for any reason, it follows that Keynesian policy is unavailable for limiting demand. It can expand purchasing power but it cannot contract it. During the twenty good years no reliable method was devised for dealing with the wage-price spiral — with direct market power as a cause of inflation. And fiscal policy was also becoming unavailable for dealing with inflation. The goals were there; the instruments for reaching them were becoming distressingly inoperative. There was one exception, and that was monetary policy. Nothing in the decline of other instruments was as unfortunate as the increasing faith in this one.

The final flaw was this revival, during these years, of faith in monetary policy. In light of the history of this instrument it was as surprising as it was damaging.

[….]

[M]uch of the revival was owing to the effective evangelism of the most diligent student of monetary policy and history during these years, Professor Milton Friedman. As a devout and principled conservative, Professor Friedman saw monetary policy as the key to the conservative faith. It required no direct intervention by the state in the market. It elided the direct management of expenditures and taxation, not to mention the large budget, which was implicit in the Keynesian system. It was a formula for minimizing the role of government — for returning to the wonderfully simpler world of the past…. It was merely that the task was far simpler than previously assumed; Professor Friedman returned to Irving Fisher and held that attention need be paid only to the quantity of money in Fisher’s equation…. If these aggregates were so controlled as to allow for a steady moderate increase related in magnitude to the increase in economic activity, the task of economic management was accomplished. There is nothing more…. Professor Friedman’s case was not casually advanced; it was supported by massive evidence which, as necessary, was arranged to serve the author’s purpose. (Substantial changes in the velocity of money use had especially to be explained away. There was also the serious and unresolved problem just mentioned of what was to be counted as money.) In the years to come, Professor Friedman’s breathtakingly simple solution…would powerfully support the hope that all problems could be solved by the magic of monetary management. Alas.

–JOHN KENNETH GALBRAITH, Money: Whence it Came, Where it Went

Jonathan Schlefer, at The New York Times, provides a brief biography of Wynne Godley, full of praise.

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If the economics profession takes on the challenge of reworking the mainstream models that famously failed to predict the crisis, it might well turn to one of the few economists who saw it coming, Wynne Godley of the Levy Economics Institute. Mr. Godley, unfortunately, died at 83 in 2010, perhaps too soon to bask in the credit many feel he deserves.
But his influence has begun to spread. Martin Wolf, the eminent columnist for The Financial Times, and Jan Hatzius, chief economist of global investment research at Goldman Sachs, borrow from his approach. Several groups of economists in North America and Europe — some supported by the Institute for New Economic Thinking established by the financier and philanthropist George Soros after the crisis — are building on his models...It was far from a first for Mr. Godley. In January 2000, the Council of Economic Advisers for President Bill Clinton hailed a still “youthful-looking and vigorous” expansion. That March, Mr. Godley and L. Randall Wray of the University of Missouri-Kansas City derided it, declaring, “Goldilocks is doomed.” Within days, the Nasdaq stock market peaked, heralding the end of the dot-com bubble.

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Matias Vernengo (nakedkeynesianism) adds some commentary: 

http://nakedkeynesianism.blogspot.com/2013/09/hydraulic-krugman-on-wynne-godley.html

Paul Krugman commented on the NY Times piece on Wynne. There are many little incorrect interpretations, which derive from his lack of understanding of the history of ideas. First, he equates Wynne's model with the old hydraulic Keynesianism (i.e. Neoclassical Synthesis) of Phillips (of Phillips curve fame, but also of the hydraulic model of the British economy). Nothing further from the truth...
Krugman then says these models were abandoned because they failed in the face of the Great Inflation of the 1970s, and because they did not deal with consumption in a coherent way. Here again he is wrong. First of all, Wynne's models had no trouble dealing with the inflation of the 1970s, correctly pointing out the effects of oil prices, devaluation, and wage pressures from the cost side rather than demand pull views, and he was one of the few that correctly foresaw the big recession that the Thatcher policies would cause. ...
PS: Full disclosure, I'm quite biased on this topic, having worked for Wynne at the Levy Economics Institute for two years in 1997-98.
PS': Two additional posts by Unlearning Economics and Philip Pilkington and a link by Lars Syll (h/t for the link to Unlearning)....

Again from Phil Pilkington's blog: Pilkington and Syll find evidence of a 1996 debate between Krugman and Galbraith...

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Lars Syll has brought my attention to a very interesting exchange between Jamie Galbraith and Paul Krugman from 1996 that is archived on the latter’s website (or a website created for him, I cannot tell). Much of the discussion is on long dead arguments from the 1990s that now look as antiquated as early episodes of Friends. But there are two things that are interesting about the debate.

First of all, in retrospect, it looks to me like Krugman is on the wrong side of pretty much every issue. He seems cavalier about the rising income inequality in the US — something he has since renounced (but only due to reality really beating him over the head). He shrugs off a falling labour share in national income — something which has since become so obvious that not even the flashiest debater could cover it up. At one point his support of Pete Peterson’s Social Security privatisation campaign is mentioned (yep, old Pete Pete was selling that hoary “Social Security is imminently broke” line back in ’96 and Krugman at one point fell for it).
There also seems to be a sense with Krugman that the Washington Consensus would lead to general prosperity, although it is hard to pin — one year before the Asian crisis and the subsequent fracturing of said consensus. And then there’s the move toward a budget surplus by the Clinton administration; something now argued by many to have precipitated the rise in private sector debt that ultimately led to the financial crisis of 2008.

Lowering Interest Rates is Deflationary by Definition

When Ford Motor lowers the price of a car, that is a deflationary act by definition.  The possibility that the lower price may lead to the sale of more cars does not alter that fact.  The fact that consumers may have some extra money in their pocket after purchasing their car, and use that to buy something else, does not alter the basic fact that lower prices are the realization of deflation.

When the Federal Reserve lowers the price of borrowing, that is a deflationary act by definition.  The fact that the lower price may lead to more loans does not alter that fact.  The fact that borrowers may have some extra money in their pocket after making payments on loans does not alter the fact that the lowered price for borrowing represents deflation in and of itself.

Compounding this obvious first order deflation, the lowered interest rates lower the fiscal balance and thus result in a smaller injection of money from the government into the economy.

There are undoubtedly other effects of lowering interest rates, but these are not so cut and dried as commonly assumed.  Any private loan has two private parties.  Lowering the price for the borrower lowers revenue for the lender, with no net change in income.

An in-depth analysis of the various effects of interest rate changes on the economy will reveal a number of additional considerations.   The argument that is generally made by proponents of monetary policy is that lower rates will lead to increased investment, since the lower price of bank loans will make them more attractive.  But, as we see via Phil Pilkington,

[Keynes'] account of a boom is to say that a high rate of investment causes a fall in expected profits as the supply of productive capacity increases… one thing he would have never have said is that a permanently lower level of the rate of interest would create a permanently higher rate of investment.

This ties into Kalecki’s argument that if central banks try to control the level of effective demand through the interest rate they will find that they will have to drop the interest rate over and over again as each boom peters out until, ultimately, they end up at the zero-lower bound. As Steve Randy Waldman of Interfluidity notes, this appears rather prescient if we look at the period after 1980 when central banks moved toward trying to steer the economy by using the interest rate alone. He presents the following graph which shows precisely this dynamic...

Randall Wray provides additional detailed analysis:

Some years ago I co-authored a paper with my colleague Linwood Tauheed, titled SYSTEM DYNAMICS OF INTEREST RATE EFFECTS ON AGGREGATE DEMAND, that investigated the likely impacts of interest rate changes on aggregate demand. We used conventional estimates of interest rate elasticities for investment spending, as well as for parameters like the marginal propensity to consume...  In particular, pay attention to the discussion of conventional estimates of interest rate elasticities—which are surprisingly small

If the price of lumber goes down by a small amount, this doesn't automatically mean that the demand for houses will surge.  Similarly, if the price of borrowing money goes down by a small amount, this doesn't automatically mean that the demand to build new factories will surge.  The cost of borrowing is just one factor among many.  Deflation in borrowing costs is deflationary in and of itself.  The second and higher order effects are subject to debate, but the empirical data from recent U.S. history shows lower interest rates highly correlated with decreasing inflation (and vice versa).  As evidence in support of this assertion, here's my favorite graph:

A Bank Run for the 21st Century

Could we have the equivalent of a 1930s style bank run in this day and age?  I think we already have, and that more and bigger are coming.

In this post, I will attempt to be non-judgmental -- to step back and look at the underlying forces at work which are based upon human nature in our earthly environment.  In the short term, we rant and rave about the evil and stupid people, but occasionally it is good to move beyond that, remove such negative emotion, and try to assess the science driving the action.

Twice in the last 13 years we in the U.S. have experienced declines in the broad stock market indexes of more than 50%.  What do we make of such massive declines in the wealth of the nation?  The conventional wisdom is that these blips are nothing to worry about.  The stock market is inherently volatile, but generally tracks the real economy.  Massive declines in the past have been quickly recouped.  So, while there may be more such scary episodes, one needs only to keep one's cool and in the long run we will continue to grow wealthier.

My take is that recent stock market crashes presage more of the same.  If the conventional wisdom is correct and we can expect more of these, then it's logical to conclude that there will be panic selling from time to time.  Is it reasonable to assume that all such panics will be temporary and quickly corrected as have been the last two (in 2001 and 2008)?

In 2001, the U.S. government reacted swiftly and decisively to the market crash.  Under the leadership of President George W. Bush, tax rates were slashed across the board on income including capital gains and estates.  In 2003, taxes on income, capital gains, and estates were cut yet again.  In the meantime, the Federal Reserve slashed interest rates from 6% to 1%.

In 2008, the U.S. central bank agreed to buy out trillions of dollars of failing mortgaged backed securities.  This was followed by additional bailouts (e.g. Troubled Asset Relief Program or TARP) and a nearly $1 trillion dollar stimulus program passed by Barack Obama and the Democratic legislature.

So the 2001 and 2008 market panics were reversed with the assistance of massive U.S. federal government bailouts and stimulus programs.  Is it safe to assume that such relief will always be available?  Do we have the equivalent of a Federal Deposit Insurance Program for the stock market?  Of course, the answer is no.  We have no systematic program to rescue the stock market.  Rather we have had a series of ad hoc government rescues.  There is no guarantee that the next time the U.S. government will react swiftly and decisively.  In fact, the political situation in the U.S. is such that precisely the opposite can be expected.

The current situation with regard to the stock market is analogous to the previous state of the banking system where periodic bank runs crippled the economy.  In recent decades, the middle class have come to rely upon the stock market for basic savings   Reaganomics in the 1980s was typified by the rise of 401k pension programs which encouraged middle class employees to fund their retirements by investing in the stock market.  This is just one of many "ownership society" programs which have tied the financial well-being of middle class Americans to the financial success of U.S. corporation.

Aligning the interests of the middle class with the interests of corporate America seemed to be a win-win proposition.  No longer would the benefits of profit-driven capitalism accrue only to the rich capitalists.  Now, the middle class would profit from the accumulation of real wealth, and the corporations responsible for generating this wealth would have a broader base of support.  But some side effects of the ownership society have come to pose serious impediments to the continuing success of this model.

With a greater stake in the stock market, the middle class increasingly favored policies designed to boost corporate profitability.  A whole slew of laws were passed to that end, including lowering of taxes on capital gains and dividends, decreased corporate regulation, and increased legal rights for corporations at the expense of workers.  But far and away the biggest boost to corporate profits has been the acceleration of globalization which has encouraged transfer of jobs to lower wage areas at the expense of places with high labor costs and aging infrastructure.  Corporate profits have claimed an increasing share of national income in the U.S., while the share going to labor has decreased markedly.

In recent years, real growth in the global economy, and in the U.S. in particular, has stagnated somewhat.  As the ownership society received successive bailouts (as noted above in 2001,2003, 2008, 2009), financial prosperity overtook the real economy.  This makes sense because it is stock market value that is now funding much of middle class retirement.  There is political pressure to keep equity prices high.  To this end, extensive sacrifices have been made in labor remuneration and security, environmental protection, and market regulation.  There is political pressure to keep stock prices high.

We've come to rely upon the federal government to keep stock prices high, but this has been accomplished in an ad hoc, contentious, and unfair manner.  The noble idea of distributing national wealth more broadly has resulted in an increasingly risky base for middle class prosperity, and an increasingly impoverished lower class.  There is no FDIC to guarantee one's savings in the stock market.

The ownership society is running out of ways to plausibly and politically maintain stock prices which have taken on a life of their own.  Inevitably, the conventional wisdom that corporate America should not be bailed out and that stock prices should not be government supported will play out in a stock market crash which will have results similar to the bank runs of the 1930s.  Loans that are backed by stock market wealth will totter, and consumption based upon plummeting paper wealth will fall.  Middle class security will evaporate before our eyes.  The Tea Party will blame Obama (assuming this happens before his 2nd term expires), and the Democrats will be left holding the bag.  The stage will be set for a change in the economic zeitgeist.

Of course it's possible that we'll have yet another round of ad hoc bailouts and continue on our present course.  But it seems implausible that we can do this for ever.  Eventually, we will succumb to political pressure to provide greater security for the politically powerful middle class.  We will implement some national wealth (stock market) counterpart to the FDIC guarantees which are taken for granted these days in our banking system.  We will look back upon the current era as a reckless and unstable gilded age.  For those of us currently in the middle class, the important point is that such security will be guaranteed only after another big collapse...

Ezra Klein is Economically Illiterate

Did you ever read an article and then come across a line or two that you so fundamentally disagree with that you stop reading at that point?  I just did that in this column by Ezra Klein.  Here is the offending text:

The point of austerity is to solve a deficit problem ... The Bush tax cuts, which were passed to pay down a surplus, should be rescinded now that deficits have returned.

My take is that there is no "deficit problem".  The deficit in and of itself doesn't hurt anyone.  In fact, most Keynesians (which most Democrats are to some degree) think the deficit is too small at the current time, exactly the opposite of what Klein is saying here!

Our current problem is high unemployment, not inflation.  Excessive deficits are inflationary.  We have an unemployment problem, not a deficit problem. I see no point in continuing to read the article when the author so fundamentally misinterprets the current state of the economy...

Budget Deficits Drive Profits

My understanding, via Bill Mitchell and Michael Kalecki is that budget deficits drive corporate profits.  Corporate CEOs aren't good at macroeconomics and most don't understand this. Their efforts to reduce fiscal deficits will ultimately backfire (be careful what you wish for).  More significantly, the U.S. pension system is now dependent upon corporate profits, through 401K and similar plans which encourage saving via stock market investments.

Focusing on the Wrong Deficit

There has been one big change in the U.S. economy over the last 30 years -- globalization.  Inflation is down, unemployment is up, wages are down, profits are up, and fiscal deficits are up because of this.  All of these are secondary to the primary effect of globalization, which is itself due in large part to improved communications technology.

http://www.data360.org/dsg.aspx?Data_Set_Group_Id=270

Investment Musings

Our society is highly dependent upon the value of assets such as stocks and bonds.  Typically, for example, our government leaders will take action when the stock market plummets.  We last witnessed this in the fall of 2008 when the financial system teetered on the edge of collapse, the stock market plunged, and Congress (both Democrats and Republicans) and the Federal Reserve stepped in to rescue the financial system by bailing out banks and related financial institutions.  The Democrats were also able to push a stimulus bill through Congress, thanks to the voters throwing out the Republicans who had been in power when collapse took place.

In terms of investments, the role of the government in maintaining asset prices varies between stocks and bonds.  U.S. Treasury debt held by the public amounts to about $11.5 trillion.  The total value of the U.S. stock market is about $14 trillion.  Both of these investment classes are extremely important to middle class Americans, and to the health of the overall U.S. economy.  A precipitous drop in value for either of these asset classes will create an overwhelming demand for government action.

In this post, I consider just U.S. Treasury bonds and U.S. stocks (equities).

The United States government, through the federal reserve, has fairly direct control over the prices of U.S. Treasury bonds.  This is seen in the ongoing quantitative easing operations, in which the Federal Reserve is directly purchasing U.S. Treasury bonds.  Any precipitous fall in Treasury prices can be met by Fed purchases to shore up the price, and this would be accepted as legal and, nowadays, conventional practice.  Thus, U.S. Treasury bonds are a relatively safe purchase.  Of course, the principle and interest payments are guaranteed by the U.S. government.  But also, with the logic expressed above, there is also a likelihood that the government will intervene if necessary to protect the prices of longer term bonds.

Equity prices, on the other hand, cannot directly or conventionally be maintained by government action.  There is no government guarantee on principle or dividend, and there is no provision for direct government purchase of stocks to boost prices.  The government has and can be expected to intervene indirectly to boost stock prices, but such action may not always be effective.

During the past 30+ years of Reaganomics and the ownership society, we have seen every possible trick used to stimulate the capitalist sphere of the economy and, by extension, stock prices.  Interest rates have been lowered to zero, to encourage the accumulation of private debt.  Labor has been outsourced and offshored to cut costs, while union power has disappeared and worker benefits, especially pensions, have dwindled.  Regulations and taxes on capital have been cut.  All of these indirect methods have been successful in maintaining stock prices, although for the last 12 years stocks have stopped rising.

My question is whether these indirect methods have run their course, and if it is possible or even likely that stocks will fall considerably before effective government action will be taken to save the pensions of retiring baby boomers, many of which are invested in the stock market.  Clearly, interest rates cannot be cut any further.  And there is little political support for further reduction of taxes and relaxation of regulations, as these tactics have clearly shown marginal utility over the last 12 years.  Labor power is already very weak, and it is difficult to imagine that the national pie can be further redistributed to capital.  Moreover, this would be counterproductive since aggregate demand is clearly lacking.  Finally, many would-be consumers lack collateral and credit worthiness, so aggregate demand cannot be boosted by measures to encourage household borrowing.

So what will the government do if we again slip into recession and stock prices fall?  The obvious solution is to boost aggregate demand by increasing spending and decreasing taxes on middle and lower income people, those who would be likely to spend any such windfalls.  Actually, this tactic is another that has been tried again and again over the past 12 years, mainly via tax cuts which are the only stimulative actions supported by Republicans.  While these repeated tax cuts (including, in some cases, outright payments to citizens) have provided temporary jolts, they have not been enough to offset the otherwise deteriorating employment and wage situation.  Now it seems likely that the temporary payroll tax cut will be ended, thus reversing this stimulus.  Of course, the "Bush tax cuts" are due to expire and are the subject of intense "fiscal cliff" negotiations.  At best we are now looking at the status quo in terms of net government spending to boost consumption.  The most likely outcome of the fiscal cliff negotiations is a slight tightening.

In my opinion, the most likely scenario going forward is for diminishing corporate profitability and falling stock prices, as wage income and aggregate demand languish due to the factors mentioned above, as well as to the global slowdown that is currently occurring.  The political situation is such that both parties are in favor of reducing government deficits.  The Republicans control the House, where spending must originate, and the Democrats control the other 2 branches of government.  There are stark philosophical differences between the two parties, as well as distrust and attention to power rather than good governance.  Thus, there is unlikely to be concerted action to effectively address the problem of a stagnant economy and falling stock prices.

Compounding this bleak outlook is, ironically, the fact that corporate balance sheets are strong.  So the downturn is unlikely to be a repeat of the financial crisis of 2008, which demanded immediate and overwhelming action to save capitalism.  Rather, it is more likely that there will be a fairly gentle, but ultimately devastating, downward trajectory.  Partisan maneuvering will take precedence over emergency rescue action for the foreseeable future.  Eventually, the voters will demand change, and perhaps that will be the time to invest in the stock market again, assuming that Democrats prevail and take action to boost aggregate demand and income security (e.g. wages, pensions, health insurance) for the majority of working Americans.

The Most Marvelous Thing (MMT)

The most marvelous thing to come out of blogging is the dissemination of modern monetary theory (MMT).  MMT explains how the economy really works.  I was an economics major in college (University of Michigan, 1974) specializing in macroeconomics, but I never really learned how the economy works until I started reading the MMT blogs about 4 years.

One of my favorite blogs on the web is Kevin Drum'g blog on Mother Jones.  Kevin is a political blogger, and not an expert on economics.  Over the years I've seen him pose a number of questions about economics on his blog.  As the years went by, I noticed, to my amazement, that I was able to answer his questions, using the information I had learned at the MMT blogs.  Here are some examples:

• What is money?
• How do banks work?  How does money get created and destroyed?
• Will the bond vigilantes strike against U.S. Treasury bonds?
• How important is it to balance the fiscal budget?
• What is the best way to manage the U.S. economy?
• What does the Federal Reserve do?  How much power do they have?  Are they part of the U.S. government?
• What is quantitative easing?  Will it stimulate the economy?  Can the Fed do more?  How about nominal GDP targeting?

If anybody wants answers to any of these questions, let me know.  Just don't be like Kevin Drum  and get some sort of mental block preventing comprehension of perfectly straightforward concepts.  That gets tiring.  

But read Kevin anyway.  Like I said, his blog is my favorite...

Blog About Japan -- Deployment

Deployment -- combo of deflation and high levels of employment.  Opposite of stagflation.  That's the ongoing "disaster" in Japan.

UPDATE:  Here's a sobering article:
Has Chinese Currency Manipulation Succeeded in Breaking Japanese Manufacturers?

My takeaway is that the conventional wisdom, as represented to some extent by the Economist, remains far removed from reality.  We may be on the verge of a deflationary trap, and the serious people are worrying about big government and deficit.  See Japan:

Meanwhile, the brutal deflation that accompanied the bust persists. Falling prices have translated into massive wealth destruction. Stop-and-go monetary and fiscal stimulus accomplished little. Consumer prices have declined for seven of the past 10 years. 

There is no clear path out of the deflationary trap. Federal Reserve Chairman Ben Bernanke, then a professor at Princeton, counseled the Japanese in 1999 to open the monetary floodgates. “Japanese monetary policy,” he wrote, “seems paralyzed, with a paralysis that is largely self-induced. Most striking is the apparent unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.”

Japanese officials counter that they’ve tried monetary stimulus, including zero interest rates and quantitative easing, but had meager results.
Richard Koo, chief economist at Nomura Research in Tokyo, argues that because Japan is stuck in a balance-sheet recession in which companies and households are retrenching, low interest rates are not stimulative because neither businesses nor households wish to borrow. He advocates massive fiscal stimulus, saying government spending is the only way to put a floor under sagging aggregate demand. Critics say past fiscal stimulus has ballooned the national debt to 200% of GDP.

Actually, Japan has low unemployment and zero inflation, with universal health care and good infrastructure.  Japan just totally fucks with the conventional wisdom in a number of respects.  The ration of GDP to national debt is totally irrelevant to the economic welfare of the country, while the universal and affordable national health care is something I wish we had here in the U.S.
Some lessons from Japan:

- monetary policy, using low interest rates and QE, can't always generate inflation
- national debt as a percent of GDP is irrelevant
- there is more to economic well-being than fast GDP growth

Kevin Drum is an Economic Illiterate

Drum posts today that:

higher inflation would be good. The simplest way to see this is to look at interest rates. Once the Fed has reduced interest rates to zero, it can't go any further. But what if the economy is so bad that all the standard models suggest you need negative interest rates to get the economy back on track? 

What he doesn't realize is that all his "standard models" are wrong.  They say that reducing interest rates is stimulative.  What they don't get is that the government pays the interest  Lower rates mean less money injected by the government into the economy.  So lower rates are deflationary, 180 degrees different from Drum's assumption.

Drum assumes that government lends money to the private sector and that lower rates means lower borrowing costs for the private sector.  However, the private sector does not generally borrow from the government to finance loans.  Rather, there is a pool of money available for loans that is the product of past government deficits.  The money has been spent into the economy by the government, and the government pays interest on this money (Treasury bonds or interest on reserves).

When the Fed lowers interest rates, the opportunity cost of lending by any single bank is lowered, since it will collect less interest on money that is saved.  That will stimulate private money creation (bank lending) in the short run, but those debts will have to be paid back, so the effect is contractionary after a year or two.  In 2012, after 30 years of steadily declining interest rates intended to boost short term private sector debt, there is little more short term gain to be achieved, as consumers are paying back money previously borrowed from the private sector.

So the net effect of continually decreasing interest rates is a double whammy to the economy:

1. Less money is provided to the economy by the government.
2. Private debt can only be juiced so far before it becomes a burden to the economy.

Anyone, like Drum, who imagines that low interest rates generate inflation, is extremely short-sighted.  Take a minute to look at the history of interest rates in the United States and Japan and you will see the proof of the point I am making.  For example: US_Inflation_rate_vs_3month_T_bill_rate --



Note that interest rates track inflation and the two are positively correlated.  Compare this reality to Drum's assumption that interest rates are inversely correlated with inflation...

Inflation Expectations and Quack Economists

There have been a lot of quack economists recommending that the Fed raise inflation expectations as a means of increasing overall economic activity and employment.  The following graph (from Cullen Roche) shows pretty clearly that this has not been effective:



Inflation expectations have spiked a couple of times in recent years and inflation, as measured by CPI, has jumped a couple of times.  But wages have steadily decreased.  Thus, increasing inflation has been of the bad type (food, gasoline) which decreases purchasing power for workers whose wages have continued to decrease.  Goosing inflation expectations is quack economic medicine which has masked a continuing deterioration in purchasing power...

Risks of Additional "Monetary Easing"

Back on August 1, Kevin Drum commented:

Easier monetary policy might or might not be effective, but it seems like even the Fed thinks it would be a pretty low risk thing to try. So why not try it? 
Kevin Drum, 8/1/2012

Since then, I've been collecting reasons why this might not be a good idea.  

As far as I know, the only monetary action under consideration is additional asset purchases, i.e. more bond swaps for reserves.   Here are some reasons why this "monetary easing" might be counterproductive:

- Lowering interest rates (by liquidating bonds) is fundamentally deflationary.  Injections of 5% or more annual interest paid on long term bonds are replaced by reserves which earn 1/4% interest.  See Ed Harrison, for example:

in periods of low credit demand growth, it is the effect on lost interest income that overwhelms the effect on credit growth. In fact, I would argue that this policy actually helps tip economies into deflation... the same people who were concerned about low rates stealing interest income become coupon clippers, knowing that deflation will bail them out. Suddenly, your economy is trapped in a deflationary rut – and central bank policy of zero rates helped to get it there.

- Banks make money by borrowing short and lending long.  You can only reduce long term rates so much before such a business model collapses.  Ed Harrison again:

the signs of malinvestment excess from extremely low interest rates are all around us. When recession hits, these losses will crystallize. And there will be no steep yield curve to bail out the banks as we saw in in the early 1990s. The banks will have to take it on the chin like the Japanese banks did in 1997 – and we know what happened there...

- Focus on Fed fixes diverts attention from the fiscal fixes that are needed.

- Removal of interest bearing bonds leads some investors to alternative investments such as commodities, pushing up the price of gasoline, for example.  Any inflation caused by debt monetization is in assets, which is the bad kind of inflation in the present economy.

- Money market funds are already unstable, as they are not legally guaranteed but cannot be allowed to fail. Reducing the interest on reserves from the current 1/4% to 0% could cause failure in this part of the financial system.  The prospect of further bailouts for the banks and the wealthy will not be popular and could cause political turmoil.  Here's a post by Cardiff Garcia of FTalphaville on this subject:

The ECB’s recent decision to lower its deposit rate to zero raised speculation in the market that the FOMC might be considering the reduction or elimination of the 0.25 per cent interest the Fed pays on excess reserves.

interest on excess reserves is like a safe asset for banks — you can consider it an imperfect near-substitute for the Treasuries and agency MBS that the Fed has removed from the market. And along with the unlimited deposit insurance on non-interest bearing accounts, it is (from a certain point of view) a kind of ongoing bailout for money market fund investors.

The risks, in sum, are that rates will plunge to zero or negative, money market funds and their investors would panic as their sources of yield disappeared, and that banks will follow Bank of New York Mellon’s lead last year and consider the (politically uber-controversial, btw) possibility of charging fees on deposits.

Money market funds would likely be subsidised for a time by their sponsors, but that can’t be counted on to the extent that it was before the crisis. Were this to pass, we couldn’t with any certainty predict the consequences — but given the panic that ensued when Reserve Primary broke the buck, it’s worth taking none of this lightly.

But in addition to general chaos in money markets, here are three more possible worries resulting from the above...

it is just as possible to imagine how, regrettably and almost perversely, negative rates would actually make things worse. How they would lead to higher demand for money itself — to deflationary expectations.

So if the economy slides back into recession in 2013, which is a likely prospect given the approaching fiscal cliff and our highly polarized and dysfunctional political environment, visions of hyperinflation caused by debt monetization may give way to a deflationary reality.  We'll see soon enough...

Second Dip Coming?

A good post by Ed Harrison got me thinking about the severity of the next recession.  The economy has been weak for the last 5 years (and was unhealthy for the previous 8 or so).  Some people (the majority of the outspoken financial community) seem to think that this means we are due for a bull market / growing economy.  My take is that we are not out of the woods yet, and in fact may be taking some counterproductive measures.  Moreover, the (neo)liberal Democratic commentariat is just as counterproductive in one respect as everybody else.

Specifically, I think that efforts to use monetary policy to boost the economy may be counterproductive.  To start with, monetary policy is massively misunderstood, as noted in my March 2012 post here.  The ongoing push, mainly by the (neo)liberals, to push interest rates down even further may be deflationary in the long run.    This is obvious from the fact that interest paid by the federal government represents money given to the private sector.  In other words, lower interest payments decrease the fiscal deficit.

So what is the real problem facing the economy, and how will decreasing the fiscal deficit affect the fundamentals? The basic problem is stagnating wage incomes, which have gotten out of whack with asset prices and consumption habits. The gap has been filled with unsustainable household debt, and this is still a problem. While housing prices have come down substantially, other asset prices, including the common stocks that many depend upon for retirement, are still overvalued. Decades of investment incentives (e.g. reduction of capital gains tax) have led to excess investment.

By seeking to further reduce interest rates in order to stimulate more investment, the neo-liberals are foolishly trying to reblow the same bubble that popped 4 years ago. Only deficit spending can provide the needed boost to household income that is needed.  As noted above, reducing interest rates reduces the desparately needed fiscal stimulus.  Trying to reignite private borrowing will just exacerbate the problem. When the next downturn comes, zero interest rates will be telling indicator of deflation, not the go signal that so many seem to assume….

Will Corporate Bosses Keep Republicans in Line?

The corporate bosses that call the shots in the Republican Party can't have been happy with the debt ceiling shenanigans last year. Rich people do not look kindly on anyone messing with their financial instruments. This year we face the "fiscal cliff". Corporate folks surely do not want economic warfare, which can only hurt them.

Obama should have a lot of leverage to follow through on his pledge to raise taxes on the wealthy. In return he'll probably make concessions on entitlements. That is, if (relative) sanity prevails. If this is how it plays out (a best case, as far as the status quo goes), then this will have a slight depressing effect on the economy next year, as increased taxes for the wealthy will mean less money around to invest in stocks and other assets. 

Here are a few things that could go wrong and make 2013 even worse:

- The temporary payroll tax cuts are allowed to expire.  This is actually likely and will be a significant blow to the economy in 2013.
- Romney gets elected and foolishly cuts government spending.
- Israel and/or U.S. attacks Iran and oil supply is disrupted.
- Obama caves and cuts spending sooner rather than later.
- A faction of Republicans favors economic pain to teach the Dems (another) lesson.  Chaos ensues, as in the debt ceiling negotiations.  To save face, the Republicans insist on some stupid budget cuts.

Here's How Screwed Up the Conventional Economic Wisdom Is

Conventional economic wisdom:
1. Interest rates for government debt are determined by the market, and are susceptible to strikes by bond vigilantes.
2. The Fed (central bank) is all powerful and can control inflation and unemployment. The only thing it can't do is control interest rates (see item 1 above).

Real World:
In fact, the only the thing the Fed does control is the interest rates on government debt.

Conclusion:
The conventional wisdom on the role of the central bank and monetary policy is exactly wrong...

The Coming Revolution

Call me a naive Pollyanna, but I believe that both parties have moved so far away from the interests of the middle class that significant change with regard to workers' rights is becoming more of a possibility.  Disillusionment with the status quo is off the charts.  

One of the major factors in the recent ascendance of capitalists at the expense of workers was the co-opting of much of the middle class through 401k plans and other similar initiatives which greatly expanded the number of voters benefiting from high returns to capital.   Can this be rolled back?  I believe so, since capitalism as always contains the seeds of its own destruction.  

Politicians have been afraid to let stock values fall.  This was seen clearly in the fall of 2008 when the bailout was rushed through in response to panicking markets.  The longer this goes on, the more overvalued markets become, and the higher the potential for a crash.  And fundamental values are actually harmed as a higher percentage of national income is devoted to capital at the expense of labor, as capital prices rise and consumption potential falls.  

With the public already massively disillusioned with the last set of bailouts for the 1%, the stage is set for political chaos the next time markets panic.  If the political system fails to prop up the markets in which many of us have invested our life savings, the ownership society we've built over the last 30 years will collapse.   If the government does prop up the markets again, both the right and the left will revolt unless the socialist intervention extends deeper into the middle class.

This is the setting that will greet President Mitt Romney, should he win the presidential election in November.  Obama has been a decent president, but has been victimized by a dysfunctional political system and will have trouble overcome racial favoritism.  Should the tone deaf Romney win, all the pieces will be in place for a middle class or 99% revolt.  Once that gets rolling, it will become self-sustaining.  As laws favoring capital are rolled back, stock market values will fall in reflection of the less friendly investment climate.  The ownership society and markets will take another credibility hit, and the rising tide favoring workers and social insurance programs will sweep away the opposition...

Republicans are Cracking Up

From the NY Times:

WASHINGTON — The House Republican leader on Sunday flatly rejected a short-term, bipartisan Senate measure to extend a payroll tax break and unemployment insurance, setting the stage for a bitter year-end Congressional collision and the potential loss of benefits for millions of Americans...The surprising setback threatened the holiday plans of lawmakers and President Obama, deeply embarrassed Republican leaders in both chambers and raised the specter of a Jan. 1 tax increase that economists have warned could set back the already fragile economic recovery...

Senator Mitch McConnell of Kentucky, the minority leader who, like scores of his colleagues, voted for the Senate-brokered agreement to extend the tax cut temporarily, retreated from the measure Sunday, throwing his support behind Mr. Boehner’s idea to come up with a yearlong extension, which was the original goal of Mr. Obama and Senate Democrats.

I'm pretty sure this is a sign that the Republicans are falling apart. Mittens will be probably be our next president, but that will be their last hurrah...

democratic Woes in the U.S. and Europe

Predictably, the Great Recession is taking its toll on democracy in the U.S. and Europe. I've recently read a couple of well written columns on this, and have a few thoughts to add in light of the Gingrich revival. Here is the short version:

1. Class war is on in the U.S.
   
2. Unpopular technocrats are running Europe.
   
3. The G.O.P. has been playing with fire for some time now and it's finally caught up with them.
   
4. The national and international politic mood has changed dramatically, and consequent political storms are headed our way.
   

We'll start with Frank Rich in The Class War Has Begun and in a follow up interview.

Just in time for election season, Obama has recovered his populist rhetoric (if not populism itself) and will say the right things about Wall Street, about that “frustration” out there, about the modest reforms of Dodd-Frank, and about millionaires who don’t pay their fair share of taxes. It’s not clear if anyone believes it, including him. Having been a bystander to history when the tea party harvested populist rage during the summer of 2009, he may have a tough time co-opting Occupy Wall Street now to plug the so-called enthusiasm gap in his base...

Despite all the chatter to the contrary, Obama is so far outdrawing all the GOP candidates combined in Wall Street contributions. His best hope is that that fact is blurred by Romney, the plutocrat from central casting...

Elections are supposed to resolve conflicts in a great democracy, but our next one will not. The elites will face off against the elites to a standoff, and the issues animating the class war in both parties won’t even be on the table.

The two powerful forces that extricated America from the Great Depression—the courageous leadership and reformist zeal of Roosevelt, the mobilization for World War II—are not on offer this time. Our class war will rage on without winners indefinitely, with all sides stewing in their own juices, until—when? No one knows. The reckoning with capitalism’s failures over the past three decades, both in America and the globe beyond, may well be on hold until the top one percent becomes persuaded that its own economic fate is tied to the other 99 percent’s. Which is to say things may have to get worse before they get better.

Though the Bonus Army was driven out of Washington in the similarly fraught election year of 1932, the newsreels they left behind turned out to be previews of coming attractions for the long decade still to come...

I wouldn't want to be an incumbent in either party (except, of course, in all those gerrymandered House districts — part of our democracy's problem). I am wary of predictions, but my guess is that there will be a political stalemate until one of the following: an unexpected speedy recovery on the jobs and housing fronts; an external existential threat to the country (see Depression and WWII); the emergence of a reformist populist leader with enormous public support. All unlikely at least in the near future; we may stew in our anger and this listless economy for quite some time.

And here's Paul Krugman from 12/11/2011 on Depression and Democracy:

It’s time to start calling the current situation what it is: a depression. True, it’s not a full replay of the Great Depression, but that’s cold comfort. Unemployment in both America and Europe remains disastrously high. Leaders and institutions are increasingly discredited. And democratic values are under siege.

Let’s talk, in particular, about what’s happening in Europe — not because all is well with America, but because the gravity of European political developments isn’t widely understood.

First of all, the crisis of the euro is killing the European dream. The shared currency, which was supposed to bind nations together, has instead created an atmosphere of bitter acrimony.

Specifically, demands for ever-harsher austerity, with no offsetting effort to foster growth, have done double damage. They have failed as economic policy, worsening unemployment without restoring confidence; a Europe-wide recession now looks likely even if the immediate threat of financial crisis is contained. And they have created immense anger, with many Europeans furious at what is perceived, fairly or unfairly (or actually a bit of both), as a heavy-handed exercise of German power.

Nobody familiar with Europe’s history can look at this resurgence of hostility without feeling a shiver. Yet there may be worse things happening.

Right-wing populists are on the rise from Austria, where the Freedom Party (whose leader used to have neo-Nazi connections) runs neck-and-neck in the polls with established parties, to Finland, where the anti-immigrant True Finns party had a strong electoral showing last April. And these are rich countries whose economies have held up fairly well. Matters look even more ominous in the poorer nations of Central and Eastern Europe.

Last month the European Bank for Reconstruction and Development documented a sharp drop in public support for democracy in the “new E.U.” countries, the nations that joined the European Union after the fall of the Berlin Wall. Not surprisingly, the loss of faith in democracy has been greatest in the countries that suffered the deepest economic slumps.

And in at least one nation, Hungary, democratic institutions are being undermined as we speak... this amounts to the re-establishment of authoritarian rule, under a paper-thin veneer of democracy, in the heart of Europe. And it’s a sample of what may happen much more widely if this depression continues...

The European Union missed the chance to head off the power grab at the start — in part because the new Constitution was rammed through while Hungary held the Union’s rotating presidency. It will be much harder to reverse the slide now. Yet Europe’s leaders had better try, or risk losing everything they stand for.

And they also need to rethink their failing economic policies. If they don’t, there will be more backsliding on democracy — and the breakup of the euro may be the least of their worries.

In the US, The Republicans have been playing with fire, and the old guard may be close to panic. Here's David Brooks last week in the NY Times on The Gingrich Tragedy:

As nearly everyone who has ever worked with Gingrich knows, he would severely damage conservatism and the Republican Party if nominated.

And here's former chief advisor (2000-2006) to President George W. Bush, Michael Gerson, in the Washington Post on Newt Gingrich’s lack of discipline:

As speaker of the House, he conducted an affair during the impeachment of a president for lying under oath about an affair. It helped undermine a movement Gingrich had helped to build.

And this indiscipline was not an aberration. It indicated an impulsiveness found elsewhere in his career. Gingrich has a history of making serious charges that turn out to be self-indictments — witness his recent attack on congressional advocates for Freddie Mac, despite having been one of its well-paid consultants. Gingrich’s language is often intemperate. He is seized by temporary enthusiasms. He combines absolute certainty in any given moment with continual reinvention over time.

Peggy Noonan in the Wall Street Journal -- Gingrich Is Inspiring—and Disturbing:

Former New Hampshire governor and George H.W. Bush chief of staff John Sununu told The Wall Street Journal this week: "Listen to just about anyone who worked alongside Gingrich and you will hear that he's inconsistent, erratic, untrustworthy and unprincipled." In a conference call Thursday, Jim Talent, who served with Mr. Gingrich in the House from 1993 through 1999, said, "He's not reliable as a leader." Sen. Tom Coburn, a member of the House class of 1994, called the former speaker's leadership "lacking," and according to a local press report, he told Oklahoma constituents last year that Mr. Gingrich was "the last person I'd vote for for president of the United States."

Who could predict the rise of a right wing demagogue in difficult economic times?

At any rate, here's (liberal) Nate Silver in the NY Times:

Republicans are dangerously close to having none of their candidates be acceptable to rank-and-file voters and the party establishment. It’s not clear what happens when this is the case; there is no good precedent for it. But since finding a nominee who is broadly acceptable to different party constituencies is the foremost goal of any party during its nomination process, it seems possible that Republicans might begin to look elsewhere...

One possibility — probably the most likely one — is that Mr. Gingrich wins South Carolina, wins Florida and holds on to win the Republican nomination.

But Mr. Gingrich might nevertheless be considered an unacceptable choice by much of the party establishment. That would put us in uncharted waters... a brokered convention is plausible...

Liberal John Cole sums things up nicely at Balloon Juice:

The thing to remember about the chaos ensuing in the GOP primaries, where each week a different candidate is the new new savior before publicly shitting the bed, is that this is all the fault of the Republican party itself. They allowed the party to create this alternate reality about, well, everything that happened the last decade. They are the ones who encouraged their party to believe that a center-left Democrat is actually an America hating socialists. They are the ones who made this mess, so when they are all horrified when each week a different candidate looks the fool by pandering to the base, remember, they are the ones who encouraged the base to think all this crazy shit.

Whew!

The mood of the country has shifted. The Republican base is no longer enamored of mega-rich establishment figures such as George W. Bush and Mitt Romney. They want red meat. The Occupy movement struck a chord with both the left and right, and the situation is Europe is as dire as it is here in the States.

Seen in the current light, Obama is a compelling figure for 2012 -- a centrist figure who might be able to hold things together. However, if Romney survives the Gingrich onslaught, which I believe he will given unanimous support for his candidacy by the GOP establishment, then we'll probably see the Republicans close ranks and successfully demonize Obama once more. The 2012 presidential election will then play out as elite vs elite as suggested by Rich. But the stage will be set for further disruption of the status quo by insurgents from the left and right, at home and abroad. Fasten your seatbelts...

Sample Blog Posting

I am with my friend Oumar at the Sierra Literacy Center demonstrating the blogging...

Here is a sample link to another blog posting.

Fundamental Issues and Symptoms

Many people are worried about the federal budget deficit, and these worries have widely been conflated with worries about our trade deficit. The result is widespread confusion, amongst our political and economic elite as well as the unwashed masses.

(As I write this, a gold commercial (with an end times subtext) is playing on MSNBC. Both right and left have been bullish on gold in recent years. This is symptomatic of the issues I am discussing.)

My take is that the currencies of industrially developed nations, including especially the United States, are grossly overvalued. This basic fact is driving everything else.

I lived in the Philippines from 1977-1979, and was figuratively clubbed over the head with the enormous disparity in the relative values of the U.S. dollar and the Philippine peso. One could live like a king in the Philippines on the income of a poverty-stricken American. Middle class Filipinos, of comparable intelligence with middle class Americans, would earn 1/10 the salary. No doubt there are logical historical explanations for such disparity, but going forward it's not surprising that there is a narrowing of the income gap, as globalization facilitates international diversification, outsourcing, and migration of labor and capital.

In an ideal free market world, the global economy would quickly adapt to globalization by lowering the value of the U.S. dollar. But of course, in the real world, there is economic friction (resistance to change). The U.S. dollar remains overvalued, in spite of an enormous trade deficit, as developing nations undervalue their currencies in the mercantilist tradition. The U.S. government enables the mercantilist policies of developing nations by running large fiscal deficits, which keeps U.S. consumption strong in the face of reduced private sector income.

The statistical manifestations of the scenes described above are large trade and budget deficits. The trade deficit is rightly seen to be endogenous. That is, the trade deficit is not the result of a single government policy. Rather, it is the market determined product of numerous factors, including the imbalance inherent in currency valuation.

By contrast, the fiscal budget deficit is seen as something that is directly under the control of the federal government. For wont of a more convenient target, the budget deficit is fingered as the culprit for the problems stemming from the initial imbalance in currency values. In the sense that the budget deficit enables the trade deficit, there is a germ of truth in this. But the preponderance of the truth lies in the fact that the former wage disparities are not sustainable in a global economy.

With respect to the current hysteria in the U.S. political zeitgeist, the emphasis on the fiscal deficit is clearly misplaced. The fiscal deficit is keeping our heads above water as our international competitiveness diminishes. Without a huge fiscal deficit, the U.S. economy would be in deep depression. Many argue that we should let that happen, so that the necessary adjustments will begin at once. I am sympathetic to that position, but also sympathetic to the plight of Americans who would be devasted by a deep depression.

An informed analysis would recognize that the fundamental problem with the U.S. economy is our overvalued currency, and would recognize that the budget deficit is a symptom rather than a cause of our misfortunes. Addressing the budget deficit will not cure the problem; rather it will cause more misery and then force us to address the root cause...

I Like Ed Schultz

The MSNBC prime time hosts are all winners, in my opinion. Uygur, O'Donnell, Maddow, Schultz and even Matthews are credible, in contrast to the conventional wisdom which likens them to Fox hacks...

And Still More

With regard to the Volcker recession in the early '80s, this was clearly a case where monetary policy did make a difference, albeit not one that we would want to repeat. Randall Wray puts this incident in perspective:

Milton Friedman played the biggest role in promoting the Fed as the all-powerful Wizard of Oz, spinning dials and controlling the money supply which then determines output and employment. However (according to Friedman), the Fed is not to be trusted, hence, should be constrained by a constant-rate-of-growth-of-money-supply rule. This was finally tried in the disastrous early 1980s great monetarist experiment run by Fed Chairman Paul Volcker (simultaneously attempted in Thatcher’s UK). I say disastrous because it wiped out half of our thrifts (home mortgage lenders-but not before helping to set off a wave of fraud that was the subject of Bill Black’s book). By the mid-1980s the Fed had given up money targets, and had also abandoned the Friedmanian myth that money and output are closely correlated-with money driving output.

In truth, central bank policy has always determined the overnight interbank lending rate (the fed funds rate in the US). Leaving to the side regulatory and supervisory power, that really is all the central bank does. There is no evidence that changing the overnight interest rate (within the usual range) has any significant or predictable impact on the economy. It truly is a Wizard of Oz-if one recalls that the Wizard behind the curtain actually had no power at all. What is unfortunate is that for a very long time policymakers believed that economic policy could be left to the “omnipotent” Fed-which means that the truly powerful fiscal policy has been neglected.

More on Monetary Policy

Here's why I say the conventional wisdom regarding monetary policy is absurd. We've had 30 years of loose monetary policy. The Fed Funds rate has decreased in fits and starts from 19% to 0%. During that same period, the rate of inflation has steadily declined. So after 30 years of loose monetary policy by the Fed, we have much lower inflation and much higher unemployment than we had to begin with! This is the exact opposite of what one would expect according to the conventional wisdom.

The simple explanation is that encouraging more private sector debt (by lowering interest rates, amongst other tools) when the economy is slumping is not the way to run an economy. While the increased borrowing will temporarily boost the economy, the more lasting effect is to increase private sector debt to unsustainable levels. This is obviously what has happened, aided and abetted by repeated bailouts of the private sector by the federal government.

Monetary Policy is a Joke

Recently, my favorite blogger (Kevin Drum) wrote what I consider to be his dumbest post in the 9 years I've been reading him. He claimed that the U.S. middle class has been "screwed" because of overly tight monetary policy. The Fed, he said, has ignored the full employment part of its mandate, in favor of fighting inflation.

This seems ludicrous to me. The main tool in the Fed's toolbox is setting interest rates. Drum's argument must be that the Fed has been keeping interest rates too high, thereby keeping the volume of loans too low and consequently failing to promote employment. A moment's reflection on the repeated bubbles we have experienced, most recently in housing, shows this to be absurd. The problem has been just the opposite of what Kevin said -- there have been unsustainably high levels of private debt. The U.S. has one of the lowest savings rates in the world as we learned to finance consumption with debt. After 25 years of increasingly loose monetary policy, the result has been the high unemployment that we have today.

The situation is equally absurd if we look at the short term effects of monetary policy. The Fed reduced interest rates aggressively beginning in August 2007. This had no discernible effect in boosting employment. In fact, unemployment soared in the face of this supposedly loose monetary policy. This is just one example of what I have noticed since I began paying attention to this sometime around 2004. Monetary policy, it seems to me, is a joke -- a sort of 21st century voodoo that generally serious people like Kevin Drum fall for...

Monetary Apologists

Not so long ago in the United States and Europe, basic religious facts were considered to be unknowable. Some still are unknowable in our day and age, but other religious assertions have become increasingly absurd over the years. For example, there is evidence that the age of the earth is billions of years, rather than the thousands of years that it would seem from a literal reading of the Bible. The facts surrounding the birth of Jesus are hard to swallow in light of historic facts such as that many of the myths are plainly recycled from other religions. Inconsistencies in the Biblical text are readily identifiable and easily communicated in modern times.

Still, for the last several hundred years, Christian apologists have tried to reconcile the absurdities. Generally liberal, the apologists tried to make sense of the changing intellectual landscape, while reassuring the powers that be and the people that believe in them that the old beliefs are still valid.

Paul Krugman is an apologist for the increasingly implausible monetary theories that we are governed by. Obviously, sovereign governments create money at will. Yet we pretend that governments borrow money from the private sector to finance their expenditures. The fact that this is untrue, in all but the most manipulated and superficial manner, cannot be acknowledged, because the nation sees this as a moral issue.

People see the workings of the macro-economy as fundamentally unknowable. Common sense dictates that government finances are just like the finances of a household or business. A moment's reflection will show this to be untrue, but we are unwilling to openly acknowledge something that may have morally deleterious consequences. If government deficits are okay, then nothing is true and the forces of hedonistic anarchy will have won.

The Mother of all Analogies

The Cheney Administration very publicly derided the CIA for not clearly identifying Saddam Hussein as having a massive WMD program, and thereby justifying the 2003 U.S. invasion of Iraq. It is well known that Cheney established his own intelligence office to bypass the old CIA and provide the intelligence that he wanted. Then, when it was evident that the logic for the Iraq invasion was based upon false claims of Saddam Hussein having a massive WMD program, the Cheney Administration blames the intelligence agencies!

Similarly, the Bush/Administration presided over a massive economic and financial collapse. Bush himself told Congress that a massive Wall Street bailout was necessary to prevent the collapse of the financial system. This was true. But then, after the financial system was saved by the government, the Republicans blamed the federal government for spending too much money, as if this was at the root of the massive problems that brought the economy to its knees.

The enormity of these lies boggles the mind, and indicates the depravity of our political system and indeed, since the lies have been swallowed to a significant degree by the conventional wisdom, of our nation itself...

Modern Monetary Theory Gains Popularity

Courtesy of Mike Norman, here are some recent articles about how the economy works (which doesn't correspond to conventional wisdom of the Democrats or Republicans):

• The Big Danger In Cutting The Deficit, John T. Harvey in Forbes
  
• Debt and Deficit in a Nutshell (9 minute YouTube video)
  
• Bill Mitchell in The Nation
  

Middle East Musings

I just finished reading a book about Hezbollah -- "A Privilege to Die: Inside Hezbollah's Legions and Their Endless War Against Israel", by Thanassis Cambanis. It's a fascinating account of Hezbollah's rise, the 2006 war with Israel, and the subsequent ascension of Hezbollah to dominance of Lebanon and leadership of an anti-western "axis of resistance" throughout the Arab & Islamic worlds. With Bill & Misty traversing the region, Joe Chahine reminding me of the intense Dearborn connection, and ongoing uprisings in Tunisia, Egypt, Libya, Yemen, Oman, and Bahrain, it's highly relevant. While extremely sympathetic, the book is an ultimately damning (perhaps excessively so) account of the principled, dedicated, and fanatical leaders (and followers) of the Shia axis of resistance.

The anti-western axis of resistance includes Hezbollah and their patrons in Iran and Syria, along with Muqtada al-Sadr in Iraq. Though a Shia movement, there are many Sunni sympathizers including Hamas. Opposed to the axis of resistance are the forces of accommodation led by Saudi Arabia. The accommodationist Sunni Arabs have been weakened by the recent revolutions including, especially, the ouster of Hosni Mubarak in Egypt. The Taliban and al-Qaeda are a third loosely-affiliated group on the fringe of current developments.

It remains to be seen what will happen as a result of the Egyptian revolution and the ongoing conflicts in Libya, Bahrain, and Yemen. There are two clear sides struggling for preeminence -- the Shia led axis of resistance and the Sunni led axis of accommodation. While the Iranian led axis of resistance is on the offensive with the fall of Mubarak, it is doubtful that the Saudis, with their enormous wealth, can be toppled. It is more likely that leadership of moderates will pass to more democratic regimes in Egypt, Qatar, and Jordan.

While openness will provide an opening for anti-western factions in the Sunni lands, it is likely that the economic might of the capitalist west will predominate. Sunni self-interest lies not in futile resistance, but rather in independent pursuit of modern technology and human rights. The best case scenario is that the axis of resistance is slowly marginalized as more liberal movements succeed. With prudent behavior by the western powers, the axis of resistance will crack when one of its members decides the west isn't so bad after all, and strikes a deal to open up and reap the rewards of modernity and liberalism. Iran is the most likely prospect in this regard, and its change of heart would likely spell the end of the axis of resistance.

Worst case scenarios include the following possibilities:

• A crushing of the axis of resistance by the overwhelming firepower of Israel and its U.S. ally. This might be similar to the crushing of Jewish resistance in the 132 CE revolt of Bar Kochba. As described in Wikipedia, "The Bar Kokhba revolt (132–136 CE) against the Roman Empire was the third major rebellion by the Jews of Judaea Province and the last of the Jewish-Roman Wars. Simon bar Kokhba, the commander of the revolt, was acclaimed as a Messiah, a heroic figure who could restore Israel...580,000 Jews were killed, and 50 fortified towns and 985 villages razed...Hadrian attempted to root out Judaism, which he saw as the cause of continuous rebellions...Modern historians have come to view the Bar-Kokhba Revolt as being of decisive historic importance. The massive destruction and loss of life occasioned by the revolt has led some scholars to date the beginning of the Jewish diaspora from this date...The disastrous end of the revolt also occasioned major changes in Jewish religious thought. Messianism was abstracted and spiritualized, and rabbinical political thought became deeply cautious and conservative."
  
• Another worst case scenario would be more of the same as we have experienced in recent years. Israel, with the backing of America, would continue to confiscate Palestinian land and mistreat Arabs in the region. The power and prestige of the axis of resistance would continue to grow as a result. Eventually, the axis of resistance could obtain weapons of mass destruction.
  

The middle case, which I would like to think of as the most likely case, is that the Saudis will be unable to continue their leadership position in the Islamic world. While western power will ensue that the oil fields are protected from radicals, the Saudi royalty will realize that their best prospects lie in relinquishing absolute power and retiring as wealthy international citizens (see Aga Khan). In combination with a more liberal Egypt and increasingly liberal regimes in Jordan, UAE, Libya, and perhaps Syria and Iran, the balance of power will tilt in favor of regimes that more legitimately represent their citizens.

Israel, faced with the prospect of an increasingly powerful, balanced, and coherent Arab periphery, will eventually make peace. Israel will retain deterrent military power, but move beyond the siege mentality and become a more mature and independent middle eastern democracy.

I admit that I'm engaged in wishful thinking here. My middle case sounds suspiciously like my best case. May it be so...

Mike Norman Says It Well

From Mike Norman --

But since global capacity exceeds the demand that the US and rest of the world can absorb, the world is faced with a demand shortage, which manifests as massive unemployment and underemployment, as well as sub-optimal economic performance resulting in massive foregone opportunity. The present approach is not working and cracks are widening in the foundation. The fact that the dollar is a source of controversy shows this. On one hand, China wants to export to the US, and on the other, fears dollar depreciation that would affect its savings in dollars.

The challenge is to increase effective demand in order to grow the global economy. Ideally, this would evolve from a democratic new world order based on interdependence in a way that is sustainable financially, economically, politically, socially, environmentally, and ecologically. For this to happen, a fresh approach to globalization based on a new vision of possibilities and a grand strategy for achieving this vision are required. This is the discussion that we need to be having now. Neoliberal austerity is leading to economic underperformance and social unrest.

Simple Economics

The government should, in general, increase the money supply over time to support the growing economy. The way it does this is by deficit spending. The alternative is that the private creates more money via loans, but this does not increase the net financial assets of the private sector, since all new money is then offset by new liabilities. Inevitably, private debt gets too high and there is a deflationary collapse, unless the government steps in with a bailout. Better to get the deficit spending up front, rather than bailing out those who made the biggest mistakes...

Economic Superstition

I've concluded that superstition reigns in our national economic discourse (as it did in religious discourse not so long ago, and still does in many places). Facts regarding how the monetary system works are subservient to superstition regarding deficits and debt, even in the speech and behavior of leaders such as Bernanke. We have basic assumptions which are faulty but taken for granted.