Archive for February 2012


The problem with gold

The gold standard got a bad reputation after the Great Depression, when it was seen as contributing to worldwide deflation.  Kurt Schuler points out that the interwar gold standard didn’t follow the rules of the game, which is true.  Central banks hoarded excessive  gold and that contributed to the deflation.  But at the end of the day I still have two major objections to returning to a gold standard.  If a gold standard requires good behavior by governments, then why not adopt fiat money?  And even if the gold standard were run according to the playbook, the recent dramatic increase in Asian gold demand would have inflicted deflation on any country with a currency linked to gold.  Here’s Ramesh Ponnuru making these two arguments in the National Review:

The doctor’s prescription is as mistaken as his diagnosis. The drawbacks to a gold standard are well known. If industrial demand for gold rises anywhere in the world, the real price of gold must rise “” which means that the price of everything else must drop if it is measured in terms of gold. Because workers resist wage cuts, this kind of deflation is typically accompanied by a spike in unemployment and a drop in output: in other words, by a recession or depression. If the resulting economic strain leads people to fear that the government may go off the gold standard, they will respond by hoarding gold, which makes the deflation worse.

If another country’s government begins hoarding gold, the same thing happens. This is not a theoretical concern: It’s what France did in the early years of the Great Depression. Countries were forced off the gold standard, and recovered in the order they left it. Representative Paul’s strategy for dealing with the theoretical and historical arguments against the gold standard in End the Fed is to ignore all of them. All he says is that problems arose in the 1930s because of the “misuse of the gold standard.” But note that the great advantage of the gold standard is supposed to be that governments cannot manipulate it. Concede that they can and the argument is half lost.

The biggest net hoarders of gold in the late 1920s and early 1930s were the French.  Some of those gold hoards recently fell on the head of a French construction worker.  Check out this link, and recall that these bags of gold were one of the primary reasons the Nazis took power in Germany.  That’s not to say the historical gold standard was all bad; it’s not clear any alternative system would have worked better between 1815 and 1914.  It may have been a useful step in the evolution of money.  But by the interwar years it was more a hindrance that help to policymakers.

PS.  Kurt Schuler points out that Ron Paul wants to abolish the Fed, which means he favors a gold standard less susceptible to interventionist monetary policies.  But even prior to the Fed the US government held large monetary gold stocks.  So even in a Fed-free world, governments had some ability to intervene in the gold market.

PPS.  David Beckworth and David Glasner also have recent posts on gold.

The 2nd German miracle

The first occurred in 1948, when the Germans refused to listen to advice from progressive American and British economists.  Here’s Donald Luskin and Lorcan Roche Kelly on the 2nd miracle:

Since bottoming in 2009’s first quarter, German output has grown at an annual rate of 2.8%, compared with 2.4% for the U.S. since its bottom in 2009’s second quarter. Germany’s unemployment rate is an astonishingly low 5.5%. German youth unemployment is lower than U.S. overall unemployment. . . .

A mere decade ago Germany was called “the sick man of Europe.” It was still painfully digesting the unification of the former West Germany’s relatively free and modern economy with the former Soviet-enslaved East. Ten years ago German unemployment was 8.2%””the same as Europe’s overall””while U.S. unemployment was 5.7%. What did Germany do that allowed it to charge ahead and trade unemployment rates with the U.S.?

Starting in 2003, Germany under then-Chancellor Gerhard Schroeder began to implement a program of long-term structural reform called “Agenda 2010.” The idea was to transform Germany into an economy where business has an incentive to invest, and where labor has an incentive””and an opportunity””to work. This was pro-growth reform that would be very familiar to Ronald Reagan and Margaret Thatcher.

The centerpiece were labor-market reforms designed by a former human-resources executive at Volkswagen AG. The power of unions and craft guilds was curtailed, making it easier for unskilled youth to enter the job market and easier for employers to hire and fire at will. Germany’s lavish unemployment benefits were sharply cut back. An unemployed person in social-democratic Germany today can draw benefits for only about half as long as his counterpart in capitalist America.

The immediate reaction was a brief rise in unemployment, as German business was allowed for the first time to optimize its labor force. And there was a backlash by powerful union and guild interests, costing Mr. Schroeder his bid for re-election. But Germany was transformed.

The recent payroll tax cut included a reduction in the maximum UI benefits from 99 weeks to 73 weeks, which seems appropriate to me.  We need to gradually move back to 26 weeks as the unemployment rate comes down.

I’m not a big fan of the payroll tax cut.  On supply-side grounds it should have been an employer-side tax cut, not employee-side.  That would have created far more jobs, given the Fed’s 2% inflation target.  If they insist on “helping people,” they should have just given everyone an $X rebate.  As it is, my wife and I are getting a large tax cut, even though we don’t need it.  So it’s not optimal on either equity or efficiency grounds.

HT:  Morgan.

An inflection point?

Matt Yglesias and Dean Baker suggested the following was very important news:

TOKYO “” Hoping to win its long-futile battle against falling prices, Japan’s central bank on Tuesday said it would try to kindle inflation, setting a goal of 1 percent, by pumping tens of billions more dollars into the economy.

While central bankers usually worry more about keeping inflation in check than trying to stoke it, Japan’s economy has labored for more than two decades against the stagnating effects of falling prices, or deflation.

The Bank of Japan on Tuesday said it would expand a program of buying government bonds as a way to inject additional money into the economy. And it set a goal of continuing the effort until inflation had reached 1 percent.

.   .   .

Politicians and economists have long criticized the Bank of Japan for not doing enough to combat falling prices. That criticism became louder after the United States Federal Reserve “” facing economic pressures of its own “” set a 2 percent inflation target last month. Adding to the concern has been the gloom that Europe’s debt crisis continues to cast over the global economy.

At its policy meeting Tuesday, the Bank of Japan’s board showed a more explicit commitment to ending deflation, voting to set consumer inflation at an annual rate of 1 percent as its price goal, at least for the time being. The bank had previously defined 1 percent only as its “understanding” of a desirable rate of inflation.

Prices in Japan have not risen at an annual pace above 1 percent since 1997, when deflation set in.

.   .   .

Tokyo stocks rose modestly, yields on Japanese bonds fell and the yen weakened against the dollar on the news.

.   .   .

Mr. Shirakawa has long argued that monetary policy alone cannot bring an end to deflation in Japan, a situation that he says is caused by a lack of demand. Economists say the bank is running out of options, since interest rates are already effectively at zero and because it has little leeway to expand its asset-buying program.

I have mixed feelings.  On the one hand there’s no reason to expect a dramatically different outcome in Japan.  You still have no level targeting, which means the BOJ is not held accountable for its mistakes.  You have the head of the BOJ saying that monetary policy cannot address deflation because it is caused by “a lack of demand.”  Hmmm, I’ve been teaching my students that monetary policy determines AD.  Does it determine aggregate supply in Japan?  It’s clear that the BOJ was pressured to do this, and that it doesn’t represent any sort of dramatic change in policy.  Bond yields fell, so the bond investors are certainly not expecting much inflation.  I think we can safely dismiss the argument of people like Volcker that a little more inflation is like giving a sip of wine to an alcoholic.  The BOJ is not about to become addicted to inflation.  Nor is the Fed or ECB.

But equities did rise and the yen fell.

Here’s why I think Yglesias and Baker might be right.  Between 1920 and 1933 the world economy was on a deflationary cycle.  Central banks switched toward inflation way too slowly, because they are big conservative institutions, slow to adapt—like generals always fighting the last war.  Then we had an inflationary cycle from 1933 to 1981.  By 1968 inflation was already too high, but it took 13 more years for central banks to make a serious effort to bring it down.  Since 1981 the world has been in a disinflationary cycle.  By late 2008 there was an obvious need to switch to policies aimed at aggressively boosting inflation–recall the US experienced deflation in 2009.

Now we may be seeing the first tiny signs of a momentous move out of this disinflationary cycle.  There is certainly nothing dramatic that one can point to, but important straws in the wind:

1.  The new ECB president is clearly more interested in boosting AD than Trichet.  That’s still not very aggressive, but it’s something.

2.  The Fed had been hinting at a vague desire for 1.7% to 2.0% inflation.  Now they have a firmer target, and they dropped the 1.7%.  It’s just 2.0% inflation, period.  And at his press conference Bernanke gave strong hints that the Fed needs to do more to raise both inflation and employment.  As in Europe it’s still far too little, but it’s something.

3.  Now the BOJ adopts a formal 1% inflation target.  Again it’s not that dramatic a change.  A cynic could argue that they already had a vague target in the general area of 1%.  But a firm target does slightly increase accountability.  The Japanese GDP deflator has fallen by 15% since the mid-1990s.  With a target of one percent inflation, the BOJ will be embarrassed if a decade from now the price level is down another 10%.  They will also be criticized if they raise interest rates when inflation is below 1% (as they did in 2000 and 2006.)  So it’s not a game changer, but it’s baby steps toward easier money.

Put all these together and it’s becoming increasing likely that we’ve reached an inflection point.  The damage from tight money has become so severe that the pressure for monetary stimulus is gradually building.  Recall that in late 2008 and in early 2009 almost the only people who insisted that the Fed could and should boost AD were a few unknown market monetarists.  Some Keynesians also argued it was worth a try, but their skepticism about the efficacy of monetary stimulus blunted their message.  People remembered the pessimism, and since it matched their prior belief that the Fed can do nothing at zero rates, these statements had the effect of pushing monetary policy off the radar screen.  So much so that President Obama didn’t even appoint anyone to fill two empty Fed seats for well over a year.

The New York Times notices that the real problem is nominal

Back in late 2008 and early 2009 most people focused on “the debt crisis” as being “the problem.”  But debt is a problem only to the extent that it exceeds one’s ability to repay the loans, which depends on one’s income.  A few of us market monetarists argued that you also needed to look at the denominator of the debt/income ratio, not just the numerator.

This NYT piece by Landon Thomas Jr. never uses the term NGDP, but that’s exactly what they see as Europe’s real problem:

The ratio of Portugal’s debt to its overall economy, or gross domestic product, was 107 percent when it received the bailout. But the ratio has grown since then, and by next year is expected to reach 118 percent.

That’s not necessarily because Portugal’s overall debt is growing, but because its economy is shrinking. And economists say the same vicious circle could be taking hold elsewhere in Europe.

Two other closely watched countries on the debt list, Spain and Italy, also have rising debt-to-G.D.P. ratios “” even though they, like Portugal, have adopted the budget-slashing and tax-raising measures that the European officials and the I.M.F. continue to prescribe.

Government debt is nominal debt, not indexed to inflation.  That means the debt /GDP ratio is the ratio of debt to NGDP, not RGDP.  Maybe that’s obvious, but most of the time when the media refers to “GDP” they mean real GDP.

Glad to see the NYT echoing market monetarist talking points from 3 years ago.

And there seems to be at least one blogger in Portugal who understands the real problem:

“Portugal would save 3 billion euros a year if it restructured its debt,” said Pedro Lains, an economic historian and a blogger at the University of Lisbon.

Mr. Lains spoke not only as a theorist. He feels austerity firsthand. Because his salary at the government-run university has been slashed by 30 percent in the last year, his family has needed to dip into its savings.

He said that wage contraction throughout the country was prompting increasing numbers of Portuguese to leave the country, even as their government labors to prove it is worthy to remain part of the euro zone.

Why, Mr. Lains asks, should he and his fellow citizens suffer while the bondholders get their money back?  “It’s not the fault of the Portuguese people,” he said. “The fault lies with the structure of the euro.” 

That’s not to say Portugal doesn’t have real problems, but the ECB needlessly turned those real problems into a crisis.

Matt Yglesias walks into a mine field

A few weeks ago I argued that saving was nothing more than resources put into producing capital goods.  Period.  End of story.  This isn’t a theory, it is a definition.  And I accused several bloggers of forgetting that identity when they overlooked the impact of consumption smoothing on investment.

Now Matt Yglesias says almost exactly the same thing:

As an individual, the way you save for the future is you reduce the dollar value of your consumption to below the dollar value of your income and then you take the difference and invest it in something. That something could be a bank account or a stock index funds or a treasury bond or whatever. But the point is that your saving of money turns into investments in financial instruments. On a social level, what we say is that savings equals investment by definition. In a given quarter the economy as a whole produces a bunch of stuff. That stuff is either exported abroad, consumed by households or the government, or else it’s investment. This is””to repeat””a stipulative definition. 

.   .   .

The relevant issue then becomes what do we stockpile. A lot of the stuff we make has a pretty short shelf-life. Computer software gets obsolete super fast. Clothing wears out. Food spoils (even Twinkies). Durable goods like cars last longer. Airplanes last even longer. But the real durability is in structures. Houses, office buildings, bridges, tunnels, factories, train tracks. As a society, we save for the future by channeling resources””steel, electricity, human labor power””into the production of things that last a long time rather than things that are more perishable.

Let’s see if he receives the same criticism I received.