TheMoneyIllusion

  A slightly off-center perspective on monetary problems.

42 Responses to “Peter Thiel (Big Think, part 2)”

1. OGT
   12. December 2009 at 09:26
   

   Morality Play politics sounds like a better and more accurate name.

   or

   Liquidationist, or Mellon-ite politics.

   or

   Zero Sum Politics.

   In any case, there’s certainly some truth to his description, and some danger in the trend.

2. MIke Sandifer
   12. December 2009 at 11:06
   

   Thiel essentially says that he has no idea how the recent housing bubble developed. In my mind, there is the simple answer that so many fail to grasp.

   Granted, few people agree with me, but to restate an earlier idea, the housing bubble and financial sector bubbles developed because almost everyone benefited on the way up. This was especially true of top executives and commissioned employees in the largest banks and other financial institutions.

   One argument against this idea was that some of these executives lost a great deal of money when their institutions’ stock prices collapsed. Fair enough, but a new study suggests that even these executives earned more than enough money in bonuses to be very profitable after these losses.

   http://www.law.harvard.edu/faculty/bebchuk/pdfs/BCS-Wages-of-Failure-Nov09.pdf

   The authors’ editorial can be found here:

   http://www.ft.com/cms/s/0/5c7cd070-e29b-11de-b028-00144feab49a.html

   Obviously, this does nothing to support my explanation, but it is at least consistent with it.

   Merely anecdotally, I have friends who are economists, I interact with others, and I remember my economics classes in college. I sense a real disconnect between what goes on in the minds of these economists and the reality on the streets, to use a cliche. As a small business owner I can tell you that it is sometimes vicious out there and backstabbing, corner cutting, and brazen outright fraud are just a daily part of doing business. No opportunity for profit, however immoral and even risky goes unexploited for long.

   Bankers have behaved the way I suggest for at least several hundred years. Banks naturally lead to market failure in absence of appropriate regulation. That regulation was non-existent during the recent bubble and low interest rates only added fuel to the fire.

   Given the lack of accountability for the damage done to the economy by these crooks, it is time to have a financial equivalent of a a night of long knives.

3. rob
   12. December 2009 at 11:30
   

   I dissent.

   “In reality, Abu Dhabi was probably quite resentful of the shiny and glittering and fake city known as Dubai and when push came to shove didn’t really want to give them more money.”

   This appears to have been the truth, and to the extent Abu Dhabi puts more money into Dubai, it will be the actions of an investor buying at fire sale prices, not the actions of a government bailing a firm out. The same would have been true in 2007, if this had happened then, so I don’t think Dubai is symptomatic of a trend.

   Would Germany bail out a poorer country? I doubt it.

   Will the USA bailout GM again and again to the end of time? Of course.

   Anyway, he is not being autistic enough. He is trying to find a story where there is none.

4. 123
   12. December 2009 at 14:11
   

   I have a different interpretation of this:
   “And I think that kind of emotional or political or social phenomenon is going to be much more widespread and the question that will come to the fore in the next few years is will Germany bail out Greece or Spain, or Italy, or Eastern Europe?”
   It seems that ECB thinks that average eurozone real interest will be lower and average eurozone real asset prices will be higher if bubble countries like Greece are forced to cut G, and monetary stimulus will be focused on healthy countries like Germany.

5. 123
   12. December 2009 at 14:16
   

   Or in other words, if ECB policy is appropriate, there is no need to promise an unconditional bailout of Greece.

6. StatsGuy
   12. December 2009 at 18:49
   

   I would not call it deflationary politics; call it “distributional politics”. Much of it is caused by the simple fact that, on the way up, the gains were heavily concentrated. Wealth distribution skew increased dramatically. Real quality of life, for many people, decreased. And arguably, monetary policy served as an engine for this by injecting money into the economy through an unregulated financial sector. Really, the problem was lack of regulation, but many do not distinguish between the subtleties – the Fed, Congress, Big Banks – it’s all a blur.

   It is tempting to blame the political shift on concentrated interests – this fits a neatly self-interested public choice type argument. But the fact of the matter is that many people are so angry about the distributional losses they’ve suffered for 25 years, at the hands of people who preached free market (it’s easy to do so when someone else is on the losing end), that they are willing to suffer to inflict pain on those who are finally getting their comeuppance.

   True, this sentiment is being marshalled by concentrated interests (consider the financial backers of the Tea Bagger movement), and by the fact that the party out of power has everything to gain from seeing the economy tank for another 9 months. (When asked about the number one thing Americans could do to help with the crisis, Orin Hatch answered, vote in the Republicans… you know, the ones who want to audit the Fed and shut it down.) Yet this does not make the public anger any less real. AND, the political damage done by Obama’s aggressive defense of TARP in combination with a tight money policy (no credit for homeowners/small business, but unlimited credit for the banks that caused the problems) has caused incalculable damage to the credibility of the current administration.

7. Mark A. Sadowski
   12. December 2009 at 19:10
   

   I am not aware of any great shift towards “deflationary politics” overseas (most of my relatives are in Europe, and I have several friends in Africa and Asia). However it is my impression that the liquidationist and creative destructive element among the American libertarian right (call it Austrian if you will) has been growing exponentially for years. Between their excessive reliance on deductive logic, ignorance and/or distrust of published empirical analysis of data and their bizarre interpretations of history I find their growth to be somewhat alarming.

8. StatsGuy
   12. December 2009 at 19:49
   

   Comments on Thiel:

   His message about blaming political power (instead of financial institutions) is somewhat self-serving, given his position as a fund manager. Smacks of Jamie Dimon’s “Don’t Villify Us” mantra. It’s hard to imagine that the AIG division (for example) made its uncovered options bets (“insurance” sales) with the expectation that they would get bailed out if it went south. Fannie and Freddie are more compelling stories, but focusing excessively on these institutions is a convenient way to deflect attention from all the other at-fault factors and players.

   He’s right about long/short term incentives in publicly held companies, but no one can quantify this. He’s right about hidden leverage – but hidden or not, the problem is probably simply excessive leverage at all. (Think about a multi-player game involving borrowing and investment, and now think about known dynamics like tournament effects in hedge fund awareness, and/or the “winner’s curse” in auction theory.)

   But while we’re all obsessing about the financial crisis this week, here are two comments from Volker and Soros:

   http://www.bloomberg.com/apps/news?pid=20601087&sid=aL6KzrXJh418&pos=6

   (“We have another economic problem which is mixed up in this of too much consumption, too much spending relative to our capacity to invest and to export”)

   http://bigthink.com/georgesoros/george-soros-on-americas-new-engines-of-growth

   to paraphrase – the US consumer cannot be the engine of growth for the next decade…

   These both prompt a question that this blog addresses less than others: Let’s accept we need monetary action… if we get it, how do we avoid another asset-value-fueled consumption boom (bubble)? That is one of the main charges levied by anti-Fed folks.

   On the international side, one question is this – if every country seeks a surplus (like Germany or Japan or China, those “responsible” countries) to insure itself against shocks to the system, then which countries provide the consumption? Remember, that in this system, net reserve surplus is injected into the system by excess consumption of other countries (e.g. national obligations, or currency). If everyone wants to build reserves (e.g. countries are risk averse) where does that leave us? If you add strong risk aversion into the balance of accounts story, it’s probably easy to show how the world would be undersupplied with money by individual country agents.

   Adequately guaranteeing against this threat would require a massive IMF resource allotment, or something similar – and that creates moral hazard for the IMF. There may be some method to the madness of Special Drawing Rights.

9. ssumner
   12. December 2009 at 20:00
   

   OGT, What I find so frustrating is that there is both a liquidationist politics and a politics aimed at bailing out special interest groups. So we are forced to choose the lesser of evils. Where is the pro-growth politics? I don’t see either side trying to raise all boats. That’s what I am trying to do.

   Mike, I can’t buy that argument because it assumes these guys were smart enough to know what was going on. And it is pretty clear they weren’t. But I do think that our financial regulations (FDIC and Too big to fail) give banks too much incentive to take risks.

   You said;

   “Given the lack of accountability for the damage done to the economy by these crooks, it is time to have a financial equivalent of a a night of long knives.”

   I don’t think the Fed is a bunch of crooks, they are just misguided. (Yes, I know you were talking about commercial banks, but the real damage was done by the Fed.)

   rob, GM will be an interesting test case. Some people are preticting it will need another bailout. It would be extremely unpopular. Of course these bailouts are also bailing out the UAW, so I guess it is a test of their political pull.

   123, I hope you are right, but the problem is that the ECB may not even know what is appropriate for Germany. ECB policy is still too tight.

   Statsguy, You said;

   “Real quality of life, for many people, decreased. And arguably, monetary policy served as an engine for this by injecting money into the economy through an unregulated financial sector.”

   I have a couple problems with this. Almost all the new money was not inhjected through the financial system, but rather directly into people’s wallets, and into drug dealers cash hoards. Very little went into the banking system until last October.

   And the financial system was highly regulated. Banks were forced to make safe investments in AAA bonds through the Basel standards, etc. The problem wasn’t lack of regulation, it was that the regulators had no idea that those AAA bonds were actually high risk. Anyone who thinks lack of regulation was the problem should listen to the Calomiris interview on Econtalk. Actually, to save time I read the summary in a post over at Econlog.

   You said;

   “It is tempting to blame the political shift on concentrated interests – this fits a neatly self-interested public choice type argument. But the fact of the matter is that many people are so angry about the distributional losses they’ve suffered for 25 years, at the hands of people who preached free market (it’s easy to do so when someone else is on the losing end), that they are willing to suffer to inflict pain on those who are finally getting their comeuppance.”

   FDR tried this policy and just inflicted pain on the people he was trying to help—the workers. Until the victims realize who the real villians are, they will be hurting no one but themselves if they strike out blindly at any convenient target. Millions of people are not losing their job because of bankers. Commerical bankers don’t determine NGDP, the Fed does. The bailouts are not primarily going to the banks, they are going to auto companies, auto unions, health care providers, health insurance companies, AIG, tire manufacturers, etc. So far the banks have actually been repaying their loans, with interest. It’s the oldest trick in the book for politicians to point fingers at the evil bankers while they are stealing money from the public’s pocket. European history is full of that sort of demogogary. What we need is to return to the Clinton-era pro-growth agenda.

   I’m a bit perplexed by your comments on the Republicans. They may indeed want to see the economy go downhill, but does anyone really believe they would know what to do to make it happen? Even the Democrats don’t seem to have a clue as to what needs to be done to fix the economy, and the Republicans are generally far less knowledgeable about policy than the Dems. If they knew what was going on, would that have run a deflationary policy in the midst of the housing crisis in 2008, especially in an election year? It’s quite a stretch to think the Republicans are even capable of that sort of sabotage.

   Mark, I think it is a mistake to mix “liquidationist” adn “creative destructionist.” This economy desparately needs a lot of creative destruction, but it is precisely because of the liquidationist policies of the right that we are moving in the other direction, toward statism. The exact same thing happened in the 1930s when right wing liquidationists policies led to very statist and counterproductive policies. Both the left and the right have their good sides, but right now we are experiencing the worst of each. The right is giving us liquidationist policies, and the left is exascerbating the problem with statist policies. Clinton was relatively successful because he combined the best of the left and the right, not the worst.

10. ssumner
    12. December 2009 at 20:17
    

    Statsguy, If we are going to prevent more bubbles, the first thing we need to do is figure out what caused them. And it certainly wasn’t monetary policy. Monetary policy was much more expansionary in the 1960s, 1970s, and 1980s, than in the last two decades, but it was the last two decades that promoted bubbles.

    I agree we consume too much, but monetary policy cannot address that problem, we need to boost the incentives to save. That means doing lots of things that are politically unpopular, or that conflict with various special interest groups. I don’t see any proposals being consider by either party to significantly promote saving.

    BTW, I’m not sure Germany and Japan “seek” surpluses. It would be insane for those two countries to not run surpluses, their demographics are awful. And no one can say those two countries run weak currency forex policies. China is a more complicated story.

    First do no harm. Then start figuring out what the problems really are.

11. Mark A. Sadowski
    12. December 2009 at 20:40
    

    Scott,
    I meant “creative destructionist” in a sarcastic sense. I don’t perceive the massive scale of current economic destruction to be very creative at all, and from an anti-statist perspective it is highly counterproductive to say the least. We have made several major sectoral shifts in the past without anywhere near this level of economic dislocation (the free market system has an amazing capacity for adaptation if given half a chance). I fear that such contemporary moralistic elements of the American libertarian right cannot conceive or else are unwilling to admit it is even possible. In my opinion feel free to pointlessly self-flagellate if that’s your thing, but don’t try and make the rest of us join you.

12. Mark A. Sadowski
    12. December 2009 at 20:50
    

    On that last point it occurs to me that I’m more authentically libertarian than they are.

13. StatsGuy
    12. December 2009 at 21:07
    

    ssummer:

    “Almost all the new money was not inhjected through the financial system, but rather directly into people’s wallets, and into drug dealers cash hoards. Very little went into the banking system until last October.”

    You are referring to new currency; I’m referring to new money, including debt – and would draw particular attention to profit from financing activities. Much of that profit, which derived from “mindlessly piling on leverage” in the words of Buffett, was _not_ clawed back. See Mike Sandifer’s link above. Finance accounted for 40% of US corporate profits during the peak boom years. This accompanied a phenominal rate of growth of credit/debt vs. GDP. The finance sector profit was carved out of _temporary_ money (debt), and when that temporary money disappeared it left a gaping hole in the system.

    Re: FDR – I never said it was _rational_. Heck, I don’t even know what _is_ rational. In an Industrial Org model with non-enforceable collusion, when one firm cheats, it’s always better for the other firm to “renegotiate” rather than punish when that punishment hurts both players. But is that _rational_? Some people would argue that our unwillingness to punish ourselves to discipline finance creates a future problem with credibility/commitment. (Worse, still, is trying to hold a hard line – as per WaMu – then backing down when you realize the impending catastrophe.) This is the “lost our soul” argument about Americans with weak character. (What you call the Puritanical argument.)

    Thiel had a very good point about the pro-cyclicality of regulatory action, one which I’ve made in the context of capital controls and loan regulations and even MtM (mark to market) accounting. He is right that the problem of pro-cyclical regulation is political, and is one of the main reasons for Fed Independence (to get counter-cyclical monetary policy).

    Re: Republican “sabotage” – it’s not that hard at all. Simply oppose everything, raise h3ll about the Fed, cry inflation till the cows come home. Not hard at all. It’s also impossible to distinguish between intentional sabotage, and “true beliefs”, although their attitude to monetary action and deficits (via tax cuts) was quite different in 2002… (And, likewise, Democratic attitudes via the deficit were different when they were in the opposition.) Our political system rewards obstruction for the party out of power, and excess spending for the party in power.

    Re: surpluses… It’s not just China… What about South Korea? (50 to 60 billion a year) Brazil? (35 billion) Are these countries also suffering from aged populations? Higher risk premia in international finance (and stiff punishments for countries that become credit risks), very much feed the zero-sum mentality. When the G-20 says the world is dependent on US excess consumption, this is what they mean.

    “I don’t see any proposals being consider by either party to significantly promote saving.”

    Neither do I… Although raising taxes and using receipts to fund/incent investments in long term infrastructure (whether that is knowledge or physical or human) could be considered a form of savings (deferred consumption). If you believe govt. has a role in coordinating/executing investment. A lower dollar may help fix the national savings problem, although the movement of savings into investment is more complicated. The big problem is transfers (and, to some degree, military). Everyone complains about non-military-discretionary, but that’s probably the one part of the budget that should increase.

14. Scott Sumner
    13. December 2009 at 08:08
    

    Mark, It is pretty clear you didn’t understand my response at all. You might want to reread it, or indeed look at this blog as a whole. There is no one more anti-liquidationist than I am. But that is a very different thing from creative destruction. So your criticism makes no sense at all.

    Statsguy, You said;

    “You are referring to new currency; I’m referring to new money, including debt – and would draw particular attention to profit from financing activities.”

    If that’s what you were talking about, then you shouldn’t have referred to the Fed injecting new money, because the Fed creates currency, not debt. The explosion of debt had nothing to do with the Fed.

    You said;

    “Some people would argue that our unwillingness to punish ourselves to discipline finance creates a future problem with credibility/commitment.”

    Why not punish banking directly by revoking “too big to fail,” so that the big banks have to suffer for their sins? What bothers me is that it is my impression that precisely people who want to punish the economy with all sorts of counterproductive regulations are the very people who don’t want to revoke too big to fail. Is that impression correct? I hope it is not correct.

    You said;

    “Re: Republican “sabotage” – it’s not that hard at all. Simply oppose everything,”

    But much of what they oppose are things that will hurt the economy. By opposing them they are actually helping the economy. And of course the Republicans no longer have any power. But again, your argument makes no sense–as it doesn’t explain why the Republicans did not complain about the Fed’s tight money policy between July and November last year, which may have cost the Republicans the White House. The truth is the Republicans were irrelevant in 2008, and are even more irrelevant today. If they stopped cap and trade, it would actually help Obama politically, as cap and trade will be very unpopular.

    You asked:

    “Re: surpluses… It’s not just China… What about South Korea? (50 to 60 billion a year) Brazil? (35 billion) Are these countries also suffering from aged populations?”

    Korea has one of the world’s lowest birthrates, they definitely should be running a big surplus. One the other hand Australia attracts a lot of immigration so they appropriately run large CA deficits. And Australia’s economy has been perhaps the best performing Western economy since 1991.
    Brazil has traditionally been a spendthrift nation, so it is nice to see it finally building up a bit of a nest egg. Well done, Lula!

    You said

    “When the G-20 says the world is dependent on US excess consumption, this is what they mean.”

    This confuses “consumption” with what is sometimes called “absorption.” The US trade deficit in no way prevents the US from adopting pro-saving policies. After those policies we might or might not continue to run a CA surplus. But even if we do, we will have solved our overconsumption problem.

    Regarding infrastructure, I might agree with you, it depends on the details. But Obama has decided not to go that route, and is instead pouring more federal money into housing, health care, etc. Take at look at China if you want to see what an infrastructure program looks like. Obama isn’t even contemplating a major infrastructure program, as after health care there won’t be any money left over–even with tax increases. The Europeans have discovered that the best way to build infrastructure is to privatize it. Their governments also lack the funds. But in America the Democrats are ideologically opposed to the only real hope for revitalize our infrastructure. Hence nothing will get done in the near future. In the distant future I expect the Dems will eventually realize what is happening in the rest of the world and get on board. They will have no choice.

15. Mark A. Sadowski
    13. December 2009 at 09:06
    

    Scott,
    I’ve read a fair amount of your blog from the beginning (through May by now). I think I understand your beliefs quite well, and in fact have found virtually nothing you have written that I disagree with (which is unusual for me). I’m pretty much sold on NGDP futures and NGDP level targeting. In my opinion it is probably time to put the Taylor Rule to rest.

    If prodded I would just say that your approach to monetary economics uses slightly different heuristics than I think is the convention. But I also think that this is not a defect at all but rather a virtue as it has allowed you not to be confounded by the zero lower bound as so many others seem to have been.

    I was just clarifying my opinion of what most Austrians seem to think, and by extension trying to reiterate my agreement with you. I am not at all opposed to creative destruction. It’s just that what the Austrians consider “creative destruction” I consider slash and burn. I think that although they may be well meaning, they are nevertheless extremely dangerous. I have a lot of experience with them, and in my opinion, they are the overwhelming source of the increase in “deflationary politics” in the United States today.

16. MLB
    13. December 2009 at 10:21
    

    Statsguy – totally agree. The US has followed a policy of “do whatever it takes to grow the pie” without thinking about the distribution of the pie. At some point that becomes problematic – I think we’ve arrived.

17. MIke Sandifer
    13. December 2009 at 10:27
    

    Dr. Sumner,

    You replied:

    “Mike, I can’t buy that argument because it assumes these guys were smart enough to know what was going on. And it is pretty clear they weren’t. But I do think that our financial regulations (FDIC and Too big to fail) give banks too much incentive to take risks.”

    I find it hard to believe that the management of these large institutions didn’t know that having 40:1 leverage in some cases and ridiculous levels of 0% down subprime liar loans with ARMs, negative amortization, etc. thought these practices were sustainable. Even given the seduction of complex mortgage derivatives, risk managers were often warning about potential dangers. Sure, the management of these institutions did not understand what the quants were doing, but that so many were willing to believe in these highly esoteric models… Again, I find it far-fetched.

    I would also point out that many of these same institutions cleary committed massive fraud that was exposed in the first half of this decade. Of course, this involved having analysts publically recommend investements that internal communications confirmed were contrary to their judgements. The banks were serving their investment banking clients and engaging in some pump n’dump.

18. StatsGuy
    13. December 2009 at 15:42
    

    ssumner:

    “Why not punish banking directly by revoking “too big to fail,”

    And precisely how would you do that? What would be the proper role of government in such an effort?

    ssumner:

    “precisely people who want to punish the economy with all sorts of counterproductive regulations are the very people who don’t want to revoke too big to fail.”

    In prior posts you wrote:

    “I don’t know much about Australian housing regulation, but I do think we can learn a lot from both Australia and Canada. I would like to see tighter rules on these sub-prime mortgages (zero money down.) I presume the Aussies didn’t get heavily involved in that type of mortgage. That may seem to violate my free market ideology, but since the government is on the hook anyway with deposit insurance and “too big to fail” it makes sense to encourage banks to be more careful.”

    http://blogsandwikis.bentley.edu/themoneyillusion/?p=1937

    Based on this previous post, I had gathered that you were in favor of regulating, since practically we’re “on the hook” with “too big to fail”. Now I’m struggling – what, exactly, is your position here?

19. StatsGuy
    13. December 2009 at 16:00
    

    ssumner:

    “Australia attracts a lot of immigration so they appropriately run large CA deficits”

    We’ll see how Australia does over the next 25 years (the US was growing like mad 25 years ago too while running large CA deficits). South Korea may have a low birth rate (for the region, at least), but if you look at the population growth rate it remains high for the medium term.

    http://en.wikipedia.org/wiki/Demographics_of_South_Korea

    As to Brazil, you seem to be arguing both sides here (older countries need to run surpluses… yay for Brazil running surpluses!) So let me ask – _which_ countries, precisely, _should_ be running large CA deficits (if not young Brazil)? In terms of congratulating “Lula”, recognize that the dominant economics paradigm in Latin America is not, and never was, neo-classicism. Current events in the US have only re-inforced the anti-free-trade import-substituting-industrialization faction. (and, frankly, they might have a strong case).

    If you look at the map of CA accounts,

    http://en.wikipedia.org/wiki/File:Cumulative_Current_Account_Balance.png

    There are only two kinds of net-positive countries: extractive export countries (Russia, Venezuala, Saudis, etc.), and countries with export-focused manufacturing policies (Germany, Japan, China, etc.). Briefly looking at this map, it strikes me that neoliberal trade in an environment with vastly differing propensities to save/consume (often driven by govt policy) is not the panacea that theory tells us it should be.

    ssumner:

    “This confuses “consumption” with what is sometimes called “absorption.” The US trade deficit in no way prevents the US from adopting pro-saving policies.”

    Consumption and absorption are different things, true enough, but the magnitude of the current trade deficit most certainly DOES limit the US savings rate, even if we do adopt _other_ pro-savings policies, which, btw, would mean a massive amount of investment to compensate for the cyclical drop in consumption we’re now experiencing.

    Also, how exactly do you envision the private sector closing the savings/investment gap by itself even while they see consumption declining (unless through some sort of government action)?

    ssumner:

    “But much of what they [Republicans] oppose are things that will hurt the economy.”

    Absolutely. Of course, by opposing everything it is inevitable that you will oppose some things that should be opposed. Much like your opinion of Dr. Doom.

    Several months ago when discussing health care, I asked you to identify the Republican proposal. At the time, they had none – now they have something that is vaguely looking like one. In the meantime, they strongly endorsed the idea of Private Health Care Cooperatives, until many Dems seized this and adopted it, at which point the Reps decided they didn’t like that either.

    You can attack many of Team Obama’s initiatives (I attack most of them), but if you attack _all_ of them without forwarding concrete alternatives, then “obstructionist” is an appropriate label.

    http://washingtonindependent.com/55547/gop-ruling-out-health-care-co-op-compromise

    http://www.cbsnews.com/blogs/2009/10/20/blogs/coopscorner/entry5399746.shtml

20. StatsGuy
    13. December 2009 at 16:03
    

    Quick note: “In the meantime, they strongly endorsed the idea of Private Health Care Cooperatives” – they did not “strongly” endorse, that is an overstatement.

21. StatsGuy
    13. December 2009 at 16:15
    

    ssumner:

    “If that’s what you were talking about, then you shouldn’t have referred to the Fed injecting new money, because the Fed creates currency, not debt. The explosion of debt had nothing to do with the Fed.”

    I did not say the Fed… I wrote: “monetary policy served as an engine for this by injecting money into the economy”

    By monetary policy, I include things like capital/asset ratios and other regulations that govern and directly influence the creation of debt (which functions in many ways as private money). Moreoover, the Fed does not _directly_ create debt, but by setting expectations for future currency and therefore price levels, it (when it chooses) rather strongly influences the rate of debt growth. Financial entities have become the preferred mechanism of money supply growth, rather than more direct mechanisms like seignorage, and this has implications for the stability of the system.

22. ssumner
    13. December 2009 at 17:48
    

    Mark, My apology. I misread your comments as directed at me. I now see that it was directed against Austrians. I sometimes read to fast, as there are many comments.

    MLB, If we are trying to “grow the pie,” we are doing a pretty horrible job! I would argue that those who are “left out” actually do much better when the pie is growing than the pie is shrinking. How did the working class do under FDR? How about Coolidge?

    Mike, You said;

    “I find it hard to believe that the management of these large institutions didn’t know that having 40:1 leverage in some cases and ridiculous levels of 0% down subprime liar loans with ARMs, negative amortization, etc.”

    I find it hard to believe the management of these banks would have bought $100s of billions of MBSs in 2006 and 2007 if they thought they were bad investments. I’m not disagreeing with your argument that banks took too many risks. It is just that I see the cause as bad regulations, and the refusal of Congress to contemplate any offsetting good regulations.

    Statsguy, If you want to get back at the bad guys, a good place to start would be by ending the practice of bailing them out when they get in trouble. The US government’s role is to operate bankruptcy courts. But of course the most useful thing the government could do would be to end its deflationary monetary policies, which is the primary cause of the banking crisis.

    My first best policy would be to completely remove government from any role in banking. But if they insist on creating moral hazard with FDIC and TBTF, then a second best policy is to require 20% down payments. Of course we will continue with the bad regulations, and there is no chance the Congress would require 20% down. What’s third best? Who knows?

    Statsguy#2: You said;

    “South Korea may have a low birth rate (for the region, at least), but if you look at the population growth rate it remains high for the medium term.”

    This assertion is directly contradicted by the link you sent me to defend the assertion. The link says:

    According to a 2006 study completed by the National Statistical Office, South Korea’s population will peak at 49.3 million in 2018 and then start to decline due to the country’s low birth rate. South Korea has the lowest birth rate in the developed world, with an average of 1.08 children per woman. [1]

    The current population is close to 49 million. I am mostly playing the devil’s advocate with CA deficits. When I lived in Australia in 1991 everyone seemded to think the country was going down the drain because of CA deficits. Since then they have only gotten “worse”. I just don’t see the downside. Indeed I don’t see how the US has been hurt by its CA deficits. Have we been hurt by a low savings rate? yes. Have we been hurt by deflation? Yes. But a CA deficit? I just don’t see how it has harmed our economy.

    You said;

    “There are only two kinds of net-positive countries: extractive export countries (Russia, Venezuala, Saudis, etc.), and countries with export-focused manufacturing policies (Germany, Japan, China, etc.). Briefly looking at this map, it strikes me that neoliberal trade in an environment with vastly differing propensities to save/consume (often driven by govt policy) is not the panacea that theory tells us it should be.”

    Does Germany have export-focused manufacturing policies? And would you recommend Saudi Arabia avoid CA surpluses?
    I just think people worry too much about this issue. Nobody in their right mind would regard trade as a panacea. How well contries do depends on lots of factors, and trade is only one. But deficits just don’t seem that important. Some US states run consistent CA deficits with other states. Is that also important? If so, why? My state (Massachusetts) has lost much of its manufacturing base to the South. Was that our loss? Or our gain?

    You said;

    “Consumption and absorption are different things, true enough, but the magnitude of the current trade deficit most certainly DOES limit the US savings rate, even if we do adopt _other_ pro-savings policies, which, btw, would mean a massive amount of investment to compensate for the cyclical drop in consumption we’re now experiencing.”

    No, we can increase our saving rate with suitable policies. The CA is endogenous. It will adjust to changes in saving and investment.

    You asked:

    “Also, how exactly do you envision the private sector closing the savings/investment gap by itself even while they see consumption declining (unless through some sort of government action)?”

    I am not interested in closing any “gaps” of any sort. I am interested in boosting saving. If there is still a S & I gap after saving increases, that is fine with me.

    I have to admit that I don’t follow Republican policy initiatives very closely. All I know is that Bush favored greatly expanded Medicare, and also HSAs. He got the greatly expanded Medicare, but not the HSAs (or at least not very much in the way of HSAs.) In general, I don’t think much of the Republicans these days.

    Statsguy, I don’t consider debt to be money, nor do I consider regulation to be monetary policy. But if that is your definition then perhaps you are right. I had thought that Basel standards, etc, were requiring higher capital ratios, but that banks kept finding ways around those regulations. But that is just my impression, I haven’t studied the issue closely.

23. StatsGuy
    13. December 2009 at 18:39
    

    S. Korea… I would consider 2018 medium term, but the growth does flattens as we approach it. On the other hand, S. Korea has run large surpluses since 1998. So that would represent 20 years of savings, which I think would be fine so long as it disgorges that savings to fund consumption fore retirees…

    One would think Japan ought to follow such a model (in which case it would be dissaving now to fund consumption), except that it hasn’t. I suspect S. Korea will follow Japan’s path in terms of national savings rate. And, yes, that is a problem given the current international trade/finance regime.

    How should it be run? An efficient solution would probably require an international monetary authority of some sort… Which, of course, means black UN helicopters.

    I suppose I do view CA and national savings rate as intrinsically linked (though I’m not stating the direction of causation). Soros and Buffett have both reiterated that view as well.

    http://www.freerepublic.com/focus/news/1053684/posts

    http://bigthink.com/georgesoros/george-soros-on-americas-new-engines-of-growth

    I absolutely agree that the mechanism for intervention should focus more on savings than directly reducing the trade gap (though I also suspect that proper devaluation of the dollar would in the long run do both).

    “If there is still a S & I gap after saving increases, that is fine with me.”

    I remain concerned about a savings/investment gap in a “global savings glut”, and I recognize that this is a distinctly Keynesian issue. It is, I think, the strongest of all the Keynesian points – but the one we are currently least focused on in public debate. While there is _some_ level of monetary stimulus that would close that gap enough to prevent mass unemployment (either by decreasing savings or increasing investment), I suspect that without some sort of policy intervention to encourage savings (vs consumption), the short term time horizons in this country would favor consumption.

    So, in a sense, if you being with the presumption that monetary policy will be run intelligently (which means there is no meaningful gap) then policies that boost savings and those that boost investment are quite similar.

24. StatsGuy
    13. December 2009 at 19:06
    

    Basel:

    Actually, many blame Basel for the problems. By splitting up bank capital into risk tiers, this created massive incentives for banks to use structured vehicles (like SIVs or CDOs) to engineer lower risk to be able to load up more on leverage. All things equal, banks preferred a better official risk tier. Some would argue the original goal of this was to drop the rates on govt debt (which was presumably safer) by relaxing capital standards for holding (highly rated) govt. debt.

    The “inevitability” that financial engineering would find ways to take advantage of this is questionable – as you yourself have noted when commenting on Canadian banks and regulators. Also, the view that bank regulation _is_ a form of monetary policy is connected to the view of “debt as money”, particularly since 1995, when innovations like sweeping made reserves less meaningful and shifted the limit on loans to capital asset ratios. Certainly _something_ changed ~1995.

    http://research.stlouisfed.org/fred2/series/m1
    http://research.stlouisfed.org/fred2/series/m2
    http://research.stlouisfed.org/fred2/series/m3

    Here’s one view I’m sympathetic to:

    http://www.econ.utah.edu/activities/papers/2008_16.pdf

    Anyway, I’m sure you have better things to do…

25. MIke Sandifer
    13. December 2009 at 19:57
    

    Dr. Sumner,

    Regarding banks and moral hazard, from my position there’s no such thing.

26. MIke Sandifer
    13. December 2009 at 20:02
    

    I forgot to add though,that it was a good point you made about banks keeping such large positions in these junk securities themselves. it’s definitely conistent with incompetence rather than purposeful neglect.

27. Bonnie
    13. December 2009 at 20:24
    

    There seems to be an automatic assumption that the bankers were the villains in the financial/debt crisis, but I have a slightly different take on it. To me, they were partners in “crime” with governmental entities, with the govt having the slight upper hand. It has to do with the incentive structure built primarily for Fannie and Freddie, that leaked out into wider use, in order get enough private financing for sub-prime to meet housing targets that were set by policy.

    First there’s the securitized mortgages that were first put together with Fannie/Freddie and Bear Sterns back in the mid-90’s. Then there’s CRA ratings, and mortgage clearinghouses that allowed originators to ditch risk. The risk premium structure, how much capital that is required to cover bad debts based upon type of loan, is probably a huge factor in the crisis, especially if an institution was purchasing MBS’s from the GSE’s. The rules were skewed in favor of lending to the government with that type having a 0% risk premium, and the MBS’s that went through the GSE’s were rated the same as government bonds, which was completely ludicrous. Hence, the institutions that were involved in sub-prime, especially ones that were joined at the hip with the GSE’s did end up leveraged up to 40:1 with regulators seeing no evil.

    I understand how a 0% risk premium on lending to the government would make sense from a view of safety and soundness, but where GSE’s are concerned it’s just packed full of unintended consequences like all the classic stuff involving misallocation of capital, but also in regard to what happens when the government leaves the financial institutions holding the bag when the correction comes along.

    In a political sense I wanted nothing to do with bailing out anyone. But with a little bit of high level knowledge about how many of them ended up out on a limb, it presents a moral quandary and requires more investigation before I can decide who the bad actors really are rather than just painting the whole thing with a broad evil brush. It would have been nice if financial institutions never took the bait but the promise of super-sized helpings of gravy on AAA securities backed by assets that “could never devalue” was just too good of a deal to pass up. It would also have been nice if the massive amounts of capital they dumped into sub-prime mortgages based on the promise of a nearly free lunch had gone to more efficient uses instead.

    My opinion is that the economic problems we have are more than likely symptoms of very large political problems, besides anything to do with the Federal Reserve. Even that, however, is an example of how far too many things are politicized to the point of being beyond rational or anything that can actually be of positive benefit to society. The government is way beyond the point of being able to ask an essential question, “Yes, we can. But should we?” To point at the bankers as being the source because they’re evil is really just looking at the surface of the here and now, and just for this one problem rather than also considering the chain of events that brought us here. With that in mind, I hope that the backlash against statism turns into a swell of individualism that might actually have a positive impact on our economic future by resizing the government to a nice fit instead of XXX-L.

28. Doc Merlin
    13. December 2009 at 23:57
    

    “I understand how a 0% risk premium on lending to the government would make sense from a view of safety and soundness”

    There isn’t a 0 risk premium on lending to the government.
    Four reasons why there isn’t a 0 risk premium on T-bills:

    1. They can always inflate or default.
    2. If you are sure there is no risk of default, you still have the same inflation risk premium as cash.
    3. You bear risk due to it being less liquid than cash and changing in price during its maturity term. If you need to convert to cash, for liquidity reasons, you have to sell the bonds on an open market. The price of bonds may have dropped during that time, if it did, you lose money.
    4. Also, since by far the largest buyer of government debt is the central bank, the prices for the debt don’t actually reflect market prices entirely.

29. Scott Sumner
    14. December 2009 at 06:37
    

    Statsguy, Throughout history exogenous devaluations have almost always failed to reduce trade gaps, for the simple reason that they don’t address the core issues. Instead, countries that go that route tend to get higher inflation, and their real exchange rate goes back to where it was before. You cannot address long term real problems with monetary policy, for the simple reason that money is neutral in the long run.

    Of course if other factors push a country toward a lower trade gap, there may be an endogenous fall in the exchange rate.

    Regarding savings “gaps.” If monetary policy is run well, it won’t be a problem. If monetary policy is not run well, no other policy can fill the gap (as we’ve just seen with the failure of fiscal stimulus.)

    Statsguy#2, Of course Basel didn’t work, but to me that shows that regulation is unlikely to solve these problems if you have a bad system in place. All I hear out of Washington is discussion of more Basel-type fixes, adjusted for what we have learned from this crisis. But the next crisis will be different. We are not getting to the root of the problems, because those fixes would be too controversial.

    Canada is far from perfect, but I don’t see their advantages as being primarily due to regulation, but rather structure. The never went for the highly decentralized approach that we used, and which led to the bank failures of the Great Depression. I seem to recall that they didn’t even adopt deposit insurance until 1967, so that there is a much more conservative banking culture in Canada. Unfortunately I have a bad memory, but I am pretty sure that they lack all the US policies that try to push up the fraction of American’s that own homes. Does anyone know whether interest is tax deductible in Canada? I seem to recall they also lack a Fannie and Freddie. Is that right?

    Mike, I thought you were arguing for moral hazard. Wasn’t your argument that they were taking too many risks.

    Bonnie, I entirely agree with your comment. When I said the bad guys needed to be punished, I was really saying the “bad guys” needed to be punished. I.e. those perceived as bad. Thus if banks took on excessive risk and lost, we need to let them fail. But from a moral perspective the problems run all through our system, including the supporting role of the various government agencies. In my view if we had complete laissez-faire in banking, plus NGDP targeting, our financial system would be far more stable than it is now.

30. StatsGuy
    14. December 2009 at 07:56
    

    “Throughout history exogenous devaluations have almost always failed to reduce trade gaps”

    I’m not arguing for exogenous devaluation – I’m arguing for proper devaluation, which means removing the artificial supports that are propping up the value of the dollar, and letting the dollar seek its natural value. And history suggests that currencies which are artificially supported for long periods of time (without controlling the trade balance) can cause excess consumption. This was precisely why mercantilists used high tariffs in combination with high currency valuations – as a mechanism of forcing domestic underconsumption/savings while keeping favorable terms of trade for commodity imports. The cost of this forced savings is deadweight loss, but mercantilists were more concerned about national power than consumer surplus.

    I agree that if you assume monetary policy is run correctly, then the choice of policies to support savings vs. directly support investment becomes a choice about structural factors related to government/private investment mechanisms. There is a separate question about whether crisis are necessary to get government to reform structural problems, but that’s basically arguing that crises are functional.

31. Doc Merlin
    14. December 2009 at 08:32
    

    In a short answer? Yes.
    Look at GM and Chrysler, their sales went way down after they were bailed out, but Ford’s went way up. Part of this effect though may be due to government mismanagement forcing them to close down so many profitable dealerships.

32. Scott Sumner
    15. December 2009 at 07:31
    

    Statsguy, Well, I think I can agree with those remarks.

    Doc Merlin, I think you have the dealerships issue backward. The auto firms have wanted to close dealerships for a long time, it was the government that didn’t let them, Once the crisis hit they were allowed to close some. These dealerships were profitable for the dealers, but not the auto companies. For many years the dealers had enough political pull to get regulations preventing the auto companies from closing them down.

33. MIke Sandifer
    15. December 2009 at 11:21
    

    Dr. Sumner,

    You replied:

    “Mike, I thought you were arguing for moral hazard. Wasn’t your argument that they were taking too many risks.”

    Well, given my notion that bank executives benefitted more from bonuses than from the health of their banks, the moral hazard argument is rendered moot. Banks have been failing due to excessive risk taking for a very, very long time. Of course, I stated my idea about the reasons.

    However, your reply that reminded me that many of the banks kept large positions of these assets on their books has me thinking twice. That being the case, there may have been incentives for keeping those toxic assets on the books. Perhaps because they had AAA ratings and it helped their balance sheets?

34. Scott Sumner
    15. December 2009 at 18:29
    

    Mike, I seem to recall that Charles Calomiris recently argued that banks actually pressured the rating agencies to give these dubious bonds a triple A rating. Then the banks could use these bonds to satisfy the regulators. So the problem at the rating agencies may have been the opposite of what most of us assumed, not the sellers of these bonds but the buyers. Perhaps you could find the Calomiris paper on the internet.

35. Doc Merlin
    15. December 2009 at 18:57
    

    @Scott:
    I didn’t know that about the dealerships. Good to learn.

    @MIke:
    “Perhaps because they had AAA ratings and it helped their balance sheets?”

    Yes, the reserve requirement was way too high, so banks “cheated” by putting AAA assets on their balance sheets as a way to get more reserve that they could multiply. Because those assets were marked to market, when the market price fell, their balances imploded. No retail bank was actually insolvent, what happened was they became over-leveraged (past the point the FDIC allowed) after their asset values collapsed. There really wasn’t any “bank runs” or anything of the sort. It was more of an asset collapse combined with strict regulatory policy that caused the “failures”.

36. MIke Sandifer
    15. December 2009 at 20:07
    

    Dr. Sumner,

    I am familiar with Calomiris, but just found his working paper on the subject. Thank you. Perhaps you can guess I’m not surprised by his conclusions and recommendations. I notice also that he’s authored some papers on the history of banking.

    Of course, without some smoking gun e-mails or something similar, I’ll never know if these institutions failed primarily due to improper incentives. However, if Enron executives, just to use an exemplar, were willing to commit serious felonies, including fixing the energy market in California, then why wouldn’t at least some bankers let their institutions implode in the interest of legal personal profit? Unforutunately, it is usually more profitable to bet against human virtue.

    Doc,

    Yeah, there’s a reason why people hate bankers, lawyers, and politicians.

37. Doc Merlin
    16. December 2009 at 03:44
    

    “Monetary policy was much more expansionary in the 1960s, 1970s, and 1980s, than in the last two decades, but it was the last two decades that promoted bubbles.”

    1. For bubbles in specific assets as opposed to general ABCT cycles, what matters more than how much money is created is who gets the money first, and the regulatory policy. You need to look at the microeconomic incentives formed by legislative and regulatory policy for asset bubbles.

    2. Central bank money not being expansionary enough + high reserve requirements also causes bubbles, due to banks needing to increase reserve requirements so taking subpar assets for their reserves instead of cash.

    3. I don’t agree that there weren’t bubbles before this.
    This paper from 1994 describes a few of them and the microeconomic incentives that lead to them. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=227162

    The only difference is that old bubbles weren’t called bubbles, but rather scams or “bad investments.” A big difference is that most of yesteryear’s bubbles in the US were financed by private entitles but this bubble was financed by the fed, and two corps that may as well have been federal agencies.

38. Scott Sumner
    16. December 2009 at 05:55
    

    Mike, My hunch is that the truth is somewhere in between. They didn’t take steps that they thought would ruin their institutions, but they took some “heads I win, tails I lose some but the taxpayers pick up part of the tab” bets. So they definitely had some incentives that were partly out of line, I just think it is to simple to say they knew these bonds were bad, there is just too much evidence that quite a few smart people and banks were investing in then fairly late in the cycle. I gather that some of the very smartest (like Goldman Sachs) avoided the worst excesses.

    I think although some individuals who did bad things retired wealthy before the roof collapsed, a more realistic appraisal notes that life goes on for these investment banks, and most people in them weren’t near retirement. I think many of them now regret what they did, as they cost their firm and themselves a lot of money. So the truth is somewhere between the two extremes.

    Doc Merlin, I meant really big bubbles. The previous post-WW2 bubbles weren’t so mind-boggling big.

    You said;

    “1. For bubbles in specific assets as opposed to general ABCT cycles, what matters more than how much money is created is who gets the money first, and the regulatory policy. You need to look at the microeconomic incentives formed by legislative and regulatory policy for asset bubbles.

    2. Central bank money not being expansionary enough + high reserve requirements also causes bubbles, due to banks needing to increase reserve requirements so taking subpar assets for their reserves instead of cash.”

    OK, but these sorts of qualifiers suggest to me that central bank actions have relatively little explanatory power, and the other factors have relatively more explanatory power. If you can’t correlate bubbles with monetary policy alone, you need a much more sophisticated argument to tease out the specific monetary effects. I remain unconvinced, except for the point that obviously a big run up in prices is more likely in an inflationary environment than a deflationary environment.

39. Doc Merlin
    17. December 2009 at 10:37
    

    “Doc Merlin, I meant really big bubbles. The previous post-WW2 bubbles weren’t so mind-boggling big.”

    1. Previous to ww1, long term inflation was tiny. Except during wartime.

    2. Demographics is important, if population is expanding rapidly, my intuition tells me they should be able to soak up some of the bad effects of a bubble. I’ll have to think of this further.

    3. The food bubble in 1919 was pretty large, and also global. The late 1920’s securities bubble was also pretty huge.

40. ssumner
    18. December 2009 at 07:36
    

    Doc, But those aren’t post-ww2

41. Doc Merlin
    18. December 2009 at 08:22
    

    Ah! I misread what you said 🙂
    Anyway, the Demographics point would still stand due to the baby boom.
    Also, I would argue that the 70’s gold bubble was pretty huge, at least in the US.

42. ssumner
    19. December 2009 at 11:53
    

    Doc, Yes, but gold and silver don’t affect the macroeconomy the way stocks and real estate do.

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