The Balcony Box

Commentary on global economic theatre

2010 and Beyond

Julius, 3 January 2010

The next ten years will be perilous.  As much as it did the Aughts, one word will define the Teens: volatility.  In my opinion there are three large risks to the world economy over the next ten years:

  1. Cascading currency crises
  2. Cascading sovereign defaults
  3. Geopolitical conflict

These risks are all interrelated, so the likelihood that one occurs and the others do not is slim.  The sad fact of the matter is that as we enter the Teens, we have no comprehensive way to deal with the debt overhang that is now plaguing the public sector.  Of course, a private sector that wasn’t overleveraged could conceivably shoulder the load and grow the economy by leveraging up and relieving the strain on the public sector.  Alas, we are all tapped out.

I personally expect that quantitative easing will continue intermittently (causing great volatility in the process) until some currency or government blows sky high.  Then the real fun begins.

Why be productive when you can speculate?

David, 22 December 2009

According to the Telegraph, hedge fund David Tepper’s compensation this year will be about $2.5B.  Of course, Tepper’s fund creates nothing useful for anyone, it simply expropriates value from the rest of society.  This is inequitable, wasteful, and, at a time when many Americans are struggling to put food on the table, morally reprehensible. Yet there appears to be absolutely no political will to get speculation and speculative profits under control (admittedly, it’s probably not surprising given the influence of the financial oligarchs in Washington).

Whither California?

David, 19 November 2009

According to today’s Mercury News, California’s budget deficit will far surpass preliminary estimates.  The Legislative Analyst’s Office is predicting a deficit of $6.3B in FY2009-10, followed by deficits of about $20B for the next five years.  Through FY2014-15, the predicted deficits total $109.7B.  (Note: that’s almost as much money as six major U.S. banks put aside for bonuses in the first nine months of 2009.)

At least the state is investing in education!  Oh, wait…
UC regents recommend 32 percent fee hike

This cannot go on much longer.

Minsky’s employment strategy

David, 18 November 2009

In his post below, Julius argues that the government should reflate by providing guaranteed employment rather than by using quantitative easing to sustain inflated asset prices.  I couldn’t agree more, and Paul Krugman has also suggested that the government consider programs that create jobs directly:

You can make a pretty good case that just employing a lot of people directly would be a lot more cost-effective; the WPA and CCC cost surprisingly little given the number of people put to work. Think of it as the stimulus equivalent of getting the middlemen out of the student loan program.

Given how many people have been turning to Hyman Minsky’s magnum opus Stabilizing an Unstable Economy for insight about the financial crisis, it’s surprising that government job-creation programs haven’t been part of the policy discussion (at least as far as I can tell).  Such programs are actually a central component of Minsky’s policy recommendations.  Of course, the recommendations start on page 319 of an admittedly turgid volume, so perhaps most readers had given up by that point.  I think it’s unfortunate that Minsky’s ideas haven’t been given more attention, since they could be exactly what we need.

Minsky’s employment strategy seeks to “achieve a close approximation to full employment” without causing “instability, inflation, and unemployment” (p. 343).  He proposes that the government act as the employer of last resort by creating an unlimited supply of jobs at a low, non-inflationary wage.  These jobs could be created within the New Deal framework of the Civilian Conservation Corps (CCC), the National Youth Administration (NYA), and the Works Progress Administration (WPA); Minsky offers detailed proposals on pages 345-6.

The beauty of Minsky’s approach is that, by setting wages at a low level, the programs neither create inflationary pressure nor crowd out the private sector.  When private sector demand for labor rises, workers will happily leave the government programs to take better-paying private sector jobs.  The approach also promises to develop human capital and prevent the skill loss and suffering associated with prolonged unemployment.  Minsky summarizes the approach as follows:

It is envisioned that WPA, NYA, and CCC when fully developed will, together with normal government activity and private employment, provide income through jobs for all who are willing and able to work.  These permanent programs will provide outputs–public services, environmental improvements, etc. that a transfer-payment government does not yield, as well as the creation and improvement of human resources.  In our urban centers, where there are concentrations of unemployed and welfare recipients, the improvement of the public environment should be marked.  WPA, CCC, and NYA will succeed precisely because they are job programs that perform useful tasks and yield visible outputs. (347)

Why not set these programs up as entrepreneurial ventures, owned and administered by the government, that compete for resources (new employees), thereby creating performance incentives and developing entrepreneurial skills?  Call them the Works Progress Entrepreneurs.  Perhaps some public-spirited, newly minted MBAs would be willing to help get the program up and running before moving on to lucrative careers on Wall Street.

A Better Way to Reflate

Julius, 15 November 2009

Those who know me know that since the beginning of this crisis, I’ve been in the Stiglitz/Johnson/Galbraith/Krugman/Calculated Risk/et al. camp, advocating for a restructuring of the banking system.  I believe that only through a restructuring of the debt loads plaguing the private sector could the system be reset to support sustainable economic activity and growth.  However, such a course of action involves short-term pain and negatively impacts the banking sector’s interests, therefore it was not tried for lack of political will.

That leaves reflation.  But is the course of action we’ve taken in the U.S. the best way to reflate?  If I may summarize the current response in a nutshell: the Fed has lowered interest rates and supported asset prices through massive QE and a variety of lending programs, while the federal government effected a weak, temporary, and fragmented fiscal stimulus program.  This has led to the worst of all possible worlds: assets that are discounting a highly unlikely stream of income, and worlwide bubbles.  Deflation is still entrenched, inflation is an unpredictable institutional risk, and economic and financial crashes are likely–especially in the emerging world.

What should they have done?  I’d argue essentially the opposite: the Fed should have considered vastly limited asset price support and stuck with moderate interest rates, and made sure that long term rates were also moderately high.  At the same time, the federal government should have instituted a massive, durable, and targeted stimulus program, perhaps 3-5 times the size of the current one and including a guarantee work program, as suggested by Galbraith.  The money for this project would have come from printing money to limit the real cost to the government.   Done deftly this would have limited the likelihood of bubbles, while allowing income to justify asset values.  Debts would be repaid and slack taken up, but new debt growth and new business investment would have been limited.  The overleveraged condition of the private sector would have thus been remedied and asset prices would be supported (albeit at lower multiple levels).  Sustainable economic activity and growth would resume. 

I believe that there is still time to institute this latter reflationary policy.  The Fed need only start raising rates into the expansion of a massive government stimulus policy, while printing money to cover the cost.

Green light for the dollar carry trade

David, 4 November 2009

From Bloomberg:

The Federal Reserve repeated it will keep interest rates near zero for “an extended period” and specified for the first time that policy will stay unchanged as long as inflation expectations are stable and unemployment fails to decline.

It would be a reasonable policy if it were coupled with capital controls to keep the easy money from wreaking havoc around the world.  No such luck, of course.

Roubini and WSJ on The Next Bubble

David, 4 November 2009

The Next Bubble appears to be expanding more quickly than I expected.  From Roubini’s comment “Mother of all carry trades faces an inevitable bust” in the Financial Times:

… the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles.

… the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall.

Of course the carry trade to which Roubini refers is the dollar carry trade.  Rhetorical question: why can’t the Fed and other policy-makers see this?  You’d think they’d be pretty familiar with how bubbles work by now!

The Wall Street Journal has more color in an article today entitled “Fears of a New Bubble as Cash Pours In“. A few tidbits:

The World Bank warned Tuesday that the sudden reappearance of billions of dollars in investment capital in East Asia is “raising concerns about asset price bubbles” in equity markets across Asia and in real estate in China, Hong Kong, Singapore and Vietnam. Also Tuesday, the International Monetary Fund cited “a risk” that surging Hong Kong asset prices are being driven by a flood of capital “divorced from fundamental forces of supply and demand.”

As far as I’m aware, the World Bank and the IMF aren’t given to hyperbole.  The facts appear to back them up:

Singapore home prices rose 15.8% in the third quarter, the fastest rate in 28 years. …

The Australian dollar has jumped about 35% over the past 12 months as investors borrow in U.S. dollars to purchase Australian currency. …

Through Monday’s trading, the broad MSCI Barra Emerging Markets Index this year was up 60.7%. Brazil was up 100%, and Indonesia had gains of 102.7%.

I doubted–and still doubt–whether the Fed could rescue the U.S. economy with another massive bubble. The housing bubble was so large and put so much money directly into the pockets of mainstream American that it’s hard to imagine a replacement.  It looks like the Fed is going to try anyway, creating asset bubble around the world.

Government Domestic Product

Julius, 31 October 2009

Unlike some, I don’t believe that government spending and investment is necessarily a bad thing.  Government spending and investment can create productive jobs and it can create sustainable economic activity.  In this sense,  I view government as analogous to the private sector: some investments are duds, some are hopelessly inefficient in terms of labor and capital, and some are spectaculor hits.

My biggest concern with government as an economic actor is that our political process often frustrates wise spending and investment.*  Since in my opinion the best government spending and investment programs need to be (a) durable, (b) targeted, and (c) large, our political system–with its frequent bureaucrat turnover, partisanship, and need for compromise and back-scratching–generates programs that are (a) temporary, (b) fragmented, and (c) watered down.

That is why I view the current government-generated global growth with skepticism.  I have seen no evidence that suggests that this growth has provided a base from which a new economy can flourish.  It appears to be a mish-mash of efforts in the form of the prior economic order–an economic order that didn’t appear to be sustainable.  Suffice it to say that I have my doubts about the global economy as government efforts slow down in the face of inflationary and fiscal concerns. 

 

*Yes, it is also true that the government is not solely motivated by profit-seeking behavior.  But I see this as a good thing: economies are not just about profits, but about fairness and justice.  I believe that government can act as a reasonable economic counterbalance to hyper-profit-seeking firms.

Cutting our way to growth?

David, 29 October 2009

In the most recent issue of BusinessWeek, Michael Mandel notes that GDP statistics ignore intangible R&D investments. In the article, entitled “The GDP Mirage“, Mandel argues that companies are cutting these investments in order to boost reported earnings and please Wall Street. The article has a lot of interesting data. For example:

many companies have taken a deep ax to their reported R&D spending, which also doesn’t show up in GDP. Alcoa (AA), in an effort to preserve cash, reduced its third-quarter R&D spending by 36% from the year before. “It’s a matter of focusing on your priorities,” says Alcoa spokesman Kevin Lowery. “We surprised people by announcing a profit [last] quarter.” Texas Instruments (TXN), meanwhile, expects to spend $1.5 billion on R&D in 2009, down 20% from 2008, owing to workforce reductions and cost-control efforts. And Johnson & Johnson (JNJ) has reduced its R&D by 13% over the past year.

As revenues fall, companies including Microsoft and Motorola are boosting profits by laying off thousands of employees.

Good luck with that recovery.

Next bubble well under way?

David, 28 October 2009

Massive fiscal stimulus and the dollar carry trade, perhaps among other factors, appear to be inflating bubbles in China and elsewhere.

This was buried deep in Michael Pettis’s latest post at China Financial Markets:

I spend a lot of time talking to large hedge funds and institutional investors – with at least three or four one-on-one meetings a week – on China and market conditions. It worries me that recently I have heard investors say many times, generally very sophisticated investors, that we are clearly in a bubble and the best strategy is to ride it out as long as we can. This has almost become one of the mantras of sophisticated investors – the less sophisticated, I guess, assuming that the crisis is safely behind us.

Certainly the dramatic recovery in emerging market equities seems consistent with the new global bubble hypothesis.

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