The visible hand in economics

Archive for the ‘US economics’ Category

I have to admit that I am confused. The US wants to pump a bunch of money into the economy in order to get consumers borrowing again – why?

I thought that one of the primary issues was that the US consumer has borrowed too much in the past, supposedly to make up for a “glut in savings”. This had to give way at some point surely.

Of course the Fed and the US Treasury should be looking at loosening credit constraints that have appeared – but are they there. Megan McArdle was able to get hold of a good number of credit cards, and as I noted there seems to be some “throwing of funds” at consumers in LA at least.

Now, businesses over there (and potentially here) are suffering from credit constraints – so why doesn’t the Fed and Treasury work on loosening the constraint on business borrowing, instead of trying to knock down mortgage rates. Businesses that haven’t shut down don’t lay off all their staff!

So the deposit insurance schemes being introduced around the world have the explicit aim of “saving the world economy from Armageddon”.  Even so, when I spent a couple of weeks in the US I got the distinct impression that this scheme will lead to more (even more substantive) issues down the track.

Here is a list of interesting things I heard on Ads (or saw on billboards) in the US:

  1. Now, thanks to the deposit insurance scheme, we don’t have to check your credit (Ad),
  2. The world is America’s ATM (Billboard),
  3. Need a $200,000 loan to start a business – with no credit check? (Ad).

Add to this the already poor nature of savings in the US, and the fact that there is no individual responsibility in the housing market or even in the realm of taxes (every third ad is either about getting a lawyer to lower your taxes or getting a lawyer to push the government to give you extra benefits).

Ultimately, I think the US has some structural issues that need sorting – trying to keep consumers borrowing to maintain short-term growth feels like the government is creating a ponzi game in favour of the initial consumers that were involved.

The paradox of thrift is one of the key lessons taught to macroeconomics students during their first undergraduate year.

Fundamentally it states that if everyone in society decides to save more right now, then it reduces consumption, with reduces economic activity and thereby incomes – and as a result it may actually decrease aggregate savings, and it will definitely reduce economic activity.

It is still widely applied, with recent Nobel prize winner Paul Krugman appealing to it in order to explain why the US needs to jump on in and get consumers spending again.

Of course this does not mean the theory is necessarily right. The paradox of thrift does not have a supply side – as long as prices and quantities can adjust to an economic shock this paradox, and the suggestion of government intervention in the face of it, does not hold water. For government intervention to be a possible solution we need a MARKET FAILURE, a market failure that causes a special macro-economic situation called “demand deficiency”. (Note: This is effectively the difference between Say and Keynes).

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Following today’s terrible house price figures (I don’t have to see them to know they would be bad :P ) I thought it would be appropriate to go back to the comparison of NZ (and Aussie) to the US – at least for housing.

Greg Mankiw links to an article in the Wall Street Journal.  Read this:

When Australians borrow money to buy a house, they know that if they default and the mortgaged property doesn’t cover the debt, they will be responsible for the shortfall. And the lender will chase them for it. It’s a neat way of reminding Australians to borrow responsibly.

In America, where populist post-Depression laws in many states have mandated loans be nonrecourse, the opposite is true. Americans can take out a mortgage more or less as a one-way bet. If you can’t afford the repayments and can’t refinance, you just send the keys back to the bank. Borrowers wipe their hands of liability.

Surely hearing how moronic lending practices are in the US makes us all feel better about the relative outlook for our banking and housing sectors.  Although I bet to spite me that a major Aussie bank has gone bankrupt while I’ve been out of the country ;) (again this was written on Sunday Nov 2)

Greg Mankiw has blogged about young voters abandoning the republican party in the recent Presidnetial election, citing this graph from Andrew Gelman

When discussing why he thinks this happened he cites anecdotal evidence from talking to undergrads at Harvard that

It was largely noneconomic issues. These particular students told me they preferred the lower tax, more limited government, freer trade views of McCain, but they were voting for Obama on the basis of foreign policy and especially social issues like abortion. The choice of a social conservative like Palin as veep really turned them off McCain.

I found this interesting as I generally fall into the same category, my utility function probably places a greater weight on social and foreign policy issues then economic issues. Since there is such a gulf between the democrats and republicans on social issues I generally tend to vote democrat in the US.

On the other hand, (despite what the parties say!) we don’t have anywhere near as much of a politcal divide on social issues in New Zealand so I generally vote based upon economic policies. Which, as you will have seen from our TVHE political quiz results, means I usually vote National.

As an aside, isn’t it random that a “Red State” is a Republican state when red is the socialist colour? According to my good friend wikipedia this just happened by accident and was a result of the the US news stations.

Agnitio:Votes blue in both countries

Complaining about inflation now may seem to be similar to the captain of a boat complaining about pushing the engine too hard when the ship is sinking – but I’m going to do it anyway ;)

Bank in September Fred Mishkin wrote an article for the Wall Street Journal (ht Economists View and Greg Mankiw).  In it he mentions that the concern should not lie with headline annual growth in the consumer price index, but a more generalised and persistent increase in the price level.  Looking at core inflation, nominal wage growth, and the such in the US indicates that they are not truly suffering from an inflation problem.

Heading into the recent crisis this still seemed to be the case.  The October NBNZ Business confidence survey (which I will discuss tomorrow) still had elevated inflationary pressure, and I suspect the labour market data we have seen today and back on Monday (note that I haven’t seen this data when I wrote this) would indicate a strong inflationary undercurrent.

The truth is, even with a drastic slowdown in domestic economic activity, there is the risk that some form of underlying inflation mark-up is occurring during the wage negotations of the firm and the price setting behaviour of other firms.  I think this is evident in changing marketing strategies – with a “fixed price contract” now seen as an amazingly special deal by electricity retailers.  Purging this from the economic environment is difficult and costly – and is the ultimate cost of loose policy over the past six years.  If our recession is deeper than that experienced by the rest of the world, we can probably put it down to a historical failure by our central authorities.

The US may be able to relax about inflation – but we still can’t :(

It’s good to know investment bankers still have a sense of humor. I just these jokes in an email from some friends in finance. From the Wall Street Journal apparently.

Given that a major NZ investment bank has just had a large culling of its staff I guess they need something to lighten the mood around the office!



Gallows humor. Wall Street might have lost tons of money, but that doesn’t mean traders have lost their ability to laugh. Some faves making the rounds:

– What’s the definition of optimism? An investment banker who irons five shirts on a Sunday evening.

– What is the capital of Iceland? About $3.50

– I tried to get cash from an ATM today, but it said “insufficient funds.” I don’t know if that meant them or me.

– What’s the difference between an investment banker and a large pizza? The pizza can still feed a family of four.

– What does a hedge-fund manager with no fund to manage say? Would you like fries with that sir?

– The credit crunch is getting bad, isn’t it? I mean, I let my brother borrow 10 bucks a couple weeks back. It turns out I’m now America’s fourth-biggest lender.

So you’ve probabaly read with great interest Matt’s post on the NZ election political quiz. I also noticed that the same quiz has a verison for the US presidential election so I thought it might be fun for us to repeat the exercise.

You may be surprised by the results:)

Agnitio: Obama (79%), Nader (72%), McCain (72%).

Agnitio Comment: Given I voted for Obama (I also hold US citizenship) I’m not surprised by this. I’m also not particularily surprised I have a high rating with McCain given I generally lean a little to the right economically.

Goonix: Barr (73%), McCain (59%), Nader (53%), the other candidate (53>x>38%), Obama (38%)

Goonix Comment: Consistent with my results of the NZ version of the quiz. There is no way I could vote for the economic policies of either major parties’ candidates (especially Obama). Similarly, I could never vote for the archaic social policies of the Republicans, or their pro-war stance (one which Obama seems to be pretty keen on now too). But I still can’t believe Barr is standing as the Libertarian candidate and is anti-choice!

Matt:Nader (68%), McCain (63%), McKinney (60%), Barr (60%), Obama (60%)

Matt Comment: Although my results were in a narrow band the politicians did very differently in the individual components I choose. Overall, this gives me the impression that US politicians are inconsistent “between-issues” at least in my little slice of reality. Thank goodness I live in Aotearoa – where politician’s inconsistency is equally spread between all the facets of governance ;)

The Fed lopped 50 basis points off its cash rate, taking it to 1%.  With real interest rates already well in negative territory I’m not sure this sort of action is really necessary – maybe they want to stabilise consumer confidence or something of the like.

Anyway, our concern here is New Zealand – so what did it do?  The TWI went up to 59 from a low of 56 – the $US/$NZ got to $0.59 from a low around $0.54, so it helped to stabilise the FREE-FALL in our currency lately (just before I’ve gone on holiday).  Oil prices also bounced back – but still lie at the “relatively” low level of $67US a barrel.  For New Zealand this might imply some stability in our commodity prices – this is an essential issue so we can only hope!

All this is a sign that the market has initially taken the rate cut well, with the DOW now up 1200 points from its low about 36 hours ago (*).  If this lasts, then we could finally be in for a time of stabilisation – if it doesn’t, who knows :P

All I know is that the Fed will print as much money as it can to prevent a “Great Depression”, ignoring the future consequences.  I will aim to discuss this more next week.

Intrade has launched a US depression contract (ht Institutional economics).

This depression is defined as:

a cumulative decline in GDP of more than 10.0% over four consecutive quarters

Do you think NZ’s very own iPredict would like to make up a similar contract for NZ?

Or so says two of the blogs I often read for US economic information:

Market Movers (*)

The Big Picture (*)

I have to concur.

However, for New Zealand there is a big plus to this collapse in US economic activity – the huge capacity constraints on shipping have lifted (Market Movers).

Shipping costs have been restrictively high for our exporters for a long time. A fall off in import activity to the US has freed up ships, which leads to much lower shipping costs for our exporters. Add to this the lower exchange rate and our tradable sector is getting one hell of a boost moving forward.

Update:  Dow breaks 8,000 on the downside.

Over at Market Movers, Felix Salmon discusses “Lehman’s Lies“.

In the wake of the collapse, it was clear that if Lehman couldn’t be trusted, then it would be silly to trust any other troubled financial institution, either — AIG, WaMu, Wachovia, Fortis, Hypo Real Estate, you name it.

This breakdown in “trust” destroyed the delicate equilibrium we were in, and has sent us spinning towards a worse set of outcomes.

Fundamentally, this has happened because “trust” (the fact that we would be playing a “infinitely” repeated game, which then rewards people for collusive behaviour) had allowed us to bypass the asymmetric information problem inherent in the market. With that trust gone, no-one will lend or purchases assets, as they think that only the worst deals are available on the market.

In this light, the behaviour of Lehman appears to be a major factor behind the crisis we now find ourselves in – damned investment banks :P

Matt McCarten was someone I enjoyed listening to when I was a young Alliance supporter many years ago – however, even in the heyday of teenage communist sympathies I would not have agreed with his conclusion that the recent credit crisis is undeniable evidence that voluntary trade does not work.

Now Kiwiblog and Anti-dismal have already gone to task explaining why they don’t believe this is a fair criticism of free trade, and good on them I think they are on the money (David Farrar focuses on why the criticism doesn’t sit well while Paul Walker paints the case for regulation being the cause of the problem – more here). The Hive also mentions dis-satisfaction with his choice of historical comparison. However, even after reading these posts you may still harbour some confusion surrounding the fact that I said voluntary trade instead of free markets.

Ultimately, his criticism of the “invisible hand” draws out something incredibly naive about the point of view that the free market is bad. Supporters of the free market are not so much saying that corporations should be allowed to manipulate information and “defraud” the public as they are saying that voluntary trade among groups is a good thing.

If two people choose to trade, it must be in their benefit and therefore giving people the freedom to trade is an important part of a society – this is what free trade represents.

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A popular explanation of the booming in house prices according to, well, everyone is that there was lots of “credit washing around” which convinced people that they should go and bid up house prices. An example of this logic is shown in this statement at the very good Big Picture blog:

The bubble in home prices, fueled by the ready availability of credit, resulted in an underestimate of the risks of residential real estate

Personally, I think this type of thinking has the causality all mixed up – if there was any error it was because people “underestimated the risks” associated with the price of residential real estate, and therefore given the “price” of credit the housing market appeared to be a better bet than it actually was. As a result, the entire blame for the bubble and associated crisis should lie with the fact that risk wasn’t being appropriately identified – not with some mystical belief that credit was springing up all over the place. If the risk problem was unsolvable, then we can blame central banks for leaving the price of credit (not its “availability) to low – however, this is a secondary issue to risk.

The whole concept of the “availability of credit” is somewhat of a misnomer.

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I don’t like thinks that sound like conspiracy theories – and the title of this post does! However, I am starting to get the impression that this is one situation where it may actually be the case. Overall it stinks like socialism for the rich (good cartoon here, good article here)

Two articles from Bloomberg this morning have pushed me into this view:

Bernanke Signals U.S. Should Pay More for Bad Debt

Bernanke Says Normal Markets Needed or Growth to Halt

As Felix Salmon states here, Bernanke’s interest in paying the hold to maturity price for assets just doesn’t make sense when a good proportion of the assets aren’t going to mature – and even if they wish to take into account risk, the US Treasury does not have time to sufficiently evaluate the risks.

Surely the aim of the bailout should be to do as little as possible to ensure that credit markets start functioning again – in this sense, over paying for assets seems excessive.

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