Probably one more set of links to come from Ed, but I think that’s it from me. Unless Yves has once again  succumbed to the lure of Water Eaton, on the way back home to the States.

Special thanks to Ed, Tom, John Bougearel, Francois T, Bob G, Mike G, Scott F, MA, anonymous, dd,  RebelEconomist and (defying bandwidth constraints) YS, for helping focus my thoughts, or providing posts or post ideas. Special apologies to anyone I should have mentioned above – it’s been a whirl.

Thanks to the rest of you for patience, encouragement, links and comments; or just for reading and thinking.

Richard

One more guest post to come, plus a farewell; I had more of my own in mind, but I’ve overrun, again. It’s certainly been demanding, or stretching, and a sharp reminder of what I do and don’t know well, and can and can’t do well; but it was also enjoyable to blether away at you all. And I will half-miss the morning’s bleary thrash through 116 RSS feeds and whatever articles had eyecatching headlines, and nearly all of the NC comments. I haven’t done anything very like that since a not-terribly-successful stint at James Capel Gilts, 20-odd years ago; I doubt whether I have improved all that much at it in the mean time, either.

Anyway, Belgium.

In all the hubbub around Eurobank liquidity or solvency or whatever you thought it was, triggered by doubts about the ability of Greece and Spain to fund themselves, and possible sovereign defaults, one country, right at the heart of the EU, with a nasty problem, got largely overlooked. But not entirely: Tracy “Argus” Alloway of FT Alphaville managed to keep one of her innumerable beady eyes fixed firmly on Belgium.

The two main horrors are budget (FT AV quoting research house Independent Strategy):

Belgium is a mess. Its sovereign debt to GDP is 100%, up from a trough of 84% a few years ago, and its budget deficit is 5% of GDP.

but most of all political risk:

Unlike the Greeks, who seem to like being Greeks and being in Greece, Belgium is a country with a dearth of nationals proud to be Belgian and where growing swathes of the population want to be in another state of their own creation. This is not a good scenario for taking tough decisions on public debt at a national level and making the necessary political compromises…

Since May, when this article appeared, Belgium has exchanged a crippled coalition government for a crippled caretaker government, which isn’t progress; and the now-largest Flemish party, the New Flemish Alliance, is openly, though unhurriedly, secessionist. There are seven parties still negotiating to form a government, six weeks after the elections.

Nor, of course, has it made any difference to the underlying ethnic divide, which is spectacular. Belgium is pretty much two countries already, apart from Brussels itself, where French (Walloon, southern part) and Dutch (Flemish, northern part) speaking populations do mix, though Brussels is an enclave within the Flemish part, just to make things a bit more complicated. Away from Brussels, local governments in both Wallonia and Flanders can pass laws prohibiting the use of the minority language, and they do. Not much sign of common national feeling there.

The new pressure on this rickety political entity now arrives in the form of a leak from the Belgian independent budget watchdog. From the FT:

The solidity of Belgium’s public finances was called into question on Tuesday after an independent budget watchdog challenged the government’s tax revenue forecasts and warned of higher budget deficits.

The leaked report from the federal government’s monitoring committee raises questions as to whether Belgium can meet commitments to bring its public finances in line with eurozone budget rules.

Cue, naturally enough, both despair about the institutional capacity to meet the budget commitments:

“In normal times, taking such measures might be straightforward,” said Philippe Ledent, economist at ING Belgium. “The problem now is that there is no government that can take them.”

and a likely sharpening of the ethnic divide:

The way in which public spending could be cut dominated the electoral campaign in Dutch-speaking Flanders, with a consensus for more belt-tightening seen across most of the political spectrum. But the issue hardly featured in Francophone Wallonia, where the victorious Socialist party has vowed to oppose any form of budget austerity.

It’s ironic that having waved Belgium into the Euro, based on its centrality to Europe, one of the original Six, integral with Benelux, and so on, the pols could hardly reject Greece et al for budget dodginess (h/t MA for this reminder). Now it’s all coming back to Belgium.

So where do we go from here? The issue will get right onto the market’s radar eventually; and it looks much less short-term tractable than the Greek or Spanish situations. If there is to be a divorce, there will be a good tussle over the ownership of the assets first; or rather, over that 100%-of-GDP debt.

For much, much more on how Belgium got to be like that, on the mean and very long-term ethnic grudge match going on behind the scenes, and on what might happen next, try this (hat tip: Scott F.). Top excerpt:

There is a growing risk of a faster than expected dissolution of Belgium which will result in sovereign default; this is based on a belief in the inability of the individual nations within the euro zone, let alone the EU institutions themselves, to realise that as nations unravel, speed is of the essence.

By John Bougearel, author of Riding the Storm Out and Director of Financial and Equity Research for Structural Logic

Fiscal drags combine with manufacturing drags in 2011 ~ these drags will subtract 2.5% from GDP in 2011

The manufacturing sector has pancaked in June and July after giving roughly a 1% boost to GDP over the last 4 quarters. Moody’s says we can expect to subtract that 1% mfg boost to the economy in 2011. “It’s becoming increasingly clear that the biggest lift from the inventory cycle is over. The inventory swing added nearly a percentage point to real GDP growth over the past year and is unlikely to add anything during the coming year. This will weigh on manufacturing output over the next several months.”

David Rosenberg adds that there will be a 1.5% fiscal drag in 2011, and reminds us of a third potential drag on the economy in 2011, the expiration of the Bush tax cuts. Bernanke floated a trial balloon to lawmakers suggesting they extend the Bush tax cuts last week, so we can expect the looming tax cut drag will disappear.  From Rosenberg: “we have at least 1.5 percentage points of fiscal drag coming out way next year so it will be interesting to see what it is that ends up preventing the U.S. economy from contracting.” Rosenberg warns that in two out of the three other aggressive tax hikes since WWII, the economy experienced hard landings. I do think lawmakers will extend the tax cuts because of the fragility, and ‘unusually uncertain’ outlook, but if not, there is a third drag. Final Q1 2010 GDP came in at 2.7%. Adv-GDP for Q2 2010 is estimated to come in at 2.5%. All told the first half of 2010 is growing at best at 2.5%. With the fiscal and mfg drags subtracting 2.5% from GDP growth in 2011, what will be there in 2011 to move the economy forward?

The takeaway is that without real and substantial job growth in the private sector, without growth in the mfg base, without gov’t stimulus, 2011 is poised to sputter. Oh, the SP500 can be expected to climb a wall of worry into Q1 2011 targeting 1313, but then what, another bear mkt? “I reckon so”, said the outlaw Josie Wales.  We should all enjoy the next stock market rally, but also remember to heed Rosenberg’s long-standing advice, these stock market rallies are to be ‘rented’ in secular bear mkts, and we are still in a secular bear mkt.

The Yen Carry Trade to buy US Treasuries in Q2 2010 is beginning to soften and can be expected to be unwound after the August 6 NFP or after the August 13 Retail Sales report. I don’t think we will see the Yen carry trade resume until 2011, when the anticipated drags on the US economy become reality.

Meanwhile, the overcrowded long gold trade continues to be unwound and is expected to persist into the first half of August, perhaps longer. Gold’s strongest correlation right now is the US Dollar. The dollar has been plunging along with treasury yields in Q2 and Q3 largely on the plunging US economic data in June and July. The dollar won’t really strengthen against the Yen until the carry trade unwind gets underway and that won’t happen until the summer doldrums data in the US bottoms. We won’t see a bottoming in most of the data until mid-August.

You can see on the gold chart below that gold reluctantly followed the dollar on a southbound trek at the end of the first half of 2010. Everyone wanted to hold the glittering gold in their portfolios until the first half of the year came to a close because it, along with treasuries were the best investments in the 1st half of 2010. Gold not so much so anymore! Another 6% lower and it will round-trip to unchanged on the year again. Equities just round tripped to unchanged on the year from way ‘down-under’ as they say in Australia this past week. Intriguingly, the 2009 yr close in Gold and the SP500 are both quite near 1100, they are sort of behaving like two ships passing in the night…..

Gold 240 minute

This post first appeared on May 11, 2007

I am beginning to suspect that many are reacting to the overstimulation of the modern world – the accelerating pace of change, data overload, time pressure, work and relationship instability – by turning off their brains. The rise of fundamentalism and the “family values” push, both efforts to turn back the clock, is one set of responses.

Another is the rise of sound-biting, of using pithy communications to cut through the clutter of the daily information assault. But sound biting is inherently reductionist. It doesn’t permit nuanced argument, or pointing out fuzziness in data, or shades of grey. Sound bites are great for simple, emotional appeals, lousy for policy development (which is one reason why this country seems incapable of having an intelligent discussion on important topics like health care. The public has been trained out of having a long enough attention span to listen to alternatives).

Sound biting polarizes people, and makes it hard to find common ground (where can Bush go with Iran now that he has called them a member of the “axis of evil,” for instance?).

So I get worried when I see smart people embracing the logic of sound biting and seeing it as a more general prescription, particularly when they want to use it to run organizations, as opposed to sell shampoo or wars. Let’s look at this post by Brayden King at orgtheory.net:

Made to Stick is a book by Chip and Dan Heath that explores why some ideas grab our attention and others quickly fade from memory. The book has received a lot of attention in the consultant-y side of the blogosphere….

One of their main premises is that sticky ideas tend to be simple. By simple they don’t mean simplistic; rather they mean that each idea can be reduced to its essential, most important core. To communicate an idea clearly, you need to strip “an idea down to its most critical essence” (28). You need to “find the core.”

My immediate thought was that I need to do a better job in finding the core of some of my papers.* But “finding the core” also applies to organizations. Most organizations are based on some sort of core idea. They have an irreducible essence upon which the logic of the organizing, decision-making, and strategizing rests. Some organizations, of course, are better at communicating that core to their stakeholders. They’ve figured out how to make that idea central to decisions and to the daily life of the organization.

One example that the Heaths provide in the book is how Southwest Airlines used the idea that “We are THE low-fare airline” to guide important decisions. When Southwest has to decide whether they’re going to offer a new food item to be served on their flights, like chicken salad, they can go back to their core guiding principle to assess whether it would be a beneficial change. The answer is no. Providing chicken salad, as good as it might sound, does not fit with Southwest’s principle of being THE low-fare airline….

I think we need to develop better theories of decision-making in businesses and I think that the identity concept is a good place to start. Some theories of decision-making seem very weak in their ability to actually predict what kinds of decisions would be good for the organization (from the manager’s perspective). For example, the rather simplistic (not simple) idea that managers make decisions based on what they think will maximize shareholder value falls apart once you consider the hundreds of ways that a manager might try to maximize value at any given moment. Using the decision-making criterion of “our company maximizes value” is vacuous. Every business works under this principle, and so it gives the manager no guidance when attempting to make a decision that is unique to its organization. It begs more questions than it provides answers. Managers need more than a motive to maximize value….

The point of bringing up Heath and Heath and Whetten’s work on identity is that both readings seem to be saying the same thing. People or organizations need a core idea to motivate decision-making. We need a simple guiding principle. Whetten says that the core idea is the identity of the organization. If you can identify the central and distinctive character of the organization, you have found that which makes the organization unique from its peers. You know what works (the identity has at least gotten you this far), and you know what stakeholders expect (enough customers and employees like your identity to make the organization a worthwhile venture).

Thus, using the identity as a core principle to guide decision-making makes sense. When faced with a decision, managers put themselves in the place of the organization as if it were a real actor – what should an organization like this do? Sure, if you’re a business you assume that the end goal of any decision should be to maximize returns. But how you do it is contingent on the unique, core idea of the organization. As Whetten and Mackey (2002: 396) argue, identity is the “court of last resort.” When you reach that fork in the road, your identity pulls you down the eventual path.

Ooof. This all sounds great (particularly the bit debunking maximizing shareholder value) until you think about it a bit. Make It Stick argues that “simple ideas (when well expressed) are memorable.” Granted. It then goes on to see simple ideas as being virtuous. That is, if you can’t reduce your idea to simple idea, by implication, there is something wrong with it or with you.

No doubt writers should strive to be as clear as possible. But some of the most thought-provoking, and useful thing I have read (and they are very well written to boot) can’t be boiled down to a simple sentence or two because they are bigger than that.

For example, the best management book I have read in quite a while is Phil Rosenzweig’s The Halo Effect. It is a brilliant, important, yet accessible piece of work, it tells you that just about everything written about management is wrong, but it cannot be summarized in a sentence, or even two. Here is one reviewer’s stab at it:

Rosenzweig tells us that our beliefs about business success are largely, perhaps entirely, wrong, distorted by the halo effect — in this case, the idea that once we consider a company successful, we tend to see it as doing everything right.

That’s about as much as you can convey in one sentence, yet you are left wondering what the book is about, and it actually does take some explaining to grasp Rosenzweig’s thesis:

In World War I, psychologist Edward Thorndike asked commanding officers to rank their subordinates on a series of qualities. He found the answers to be highly correlated; in other words, the officers saw the soldiers in broad-brush positive or negative terms, as either all good or all bad….

To illustrate his point, Rosenzweig goes through case studies of Lego, Cisco, and ABB. For example, when its fortunes were rising, Cisco was praised for “extreme customer focus,” skill in acquisition and integration, and highly motivated employees. Yet when performance fell, critics saw many of these previously admirable attributes as causes of failure. Cisco’s problem wasn’t that it had ridden a bubble that collapsed — no, it had “a cavalier attitude toward customers.” Its deals had been haphazard, employees had been “too busy taking orders and cashing stock options to bother with efficiency, cost-cutting, or teamwork.” Academics joined the media in this reputational pump-and-dump. As the author explains: “No one was saying that Cisco had changed between 2000 and 2001. It was just that now, in retrospect, Cisco was described through a different lens — one of failing performance. . . . Placing these accounts together, the impression is nothing short of Orwellian — a rewriting of history that thrusts facts into the past, rearranging the record . . . reinterpreting the past to suit present needs.”

The implication is that books like In Search of Excellence and Good to Great are mere exercises in storytelling, because their main data sources, press reports and retrospective interviews, ar hopelessly tainted by the halo effect. And he goes on to prove analytically that their findings were incorrect.

Now Rosenzweig’s book has a very important message, but I challenge you to boil it down to even three sentences. As a consequence, (and Make It Stick is borne out here) it won’t have the impact it ought to. But by the Heaths’ logic, popularity is tantamount to merit. That just ain’t so. In fact, one could argue that one way to get ahead in a competitive world is to have an information advantage, and seek out more complicated constructs that are ignored in a dumbed-down world.

Let’s go on to their organizational argument, that companies should find a simple idea to guide all their decisions, which is even more dodgy. That premise holds if you have a strategy, like Southwest’s, that is distinctive and can be boiled down to a simple tag line.

I can too readily think of companies that have powerful cultures that are key to their success where no such tag line would or could exist. Let’s start with two: Goldman Sachs and Toyota. Each is unquestionably the dominant player in its arena. Each has a very strong culture. But if you were ask employees of either firm for a single principle, you wouldn’t get the simple actionable phrase that the Heaths idealize. At Goldman, they’d look at you like you were nuts. The firm has 14 guiding principles. Each is more than a sentence long. And the firm (at least historically) believes deeply in them and amazingly enough, operates from them.

A recent New York Times feature on Toyota describes a similar, multifaceted, yet cohesive culture. Toyota, unlike Goldman, does have an overarching ambition: “To enrich society through the building of cars and trucks.” That doesn’t provide the kind of decision guidance that the Heaths like, and the American writer has to explain what it means:

I lost count of how many times Toyota executives, during the course of my reporting, repeated it and how often I had to keep from recoiling at its hollow peculiarity. And yet, the catch phrase — to enrich and serve society — was not intended, at least originally, to function as a P.R. motto. Historically the idea has meant offering car customers reliability and mobility while investing profits in new plants, technologies and employees. It has also captured an obsessive obligation to build better cars, which reflects the Toyota belief in kaizen, or continuous improvement. Finally, the phrase carries with it the responsibility to plan for the long term — financially, technically, imaginatively. ”The company thinks in years and decades,” Michael Robinet, a vice president at CSM Worldwide, a consulting firm that focu

ses on the global auto industry, told me. ”They don’t think in months or quarters.”
The core mission is elucidated through other Toyota maxims, some of which make more sense to Westerners than others. And it also leads to behaviors that are alien to most companies. Toyota employees are obsessed with finding problems, be they with the cars, with marketing, with processes, because they see them as an opportunity for improvement. And to them, it is all part of “enriching and serving society by making cars and trucks.” But that message has all of the other ramifications because management has imbued that simple phrase with a great deal of meaning and many corollaries. The phrase is not what guides the culture. The phrase is much smaller than what it has come to mean at Toyota. The NYT author spent a long paragraph explicating it and still hadn’t distilled it.

The failing of the Heaths’ idea is due to another important construct, obliquity that isn’t summarized in a tag line. A Financial Times article explains:

If you want to go in one direction, the best route may involve going in the other. Paradoxical as it sounds, goals are more likely to be achieved when pursued indirectly. So the most profitable companies are not the most profit-oriented, and the happiest people are not those who make happiness their main aim. The name of this idea? Obliquity….

George W. Bush speaks mangled English rather than mangled French because James Wolfe captured Quebec in 1759 and made the British crown the dominant influence in Northern America. Eschewing obvious lines of attack, Wolfe’s men scaled the precipitous Heights of Abraham and took the city from the unprepared defenders. There are many such episodes in military history. The Germans defeated the Maginot Line by going round it, while Japanese invaders bicycled through the Malayan jungle to capture Singapore, whose guns faced out to sea. Oblique approaches are most effective in difficult terrain, or where outcomes depend on interactions with other people. Obliquity is the idea that goals are often best achieved when pursued indirectly.

Obliquity is characteristic of systems that are complex, imperfectly understood, and change their nature as we engage with them…..Obliquity is equally relevant to our businesses and our bodies, to the management of our lives and our national economies. We do not maximise shareholder value or the length of our lives, our happiness or the gross national product, for the simple but fundamental reason that we do not know how to and never will. No one will ever be buried with the epitaph “He maximised shareholder value”. Not just because it is a less than inspiring objective, but because even with hindsight there is no way of recognising whether the objective has been achieved…..

Most businesses operated in competitive environments far too complex for a terse phrase to be a useful guide to action. Yet a magic incantation, a talisman, a battle cry is terribly appealing. But those who can resist the temptation of relying on a simple playbook and face the complexity and uncertainty of their environment are likely to steer a better path. But understanding risk and adapting also demands far more courage that trusting simple ideas.

→ Rajiv Sethi

In a recent post on his (consistently interesting) blog, David Murphy questions the value of equilibrium analysis in economics and finance, and points to two earlier posts of his in which the same point is made. Here he is in July 2007:

An interesting post on the Street Light Blog, on currency misalignments, suggests an interesting question: is economics an equilibrium discipline? The very idea of a misaligned FX rate suggests that the natural state is an aligned one: perhaps the fundamentals move faster than the markets adjust, so FX is never in equilibrium. Perhaps (in the language of statistical mechanics) the relaxation time is much longer than the average time between forcings.

And here, in August 2008:

My own view is that finance is not an equilibrium discipline, mostly, so while classical economics might work well in explaining the price of coffee… it does rather less well in asset allocation or explaining the return distribution of financial assets. Rather new news arrives faster than the market can restore equilibrium after the last perturbation, meaning that most of the time equilibrium is not a useful concept.

In a 1975 paper that remains worth reading to this day, James Tobin was explicit about the limitations of equilibrium analysis in understanding large scale economic fluctuations:

Keynes’s General Theory attempted to prove the existence of equilibrium with involuntary unemployment, and this pretension touched off a long theoretical controversy. A. C. Pigou, in particular, argued effectively that there could not be a long-run equilibrium with excess supply of labor. The predominant verdict of history is that, as a matter of pure theory, Keynes failed to prove his case.

Very likely Keynes chose the wrong battleground. Equilibrium analysis and comparative statics were the tools to which he naturally turned to express his ideas, but they were probably not the best tools for his purpose… The real issue is not the existence of a long-run static equilibrium with unemployment, but the possibility of protracted unemployment which the natural adjustments of a market economy remedy very slowly if at all. So what if, within the recherché rules of the contest, Keynes failed to establish an “underemployment equilibrium”? The phenomena he described are better regarded as disequilibrium dynamics.

Tobin then goes on to develop a dynamic disequilibrium model of the macroeconomy (discussed at length here) which has a unique equilibrium characterized by full employment, steady inflation, and correct expectations. He shows that even if this equilibrium is locally stable, so that small perturbations are self-correcting, it need not be globally stable: sufficiently large shocks to the economy can result in cumulative divergence away from equilibrium unless arrested by a significant policy response. This seems to describe what we have experienced over the past couple of years better than any equilibrium model of which I am aware.

Note that Tobin’s model is deterministic. The problem here is not that the economy is being buffeted by frequent shocks that arrive before a transition to equilibrium can occur, it is that the internal dynamics of adjustment simply do not approach the equilibrium from certain (large) sets of initial states even in the absence of shocks. The idea that the instability of steady growth with respect to disequilibrium dynamics is an important feature of modern market economies, and cannot be neglected in a comprehensive theory of economic fluctuations was forcefully advanced by Richard Goodwin as far back as 1951, and Paul Samuelson had explored the possibility even earlier. As Willem Buiter has recently lamented, this line of research in macroeconomics simply dried up about a generation ago.

Another area in which equilibrium analysis is likely to be inadequate is in the study of asset markets with significant speculative activity. Price and volume dynamics in such markets depend not just on changes in fundamentals but also on the distribution of trading strategies, and this in turn adjusts under pressure of differential performance. The idea of an equilibrium composition of trading strategies is a contradiction in terms: if there were any such thing there would be a new strategy that could enter to exploit the resulting regularity. It is the complexity of this disequilibrium process that allows information arbitrage efficiency to be approximately satisfied, while allowing for significant departures from fundamental valuation efficiency (the distinction, naturally, is also due to Tobin.)

Finally consider Hyman Minsky’s financial instability hypothesis, built on the paradoxical idea that stability itself can be destabilizing. In Minsky’s framework stable expansions give rise to increasingly aggressive financial practices as those firms having the greatest maturity mismatch between assets and liabilities profit relative to their closest competitors. The resulting erosion in margins of safety increases financial fragility, interpreted as the likelihood that a major default will trigger a crisis of liquidity. Such a crisis eventually materializes, devastating precisely those firms whose actions gave rise to greater fragility. The balance of financial practices is then shifted in favor of increased prudence, and the stage is set for another period of stability. Trying to give this analysis an equilibrium interpretation is a futile exercise; expectations of financial market tranquility are self-falsifying, and no fixed distribution of financial practices can be stable.

Given the potential of disequilibrium dynamic models to illuminate our understanding of the economy, why are they generally neglected in contemporary economics? In part it is because the quality of a disequilibrium model is hard to evaluate and the dynamics are necessarily arbitrary to a degree. There is a professional consensus on how equilibrium analysis should be done, but none (so far) when it comes to disequilibrium analysis. Furthermore, equilibrium models can be enormously insightful, even in applications to macroeconomics and finance. The work of John Geanakoplos on the leverage cycle is a case in point, and Abreu and Brunnermeier’s paper on bubbles and crashes is another. I have used equilibrium methods frequently and will continue to do so. But it seems that there ought to be greater space in the profession for serious work on the dynamics of disequilibrium.

Is this xenophobia?

Video – Jan Brewer: Most illegal immigrants are ‘drug mules’ CNN (Hat tip Glenn)

Bias and Bigotry in Academia Patrick Buchanan

Losing White America Patrick Buchanan

Long-Term Economic Pain for American Families Bob Herbert, NYTimes (this is why latent xenophobia has come to the surface in my view)

Xenophobia is the uncontrollable fear of foreigners. It comes from the Greek words ξένος (xenos), meaning “stranger,” “foreigner” and φόβος (phobos), meaning “fear.” Xenophobia can manifest itself in many ways involving the relations and perceptions of an ingroup towards an outgroup, including a fear of losing identity, suspicion of its activities, aggression, and desire to eliminate its presence to secure a presumed purity.

-Wikipedia

I would argue that latent xenophobia always comes to the surface during periods of economic insecurity. This is natural. So I certainly see the links above as manifestations of xenophobia. The question is whether policy remedies used to allay economic insecurities are appropriate. For example, Pat Buchanan makes a number of valid arguments in the article on academia. What should be done, then from a policy perspective?

My take: there is always going to be some measure of ‘xenophobia overreach’ in tough times. How much is the question. Discussing these divisive issues without a reptilian response is difficult but necessary to avoid particularly nasty cases of xenophobia overreach. I disagree with the ethos underlying Buchanan’s take on losing white America. But perception is reality and he does seem to be expressing views many voters have. What about addressing these concerns constructively instead of dismissing them out of hand?

Other Links

Baseler Ausschuss: Deutschland stimmt neuer Bankenregulierung nicht zu FAZ

Researchers link undersea oil plumes to BP spill LA Times

Watchdog questions Belgium’s finances FT (Hat tip Richard Smith)

Is Google Watching You? New Plugin Will Let You Know Mashable

The PBoC can’t easily raise interest rate Michael Pettis, Credit Writedowns

Old Spice Sales Double With YouTube Campaign Mashable

Anchoring Effect You Are Not So Smart (must read piece on irrational expectations)

The Real Sin of Michael Steele Patrick Buchanan (Buchanan is not NC’s usual fare but his foreign policy views are also important)

Elizabeth Warren and Her Discontents HuffPo

"Government as Deux Ex Machina"? Mark Thoma

How Preschool Changes the Brain Jonah Lehrer

Guest Blog: Of two minds: Listener brain patterns mirror those of the speaker Scientific American

Consumer demand ‘fuels faster Russian economic growth’ BBC News

Chinese Banks At Risk, Part 1 Patrick Chovanec (also see Richard’s recent post on this)

For Edwards, the Japanese lesson still holds… FT Alphaville

Bell council cuts salaries 90%; some will forgo pay LA Times

Niall Ferguson Debates Himself Matthew Yglesias

Fiscal policy: When does fiscal stimulus work? Ryan Avent

Too Cash-Strapped for a Boom: How Italy’s Permanent Crisis Saved It From the Downturn Der Spiegel

Thoughts on Academic Tenure Arnold Kling

Antidote du Jour: Great Hornbill (hat tip MarcoPolo)

PS. – if you love birds, listen to the call of the Great Hornbill. Amazing stuff.

We’ve done local colour on China property, plus some horror graphs already today. Now a proper China watcher, Michael Pettis, chimes in, over at Ed’s place, with more background, especially on the interest rate policy bind that the Chinese are in. With respect to rate rises, his verdict in short form:

they’re damned if they do and damned if they don’t

There’s plenty more to it than that, so read the whole thing, of course. Note also that he is more sanguine than your scribe about how long the ball can be kept in the air. though that mild optimism is balanced by this all too plausible guess at how things really are, behind that report on local authority loan losses:

I would suggest, based on my pretty extensive experience in emerging markets, that we should assume the real problem is worse than the initial evaluation.  It almost always is.

For my part, I think there has already been a tightening of sorts, via the regulatory change that I remarked on already today:

But analysts say the apparent success of the clampdown on lending disguises a worrying new trend that involves banks co-operating with lightly regulated trust companies to keep loans off their books.

The regulator ordered a stop to this type of lending at the start of the month.

So I suppose we just keep our ears open (and we might want ear plugs).

Complementing today’s piece on the Chinese property bubble, a cross-post from VoxEU, with some graphical depictions of how wild the bubble has become. The NYT article referenced in the piece is here – RS.

By Yongheng Deng, Professor of Real Estate and Finance at the National University of Singapore, Joseph Gyourko, Professor of Real Estate, Finance and Business and Public Policy at the University of Pennsylvania, and Jing Wu, Assistant Research Rellow at the Institute of Real Estate Studies, Tsinghua University.

Reinhart and Rogoff’s recent influential study of financial crises finds a recurring root – the country’s property markets. This column argues that a similar housing bubble may be developing in China. Urgent research is needed to determine the risk of a full blown crisis.

China is experiencing spectacularly fast growth – so fast that many fear it is driven by a bubble – a property bubble to be precise. Recent memories of what happened when the US housing market bubble burst make the possibility of a Chinese housing bubble a critical concern for the world economy. So, is there a bubble or is it simply hot air?

Financial bubbles are governed by something like the economic equivalent of physics Heisenberg’s uncertainty principle. It is impossible to observe a bubble with certainty without actually altering the bubble itself. If people knew it was a bubble, it wouldn’t be a bubble – it would have already collapsed. It would not, however, be impossible to envision “diagnostic tests” that would provide a probabilistic identification of a bubble. Unfortunately the state of economics does not provide such a procedure (see Flood and Hodrick 1990 for an early analysis of what would be required to determine convincingly whether or not a speculative bubble exists).

The problem is particularly acute in the case of Chinese housing. Data limitations arise from the fact that there was no real private market in land or housing units in China until the late 1990s, so it is only possible to compare current conditions to little more than a decade of previous data. It is not hard to find highly respected professional investors with opinions on both sides of the question over China’s bubble (see the article by Barboza 2010 in The New York Times for a discussion).

New evidence on a Chinese housing bubble

Our look at the available data strongly suggests that prices are quite risky at current levels, and that it would take little more than a modest decline in expected appreciation to engender sharp drops in prices. The first foundation of this conclusion is that home prices in China are at their all time highs, and have been appreciating at especially high rates recently. This is documented in Figure 1 which plots real and nominal price indexes developed at the Tsinghua University for newly constructed homes in 35 major cities.

Real prices more than doubled over the past decade, with appreciation rates escalating at the beginning of 2007 and then again in early 2009. The most recent data show a record 41% (annualized) growth rate for the first quarter of 2010.

Figure 1. Constant quality price index for newly-built private housing in 35 major Chinese cities, 2000-2010

Source: Wu, Gyourko and Deng (2010). The underlying data source is the Institute of Real Estate Studies, Tsinghua University. See the discussion in Wu, Gyourko and Deng (2010) for more on how these indexes are created.

But it was not high price levels alone that convinced Case and Shiller (2003) and Shiller (2005) that US house prices had become unsustainable – it was the all-time high price-to-rent and price-to-income ratios.

Information on price-to-rent ratios is less widely available for Chinese markets. Figure 2 plots them since early 2007 for eight major Chinese cities. Price-to-income ratios are then plotted in Figure 3 for these same markets, using data back to 1999. For those unfamiliar with these markets, they are listed on the map in Figure 4. Each is among the largest markets in China, with none having a population below 8 million.

• Price-to-rent ratios have increased by at least 30% over the past 3 or so years in each of these cities.
• The jump was very large in Beijing, rising by almost three-quarters from 26.4 in 2007 to 45.9 in the first quarter of 2010.
• Hangzhou, Shanghai and Shenzhen also have seen their price-to-rent ratios rise sharply to over 40.

Even though income growth has been strong in urban China, price-to-income ratios also have been increasing in these same markets.

• Income growth did keep pace with house price appreciation in the other large markets, so housing has not become less affordable everywhere, according to this metric.

Figure 2. Price-to-rent ratio in eight major Chinese cities, 2007-2010

Source: Wu, Gyourko and Deng (2010). The underlying data were collected by the Institute of Real Estate Studies, Tsinghua University. See the discussion Wu, Gyourko and Deng (2010) for more on the creation of these ratios.

Figure 3. Price-to-income ratios in eight major Chinese markets, 1999-2010

From Wu, Gyourko and Deng (2010). See that article for more on the creation of these ratios.

Figure 4. Map of the eight major Chinese cities

Chinese government data indicate that these price rises are underpinned by rapidly escalating land values. Because the Chinese government still owns all the land in urban areas and leases its use for long periods of time, we can observe land prices independently from home sales (which include the land plus the structure). We collected data on all the residential land parcel auctions in Beijing dating back to Q1 2003, and created a constant quality price index for Beijing residential land, controlling for a number of location and site quality variables that are described in Wu et al. (2010).

Figure 5 shows that real, constant quality land values increased by over 750% since 2003 in the Chinese capital, with more than half of that rise occurring over the past two years. Additional regression analysis showed that state-owned enterprises controlled by the central government played a meaningful role in this increase, as prices were 27% higher on the parcels they won at auction compared to otherwise equivalent land sites purchased by other investors.

Figure 5. Real constant quality residential land price index for Beijing, 2003-2010.

From Wu, Gyourko and Deng (2010). See that article for more on the creation of the index.

Suspicions if not proof

While it is impossible to conduct a formal test of whether there is any fundamental mispricing in Chinese land and housing markets with these limited data, there certainly is much to make one more than a little suspicious that prices are unsustainable.

• The magnitude of the increase in land values over the past 2-3 years in Beijing is, to our knowledge, unprecedented.
• These increases post-date the Summer Olympics and the recent price surge in early 2010 suggests a relationship to the Chinese stimulus package which itself is temporary.

The role of state-owned enterprises also is potentially worrisome. It could be that these entities are superior investors and are purchasing sites that are of especially high quality in ways that we cannot control for in our empirical analysis. However, it also could be that moral hazard is at work here, as these entities are thought to have access to low cost capital from state-owned banks and may believe they are too big to fail. If this is the driving force, then prices are being bid up as one arm of the government buys from another.

More broadly, the sharp rises in price-to-rent ratios in Beijing and the other large markets look to be very difficult to explain fundamentally.

• Most true fundamentals just do not change so discretely or in such magnitudes as to be able to explain these changes.
• The standard economic model of home valuation indicates that owners must be expecting very high rates of price appreciation for these price-to-rent ratios to be sustainable.

That people might believe in such high appreciation is not incredible given the recent history of Chinese house prices. However, this sort of backward looking expectation formation is a classic element of bubble psychology. Moreover that history is quite limited and tells us that prices never go up forever – much less at the extremely high rates experienced over the past few years.

What happens if the bubble bursts?

To provide some insight into just how risky prices and price-to-rent ratios are at these levels, we calculated what would happen if people began to expect that their homes would grow in value by only 4% per year. For Beijing, prices would fall by over 40%, absent offsetting rent increases or other countervailing factors. While a 4% rate of appreciation is lower than what has been experienced in the capital city over the past few quarters, house prices did grow by less than that for five consecutive years from 1999-2003. Indeed, 4% is not an especially low rate of appreciation in the broad scheme of things. If it were to continue for a decade, prices would be 48% higher; over 20 years, prices would more than double (+119%).

Reinhart and Rogoff’s recent study of financial crises often finds the genesis in the country’s property markets (see Reinhart 2008 on this site). Recent data indicate there is reason to suspect a similar predicament in China’s housing sector. Whether it leads to a full blown crisis is another matter, of course, that depends upon the amount of leverage in the system and the safety and soundness of the regulatory environment, among other factors. Those clearly are matters in need of urgent research if we are to fully understand the potential fallout from a meaningful drop in Chinese house prices.

References

Barboza, David (2010), “Contrarian Investor Sees Economic Crash in China”, The New York Times.

Case, Karl and Robert Shiller. “Is there a Bubble in the Housing Market?” Brookings Papers on Economic Activity, No. 2 (2003): 299-362.

Flood, Robert and Robert Hodrick (1990), “On Testing for Speculative Bubbles”, Journal of Economic Perspectives, 4(2):85-101.

Reinhart, Carmen and Kenneth Rogoff (2009), This Time Is Different: Eight Centuries of Financial Folly. Princeton University Press.

Reinhart, Carmen (2008), “Eight hundred years of financial folly”, VoxEU.org, 19 April.

Shiller, Robert. Irrational Exuberance (2nd edition), Princeton: Princeton University Press, 2005.

Wu, Jing, Joseph Gyourko and Yongheng Deng. “Evaluating Conditions in Major Chinese Housing Markets”, NBER Working Paper 16189, July 2010.

From Ed

…the private sector in the west is in a higher savings and slower growth mode. The only way that the government can net save at the same time is via an increase in net exports to the emerging economies. The FT’s Geoff Dyer is right when he writes the “G20 looks to Beijing to drive global growth.” For the global economy, it’s China or bust.

So China had better be growing healthily, hadn’t it?

There’s been a steady drumroll of comment about the burgeoning real-estate bubble in China for a year or ten now, from many quarters. Mike Shedlock is a handy source for the doomier end of the recent commentary spectrum; anyone with ideas about trustworthy specialist commentators is invited to put them up. Here, anyway, is Shedlock at the end of last year, rounding up his prior commentaries and showing us video of huge, completely empty property developments in China (some of these have been empty for five years, it seems), accounts of massive speculation in metals by Chinese private investors and balance sheet manipulations by Chinese banks. His summary:

China is in a Scylla or Charybdis scenario. If China continues to inflate it will overheat. If it doesn’t, unemployment and unrest will soar, and the economy will implode. Either way, there is no winning solution.

Rebuttals of this gloomy position by semi-insiders don’t look terribly convincing. From the FT in March, in an article by one of JPM’s local China specialists, Jing Ulrich, optimistically entitled “Debunking the myth of a China collapse”:

The worst-case fears concerning the property market are based on a layer of truth and we have previously highlighted the untenable nature of price increases in some big cities, as well as the possibility that last year’s boom was partly fuelled by misdirected bank loans. However, there are crucial differences between China’s property markets and those of the US or Dubai…

The combination of excessive leverage and mortgage securitisation were at the epicentre of the US sub-prime crisis. Both these factors are absent in the Chinese context.

…The crux of the problem with the Chinese real estate sector is that property is seen by the country’s investing class as a store of value, within an economy that offers its citizens limited investment options. I share many of the concerns about flawed incentives and overheating in the property market – but even if prices were to correct, this would not trigger the devastation that might arise in an over-leveraged economy.

Well, maybe securitisation is absent. But it’s perfectly possible to have a first rate banking crash without securitisation anyway, as the history of banking crashes from the dawn of time to July 2007 attests. You just need leverage; of the kind you can build up by the balance sheet manipulation that Mish describes, for instance.

Even the real insiders don’t necessarily seem that convinced that all is well in China. Yves commented on another sighting, FT in June, from the perspective of monetary policy; the interviewee, Li Daokui, is a member of Chinese central bank’s monetary policy committee. The glimpse of official concern about the state of the housing market is telling (FT via Yves):

“The housing market problem in China is actually much, much more fundamental, much bigger than the housing market problem in the US and UK before your financial crisis,” he said in an interview. “It is more than [just] a bubble problem.”…

Mr Li said the high cost of housing could hamper future growth by slowing urbanisation. Rising prices were also a potential political flashpoint, especially among younger people who felt locked out of the property market.

“When prices go up, many people, especially young people, become very anxious,” he said. “It is a social problem.”

In spite of the sharp slowdown in property sales and the troubles in Europe, he said economic activity was still too strong. “China is running the risk or is on the verge of overheating,” he said. Although he added: “I would say the situation is not out of control.”

Oh good. Now let’s see: you have Chinese who buy property as a store of value (according to Jung Ulrich; that’s what all those empty houses are: they’re owned, but not occupied), and other Chinese who can’t get into the market because of the price rises (according Li Daokui); those price rises are partly induced by the activities of the first group of Chinese, and partly inflationary (inflation which increases interest in value stores, feeding demand from the first group of Chinese again). All this despite breakneck building by Chinese developers and breakneck lending by Chinese banks. That really doesn’t sound like a situation that gets into balance without a smash-up of some kind.

Some more local colour from Mish suggests that the whole bubble may now at last be on the brink: some of it seems to be funded by Ponzis, and the retail investors have had enough. Some sort of confirmation of a turning point comes from this recent report that developers are now cutting prices. If Ponzis are a significant factor in Chinese RE finance, that turn in prices will expose them very quickly indeed, en masse. And that will make some small investors very angry, of course, as well as broke.

And a 15% price drop will expose any extreme leverage that exists, too, tucked away behind respectable looking LTVs.

On the more official end of the financing spectrum, we have the recentish surge in the bond yields of Chinese development companies; and from the FT, this week:

China’s banks are facing serious default risks on more than one-fifth of the Rmb7,700bn ($1,135bn) they have lent to local governments across the country, according to senior Chinese officials.

In a preliminary self-assessment carried out at the request of the country’s regulator, China’s commercial banks have identified about Rmb1,550bn in questionable loans to local government financing vehicles – which are mostly used to fund regional infrastructure projects.

This isn’t too bad by itself, if you believe S&P’s local analyst, as quoted in the FT again:

Rating agency Standard & Poor’s estimates that if 30 per cent of loans to local government vehicles become irrecoverable, it would add 4-6 percentage points to overall non-performing loan ratios at the banks. “The pain will be uneven across the sector; the major banks should be able to keep the impact to a manageable level because of their stronger credit risk controls but smaller institutions could struggle due to their proportionally heavier exposure to local government vehicles and lower profitability,” said Liao Qiang, an analyst with S&P.

But what about property, commercial or residential loans, rather than infrastructure? I’d like to hear from Chinese officials about those. Here’s a credit checking process to admire, plus a comparison that will be recognisable to Floridans, Californians or Brits, quoted in the Washington Post:

Wang Zhongwei, a 35-year-old stock market analyst who owns the apartment where he lives, bought two apartments in 2004 for investment purposes. He borrowed from family and friends to meet mortgage payments twice as big as his take-home pay. But in the middle of last year, he sold the apartments for twice what he paid and made $145,000, a fortune here.

“It’s much easier than working every day to make money,” Wang said. “I work very hard and compete for my so-called career every day, but I don’t make that much money from work.” In November, he bought two more apartments.

What about the balance sheet manipulation by banks, now spotted by the FT, too?

Headline growth in China slowed to 10.3 per cent in the second quarter from 11.9 per cent in the first quarter, and loans to property developers dropped 62 per cent from the first quarter to Rmb121.6bn in the second quarter, according to figures from the central bank.

But analysts say the apparent success of the clampdown on lending disguises a worrying new trend that involves banks co-operating with lightly regulated trust companies to keep loans off their books.

The regulator ordered a stop to this type of lending at the start of the month.

China’s banking system had a non-performing loan ratio of more than 50 per cent a decade ago. Today the country is a breeding ground for the world’s largest and most profitable banks with an average NPL ratio of just 1.3 per cent as of the end of last month.

That sounds like a banking system that is very unlikely to have remotely enough capital in it, with a crash to come sooner, rather than later (six months? 18? Come on, who knows?). And that won’t help growth much, within China, or outside it.

Augmenting Ed’s recent links re Tom Adams, regular readers will remember Yves got a magazine cover and write-up in Calcalist.

Now Tom Adams, another contributor to “Naked Capitalism”, (and ECONned helper, Magnetar sleuth, etc etc), has got a writeup by Calcalist. The main article is here, and it’s all in Hebrew, which Google Translate struggles with, though you can make out roughly what’s going on.

There’s a sidebar article too, though, which is short enough to clean up, thus (and with apologies to genuine Hebrew speakers for any unintended liberties with the translation!):

Tom Adams and Yves Smith Change Wall Street

by Uri Psuvsky, Calcalist

A few months after his dismissal, in an attempt to understand what really happened to him and his company, Tom Adams opened an independent investigation. This led him to meet Yves Smith, (Susan Webber), who runs the world’s leading financial blog, Naked Capitalism (an extensive interview with Smith was published two months ago).

“When I met Yves, in early 2009, the level of denial and fear in the market were high, and very few financial or media people wanted to find out what really happened”, says Adams. “I had bad feelings about the role I played by the collapse, I thought I was damaged goods and I was not sure about my future employment prospects. But when I was working with Yves, publishing my findings at “Naked Capitalism”, I began to realize the value of 20 years of experience in providing an insider’s introduction to the crisis. Then I started to receive consultancy requests from organizations who needed counseling, and I realized that I could contribute to changes in the industry. ”

The collaboration between Adams and Smith did indeed led to changes in the industry. Among other things, they broke the conspiracy of Magnetar, the Chicago hedge fund, now under investigation by the Israel Securities Authority, that inflated the real estate bubble in order to bet on its collapse. Another success story: how they managed to bend the central bank’s hand and to publish full details on AIG’s rescue , which the Fed was trying to keep classified for ten years. Adams was able to recover all the information and publish it at Smith’s blog, leading to the leaking of the original documents by a member of Congress, and opening the current demons’ dance against Goldman Sachs.

This post first appeared on May 8, 2007

The debate among Serious Economists about the benefits of free trade continues, and Dani Rodrik continues to take a dispassionate look at the data and the models.

This post, although a bit geeky, is intriguing because Rodrik dissects an analysis cited by Bernanke in a recent speech, which found that the benefits of free trade per US household since World War II are roughly $10,000, and full liberalization would generate another $4,000 to $12,000 per HH. Rodrik finds those numbers to be “grossly inflated” and explains why in “The Globalization Numbers Game.”

At the end of the post, Rodrik chides his peers for goosing numbers to make their case:

What puzzles me is not that papers of this kind exist, but that there are so many professional economists who are willing to buy into them without the critical scrutiny we readily deploy when we confront globalization’s critics. It should have taken Ben Bernanke no longer than a few minutes to see through Bradford et al. and to understand that it is a crude piece of advocacy rather than serious analysis. I bet he would not have assigned it to his students at Princeton. Why are we so ready to lower our standards when we think it is in the service of a good cause?

There is a simple answer: because with honest numbers, the case may not be compelling. These models (as I understand them, which admittedly may not be perfectly) rest on certain assumptions, many of which do not operate in practice. Thus, there is the real possibility that adjusting any model’s results to more closely approximate real world conditions may reduce (or improve) the theoretical benefits to open trade. Give that many observers believe that America’s free trade deals tend to favor its corporations rather than the population as a whole, it seems more likely than not that any rectification of theory to reality would lower the level of benefits.

If the economic benefits of trade are less than compelling, it then becomes fair to talk about intangibles: job losses, destruction of communities, loss of capabilities. I say intangible not in the sense that one can’t assign dollar values to some of them, like employment losses, but that there are also non-monetary considerations too. For example, we consider home ownership to be a good thing. Why? Well, presumably because it’s of economic benefit to the owner. Yet, as we have observed, when you factor in lowered labor mobility, and the fact that some buyers may not get the tax bennies (either by being in low income cohorts or by the operation of AMT), the financial benefits aren’t always as clear cut as the party line suggests. One of the big, often unstated reasons to encourage home ownership is that it (presumably) promotes stable communities. If that value is an important part of government policies to foster home ownership, shouldn’t it also be a consideration in weighing the pros and cons of trade liberalization?

That’s why the free trade advocates don’t want to put forward more honest numbers. They might not win the debate.

From Rodrik:

Many many years ago …, I heard Gary Hufbauer tell an anecdote at a conference on international trade. A government economist is called in by his superior, who tells him “Look, I have to make a case for this policy in front of Congress, and I need a number real bad.” The economist responds, “well, I haven’t done a proper analysis, so I can give you a real bad number.” Perhaps it was a true story based on Gary’s own government experience.

I am reminded of this story by Mark Thoma’s post, which focuses on the magnitude of the gains from globalization. He says “there’s something important that’s generally missing from the attacks on globalization’s supporters, actual evidence.” He refers to a Bernanke speech and at length to a paper which Bernanke cites by Bradford, Grieco, and Hufbauer (yes, the same Hufbauer). The Bradford et al. study argues that removing all remaining barriers to trade would raise U.S. incomes anywhere from $4,000 to $12,000 per household (or 3.4-10.1% of GDP). That is a whole chunk of change! Thoma writes:

Whatever the theory says, the evidence in this paper and the evidence more generally is pretty clear, globalization has large net benefits….

If you disagree that trade benefits the US overall, what are the problems with the econometric methodology used to produce these results or the results in other papers coming to similar conclusions? Saying the results must be wrong because they don’t support your point is not an argument. What specifically in the data, estimation procedures, etc., do you think is problematic and leads to the wrong result? Are there other notable academic papers that come to different conclusions? If so, what is the source of the difference in the estimates? Is it the data, the estimation technique, the theoretical assumptions, or what? Help us to understand why we should be doubtful about the results Bernanke cited, or about the results of other papers reaching similar conclusions.

As Thoma says, we cannot dismiss “evidence” just because we disagree with it. …[W]hile I would not quarrel with the assertion that globalization increases the size of the pie for the U.S., I do have a big quarrel with the kind of numbers presented by Hufbauer and company. They seem to me to be grossly inflated. Let me take up Thoma’s challenge and explain why.

First a reality check. The standard partial equilibrium formula for calculating the gains from moving to free trade is 0.5 x [t/(1+t)]^2 x m x e, where t is the tariff rate, m is the share of imports in GDP, and e is the (absolute value of the price elasticity of import demand). In the U.S. average tariffs stand in low single digits and imports are less than 20% of GDP. There is no way of tweaking this formula under reasonable elasticities that would get us a number anywhere near the Bradford et al. estimates. For example, using the generous numbers t = 0.10, m = 0.2 and e = 3, the gains from moving to complete free trade are a meager 0.25% of GDP (compared to Bradford et al.’s lowest estimate of 3.4% of GDP).

Now of course this is a back-of-the envelope calculation, and in particular it ignores general-equilibrium interactions–both across sectors within the U.S. and among countries. What if we take those into account? There is a cottage industry of computable general-equilibrium models which attempt to do just that. … The most accomplished work along these lines takes place at the World Bank and at Purdue. A representative recent estimate comes in a paper by Anderson, Martin, and van der Mensbrugghe–hardly a bunch of rabid anti-globalizers. Their bottom line for the U.S.: full liberalization of global merchandise trade would eventually increase U.S. income by 0.1% by 2015 (see their Table 2). No, you did not read that wrong. The gain amounts to one-tenth of one percent of GDP! (And the bulk of it comes not from the liberalization in the U.S., but from the terms-of-trade effects of other countries’ liberalization.) Is this number right? I have no clue. But at least it passes the test that it is consistent with first principles.

So how come Bradford et al. get wildly different numbers? Some of the difference is due to Bradford et al.’s attempt to take into account liberalization in services as well as in merchandise trade. But that is only a small part of the story. The real action is in the non-standard methodological choices made by Bradford et al.–choices which are designed to generate large numbers.

Bradford et al. report three different methods of arriving at their estimates. One is based on a University of Michigan computable general-equilibrium model with increasing returns. As I have already discussed (see point 5 in this post), increasing returns greatly enlarge the range of possibilities from trade opening. You can easily magnify the gains from trade, as well as produce losses, depending on how you build your model. The model Bradford et al. rely on is designed to do the former (surprise, surprise!). The results are entirely model-driven, and it is hard to see how they could count as “evidence.”

The second approach is based on estimating the gains from price convergence. The basic idea is that removing remaining restrictions on trade in goods and services should equalize prices at home with those abroad (making due allowance for transport costs). The difficulty with this is that the bulk of these price discrepancies today arise not from trade restrictions per se, but from jurisdictional discontinuities that arise from differences in legal regimes, regulatory systems, and currency arrangements across countries. If you want to believe that globalization will yield full price convergence, you must also believe that it is practical and desirable for the U.S. to harmonize its laws and regulations with those of its trading partners and to join a currency union with them. (To imagine what this might look like, you may want to think of the contortions that the EU is going through–with its common currency, European Court of Justice, 80,000-plus pages of regulations, and huge inter-regional transfers–in order to achieve a “single market” on a much smaller scale and among an already like-minded set of countries.)

The final calculation is based on an econometric estimate by Andy Rose of how much a regional trade agreement raises the volume of trade. At least that’s what Bradford et al. say. When I checked out Rose’s paper, I could not find the number that Bradford et al. use. (Rose says “belonging to a regional trade agreement raises bilateral trade by (exp(1.17)-1»)222%,” whereas Bradford et al. use 118%, without explanation). In any case, Rose explicitly discounts his own estimate (pp. 9-10), saying that it is too large to be credible and too large by the standards of other findings in the literature.

I don’t really mean to pick on Bradford et al. (although as a particularly egregious example, their paper fully deserves it). But as Thoma rightly says, we can move the discussion forward only when we present specific critiques of the work out there that disagrees with our own conclusions. So consider this an exercise in that vein.

What puzzles me is not that papers of this kind exist, but that there are so many professional economists who are willing to buy into them without the critical scrutiny we readily deploy when we confront globalization’s critics. It should have taken Ben Bernanke no longer than a few minutes to see through Bradford et al. and to understand that it is a crude piece of advocacy rather than serious analysis. I bet he would not have assigned it to his students at Princeton. Why are we so ready to lower our standards when we think it is in the service of a good cause?

Come to think of it, did I not write about this earlier?

Thoma comments:

I can’t say whether Bradford et al. intentionally made “non-standard methodological choices … designed to generate large numbers” in order to sell their case rather than the choices they believe give us the best answer to the question. They will have to speak to that themselves. But let me emphasize that we are not debating whether benefits from trade exist for the U.S., but rather about the size of the gains.

Dear Naked Capitalism people!

Here they are: the links. Today, I have more links than I can possibly put in the links post. I’ve chopped some good stuff. If you want to see them all, either go to the News Feed at CW or subscribe to it here.

Ed

PS – My home has been blacked out for two days now. Washington is one big adventure, isn’t it?

 

More on WikiLeaks

WikiLeaks | Weight of pages, but the best is yet to come  Sydney Morning Herald (Hat tip Crocodile Chuck)

The New Pentagon Papers: WikiLeaks Releases 90,000+ Secret Military Documents Painting Devastating Picture of Afghanistan War  Democracy Now (Hat tip Cynthia)

Why WikiLeaks’ ‘War Logs’ Are No Pentagon Papers ProPublica (Hat tip Conor)

The Afghanistan War Logs Released by Wikileaks, the World’s First Stateless News Organization PressThink (Hat tip Conor)

WikiLeaks and the Afghan War Stratfor (Hat tip Stephen)

Afghanistan war logs: IED attacks on civilians, coalition and Afghan troops The Guardian

Yves Smith Watch

Hunting: Chase for the nice people who plundered the American economy – Calcalist

This is an Israeli piece featuring our beloved Yves. Here’s the translated version for those of you who don’t read Hebrew (like me!) http://translate.google.com/translate?hl=en&sl=auto&tl=en&u=http://www.calcalist.co.il/local/articles/0,7340,L-3412141,00.html

Other Links

James Montier does MMT Credit Writedowns

Should the Fed Buy Gold At $5,000 per Ounce? Should Mexico Go to a De Facto Silver Standard?Jesse’s Café Américain: (Whalen is wrong on Chartalism, by the way. Don’t confuse modelling and accounting with policy recommendations. Policy is political – the model is not. I use the sectoral balances model all the time now. Read the post above and you’ll see what I mean. Does that mean I advocate printing money as a policy remedy? No. Read this post with extreme caution.)

Cuidado con los aprobados raspados ELPAÍS.com (Hat tip Diego)

Video – Americans mistakenly deported CNN (Hat tip Glenn. One commenter wrote in an earlier links post "Recessions and bad times may cause people to focus on things they might otherwise tolerate." He opined "but that is not necessarily a bad thing." My take: when economic times get tough the desire to crack down on free riders will produce many more of these kinds of events.)

The political genius of supply-side economics Martin Wolf

We had to burn the euro to save it Reserved Place

Fake £1 coins rising in circulation, figures show BBC News

Deficit Deal Only Gets Tougher After the Election Stan Collender

Deutschland gehört zu den Gewinnern NZZ (Die Frage ist, ob dies wahr ist)

The Death of Paper Money Ambrose Evans-Pritchard

Android Will be Dominant Mobile OS According to Motorola’s Sanjay Jha Phandroid

David Rosenberg raises odds of double-dip recession to 67% Financial Post

Arctic Ocean May Have Limited Ability to Absorb Carbon Dioxide Scientific American

‘Underwear Bandit’ apprehended; woman covered face with girdle to rob McDonald’s restaurant NY Daily News

Let Them Eat Losses The Daily Reckoning

Bruce Bartlett on the deficit, economy and VAT: Six questions for Bruce Bartlett The Economist

Department of Complete 180 Degree Intellectual Reversals… Brad DeLong

Some Simple Analytics of Anti-Marijuana Laws David Henderson

Antidote du Jour: The Quest For A Simpler Garden — And Perhaps A Chipmunk (we love you, Nancy!)

It occurred to me that this story might not get all that much mainstream air time in the US, for reasons that will become obvious.

We’ve been having an inquiry into the background to the Iraq war over here. There was another enquiry back in the Blair era, Hutton, summarised by wikipedia:

On 18 July 2003, Kelly, an employee of the Ministry of Defence, was found dead after he had been named as the source of quotes used by BBC journalist Andrew Gilligan. These quotes had formed the basis of media reports claiming that Tony Blair’s Labour government had knowingly “sexed up” the “September Dossier“, a report into Iraq and weapons of mass destruction. The inquiry opened in August 2003 and reported on 28 January 2004. The inquiry report cleared the government of wrongdoing, while the BBC was strongly criticised, leading to the resignation of the BBC’s chairman and director-general.

The reported intelligence in the run-up to the war, and the result of this enquiry, both  stank to high heaven at the time, to many.

We’re a safe distance from those events now, Blair has his £5m per annum sinecure with JP Morgan, the political imperatives have changed, and you can’t kick the British establishment around, the way Blair and cronies did, without there being some scores to settle. So the official verdict, on the pre-war intelligence at least, is now somewhat different. From the FT:

So now we know. Iraq posed no real threat prior to the Anglo-American invasion of March 2003. There was no credible intelligence to suggest any link between Saddam Hussein and Osama bin Laden. But what the assault on Iraq did do was proliferate jihadism across the Middle East and incubate Islamist extremism in the UK, leading to the London Tube and bus bombings five years ago and 15 other “substantial plots”.

Now we know? Hmm. Noted commie radical pinko Eliza Manningham-Buller, (I jest), weighs in with what has pretty much been the anti-war protesters’ view all along. FT again:

“Arguably we gave Osama bin Laden his Iraqi jihad,” Eliza Manningham-Buller, former director-general of MI5, the British domestic security service, told the UK war inquiry this week.

And the Hutton conclusion may or not have been right about Gilligan’s specific allegations, but it is now a matter of public record that  there were attempts to manipulate the intelligence to show a greater threat from Iraq than actually existed. FT again (my emphasis):

…what makes Lady Manningham-Buller’s testimony so devastating is that this was the advice her service gave Tony Blair’s government at the time. Indeed, MI5 refused a request “to put in some low-grade” intelligence to beef up the September 2002 government document making the case for war “because we didn’t think it was reliable”.

A former UK diplomat, a Carne Ross, very angry about the victimization of David Kelly, described the manipulation process; FT again for the key summary:

Mr Ross…says containment of Saddam was working but neither the UK nor the US seemed interested in taking obvious steps to reinforce it. Instead, they gradually exaggerated the threat he posed, suppressing contrary opinion.

“This process of exaggeration was gradual, and proceeded by accretion and editing from document to document, in a way that allowed those participating to convince themselves that they were not engaged in blatant dishonesty. But this process led to highly misleading statements about the UK assessment of the Iraqi threat that were, in their totality, lies,” Mr Ross said.

“Lies”. Well, I did say, former diplomat. In fact he resigned from the Foreign Office in protest at the way the run-up to the war was conducted. He is slightly more indirect about the Hutton enquiry, but you don’t have to read very diligently between the lines to see that as the same sort of manipulation.

So…pending a similarly frank and revelatory enquiry in the States, I would recommend judicious scepticism about reports, let’s say, of alarming Iranian nuclear plans. If I understand the import of this enquiry testimony aright, I can’t imagine that supporting British intelligence will feature much in any such reports – the US will have to make its own evidence up next time. A chap can act as a poodle up to a point, but there’s a limit.

Of course you can transfer that scepticism across to anything else the adminstration of the day really, really wants to do. But I think many of you do that already.

Cross-posted from The price of everything

By Tim Price, Director of Investment at PFP Wealth Management, a London-based fund manager

“More than half of all workers have experienced a spell of unemployment, taken a cut in pay or hours or been forced to go part-time. The typical unemployed worker has been jobless for nearly six months. Collapsing share and house prices have destroyed a fifth of the wealth of the average household. Nearly six in ten Americans have cancelled or cut back on holidays. About a fifth say their mortgages are underwater. One in four of those between 18 and 29 have moved back in with their parents. Fewer than half of all adults expect their children to have a higher standard of living than theirs, and more than a quarter say it will be lower.. for many Americans the great recession has been the sharpest trauma since the second world war, wiping out jobs, wealth and hope itself.”

-       From a Pew survey on the effects of the American recession, cited in the current issue of ‘The Economist’.

“Three years ago, it seemed inconceivable that a country such as Greece would be allowed to default, or exit the euro zone. But back then it seemed equally hard to imagine that Lehman Brothers might fail. Now that Lehman has gone, who knows what the worst-case scenario might be ? Could the euro zone break up ? Could Greece default ? What might happen to other debt-laden nations, such as the US, if the worst case scenario occurred ? The one thing that is clear is that the answers to those questions now depend as much on culture and politics as on macro-economics.. In this new world of sovereign risk, what really matters is a set of issues that cannot be plugged into a spreadsheet. The old compass no longer works.”

-       Gillian Tett in ‘The Financial Times’, April 2010.

“Two prisoners have escaped from a prison in Argentina after guards placed a dummy with a football for a head in the watch tower because of a shortage of manpower.. The source said that the video cameras monitoring the perimeter wall had stopped working some months ago. He said that he hoped the incident would alert the authorities to the problems with lack of resources and that politicians would act to improve the conditions.”

-       ‘Prisoners escape after guards put dummy in watch tower’, ‘The Daily Telegraph’, 21 July 2010.

Why did US stocks crash on May 6th this year ? That date saw the biggest one-day points decline – 998.5 – in the history of the Dow Jones Industrial Average. For a brief period, $1 trillion in market value evaporated. Eight large company stocks, including Accenture, fell to a price of one cent, while others, including Apple and Hewlett-Packard, rose to over $100,000 per share. Having fallen by nearly 10%, the market then largely recovered. The precise cause of this extraordinary intra-day volatility remains a mystery. What seems reasonably plausible, though, is that some form of algorithmic trading, whether executed by hedge funds or investment banks (like there’s a difference), played a role. The ‘essential’ function of the stock market is to raise capital for businesses. A secondary but meaningful function is to assist in price discovery, the more or less democratic process of evaluating those businesses, with capital assessed as votes. What is not a core function of the stock market is to act as a playground for high speed leveraged speculators. As Keynes said,

“When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”

To read more,

Download Something has to give

This post first appeared on May 6, 2007

I’m certain you’re familiar with the expression “death wish.” I am beginning to wonder whether America has a banana republic wish. The country has been taking steps towards being a small-minded, elite-dominated, sham democracy.

Mind you, I am pointing to a tendency, not an established fact. The US isn’t Haiti, or even Argentina. But we are moving in that direction on a variety of fronts, and the devolution seems so concerted that I wonder if there is some unconscious mass desire to give up on the messiness and ambiguity of an open society and surrender to the certainty of one with institutionalized inequality, more authoritarianism, but greater certainty, and perhaps an illusion of greater security.

What triggered this line of thought? Something surprisingly minor: the April employment report, which by any standards was weak. The Bureau of Labor Statistics said that 88,000 nonfarm jobs were created in April, when it takes 150,000 new jobs to absorb labor force growth, and consensus forecasts were for 100,000 new positions.

But even this disappointing figure may have been the product of manipulation, as we will discuss in due course. And we’ve now had so many instances of what charitably may be called artful reporting that it’s beginning to undermine my faith in government statistics. Unreliable government statistics are a Banana Republic Indicator.

Let me go back to 1984, when I went to Mexico City to value a privately held air conditioning company (I was working for a top US consulting firm at the time; we normally didn’t do assignments of this nature, but the client was important).

At the firm’s office, I tried rounding up the usual data: GDP growth, inflation, bond rates, PE multiple, microeconomic stats. I came up with nothing. Everyone acknowledged the governments stats were wrong. The logical suspects, like investment banks, that might develop their own estimates didn’t (or at least didn’t publish them) since the only entity in the economy that was a prospective client was the government, so no one wanted to offend them. Inflation was so high that there was no long term bond market, and there were only 24 public companies that traded at PEs of either 2 or 4. I was soon stomping around the office, complaining that there was no data in the entire economy. Everyone was very pleasant, agreed, and one consultant offered some advice: “We do a lot based on feelings.”

Now I am sure some of you are thinking I am daft. The US isn’t Mexico, and we have lots of economic and company data. Technically, yes, but the integrity of that data is becoming compromised on enough fronts so as to render them suspect. And inaccurate data leads to bad business and bad policy decisions. Bad policy decisions are particularly likely since the information is massaged so as to minimize unpleasant news.

Let’s look at GDP. That’s a fundamental figure, surely beyond question or compromise. Really? Our GDP stats include something called a “hedonic price index” basically to allow for the fact that computers are becoming more powerful at lower costs. In essence, the US grosses up the price of computers in its GDP reports to adjust for the fact that computer prices are dropping.

These adjustments are significant. The US is the only country that uses hedonic indexing. The Bundesbank complained that if they calculated GDP the way we did, their GDP growth would be 0.5% higher. And the cumulative distortion is massive. In 2005, Michael Shedlock contacted the Bureau of Economic Advisers and they supplied some dated information on hedonics (including a spreadsheet). Even so, he found that hedonic adjustment to GDP was 2.257 TRILLION dollars, or 22% of then-current GDP.

Another fundamental statistic, inflation, is also manipulated. The hedonic adjustments of GDP means we can’t rely upon a simple, economy measure other countries use to look at inflation, namely a GDP deflator. No, we have to rely on indices, which means we have to rely on the selection of baskets of goods and services that get tracked over time. But things get thrown out of those baskets if they become inconvenient. For example, now when the powers that be report the Consumer and Producer Price Indexes they focus on “core inflation” which excludes food and energy prices ostensibly because they are volatile. But what good is an index if it omits a very big portion of household budgets? Yet most reporters and analysts happily follow the government’s lead. Barry Ritholtz calls this “inflation ex inflation.”

And this pattern of excluding ugly data is becoming more popular. Last week, Caroline Baum of Bloomberg was widely quoted for writing:

To say that ex-housing the economy is doing just fine is tantamount to claiming that, ex-Iraq, Bush’s Middle-East policy is a rousing success.

Now let’s go back to the April jobs figures. James Hamilton at Econbrowser highlights that a “birth/death adjustment” (a figure the BLS adds to allow for the fact that its survey doesn’t capture the creation or failure of businesses) was unusually large and increased the level of reported gains:

The Bureau of Labor Statistics reported today that the number of workers on U.S. nonfarm payrolls, as measured by their survey of establishments, increased by a seasonally adjusted 88,000 workers in April, of which 25,000 were government jobs. On Wednesday, Automatic Data Processing gave its estimate as 64,000 private sector jobs. The ADP estimate is based on actual payroll data, not a survey, and covers twice as many individual businesses as the BLS. When you add in the public employees (64 + 25 = 89), ADP called the nonfarm payroll number essentially spot on this month two days before we heard from BLS.

Unlike many analysts, I also pay attention to a separate employment estimate that comes from the BLS, which is based not on asking businesses how many people are working for them, but instead comes from sending interviewers to pre-selected residential addresses to ask how many individuals at that address are working. This BLS household survey claimed that the number of people working in America fell by 468,000 in April compared to March, on a seasonally adjusted basis.

I favor looking at all these numbers together because one survey can pick up things the other two might miss. One of the blind spots of the BLS and ADP establishment data is that, by definition, they cannot directly measure somebody who’s employed with a company that didn’t exist at the time the survey was set up. One of the ways that BLS tries to correct for this is with their CES Net Birth/Death Model, which tries to estimate what might be going on with new firms that aren’t in the sample on the basis of regular seasonal patterns and what is currently observed for those firms that are sampled. This imputation led BLS to suspect that there were 317,000 new jobs this April that they did not actually observe, which is three times the average absolute monthly adjustment for 2006.

Now the fact that the BLS result was very close to the ADP figure may mean the report wasn’t so sus after all, but other data watchers took a dim view of the adjustment.

This focus on data has prevented me from discussing other Banana Republic Indicators. Let me give you a starter list:

Compounds with private security for the very rich
Limited economic/class mobility
Debasing of the currency
Very high concentration of income and asset ownership in the very top echelon
Government policies heavily skewed towards the very rich; looting of the treasury
Limited/no press freedom
Election fraud; in extreme versions, coups, one party rule
Attacks on judicial independence/kangaroo courts

This list is admittedly incomplete; I’ll add to it as news items prompt me. On the one hand, America doesn’t hew closely to that profile. On the other, just like the dubious statistics, we have started down the slippery slope on some of them.

In the interest of time, I’ll deal very briefly with two: press freedom and election fraud. The degree of self-censorship in the American press is high and troubling. It seems to have started with the Bush Administration freezing out critics from any contact with their officials, and concerns about appearing unpatriotic in the wake of 9/11. But even now that the Bushies are on the ropes, the level of candor and criticism is oddly muted.

As for election fraud, it was well reported by Greg Palast on the BBC, and virtually untouched here. In Florida, the state scrubbed nearly 90,000 voters from the rolls. An estimated 97,000 ballots were discarded in Florida (virtually all ballots were counted in white counties, while in largely black precincts, it appears any excuse was used to throw out ballots). Another 91,000 voters were excluded incorrectly, and again that population was heavily black. Do the math. Blacks voted nearly 90% for Gore. Including even a small portion of the votes that were denied would have overwhelmed the 500 vote margin of Bush’s victory. Palast also uncovered large scale exclusion of black voters in Ohio in 2004. But again, no one wants to consider that our election process might have been hijacked.

Cross-posted from New Deal 2.0

By Wallace C. Turbeville, the former CEO of VMAC LLC, and a former Vice President of Goldman, Sachs & Co.

The current system of trader compensation will continue to decay the heart of Wall Street.

Which is a greater threat to the nation — terrorism or the relentless decline of middle income families? Unless we abandon our core values out of unwarranted fear, terror cannot fundamentally change our way of life. The number of people affected by growing income disparity is vast. When I was a student, income disparity was indicative of an underdeveloped and unstable society.

The government appropriately devotes enormous resources to protect our lives and property from terrorism. It is unthinkable that a leader would display any weakness opposing this threat. Politicians have stiff backbones when it comes to terrorism.

In contrast, the government is timid and half-hearted in its approach to the system which perversely rewards a few Wall Street traders with billions of dollars of bonuses, yet allows the foundation to decay.

Kenneth Feinberg issued his report identifying outrageous Wall Street compensation of executives despite their role in the financial disaster and bail out. He proposed that the banks voluntarily adopt “brake provisions” that permit boards of directors to nullify bonuses in the event of a new financial crisis.

He might have more success asking the lions of the Serengeti to give the wildebeests a sporting chance of making an escape.

Over the last fifteen years, the financial sector’s percentage of GDP has increased dramatically. At the same time, the median family income stagnated and then declined. I do not believe that this is a coincidence.

The large banks have changed. They slice and dice the constituent elements of a stagnant economy, squeezing value out in ever more sophisticated ways. Wall Street has turned away from its roll as the financial backer of industry and commerce. In the short term, it is more profitable for them to use their capital for trading. Newfangled software and MIT “quants” allow the traders to “rip the faces off” of corporate counterparties and investors which were once trusted clients.

These young traders are simply doing what America has told them to do. They are allowed to earn obscene amounts of money using the advantageous information, technology and capital of their employers. Making money from less powerful counterparties is like shooting fish in a barrel. The banks make so much money that they have no problem shoveling it out to the traders.

The alternative careers for these talented young people offer upside which is modest by comparison. Besides, the trading world, in which the law of the jungle prevails, appeals to youthful aggressiveness. Michael Lewis expected that college students would be appalled by the amoral environment he described in “Liar’s Poker.” Instead, the overwhelming response he received from students was a desire to get in on the action. The draining of talented and energetic young professionals away from corporate America where they could help create jobs by the millions may be as damaging as the new allocation of wealth.

The government’s flaccid approach to Wall Street compensation, embodied in the Feinberg report, is appalling. Geithner and Bernake appear intimidated by Wall Street, yet intent on its approval. Why do they guilelessly buy into the notion that giant, multi-purpose banks dominated by trading are essential to America’s competitiveness in the world? Smaller, less risky institutions aligned with economic growth would seem to be a better idea for the vast majority of Americans.

Greenspan and his progeny, including Geithner and Bernake, are enthralled by financial innovation. Innovation, by itself, can be good or bad. Innovation does not fall into the “good” category if it corrupts the home mortgage market, siphons off business productivity and the jobs and wages of employees and unfairly enriches the few at the expense of the many. It is good if it creates jobs and enriches the public as a whole.

Trader compensation is at the heart of the problem. It encourages behavior that is inconsistent with Wall Street’s most important function: raising capital for industry and commerce. The banks and the government are afraid that the traders will desert the banks and move to hedge funds if their compensation is reduced. If they do jump ship, it is all the better for America. At least hedge funds can blow themselves up without crippling the US economy in the process.

Former traders now run most of the financial sector. They believe that the traders somehow deserve compensation at the prevailing levels. The system will not change unless it is forced to do so. The restrictions in the financial reform legislation only inhibit specific abuses. The banks will concoct new ways to trade risk. It is the only way to maintain their unconscionable profits (that is, until the next bubble bursts and we are in an even worse predicament). The only way to really change the system is to reduce short term incentives, that is to say limit bonuses. The government needs the kind of resolve it uses when fighting terrorism. After all, the stakes are actually higher.

Well, the Saturday hot spot forecast is panning out, patchily.

The market is doing its own stress test calculations and coming up with radically different answers: JP Morgan thinks 54 banks fail their version of the tests. Barcap is picking at the funding mechanism that would be needed if there was ‘real’ stress, beyond that  envisaged in the undemanding official scenarios.

There is official moaning about non-revelation of sovereign exposures by some banks. FT:

European regulators have accused Germany and its banks of reneging on a deal to publish full details of sovereign debt holdings, as part of the four-month-long stress test exercise of the country’s banking sector.

In an interview with the Financial Times, Arnoud Vossen, secretary-general of the Committee of European Banking Supervisors, the pan-European banks regulator, said: “We agreed with all supervisory authorities and with the banks in the exercise that there would be a bank-by-bank disclosure of sovereign risks.”

Deutsche, the most conspicuous offender, sagged a bit at the open, but the market will be chary of expressing too much disapproval just now: Deutsche’s quarterly results are due tomorrow. Not much action in ABN-Amro, so maybe they did put their sovereign exposures up, somewhere.

Elsewhere the circularity sovereign stress-> bank stress -> sovereign support is attracting some scrutiny.

All quiet…except Euribor is getting worse

Dear Naked Capitalism readers, the links are a tad thin today because I was away until yesterday and my house was blacked out when I got back so I’m still getting back up to speed. Feel free to send more links. Cheers, Ed

Wikileaks

The Afghanistan Protocol: Explosive Leaks Provide Image of War from Those Fighting It Der Spiegel

Afghanistan war logs: Massive leak of secret files exposes truth of occupation The Guardian

Afghan War Diary, 2004-2010 Wikileaks

View Is Bleaker Than Official Portrayal of War in Afghanistan NYTimes

Pakistan Aids Insurgency in Afghanistan, Reports Assert NYTimes

What the Wikileak Means for the Afghanistan War Swampland

The rest

Lockerbie: now pressure switches to America Herald Scotland (Hat tip Frederick)

The Gray And The Brown: The Generational Mismatch National Journal (Hat tip Francois)

Positive Konjunkturprognosen: Ökonomen jubeln über Super-Aufschwung Der Spiegel (Hat tip Euro Savant)

BP set for deep-water drilling off Libya FT

AIB and BoI in most vulnerable European group Independent Ireland

BlackBerry poses social, security risks: UAE Financial Post

Tony Hayward to quit BP The Guardian

Deportation of illegal immigrants increases under Obama administration Washington Post

Antidote du Jour: Gorillas (you rock, Desmond!)

GM, with $75 bn in cash in reserves, bought AmeriCredit, a small subprime lender,  in an all cash deal for $3.5 bn. GM is also currently in bankruptcy.

AmeriCredit, which is rated BB by Fitch, was put on watch by Fitch, after the deal announcement.

Fitch is unsure whether the deal will help or hurt the debt rating of AmeriCredit.

A giant, though bankrupt, company, that is effectively a ward of the state, with an upcoming IPO being steered by US Treasury, is buying a tiny subprime lender for all cash – and Fitch says it can’t tell which is the good company and which is the bad.

That is the current state of finance, rating agencies and Treasury department machinations, in a nutshell.

The officers of AmeriCredit probably don’t care either way though, because they all just got cashed out.

h/t anonymous.

Economists really do seem to struggle with history – and sometimes geography, too. Brad DeLong needs to remember that the Financial Times is published in London. As far as most combatants were concerned, the second world war broke out in September 1939.

Niall Ferguson, FT, 20th July 2010.

Goodish point. On the other hand, Ferguson isn’t quite so solid when it comes to counting up the number of wars in which the U.S. is currently engaged:

People are nervous of world war-sized deficits when there isn’t a war to justify them.

Niall Ferguson, FT, 19th July 2010.

So he’s lousy at sums, or very fussy about what counts as a war, but good at geography. But what happens when Fergusonian neo-imperialist historical revisionism encounters Fergusonian austerity economics? Let us see.

My texts today are “Royal Navy strategy in the Far East, 1919-1939: preparing for war against Japan”, by Andrew Field, which, if you like that kind of thing, you can order from Amazon, and “The Economic Consequences of Mr Osborne”, subtitled “Fiscal consolidation: Lessons from a century of UK macroeconomic statistics” by Victoria Chick and Ann Pettifor, which is available online. With a dash of wikipedia, for quickness.

We’ll kick off with the demobilisation hit in the UK at the end of the First World War, raiding Chick and Pettifor for the numbers:

Public

Expenditure

£

million

Nominal

GDP

£

million

Expenditure

as share of

GDP

%

Public

debt

% GDP

Interest

rate

Real

GDP

growth

Unemploy

–ment

rate

GDP

deflator

growth 1918 1850 5243 35.3 114 4.4 -­‐1.8 0.8 18.6 1919 968 6230 15.5 136 4.6 -­‐8.7 6 17.8 1920 591 5982 9.9 133 5.3 -­‐6.7 3.9 20.3

“After World War I, expenditure was cut sharply between 1918 and 1920” – Chick and Pettifor

There is always a demobilisation hit after a big war; but yes sirree, that is quite some cut. Despite the GDP contraction, there is still some vigorous inflation (this kicked off early in the war, just as it did in Germany, as the mutual blockade bit), and the debt/GDP ratio has got a lot worse.

In the mean time, British politicians are fretting about a resumption of the pre-war arms race in battleships; this time the expected competitor is none other than the United States of America. To digress: these today-unimaginable threat assessments are always rather quaint; my all-time favourite is the Thirties US Army study that took the main threat against the US to be an onslaught from the north by three million rampaging Canadians.

An enterprising British Admiral suggested the right answer – just explain to the Americans what ships we think we need to build, and why, and they’ll be fine with it. And it worked! Aren’t Americans nice? Incidentally this success prompts Ferguson to suggest in one of his books that the same diplomatic technique could have been deployed on the Kaiser, pre-war, averting the whole naval buildup 1904-1914. Huh. Anyhow, the whole deal is codified in the Washington Naval Treaty:

After the signing of the Washington Naval Treaty [1921], the Royal Navy achieved parity with the United States Navy, and superiority over the Imperial Japanese Navy, by slashing existing construction programmes (largely on paper in the British case, although many of the older British battleships also had to be scrapped) and limiting future construction, until after a ten-year ‘holiday’ on building.

- Field

The Brits got pretty much what they asked for out of this. They could stop worrying about annoying the Americans, and start to concentrate on what they new, even in the early 20s, was the real threat to British interests, Japan. That ten-year ‘holiday’ was not an Admiralty idea, though:

…The Admiralty continually represented its case for a navy sufficiently large to ensure the safety of British possessions and maintain sea lines of communications. Their reasoning though was often too imprecise to politicians keen to accept naval arms limitation and seeking cuts in expenditure, despite the erosion of the pool of specialist warship builders and the loss of skilled men from their yards that this would entail. The danger was that at the end of the ten-year building holiday, with an ageing British fleet needing to be modernized and replaced, the shipyard capacity and workforce to do the jobs would no longer be there.

Field

And the treaty holiday – the abrupt cessation of a huge chunk of manufacturing activity – ripples straight back into the already demob-hit British economy – shipbuilding, steelmaking, armaments manufacture, what passed for high tech in those days. Back to Chick and Pettifor:

Public

Expenditure

£

million

Nominal

GDP

£

million

Expenditure

as share of

GDP

%

Public

debt

% GDP

Interest

rate

Real

GDP

growth

Unemploy

–ment

rate

GDP

deflator

growth 1921 648 5134 12.6 150 5.2 -­‐5.8 16.9 -­‐10.5

1922

555

4579

12.1

170

4.4

3.5

14.3

-­‐16.1

1923

483

4385

11

180

4.3

3.1

11.7

-­‐8.0

“The post-­‐war macroeconomic outcomes were nasty. There was a very sharp rise in unemployment and fall in GDP – especially in nominal terms; a severe dose of inflation was followed by a severe deflation. Government bond yields remained virtually static in nominal terms, but in real terms yields turned extremely high (not shown, but derived by comparing interest rates with the GDP deflator growth).” - Chick and Pettifor

And then there was the “Geddes axe” (the massive naval cuts of 1921), and then more axework in subsequent years, as politicians contemplated that ever worsening debt/GDP ratio, and cut, and cut, and cut:

Expenditure on the Royal Navy, and financing its plans at a time of economic depression continued to be a bone of contention, and in 1923, on the heels of the 1921 ‘Geddes Axe’, a committee, chaired by Sir Alan Anderson, reported on naval pay. The committee concluded that naval pay was too high relative to other workers and in 1925 an Admiralty Fleet Order established a lower rate of pay from men joining after 5 October, but seemingly guaranteeing the older, higher rate to those who had joined before this date.

- Field

The General Strike (1926) seems to have achieved a temporary halt to the cutting frenzy. Note the identity of the axe-wielding Chancellor whose fondness for the Gold Standard precipitated the General Strike:

Churchill was appointed Chancellor of the Exchequer in 1924 under Stanley Baldwin and oversaw Britain’s disastrous return to the Gold Standard, which resulted in deflation, unemployment, and the miners’ strike that led to the General Strike of 1926.[80] His decision, announced in the 1924 Budget, came after long consultation with various economists including John Maynard Keynes, the Permanent Secretary to the Treasury, Sir Otto Niemeyer and the board of the Bank of England. This decision prompted Keynes to write The Economic Consequences of Mr. Churchill, arguing that the return to the gold standard at the pre-war parity in 1925 (£1=$4.86) would lead to a world depression. However, the decision was generally popular and seen as ’sound economics’ although it was opposed by Lord Beaverbrook and the Federation of British Industries.

Churchill later regarded this as the greatest mistake of his life. However in discussions at the time with former Chancellor McKenna, Churchill acknowledged that the return to the gold standard and the resulting ‘dear money’ policy was economically bad. In those discussions he maintained the policy as fundamentally political – a return to the pre-war conditions in which he believed. In his speech on the Bill he said “I will tell you what it [the return to the Gold Standard] will shackle us to. It will shackle us to reality.”

- wikipedia

The axes came out again after the Wall Street Crash:

After the 1929 Wall Street Crash and the start of the Great Depression in Britain in 1931, and with the country in a grave financial state, another committee was set up, chaired by Sir George May, to determine how to cut public expenditure even further and retain the Gold Standard. His Committee decided that cuts in naval pay would be necessary and that no guarantees regarding the higher rate of pay had been made. Despite the First Sea Lord’s protests, the First Lord, Alexander, had little alternative but to announce that the Royal Navy would accept the May Committee’s recommendations.

Most of the Royal Navy’s personnel found this out from the press and not from their officers. The result was…the Invergordon mutiny”

- Field

British labour relations were not at their best that day. The Invergordon mutiny was quite a small mutiny, 1,000 sailors for a couple of days, but RN sailors aren’t supposed to do that, and the effect was convulsive. The mutiny took place on the 15th-16th September 1931; by the 20th, there had been a stock market crash, a run on sterling, and the UK was off the Gold Standard, for good this time:

…This was a low point for morale in the Royal Navy and great damage was done, not just to the prestige and image of the Royal Navy, but also to the nation as a whole; confidence in Britain slumped, inflation rose and the government had to abandon the Gold Standard. For the rest of the decade the Royal Navy would struggle, not just to build up the battle fleet at a time of economic constraint, but also to rebuild its self-confidence.

- Field

So that’s the shipbuilding capacity impaired, the technology investment chopped off, the design expertise and design teams dispersed, a massive morale hit, the economy more or less growth-free for a decade, and we are still short of the deepest point of the Great Depression. The Royal Navy’s preparations for war with Japan do not appear to be going well, do they? They never did get the ships they needed to implement their policy; here’s how it ended:

On 10 December 1941, three days after the attack on Pearl Harbor disabled the US Pacific Fleet, Force Z, the Royal Navy’s battleship Prince of Wales and the battlecruiser Repulse, were sunk by Japanese aircraft. On 25 December the colony of Hong Kong fell to Japanese forces and on 15 February 1942, Singapore, with its extensive naval facilities, surrendered. Twelve days later, at the battle of the Java Sea, Allied naval forces were annihilated by Japanese forces.

…British Far Eastern naval strategy, carefully crafted and developed in the years following the First World War, was shattered by these disasters…it would be 1945 before a Royal Navy fleet was again active in the Pacific. By then the United States Navy reigned supreme, the largest and most powerful naval force in the world, and the end of Britain’s imperial presence in the region was inevitable.

- Field

Now I am not such a big fan of Empire as Ferguson, though I do quite like the story of the Navy. But I do find it hugely ironic that it is so easy to argue that the very economic measures that he espouses destroyed the British Empire.

Different times now: not much manufacturing sector left to chip away at, and no empire to lose, and no really big war just behind us.

One thing though: here in the UK, we are now constructing our biggest naval ships since the end of World War One; perhaps this is some sort of leading indicator of crashes for us, like the height of skyscrapers in the US. The general debt set-up does seem unnervingly similar; this time a small war, a bank bailout and a hefty public sector commitment stand in for the big war. And the mindset is the same. So we are about to see how Mr Osborne compares with Mr Churchill.

Powerful stuff, this austerity economics. Perhaps the subversive fringe should actually be more in favour of it; it seems to be good for ushering in new world orders. A new world order might be the result this time, too, making due allowance for the different politics and economy of the US.