Economic Stability

A big reason why we have a Federal Reserve handle monetary policy is to smooth out the economy over time and prevent recessions and booms.

But interest rates aren't the only reason why economies fluctuate. These days, oil prices are really important--their spike last year is a big and underappreciated contributor to the current economic problems.

The reasons why oil went up that high haven't gone away. Much of the remaining oil is controlled by autocratic regimes with nationalized oil companies, who chronically underinvest in new production. The rest is barely accessible, poor quality crude, in deep sea deposits, or tar sands. Combined with price controls in important consumer areas--the Middle East, South and East Asia--this results in inelastic demand and supply.

And that means huge price fluctuations in energy. But today's economy is very dependent on energy prices--it made the crash worse, then low prices contributed to a quick rebound, and higher prices in the future might cut off a recovery.

That means, as long as the price of oil remains as volatile, America's economy will remain very unstable, and will respond to and drive the cost of oil. Especially now that monetary policy is very limited, being immune from world energy prices would really help stabilize the economy.

And that would require a very different energy source.

Memorial Day

Look, I respect fallen American soldiers--just as I respect those killed in action from other countries (every country?).

But, as a sometimes libertarian, it disturbs me a little how Memorial Day has expanded from an activity simply remembering fallen soldiers into one which equates their sacrifice with American freedom. This is the old "liberty comes from the blood of patriots" line. Something like this did happen in the Revolutionary and Civil Wars, and the American military did a lot to preserve the liberty of other countries in World War II.

But these actions, strictly speaking, only established the independence and unification of America. Plenty of countries are independent and whole--acts often achieved from the blood of patriots--but not free. Liberty in America came from something else: The desire of the property-holding class to limit the powers of government, and then from the continual actions of civil society to hold government accountable.

You have a similar situation in other countries. You could say that Britain "fought" to establish its parliamentary system, but really, liberty came when groups within society asserted their rights against Leviathan. Or look at the democratic transitions in East Asia, which generally happened without much bloodshed in response to political activism from the middle class. In India, democracy is boosted by an engaged and energetic professional elite, and sustained by enthusiastic participation by all sections of society. Soldiers weren't even necessary to liberate the country, while in neighboring Bangladesh and Pakistan, the Army constitutes the biggest threat to democracy.

Liberty doesn't, fundamentally, come from soldiers--who fight for a state which may or may not promote freedom. It comes from within, from the selfless actions of activists, journalists, and protestors, as well as from the selfish acts of the bourgeois class.

The Costs of Empathy

The buzz about Obama's nominee for the Supreme Court is that her diverse life background will add an important perspective to the deliberations of the nation's highest judicial body.  This may or may not be true, but it is also partially irrelevant--this is a choice driven to gain the votes of a particular demographic.  

But why do people keep assuming that high-profile minority appointments will translate into political gains?  The experience of the Bush Administration--which had posts given to the likes of Alberto Gonzalez and Colin Powell--comes to mind.  It's not as if Clarence Thomas, Antonin Scalia, or Ruth Ginsburg brought in their respective demographics into either party.  Voters simply don't make their decisions based on these types of issues--often, they are not even aware.  

But the cost of going with the best jurist who is a female Hispanic, rather than the most talented legal theorist, will be felt in the coming years.  Had Obama went with an intellectual hotshot, one who could rival Roberts and Scalia by establishing a liberal counterweight, and who could woo the centrists through competent jurisprudence, he could drastically change the temperature of the Supreme Court, even as the executive and legislature have gone through major political shifts.  This is the stuff of realignment.  

This appointment is symptomatic of the broader problem of short-term politics.  Politicians often seek to dominate the short-term news cycle, and gain the approval of the heads of interest groups.  But that's not what voters care about.  Throw away the weekly opinion polls, narrowly targeted policies, and stop talking to union bosses and teachers unions.  Focus entirely on offering good governance.  If employment is high, and inflation low--Obama will win a second term, no matter who his nominees are.  

More Bad News

From Matt Yglesias,

The only way to clean [Financial Crisis] up on a tractable time frame is to take insolvent banks into receivership, explicitly pay off enough outstanding bank obligations to get things in decent shape, break up and reprivatize new healthy institutions, and manage “legacy assets” for the long-run.

But basically nobody wants to do this. Obama and congressional liberals want to focus on their core agenda—health care, energy, labor law, education. Republicans don’t want to appropriate money. And bank managers want to continue to take advantage of implicit government guarantees and recapitalize themselves out of operating profits while paying themselves multi-million dollar strategies. Given enough time, that should work. But it could easily take years and give us a prolonged period of sluggish growth.

The political economy here is really messed up.  Because the government cannot spend enough money or muster the political capital to really deal with the banking crisis, the problem continues to fester.  But because the government has some influence, it tries desperately to prevent institutions from failing, and so throws money around, preventing the banks from bothering to solve the problem themselves.  Continued political meddling from Congress makes any private actor very reluctant to trust government policies.

I suspect that had the government taken a clear stance early on not to bail out financial institutions, we would be in a much better place.  In the end, how bad was Lehman's failure?  We've already endured all of the problems that would supposedly happen if banks failed.  Without implicit government guarantees, and government meddling, people on their own would have much bigger stake to solve the problems themselves.  

But if you are going to bring the government into it, you might as well do so in a way that manages to fix the problems, while not risking taxpayer money.  That's not happening.

The Republicans/populists now stand in the way of the kind of spending and policies necessary to fix the banks.  But the Democrats too are unfocused on the problem, preferring to capitalize on the crisis to pass sweeping reforms on the domestic front rather than solve the crisis.  As the economy fails to recover, because we will still have a financial crisis, these debts will pile up.  And they will be inflated away at massive cost to ordinary Americans.  

Bank Nationalization

From the WSJ:

We've come to this pass in part because the Obama Administration is afraid to ask Congress for the money for a meaningful bank recapitalization. And it may need that money now in part because Mr. Paulson's Treasury insisted on buying preferred stock in all the big banks instead of looking at each case on its merits. That decision last fall squandered TARP money on banks that probably didn't need it and left the Administration short of funds for banks that really do.

The sounder strategy -- and the one we've recommended for two years -- is to address systemic financial problems the old-fashioned way: bank by bank, through the Federal Deposit Insurance Corp. and a resolution agency with the capacity to hold troubled assets and work them off over time. If the stress tests reveal that some of our largest institutions are insolvent or nearly so, it's then time to seize the bank, sell off assets and recapitalize the remainder. (Meanwhile, the healthier institutions would get a vote of confidence and could attract new private capital.)

Bondholders would take a haircut and shareholders may well be wiped out. But converting preferred shares to equity does nothing to help bondholders in the long run anyway. And putting the taxpayer first in line for any losses alongside equity holders offers shareholders little other than an immediate dilution of their ownership stake. Treasury's equity conversion proposal increases the political risks for banks while imposing no discipline on shareholders, bondholders or management at failed or failing institutions.

Populist anger is building, and will soon be so strong as to prohibit any useful action to save the economy from taking off.  Obama needs to get on TV right now and build political capital to make the unpleasant and necessary spending to fix the banking sector while he's still popular.  

Instead, he's saving a few million here, overhauling the autos, etc etc.  Fixing the banks should have been the priority for the last year.  It's a lot more important than the million and one commitments the government has recently entered into.  And Geither has neither the money or people to do his job.  We're tracing one by one the steps Japan took into its lost decade.  

 

Freshwater Economists

This is getting a little out of hand--Brad DeLong and Krugman know more about Chicago economic theory than Chicago economists.  I'm not a fan of the Treasury's plan to fix the banks--I don't think anyone is--and I'm fairly mistrustful of the stimulus as passed.  The administration's plans on energy, healthcare, and education leave me a little worried.

But even more scary is the complete lack of credible opposition.  A world in which Cochrane and Lucas are apparently willing to have the government do nothing about a massive credit crunch and economic downturn is one that spells complete intellectual disrepute for the conservative movement.  Add the fact that the media foot soldiers--your Rush Limbaughs and so forth--are completely radioactive.  And then that Republicans in Congress can't think beyond spending freezes, and apparently don't realize that Americans want affordable healthcare.  

Sure, Republicans will win again after liberal overreach.  But the quality of that governance will depend on people thinking now about how to apply their principles to pressing issues.  

No More Brain Research!

I'm not sure why I keep bothering with this, but there's another neuroscience article going around on how poverty causes stress which causes inter-generational poverty; a fact that scientists discover by peering into stress levels in the brain.  

I don't even care for the moment whether the causal link is true or not; for all I know, it may be.  The broader point is that things can be real without you finding where they are in the brain.  Moreover, you finding a correlation between something in the brain and something in the real world does not let you ascribe full causal force to the thing in the brain.  And if you want to link the thing in the brain to future poverty, you might as well actually test that link, instead of saying "it hurts working memory by a little!  Our work is done."  Plus, how many interesting dynamic things are the in the world, where, say, poverty changes or income changes or something happens.  This kind of stuff happens all of the time.  Notice how you can explain exactly none of those changes using something that is a fixed human constant.  

This stress thing is really popular among people who study healthcare too.  But there's really nothing you can do about stress without radical social engineering.  On the other hand, there are a million and one interventions you can think of on education and healthcare that can radically improve both.  DC's voucher program, for instance, improves kids reading scores by a half grade. Except that program just got killed by Congress.  Awesome.  

Defense Cuts

If Gates gets away with his sweeping budget cuts in Defense spending, I'll be really happy. Cutting the F-22? Cutting white-knight, pie in the sky projects like the Future Combat Systems? Cutting missile defense spending? That's amazing. It'll be even more amazing if this can survive Congress.

Unfortunately, Defense spending is still going up, because spending on unconventional wars is rising. Obviously some of this is necessary for Afghanistan and Iraq. But how much of that reflects the conflicts America will get into after these wind down? One school of thought suggests that American strategic interests will demand future interventions in failing states to curb instability and terror. This is no doubt what will actually happen.

Alternatively, people could set 'Defense Priorities' with actual resources in mind. We could say that sending soldiers into every last rotten country around the globe doesn't represent an affordable goal. We could say that Europe and South Korea can shoulder their own defense needs on their own, instead of piggy-backing on American tanks. They also depend on American pharma research because they've destroyed their own industry with price controls, and need to be gifted iPods because their firms are too lazy and their consumers too complacent to develop technology.

Anyway, back to the point: Serious draw-downs in military spending will only happen when the last neoconservative is strangled with the entrails of the last humanitarian hawk.

Post-Modern Journalism

People are concerned about trends in journalism which elevate partisan and political folk over your tried and true journalists.  It's true; the lines between objective media and normal, partisan, rabble-rousers are blurring.  But there are reasons to think that this was never a particularly strong link to begin with, and that breaking it may even have some good effects.

Consider all that we know from psychology about the impact of beliefs on behavior.  Even when the NYT puts up a solid, grounded article, the biases of the author are going to show up.  It's impossible to judge facts or events without a worldview, and it's better to be forthright about what that position is (like British newspapers, or American ones in the 19th century), than to studiously pretend that some sort of 'objective' middle ground can be reached.  

This is also part of the trend where we get rid of 'jounalists' who use their intrepid fact-finding abilities to ferret out the truth, regardless of the subject at hand or their initial knowledge.  Now, people can turn to actual experts (or smart lay-people) on the subject, who can communicate directly with readers instead of being intermediated by journalists.  I can't imagine a world in which the only news I had about the financial crisis came from the NYT, instead of, say, commentary from Brad DeLong, Tyler Cowen, and so forth.

Populist Outrage

Looks like Goldman Sachs is about to return its bailout money, as a number of other banks are about to do as well.  While Goldman might be doing fine, it points to a general problem: No one thinks that the banks are capitalized.  They're still short of capital, and billions of public dollars are necessary so that people trust the banking system and credit starts flowing again.  This is unpopular, but nothing short of ruining the taxpayer will prevent large-scale economic chaos.  

But that's not what people are focusing on, reflecting a lack of coherence across two administrations.  Paulson and Bernanke ignored the problem as long as they could, then came into Congress with the half-assed TARP plan.  This wasn't a great idea, but at least it did something--and was eventually used to pump in capital at a time after Lehman when people were really afraid about general collapse.  

Then six months passed, and the best government plan is still TARP, plus some private additions.  The ruckus over the AIG bonuses has destroyed whatever credibility that bailouts had in the first place, so Geithner is left cobbling together a solution without additional funds from Congress.  Nobody thinks this will be enough.  Worse, he's doing this while trying to create a new regulation regime, and has for months been working in an office which has been understaffed due to tight ethics standards for appointees.  Everybody else has been working on the stimulus package.

This is exactly the road Japan went down, and they found that nothing will get better until you tackle the banks, no matter how hard it is, or how much you work on rebooting the economy in other ways.  Everything can wait until the banks are fixed.

Just A Thought

One of the things I should have mentioned when talking about Freeman Dyson earlier is his skeptic role in doubting the severity of actual future climate change, not just the optimal mechanics for dealing with it.  

This is really a debate I have no competence to judge; I'm not a climate change denier.  But given the total failure of financial models to manage risk over the past years, it is certainly strange to see people give complete credibility to scientific models which predict climate changes over hundreds of years, and place the entire onus on human action.  

Colonizing Education and Healthcare - Part I

Once upon a time, being a loan officer at a bank was a highly respected and prestigious profession, as these guys had total authority to accept or reject a loan application.  Then, banks discovered that computer analysts could do a better job at identifying good which people would be most likely to pay back their loan by looking at quantitative data like FICA scores and credit histories than the average loan officer.  That a few talented individuals could do even better, or that the prestige of the profession would fall, was not taken into account.  Now, these jobs are much lower in status, but it's now easier and fairer to get a loan.

As went loan officers, so has much of our economy been computerized and managed using empirical grunt-work.  For instance, see--logistics, telecommunications, airplane booking, retail, internet search (pretty much anything internet really) and so forth.  This technology boom is behind the growth in prosperity over the past decades (I don't care what the Democrats say, I'd rather live now than in the 1970s, no matter how much the top 1% make).  There is a tradeoff to be made in terms of the lost career autonomy in certain fields, but it is one that free markets make willingly, and people overall accept due to the gains in widespread prosperity, as well as the job gains in other, often more satisfying, fields (such as identifying best practices).  A common characteristic of this part of the economy is that things get cheaper over time, and take up less and less of the GDP to produce higher quality stuff with fewer people doing more skilled tasks.  

Education and healthcare are still terra incognita for this reform movement.  Tuition bills and healthcare costs have skyrocketed, but despite large gains in technology, these sectors are not vastly more productive than they were, say, fifty years ago.  The cost of these services rises in proportion to growing wages (which are going up because of the sector described above), but we really aren't seeing a corresponding improvement in quality of services.  

Of course, the labor-intensive nature of these services means that these will continue to become more expensive over time.  Yet the unwillingness to consider data-driven approaches on how to educate or deliver healthcare are also behind the relative backwardness of these parts of the economy.  It's a little strange in a way, because our teachers are smarter than ever before, our surgical equipment shinier, and our computers ever-more modern.  It's the institutions and mindset behind education and medicine which have fallen behind, that contribute to, say, the failure of inner-city schools or the impact of the rising cost of healthcare on the exploding fiscal deficit.  

This is a three part series.  Tomorrow (or when I feel like it) I'll talk about education.   

Climate Change and Freeman Dyson

Interesting New York Times Magazine article on Freeman Dyson, a climate change skeptic.  Some good bits:

Dyson has said that it all boils down to “a deeper disagreement about values” between those who think “nature knows best” and that “any gross human disruption of the natural environment is evil,” and “humanists,” like himself, who contend that protecting the existing biosphere is not as important as fighting more repugnant evils like war, poverty and unemployment.

Dyson has always been strongly opposed to the idea that there is any such thing as an optimal ecosystem — “life is always changing” — and he abhors the notion that men and women are something apart from nature, that “we must apologize for being human.” Humans, he says, have a duty to restructure nature for their survival.

Dyson has great affection for coal and for one big reason: It is so inexpensive that most of the world can afford it. “There’s a lot of truth to the statement Greens are people who never had to worry about their grocery bills,” he says. (“Many of these people are my friends,” he will also tell you.) To Dyson, “the move of the populations of China and India from poverty to middle-class prosperity should be the great historic achievement of the century. Without coal it cannot happen.” 

He points out that tackling overfishing and species extinction may be better than curbing the growth of poor countries for uncertain future benefits.  Elsewhere, he writes:

The practical consequence for global-warming policy is that we should pursue the following objectives in order of priority. (1) Avoid the ambitious proposals. (2) Develop the science and technology for a low-cost backstop. (3) Negotiate an international treaty coming as close as possible to the optimal policy, in case the low-cost backstop fails. (4) Avoid an international treaty making the Kyoto Protocol policy permanent. These objectives are valid for economic reasons, independent of the scientific details of global warming.

The "low-cost backstop" refers to Dyson's ideas of coming up with new technologies to radically lower carbon emissions--such as using biotechnology to develop plant species which absorb substantially more carbon.  While carbon sequestration technologies have gotten much more press, people are developing ways to remove carbon directly from the air.  Pricing carbon would spur research in this area.  

One thing Dyson doesn't get into, but is pretty important, is the importance of adapting and mitigating the effects of global warming.  This is much easier in a rich than a poor country--the Netherlands can likely counteract against any rise in sea levels, while Bangladesh might be flooded.  This calls for developing Bangladesh, so it can have the same options for dealing global warming as other countries have.  

From the Mitch Daniels for President Blog,

A key plank of Obama’s campaign was a theme that we need to “reduce our dependence on foreign oil.”  This was really more of a populist crowd-puller, and I assumed that it would kind of go away once oil prices came back to Earth.  Instead, this call to action is informing tens of billions of dollars in spending on a variety of renewable energy projects.  

Thing is, this really makes no sense.  Foreign oil is bad because it pulls us into Iraq-like conflicts?  That only tells you that invading Iraq was a bad idea–every other country on Earth manages to survive on imported oil just fine.  In fact, every other nation is also dependent on others for some sort of energy, even Saudi Arabia.  Energy autarky is a dangerously misguided notion.  

But maybe it’s bad because of the whole carbon thing, and we should also get rid of coal energy as we go along.  If that’s the problem, then put in a carbon tax–as Norway did, with amazing results–so we properly price carbon and use less of it.  While some sort of cap-and-trade may be in the works, the dominant tactic for achieving this goal seems to lie in massive subsidies for researching ‘green’ technologies.  

Of course, nuclear energy–one of the cleanest and cheapest technologies around, one that America is perfectly willing to export to the rest of the world–doesn’t count, because the Senate Majority Leader is from Nevada, where the waste would go.  Hydro power doesn’t count either.  Natural gas exists in abundance in this country and can be cheaply imported in liquid form.  Many countries are switching over to gas for their cars and buses because it’s cheaper and pollutes far less.  Yet Obama’s budget punishes natural gas drillers.  For some reason, our technocrats have determined that our economy needs to shift to an entirely different mode of power because, well, windmills look awesome and take away our guilt.  A lesser person than I, one far more cynical, would think that green-boosters are more interested in manufacturing a crisis to meet a pre-existing agenda rather than finding the most cost-effective solution to a well-defined problem.  

Europe's Stimulus

Many people are wondering why America has opted for a large fiscal, as well as monetary, stimulus while Europe is lagging behind on both fronts.  As far as the monetary side is concerned, this seems to related to the fact that Euro policy is largely set by Germans, who are continually apologetic to the world for letting the hyper-inflation of the 1920s lead to Hitler.  Talk about closing the barn door after the tanks have blitzed away.  

But on the fiscal side, a major reason is that high levels of unemployment benefits in Europe insulate people from downward shocks, so people aren't quite as insistent that the government do something.  Whatever else you think about the rest of their social security system, this seems like the right approach to take.  People who are lose their jobs still have to meet commitments--like, say, their mortgage payments--so you can help them maintain their old standard of living.  Right now, it's a little tough to believe that these benefits are going to disincentivize work.

Of course, the great thing about the American system is that benefits can be raised during a time of crisis.  The most recent stimulus did that to an extent, but unemployment benefits still don't cover many workers who are laid off--while some of the Republican governors reject this spending entirely.  Well, the whole point of the stimulus bill was to tackle unemployment and help struggling workers--but both these goals are best achieved by giving money to the unemployed so they can maintain their consumption levels, and extending a payroll tax holiday to everyone so all workers are better off.  Rushing spending through government agencies ill-equipped to handle the spending--not quite such a direct effect.  If the unemployed still collect checks, and workers make more money after tax, then we don't even really face a crisis at all.

Banking Regulation

Today's installment of "Things Geithner does which are not helping" is this new financial regulation plan that targets the 'exotic' finance bits for new regulation.  

I'm a little ambivalent about this nearly universal trend to blame the (this really needs a better name) ongoing financial worries on poor or insufficient regulation.  One one hand--clearly more regulation could have helped.  Some combination of 1) Cheap credit 2) Low interest rates 3) Complex Securities 4) Asset bubbles 5) Too much leverage, etc. are behind this and every other financial panic which has hit somewhere in the world roughly every ten years, and these are all influenced by policy.  I don't think we're ever going to fully fix this--not even if we bring in the physicists or Roubini or whatever group "called" the crisis--so it's in some sense a tax we pay for living in a country more advanced as a capitalist economy than Burma. 

Still, it's a little worrisome that the top-of-the line Basel financial reforms were counter-productive, if anything, that the crisis has hit the most regulated parts of the financial sector--banks and housing--the worst, and that the potential regulators (President, Congress, Federal Reserve) were as gung-ho about housing as the private sector.  

It's also a little ironic that Geither thinks that these unregulated hedge funds represent such a large problem given that they are, you know, kind of key to his plan for bailing out the entire financial sector.  How good could the hedge funds be at this job if they had been subjected to this kind of scruitiny from the beginning?  Is there any problem here that needs fixing?

Then you can look at the failures of regulation over the past several years.  As someone said, financial regulation is a little like shooting a moving target--despite the various and sundry rules and regulations we had on the books, banks found ways to disregard them and do whatever it took to make them money.  Exisisting compensation plans actually incentivize people to think long-term quite a bit by making people hold stock for a long time.  The general pattern seems to be that after a crisis, regulators clamp down on whatever was directly responsible, then bankers figure out new and innovative ways to ruin the economy.  It's not like "regulation" is something that exists on an axis, and some sufficient amount of it can protect you against any problem--you genuinely need good regulation that works by setting broad principles and guidelines.  Now is probably not the best time to figure out what that means.