Harvard’s Robert Barro interviewed about Keynesian spending, tax cuts, Paul Krugman, and. . .
Tax cuts are bound to be better. I think the best evidence for expanding GDP comes from the temporary military spending that usually accompanies wars — wars that don’t destroy a lot of stuff, at least in the US experience. Even there I don’t think it’s one for one, so if you don’t value the war itself it’s not a good idea. You know, attacking Iran is a shovel-ready project. But I wouldn’t recommend it.
Noam Scheiber navigates the waters between Larry Summers and Tim Geithner and . . . Hillary Clinton?
Steve Forbes with a resounding call for stable, low-entropy money.
Greenspan truly began to think he was a monetary philosopher king who could fine-tune economic activity by manipulating short-term interest rates. Greenspan’s Louis XIV “I am the state” proclivities were intensified when he fell under the sway of a strange theory of Ben Bernanke’s. Bernanke joined the Fed as a governor in 2002 and posited that the world was plagued by “excess” savings. China, India and other countries were saving too much money. Preposterous! In a properly functioning global financial system there can be no excess savings. The whole purpose of finance is to direct savings from one party to be invested with another party. The enormous amounts of liquidity that led to the housing and commodities bubbles of recent years cannot be blamed on thrifty Chinese but on the excess money creation of Greenspan and Bernanke. If their central goal had been a steady value for the buck, those bubbles would never have reached the sizes they did, and volatility in the financial markets would have been only a fraction of what it is today.
Here’s Forbes making the point from Davos.
See my latest on the nexus of China trade, monetary policy, and our current crisis in Monday’s Wall Street Journal. Contrary to the new conventional wisdom, which is gaining considerable steam, I argue that:
America did not underreact to the supposed Chinese threat. It overreacted. The problem wasn’t “global imbalances” but a purposeful dollar imbalance. Our weak-dollar policy, intended to pump up U.S. manufacturing and close the trade gap, backfired. Currency chaos led to a $30 trillion global crash, an energy shock, bank and auto failures, and possibly a new big government era. For globalization and American innovation to survive, we must first understand the Chinese story and our own monetary mistakes.
A “more competitive currency” and monetary “stimulus” cannot create new wealth. Only technology and entrepreneurship can do that. The “China currency” issue distracts America from all the important things that could actually make us more competitive –e.g., better K-12 education, much lower corporate tax rates, cutting-edge broadband networks, less (not more) centralization and power in Washington, and, of course, a stable dollar.
Excellent summary on the euro currency’s first decade of life:
As important, the creation of a single European Central Bank (ECB) has better insulated monetary policy from political manipulation. Politicians could no longer attempt to inflate their way out of their employment or fiscal problems. National central banks could no longer finance fiscal deficits, removing a source of economic instability.
The single economic space anchored by the euro has also forced European policy makers to compete for people, goods and capital with improved policies. While we had hoped to see more reform by now, the pan-European reduction in corporate tax rates is one fiscal benefit of the euro. Even Germany has cut corporate taxes, after its efforts to harmonize rates across the European Union failed.
Good sense from Greg Mankiw:
Usually, GDP is a reasonable proxy for economic well-being, so more is better, but that is not true in this example. Part of the problem here is that GDP includes government purchases at cost. If the government hires people to produce stuff that is worthless, that stuff is included in GDP just as much as if the government buys something valuable. When calculating GDP, the national income accountants do not pass judgment on the social utility of government spending. Anyone concerned with economic well-being has to go beyond thinking about GDP.
I’ve been a harsh critic of the Greenspan-Bernanke monetary policy that was the chief cause of our current economic mess. But it’s also true that, once the financial firestorm hit, Ben Bernanke, perhaps the world’s leading student of financial crises, has taken bold and creative action to douse it. Nobel laureate Bob Lucas thinks Bernanke is on the right track:
monetary policy as Mr. Bernanke implements it has been the most helpful counter-recession action taken to date, in my opinion, and it will continue to have many advantages in future months. It is fast and flexible. There is no other way that so much cash could have been put into the system as fast as this $600 billion was, and if necessary it can be taken out just as quickly. The cash comes in the form of loans. It entails no new government enterprises, no government equity positions in private enterprises, no price fixing or other controls on the operation of individual businesses, and no government role in the allocation of capital across different activities. These seem to me important virtues.
Gold’s on the move again, up to $867 an ounce this afternoon. It still does its job exposing the crucial monetary mistakes that drive our dramatic booms and busts.
The Wall Street Journal documents Japan’s endless series of profligate pump-priming “stimuli” in the 1990s.
The experiment, predictably, failed.
Here’s Dan Mitchell with a critique that goes beyond Japan:
That, it seems, is the economic prognosis of the Obama financial team, looking ahead at a total global “demand collapse” and the total failure of fragile states like Pakistan.
the sense I get from them is that they are very worried that the economy will get a lot worse before it gets better. Not just worse… a lot worse. As in — double digit unemployment without the wiggle factors. Huge declines in aggregate demand. Significant, persistent deficits. That’s one reason why the Obama administration seems to be open to listening to every economist with an idea and is stocking the staff with the leading lights of the field. . . .
Where the discussion isn’t going, at least in public, (or the PR level), is the possibility that the first foreign policy crisis the administration will face will be the complete economic collapse of a large, unstable nation. To be sure, Pakistan is nearly broke, and U.S. policy makers seem to be aware of that; but a worldwide demand crisis could lead to social unrest in countries like Indonesia and Malaysia, Singapore, the Ukraine, Japan, Turkey or Egypt (which is facing an internal political crisis of epic proportions already). The U.S. won’t have the resources to, say, engineer the rescue of the peso again, or intervene in Asia as in 1997.
Team Obama may believe this. And they may be right. But it probably doesn’t hurt their cause to make people think they believe this. If things do get much worse, they can say they anticipated it. If things improve, they can take credit for a heroic and historic rescue. (See, “Committee to Save the World.” ca. 1999.)
To a number of smart people, all this seems like too much “depression lust.”
Bill Frezza with a hilarious send-up of the “science” of macroeconomics.
I confess that the only Hayek book I made it through without my eyes glazing over was “The Fatal Conceit.” It’s a slim volume written later in life, apparently after Hayek discovered humbleness, an unusual discovery for an economist. His thesis is simple – “I don’t care how smart you are, you can’t keep track of all this s**t.”
Brian Wesbury expands on a chief cause of the vortex that took down the U.S. financial sector.
Suspending mark-to-market accounting will not keep institutions that took excessive risk from failing. Bad loans are still bad loans and there is no way to avoid the pain that they cause. It will, however, end the negative feedback loop, which drags everyone down. It allows time to see if the wind shifts and keeps the flames from spreading.
In the 1980s, loan problems took down thousands of banks, but because we did not force fair value accounting, the economy and stock market actually thrived. Every money center bank would have been insolvent in the early 1980s if they were forced to write down Latin American debt to 10 cents on the dollar. Add in bad oil loans which took down Pen Sqaure and Continental and bad S&L loans, and it is easy to see that the bank problems in the early 1980s were much more severe than those of the 2000s. But the rules were not as inflexible as their are today. Problems did not spread, many banks eventually recovered their principle on Latin American debt and the economy grew.
In contrast, today’s problems are expanding, and have now caused the government to put almost $4 trillion of taxpayer funds at risk to support the financial system. This is an amazing sum of money, equaling 28% of GDP, or 42% of total US stock market capitalization, or more than a quarter of all household debt outstanding, or nearly 40% of all private household mortgage debt, or three times the amount of subprime loans outstanding at their peak.
The government has tried multiple strategies. The only thing they have in common is that they are designed to offset or stop the damage caused by mark-to-market accounting.
Treasury Secretary Hank Paulson is back at it. Having presided over the debasement of the U.S. dollar, he is once again cajoling the Chinese over the value of its currency, the renminbi (or yuan). Paulson earns a few points for his semiannual Special Economic Dialogue that has facilitated U.S.-Chinese cooperation on some fronts and helped defuse some of the worst protectionist policy on both sides. But the Greenspan-Snow-Bernanke-Paulson weak dollar policy — which was in itself deeply protectionist, and ultimately highly self-destructive — utterly swamped any of Paulson’s good intentions vis-à-vis China.
Digging through some old files, I found a May 13, 2006, e-mail I wrote to a senior White House economic official, warning of the certain harmful effects of its weak-dollar policy. (I had, six months prior, met with the official in the West Wing to discuss the matter.) The morning of my e-mail, The Wall Street Journal, citing top Administration officials making clear their weak-dollar preference, had published a major story: “U.S. Goes Along With Dollar’s Fall to Ease Trade Gap,” with the subhed, “Quiet Acquiescence Holds Possible Risks for Economy; Surge in Exports in March.”
The previous week economist John Taylor, just off his post as Treasury Undersecretary, had, in another Wall Street Journal article, dismissed the views of Nobel laureate Robert Mundell and Stanford economist Ronald McKinnon. Mundell and McKinnon had been arguing against dollar weakness and urging dollar-yuan stability. Taylor’s offensive, moreover, had been previewed by yet another two articles, one from Martin Feldstein and another from Lawrence Lindsey, arguing for a “more competitive” dollar. That’s a euphemism for weak, as in competitive devaluation. (See, not supposed to happen in America).
Written in the heat of battle, I think my e-mail memo holds up pretty well:
From: Bret Swanson <bret.swanson@********.com>
Date: Sat, May 13, 2006 at 1:38 PM
Subject: stunning protectionist mercantilism
To: [senior White House official]*** Warning: Blunt Statements to Follow ***[senior White House official],
Even considering Treasury’s misguided currency stance these past few years, today’s news in the Journal that the White House approves of the further weakening of an already too-weak dollar is stunning and alarming.Using monetary policy to target the trade deficit instead of using monetary policy for its only legitimate purpose of price stability and currency stability, is massively irresponsible. The trade deficit is a mostly meaningless accounting number that if anything demonstrates the strength of the American economy, not its weakness. “Competitive devaluation” is what Third World nations did for decades. It’s what helped keep them poor. It’s what we did in the 1970s, a lost decade of malaise. In an era of globalization, currency devaluation is more damaging than ever when there is more cross-border trade and investment and a larger proportion of inputs into our final products and services come from abroad.
An already inflationary dollar will become more inflationary. Oil prices will rise further. Recession in 2007 now becomes a real possibility because the Fed will likely now overshoot on interest rates to combat inflation that they and Treasury created but which they never see until it’s too late. Why are we risking ruin of a robust economy?The best economists I know are alarmed at the Fed’s lack of vigilance and the deepening of Treasury’s weak-dollar policy. Having now lost faith in the Fed and Treasury, these economists have changed their outlooks for the U.S. economy from positive to negative.
Lindsey and Feldstein are 180-degrees wrong on monetary/currency/trade policy. Clearly their recent Journal articles were a set-up for this potentially disastrous currency move. John Taylor’s statements last week pooh-poohing Mundell and McKinnon — who are absolutely right on China — were equally discouraging. Not since Richard Nixon have Republicans stood for debasing the currency. It’s painful to agree with those who say this may be the most protectionist Administration since Herbert Hoover.The U.S. Auto Companies and manufacturers want a weaker dollar — manufacturers always do — but the dominance of the Japanese auto makers is not a currency issue. Japan has just come out of a decade of deflation — the yen was way too strong, not artificially weak — exactly the opposite of what the auto makers say. Manufacturers in general face a huge challenge from China, but not because of the yuan, which is exactly in line with the dollar. The China challenge is real, not monetary. The U.S. must become more competitive via lower tax rates and less regulation. Currency is nothing but a scapegoat, and focusing on it reduces the chances we can solve our real competitive disadvantages on taxes and regulations. Because changing the unit of account cannot change the terms of trade, debasing the dollar does not make us more competitive; it makes us less competitive because it fosters inflation and possibly recession.
Furthermore, autos and manufacturing are a shrinking portion of our economy, and this misguided protectionist policy at their behest is highly damaging to the real, growing, leading edge sources of American wealth and power: our prowess in technology, finance, and entrepreneurship.Please forgive my blunt statements. I make them with respect and concern for the success of this White House. I know you can’t comment on currency matters, but if I am overreacting or wrong on my interpretation of what appears to be happening, please let me know.
Very best,
Bret
I then sent the following warning to a number of friends at the U.S. Chamber of Commerce, who had been seeking my views:
From: Bret Swanson <bret.swanson@*******.com>
Date: Sat, May 13, 2006 at 2:26 PM
Subject: ALERT: stunning protectionist mercantilism
To: [U.S. Chamber officials]ALERTI believe the outlook for the U.S. economy could be shifting. An article in this morning’s Wall Street Journal makes clear that instead of reversing the dollar’s decline and inflationary pressures, the White House and the Fed are actually encouraging a further fall of the dollar. Amazing. This means more inflation, a potential Fed overshoot on interest rates, and a slow-down and possible recession in 2007. None of this was necessary. We’ve had a very robust economy since mid-2003, and it could have easily continued. Debasing the dollar in a misguided protectionist attempt to reduce the trade deficit is hugely counterproductive. I warned of this possibility in my February memo but held out hope that the Fed and Treasury would reverse its inflationary/weak-dollar course in time to blunt these effects. No such luck.
What this means: The Chamber should prepare for a slow-down/recession in 2007-08. We should prepare for an inflationary environment. This policy means gas prices will probably stay high or go HIGHER. Some auto and manufacturing companies could benefit in the very short term, but overall this is bad for the larger economy, especially for technology and financial firms and for entrepreneurs. When the Fed figures out what’s going on, it will have to raise interest rates more than if it had gotten ahead of the curve in 2004-05. Commodity based businesses will continue to do well for a while, with intellectual property based businesses being hit the hardest. Eventually a recession would hurt everyone.Currency volatility will also discourage international trade and investment, which could lead to slower global growth.
I’ll continue to think about what this means and how the Chamber should prepare.
Best,
Bret
Most of this scenario came to pass. Oil and commodity prices rocketed. Subprime loans, fueled by easy weak-dollar credit, kept flowing through 2006 and 2007. And the U.S., we now know, hit recession in “2007-08.”
Only the mechanism was a bit off. With elevated inflation, real interest rates never got very high — certainly not to the point that normally causes recessions. But the bursting of the adjustable-rate housing bubble, enabled by weak-dollar easy money, and the ensuing credit crisis had the same effect as a high real Fed Funds rate.
Many of the easy money mistakes had already been made by the Fed in 2003-2005. But this crucial period in 2006, when the U.S. government doubled down on a misguided weak-dollar strategy, told foreign capital to stay away, directly devalued all dollar assets, accelerated the financial collapse, and destabilized the globe.
Please, Mr. Paulson, enough with the currency lectures.
(You can find a much more detailed history of the whole era within this longish economic history of China (1978-2008) or this shorter article.)
Time, February 15, 1999
Robert Rubin famously was part of the “Committee to Save the World,” so dubbed by Time magazine, as he, Alan Greenspan, and Larry Summers supposedly prevented the Asian flu of 1997-98 from spreading around the globe.
But finally — finally — the mainstream press is wondering whether Rubin’s reputation over the years was justified. From today’s Wall Street Journal:
Mr. Rubin’s salary made him one of Wall Street’s highest-paid officials — and a controversial figure among Citigroup shareholders and some executives, who questioned whether his limited duties justified the big paydays.
“Even though he has no ‘operating’ responsibilities, he still has a fiduciary responsibility as a board member,” said William Smith, a New York money manager and frequent critic of Citigroup’s current management and board. “He has overseen the entire meltdown, yet been compensated as an operating employee while bragging about having no operating responsibility.” Mr. Rubin can’t “have it both ways,” Mr. Smith added.
Somehow, the most central factor — the fundamental cause — of both the late-90s Asian meltdown and our current crisis — namely monetary and dollar policy — has escaped much criticism. Yes, the argument that Alan Greenspan and Ben Bernanke held interest rates too low for too long in the 2003-06 period can now be discussed in polite company. But it often is thought to be peripheral, or more often it just gets lost in all the chaos.
The late-90s mistake was just the opposite of this decade’s easy-credit mistake, with predictable mirror image effects. Back then, Greenspan and Rubin held a super-tight squeeze on dollars, pushing the dollar ever higher versus foreign currencies and commodities, crushing all dollar-debtors across the globe, from Thailand, Indonesia, and Korea, to Turkey, Russia, and Argentina. The world’s capital abandoned hard assets and flooded into the U.S. in general and into our soft, intellectual assets like Microsoft, Cisco, and dot-coms in particular. Eventually, after the “Committee to Save the World” had worked its magic and basked in its cover-boy status, the deflationary Greenspan/Rubin policy in 2000 toppled the U.S. markets, too.
Mr. Rubin likes to offer his wisdom “in an uncertain world” — the title of his memoir. But the world would be much less uncertain if the Rubin-Greenspan-Bernanke-Snow-Paulson monetary/dollar policy weren’t so manic.
P.S. Yes, to reiterate, these are supreme cases of the arsonist posing as heroic fireman.
Greg Mankiw agrees with Paul Krugman that Obama’s econ team so far is impressive but firmly rejects, with some objective references, Krugman’s assertion that Bush’s economists were “hacks and cronies.”
Mankiw’s right that Harvey Rosen, Ed Lazear, and Glenn Hubbard, among others, are highly-respected, first-rate economists. Too bad a few simple, bad decisions — like the indefensible and disastrous weak-dollar policy pushed by otherwise smart people like John Taylor and Martin Feldstein — completely swamped the demonstrably positive yield of Bush’s tax cuts.
We will be teasing out the different strands of Bush economic policy for a very long time.
Amity Shlaes, author of the terrific The Forgotten Man, a new history of the Great Depression, responds to criticism from Paul Krugman.
Dr Krugman makes a second charge, that I misrepresent John Maynard Keynes by associating Lyndon Johnson’s Great Society with Keynes when the Great Society was a social and not an economic program. In 1964 Johnson pledged to build a Great Society with an emphasis on social improvement in his Great Society speech, just as Dr Krugman said. My point was that the political engine of the 1960s treated any spending, including Great Society spending, as a stimulus. Keynesianism defined the very lexicon of policy – that is why Milton Friedman said “we are all Keynesians now.” TIME even gave Keynes a cover: “The Keynesian Influence on the Expansionist Economy,” read the banner in the corner. Keynesianism was crucial window dressing for the Great Society show. Spending on all sides became permissible, and that only made sense if you cared less about deficits and more about growth – Keynesianism. Thus in July 1965, after many pieces of new legislation, The New York Times was writing headlines such as: “Johnson Policy Will seek to Prolong Boom: Administration Commits Itself to Spur Economy by Tax Cut or New Spending…” The same story has Johnson saying his new budget would “include sharp increases in spending from programs enacted during the past few years.”
Greg Mankiw wonders about Obama’s stimulus plan: $280,000 per job?
Even by Keynesian standards, that’s pathetic.
“tax increases appear to have a very large, sustained, and highly significant negative impact on output.”
“tax cuts have very large and persistent positive output effects.”
tax cuts do “not have any clear impact on revenues at horizons beyond about two years.”
— Christina Romer, Berkeley economist and Obama appointee as chair of the Council of Economic Advisors, in two working papers, the most recent versions of which are very timely: November 2008 and July 2008.
It looks like Tim Geithner of the New York Fed is Obama’s pick for Treasury Secretary, beating out Larry Summers. Geithner is a wily technocrat good at working the bureaucracy and the press. Summers is an intellectual famed for the just the opposite — his lack of skill with colleagues and reporters. Especially at this dangerous economic moment, I would have preferred Summers’ substance over Geithner’s guile. But I know far less about Geithner’s policy views and will retain an open mind. Good luck to him.
Update: Missed this from the article:
The president-elect might name Mr. Summers, a highly regarded economist and a former president of Harvard University, as a senior White House adviser, people involved in the transition said.
On second thought, maybe that’s the perfect arrangement.
Update II (Saturday night): Summers will be director of the National Economic Council in the White House. Good move.
Matthew Slaughter of Dartmouth’s Tuck School, one of today’s best thinkers on trade and globalization, says the consequences of any Big Three Auto bailout go far beyond the initial price tag.
First, it would hurt foreign direct investment in the U.S. and thus the insourcing of U.S. jobs:
In 2006 these foreign auto makers (multinational auto or auto-parts companies that are headquartered outside of the U.S.) employed 402,800 Americans. The average annual compensation for these employees was $63,538.
At the head of the line of sustainable auto companies stands Toyota. In its 2008 fiscal year, it earned a remarkable $17.1 billion world-wide and assembled 1.66 million motor vehicles in North America. Toyota has production facilities in seven states and R&D facilities in three others. Honda, another sustainable auto company, operates in five states and earned $6 billion in net income in 2008. In contrast, General Motors lost $38.7 billion last year.
Across all industries in 2006, insourcing companies registered $2.8 trillion in U.S. sales while employing 5.3 million Americans and paying them $364 billion in compensation.
Second, Slaughter says, a Big Three bailout could hurt U.S.-headquartered multinationals:
these companies employ more than 22 million Americans and account for a remarkable 75.8% of all private-sector R&D in the U.S. Their success depends on their ability to access foreign customers. . . .
This access to foreign markets has been good for America. But it won’t necessarily continue. The policy environment abroad is growing more protectionist. . . .
Will a U.S.-government bailout go ignored by policy makers abroad?
No. A bailout will likely entrench and expand protectionist practices across the globe, and thus erode the foreign sales and competitiveness of U.S. multinationals. And that would reduce these companies’ U.S. employment, R&D and related activities. That would be bad for America.
Rising trade barriers would also hurt the Big Three, all of which are multinational corporations that depend on foreign markets. In 2007, GM produced more motor vehicles outside North America than in — 5.02 million, or 54% of its world-wide total.
Finally, a bail-out further endangers the dollar:
Will a federal bailout that politicizes American markets bolster foreign-investor demand for U.S. assets?
Not likely. Instead, America runs the risk of creating the kind of “political-risk premium” that investors have long placed on other countries — and that would reduce demand for U.S. assets and thereby the value of the U.S. dollar.
Read the whole thing.
Bailing out Detroit means bailing on free trade and American innovation.
Maximum Entropy