Snippets: Columbus Day Style

Well the grumpy mood continues after the recent IMF meetings, and the economy lingers in the penumbra not quite sure whether to surge into sunlight or scuttle back into the dark. These are strange times. So, in no particular order some snippets from today’s news:

1. The Nobel Prize for economics was awarded over the weekend to three economists who all worked on issues to do with unemployment. Obviously they didn’t come with a fix. But, hey, who said that economists have to get their hands dirty in the real world? Anyway: Peter Diamond of MIT; Dale Mortensen of Northwestern; and Christopher Pissarides of the London School of Economics [yea!] all have written extensively on the way in which unemployment can persist even in healthy economies. Presumably all three deserve the prize, although I must admit that my cursory reading of some of Diamond’s work this morning left me decidedly unimpressed. His contribution seems to be more a tweak of the already insanely irrelevant macroeconomics models that dominate policy making, rather than anything startlingly new. Which reminds me: far too much work that is considered “breakthrough” in economic theory is simply a statement of some commonplace knowledge. The breakthrough then consists of the revelation that the real world bears little of no resemblance to the fantasy world of orthodox economics. Basically economists need to get out more and live a little. Then they would not treat these breakthroughs as being of any consequence. I mean: is it really stunning that wages do not instantly change in the face of unemployment increases? Or that workers are not always unemployed voluntarily? Or that technology may have something to do with economic growth? The list goes on. Economics is a shambles and an embarrassment. That markets don’t work well all the time should not be prize worthy thinking.
2. Oh, and that “Nobel Prize” is not actually a Nobel Prize. Technically it is an award sponsored by the Swedish Central Bank, and is only administered by the Nobel committee. Economists yearn to be treated as true scientists, and so elide the reality of the prize. Which is odd given their predilection for pseudo precision in their theorizing.
3. Those IMF meetings ended in official accord, but in unofficial discord. The problem is the looming trade and currency war. As countries realize the depths to which we have sunk, courtesy of the big banks, they are reaching for ever more desperate counter measures. Sooner or later a trade war was likely. This is particularly true when we consider China and its persistent rigging of its currency. The spat between the US and China will only get more heated. Ultimately the Chinese are going to have to allow their currency to rise in value. Their position right now hurts not just the US but all its trading partners: China, by fixing its currency value to the dollar – unofficially – prevents the normal process of adjustment to occur when a surplus or deficit opens up. That normal process is the revaluation of a currency in order to maintain balance between two trading partners. In our case the dollar should fall and the remnimbi rise until the bilateral trade deficit is eliminated. That is to say that goods manufactured using remnimbi should rise in price when their cost is translated into dollars. That reduces Chinese competitiveness here in the US and therefore reduces the trade gap between the two countries. By refusing to allow that adjustment, the Chinese are artificially inflating their export businesses at the expense of their domestic businesses. In effect they are exporting unemployment. Since unemployment is our number one issue their position is becoming untenable from our point of view. Hence the tension. Multiply this problem across many countries and many trade imbalances and we quickly enter the twilight zone of trade war. The problem is, of course, that no one really wins in such a war since everyone tries to outdo the other. A “race for the bottom” ensues that culminates in the loss of trade, and jobs, for everyone. This is something we all need to avoid. Trade is essential for global wealth creation since it allows resources around the world to be more advantageously employed than would be the case were everyone to meet local needs only from local resources. This general rule of comparative advantage is well established in economics, but is routinely forgotten and set aside. It is also one that needs constant vetting to ensure it does not open up the possibility of exploitation. We have a system of rules that govern trade and attempt to even pout the playing field, but those rules are too often tilted to favor the more advanced nations at the expense of the poorer economies. Nonetheless trade has its benefits and is worth protecting from the kind of rigging practiced by the Chinese.
4. Krugman makes a fine point this morning: there is much talk in the media about increasing “big government” under Obama. The problem is that the facts do not support the claim. In fact there are about 350,000 fewer government workers now than when he came into power. The problem is that most of this reduction is at the state and local level – mainly teachers, police, and fire workers fired to help state budget cuts – and so the illusion of bigger government pervades at the national level even though it is fictional. When we look at the “big” programs of the last few years, the biggest expansion of government spending was the defense and Medicare programs of the Bush era. Bush was also responsible for bailing out the banks and TARP. The only new programs under Obama have been health car reform, which hasn’t kicked in yet and so hasn’t enlarged government; and the stimulus of early 2009. The stimulus didn’t increase government either, since most of the cash went into tax cuts or state and local government aid. There are no new government jobs programs and no government departments have expanded. Which only goes to show how effective the fact less and made up claims of the Republicans have been able to stick. Alternatively it also shows how ineffective the Obama team has been in communicating what it is doing. It is tough to run a good democracy in the absence of truthful information. Voters need to be better informed if they are to avoid making mistakes. Don’t hold your breath.
5. Next, the banks continue to whine about the undue attention they are getting from regulators. Tough. They are responsible for the crisis, and, in my opinion have not yet paid for the problems they created. On the contrary regulators have trodden lightly compared with what should have been done. Nowhere have the mega banks been broken up, which is the single solution to the instability of finance. Nothing remotely draconian has been done. So-called stress tests were hardly stressful. Capital increases have been mandated, but will be implemented at a snail’s pace, and appear too low in any case. Bonuses are being attacked, but there is no international coordination mainly because the US is seeking to protect bankers who are very large campaign contributors to both parties. So banker power is still way too high for the safety of the global economy. Nonetheless bankers cry foul whenever their pay is called into question. I would too were I still in the industry. One interesting snippet today coms from the Financial Times Op-Ed page. The issue is this: should we force bankers to be paid their bonuses in stock options. In theory this ties them to the bottom line and should force them to behave less anti-socially. But: stock options have no value when the strike price is below market price. In this circumstance the incentive is perverse. Options out of the money can be forced back into value by reckless behavior. Workers who see their options without value may follow even more risky deals in order to pump up profits. It is interesting to note that the two biggest failures of the crisis: Lehman and Bear Stearns, both had very large management participation in their respective stocks. Both gambles recklessly in order to restore stock values for management. Not such a good idea. So maybe we need the payment of bonuses to be in the form of debt. Put management on the same footing as the secured creditors. That would eliminate equity participation and thus the incentive to pursue risky strategies and, at the same time, force managers to take a long term view.
6. Oh! Wait. That won’t work either because banks are always bailed out and their creditors thus protected. So there would be no better alignment of incentives and bankers would still be able to trash the economy without punishment. That’s why we need to break the banks up and make them insignificant. That way they can fail, which is what the deserve if they are incompetent the way Bear Stearns and Lehman were. My problem is that the others, the ones we bailed out, never learned their lesson. They are still gambling away merrily and relying on us to create the conditions in which they can make big bonuses for themselves. Our safety net reduces investor risk and thus funding costs. This widens spreads and thus profits. We, the taxpayers, are underwriting those bonuses. The bankers are not earning them on merit. They are earning them on welfare. A nice scam if you can get in on it. And they still whine. What children. They should grow up and act as smartly as they keep telling us they are – without the training wheels.

Food for thought.