By Rok Spruk, on March 31st, 2010
In Friday’s edition of NY Times, David Brooks wrote a very interesting column (link) discussing the state of economics. Although subtle and rigorous in its assertions I doubt that the field of economics needs a fundamental change in the philosophical origins of economic methodology. I agree with the author that economists often ignore the notion of moral philosophy and history in economic analysis but that doesn’t mean that old textbooks on classical microeconomics need to be disposed. The author points out the role of economic forecasters who often appear on the TV, essentially trying to forecast economy’s future path. Econometrics, which constitutes time-series forecasts on which most economic projections are based, is a real discipline to which numerous new scientific articles are devoted, published mostly in The Econometrics Journal and Econometrica. In his famous 1983 article (link) Let’s take the con out of econometrics, Ed Leamer wrote how econometric modeling can be misused if a researchers ditch the true role and significance of assumptions. A prominent example is the study of death penalty on crime deterrence. As you can read in more detail in Leamer’s article, one study found out that each capital punishment deters more than 9 murders while another one found out that each additional capital punishment causes more murders.
The contradicting evidence doesn’t imply the falsification of the scientific method in economics. It merely reveals the hidden difference in how economists set assumptions regarding the behavior of individuals, firms and countries. David Brooks pointed out that economists failed to predict the recent financial crisis. However, many economists (myself included) pointed out the true dangers of an over-leveraged economy and monetary easing which led to subprime mortgage crisis and the consequential aftermath.
Many of us have had clear evidence, models and studies that showed how an over-leveraged financial sector can induce a significant economic downturn. However, many policymakers ignored the evidence of the behavior of the financial system which could be easily compared with chaos theory in mathematics. In my recent paper on Iceland’s financial crisis I showed that the depository banks’ overall leverage and indebtedness in the small country was growing exponentially, beyond the limit of capital adequacy.
As Paul Krugman recently noted, lessons from the Great Depression were not learned because people forgot it too quickly. Although mainstream economics, as every field within economic science, needs some major cures, I disagree with author’s assertion that economics is not a real science but a moral philosophy. True, economics is not exact science because human behavior is not as experimental as particle analysis in physics but economics tries to resemble the scientific methodology through models, data, statistical inference and evidence. In fact, new interdisciplinary fields within economics are emerging such as behavioral economics, neuroeconomics and transport economics in which economic analysis is combined with other disciplines such as law, psychology, sociology and neuroscience.
The limits of mathematical recourse in economics were already discussed by economic thinkers such as John Maynard Keynes. And agreeably, mathematical reasoning is bounded by economic reasoning. However, from the real point of view, we need models to address human behavior mostly because, as F.A Hayek noted, it’s too complex to capture its essence in a scientific entirety. If the necessity of assumptions, models and evidence were not the case, hardly any lessons would be learned from the episodes of crises, booms, busts and periods of economic advancement in human history.
By Eldon Mast, on March 31st, 2010
On Tuesday there was more evidence that U.S. consumers are starting to release their pent up propensity to spend. Redbook reported an extremely strong plus 4.4% year-on-year same-store sales rate in the March 27 week — by far the strongest gain of the recovery thus far.
Redbook also upped its estimate for a plus 1.2% March-from-February rate, up 3 tenths from its estimate last week. Keeping in mind that retail sales makes up nearly 70% of the annualized U.S. GDP rate, first quarter growth rate continues to look like it is accelerating from the already strong showing in Q4.
If the Redbook rate is annualized it points currently to a torrid 14.4% growth clip for the largest contributing segment of the U.S. GDP.
By B.P.T., on March 31st, 2010
At 8:15 AM EDT, the ADP Employment Report will be released. Investors will be watching this number to get advance notice on the state of the job market in advance of the government’s report on Friday.
At 9:45 AM EDT, the Chicago PMI Index for March will be announced. The consensus index value is 61.0, which would be a slight decline from February, but still represents an improving economy in Chicago.
At 10:00 AM EDT, the Factory Orders report will be released. The consensus is for an increase of 0.4% in orders in February.
At 10:30 AM EDT, the EIA Petroleum Status Report will be released. Given that oil prices have been on the rise over the last month, this report will be used as evidence of inflation and an improving economy.
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By Ajay Shah, on March 30th, 2010
When we look back at the sweep of history, the 20th century stands out. It stands out as a time of immense progress in our knowledge, a time of great carnage, and the time when the great debate about socialism and the market economy ended. I think it was Arthur C. Clarke who said that one of two things will come next: either we will look back at the 20th century as the most amazing time when everything happened, or the pace of change will further accelerate thus making the 21st century even more incredible than the one that went by. (Does someone know the exact quote?).
Economists have been arguing that the creation of knowledge responds to the inputs going into it. And there is no question that the number of people engaged in knowledge professions today is greater than ever before in human history. Information technology has added strength to this pursuit, amplifying what a puny unaided human mind could do on its own. Earlier, the West dominated the production of knowledge; now we have phenomena like R&D labs in India giving a new kind of low cost production of knowledge, and increased opportunities for risk-taking in research. These factors should increase the pace of progress of creating knowledge. It should take us closer to the scenario where the 21st century will be even more exciting than its predecessor in terms of creating new knowledge.
I find myself nervously looking around, in 2010, and wondering if we are actually doing that much better.
From 1900 to 1910, here are a few of the great things that happened:
- In 1900, Max Planck proposed quantum theory, Hilbert posed his 23 problems, and Louis Bachelier was the first researcher in finance.
- In 1901, Marconi did the first wireless trans-atlantic transmission.
- In 1902, the first car ride from San Francisco to New York took place, and the Wright brothers flew the first plane.
- In 1903, construction of the Panama canal began.
- In 1905, Einstein wrote four papers.
- In 1906, Mahatma Gandhi coined the phrase satyagraha, and the first `vitamins’ were discovered.
- In 1908, the first oil was extracted from the Middle East, and Henry Ford sold the first Model T.
I’m sure there were many interesting things going on, but these were the big things of that period that meant a lot to me. When I look back at 2000 to 2010 and … what cool things can we remember which would change the world?
Or is that all sorts of wonderful things have been going on and it is my lack of knowledge? E.g. if I had lived in 1905, I might not have heard about Einstein’s four papers.
If it’s not just me, and the pace of progress has slackened: Why did we not get amazing progress from 2000 to 2010, despite the expansion of inputs into the systematic quest for new knowledge? Are we hitting diminishing returns; are we in the sad stage of adding decimal places to fundamental constants? Is our production function faulty?
By Trace Mayer, on March 30th, 2010
Starting 25 March 2010 the CFTC has been conducting an investigation into the concentrated short positions in the gold and silver markets. There has been some very interesting testimony come out of the Goldman Sachs vampire squid’s mouths that the informed gold bugs already knew. The size and scope of this Ponzi scam is beginning to be comprehended. As the idea spreads the demand for various types of ‘physical gold’ will increase and decrease.
STRAIGHT FROM THE VAMPIRE SQUID’S MOUTH
On 9 September 2008 I appeared on Adam Curry’s Daily Source Code in episode 788, which has hundreds of thousands of subscribers and has recently been reactivated, I casually remarked, “There are about 140 ounces of paper gold for every one ounce of physical gold.”
Jeffrey Christian, formerly of Goldman Sachs and currently of CPM Group, considers himself among the world’s foremost experts on gold. Before the CFTC Christian testified:
One of the things that the people who criticize the bullion banks and talk about this undue large position don’t understand what is the nature of the long positions of the physical market and we don’t help it; the CFTC when it did its most recent report on silver used the term that we use “the physical market”. We use that term as did the CFTC in that report to talk about the OTC market in other words forwards, OTC options, physical metal and everything else. People say, and you heard it today, there is not that much physical metal out there, and there isn’t. But in the “physical market” as the market uses that term, there is much more metal than that there is a hundred times what there is.
WHAT IS PHYSICAL GOLD?
Let’s untangle some of Christian’s weak verbal jiu-jitsu. In my book The Great Credit Contraction I start off the first paragraph of the first chapter with definitions because if there is no agreement on definitions then it is impossible to analyze and conclude properly. While I focus on the terms money, money substitutes, illusions and currency we may want to shift our focus and attention towards the bottom of the liquidity pyramid and the terms ‘gold’ and ’silver’.
Physical gold, AU 79 on the periodic table, has a density of 19.30 grams per cubic centimeter at room temprature and a liquid density at the melting point of 1,947.5°F of 17.31 grams per cubic centimeter. Physical silver has a similar definition.
Physical Fake Tungsten Gold has been demonstrated to exist and is differentiated from physical gold because of its tungsten composition.
GLD ETF gold differs from physical gold in many ways which I have examined several times. On page 11 of the prospectus it states:
Neither the Trustee nor the Custodian independently confirms the fineness of the gold allocated to the Trust in connection wtih the creation of a Basket [issuances].
So for that reason and many others, in A Problem With GLD And SLV ETFs I concluded, “There is no assurance that the ‘gold’ held in the ETFs is actually the same gold as defined under the periodic table.”
I casted even more aspersions on these instruments in Another Problem With The GLD ETF where I showed from the 21st of November 10-K:
“Gold held by the Custodian’s currently selected subcustodians and by subcustodians of sub-custodians may be held in vaults located in England or in other locations.” and “In addition, the Trustee has no right to visit the premises of any subcustodian for the purposes of examining the Trust’s gold or any records maintained by the sub-custodian for the purposes of examining the Trust’s gold or any records maintained by the sub-custodian, and no sub-custodian is obligated to cooperate in any review the Trustee may wish to conduct of the facilities, procedures, records or creditworthiness of such sub-custodian.”
Physical London LBMA OTC Forward gold is another interesting form of Christian’s physical gold. But I touched on the Massive Institutional Gold Market Change over six months ago.
CFTC TESTIMONY
Here are two key excerpts from the CFTC gold and silver hearings on 25-26 March 2010.
And the clip with Christian’s failed verbal jiu-jitsu which is actually a blatant admission (at 3:48) of the Ponzi scam nature of the ‘physical gold market’.
So what has Christian attempted to do? Conflate the gold as defined in the periodic table with other forms of ‘gold’ such as GLD ETF gold, London LBMA OTC gold, Comex futures gold, etc. under the term ‘physical gold market’. Of course, such contorted logic is absurd. The ability of a piece of paper with the letters ‘G-O-L-D’ written on it, that can become worthless, is no more efficacious at providing protection of value than a piece of cardboard with ‘C-O-W’ written on it is efficacious at providing a gallon of milk.
CONCLUSION
The knowledge that there are at least a hundred pieces of paper masquerading as physical gold in the physical gold market for every ounce of gold as defined on the periodic table is old news. What is breaking news is that one of the vampire squids would testify before government officials that this is the case.
So, if possession is 9/10ths of the law and if there are 100+ claims on an ounce of gold for every actual physical ounce and if there is a demand by the market for those actual physical ounces, because The Great Credit Contraction continues and capital seeks safety and liquidity by moving down the liquidity pyramid, then what happens to the value of the gold ounce in one’s hand or trust third-party service? For comparison there is about $7,000,000 of capital, real and fictional, for each ounce of physical gold.
Of course, Christian would probably argue it is illogical and irrational to contemplate such events unfolding. But they already have. David Einhorn moved billions from the GLD ETF into physical gold in his own warehouse.
DISCLOSURES: Long physical gold, silver and platinum with no interest in the problematic SLV, Streettracks Gold ETF Trust Shares or the platinum ETFs.
By B.P.T., on March 30th, 2010
The weekly ICSC-Goldman Store Sales report will be released at 7:45 AM EDT, and another strong week of sales is expected.
The monthly S&P/Case-Shiller home price index report will be released at 9:00 AM EDT. Given that most economists don’t expect the overall U.S. economy to improve until housing prices end their decline, the market will be watching this number closely.
The monthly report on Consumer Confidence will be released at 10:00 AM EDT. The consensus index level is 50.0, which would be a slight increase over February, but is still below the level reported in January.
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By Eldon Mast, on March 29th, 2010
 You may remember that last year Citigroup (C) got a $25B bailout that was much bigger than the rest of the big banks. Now — about a year later — the company is about to pay dearly for the taxpayer provided lifeline.
In today’s market, the TARP’s 27% take in Citi has grown in value to $33B. And as the bank contemplates it’s payback, the ultimate size of the deal may be the largest in Wall street history… and may net U.S. taxpayers another cool $8B for their trouble. (Federal taxpayers received a 23% annualized return on their investment in Goldman Sachs when that wall street firm paid back it’s bailout.)
Leading financial firms, including J.P. Morgan Chase and Morgan Stanley, are vying to be chosen as the deal’s underwriters to gain the prestige of managing a historic stock sale as well as the fees from investors who buy the shares. To improve their chances, some big banks, such as Goldman Sachs, are offering their services to the Treasury Department at almost no cost.
The windfall expected from the stock sale would amount to a validation of the rescue plan adopted by government officials during the height of the financial panic, when the banking system neared the brink of collapse. A year ago, Citigroup’s stock hovered around a dollar a share, and the bank’s future seemed in doubt. On Friday, the stock closed at $4.31.
If the sale proceeds as planned, Citigroup would be able to cut nearly all of its ties to TARP and the Obama administration can continue to highlight the profit generated from the rescue of big banks.
“It’s unprecedented to do [a stock sale] of this size right after the financial industry has been so battered,” said one industry official on Friday. “It’s just a very bullish sign.”
Citigroup was among nine major banks that were the first to take bailout funds in October 2008, and all have returned their federal loans. In addition to these repayments, the Treasury has received interest, dividends and about $3.5 billion from the sale of warrants, which are contracts allowing a holder to buy a company’s stock in the future.
To many it is now clear that rescuing large the Wall Street firms has come at a much lower cost to taxpayers than many had expected. In fact, so far the investment program has produced all net positive results for the U.S. Treasury.
By Russ Nelson, on March 29th, 2010
Health care in the USA is completely broken. Health care is a difficult problem, to be sure, but I think it’s clear that we’re currently solving it very badly. Two problems with health care: One is that people expect everyone to have the same health care as a rich person, even if they’re not rich themselves. Another is that health care, not being exposed to the discipline of the market, is very expensive. If everyone gets the same health care as a rich person, then there is no pressure to create more frugal health care.
Health care then being expensive, everyone expects somebody else to be paying for their health care. This creates bizarre solutions. For example, the Canada, health care is paid by the federal government. In order to hold down taxes, access to health care is limited; typically by waiting periods. Or in the USA, most working people have
their health care paid by their employer, except for a very small deductible. This makes it difficult for employees with health problems to switch employers. The government has created a ham-handed solution which permits former employees to continue their health insurance by paying the premium out of pocket.
Health care is important, without doubt. So is food (insufficient calories reduces your resistance to ordinary infections), but we generally don’t expect everyone to be able to dine on caviar and steak every day. Many different kinds of food are available in many different venues and preparation styles, at reasonable prices. Yes, the poor may need to dine on beans and rice, but except for the most indigent, everyone can get enough calories, protein, and vitamins to stay healthy. Health care could be the same way; with cheap, worthwhile health care being available to everyone at affordable prices. We have chosen a different path; much to our detriment.
By B.P.T., on March 29th, 2010
The monthly Personal Income and Outlays report will be released at 8:30 AM EDT. The consensus for Personal Income is an increase of 0.1% over the previous month, which is the same rate of increase as January. The consensus for Consumer Spending is a 0.3% increase since January, and the consensus Core PCE price index change is an increase of 0.1%, after it was flat in January.
Also, there are auctions of 3 month and 6 month Treasury Bills this morning. The market’s reaction to these auctions should be interesting to watch after lower demand for 10 year notes caused a rise in yields on Friday afternoon.
By Claus Vistesen, on March 26th, 2010
Most, if not all, of the deficit nations that make up the Bretton Woods II edifice and subsequent global imbalances have seen notable housing and construction bubbles as part of their path towards excess leverage. The demand for housing and thus in some sense construction on the aggregate macroeconomic level can be tied to demographics and specifically the idea of a life course [1]. So, could we say that this was one of the channels through which demographics have indirectly affected global imbalances?
I think so and below I will argue why, but first things first. In fact, blame it on that double shot latte that I enjoyed a couple of days ago early in the morning reading this paper by Pedro Gete from Georgetown University, but what follows will be terribly wonkish. Yet, intellectually and theoretically I think it represents an important piece of the puzzle so if you have the energy I welcome you to indulge me.
The Model,
Mathematical economics, rational expectations, and representative agent modeling have taken their share of the flak in the context of the macroeconomic shake-out following the financial crisis. For the most part I agree with the critics, but let the following be a counter example on the general blurred and fuzzy nature of economic modeling. In this way, the model developed and discussed in Gete (2010) is neat, concise, and easily allows for an intuitive expansion of perspective. In short, I like it; a lot! For good measure, here is the abstract;
This paper makes a theoretical and an empirical contribution to the debate on what caused the global imbalances. On the empirical side, I provide different types of evidence to support that housing demand shocks (shocks to the aggregate marginal rate of substitution between housing and tradables) help to explain the global imbalances. On the theory side, I show that shocks to the demand for housing generate trade de
cits without need for the standard ingredients used by others to model housing (wealth effects or trade in capital goods). I model housing as a durable and nontradable good. Countries import tradable goods during periods when more domestic labor is devoted to produce nontradables to smooth consumption between tradables and nontradables. Housing booms are larger if the country can run a trade de
cit because the de
ficit lowers the opportunity cost of building, which is the foregone consumption of tradable goods due to reallocation of labor to the construction sector. Concerning the empirical evidence, I first document that over the last decade there has been a strong cross-country correlation between housing variables and current account dynamics. Second, I show that using the cross-country dynamics of employment in construction as the explanatory variable, the model generates current account dynamics matching recent global imbalances. Finally, I use sign restrictions implied by the model to estimate a vector autoregression and identify the effects of housing demand shocks on the U.S. trade de
cit. The results suggest that housing shocks matter for current account dynamics.
In order to spare my readers the nitty gritty of the model I will not do the math here, but merely describe the model verbally. In this way, the nice aspect of the model and thus intuition in Gete (2010) is that it assumes that housing shocks are exogenous (which of course they aren’t), but by doing this he creates a simple laboratory through which to impose different assumptions on what might actually make shocks to the demand for housing endogenous (hint: this is where demographics come in, but first things first).
The economy in Gete (2010) is very simple. It consists of two sectors, a tradable and a non-tradable (housing), and only one input to production which can be shifted without adjustment costs between the two sectors (but not between countries). Now, in a model like this with exogenous preferences there is really not a lot we can do and this is especially the case if we assume a two economy world where relative preferences between tradables and non-tradables in both economies are the same. In such an economy, we simply solve the respective optimization problems and each economy consumes the same amount of tradables and non-tradables (housing). However, let us introduce a deus ex macina and assume that the demand for housing suddenly increases in one of our economies. What will happen?
Well, those of you with a fondness for core economic theory should start to feel that warm fuzzy feeling just about now while the rest of you … are you even still with me?
Moving back on track, and given that our only input to production is labour, the economy will have to shift labour from the tradables sector to the non-tradables sector and thus production of tradables will give way for production of non-tradables (housing) [2]. But does it also mean that we have to give up consumption of tradables? No, and this is the key mechanism by which Gete (2010) explains how an increase in the demand for housing/construction leads to a trade deficit and thus may explain global imbalances to the extent that the deficit countries are the ones who have seen housing booms. Specifically and in the jargon of the trade, the economy who sees a positive shock to housing demand may smooth consumption of tradables and non-tradables by running a current account deficit; effectively borrowing to consume tradables which it no longer produces itself because labour has been allocated to the construction of housing.
The empirical evidence presented in Gete (2010) is circumstantial although the simulation based on the model turn out quite well. One chart however which shows the proposed relationship quite well is the following which plots the change in the CA/GDP ratio (in % points) on the y-axis against the change in the labor share of construction on the x-axis. Moreover, I have made my own small replication with different data and a slight change methodology (and sample [3]) and the picture is the same.
In this sense the relationship seems solid enough to vindicate the overall claim that raising the weight of housing/construction leads to excess investment over the capacity of domestic savings and thus an external deficit. Note especially that my sample, data, and methodology are quite different from those in Gete (2010) Whether Mr. Gete is right in that it relates to tradables vs. non-tradables is a theoretical discussion in its own right, but I am willing to go with this issue for now although, from a life cycle/permanent income perspective, I would not discount the wealth effect argument entirely.
Endogenizing Housing Schocks, introducing Life Course Theory
Stepping outside the realms of Neo-Classical representative agent modelling and real business cycle simulation, how might we operationalize this argument in a realistic theoretical context [4].
Before moving on, remember the key premise set up by Gete (2010). Preferences are exogenous and thus what this paper really sets out to show is how the distinction between housing as a non-tradable and “other goods” as tradables may lead to capital flows between economies. Specifically, this is put up as an alternative explanation to how an increase in housing demand may generate a trade deficit relative to the traditional account of a strong wealth effect from housing which translates into a demand for consumption today relative to savings tomorrow (or through the fact that it increases permanent income). For the purpose of what follows, this particular distinction is not so important. What is important however is to find a way or mechanism through which to endogenize the preference for housing and thus a way to model this purposed shock.
Enter life course theory.
Life course theory essentially deals with the timing and significance of key events in an individual’s life from birth to death. As it is presented in presented e.g in (ed. Mayer (2006)) it primarily operates on core sociological parameters such as age of leaving school, age of labour market entry, age of retirement, age of marriage (fertility decisions). This makes it a broader framework than the life cycle framework, but in fact the two are tightly joined at the hip. In this sense, one could also imagine more strict economic parameters such as age of first acquisition of house, car, or other “durable” goods. Specifically, one would probably tie this together to the capacity and willingness to take on debt to finance large durable purchases which are, by definition, very rarely financed through non leveraged lump sum transfers.
Slowly but surely we are moving towards a working model here. One way to conceptualize the way demographics may serve to generate international capital flows would then be to take a life course/life cycle perspective of the demographic transition in which an economy harbours the capacity sustain and develop a construction/housing boom which, through the mechanism described in Gete (2010), may serve to facilitate an ongoing trade deficit. Specifically, we could say that an economy must have a certain and relative amount of workers in their most productive age (say 30 to 45) to generate this dynamic which, by far, is not automatic since evidently; for an economy run a large current account deficit there need to be a corresponding pool of foreign savings.
As shown, Gete (2010) provides tentative evidence to suggest how the correlation between a large share of construction as percentage of GDP is closely associated with a trade deficit.
In general however, does my theory square off with reality?
Well, consider the fact that no economy with a median age over 40 have seen a sustainable housing boom which has led into an external deficit. In fact, based on the assumptions laid out above in the small laboratory set up by Gete (2010) and my endogenous imposition through demographics, we could say that as long as there is a balanced amount of economies with relatively stable population pyramids contrary to a group of rapidly ageing economies the system may work. Apart from mercantilist Asia and the petro exporters, I would hold this to be an important part of the source of the underlying stability of Bretton Woods II. The problem is that we are all ageing beyond the threshold where we can reasonably expect the economy to shoulder a large an ongoing deficit based on a rapid increase in construction and housing. This then becomes just another, and very specific, perspective on the gordian knot which is the global economic system with so many would be savers (exporters) and too few economies willing and able to suck up the excess liquidity [5].
Consequently, and if we can say that if the characteristics of a classic external deficit economy based on demographic fundamentals include a large share of construction/housing as a percentage of GDP, the recent economic crisis has drastically limited the peloton of such economies while simultaneous increasing the number of economies more than willing to finance whatever housing bubble there might be left somewhere.
Is this a new proposition then?
Not quite and if we look at the argument as a two step theoretical construct, the first step in terms of linking the demand for housing/construction to demographics is not new. Mankiw and Weil (1989) who examine the effect of the boomer generations move through the population pyramid is a seminal contribution with Green and Hendershott (1996) and related study. Far more interesting however are studies who try to combine both steps and thus tying together construction, demographics, and external account dynamics. Here especially Malmberg and Lindh (1999a and 1999b) is interesting as it shows how the disaggreation of investment reveals significant effects in a classic empirical context à la Higgins (1998) and Lürhmann (2003). Note especially this from the abstract;
Disaggregating investment we find that young cohorts have a positive correlation with housing investment while older but still active cohorts have a positive correlation with business investment. The differences in saving and investment effects are, nevertheless, sufficient to generate persistent and sizeable age effects on the current account. Our results suggest that policies concerning current account balance should take into consideration age distributions and the degree of development.
This would seem to fit not only with the picture laid out in Gete (2010), but also crucially with a strong life course effect and thus an argument to support a strong eye to life course/life cycle dynamics when modelling current account dynamics.
With respect to the global imbalances this perspective also offers a valuable lesson.
In a nutshell, if demographics drive housing and construction activity, and the latter drive current global imbalances it then follows naturally that demographics have something to do with current account imbalances. Yet, it may not be so simple. Consequently, it is dubious to claim that the reason why excess global liquidity was channeled into housing in the first place falls exclusively on the effect from demographic change. However, this would also be the wrong way to present the main argument. In this way, we can say that the extent to which a given economy was able (willing) to respond to excess global liquidity by developing a housing/construction bubble was a function of a specific demographic strucuture. More to the point even; the inability to harbour a housing/construction bubble and thus a matching current account deficit for all this liquidity splashing around is marked by the absense of a certain demographic structure namely that of a median age below 40 (to put it really strict). Basically, and as I have argued time and time again, the unwinding of global imbalances are greatly complicated by the fact the global economy increasingly is going to be populated by economies who cannot be expected to push up domestic demand to meet the propensity to save by others. In fact, this bites itself in the tail since those very same economies are the ones who are now dependent on exports. So, something has to give and while we cannot, yet, export to Mars this still becomes an important externality to consider in the context of the dynamics of the global economy.
This final point is perhaps the most important lesson to take home from my considerations above.
Summary
Well, I told you that this would be wonkish, but even if you have not read all those academic references above I hope that it is still possible to dissect the main message here. Demographics matter, but much more than this a strong methodological foundation in a life course/life cycle framework enables us to see how the demographic transition casts a long and significant shadow over the economic profile of individual economies as well as the aggregate global economy. Of course, this is my all time favorite hobby horse, but I do think that the facts are there to back me up.
As for Gete (2010), I would warmly recommend you to read it especially if you have lost faith in classic economic modelling where, I think, it provides a good example of an intuitive and easily comprehendible model of the world.
For future reference the topic above is naturally one that I will be pursuing vigorously as I move forward, so this is not the last time that I have treated this topic since it has much, much more to offer.
List of References
Gete, Pedro (2010) – Housing Markets and Current Account Dynamics, Working Paper (Georgetown University)
Green R. and P.H. Hendershott (1996) – Age, housing demand, and real house prices. Regional Science and Urban Economics, 26(5):465–480,
Higgins, Matthew (1998) – Demography, National Savings, and International Capital Flows, International
Economic Review, Volume 39 (1998) Issue (Month): 2 (May) pp 343-69
Malmberg, Bo and Lindh, Thomas (1999a) – Age Distributions and the Current Account A Changing
Relation? Working Paper Series 1999:21, Uppsala University, Department of Economic
Malmberg, Bo and Lindh, Thomas (1999b) – Demography and housing demand—what can we learn from residential construction data. Workshop on Age Effects on the Economy, Stockholm, pages 2–3, 1999
Mankiw, N. Gregory and Weil, David N (1989) – The baby boom, the baby bust, and the housing market, Regional Science and Urban Economics Volume 19, Issue 2, May 1989, Pages 235-258
Mayer, Karl Ulrich (2006) – Handbook of the Life Course (review) Social Forces – Volume 84, Number 4, June 2006, pp. 2363-2365
Lürhmann, Melanie (2003) – Demographic Change, Foresight and International Capital Flows, MEA
discussion paper series 03038, Mannheim Research Institute for the Economics of Aging (MEA),
University of Mannheim
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[1] – No, not life cycle which is also important, but indeed life course.
[2] – Think undergrad microeconomics here with allocation of labour in a two goods economy with a corresponding production possibility frontier and indifference curve.
[3] – I have the following countries; Australia Austria Belgium Czech Republic Denmark Finland France Germany Greece Hungary Ireland Italy Japan Korea Luxembourg Mexico Netherlands Poland Portugal Slovak Republic Spain Sweden Switzerland United Kingdom United States Estonia Slovenia.
[4] – And yes, here I AM implying that RBC simulations and neo-classical economic modelling are not very realistic even if they may hold some intuitive appeal.
[5] – … which again is created by the fact that OECD central banks are in QE mode in an attempt to spur growth in their domestic economies, but where the liquidity simply ends up moving through the back door ending up whereever there is yield to be found. And round and round we go …
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