By Bron Suchecki, on September 15th, 2009
Steve Keen is an Australian Post-Keynesian economist credited as having “seen it coming” in this survey of research by economists or financial market commentators. Keen was one of only eleven researchers who qualified, which included Schiff, Roubini, and Shiller.
Steve Keen is a follower of Hyman Minsky’s “Financial Instability Hypothesis”, which he summarises as:
1) Capitalist economies periodically experience financial crises;
2) These are caused by debt-financed speculation on asset prices leading to bubbles in asset prices;
3) These bubbles must eventually burst because they add nothing to productive capacity while increasing the debt-servicing burden;
4) When they burst, asset prices collapse but the debt remains;
5) The attempts by both borrowers and lenders to reduce leverage reduces demand and causes a recession;
6) If the economy survives such a crisis it goes through the same process again, with another boom driving debt up even higher, followed by yet another crash; but
7) This leads to a level of debt that is so great that another revival becomes impossible since no-one is willing to take on any more debt;
 Then a Depression ensues.
A plausible but dismal explanation. Consider this comment on Steve’s latest blog post:
“This is one of the great questions for all of history, how to get out of this. For one thing, one persons debt is another persons asset or in many cases their money. … It is clear that everyone that has something is going to take a haircut on it. Either by a systematic bankruptcy or by a natural one.”
As Steve Keen says:
Some form of price chaos has to be expected though, whatever is done. One side-effect of the bubble has been an enormous dislocation in prices, not just with overvalued financial assets, but also with drastically overinflated incomes for the financial class, and concomitant price distortions all the way through commodities.
How do you protect yourself from this economic World War III? Simply swallow the red pill and step outside the Financial Matrix: bail out of your “has something”s into precious metals and sit by and watch the annihilation as everyone else takes “a haircut”.
By D H Smith, on August 27th, 2009
Ann Elk: Where? Oh, what is my theory? This is it. My theory that belongs to me is as follows. This is how it goes. The next thing I’m going to say is my theory. Ready?
TV Interviewer: Yes.
Ann Elk: … This theory goes as follows and begins now. All brontosauruses are thin at one end; much, much thicker in the middle; and then thin again at the far end.
(From Monty Python’s Flying Circus)
I too have a theory, which is to say it is a theory and it is mine. I hope it’s a bit less silly than Ann Elk’s theory, but in any case let’s try it on. The next thing I’m going to say is actually not my theory, but another theory, which is someone else’s and got me to thinking about my theory.
This other theory is something called Dutch Disease, which is an economic diagnosis of the Netherlands’s loss of competitiveness in goods producing industry following a 1959 discovery of natural gas off its North Sea coast. In the simplest terms, this leads to inflows of investment, which pump up the exchange rate and alters terms of trade in such a way that exports become uncompetitive. In this perverse fashion, a lucky strike in natural resources creates not employment and growth but unemployment and stagnation.
America, my theory states, has a version of that, only the natural resource is money. I want to name the problem “American Disease” but I read in an article by Bryan Caplan (http://bit.ly/tkDRJ) that that’s the name of a syndrome of Americans living beyond their means. Actually the problem I pose is closely related, just as H1N1 influenza is closely related to other strains of the flu. Perhaps I can say “2009 American Disease” to differentiate it from old established strains, or should I call it “California Disease” to reflect the fact that the disease has advanced furthest in the Golden State?
America is a country with real natural resources, of course, but the high costs of extraction and environmental compliance and restrictions on land use places them increasingly out of reach. In the days when the country did produce resources and processed them into manufactured goods which foreigners bought, the U.S. generated a vast amount of wealth, much of which was invested in buildings and infrastructure and so remains visible in the present day as a reminder our peak of economic power.
(Exactly the same is true of Argentina, by the way, which was the wealthiest country in the world 100 years ago and still has the buildings and boulevards to prove it, even though Mr. Juan Peron and the generals set the country on an unusual course from first world to third world status.)
Now, even after the financial crisis, America’s most important industry is finance, broadly defined. The financial industry differs from the auto industry and the chemicals industry in one interesting respect. The auto industry inputs steel and plastic and outputs autos, the chemicals industry inputs primary and intermediate materials and outputs finished chemical products – in other words, they work on raw materials and change them into something else. Most industries do this. But the finance industry has money both as input and output – it changes money’s form but not its nature in its processes. Money is both the input and the output, the resource base and the finished product.
The American finance industry is competitive, one of the nation’s success stories in terms of services exports. Our political class, which increasingly impedes us from taking coal out of our mountains, irrigating our farmlands, and manufacturing products with processes that are not squeaky clean, has long promoted clean, non-polluting financial services, and it has prospered as the industry prospered.
However, I believe that too much money in an economy based on financial services has given us a condition akin to Dutch Disease. It could probably be shown that the maintenance of the U.S. as a financial center has made the American dollar stronger than it would otherwise have been, reducing our competitiveness in global markets. Moreover, the high level of compensation in the financial industry and supporting services has probably driven up wages and benefits throughout the U.S. labor economy, another blow to the competitiveness of any entrepreneur who wants to defy the odds and manufacture a product for our own use.
While the American political class stands in the way of development of (real) natural resources and domestic manufacturing, it does see the residual financial wealth of the nation as a resource that it can cut and drill and strip mine – endlessly, in fact, as it recognizes no restraint on the size of resource, but treats it as infinite. The people entrusted to run the country reckon without the necessary diminution of the resource as taxes, penalties, and compliance costs leave less and less to reinvest, even as the potential returns on investment are inevitably being reduced. Their static models fail to capture the fact that producers will not produce – or innovate, or hire – out of sheer altruism even as the returns on their capital and labor are stolen.
The impoverishment of the United States by the Argentine model is thus well under way.
Oh, and why do I say California has the most advanced case of the “2009 American Disease?” Well, just look at the Golden State. There is oil offshore, but its development is not permitted. Manufacturing is being driven out. And the Central Valley is experiencing 40% unemployment in agriculture in order to mudfish habitat; but the fiscal position continues to deteriorate as California’s political class absolutely will not live within the means of the state’s reduced circumstances.
As California is the United States only more so, California’s political class is America’s in microcosm, with all its pathologies subjected to magnification. It puts me in mind of the passage from Atlas Shrugged:
As they proclaim that the only requirement for running a factory is the ability to turn the cranks of the machines, and blank out the question of who created the factory—so they proclaim that there are no entities, that nothing exists but motion, and blank out the fact that motion presupposes the thing which moves, that without the concept of entity, there can be no such concept as ‘motion.’ As they proclaim their right to consume the unearned, and blank out the question of who’s to produce it—so they proclaim that there is no law of identity, that nothing exists but change, and blank out the fact that change presupposes the concepts of what changes, from what and to what, that, without the law of identity no such concept as ‘change’ is possible. As they rob an industrialist while denying his value, so they seek to seize power over all of existence while denying that existence exists.
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By Winton Bates, on May 13th, 2009
In attempting to understand the current financial crisis I don’t have the benefit of a great deal of knowledge of macroeconomics. Nevertheless, I can understand only too well what many macroeconomists are saying about fiscal stimulus and multipliers because they are using Keynesian language that I learned in my first year at university 45 years ago.
During the 1970s nearly all macroeconomists seemed to abandon the crude Keynesianism that I learned about at university. Why have so many reverted to it at this time? The answer might have more to do with the desire for a comfort blanket in times of uncertainty than with the merits of Keynes’ approach. The Keynesian remedy does not seem to me to be much more relevant to the current situation than it was to the stagflation of the 1970s. It suggests that when you wake up with a debt-induced hangover, then you will soon feel better if you get the government to take on some more debt on your behalf. That doesn’t sound to me like a recipe for a more healthy world economy.
So I have been looking for articles which will help me to understand why the world is in recession and what can be done about it. The best aid to understanding that I have found so far is John Cochrane’s refinery analogy:
“Imagine by analogy that several major refineries had blown up. There would be tankers full of oil sitting in the harbor, and oil prices would be low, yet little gasoline would be available and gas prices would be high. Stimulating people to drive around would not revive gas sales. Borrowing gasoline and using it on infrastructure projects would be worse. The right policy action would obviously be to run whatever government or military refineries could be cobbled together on short notice at full speed, and focus on rebuilding the private ones.” John H Cochrane, ‘Fiscal Stimulus, Fiscal Inflation or Fiscal Fallacies’.
The “major refineries” correspond to the banks that have loaded themselves with toxic assets. The oil tankers sitting in the harbour correspond to the savings that are going to government securities paying low interest rates and the high gas prices correspond to the high price of credit to businesses and consumers (in many countries). The running of government and military refineries at full speed corresponds to the government raising funds by issuing debt and lending it to businesses and consumers.
Cochrane recognizes that this analogy does not give a complete picture of the current situation. He explains that if we just had a shock to the supply of credit (blown up refineries) we would expect to see stagflation – lower quantities of goods and services sold, but upward pressure on prices. Instead we are seeing lower quantities sold and lower inflation. So, we are also seeing a demand shock as a result of people becoming much more averse to holding risks. (The refinery analogy could possibly be stretched to accommodate this. If several major refineries were blown up then investors could be expected to seek to reduce the exposure of their portfolios to other firms that might also be at risk of “blowing up”.)
Would the situation be resolved if the central banks were to target a specific rate of growth in nominal GDP (as I discussed in an earlier post)? The answer might depend on what assets the central banks purchase from the public in pursuit of this objective. If they buy government bonds this will help satisfy the increased demand for money, but not address the supply shock in the credit market. It is possible that the market could take care of this problem e.g. major firms may be able to by-pass the damaged banks by raising funds directly from the public. However, when central banks buy newly-issued commercial paper and securitized debt they are acting directly in place of the injured banks.
As a stop-gap measure this kind of by-pass intervention has the important merit of being a lot easier to unwind than alternative approaches. If central banks confine their purchases to quality assets they will not have any difficulty selling them when inflation begins to rise and people get tired of holding so much money. The effects of fiscal stimulus involving cash splashes by governments are likely to be much more difficult to unwind without a decade or more of high-tax and low-growth stagflation.
It seems to me that current debates about the effectiveness of stimulus packages in lifting aggregate demand tend to miss a more important point about consequences beyond the immediate short term (i.e. long before Keynes’ long run when we will all be dead). John Cochrane makes the point as follows in relation to the U.S. economy:
“If the resources are not there to unwind our current operations, to quickly retire … newly created debt, a large inflation will result as people dump government debt. If history is any guide, this outcome will unleash economic dislocations on a scale to make our current troubles look like a pleasant memory.”
By Ajay Shah, on May 11th, 2009
As we come to the beginning of the end of the financial crisis, the calls for the blood of bankers have abated. There is universal agreement that the system overall was flawed, and it is unfair to burden a particular group with the full responsibility of our current sorry state.
The time has come to dispassionately step back and ask the tough question. It may or not be unfair, but is it incorrect?
Consider first the arguments for those who claim that the Bankers have suffered enough.
There was a sense of outrage that that the Bankers had not paid for their sins. This is simply not true. As a percentage of their wealth, Bankers have lost more than everyone else combined. Fully 40% of Lehman stock was held by its employees. When that stock was worth $85, the company was worth around the same, in billions of dollars. Every person in Wall Street has the right to claim that they could not foresee the collapse. The original argument was that it took mala fide intent, or stupidity to not have seen the risk. It turns out that stupidity was the right answer, since every idiot on Wall Street was in fact heavily invested in – you guessed it, Wall Street.
Which brings us nicely to point 2. The idiots could not be held responsible, since there was not deliberate fraud. There is today only a perplexing cloud of sub moronic decisions. How, is everyone asking, could we not have foreseen this ? Naturally, we forgive ourselves, and having done that, find it easy to extend the forgiveness to Wall Street. They could hardly be held responsible for the wrong decisions. After all, we made them too!
Finally, we all would like to look at who else we could hold responsible. There is a popular cry that Rating agencies should have done more, or that the entire process of Ratings is intrinsically flawed. Regulatory agencies are also very popular invitees to the whip-them-all parties. Finally, what about the consumer, the buyer of gas guzzling Hummers, the takers of sub-prime loans to purchase houses three sizes too big? Surely, some of the pie, humble or otherwise, belongs to him as well.
These arguments are not unjust, but unfortunately they miss the point. This is not a bad thing – it shows our intrinsic humanity. It takes a special kind of cruelty to turn away from justice for the past and coldly consider what is best for our future. But it must be done. “The greatest good of the largest number” is a disgusting motto, but we it does help in analysing the issues.
I will get to the inconvenient truths, but first let me speculate about why the Bankers lost so much money.
<nasty on>The reason that the Bankers lost so much of their personal money was that they were all overpaid, and behaved exactly like people do when they come into money that they know they haven’t earned. They throw it into the riskiest earnings streams that they can find. That comforts them, because if they lose the money, well then, they did not do such a bad thing after all, since they didn’t take the money home with them. And if they win, well then, this time the money was made by them, so that feels good as well! <nasty off>
Well, that was nasty, but my personal belief in this comes from the incidence of Wall Street Bankers in Las Vegas during the boom years. It really doesn’t take too much intelligence to know that you are playing against the house, so why do such highly educated and well paid people – which probably means that they are intelligent – keep playing these games?
To come to somewhat more factual matters, the arguments for letting Ken Lewis and all the other CEOs “pursue other interests” are as follows.
The current incumbents cannot effect the change we need. It is sad but true that it is only after Obama won the presidency has it become acceptable to admit that it was a mistake to give Bush carte-blanche in Iraq. Only Senator Edwards had the courage to admit that he made a mistake, and in retrospect, it may be because it was one of his smaller ones  The current lot will go right back to making original sin #1, forcing really intelligent people to think like idiots because of misguided compensation structures.
Which bring us to point #2. While it is probably correct to absolve the CEOs of fraud, it would be incorrect to absolve them of stupidity. One has to assume that they have blundered, and it would not be right to not hold them accountable for their blunders. In this case, by kicking them out.
The last and final point is simply a rebuttal of the desire to make major changes to the infrastructure, or to the nature of human beings at large. It may or not be feasible to make major changes to the infrastructure and social polity within which Wall Street operates. It is simply not the better answer. We don’t need change around Wall Street, we need it in Wall Street. The best way to effect that change is change the players, not the environment within which Wall Street operates.
The last point is the coldest of them all, because it makes no bones about asking Ken Lewis to lose his job so that we can get on with our lives without having to wait 10 years for a new world order to come into place. But it is also the most important. It is simply the most practical decision to get a new broom to sweep clean.
By Ajay Shah, on April 23rd, 2009
On 14 October 2008, Jahangir Aziz, Ila Patnaik and I released a short note on what was going on. It was titled The current liquidity crunch in India: Diagnosis and policy response.
On Monday (20th), Ila Patnaik has an article in Indian Express with one more piece of evidence that the APS story was basically on the right track.
Today, when we look back at the APS paper, it seems mild. But I distinctly remember at the time, the world was much more confusing. Lehman died on 15 September. After that, there was a ‘fog of war’ problem: a lot was going on, there was information overload in many ways, lots of critical information from within RBI is not released into the public domain in a timely manner or is not released at all, and the statistical system has such long lags that on 10 October, when we started writing, almost nothing was known about the period immediately after 15 September.
Speaking for me personally, I had the right starting conditions in terms of being oriented towards the themes of de facto convertibility, Indian multinationals, etc. I should have got the story quickly after 15 September. But still, it took me a long time to understand what was happening.
Similar problems — on an immensely magnified scale — have afflicted crisis responses everywhere in both the private sector and governments. Whether it was Northern Rock, Bear Stearns, or Lehman: analysts and decision makers have been ambushed by difficult questions, very little time within which to make calls, and bad information at the time. With the benefit of hindsight, it’s easy to criticise what was done, but this stuff is hard.
By Cheryl Grey, on November 11th, 2008
When the U.S. government refused to bail out Lehman Brothers and no buyer could be found for the tottering investment bank, traders and investors around the world realized something terrifying: their profits—worse yet, their capital—were at risk, and the Fed’s lack of action proved no one was going to save them.
Results Round One
The result was panic. Faced with massive losses, these international investors yanked their funds from commodities, stocks and other investment vehicles in emerging markets around the globe and bought bonds offered by developed nations. Any investment seen as riskier than a 90-day T-bill was spurned in what has come to be called “the flight to quality.”
The result of that result was the unwinding of carry trades. In that scheme, traders take out loans in nations with low interest rates (such as Switzerland at 2.0%, the U.S. at 1.0% or Japan at 0.3%) and invest the funds in nations with high ones (such as New Zealand at 6.5%, South Africa at 15.5% or Iceland at 18%), thus earning the “spread” between those rates. But currency fluctuations, caused by shifting interest rates or decreasing economic potential in the investment nation, put both profits and capital at risk, and during the flight to quality traders dumped these investments and repaid their loans. In the process, the South Korean stock market collapsed 40%, Ukraine’s 60%, Iceland’s 90% (see chart of the Icelandic index above, October 17). The Russian market ceased trading for two days, hoping for stability to emerge; it didn’t happen.
The next result was the appreciation of the U.S. dollar against every currency in the world with the lone exception of the Japanese yen. Since mid-August, when the unwinding of carry trades began in earnest, JPY has appreciated almost 18% against USD as these international traders “sell” the dollar and “buy” the yen to repay their Japanese loans. The yen rose so high that the affordability of, and therefore the profit from Japan’s exports, slumped, with Toyota’s profits shrinking 69% in the most recent quarter and Sony’s by 72%.
Results Round Two?
And that’s the good news.
With the worst of the flight to quality complete, most major currencies appear to be stabilizing against USD, albeit at lower than anticipated levels. The Euro, which was worth an historic high of $1.60 as late as July 14, lost $0.37 in value by October 28, or 23%. The U.K. pound, which was as high as $2.11 a year ago, currently trades at $1.56, down 26%. These currencies are also shifting in value against each other. The exchange ratio between the Euro and the Swiss franc, another traditional safe-haven currency in times of financial stress, has fallen 12.6% since July 31.
In terms of international finance, these are huge moves, particularly for emerging economies. With the rise of globalization, loans of all varieties—corporate, individual, inter-governmental—are now made across national boundaries and across currencies. As currencies shift into new relative value ranges, the payment terms of these loans shift to follow, meaning that Swiss loans to Euro-funded nations are now 12.6% more expensive than they were three months earlier.
Current estimates place 90% of all Hungarian mortgages written since 2006 in Swiss francs. With the Hungarian forint down 17%, these mortgages are ballooning in cost just as their adjustable-rate counterparts did in the U.S. when the Fed raised the prime interest rate. The financial world already knows the rest of that story. Rather than waiting for the rush of defaults and foreclosures both corporate and domestic, the International Monetary Fund, European Central Bank and World Bank loaned Hungary 20 billion Euros (US$25.5 billion) on October 29. Loans to Ukraine, Pakistan, Iceland and other nations are following quickly.
But similar circumstances in Romania, Bulgaria, Serbia, Lithuania, Latvia, Croatia, Poland, Slovakia, Belarus and the Czech Republic mean the second round of the financial crisis may be happening across the Atlantic. Even worse, the story is repeated in parts of Asia and in Central and South America. All told, a total of US$4.7 trillion in loans cross these international borders, and Western European banks hold three-quarters of those notes, an amount that dwarfs U.S. banks’ exposure in the first round of that crisis. In Austria alone, bank exposure to these notes is 85% of national gross domestic product and in Switzerland it’s 50%.
Steve Forbes may believe the worst is over. Europe doesn’t necessarily agree.
By Mary Nichols, on October 22nd, 2008
The current financial crisis in the U.S. is hitting everyone hard, perhaps not least the older population. Many in this age group will have taken early retirement in recent years and may now be starting to feel the pinch due to unexpected price rises. Some of these seniors, along with others who just miss the activity and companionship of the workplace, may be considering a return to work on a full or part-time basis.
In fact, the trend towards earlier retirement in recent decades means that the U.S. has a large non-economically active older population in their 60s and early 70s, many of whom hold valuable skills and experience and who enjoy much higher levels of health and fitness at this stage of life than any earlier generation.
Increasingly, employers will need to tap into this older labor pool in order to ease recruitment difficulties. Demographic changes, including a falling birthrate and the aging of the U.S. population, mean that fewer young people are now entering the labor force. As the first cohort of the baby boomer generation reaches retirement age this year, the labor force can be expected to shrink considerably within a short period of time, even taking into account a continuing influx of immigrants.
Aging Workforce
Moreover, the workforce itself is aging, as reflected in the U.S. Bureau of Labor Market Statistics’ data on the employment participation of different age groups. Between 1977 and 2007, it is reported, there was a 101% increase in the employment of workers aged 65 and above, compared with a 59% increase in total employment. By 2016, it is estimated, the number of workers aged 55 to 65 will increase by 36.5%, while the number of workers aged 65 and over will increase by more than 80%, with the latter group accounting for more than 6% of the total labor force by that time.
Simple supply and demand considerations, therefore, suggest that future employment opportunities for older people will be good. Moreover, a raft of legislative and policy changes over recent decades, including the Age Discrimination in Employment Act (ADEA) of 1967 and the elimination of mandatory retirement in 1986, have also theoretically improved recruitment and retention prospects for the country’s seniors.
Yet there is evidence that age discrimination on the part of employers is rampant in the U.S., hindering not only the opportunity for older people to improve their finances but also potentially hampering the ability of the labor market to adjust to the demographic changes. Equal Employment Opportunity Commission statistics show a vast increase in age discrimination lawsuits in recent years, while research studies also provide evidence that age discrimination is widespread, at least in terms of recruitment and displacement, if not in terms of earnings. However, this is often very subtle and more difficult to prove than other forms of discrimination; for this reason it is likely that the statistics vastly under-estimate its true extent.
Benefits of Retirement-Age Workers
Studies have suggested that many employers are reluctant to hire older workers as they fear higher healthcare and insurance costs and hold concerns about their abilities and likely productivity. In fact, while there is some evidence that physical strength steadily declines after the age of 40, research has also indicated that there is little deterioration in mental faculties until over the age of 70. Moreover, published case studies of organizations in the U.S. and Europe that actively recruit and retain older workers, including McDonalds and the book retailer Borders, provide evidence of many benefits of such policies, such as lower rates of absenteeism, lower turnover, higher profits and improved customer satisfaction.
The increased employment of older workers is also likely to bring wider economic benefits to the U.S. by helping to ease the burden on the Social Security and pensions schemes resulting from early retirement patterns and the increased lifespan of Americans. A remaining barrier, however, is the restrictive pension scheme regulations which often deter older people from continuing to work beyond retirement age or re-entering the workforce. The U.S. may be well-advised to consider adopting the type of gradual retirement programs already in place in many Scandinavian and European countries.
References
Adams, S.J. & Neumark, D. (2002). Age Discrimination in U.S. Labor Markets: A Review of the Evidence. Public Policy Institute of California Working Paper No. 2002-8.
Anonymous (2007). Age discrimination: don’t let the joke be on you; Best practices from JD Wetherspoon, the Metropolitan Police and McDonalds. Human Resource Management International Digest, 15, 3, 21-23.
Conference Board of Canada (2006). Canada’s Demographic Revolution Adjusting to an Aging Population.
Crampton, S.M. & Hodge, J.W. (2007). Age Discrimination and Downsizing. The Business Review 7, 1, 341-347.
Dychtwald, K., Erickson, T.J. & Morison, R. (2006). Workforce Crisis : How to Beat the Coming Shortage of Skills and Talent. Harvard Business School Press.
Kantarci, T. & Van Soest (2008). Gradual Retirement: Preferences and Limitations. De Economist, 156, 2; 113-144.
MacNicol, J. (2006) Age Discrimination: An Historical and Contemporary Analysis, Cambridge: Cambridge University Press.
McMahan, S. & Philips, K. (1999) America’s Ageing Workforce: Ergonomic solutions for reducing the risk of CTDS. American Journal of Health Studies 15, 199-202.
Santora, J.C. & Seaton, W.J. (2008). Age Discrimination: Alive and Well in the Workplace? The Academy of Management Perspectives 22, 2, 103.
Turner, J.A. (2008) Work Options for Older Americans: Employee Benefits for the Era of Living Longer. Benefits Quarterly, 24, 3, 20-26.
U.S. Bureau of Labor Statistics (2008). Spotlight on Statistics: Older Workers. July 2008. Retrieved from http://www.bls.gov/spotlight/2008/older_workers/
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