Is Larry Summers The Next Gordon Brown?

Gordon Brown, the British Prime Minister, is in big trouble.  It turns out that a medium-sized industrialized democracy like the UK can be run in pretty much the same way as a traditional emerging market – fiscal irresponsibility (cyclically-adjusted general government deficit now forecast at 12.2 percent of GDP for 2010) gives you a boom for a while, but the eventual day of reckoning is economically painful and politically disastrous.  If you also need to deal with an oversized bubble finance sector, that makes the adjustment even more painful.

It is of course sensible to use fiscal stimulus to offset a fall in private demand, and to some extent this can be effective – with a lag.  But if you lose control over public spending and borrow too heavily (helped by the fact people like to hold your currency), it ends badly.

From the beginning, we’ve expressed concern here that the entire Summers Plan was overweight fiscal, i.e., not enough resources for recapitalizing banks and addressing housing directly (for the context of this assessment, see our full baseline view).  Back in December/January, this was a strategic choice worth arguing about; now it’s a done deal and following the (very) limited recapitalization outcome of the bank stress tests, it seems likely that household and firm spending will remain sluggish.  If that is the case, the Administration’s logic implies throwing another big fiscal stimulus into the mix – and the Summers’ team is already preparing the groundwork.

The IMF is now warning against the risks of this approach, albeit using carefully worded language.

In a 20 minute presentation at the Carnegie Endowment on April 30th, Olivier Blanchard made statements that are striking coming from the IMF’s chief economist (webcast; slides; fan chart for growth forecast).

Remember that the IMF is the custodian of the official consensus on the global macroeconomy and financial system – so if their baseline view is in the same ballpark as your stress test results, the IMF is telling you to be more pessimistic.  They can nudge a powerful government, like the US, in a particular direction – but not too hard in public on a politically sensitive issue such as fiscal sustainability (or lack of capital in the banking system).

Blanchard is clear that the IMF sees the need to “fix the financial system”.  He also assumes this will happen slowly, and indicates this slowness is not helpful for the recovery.  The implication is that the US will resort to even more fiscal stimulus if the recovery proves sluggish – look at his slide on p.7, dealing with fiscal sustainability (this is discussed at about minute 11 in the webcast).  This presentation of country averages is an IMF way of talking about difficult country-specific situations without being indelicate  – and the point here is to push you to think about the nonconvergent (red…) debt path with contingent liabilities (i.e., what the government is committing to the banking system without acknowledging the fact); the yellow path for debt, with slow economic growth, also does not look good.

Blanchard doesn’t show the US debt forecast – presumably that would be indelicate.  But at the 13:13 mark, he warns that the US may be heading in the same fiscal direction as Ireland (!), “the [US budget] numbers are not great but we hope that something will be done.”  

The content and timing of that  “something” is left vague – add your suggestions below.

By Simon Johnson

41 responses to “Is Larry Summers The Next Gordon Brown?

  1. Bankrupt banks should absolutely not be recapitalized, they should be placed into receivership. This is flatly insane – “recapitalizing” these bankrupt institutions is going to very soon cause a hyperinflationary blowout of the US Dollar.

    It’s astounding that anyone would suggest that we can save the paper – the trillions upon trillions in worthless derivatives the banks hold. What you’re suggesting here is tantamount to saving the afterbirth and killing the baby. MONEY IS JUST THE MEDIUM OF EXCHANGE. MONEY ITSELF HAS NO VALUE. Cursed are those who worship at the Altar of Mammon.

    You’re approaching this from an entirely erroneous perspective. Why are the banks insolvent? Because people can’t pay their bills. Why can’t people pay their bills? Because they have too much debt and not enough income. Why is that? Because for 3 decades, the neoliberal/fascist money-worshipers have let the PRODUCTIVE PHYSICAL ECONOMY rot away in order to invest in worthless paper financial assets and create the largest debt bubble in history.

    The problem is that you assume that economy is a monetary phenomenon. It is not, an economy is a physical entity, and it is governed by physical laws.

  2. Coffee Boy

    I’ve been wondering about this for some time now: have we ever seen a modern economy REDUCE its outstanding debt meaningfully? (outside of going bankrupt and defaulting on the debt). I made a similar point earlier when I talked about “career risk,” but I would venture to say that the incentives around government budgets are so skewed such that its nearly impossible for a government to have a balanced budget.

    Firstly, the individuals responsible for our budget (congressmen and the president), operate an institution that has zero perceivable default risk, and a seemingly infinite capacity to borrow. I use the words “perceivable” and “seemingly” because there is obviously default risk, but its such a tail risk event that for 99.9% of the time, politicians don’t consider it in their decision making process.

    Secondly, performance criteria that our politicians are judged by are completely uncorrelated with balanced budgets (and may even be negatively correlated with it). Our politicians’ incentives are aligned with appeasing constituents and looking “active.” Unlike a CEO (or CFO, or any other private sector decision maker), if our government “makes a loss” (ie spends more than it earns), no one bats an eye. If this happened in the private sector, heads roll. Of course, private sector entities are just as culpable in terms of borrowing too much to finance fickle projects, however, the “mean-reversion” process is much quicker – if the entity becomes insolvent, it goes bankrupt, the creditors take some pain, and the heads of senior management roll. When it comes to our government, we have NO IDEA whether or not it is solvent (PV of tax receipts = PV of outstanding debt).
    The worst part is, as far as being an “admirable goal,” having a balanced budget is a vague and non-specific goal that resonates too little with taxpayers, whereas specific projects and programs to help local constituents are politically much more valuable.

    All of this means that incentives are always aligned towards MORE government spending, and LESS regard for a balanced budget. Someone made a comment earlier saying that the US govt could feasibly be running the largest Ponzi scheme in written history if this debt keeps being rolled over. And, before anyone says it, hyperinflation isn’t a solution. On paper, the debts get repaid, but the precipitous fall in the value of our currency precludes that option.

    We talk a lot about the market failures and skewed incentives that have led to overleveraged banks and a broken financial system. Despite my previous defence of a market-based system, I agree that we need to fix these problems so that we can well-functioning private-sector financial system. However, we need to pay as much or even more attention to the “political externalities” that prevent us from getting our fiscal house in order. We need to realize that there’s not a single soul in Washington with decision making power whose incentives are aligned with a balanced budget. This is a political externality that needs a constitutional amendment to be remedied. Otherwise, the fiscal crisis that we pass on to our children’s children will be a lot scarier than global warming, stifling pollution, and the other wonderful inheritance gifts we have stored up for them.

  3. My concern regarding these issues is that because the largest banks (among them some of the most insolvent) have now been explicitly guaranteed by the government, they now follow this same incentive structure. To have our government run atop an insane debt structure for thirty years has built structural problems we have yet to face. Add to that the brand new element of banks also being rewarded for running “deficits”? This cannot be a good thing.

  4. Could someone please put together a nice “Real National Debt Per Worker” Chart. It’s not a perfect proxy for a “average worker’s debt burden” but it would still be interesting to see.

    I can see that it would tend to exaggerate the situation during a downturn because deficit spending usually goes up while employment contracts, but perhaps it would help to compare the present situation to past recessions.

  5. Carson Gross

    I agree with The Daily Elitist.


  6. Before economics and political science were broken up into separate disciplines, courses on something called ‘the political economy’ were routinely taught at most universities. Only Paul Krugman and Simon Johnson seem qualified to teach such courses today.
    If Obama has gotten his bank plan wrong (and who can doubt that fact at this point?) everything else he does over the next four to eight years will be a failure. Even if he signs healthcare reform and other big initiatives into law, there will be NO money to pay for them. In fact, proping up states and other political subdivisions is going to be one of the biggest jobs going forward. As soon as he starts raising taxes–and they will have to be increased significantly to meaningfully offset deficit spending–the economy will stall, in not tank.
    Dean Baker said putting Summers and Geithner in charge of Obama’s economic team was like naming Osama bin Laden to be his head of Homeland Security. It looks like Baker might have been right.

  7. Point by Point:

    1) “Gordon Brown is in big trouble”: The article is entirely about misuse of expenses (e.g. perks and such), entirely unrelated to the deficit. Arguably, public approval of Gordon Brown’s handling of the financial crisis has been reasonably well received – since June 08 Labor has managed to close most of the Tory lead, a fair amount of that since September of 08.

    I’m sorry – where is the connection between the deficit and Brown’s electoral challenges? Much of the criticism of Brown seems to have been directed at him _personally_, less to Labor’s policies in general.

    Please connect the dots.

    2) “UK fiscal responsibility was run like an emerging market – fiscal irresponsibility gave a boom for a while but the day of reckoning is approaching”

    It seems like the issue was less clearly fiscal irresponsibility as a currency that was consistently overvalued, and an overreliance on the finance sector as the engine of growth. If you observe page 7 of that report, it makes the point –

    MOST of the projected deficit is NOT discretionary spending (aka, Stimulus). Indeed, almost all.

    Half of the deficit is committed spending (“automatic” stabilizers, like the social safety net). But this half is in total smaller than the contribution for “automatic” stabilizers in Germany, and barely larger than in France and Japan.

    Indeed, the greater chunk of the deficit – the blue bar – is “Other”, which presumably includes the rescue of the financial system.

    So are you accusing UK of in general being fiscally lax? (If so, what about Germany?) Or of allowing its financial system to trample the other economic engines of the country?

    3) “Summers could be next if he doesn’t learn a lesson from the UK.” *(paraphrased)

    Personally, I am impressed by the UK on at least one dimension – they had the political will to devalue their currency. Ultimately, their existing imbalance can only be sustained by continued increase in demand for the currency for its own sake (e.g. US dollarization), continually increasing accumulation of debt to foreign lenders (bad bad bad), or perpetual disparity in labor productivity (unfortunately, labor productivity is increasing rapidly in developing countries as they adopt western innovations).

    The devaluation of the pound, and increase in consumer prices, is an absolute necessity for Britain if they want to have a hope of keeping anything resembling a real economy. UK is adjusting faster than the US; its foreign debt load is unsustainable, and it is doing the rational thing. Printing money. This should allow the pound (and Britain’s pound-demoninated debt) to devalue fast enough that Britain’s economy does not implode due to crushing (domestic and international) debt payments.

    4) This post somewhat ignores the main proposition behind Blanchard’s talk, that there are two countervailing forces at work on the world economy: Endogenous multiplier effects (e.g. money velocity) and “natural stabilizers”+Demand Policies.

    On interpretation is that the national stabilizers+demand policies are helping right now because the multiplier effects are creating so much drag, but that when the multiplier effects reverse we could be in for quite a ride.

    Great point! We’ve all been talking about that for ages, and Blanchard marshalls some data in support. So we have a couple options:

    a) Manage the multiplier effects – for example, impose a phased reduction on the capital-asset ratios for banks. Consider policies to reduce volatility in international capital flows (lag times, small transaction taxes, etc.). Cap certain types of financial instruments that expand leverage outside the scope of regulatory environments. Tighten up money havens.

    We have heard little talk of such policies by anyone in the policy arenas. (Although Krugman briefly considered the Tobin Tax.) Why, I wonder?

    b) Remind the world – as Blanchard does – that when things turn up we’ll need the political will to turn off the spigot. Fair point! Yet it seems that many in the anti-inflationist crowd are launching pre-emptive attacks against fiscal spending for fear that once the public has learned that moderate inflation won’t cause the collapse of civilization, policymakers will have difficulty putting the “inflation genie back in the bottle”.

    c) My own fears are quite the reverse! I’m quite terrified of a return of Reagonomics – that is, a strong dollar policy (e.g. monetary tightening) coupled with massive FISCAL deficits, in which we avoid inflation by indebting future generations to foreign economies. I would rather pay the inflation tax now, thank you very much, than pass it to my children and pretend we’re “cutting government spending” while instead handing out tax cuts that are being paid for by selling government bonds to foreign investors.

    In other words, fiscal policy should serve as an agent of monetary policy (e.g. to force money into the economy to offset debt-deflation); fiscal policy cannot serve as the engine of recovery by itself.

  8. Pingback: Secondary Sources: Consumer Debt, U.S. Position, Crisis Stories - Real Time Economics - WSJ

  9. Well, I was able to put this “average worker’s real national debt burden” chart together. Believe it or not, it’s fairly continuous and you don’t see wild jerks out of trend. Here’s a quick description by period, in 2000 chained dollars, data starts in 1966.

    1. From 1966 to 1982, it was flat, at around $20,000
    2. From 1982 to 1994, steady growth to the mid 40′s.
    3. From 1994 to 2002, it stayed in the mid 40′s.
    4. From 2002 to mid 2008 it grew quickly, but then leveled off, in the low 50′s.
    5. From mid 2008 to now it has spiked to nearly $70,000.


  10. middle world guy

    We’ll see in the next decade or two if our debt ratio is unsustainable. Forget what the GDP +/- is for this year or even the next. What really matters is the average GDP growth for the next 10-20 years. Using a rough rule-of-72 guide – if it’s real growth rate of 3-4% then we’re going to be ok. If its more like 1-2% we’re in serious trouble and we’ll take a tremendous hit, manifested through some sort of massive default or hyperinflation.

    We’re already digging ourselves into a hole by the nearly complete absence of new private credit in the past year or so. It’s kind of like missing a year’s harvest because you were unable to plant any crops. Did the government step in and plug the hole with timely and savy public investment? We’ll see, but the reality is the government was too busy allocating capital to zombie banks to really focus on real growth going forward.

    Predicting the future is almost always wrong because we fail to take into account the unexpected that ends up throwing the entire prediction off. This is a good thing because we tend to accentuate the negative, based on our present reality. Maybe in ten years we’ll scratch our heads as to why we couldn’t see the “next big thing” that propelled us to a new prosperity. But what if we start making choices that don’t jive with economic growth? For example, the internet is largely de-monetizing. It is becoming a graveyard for would-be companies trying to base a business model off of it. Just ask any media company. Similary, perhaps citizens will start moving into smaller, simpler homes devastating entire industries built around this type of conspicuous consumption. Maybe our society will start trading off economic growth for other quality-of-life considerations. That may be ok, but we have a big bill to pay. What happens to that big bill if we are unwilling or unable to pay?

  11. @CoffeeBoy

    While talking about externalities, here’s a conundrum for market purists:

    How do we handle the problems caused by currency export? For example, Dollarization. If dollars are sucked out of the US economy by foreign economies (who are effectively buying our currency in order to run their own transaction economy with dollars as a basis), this effectively increases the value of the dollar in terms of its impact on the real economy – harming physical US exports and encouraging the shift into a financial-services economy.

    This trend can become self-reinforcing – there is no manufacturer that is capable of “waiting out” a 20-year dollarization trend, and by the time the trend reverses the “hollowing out” process has already finished gutting the economy.

    Do we simply let these 20+ year cycles come and go, or do we actively manage currencies so they do not cause distortions in the real economy?

    I wonder what the IMF position was on this problem before the crisis began? (Did they even recognize it as a problem?)

    Let me also place this in the context of Baseline’s anti-Too-Big position: the crippling anti-competitive influence of the too-strong dollar was a major factor in strengthening the political influence of the banking industry on two fronts. First, killing off competing industries that had trouble in a “market economy” (that was distorted by unnatural currency disparities). Second, the sheer strength of the dollar – combined with the ability of banks to create their own money by leveraging against capital – further swelled the influence and profits of banks.

    While the IMF is terrified of democratic governments printing money, it seems utterly ironic that the democratic governments did not debase the currency by “voting themselves” richer.

    Rather, it was the banks that debased the currency.

    How does a market-purist approach address this challenge?

  12. “Because for 3 decades, the neoliberal/fascist money-worshipers have let the PRODUCTIVE PHYSICAL ECONOMY rot away in order to invest in worthless paper financial assets and create the largest debt bubble in history.”

    Hear, Hear!

    I own a factory, producing stuff out of steel for the last 25 years, working hard on production and marketing, creating products and selling them at a competitive price.

    At the same time I’ve seen the stock market go beserk three times: in the 80′s, the internet bubble and now the financial bubble. I’ve seen these pinstripe suited financial honchos driving their Porsches and Ferrari’s becoming the contemporary idols (American Psycho! where a poche business card and utter greed is more important than a good product and good people management.

    This devils network has to be exterminated from the roots up.

    Banks should be forced to go back to where they belong: serving the community and industry. But as I’ve said before, only a REVOLUTION could make this work, not these soft half working measurements.

    “Change, Yes we Can!” But, can we??

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  14. “Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves.”
    – Andrew Jackson
    (1767-1845) 7th US President

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  16. middle world guy

    Now there’s something to make David Ricardo’s head spin. What happens when one country’s competitive advantage is the actual means of exchange? Yikes!

  17. Interesting point. I’d not heard of the “currency theory” of a maturing economy before. I previously assumed that we were on an economic development path that was quite linear and that we were about 50 years behind the UK as we went from an agricultural, to industrial, to service economy. I think I just assumed that this was the given trajectory, and my grandchildren could kiss goodbye a stable manufacturing sector.

    It seems logical that currency overvaluation was the immediate cause of the “killing” of the rest of our sectors, but I don’t know that it benefitted the financial sector over other services. In fact, I would contend that the only sectors which were hurt by it were those that relied on unskilled labor. Mining, lumber, and other “primary resource” sectors are more beholden to the actual natural resources we have than the cost of labor. Skilled manufacturing jobs, (with employers such as Boeing, etc.), will stay in a strong currency economy because of the educational premium that our workers command over mexico. Higher up the chain, real economy jobs such as the production/design of pharmaceuticals, microchips, and other technology products are all still thriving within the US. Once the production process has been “commoditzed” and can be shipped overseas, then the jobs will leave, but the majority of the process is still dependent on a skilled workforce. Intel still designs its chips in silicon valley, and rest assured they are produced in Korea and not Mexico or Somalia. In fact, the only major “real economy” industry which has fallen victim to labor cost disadvantages has been our domestic auto industry. (I may be missing a few, but this is off the top of my head). BUT, hear again, I would argue that this has other causes outside of a strong dollar. One has only to look at the number of plants Toyota and Nissan and Honda have built within the US to see that even auto manufacturing commands enough of a “skill premium” to stay within the US. The problems of our Big 3 have more to do with underfunded liabilities which were foolished promised 30 years ago than a strong currency. Also remember, the Germans and Japanese have well functioning domestic auto manufacturing going on within their borders, and I would argue it has more to do with superior engineering than labor cost competitiveness.

    On the flip side of the coin, I don’t see how the banking sector in particular has been the major beneficiary of “flight” of low cost labor jobs: I think all services and white collar jobs in general have benefitted. Finance aside, one has only to look at global supply chains to see what I mean. R&D, design, and engineering are all still done in the US (at least for US based multinationals). Some production is still based in the US. Only once a process has been streamlined enough to be “unskilled” does it get shipped offshore.

    I agree that we need to tilt our economy more in favor of “real economy” industries and away from finance, but I don’t know that we can tilt it back towards blue-collar vs. white-collar work. Skilled labor still commands a premium, and the economy with the best universities is most likely to benefit. The only reason we would have to worry is if our children can’t compete for skilled jobs. Even anecdotes about chinese and indian engineers stealing jobs from the US, anyone within the tech sector knows that even within the “white-collar” space, innovation and design is still primarily done in the US, and the “commoditized” white-collar work is done offshore.

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  19. middle world guy

    Our advantage on education over the past many decades (and therefore our advantage at keeping the best jobs) is based on education economies of scales not possible in Japan, Germany and other comparable countries. We acheived this scale due to the massive size of our middle class.

    The destruction of “blue-collar jobs” hurts the next generation of education. As the middle class shrinks, the base of quality public school systems and universities will shrink. An economy that once produced 10,000 new electrical engineers may only produce half that in the future. That kind of change may be the tipping point for intel to decide between a new plant in the U.S. or India.

  20. Wait, Simon Johnson is one of the only people “qualified to teach [political economy] today?” Oh please.

    This is a man who, despite having never worked in finance or the federal government, is absolutely convinced that there’s a “financial oligarchy” that has captured US regulators. This is also a man who constantly asserts, apparently without irony, that the financial crisis is the result of this regulatory capture by Wall Street — even though the financial crisis went from bad to ungodly, epically horrific when the Treasury and the Fed REFUSED to bail out one of largest investment banks in the world. (Apparently refusing to bail out Lehman doesn’t count as “standing up to the bankers.”)

    Simon Johnson has one wildly speculative theory about political economy — that doesn’t make him a top expert on the subject. It has, however, made him a hero to the blogosphere and the chattering class. But to the people who actually understand the nitty gritty of how the US financial system works, it’s made him a laughingstock.

  21. Isn’t it still nationalize, reregulate, stimulate, like Krugman has been saying all along? Restoring the bankruptcy laws to something reasonable (cramdown!) is also probably going to be necessary.

    So does Krugman take Summer’s job, despite all protestations? And what are we going to do about the Senate, which will fight every step of the way?

  22. Bill Bradbrooke

    Excellent post, StatsGuy. Our money supply continues to grow. Accordingly, it’s more important to manage velocity than to over-stimulate it. Our financial system must be protected from excesses of velocity which is best done (I agree) by limiting leverage and use of instruments that extend leverage.

    Here’s a good article from the Economist about Germany and the hazards of too many small, government-owned and subsidized banks:

    The gist is there are too many banks in Germany. Many are owned and are subsidized by the state. They have used cheap capital to purchase toxic assets, estimated earlier this month to total around $1.1 trillion (presumably at cost.) Now these institutions and local governments are resisting consolidation.

    In other words, fiat power has been used to direct capital to a myriad of independent, state-owned banks that are now in trouble due to a concentration of blighted securities in their portfolios. Ironically, the solution posed by the IMF: consolidate & resolve. Clearly, many small banks can go as far astray as few large banks.

    We cannot solve tomorrow’s problems today. We have to go a step at a time. Looking back it’s chilling to think what might have happened if Paulson had used TARP money to, in fact, purchase toxic assets last October [put a metric on those assets as they were moved off bank balance sheets] or declared a “conservatorship” for Merrill or Wachovia? How prepared were we then to bite the bullet, nationalize weak banks, break up big banks, recapitalize the remainder and move on?

    How prepared are we today? We’re closer. There’s a dry-run being taken at a “negotiated bankruptcy” in the autos. It isn’t pretty but it’s being staged in an industry long ago sidelined. We have a mortgage reform bill, which is a start, and some evidence that going slowly is the right course. Private capital has been raised and quickly! Again, looking back, what if the stress tests had been “real” ? [Everyone knows the stress tests were phony - one hand of the oligarchy passing taxpayer dollars to the other.] How much private capital would have been raised if all 19 institutions were shown to be deeply undercapitalized? By the way, who do taxpayers have to thank for this? Tim Geithner.

  23. Nick–

    I would not call Simon Johnson’s ideas wildly speculative. And I know for a fact that among at least some of the people who have a very good understanding of how the US financial system works he is the furthest thing from a laughingstock.

    Bluntly, the politics got put back into political economics last fall, when the U.S. financial systems, by most traditional metrics, failed. They exist today only because of extraordinary government actions taken to underpin them. Slowly but surely the political caste and chattering classes are losing their confidence in that financial elite whom you object to calling “oligarchs” (I can understand your objection, the term drips implicit contempt for various facets of the status quo in a way that would be offensive to one who believes one must have worked either for the federal government or the private sector to be an expert in the field, though I find it amusing and provocative rather than ‘wildly speculative’).

    It is worth thinking about how this all plays out. That’s all Simon Johnson is trying to do. The answers don’t lie in traditional expertise. I’m not sure where they are found. But it’s worth looking around.

  24. Nick,
    I would be careful with your words and assertions against Prof. Johnson.
    First, what Simon has put together builds on works by Milovan Jilas and C Wright Mills to name but a few, given their tracts were published more than 50 years ago, its surprising how little has change. At Uni. reading politics and history, we had to do a special course of political economists, much of the work appearing in most undergraduate sociology texts books on bureaucracy and oligarchic structures. now, this may all seem a little ‘left wing’ or too socialist for many sensitive souls in the States, the fact remains, and here’s the, that what Simon is saying is certainly not the views of a conspiracy theorist, rather, as Spitzer points out in his article, you had a self reinforcing circle of individuals running US monetary policy without oversight and none of them elected officials. Now, if this is not by a clear use of the term ‘an oligarchic structure’, then perhaps its time to return back to college. you can pick up a lot of this also in the economic works of Marx.
    Now, before I get attacked for being a ‘commie’, do a little further research and I suggest, read C Wrights Mill’s exposition the ‘Power Elite’, a number of the names published in that book more than 50 years ago are still part of the ‘Power Elite’, this being an oligarchy. What Simon has revised is the fact that powerful forces within Wall Street have become an oligarchy in themselves and seized control, if this is the correct use of the word, economic control in the USA – which under the constitution resides with the treasury alone.
    now, please look at the names giving President Obama financial/economic advice. Isn’t it amazing how many of those names are linked with Goldman Sachs. This is not a new phenomonon though, for if you look at the financial oligarchy surrounding both the Coolidge and Hoover administrations, JP Morgan and a handful of other powerful bankers names crop up continually, now go and look at the Wall Street Crash and Financial Meltdown of September last year – do you see any similarities? Now that is what you call powerful oligarchies, the very thing the IMF tries to eradicate when it goes in to help emerging economies get out of a mire.
    Sorry for being a pendant but one has a Masters in US Federalism, so its nice to see it comes in handy on the odd occasion.

  25. Some specific points:

    Toyota/Honda largely keep plants in the US to moderate US anti-import sentiment. They learned this after Reagan/Bush, and SII (Structural Impediments Intiative). Moreover, this strategy worked for the Japanese manufacturers. Much of the rejection of US automakers and acceptance of Japanese presence has been because Japanese cars are “substantially” assembled in the US, often with US parts, and employing US workers (with better job security, in some cases, than is offered by US firms). Quite possibly, those cars could have been assembled less expensively elsewhere, but with a steep political cost.

    With regard to Intel, it keeps its plants in higher cost areas because labor is relatively inexpensive compared to the vast capital costs of plants. The primary considerations in siting an Intel plant include such things as property rights security, clean water infrastructure, stable/high quality electricity supply, distribution network, cost of land… and productive labor.

    “Only once a process has been streamlined enough to be “unskilled” does it get shipped offshore.”

    This was true 5-10 years ago, it is no longer completely true.

    More generally, I am not arguing that Dollarization was the sole cause of the hollowing out of the US economy, but that it was a contributing factor. And the financial sector, in particular, benefited heavily from it at the expense of other sectors (the brain drain being one particularly deleterious example) – yet “innovations” in the financial sector do not seem to deliver major improvements in human productivity, national political/economic/military power, and general quality of life.

    So, in addition to all the other challenges free markets face – externalties, informatin asymmetry, transaction costs, etc. – let’s add enduring currency distortions resulting from prima facie foreign demand for domestic currency/debt (either as a store of wealth, or a unit of exchange).

    As a general rule, real-world businesses that go 2-3 years without a profit do not survive; a 20 years “temporary phenomenon” is an eternity for businesses (and people).

  26. Gordon Brown was always a straight talker and we could all do with a little bit more of that:


  27. Nick,
    Who in YOUR opinion is qualified to teach a course on the political economy? Geogre W. Bush, Dick Cheney, Hank Paulson, Karl Rove, Phil Grahm, Art Laffer or John Thian (McCain’s proported pick for Secretary of the Treasury? Or how about Chris Dodd or Barney Frank? They certainly have the experience of overseeing the financial industry you find to be so desperately needed? Go back to your little green footballs site where you belong.

  28. The white elephant in the living room that no one wants to talk about is the $56 trillion fiscal exposure (75 year horizon) of the Social Security and Medicare trust funds. In the final installment of President Obama’s FY2010 budget (OMB, 5/11/09), he proposes spending $1,148 billion on Social Security and Medicare in FY2010 (see Table S-3, p. 6). As Pete Peterson will tell you, it is this $56 trillion fiscal exposure that will bankrupt the United States.

    My suggestion for “something” would be to first gift the federal government’s common shares (including voting rights) in the troubled banks to the American People, and then contribute them to the Social Security and Medicare trust funds on their behalf. Like David Swensen’s “equity-oriented” Yale Endowment Fund and taking advantage of what Albert Einstein called the more powerful force in the universe (compound interest), capital appreciation and common stock dividends over a 75-year horizon would go a long way towards curing the $56 trillion fiscal exposure of the federal entitlement trust funds.

    Another suggestion to would be for the federal entitlement trust funds to invest in the AAA-rated, TALF asset-backed securities (which with leverage from the Fed could have returns of up to 20%). Wow! So not only would these ABSs throw off massive amounts of interest income to finance Social Security & Medicare disbursements, but their investment by the federal entitlement trust funds would create such a monster demand that it will certainly restart the ABS markets of the shadow banking system.

  29. Returning to my first suggestion above, to “fix the financial system” I would have created ultra-clean new banks with tabula rasa (zero legacy) loan portfolios under the resolution authority of “prompt corrective action” by putting the entire loan portfolio (legacy & toxic) of troubled old banks into conservatorship for orderly liquidation (sort of like runoff mode for insurance companies). (The ultra-clean new banks would own the operating assets of the troubled old banks.)

    Why the *entire* loan portfolio? First, the FDIC would not need to go through the labor-intensive determination of going through a bank’s portfolio loan by loan to see which now-performing loan could become toxic. Second, under the watchful eye and heavy hand of bank regulators, equity investment in “virgin” ultra-clean new banks would be safe and suitable for the federal entitlement funds. Third, an ultra-clean bank with a tabula rasa portfolio means that it would have no excuse not to lend to creditworthy borrowers (Blanchard’s chart 12 on credit standards). Under the Fed’s 10% reserve ratio a $100 billion capitalization could have created $1 trillion in fresh lending capacity overnight! Fourth, bank profits from spread income due to the Fed’s near-zero QE interest environment and zero exposure to credit bubble-vintage legacy loans would have provided *lush* common stock dividends for the federal entitlement trust funds.

    Thus just like killing two birds with one stone, for the same issuance of federal debt, President Obama could have recapitalized the banks and cured the $56 trillion fiscal exposure of the Social Security and Medicare funds. In fact, because it would avoid touching the third rail of committing political suicide by raising taxes and/or cutting benefits, Congress should have been more the eager to fund the trillions necessary to give the finance system a “fresh start” recapitalization.

    Also note that a semi-permanent, passive, diffused ownership stake by the American people (including voting rights) solves the nationalization issue of corporate control, and the problem of exit policy (Blanchard’s chart 14).

    Unfortunately the second suggestion of ultra-clean new banks is now foreclosed by Geithner’s stress test. However two things that could derail it are:
    1) the horizon of the stress test was to the end of 2010 [1]. This means that it completely ignored the pay-option ARM default wave, which assuming a 12 month delay from rescheduled resets (whose negative amortization ceilings are now slowed by ultra-low interest rates) will not peak until summer 2012 [2] [3].
    2) political outrage over the Private-Public Investment Partnership (PPIP) where the FDIC could be abused as a toxic waste dump to dispose of now performing (and thus high priced) but later to toxic pay-option ARMs and their RMBS and CMO derivatives [4 [5]. In fact maybe PPIP may not be needed since the 19 banks passed their stress tests relatively unscathed!

    In closing, apologies to Simon and James for repeating my “pet policy” solution but I did so because it addresses all of Blanchard’s concerns. Nevertheless, the federal government’s common stock shares in say, CitiGroup and Bank of American can still be gifted to the American people and then contributed to the Social Security & Medicare trust funds on their behalf; and these federal entitlement trust funds can still invest in AAA-rated TALF asset-backed securities, which would have the salutary benefit of creating monster demand thereby restarting the ABS markets of the shadow banking system.

    The missed opportunity though is that like killing two birds with one stone, the same issuance of now low-interest federal debt could have been used to fix the US financial system and the $56 trillion fiscal exposure of the US federal entitlement trust funds–thereby providing relief for the federal budget. Why so much silo thinking by Geithner, Summers & Co.? All this to save the unsecured creditors of troubled banks?

    [1] See footnote 7 on page 8 of the Fed’s “Supervisory Capital Assessment Program: Overview of Results” (May 7, 2009). My guess is that the Fed DID NOT COUNT the 2011 and 2012 pay-option ARM resets in its stress tests. Like being in the eye of a hurricane, 2009 and early 2010 will be a quiescent period for residential real estate defaults.
    [2] Gopalm, Prashant, “Good News: Option ARM Resets Delayed,” Business Week, April 16, 2009 (see chart for reset schedule).
    [3] “A Second Mortgage Disaster On The Horizon? New Wave Of Mortgage Rate Adjustments Could Force More Homeowners To Default,” CBS 60 Minutes [video], December 14, 2008.
    [4] Christie, Rebecca, “FDIC May Let Investors Buy Toxic Assets Without Treasury Stake,” Bloomberg, April 30, 2009.
    [5] “The Greatest Boondoggle in History: Banks Buoyed at Taxpayers’ Expense,” Yahoo! Finance Tech Ticker [video], Posted May 08, 2009 (“While much of the focus is on the stress tests and banks’ efforts to raise cash, the real story is Geithner’s Public-Private Investment Program (PPIP), says William Black, an Associate Professor of Economics and Law at the University of Missouri-Kansas City. The PPIP is the “greatest boondoggle in the history of the world,” says Black, a former bank regulator who was counsel to the Federal Home Loan Bank Board during the S&L crisis. As occurred during the S&L era, Black says the PPIP will allow banks to exchange “trash for cash” and turn “real losses into faulty gains.” If the goal of Tim Geithner and other regulators was “to rip off the American taxpayer for the benefit of the least-deserving wealthiest people you can imagine, well–mission accomplished,” Black says.”)

  30. that’s kind of it, but the dollar wouldn’t be a competitive means of exchange without the backing of the us government which is in turn backed by the ability of the government to tax its citizens.

    dollars carry implicit insurance in that respect — the insurance is the competitive advantage.

    of course that has a problem — because of this the currency gets overvalued, which creates a lot of distortions, which has the potential of causing the currency to become less valuable.

  31. Coffee Boy

    Actually all of those. Regardless of your opinion on how they conducted their jobs within the public spotlight (as prominent politicians, civil servants, and businesspeople), they have much more of a firsthand knowledge about the demands of balancing politics and economics than any sideline pundit ever will. Prof. Johnson obviously is not a “sidelined pundit” having been chief economist at the IMF, but my point is that you don’t have to agree with someone’s politics for them to make a good professor. I would love to attend a course taught by every single one of the people you mentioned above. I may not agree with all their views, but I will always appreciate that their opinions are battle-tested, and taht they had a job that involved “being involved.” There are too many people whose job is glorified punditry…say what you want about the financial elite and financial oligarchy…they are still adding a LOT more value than the talking heads on CNBC.

  32. CANADA is a modern country that has reduced both the total debt and % of GDP Coffee Boy

    It takes a bunch of things for that to happen though. As best as I can tell the top 3 are:

    1) You need moderately high taxes (empirically speaking lower taxes = more spending since there is no “cost”, politicians compete on who can give the most away)

    2) You need a moderate liberal government to hold power for a long time. See point 1 and what has happened in Canada (and of course the US) when “conservative” politicians take power and cut taxes.

    3) You need meaningful economic activity and a moderate amount of income inequity (too much and you get South America, too little and you get the USSR).

  33. I’m a lifelong Democrat, thanks. I didn’t say “overseeing the financial industry” was a prerequisite to being one of the top political economy experts. But if you’re going to constantly go on TV and write op-eds claiming that the US financial sector is an “oligarchy” that has captured the federal regulators, then you should at least have SOME experience in EITHER finance or the federal government.

    Johnson has absolutely no idea how the interactions between the banks and the regulators actually play out. He’s a career academic. (And chief economist at the IMF is an extremely academic position, not to mention that there were a total of zero emerging market financial crises during Johnson’s tenure at the IMF.) If this was a debate about Euler equations, then Johnson’s opinion would carry some weight. But it’s not. When it comes to financial markets, Johnson clearly has no idea what he’s talking about (did he just learn what CDS were last year or something?). And that’s why everyone else I know in finance thinks Johnson is a joke.

  34. Hoi Polloi

    “And that’s why everyone else I know in finance thinks Johnson is a joke.”

    O Reilly? Ad hominem attacks don’t make your arguments any better. Everyone else in the finance industry would love to keep the status quo. Sit out the crisis and continue like it was as soon as the situation improves and the tax payers have paid for all them bankster losses. Never kill the chicken with the golden eggs.

  35. In the September 2006 issue of The Atlantic Clive Crook wrote an article titled The Height of Inequality. The disparity of wealth in the US is incredible. Ian Dew-Becker and Robert Gordon of Northwestern University observe that, “Between 1966 and 2001, median wage and salary income increased by just 11 percent, after inflation. Income at the 90th percentile …increased nearly six times as much –by 58 percent. At the 99th percentile…the rise was 121 percent. At the 99.9th percentile…it was 236 percent. And at the 99.99th percentile…the rise was 617 percent.” I understand that this vast wealth is owned by about 15 percent of the US population while about 85% of our population owns only about 15 percent of the wealth. With about 70 percent of our economy driven by consumer spending (the 85% who oly possess about 15 percent of the wealth), how can we reamain a viable nation or are we doomed to slip into being a third world like country? I already feel a bit like a serf!

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  37. Nick-
    Please explain to us, then, how the nitty gritty works. Please don’t tell me it’s too complicated for me to understand, since I’m one of those people who are paying for the nitty gritty. Because the nitty gritty of the US financial system, not to get too nitty about it, seems to have gotten kind of gritty.

  38. GotLife Too

    Not convinced that the Canadian government moderate Liberal policies are the beneficent source of Canadian wealth. Can’t a case be made for Canada’s abundant natural resources (minerals, energy, water) that are sold in abundance to its NAFTA trading partner? How about the benefit of a small population with a productive agriculture? Aren’t Canada’s immigration policies sound and economically beneficial as well?

    Canada is similar in size to California. The disastrous California property tax policies and uncontrolled immigration have lead to inflated home prices and extreme bias toward leveraging up through residential real estate. The current California burst bubble will only lead to a new bubble with low mortgage rates and no correction to property taxes or immigration growth. Unfortunately, the US considers no other avenue other than to copy the California mystique (which by the way ended ten years ago.)

    Finally, you should have added to your comment …”when ‘conservative’ politicians take power and cut taxes.”… WITHOUT correspondingly cutting spending, controlling costs and reducing debt. Minus these steps, you are only a half of a conservative and what “party” is that? Moderate, moderate liberal, liberal conservative? How about “out of power?”

  39. GotLife Too

    US politicians learned they never have to actually pay for a program, merely the interest on the debt it incurs. Furthermore, foreign governments will line up to purchase T Bills in exchange for the currency excesses they incur through trade since these countries have few other options for their reserves. And, if these US politicians get in trouble, they merely need to turn on the printing presses to repeat this cycle. Is there even a bigger bubble on the horizon or does the world truly not have an option?

  40. Re S.Johnson’s about “. . .Summers the next Brown”.

    His comment “Remember that the IMF is the custodian of the official consensus on the
    global macroeconomy and financial system”. If the IMF is that big/powerful/interconnected, why isn’t it considered “too big to fail” in Johnson’s argument to bust up the same?

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