I’m continually amazed by how easy it is for government officials to hoodwink most of the news media. All it takes is for a couple of leading finance ministers to get on roughly the same page, and we’re reading/hearing about “substantial progress” or “major steps forward.” If someone provides an articulate background briefing to a leading newspaper on the supposed debate within a group of countries, this becomes the dominant news story.
Saturday’s G20 meeting of finance ministers and central bank governors is a leading example. It was a disaster – we face what officials readily concede is the biggest financial and economic crisis since the 1930s, yet this conclave agreed precisely nothing that will make any difference. If the G20 heads of government summit on April 2nd is a similar failure, we will be staring at the real possibility of a global catastrophe. Yet the spinning storytellers of the G7 have still managed to get much of the press peering in entirely the wrong direction.
For more on what would the right direction, take a look at my piece in Britain’s Sunday Telegraph.
The Baseline Scenario 
Somewhere I read that Israeli-Palestinian negotiations are conducted in three languages: Hebrew, Arabic, and Bullshit. I don’t know how many languages these G20 meetings are conducted in, but I’m pretty sure one of them is Bullshit.
So, Simon, is it fair to characterize the response of American and European finance ministers and central bankers as bluffing? Dribble in money where possible, talk up the banks as “sound” and hope some collective Borg-like market will buy it?
Is that the way our officials are dealing with “too big to fail” and “too big to succeed”?
US, China and Japan have all in agreed to increase government spending to pick up the slack. These 3 are the top 3 economy of the world and accounts for ~50% of the global economy. Many smaller economies are also on board.
There are some signs of hope.
I used to post this saying in my office for the staff, “don’t sit around waiting for something good to happen”
Thats what is now happening.
When bad news hits, they duck, peek out and say, still alive, resume waiting.
I’ve just heard the following podcast. It is an interview of Prof Calomiris of Columbia University.
[audio src="http://media.bloomberg.com/bb/avfile/Economics/On_Economy/v2rHC6K9VSwk.mp3" /]
I find his views very compelling. What do other folks think?
On a side note, I really enjoyed bloomberg’s podcasts. I’ve learned a lot.
http://www.bloomberg.com/tvradio/podcast/
I think most economists, policy makers and politicians are a bunch of liars.
The US economy is a Ponzi scheme anyway. Our GDP is inflated by 20 to 30%.
The only way to go forward is to:
1. Let the banks fail, and then nationalize them. It would wipe out the shareholders, bondholders will loose big time. However, the public and depositors will be protected under FDIC
2. Prosecute the top bank executives, ratings agencies
3. Government finally takes over the currency
4. There is no need for world-regulation. Simply require money managers to have 100% of their income in the fund they manage. Violators will fact strict penalties. This is their version of the hippocratic oath.
5. Economy is built by entrepreneurs not bankers. Allow for public banks that can compete with private banks. Only public banks are guaranteed public money. Their role would be allow growth of entrepreneurs. If the government can foster the growth of research universities, they can similarly foster entrepreneurship.
Private banks will be highly regulated.
Sounds good in theory. But have you considered what destroying bondholders et al will have on individual retirement provisions, and on idividual reserves for school fees etc. Might be worth deternmining the impact of such action before embarking on same?
Deciding to bell this cat is the easy part. But the collateral damage could cause catastrophic grief to many people who did not cause the problem.
How about refining your solution?
Sorry folk, last post related to ‘Incredible’ reply.
It seems that fix plans of G8,G20, and Obamaites aim to recreate the financial machines with unchanged management and playing rules, which caused this mess.
I suggest we need to separate US$ domestic and international reserve currency functions. This can be progressively done starting with foreign purchases of US debt backing bond issues to be denominated in currency choice of investor. Immediately Chinese investors can have their investments insulated from US$ inflation as the Chinese currency borrowings remains constant value.
This will encourage nations to not inflate liabilities away.
The next step would be to create a global currency (shades of latin for medical matters?) and have all trades denominated in the unit. Banks would not be able to manipulate currency exchange rates and fees as we all use one currency rate. External reserves probably held in this denomination. No more complicated than UK using Euro and pound.
I can expand on this if anyone is interested but I am sure readers can provide necessary details.
re: “spinning storytellers” and “anything that sounds meaningless is meaningless”
“….How do [“we”?] [“break”?] this power and move resources into [“something”?] [“more productive”?] and less inherently unstable? How do [“we”?] deal with the failures of risk management, CEO leadership, and corporate governance in [“our”?] still massive banks? Can [“we”?] break [“them”?] up before [“they”?] break [“our”?] economies?…”
“…The real agenda of the G20 should be [“helping”] save Europe from itself, for example by encouraging the creation of a €2-trillion European emergency economic stabilisation fund, funded primarily by richer Eurozone countries…”
~~~~~~~~
how are you, or the g20 going to force Europe to cough up 2 trillion? and whether or not Simon Johnson is the proposed manager of said fund – might it be some sort of temporary subsidiary of the IMF or a new entity staffed at what cost? – after administrative expenses, how would you allocate the remaining loot (how did you arrive at 2 trillion?) into “something more productive” and “less inherently unstable”? who pays for the damage if you fail? surely you’ve thought through the risks associated with your proposal.
perhaps you were simply in a rush when you penned the piece for the telegraph’s spin machine and can provide a link to a paper that fleshes out the substance of your argument and details of your recommendation in a transparent fashion.
“Government finally takes over the currency”
and puts the economists, policy makers and politicians in charge
The Professor is absolutely correct in identifying a lot of the problems, though I would add the massive contractions in East Asia and the worldwide debt load. (It would have been nice to see just a bit more emphasis on global monetary policy coordination in the Telegraph article, but it was a brave article. I can only imagine how many enemies he is accumulating.)
What I don’t get is this – EVERYTHING the US proposes is designed to (temporarily) restore growth without a currency adjustment and without printing money.
Fund the IMF without adjusting currencies? Why? So countries can impose fiscal austerity to repay debt and thereby stimulate the economy?
And the Europeans are even worse. Lower Eastern European wages/spending by 20%-30%? How did Merkel’s cronies think of this one? Perhaps they Googled “Recipe for Deflation”?
Two weeks ago, I predicted the G20 would come out with empty promises to cooperate, and zero details.
The US, for its part, needs to focus more on monetary policy (particularly creating money by itself rather than pleading with banks to create money by lending). Nor will the US need to print a ton – just enough to show that it is willing and committed to reflating the currency; that demonstration of commitment should by itself scare the hedge fund cash out of the mattresses and begin reflating assets, which will then restart lending.
Furthermore, it has a positive contagion effect on monetary policy in other countries – Japan, China, and even the EU.
What we are observing here is either monumental idiocy, or something deeper and more pernicious.
Perhaps we are observing a battle between EU and US over who gets to be the world’s reserve currency? (A game of chicken – the first to flinch by printing money loses, so it’s a question of which economy can absorb more pain to prove it has more idiocy amongst its policymakers).
A bit ago, I said the next event of note was the G20, but even while international events have gotten worse, domestic policy has slowly seen some improvement.
Next up: Do we get any real action (or detailed pledges) from Bernanke and his team this Wednesday? Or just an empty Fed policy statement? I predict the latter.
Points 2, 3, 4, and 5 are great. I doubt you could enforce 4, but it’s pleasant to think about.
Point 1 would have some… er, negative externalities. As Fred suggests, perhaps you could refine this a bit?
As to point 2, Congress has the power to subpeona records. It could, if it wanted, investigate records from the ratings agencies to see if anyone actually realized the _real_ risk involved in the AAA CDOs. There are a lot of smart statisticians in there. I would hope someone in my profession would have understood the faulty assumptions in the models being pushed by the investment bankers.
And if so, did the ratings agencies ignore them?
Unless there’s a whistleblower, it’s unlikely they’ll find this evidence (even if it wasn’t already destroyed).
Maybe they should have spent the weekend reading (or hopefully re-reading) Der Untertan (http://en.wikipedia.org/wiki/Der_Untertan). Then they can hold a quizz to find out which of them is the new Hessling.
I’d like to follow up on the question of the statistical modeling. Is there much (or any) evidence that models like Black Scholes actually explain/predict financial data? Or is it just a matter of, say, fitting a regression model to scads of data and then assuming that future data will follow it?
The point I’m trying to get at is that it’s easy to write down any number of mathematical models, but it takes discipline to assess whether they are appropriate for the system under consideration.
StatsGuy, that is a pretty good idea! Let’s print some money and scare’em hedge funds. While we are at it let’s scare those Europeans, Arabs and Asians investors too. That’ll teach’em for thinking so foolishly that the US is the safest place to invest their money. Yeah, they’ll flee with theirs tails between them legs! Who need them foreigners to bid up our precious assets! We much prefer an asset collapse and another great depression!! We’ll show them how we roll. Yee Haw!
Brown finds two insurmountable problems at G20
I can’t hope to fully reply to that question here. So, some quick points:
1) Prediction and Explanation are two different things.
So long as the world is relatively stable and we have good data, we can often predict. Explanation requires that the assumptions underlying the model are true. If the assumptions are true, we can test a hypothesis (or estimate a posterior distribution if you’re a Bayesian).
Sadly, it’s very hard to _know_ if the assumptions are true. We might have left a variable out of the model (creating spurious correlation), or have reverse causation (for example, rational expectations causing a dependent variable to anticipate changes in an independent variable), or one of many other issues.
Thus, modeling can never replace common sense.
2) Statistical models are merely fancy ways of fitting conceptual ideas of how the world _might_ work to data in a manner that makes the most efficient use of that data.
3) Correlation is not necessarily causation. (see point 1, for instance).
4) Predictive financial models have a decent _short term_ track record; that is, they’ve been able to outpredict people, such that several hedge funds were run by computer models. So long as the world doesn’t change too much, the models can tell us how predictive they are (how well they fit past data). Those models, which were doing pretty well for 5 or so years, got killed when the financial crisis hit. Why? The world had changed. The data the models had “learned” from was no longer valid.
5) All models – every last one – is incomplete. They assume everything not included in the model is held constant (even if they get the precise causal mechanism right and select the right functional form for the relationship).
The question with models is whether they are mostly right – or, frankly, right enough to at least be somewhat useful.
I doubt that was helpful, sorry.
Hayman Capital: The Failure of the 38-Year Experiment
from Option ARMageddon by RolfeWinkler
Hayman Capital has made some incredibly shrewd investments capitalizing on the implosion of the economy. Its Master Fund claims a 340% return since inception in 2006. Here is a pdf of their latest investor letter (hat tip AKS via Zero Hedge). It has lots of data/charts and addresses the crisis very comprehensively from an investor’s point of view.
It’s Sunday’s must read. Here’s an excerpt:
Once you have a deep understanding of how the U.S. and world banking systems work, it gives you a sense of how bad things really are and may become.
http://optionarmageddon.ml-implode.com/2009/03/15/hayman-capital-the-failure-of-the-38-year-experiment/
Joe
Read this blog:
http://blogsandwikis.bentley.edu/themoneyillusion/?p=573
If this blog is right, and I do think it is, StatsGuy is not kidding – we wont have to print much. It is a question of expectations, and Bernanke can change them – if he wishes. Right now he is a deflationist. The Taylor rule says that interest rates now should be at minus six percent. Lets get them there.
It is not a question of collapsing the dollar – we can avoid that. It is a question of restoring positing, upward looking, future price expectations – which Bernankle can do just by saying that he is committed. Its that simple.
That actually is quite helpful. Do you happen to have a link/reference that might be a good introduction to practical financial modeling? (A mathematical intro is not a problem.) I’ve never looked into these models, but I’m kind of interested now that they’ve been having trouble. Thanks!
verybody….the g20 knows that it is out of thier hands…the chips,cards,shit will fall as it may…just relax and enjoy how things will unfold…i am more concerned about domestic issues….there’s work to be done
also,,would like to add that the gov’t has been following this sit for a long time now….they know how it works….once again just relax..go rent a movie..alien vs predator is a good one i just watched.
StatsGuy has a very superficial knowledge of economics. He never had any formal education in this subject. He spouts a lot of nonsense on this site. You can get a sense just by looking at some of his posting in this thread. Much of what he says is obviously wrong. Yet, he says with much conviction. He also has no sense of humility. He has declared everyone working on fixing this crisis are monumentally stupid. So much ignorance coming from a guy who doesn’t even understand econ 101.
If you can ignore the polemics, it’s a good read. There are some basic common sense points. My favorite:
“To be clear, we believe that the U.S. (and in fact, the world) is in an ongoing debt deflationary spiral that
will likely continue for some time (possibly years). The rampant printing of currencies around the globe
is not, in our opinion, likely to be immediately “inflationary” (in the common understanding of the term)
as leverage comes out of the private sector and asset values continue to decline. The greater concern is
the potential inflationary time bomb that grows as governments continue to borrow, print and
“stimulate.” What happens to inflation when the velocity of money goes from zero to 100?”
This is absolutely _THE CORE_ of the issue. We have a hugely levered society, and absolutely no control over the velocity of money. This means that your classic IS-LM models are totally defunct. The inability to control the “risk premium” that Charles Jones uses to make his model conform to reality(https://baselinescenario.com/2009/03/10/financial-crisis-macroeconomics-charles-jones/) means that the equilibrium point can change precisely as rapidly as the risk premium changes – and the model offers no insights on what could change the risk premium.
And since the risk premium is a matter of perception, events become self-fulfilling.
Unless the Fed manages to get ahead of the velocity issue, their efforts will only create more and more base money (and thus more _potential_ for inflation) while the world continues to deleverage and deflate. At some point, we will see a turn. All at once, investors will realize just how dangerous it is to hold onto cash, and rush out – and then we’ll see real inflation.
The Fed needs to control velocity. Unfortunately, the instrument they have clearly chosen right now is public relations. Witness the recent string of events:
1) Announcements of anticipated profits by big banks before quarterly reports
2) Obama talking up economy
3) Bernanke going on Sunday TV to talk about a recovery in 09
4) Aggressive moves on Mark-to-Market and the Uptick Rule (the former has a real impact, the latter is arguably just psychological)
As much as I don’t think this will work, I really hope it does.
I think we’d be better off, however, if Bernanke just flat out said, “Enough is enough, we’re funding the stimulus immediately as needed.”
The longer we delay, the worse it gets on every conceivable dimension.
Well, I’ve found StatsGuy’s posts to be useful. If you have a link/reference on practical financial modeling, I’d like to hear that as well.
stats guy really makes sense to me since i first found this site….his ferver is second to none which is respectable….to be quite honest,,,take alook at his theories….makes me want to be young again…the angela are watching.
all i am saying that you might have 6 phd’s in econ there is still the unexpected variable that has to be factored in……which makes econ theory….that unexpected variable is god….we all know this….but really keep talking it up,,,,especially you stats guy….this is what makes the usa the country for everyone else to chase from now to eternity…..IF we don’t royally f it up….come on mit,,,your the best,,,try to figure out that unexpected variable.
Simon,
In 1985 AT&T was broken up by anti-trust court action. Many new phone companies were the result, Competion increased,lower prices and in the 90s a massive effort at laying the fiber-optic network was made, The latter helped to create the availablity of broadband internet. Although the last administration fostered an FCC that undermined this multiplicity in the indurstry, as did the 1997 Telecom Act, the 1985 court order had a tremendous effect of diversifying the telecom industry for 25 years. What do you think the chances are of anti-trust action regarding the banks? The present crisis is a good reason for such action. It would be so much less risk if banks were taken back to being contained by state boundaries. This would keep them smaller, regulated by state and Federal regulators. It would keep the wealth dispersed around the courtry rather than so intensly concentrated in behometh corporations. Repealing banks back to state contol might have bi-partisan appeal and sure could address the oligarch issue.
god has you by the balls.
Has anyone sat in on a meeting with 20 people ? Nothing gets done. Now, think of that as 20 different nation-states, each with its own power bases. The best thing that can be said for the G20 is their selection of wines.
Regarding an international currency, why would the U.S. ever agree to that ? Wall Street only exists because of dollar hegemony.
StatsGuy, please dazzle us with your in depth technical knowledge? I can’t wait either!!
Hmm, maybe diving into Black–Scholes right away is too much for us to digest. Maybe you can start with showing us how to do a simple integral? I am sure simple freshman calculus is no problem for you right!? Once you lay the math foundation you’ll be able show us how to work the economic models with style! Yeah!
StatsGuy you’ve called Ben a monumental idiot so I am sure you know more. But you know Ben probably knows calculus. StatsGuy, I am sure you are not the monumental idiot!… Right?
Charlie, the challenge of running economic models are 2 folds. First, you need a level of mastery of technical knowledge. Second, you’ll need good data source. This is very important. Even if you have the technical skill, but without good data, you’ll just get “garbage in garbage out”.
To have high quality economic modeling results, you’ll need serious resource. Without quality there is little point to run the model in the first place. Certainly, you wouldn’t want to use low quality results to guide your investment. To be honest, I find doing my own modeling a hopeless endeavor.
Fortunately, the US gov and academia put a tremendeous resource into economic modeling. These are often free and you just need to dig it up. There are a lot of sources. I’ll just list a few here. Be warn, you’ll need to do a lot of dry reading. However, the information is all there and is all free (Internet rocks!).
http://www.cbo.gov/
http://www.federalreserve.gov/
http://www.imf.org/
The financial industry also put a lot of resource into modeling. Many do require you to be a customer before they’ll share their results.
First, put yourself in a foreign sovereign funds shoes. We scare them with inflation. How many sovereign funds will stick around to find out how far we’ll go? How much do we have to print to pay for our recovery if there is reduce demand for treasury from foreign banks? Do you notice a self enforcing feed back loop here? Print money -> less borrowing -> more printing of money -> even less borrowing and etc…
Second, it is probably fair to say the MAIN issue plaguing the market right now is investor confidence. Instead of the market place, what do you think will happen when foreign investor also loose confidence of the US? What do you think will happen to the world and the US than?
@ Charlie
For a quick overview intro, try:
Click to access overview.pdf
or
Click to access fmetrics.pdf
The field is Financial Econometrics.
joe,,,bingo
Life gets more interesting for the G20:
http://www.bloomberg.com/apps/news?pid=20601109&sid=af81EoUv7m24&refer=home
Go Brits. And who knew that Bernanke and Governor King were office-neighbors when they were lowly assistant Profs? Small world, eh? Maybe they can get a few beers together at John Harvard’s, and Bernanke will have an epiphany.
On the other side of the Channel from the UK, however, Spain is in quite the pickle:
http://krugman.blogs.nytimes.com/2009/03/14/spanish-doldrums/
Remember previous conversations about currency adjustment being a way to simultaneously renegotiate tens of millions of contracts without having to spend 20 years in court?
Well, Spain is becoming a poster child for economics classes to discuss what happens when an economy with real transaction costs is subjected to massive disequillibria. If markets were perfect and well greased, wages and prices in Spain would all smoothly readjust to the reality of less wealth – and there would be no need for currency adjustment. Just some “negligible” distributional consequences that don’t impact efficiency (unless, of course, they create a massive negative aggregate demand shock resulting from a wealth effect on the middle class – but that’s not in the model).
Oh, Krugman shows two nice graphs – income, and current account… He only briefly mentioned housing prices and mortgage debt. Well, if you thought the US had it rough…
http://www.ritholtz.com/blog/2008/11/global-real-estate-ratios/
Lovely graph. See the US in the middle? Now do you see Spain? So, even if Spain miraculously drops wages by 15% to prevent its exports from being priced out of the market, how its people pay off their debts?
Answer: They can’t.
And remember, unlike the US, it’s harder for labor to relocate across “state” borders, and “federal” (EU) expenditures are a fraction of “state” expenditures. The equalizing factors in the US that come from true national unity are not (yet) present in the EU.
Unless the G20 moves fast, or the US forces a move (let’s pray), we are only just starting this crisis.
I don’t feel especially let down by the G20…as my expectations were already pretty low.
I’m pretty sure there will not be substantial progress on a European emergency economic stabilisation fund. The news media might be hookwinked–but the rest of us are not. So…if they had the fund…they could argue how to best use it. Makes me glad not to be a European for a moment.