Category: Commentary

IMF Speaks

On Monday, the IMF released a new research “note” entitled “Fiscal Policy for the Crisis,” which sets out recommendations for fiscal policy to address the global economic downturn. The premises of the note are, first, that the financial system must be fixed before it is possible to increase demand and, second, that there is limited scope for monetary policy, leaving fiscal policy as the main weapon. The executive summary provides the main recommendation in short form:

The optimal fiscal package should be timely, large, lasting, diversified, contingent, collective, and sustainable: timely, because the need for action is immediate; large, because the current and expected decrease in private demand is exceptionally large; lasting because the downturn will last for some time; diversified because of the unusual degree of uncertainty associated with any single measure; contingent, because the need to reduce the perceived probability of another “Great Depression” requires a commitment to do more, if needed; collective, since each country that has fiscal space should contribute; and sustainable, so as not to lead to a debt explosion and adverse reactions of financial markets.

Continue reading “IMF Speaks” →

Human Nature

Or, why human beings are bad investors.

Free Exchange has Anthony Gottlieb’s recollections of interviewing Bernie Madoff about financial regulation:

at the time he came across merely as calm, strikingly rational, devoid of ego, and the last person you would expect to make your wealth vanish. I certainly would have trusted him with my money. I cannot say the same of other financial superstars I interviewed. . . . Perhaps it is the most confidence-inspiring ones that you have to look out for.

I couldn’t agree more. We human beings have this completely misplaced confidence in our ability to judge people by “looking them in the eye.” I recall reading about one study (sorry, I don’t remember anything else about it) which showed that hiring managers were more likely to make good hires by selecting solely on the basis of resumes than by interviewing people – because using resumes is completely objective, while interviews allow you to interject your own erroneous beliefs. (I do believe that if you use interviews well – that is, to obtain factual information, like how well someone can actually write a computer program – you can do better than just using resumes; but maybe I’m just fooling myself.)

There are a couple of ways to look at this phenomenon. One is to think about motivations. There are people who are trying to rip you off and people who aren’t. The latter have no motivation to try to seem trustworthy, so they don’t bother. The former do have that motivation, so they try. Some are bad at it; some, however, are very good at it.

More broadly, what does it mean to appear trustworthy? “Trustworthiness” is just a set of signifiers that are generated by one person and that enter the brain of another person, like a firm handshake or a steady gaze. It’s like those luxury car manufacturers who expend effort and cost engineering the sound of the car door closing, because that sound is a signifier for quality. There is some evolutionary process whereby these signifiers got attached to the concept of trustworthiness in our brain over the history of the species, and maybe the connection was valid at some point. But now that people can reverse-engineer the connection and replicate the signifiers whether or not they are actually trustworthy, our instincts aren’t much use anymore.

The only way not to be fooled by your instincts is to rely solely on objective facts. Now, in the Bernie Madoff case, one can object that the only visible “facts” were themselves cooked, and that is true. But that just means we need better policing of things that are presented as facts. And I think the overall point still holds.

French Car Wreck

The latest economic data from France look bad.  The strategy of keeping official growth forecasts high (despite the evidence) is coming under increasing pressure and there may be substantial revisions to the outlook in the pipeline – once you break through to being more honest, there is some catching up to do.

Even more worrying are the plans apparently under preparation to support the French auto industry.  Officially, these plans are still under development (AP).  But from what we can see, including unofficially this week, the next phase of assistance could well be even more problematic than the support provided to the US auto industry which, so far, only got a bridge loan. Continue reading “French Car Wreck” →

Exit Strategy: Inflation

We know there is going to be a large fiscal surge in the US (the latest estimate is a stimulus of $675-775bn, which is a bit lower than numbers previously floated).  This will likely arrive as the US recession deepens and fears of deflation take hold. 

The precise outcomes for 2009 are, of course, hard to know yet – this depends primarily on the resilience of US consumer spending and whether large international shocks materialize.  But we can have a sense of what happens after the fiscal stimulus has played out (or its precise consequences become clear).   There are two main potential scenarios. Continue reading “Exit Strategy: Inflation” →

What You Can Do

On one level, recessions are about numbers, like the post I just wrote about the November statistics. On another level, recessions cause enormous hardship and misery to real families. I know most of us have less wealth than we did a year ago, since two major sources of household wealth – stocks and housing – have fallen steeply in value this year. But even if you don’t feel like you can afford to donate as much as usual to charities, there is still something you can do.

Most middle- and upper-income American households have lots of stuff. Many of us, particularly adults, have lots of clothes and other things we rarely or no longer use. You can think of this either as a behavioral phenomenon (people don’t like to get rid of things, even if they cause more disutility by taking up closet space than any utility they will ever provide) or as a market failure (it’s too much of a hassle to get rid of things, so we keep them). But if you just take a day, identify the things you will never use again, put them in bags, and drive them to a local shelter, you can help allocate those goods to the people who value them most. Or, as non-economists put it, you can help people. And, of course, you can get a tax deduction (the shelter in my town recommends using the Salvation Army valuation guidelines), which is itself probably worth more to you than those clothes you will never wear again.

Silver Linings?

We got one of our last batches of economic data for this calendar year today, and there may have been a glimmer of good news in there. In the news stories about the November data, I read that personal income went down, but real personal consumption went up, and the savings rate went up, which I found confusing, so I looked directly at the Bureau of Economic Analysis news release.

To summarize (all numbers are November’s change from October), personal income went down by 0.2%, and disposable personal income (after taxes) went down 0.1%, but in real terms (after adjusting for inflation, or deflation in this case), disposable personal income went up by 1.0%, which is huge (remember, that’s month over month). This was entirely due to falls in food and energy prices (mainly gasoline), since the core price deflator (excluding food and energy) was flat. Of that 1.0% increase in real disposable personal income, 0.6% turned into increased consumption, and 0.4% turned into increased saving, raising the savings rate from 2.4% to 2.8%.

Continue reading “Silver Linings?” →

Too Small To Fail

By now you probably know all you need to know about Too Large To Fail (Citigroup), Too Interconnected To Fail (AIG), and Too Many Potential Job Losses To Fail Before A New Administration Takes Office (GM).  Almost all the bailout cases we have seen recently were some combination of the above and they generally shared the characteristic of being large relative to the US and perhaps global financial system.  We have become accustomed to bailout increments in the hundreds of billions of dollars, and to periodically reassessing how many trillions have been committed by the Federal Reserve and others.

Today we received confirmation of something quite different: a bailout package for Latvia.  Latvia is a small country (2.2m people) and it is receiving a loan of just $2.35bn from the IMF.  The loan is obviously tiny compared with other bailouts (Citigroup received at least 10 times as much in November), but it is big in relation to Latvia’s economy – in IMF parlance, the loan is 1,200 percent (or 12x) Latvia’s quota.  Quotas are based on the size of your economy, among other things, and it used to be that 3x quota was a big loan and 5x quota really raised eyebrows.  (Iceland recently broke some records in this regard (official numbers here), and perhaps we are now in a brave new world where borrowing over 10x quota becomes more standard.)

We can scrutinize the full details of the program when it becomes public, but the press release already makes the key point quite clear,

Continue reading “Too Small To Fail” →

Thanks, But We Can Take Care of Ourselves

Every once in a while, someone leaves a snarky comment on this blog along the lines of “Well, have you ever started your own company?” I usually leave them alone, although occasionally I can’t resist responding. In general, I just think that my experience co-founding one company in one industry does not really qualify me to say anything that knowledge and logic wouldn’t qualify me to say anyway. In particular, having been through the experience, I can say that the amount of luck you need dwarfs any other attributes you bring to the table, so starting a company is not a particularly useful filter.

But now Michael Malone has managed to aggravate me with an op-ed in the Wall Street Journal called “Washington Is Killing Silicon Valley.” And Silicon Valley being one of the parts of our economy I know particularly well, I feel compelled to respond.

Continue reading “Thanks, But We Can Take Care of Ourselves” →

German Finance Minister Confirms What We Have Been Saying

The Wall Street Journal’s Real Time Economics/Secondary Sources today juxtaposes:

1. Peer Steinbruck, the German Minister of Finance, saying that Germany will not engage in “extensive debt financed-spending or tax-reduction programs.”

2. My posting, from yesterday, which makes the point that a big fiscal stimulus in the US strengthens the incentive for our major trading partners to free ride, i.e., not to engage in their own extensive debt financed-spending or tax-reduction programs.

Looks like we are still on at least this part of our baseline.

What About Bank Capital?

The Obama team’s plans are big and bold on key dimensions.  The fiscal stimulus will be one of the largest ever in peacetime.  We don’t yet know how much support there will be for a housing refinance initiative, but there is no question that the proposal will be huge.

But in this mix the lack of serious discussion (yet) of the need for new capital in the banking system is striking.  It could be, of course, that reports on the lack of capital have been greatly exaggerated.  And it could also be that a detailed assessment of the capital injections so far might indicate they have had less effect than previously expected – although you have to think about the counterfactual, what would the situation be now without these capital injections?

Most likely, the strategic thinking is along three possible lines here.

1) No more capital is needed because the fiscal stimulus will be large enough to turnaround the economy, bringing back growth and gradually steepening the yield curve (so banks can go back to making money the good old-fashioned way; borrow short, lend longer).  This is a plausible approach, but  risky.  There is a great deal that can go wrong or at least delay the positive effects of a big fiscal push, particularly in the current global economic environment – see my piece on Forbes.com today.

2) If more capital is needed at any point, it can be provided on the same sort of terms that Citigroup received in November.  This seems dubious because I would expect a political backlash if there is an attempt to repeat or scale up this deal.  The terms were simply too unfavorable to the taxpayer.  And we should probably now move beyond relying on weekend rescues of major financial institutions; too much can go wrong under that kind of pressure.

3) If more capital is needed, there is a plan but it is secret for now.  This might have some appeal, in the sense that any plan would be controversial and could distort incentives.  But Congress would surely appreciate knowing at least the potential scale and strategic direction for bank recapitalization in advance – after all, Mr. Paulson’s surprise request to them in September did not go down well initially and did not work out well later.  Any sensible plan would presumably involve the commitment of some hundreds of billions of dollars.  This would be an investment on which the government can earn a good return, but more details in advance on potential deal structures could help us understand exactly the value proposition for the taxpayer.

Some proposals – after we saw what happened at Citigroup – for recapitalizing the banking system are here.  Our approach may not be the answer, and I understand why many on Wall Street would prefer to do things differently.  But I do think we need more debate around a plan for recapitalization contingencies, and this should be done sooner rather than later.

The Perils of Exports

The steep decline in U.S. consumer spending is clearly taking its toll on the U.S. economy. But still, the U.S. has one advantage over many of its trading partners. Theoretically at least, our government has the tools it needs to boost domestic demand and thereby increase production. This is not true of the many countries who depend on exports for a large share of their economic growth.

I was taking a tour of the world’s news today and came across the following (courtesy of the FT):

  • Japanese exports fell 27% year-over-year in November, the largest fall ever; remember, exports were a major reason Japan finally emerged from its decade-long slump a few years ago.
  • Thai exports fell 19% year-over-year in November, the first decline since 2002 – and exports make up 70% of GDP. The numbers may have been artificially reduced by political conflict in late November, but political conflict is hardly a good thing in itself.
  • China is looking less and less like the big winner of the global recession and more and more like a significant loser. 10 million migrant workers have lost their jobs by the end of November. In response, “the State Council, China’s highest governing body, issued a decree to local governments over the weekend ordering them to create jobs for migrant workers who had returned to their home towns.” Prime Minister Wen Jiabao went as far as saying that a government priority is to “make sure all graduates have somewhere constructive to direct their energy” – somewhere other than social protest, that is.

One of the challenges of an export-driven economy is that when your consumers (Americans and Europeans) stop buying, you have few direct tools to get them buying again. There has been speculation that China could take the opportunity to stimulate domestic consumption and shift its economy away from reliance on exports, but that clearly can’t happen fast enough. Another trick exporters can use is to devalue their currencies, but that will crimp domestic purchasing power and potentially lead to a round of competitive devaluations, with wealthy countries printing money in an effort to stave off deflation and thereby devaluing their own currencies. In the meantime, everyone will be watching the Obama stimulus plan carefully.

One World Recession, Ready or Not

The usual grounds for optimism these days is the fact that the Obama Administration is clearly going to propose a big fiscal package with two components: a large conventional stimulus (spending plus tax cuts); and a big housing refinance scheme, in which the Treasury will potentially become the largest-ever intermediary for mortgages.

These ideas are appealing under the circumstances, but this Fiscal First approach also has definite limitations, for both domestic and foreign reasons.  Continue reading “One World Recession, Ready or Not” →

When Will the G7 Intervene?

The dollar is depreciating in eye-catching and headline-grabbing fashion.  The Japanese authorities are signalling that they are prepared to intervene.  The G7 (remember them?) has the established role of coordinated intervention in major currency markets when things get out of hand.  So where are they now and when will they come in?

The answer is: you may have to wait a long time.  This round of dollar weakening is the direct result of easing monetary policy in the US.  The Fed doesn’t usually talk about the dollar (leaving this to the Treasury, which has a tradition of obfuscation on the issue), but dollar depreciation is fully consistent with (1) wanting to prevent deflation, and (2) hoping to stimulate growth through exports.  The spinmasters would probably also say that actions to restore confidence in the global financial system are reducing demand for dollars as a safe haven, and this is reflected in currency markets.

You may or may not agree with this logic, but from a US perspective there can be little interest in immediate intervention.  The Japanese are obviously unhappy when their exchange rate appreciates beyond 95 yen to the dollar, but their G7 partners are pretty unsympathetic at that level – Japan has been running a massive current account surplus (hence its reserves of over $1trn) and has long been in line for some appreciation.  At 85 yen to the dollar, things would start to get more animated, and almost everyone would support intervention at 80.

The dollar-euro thinking is even more interesting.  The US (and my former colleagues at the IMF) are obviously pressing for a big fiscal stimulus in Europe.  But key European governments are just as obviously demonstrating the desire to free ride, i.e., you put through a hefty fiscal package of $850bn and I’ll get back to growth through selling you more BMWs.  While the US will of course observe every diplomatic nicety in this situation, privately the outgoing and incoming administrations must be enjoying the fact that dollar depreciation puts the European Central Bank – and particularly the Germans’ export driven economy – very much on the spot.

Personally, I think the euro-dollar rate would have to move much further, probably close to 1.6 dollars per euro, for the intervention conversation to get serious.  Of course, if markets become “disorderly” so that prices jump around in an unusual way, there are always grounds for intervening.  But, on the other hand, in this situation you can rationalize almost any short-term exchange rate movement as the market adjusting to new fundamentals.  And you can look very pointedly at the European Central Bank when you say this.

Expansionary Monetary Policy is Infectious

The Federal Reserve’s announcement yesterday makes it clear that we should see its leadership as radical incrementalists.  They will move in distinct incremental steps, some small and some larger, but they will do whatever it takes to prevent deflation.  And that means they will do what it takes to make sure that inflation remains (or goes back to being?) positive.  If they need to err on the side of slightly higher inflation, then so be it.  This is pretty radical (and a good idea, in my opinion.)

What effect does this have on the rest of the world?  Continue reading “Expansionary Monetary Policy is Infectious” →