About Tony Curzon Price

Tony Curzon Price was Editor-in-Chief of openDemocracy from 2007 to 2012, where he is now contributing editor and technical director. He blogs at tony.curzon.com

Articles by Tony Curzon Price

This week's editor

AdamWidth95.jpg

Adam Ramsay is co-editor of OurKingdom.

BoE forecasts very tight electoral window for Brown

The Bank of England has just come out with its quarterly inflation report.

The big headline is that recession for the next 12-18 months is almost certain.

A comparison with August's forecast is interesting:

Although the shape of the downturn is broadly similar, the current forecast has essentially shifted down between 3/4% and 1.5%. Note also that the BoE has been consistently optimistic in its forecasts---if you look at the balck "ONS Data" line, that is how things actually turned out. You might have thought that the statisticians at the BoE might have learned by now to take the pinch of salt into their own forecasts by now. (Actually, the optimism seems even worse than the graphic suggests. The Quarter 3 out-turn growth was a whisker above 0%, which is right on the outside edge of the outside August probability band. However, the BoE has decided to represent this graphically in the November chart as being on the inside edge of the outside band. (Ah! The rhetoric of charts!)

Anyway ... what we now know is that the BoE thinks we have a nastier and sharper depression coming than it thought in August. It is interesting -- particularly so given the election cycle that sees a general election by May 2010 -- to see what kind of shape they predict for the end of the depression.

Their central estimate is that things are getting better very fast by May 2010, with growth around 2% and the rate of change of growth very rapid --- things have been pretty bad just 6 months earlier. Sounds good for Brown. Indeed, one assumes that an independent bank must play the election calendar into its scenario-building, and must be assuming heavy government action in its central case.

In this respect, it is interesting to compare the August and November inflation forecasts. This is the current forecast of inflation:

And this was the August forecast:

In August, the rate of price growth rate was expected to fall for the whole 3 year forecasting period. Now, inflation starts to rise again (although from a lower base) already by mid-2010. This seems clearly compatible with a change in the basic assumptions about increased government borrwing and a lower sterling exchange rate.

Based on these BoE forecasts, Brown's window for an election in 2010 looks very tight---when incomes have started growing again and before inflation has shown the economy to come out of the depression in a pretty unproductive state.

And remember the BoE pinch of salt -- that will make the window even tighter.

Lame duck G20

The Group of 20 meeting in Washington this week-end will do little in the way of solving the financial crisis, let alone designing a new World Economic Order (WEO). The Green New Deal (GND) hopefuls would like to see  environmental concerns built into the fabric of the WEO --- if banks can have reserve requirements, then why not carbon per dollar loan limits too? --- or at least make the idea of Keynesian reflation focused on programs for renewable energy. Whatever the fundamental problems with the suggestion (see my response here), the two practical problems for the GNDers are firstly that Obama will not be present at the Washington meeting and secondly that there is a remarkable lack of support for an international-level tie of the financial and green agendas in the economics community. The creative and very timely Vox ebook edited by Barry Eichengreen and Richard Baldwin has many radical suggestions, but not a mention of any GND ideas.

This may be disappointing for all of us concerned with the environment. But it seems right. We can still avoid depression, and we should focus our attention on that. The unforeseen consequences of the crash of 1929 were horrific, as could be the consequences of depression over the next decade (Simon Maxwell and Dirk Messner in oD are very good on this). This is especially true for emerging nations and powers whose social stabiltiy and geopolitical good behaviour requires delivery of improving economic conditions.

Maxwell and Messner get the balance just right, I think -- the November 30th Copenhagen climate change summit must keep the environmental agenda moving with an eye firmly fixed on the middle-distance. The G20 summit must deal with the immediate and dangerously close.

Supra-nationalised banking

The European Investment Bank's deal, announced yesterday, whereby it made €30bn available for lending to the Europe's small and medium sized companies is interesting for the model of emergency banking that it suggests and pilots.

Westminster is delegating two ways: first, the administration of these loans is going to the big clearing banks, who know the businesses in question, have their credit records and bank movements; second the source of the funds is coming from a European institution that is used to spending and accounting for public money.

So when we've had enough investing in propping up bad banks, here is what we do: we massively increase the capital available to the EIB---as taxpayers, we put our money there rather than in idle accounts with the banks through their equity account---and we employ the bankrupt bad banks to be our agents in lending the money.

We'll need to design the incentive contract with the bad banks ... but with financial sector employment falling fast, that negotiation shouldn't be too tough on us. The banks can get some variable amount depending on a host of effectiveness indicators: volume lent, default rates, GDP growth ... with a bonus "kicker" in the contract on average median incomes and carbon emmissions for the whole economy over the next 20 years.

Mary Kaldor's Schumpeterian analysis

I have just published Mary Kaldor's latest column, which I think makes a really valuable contribution to our view of the financial crisis. The economics commentary, however much it professes to have learnt its new growth theory from Schumpeter, does not think about the actual characteristics of the technology development phases we are in or relate this to the current crisis.

MK's view (which borrows much from Carlota Perez) is that this crisis should be understood in relation to the new technologies as the 1930s crisis was understood in relation to Fordism and mass consumerism. MK sees deregulation and liberalism not just as the advance or retreatof some ideology, but rather as a phase which is suited to the early development of a technological/economic/institutional epoch --- a phase which finds justifications to shake off institutions from a prior age. But initial investments and returns are not sustained, and the financial sector becomes "creative" in the search for the return it has started to consider to be rightfully its own. This is what happened after the dot com bust and the mass move of finance into the extraordinarily unexciting business of (over)-financing home building.

One of the nice things about this way of looking at the crisis and at economic history is that it contextualises economic ideologies and offers a creative synthesis that might take us beyond state/market arguments. It encompasses each in different phases of the epochs of development.It also allows us to look at the 1930s asking not so much about the lessons in terms of technicalities of money supply management, but more in terms of the political and institutional shifts that took the world economy beyond 1930. Can we hope that creative destruction might be a little less destructive this time around?

I'd still like to see the analysis become more specific. From the vantage point of the early 1930s, could one see that Fordism would require/engender national welfarism, American economic hegemony, etc? And if we can, what does the nature of new information and energy technologies imply is needed for the next epoch? World-wide welfarism? Democracy support? A new finance infrastructure, including learning from micro-finance? Anti-consumerist values ...

Is there a Schumpeterian who would like to stick their neck out with a forecast? 

Osborne/Today - endless equivalence

Today

Tony Curzon Price (London, openDemocracy): George Osborne gave the Today program an opportunity to demonstrate the great emptiness of the media-political conversation this morning.

Paraphrasing, here was the interview:

SM (interviewer): "What is wrong with Darling's plan?"

GO: "You can't spend your way out of a recession with a Keynesian splurge on big projects"

SM: "What would you do differently?"

GO: "Freeze council tax, give small businesses help and let the bank of England cut interest rates, putting money in people's pockets."

SM did not then ask why this wasn't itself Keynesian splurging. There are three points here:

1. what should be the level of fiscal largesse?

2. is it better to spend this mainly on public investment or to delegate that spending to households and small businesses?

3. who eventually pays for fiscal largesse?

Osborne/Today - endless equivalence

George Osborne gave the Today program an opportunity to demonstrate the great emptiness of the media-political conversation this morning.

Paraphrasing, here was the interview:

SM (interviewer): "What is wrong with Darling's plan?"

GO: "You can't spend your way out of a recession with a Keynesian splurge on big projects"

SM: "What would you do diffferently?"

GO: "Freeze council tax, give small businesses help and let the bank of England cut interest rates, putting money in people's pockets."

SM did not then ask why this wasn't itself Keynesian splurging. There are three points here:

1. what should be the level of fiscal largesse?

2. is it better to spend this mainly on public investment or to delegate that spending to households and small businesses?

3. who eventually pays for fiscal largesse?

GO pretended to answer "1" by answering "2", and Today let him get away with it. "3" is a very interesting question which GO proposed one answer to that was never challenged by SM. The point about "who pays?" is closely linked to Ricardo's equivalence, the argument that claims that there is no difference between financing government spending through borrowing or through the raising of taxes. Public borrowing has to be paid back, eventually through higher taxes. Taxpayers, if they understand this, will know their lifetime consumption possibility has fallen by exactly the amount of the public spending, so who cares if it is financed through taxes now or higher taxes later (higher in order to cover interest payments)?

The argument is fine in a classical regime - as long as we do not currently face the risk of a Keynesian recession. The point of a Keynesian recession is that capital markets do not work; hence the equivalence argument based on households comparing present and future consumption is simply not applicable. The only question that Today's interview should have drilled towards was this: does GO think there is no risk here (there is certainly a case to be made -- Tim Congdon has made it recently -- but is GO really taking the political risk of supporting this view)? Or does he deny Keynesian efficacy in such an eventuality? 

One day, Today will ask the hard questions.

 

Why the banks are hoarding cash

The BoE quarterly report has a table (reproduced below) of all the measures that have been taken by central banks world-wide to get banks lending again. The fact that, after all we are doing, they still are keeping all the cash they can get their hands on for themselves, shows that their difficulties are much worse than these solutions envisaged. I have written several times about the Credit Default Swap market, and here is a really insightful article (hat tip Eurointelligence) describing exaclty how the "CDS overhang" (or should that be hang-over?) is causing a sort of financial black hole into which any cash that comes into the orbit of a bank gets whooshed.

What the article makes clear is that taxpayer funds and guarantees -- worldwide amounting about £4.5 trillion -- do not cover the losses that banks are exposed to on their unregulated CDS dealings. A CDS is just an insurance contract: a bank agrees to pay out some stated amount if some specified  loan (bond)  goes bad. Banks, hedge funds and insurance companies found they could sell thisinsurance in large quatities -- far larger than the value of the loans being insured. In the casino on which the sun never set --- our modern financial markets --- there was a market in bets on other people's ability to pay, whether you had a stake in the game or not. There are $50 trillion of outstanding CDS contracts. It is fear of these liabilities that is making banks cash-hoarders.

But liabilities may well be capped below the $50 trillion number. When Lehman's was bankrupted, institutions that had insured Lehman bonds had to find cash to pay out on the insurance. CDS's are non-regulated, non-standardised, 'over the counter' (OTC) products and come with a wide variety of terms. According to the article, some of the CDS's required that the insured party deliver the underlying debt in order to get paid. This limits the size of the CDS payout overhang. Unsurprisingly, insurers have been asking for delivery of Lehman debt before paying out. It will be interesting to see if the price of bankrupted Lehman bonds starts to move up. 

 

 

 

Bjork the Autarch

Iceland's chill has led Bjork to tune in to her inner philanthrocapitalist. (Hat Tip CalendarGirl ). In this interview, Bjork describes her reaction to Iceland's economic woes and explains what she is actually doing to build a new economy based on green localist principles. Admirable for its pragmatism, is it a model for all of us?

Bjork

Bjork is looking to encourage MBA students, geeks and rural workers in Iceland to produce business plans that provide good incomes in the knowledge and eco-tourism economies in order to avoid building more  aluminium smelting plants --- that's what Iceland resorts to when it is in a fix, exploiting its huge hydro potential.

The dilemma faced by Iceland today---pay bills by inviting  ALCOA (The Aluminium Company of America, whose CEO was Donald Rumsfeld) to build more dirty business, or feel financially poorer but preserve the environment---is one we will all face soon. Is environmentalism a luxury?

Bjork wants to attack the problem by offering an alternative to ALCOA, a vision of "a new, independent, environmentally friendly Icelandic economy". She is building -- or thinking of building, I am not sure which -- an incubator for these new businesses. Sounds very attractive:

It's one big institution where everybody who has a good idea goes and they all work together and help each other and then companies start to come out of there. But it takes like eight years. For me, it's sort of like a record company. It's like an indie label in a way. It's grassroots, where all these people can come and feed off of each other and get support. Where if one person gets a good idea, the other five will help them..

But there are pieces of the idyl that are much less attractive:

  •  [We want to] "build this purely Icelandic thing up with Icelandic money, Icelandic companies."
  • "We should make companies here made of Icelanders, both working class and the brainpower, discover new things that stay in the country."
  • "Why not have the Icelandic people who are educated in high-tech and work already in those factories in the higher paid jobs, why not let them build little companies who are totally Icelandic with the knowledge they have? Then they get the money and it stays in the country."

There are hints of looking to use the incubator and environmentalism to keep the nasty world out in all these identitarian references. Why can't we have what David Hayes and Andrew Dobson have characterised as a Cosmopolitan Localism -- a localism and environmentalism that does not see the world as a threat, and that has the confidence to live its identities in the open? Iceland has just been slapped for its Viking raider hubris of the past 10 years. So a desire to retreat into autarchy is understandable. But it too should be resisted. It is just as much of a perversion as the raider mentality.

(Thanks to  verapalsdotir for the photo)

 

Darling and the Economics of Keynes

Tony Curzon Price (London, openDemocracy): Darling is going to announce that the budgetary prudence rules of his predecessor---to balance the budget over the cycle, unless the spending is on long term public good investment---don't apply. And he is right. But why does a rule that sounds so sensible have to be thrown out so soon after it was proposed?

BoE snapshot of crash

Tony Curzon Price (London, openDemocracy): The Bank of England's report on the state of finance has about 3 worrying graphs per page.

Here's just one example - the amount that UK banks will need tofind next year to pay back loans that are coming due.

 

Any wonder the banks are hoarding all that taxpayer investment they
are getting and not lending on? And if you were asked to invest in a
business that you knew had to stump up these sorts of sums next year,
would you worry that your investment was just going to stright into the
pocket of a creditor whose lending terms are tougher than your
ownership terms?

I'm all for the State being the bank of last resort, but I don't have any taste for the taxpayer being the dupe of last resort. Why don't we let these banks go under while putting in place an emergency financial system. I am glad to see that Walter Munchau has started to suggest this option.

BoE snapshot of crash

The Bank of England's report on the state of finance has about 3 worrying graphs per page.

Here's just one example - the amount that UK banks will need tofind next year to pay back loans that are coming due.

 

Any wonder the banks are hooarding all that taxpayer investment they are getting and not lending on? And if you were asked to invest in a business that you knew had to stump up these sorts of sums next year, would you worry that your investment was just going to stright into the pocket of a creditor whose lending terms are tougher than your ownership terms?

I'm all for the State being the bank of last resort, but I don't have any taste for the taxpayer being the dupe of last resort. Why don't we let these banks go under while putting in place an emergency financial system. I am glad to see that Walter Munchau has started to suggest this option.

Jarvis describes ... what oD tries to do

Here is Jeff Jarvis in the Guardian today:

"I want a page, a site, a something that is created, curated, edited and discussed. It will include articles. But it's also a blog that treats a topic as an ongoing and cumulative process of learning, digging, correcting, asking, answering. It's a wiki that keeps a snapshot of the latest knowledge and background. It's an aggregator that provides curated and annotated links to experts, coverage from elsewhere, a mix of opinion and source material. Finally, it's a discussion that doesn't just blather but tries to add value. It's collaborative and distributed and open but organised.

Think of it as being inside a beat reporter's head, while also sitting at a table with all the experts who inform that reporter. Everyone there can hear and answer questions asked from the rest of the room - and in front of them all are links to more and ever-better information.

It's not an article, a story, a section, a bureau, a paper, a show, a search engine. It's something new. What do we call it? The topic table? The beat bliki (ouch)? The news brain? I don't know. We'll know what to call it when we see it."

 

Jeff talks about the unsatisfactory atomisation that blogism has brought, and I have tried to express this in my piece on "The Blind Newsmaker". There is a sort of fallacy of decomposition that says that the web can recombine all the bits of journalism to create a satsifactory whole. Blogism does not produce the right atoms for that, because how you create determines what you create.

My view is that commissioning is the ingredient that has too often been dropped from the auto-publish web. In his article, Jeff is asking for coherence, for meaning, for a discursive arrival at partial understandings. The editorial conversations that lead to commissioning are at the heart of the creation of temorary moments of understanding.

openDemocracy's "open source model for news analysis"  is trying to work towards Jarvis' ideal newsroom.

 

Keynesian remedies and ignorance

The Sunday Telegraph publishes a letter from the rump monetarists---many familiar names from the economic crusades of the 1980's.
It is interesting to see how those old arguments play today.
Take this chestnut:
"It is misguided for the Government to believe that it knows how much specific sectors of the economy need to shrink and which will shrink "too rapidly" in a recession. Thus the Government cannot know how to use an expansion in expenditure that would not risk seriously misallocating resources."

This is true, of course, in some absolute sense of "know". However, as these very same economists have been quick to point out whenever it comes to governments dealing with clear errors of markets, for example with environment or anti-competition issues, the ideal does not make for a good benchmark. Just a market failure should be remedied if imperfect government can do better, so imperfect governments should be compared to actual markets, not imagined ones.
Look at the argument again: the financial system, which brought us massive over-investment in technology, in housing, in commodities, in conceptual art ... this is the process that should be trusted with avoiding "serious resource misallocations"?
The financial crisis has brought the government back into policy not so much because it has any answers, but because the market has demonstrated so unequivocally that it does not.

"Crisis? Did you say 'Crisis'?"

I went to a fascinating lecture by Daniele Archibugi yesterday at Birckbeck who argues that the prospects for global democratic institutions are actually quite good. The essence of democracy, he argued, are non-violence, public control and political equality. The first is about some sphere of social change being outside the realm of might; the third is the principle that those affected by an action should have a say in the action. The second is the one where Daniele mentioned the financial "events" of the past few days---when the G7, IMF and various finance ministers have met, we have known nothing of their actual deliberations. The degree of public accountability is very tenuous. In all three cases, Daniele thinks that the international system shows signs of beign able to grow in the right direction: the strengthening of the ICC; the accountability mechanisms we do see; the growth of the EU as a systematic experiment in "accountabiltiy beyond borders".

I asked Daniele in the question session afterwards whether the hopes might be misplaced that the financial crisis would be the sort of moment to bring about pro-democratic reform at the global institutional level---after all, the muddling along of ad hoc groupings is coping (...so far...); and if they are misplaced, what sort of crisis is that will actually bring about the democratisation that he is talking about?

At first, I did not understand his response. He said: "Did you say "crisis"?" (I nod). "Which crisis? There has been no crisis." Still puzzled, he went on to clarify:  "... This is somewhere Schumpeter was right and Keynes was wrong: capitalism moves in waves of creative destruction, and the moments of destruction are necessary and part of the system. There is no system crisis here."

This is very persuasive. Schumpeterians have been in the ascendant in economics recently, with theories of growth explicitly relying on the idea that the culling of inefficient, non-innovative firms and the liberation of resources for new ones is what sets the scene for economic growth. Creative destruction and its dynamic are asumed by capitalism, and will not be the conditions that rock capitalism. For Schumpeterians, business cycles are like the evolutionary force of selection---who makes it through? Daniele was contrasting Schumpeter to Keynes who "saw nothing good in the business cycle"and hoped his general theory would help to eradicate the cycle. The Schumpeterian view is given full treatment by Edward Chancellor in the FT yesterday, where he rattles off all the recent historical examples of crisis to point to their systemic nature.

But even if Schumpeter is right about the links between creative destruction at the firm and industry levels, the business cycle,  and the "evolutionary strength" of capitalism, there still seems much to explain. Is the psychology of boom and bust created within the system---the overconfidence, the resilience to criticism, the in-group mentality that create exuberance, as much as the fear and self-loathing that perpetuate depression---or are they caused elsewhere? Despite economists' imperial urges to make everything determined within their system, I suspect the "elsewhere" is important.

Krugman wins economics prize

While I am 100% with Yves Gingras that Economics should not have a Nobel, I am very pleased that Paul Krugman has been awarded the The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel.

 PK has been a voice of sense on many issues, not least the Financial crisis - I have often linked to his NYT column from this blog. My personal favourite amongst his wide-ranging economics are his books and articles on Economic Geography. His "Self Organising Economy" has a particularly nice account of the forces that lead to the emergence of Edge Cities. Clear, simple and essential.

 

Time to rupt the banks

Will Hutton writes in his Observer column that "big public stakes in banks and offer guarantees to the interbank market [...] is a necessary condition for stabilisation [but] it is not sufficient."

While I agree with Will that we need to sort out the "black hole" of the Credit Default Swap insurance pyramid, I think that the time for recapitlaisation is now passed. Recapitalisation is not a necessary condition for stabilisation. The rapid creation of a new state lending bank is what is needed.

Recapitalisation might once have worked: financial pyramids are a confidence trick, and a state recapitalisation of the order of a few percentage points of GDP might have allowed a gradual, orderly wind-down of the massive liabilities. But the kind of confidence that would allow a gradual, muddle-through solution of the sort that happened in the Latin American debt crisis of the 1980s is simply no longer there. Barclays and RBS alone are the ultimate insurers against default of contracts worth more than the annual income of the UK. These are the sorts of contracts which, in an auction on Friday of Lehman Brother's assets, went for less than one tenth of their face value. The trouble with nationalisation and recapitalisation is that the liabilities do not disappear. When the slate is this heavy, you need bankruptcy to wipe it clean.

The financial sector is scrabbling aorund for whatever cash it can lay its hands on because every institution is likely to find itself in the position of having to pay out on insurance contracts with other parts of the financial sector that they know they cannot currently cover. The taxpayer with our capital injectionshave become the latest source of that cash, and we will see it disappear into the black hole of CDS liabilities.

The time for confidence tricks is passed. The banks are bankrupt.Time to stop  putting in good money after bad -- it simply will not help.

Save the real economy by rapidly creating a State bank that will lend directly to business, and let the finance system diappear into the black hole that it has dug for itself.

 

 

 

 

Plan-B

 

Plan 'B"

Tony Curzon Price

October 9th 2008

Face up to it: the Brown re-capitalisation plan may not work. The banks have relied to a massive extent on Credit Default Swaps, a sort of insurance on lending. They have given themselves false comfort, and in some cases very real cash-flow, on an insurance pyramid that will not hold-up under even modestly higher default rates. Liabilities under these insurance contracts are vast. One hedge fund was insuring 100 times its cash base before it went under. If the banks that we are now the proud part-owners of end up being heavily exposed to these liabilities--the total CDS market is measured around $50 Trillion, almost 1000 times more than the Brown rescue--we should just cut our losses and let the banks go under.

The problem is the protection of the real economy. The Federal Reserve has shown the way here, with its direct lending to companies, started 2 days ago. We should start a new state bank, recruit bankers and accountants from the City, and get them to work on lending to the real economy. At first, they will not have the time to distinguish good and bad loans. They will have to be lax but short-termist in their lending decisions. Their task will be to rapidly and efficiently become ``relationship bankers''--understanding the underlying businesses they are lending to and setting appropriate and gradually tougher lending terms. Once financial flows to the real economy are safe, the state bank should be broken into 10 identical pieces and with 9 sold to private investors who will operate in a new regulatory regime. The tenth should remain in state hands, as a benchmark bank, a way for the state to stay close to what is happening in the markets.

It is disturbing that the Brown re-cap was hatched by the Treasury, the Bank of England and top bankers. The trouble any regulator has is that the people who best understand the business and the crisis are the people you are trying to regulate. This is the basis of every regulatory capture. You cannot trust what the knowledgeable say to you. If the liabilities of the banks start to mount, let's make sure this plan B is ready to be deployed.

 


The essence of the de-leveraging crisis

Tony Curzon Price (openDemocracy, London):Paul Krugman has a simple model of the crisis that is a pretty useful tool to think about what is happening and what should be done immediately. It is not a model of why we got here, but a diagnostic tool for short term action.

First, Krugman's conclusions from the model are a) that taxpayers becoming shareholders in banks is a good next move and b) that international coordination of rescue plans is particularly important. Quoting him directly: 

First, it suggests that the core problem is capital, not liquidity - or at least that you can explain much of what's going on without appealing to a breakdown of buying and selling per se. To the extent that this is true, rescue plans centered on making troubled assets liquid, like the Paulson plan passed last week, won't do the trick. Instead, what's needed is an injection of capital, which can't reverse the original shock, but can undo the financial multiplier effect of that shock.

Second, the international implications: to the extent that we regard falling asset prices and their consequences as a bad thing, which we obviously do right now, this analysis suggests that there are large cross-border externalities in financial rescues. Macroeconomic policy coordination never got much traction, largely because economists never could make the case that it was terribly important. Financial policy coordination, however, looks on the face of it much more important. Capital injections by U.S. fiscal authorities would help alleviate the European financial crisis, capital injections by European fiscal authorities help alleviate the U.S. financial crisis. Multilateral Man, come home - we need you! 

Shorting neo-liberalism

I posted Gideon Rachman's FT column  on oD's The World link-watch page on diigo earlier today. Gideon writes:

Investment bankers, the shock- troops of the Reagan-Thatcher revolution, were allowed to bet their banks on this new market, because regulators and politicians believed so firmly in the magical and self- regulating qualities of the market.

The same process of intellectual overshoot happened with other signature ideas of the Reagan- Thatcher era: privatisation, scepticism about environmentalism and democracy promotion.

Well ... I think there is a kind of "democracy promotion" --- the kind openDemocracy stands for --- that is not neo-liberal and is in the wings, waiting for its open moment, as it were.

That apart, Gideon's judgement of ``overshoot'' is very welcome. I wrote asking him about the idea of "progress"  -- did he think that was oversold too? The pessimistic conclusion to his column, in which he saw just a batting back and forth between over-regulation and over-deregulation, suggested that he might be shorting progress too. Can we socially  learn from these crises?

 

 

Krugman explains de-leveraging

 

The essence of the de-leveraging crisis

Tony Curzon Price

October 7th 2008

Paul Krugman has a simple model of the crisis that is a pretty useful tool to think about what is happening and what should be done immediately. It is not a model of why we got here, but a diagnostic tool for short term action.

First, Krugman's conclusions from the model are a) that taxpayers becoming shareholders in banks is a good next move and b) that international coordination of rescue plans is particularly important. Quoting him directly:

 

 

First, it suggests that the core problem is capital, not liquidity - or at least that you can explain much of what's going on without appealing to a breakdown of buying and selling per se. To the extent that this is true, rescue plans centered on making troubled assets liquid, like the Paulson plan passed last week, won't do the trick. Instead, what's needed is an injection of capital, which can't reverse the original shock, but can undo the financial multiplier effect of that shock.

 

Second, the international implications: to the extent that we regard falling asset prices and their consequences as a bad thing, which we obviously do right now, this analysis suggests that there are large cross-border externalities in financial rescues. Macroeconomic policy coordination never got much traction, largely because economists never could make the case that it was terribly important. Financial policy coordination, however, looks on the face of it much more important. Capital injections by U.S. fiscal authorities would help alleviate the European financial crisis, capital injections by European fiscal authorities help alleviate the U.S. financial crisis. Multilateral Man, come home - we need you!

 

On the specifics of how to re-capitalise the banks, I have to agree 100% with the basic framework proposed by Willem Buiter.

The model makes it clear why we might want to re-capitalise the banks rather than allow the de-leveraging to run its course. Ordinary savers are quite right to be wanting to reduce their holdings of risky assets--they have understood that the investments they held were much less good quality than they previously thought. The price of houses, art works and all the bubble assets must still fall a great deal. But this adjustment, which is just a welcome return to reality, is creating massive knock-on effects as the ``Highly Leveraged Institutions'' of the financial sector have to reduce their lending because the price of the assets they were using as security for the lending is (rightly) falling. This forces the financial institutions to sell assets, making the problem worse. As Krugman points out, this is exactly the way that contagion spread from the Russian to the Asia to the Brazilian crisis in 1998.

Worryingly, the model leaves open the possibility of instability. In particular, if we --- we the ordinary savers --- become extremely unwilling to hold assets with any risk at all, then the model predicts that we spiral into a very nasty loop indeed. I do not think we are there yet, but the model underlines the importance of investor psychology at this point.

A financial system based on such highly leveraged institutions is not right. But we need to wean the system from that leverage slowly, giving the real economy time to adjust, while the logic of Krugman's de-leverage model is that this is being forced on banks at lightning speed. Re-capitalising the banks is a way of breaking the cycle of de-leveraging. Krugman's international conclusion comes form the fact that the banks all hold assets from all countries, so that asset price shocks ripple through the leverage multiplier much faster than would be suggested by the extent of movements of goods and services around the world. Krugman illustrates this with a nice graph.

So the way forward is becoming clear. Put capital into the banks following the Special Resolution Regime proposal of Buiter's to stabilise the system. Once the real economy has access to the credit it needs to operate, nationalise or hyper-regulate the banks and let the real economy slowly - over five years - reduce its dependence on bank credit.

The chart shows rest-of-world assets in the United States (red) and US assets abroad (blue) as a percentage of non-US GDP. What this shows is that when US asset prices fall, foreign financial firms feel the de-leveraging squeeze; and when foreign asset prices fall, so will US financial firms.

 

Krugman, Blinder & Co YouTube

Sounds like a firm of City lawyers -- Krugman, Blinder & Co. In fact, it is half the panel line-up on this excellent film of the Princeton Economics Department panel on the subprime crisis.(YouTube embedded below - the whole thing is about 1 hr, with the first 1/2 hour most informative, IMO).

Unfortunately, Blinder is mostly cut. Brunnermeier is fascinating on really detailed stuff---economists will never be short of clever fixes to regulation problems; Hong is really  interesting --- I want to post on his point about the psychology and sociology of systems prone to bubbles; Krugman --- well, if you've followed him in the NYT, you won't find any surprises here. 

The American Left's remedy for the meltdown

The progressive pressure group Campaign for America's Future - the left counterpart of the centrist Democratic Leadership Council - welcomed the House's rejection of the bailout and released three guidelines for further government action. Tony Curzon Price critiques the American Left's remedy for the current financial crisis. For more of Tony's analysis of the meltdown, go here. (editor's note

Invest In Main Street: On Main Street, jobs are disappearing, infrastructure is crumbling and local budgets are straining. A $200 billion economic rescue package for Main Street would generate clean American energy, extend unemployment benefits, aid states and localities to avoid debilitating cuts and modernize our crumbling infrastructure. 

More redistributive taxation in the US makes sense, as does generous, Danish-style unemployment insurance tied to re-training. Convincing America of this is a different matter. New Deal-style public works programs do not (yet) make sense. Most of the spare money for US investment is coming from Asia. Does it make sense to spend the savings of India and China on better roads in the US? No! Public works are useful in a depression, but we're not there and may never get to that point. It is not useful to confuse the finance bail-out with every other pet project one might have. 

Unwilling capitalists

My note to Willem Buiter on his praise of the Fortis "nationalisation":

Dear Professor Buiter,
I agree that Fortis shows that the worry - expressed just today by Munchau in the FT - that Eu cannot respond in a crisis is wrong. But the outcome of the capital injection seems favourable compared to what would come out of TARP, no?

51% of old shareholdings preserved --- doesn't this show that a little more transparency to voters in the Benelux might have got them a better deal?

Taxpayers are unwilling risk capitalists here, and that should make our representatives negotiate harder for our upside, not less hard.
Best wishes,
Tony

Unprincipled madness

Yesterday, I (and many others, I imagine) were surprised to discover how polarised American politics really is. Tactical explanations of the vote abound--Mark Thoma points to Bloomberg's report that explains the Republican anti-vote as `Because somebody [Nanci Pelosi in her speech to Congress] hurt their feelings they decided to punish the country.' Jeff Frankel concludes wearily: ``I suppose it is not surprising that Congressmen facing elections in 5 weeks don't want to go on record supporting something so unpopular.'' Brad De Long gives up on analysis and appeals to extra-economic solutions: ``raze the Republican Party to the ground. Plough it under. Scatter salt in the furrows so it can never grow back. We need another, very different opposition party to face the Democrats. We need it now. ''

 

openDemocracy's netvibes pages on the economy are here

But tactics arise out of a climate of belief. Yesterday's surprising discovery of polarisation was here. Vocal voters in marginal districts think and believe--this is what connects tactics to fundamentals. They phone Representatives with opinions influenced by media, church, thought, conversation. Willem Buiter comes closer to a real account when he writes that there were two types of vote against the bail-out: Libertarians (mad but principled) and voter-scared populists (mad and bad). He wishes a short recession to the first and a nasty recession to the second. I imagine the compartments are not so water-tight: the populist is responding to a climate of opinion carefully nurtured by the ``mad but principled''. What are these mad principles, and what are they saying tactically about the bail-out vote? I set out to find Buiter's ``mad principled'' voices to understand the climate of opinion which leads to the electoral tactics we saw yesterday.

I go first to Chicago economist Gary Becker to find the thoughtful Libertarian commentary. Gary does not like the plan much, and picks away at the details that Dodd and the Democracts insisted should go in. He wants the economy eventually to move away from ``too big to fail'' banking institutions, hoping for a less brittle, less catastrophe-prone system:

the "too big to fail" approach to banks and other companies should be abandoned as new long-term financial policies are developed. Such an approach is inconsistent with a free market economy. It also has caused dubious company bailouts in the past, such as the large government loan years ago to Chrysler, a company that remained weak and should have been allowed to go into bankruptcy. All the American auto companies are now asking for handouts too since they cannot compete against Japanese, Korean, and German carmakers. They will probably get these subsidies, even though these American companies have been badly managed. A "too many to fail" principle, as in the present financial crisis, may still be necessary on hopefully rare occasions, but failure of badly run big financial and other companies is healthy and indeed necessary for the survival of a robust free enterprise competitive system.

But--and this quote is from a pre-vote analysis--he concedes that short term intervention is needed.

I get closer to the principled objectors at the Cato institute web site where Jagadeesh Gokhale writes of the vote: ``score one for supporters of the free market who insist on allowing market reorganization of the financial sector to continue unimpeded...albeit at high risk to the economy over the next few months.'' Although thin on analysis, Gokhale is getting closer to the view that catharsis is needed, that a no-vote is a necessary sacrifice in a long battle of principle. In a separate, pre-vote piece, Gokhale analyses the problem as coming from low post 2001 interest rates; a (causally related) pressure on banks to find more and more projects to invest in, even where their quality was dubious (the subprime crisis) and a failure on the part of regulators to control bad lending. It might seem odd to have the mother-ship of all libertarian think-tanks blaming bad regulation, but the subtext of Gokhale's analysis is that Greenspan was operating in a system of highly government-manipulated interest rates, but justifying a laisser-faire approach in just a subset of the economy. No wonder, goes this view, that laisser-faire failed: it was not real laisser-faire. (The structure of the argument is very familiar in ideological thinking and brings to mind the very common--and similarly correct--argument that the Soviet Union did not represent ``real Communism'', where ``real'', rather strangely, refers to the ideal system and not the real one).

Gokhale's analysis, however, is still not the principled Libertarian objection to the bail-out I am looking for. It leaves room for a Becker-style accommodation with short-term intervention. ``We're not (yet) in Libertarian utopia, and the path to it is strewn with compromise,'' can be the line from Cato.

I find what I am looking for at the Ludwig von Mises Institute , where Frank Shostak argues that ``The Rescue Package Will Delay Recovery''. Skip two sections of throat clearing ideo-babble and you get to the commentary on where we are:

  1. Loose monetary policy since 2001 has led to money creation through bank credit expansion and bad investment decisions that happen to have appeared in the mortgage sector;
  2. The tightening of monetary policy since 2004 has slowly been taking funds out of ``bubble activities'', so the finance industry that serviced those bubble activities is naturally going to be hit hard
  3. Bank balance sheets look bad because banks made bad business decisions, and re-capitalising banks is not going to help the basic problem of wasteful investment--
    Decades of nonproductive consumption (consumption that is not backed up by production) that emerged on the back of loose monetary and fiscal policies have severely damaged the store of wealth that serves as the foundation for credit markets [...] it will be futile to try to boost lending by pushing more money into the banking system.
    Some creative destruction of banks and other firms will be necessary now.
  4. The errors have all already been made--credit expansion, bad investments--and the bail-out is self-servingly chasing symptoms of these errors
  5. The virtues of thrift and careful lending must be resumed as soon as possible and the mistakes of the past must be paid for.

From a purely analytical point of view, this position has a surprising amount in common with Ann Pettifor's here on openDemocracy . The surprise is that the hard-core Libertarians should share their diagnostics so closely with Ann Pettifor's progressive radicalism. Her 2003 book and article point to credit expansion, first permitted by Nixon's abandonment of dollar-gold convertibility in the face of the need to finance the Vietnam war, as the false-foundation of apparent globalisation-led growth. She asks for an end to ``easy money'' in much the same way that Frank Shostak points to loose bank lending as the mistake made many years ago, and not solvable by a bail-out now. It is no surprise that neither Pettifor nor Shostak are pro-bail-out.

Both have the sense that the financial system has produced an illusion of wealth while actually, in important ways, eating at the core of what makes for a good society.The difference comes in a disagreement about the nature of the good society, and not in the analysis of what has gone wrong with our own bad societies. Pettifor stands for social equity, Shostak for market-faith. Pettifor goes much further in her analysis of the manufacturing of demand for debt through consumerism and her analysis of the distributional consequences of low input price for banks (in the form of cheap money) and high output prices for banks (in the form of expensive consumer debt).

Nevertheless, Shostak and Pettifor are in a strange analytical agreement over the mechanism of the mess we're in. It is therefore slightly less surprising that many Republicans and many Democrats voted against the bail-out: the orthodoxy at the centre of American politics is under attack--under an analytically similar attack--from both left and right. The vocal voter phoning in to their Representative is pretty likely to be able to justify a strong sense of indignation against the bail-out, whether they are free-market mystics or Democratic progressives. Buiter correctly identifies some of the anti-bail-out sentiment as ``mad but principled''. If the shrinking centre-ground means that it is made up of the ``unprincipled but sane'', it may be time to abandon the centre and to have the real argument over the shape of the good society.

Keeping up with the economists

There's a huge amount of excellent and important commentary on the financial crisis. I have collected together the RSS feeds I'm using in 4 netvibes tabs that I am skimming through to keep abreast. You'll find feeds from Krugman, Roubini, Setser, DeLong, Thoma and many others who are commenting regularly on the crisis.

If you're not a netvibes user, go to the link here. You will see tabs across the top of the screen with Economics 1 to 4 - click those for the feeds. Click on a feed to have a quick read of what it contains, or do "shift+click" on a title to open the originating article.

The professional economics blogosphere, mainly under the influence of american academics, offers a pretty complete substitute for the analysis pages of the main newspapers. There are just a few exceptions - like the FT's own economics blogs (and especially Buiter's Mavrecon). An excellent European voice comes from VoxEU, a group blog of Euroconomists.

I hope you find these feeds useful, and drop me a line (tony dot curzonprice at opendemocracy dot net) if you've got some RSS feeds or sites that you think should be added to this list for crisis-watching.

Syndicate content