Thursday, October 30, 2014

Larry Summers Describes The Problem Of Achieving Financially Stable Growth With Full Employment

This article by Larry Summers argues that it will be difficult to achieve a full employment economy in the industrial world along with financial stability.   He claims that the basic assumptions of classical macro theories, as well as the new Keynesian theories, have proven to be inadequate.  Both of these theories assume that flexible prices will enable the economy to arrive at a full employment equilibrium over time.  Interest rates have dropped about as far as they can and a further decline in wages and prices leads us into a deflationary spiral that is difficult reverse.  Moreover, the IMF and the CBO continue to lower their forecasts of the level of potential GDP.  This calls to question the assumption that output will rise the trend line that existed prior the Great Recession.  That is, we may be in for an extended period of lower economic growth than we have anticipated.  Summers reviews the data that support his hypothesis and he considers possible solutions to the problems that he views in the global economy.  He concludes that normal monetary policy cannot produce a full employment economy without creating the kind of financial instability that led to the financial crisis.  In fact, the collapse of the financial system may have been predictable in hindsight.  Unsustainable credit risks had masked the difficulty of sustaining adequate economic growth.

In the US, the economy looked pretty good between 2003 and 2007, leading up to the financial crisis.  Low interest rates were an important factor in achieving a reasonable growth rate. However, low interest rates encouraged investors to take on greater risk to increase the yields on their investments.  The banking system obliged by extending credit to high risk borrowers.  That led to a real estate boom that eventually collapsed and produced the Great Recession.  Summers extends this analysis even further into the past.  He argues that unsustainable credit growth had been fueling the economy for the last 20 years in the US.  That leads Summer into an analysis of the factors in the economy that required unsustainable credit support to maintain full employment.  That is, the forces that were reducing potential output without support from credit expansion.  In doing so, he turns Say's law, which holds that supply creates its own demand, on its head.  He concludes that falling demand leads to falling supply.

To support his hypothesis he shows that there has been a steady and substantial decline in real interest rates since 1985.  They reached a trough in 2011 where the real interest fell to fell to zero.  The implication is that the full employment real interest rate may be much lower than it has been in the past.  Therefore, monetary policy will have difficulty maintaining full employment and production at potential GDP without increasing the risk of financial instability.  Increased inflation would lower the real interest rate but that does not lower the risk of financial instability.

If monetary policy has reached its limits, fiscal policy, along with a reduction in income inequality that redistributes income to households with a higher propensity to consume,  is the only solution available that does not increase the risk of financial instability.

Summer's analysis is receiving more attention within the economics profession and among policy makers.  It will be strongly resisted, however, because it flies in the face of a dominant ideology, and it would reverse the policies that have been promoted by those who have benefited the most from the current arrangement in the US and in England.  Reagan and Thatcher are alive and well in both countries.  The mid term elections are likely to increase the political power of the party that worships at the Reagan alter and the party of Thatcher controls the UK economy.

Wednesday, October 29, 2014

Federal Reserve Announces End To Quantitative Easing

The Fed announced today that it would end its purchase of treasuries and mortgage securities.  It concluded that the economy had recovered sufficiently and that inflation was close to its 2% target.  This article provides a good overview of quantitative easing and what it accomplished.  It kept the interest rate on mortgages low and that helped to keep the housing market afloat.  It also made it less expensive for corporations and households to lower the cost of debt service.  The economy has had a moderate recovery but it still operates below its potential.  Job creation has improved but not as much as most would have liked.  The biggest winners from the program may have been holders of corporate stock.  The PE ratio is not as high as it was during the dotcom boom but it is high relative to historical averages.

Corruption Of State Attorney Generals Has Become A Big Business

Two decades ago 40 state attorney generals banded together to sue the tobacco industry.  They won a $206 billion settlement from the tobacco industry.  That got the attention of corporate executives.  Corporations are now lobbying state attorney generals to protect themselves from harmful litigation.
This article describes the ways in which the lobby industry has been organized and how attorney generals have benefited from the lobbyists.  Legislators are no longer the sole beneficiaries of the goodies provided by corporate lobbyists.  State attorney generals have gotten into the game and some familiar patterns have developed.

One of the familiar patterns is the revolving door.  Attorney generals frequently join a lobbying firm after leaving office.  That gives them an incentive to be "cooperative" while they are in office because that makes them more attractive to law firms that represent corporate interests.

The AG's have also organized themselves to attract and distribute corporate campaign contributions.  Republicans formed the Republican Attorney General's Association (RAGA) and the democrats followed with the DAGA.  Donations from corporations, either directly or indirectly, go to these organizations.  In turn, each of them provide funding for AG election campaigns.

The AG's also join an organization of former AG's when they leave office.  The alumni organization is often targeted by lobbyists and many work for law firms that represent corporate interests.

As one might imagine some of the law firms that represent corporate interests become better at it than others and their work is described in this article.

A strange kind of game tends to develop over time.  AG's have in incentive to take actions which raise the threat to some corporations.  That makes corporations more anxious to raise the stakes in the lobbying game that gets played.  Corporations often try to prevent AG's from organizing together on law suits like they did in the tobacco case;  they also try to block legal action at the state level.  Some AG's who have been highly favored by a particular lobbyist have tried to prevent their peers from joining together on a legal action.

In addition to being hosted at fancy venues by lobbyists, many AG's have would like to further their careers outside of the lobby industry.  Some want to run for higher state or national office. Several of the AG's investigated in this report are being championed for higher office by lobbyists and the corporations with whom they have developed a "personal relationship".

This investigative report by the NYT is a good example of what journalism is capable of doing in a democratic society.  It would not be possible in many nations.  It includes details from emails that would be an embarrassment to those involved if this information was widely distributed.  Unfortunately, only readers of the NYT will be informed by the information provided in this article.  It will not be picked up by the local press in most affected states.

Tuesday, October 28, 2014

An Interview With Adair Turner On The New Economy That We Created

This link is to a post and a video interview in which Adair Turner describes the four broad changes that he sees in the economy.  It is referred to as "money manager capitalism".  The four broad changes in the economy are: growth in inequality, increase in wealth to income ratio, increase in debt to GDP ratio, and historically low interest rates.

Ben Bernanke argued that low interest rates are the result of a "savings glut".  Turner believes that there has been decline in investment demand which keeps interest rates low.  He uses Facebook as an example of the high tech industry that we have today which is very different from what we had in the past.  Facebook has a market capitalization of around $180 billion.  It required around 5,000 man years of software engineer labor to build its enterprise.  Henry Ford required a much larger capital investment to develop the Ford motor company.  (He also needed a very large workforce to manufacture his product).  The low demand for capital investment has enabled investors to borrow money at low interest rates to leverage their investment in financial products and in real estate. 

Turner also explains why real estate has returned as a major source of wealth.  In the past real estate derived its value from producing food, or as a source of natural resources.  We are experiencing a boom in commercial and residential real estate in places like London, NY, Vancouver, Paris etc.  That is because real estate is a positional good.  Wealthy individuals want to live in high prestige locations.  Moreover, the demand for property in high prestige areas is international.  There is a finite supply of high prestige locations and an infinite supply of money which is created when banks issue loans.  Much of the investment in real estate is used to generate rent income.  Rent income has been increasing as a percent of income in the US, England, France and Canada.  We are experiencing a return of the rentier society in which real estate is a major source of income and asset appreciation.

Turner was asked about the situation in Europe and he compared the EZ to Japan in the 1990's.  There is a huge private and public debt overhang and the politics of the EZ are much more complicated than that of Japan.  It has been difficult for Japan to deal with its debt overhang but it is much more difficult for the EZ to respond to its economic problems.  He sees immigration as one of the major political issues in Europe.  Immigrants want to find jobs and they compete with low skill labor for low wage jobs.  Much of the anti-EU sentiment comes from those who compete for jobs with immigrants.  The free movement of labor is one of the basic features of the EU and that is why there is so much populist opposition to the EU in England.

Monday, October 27, 2014

Why Did Steve Balmer Pay $2 Billion For A NBA Team?

Steve Balmer paid $2 billion for the LA Clippers.  The was almost for times the previous record for a NBA franchise set in May when the Milwaukee Bucks were sold for $550 million to a couple of hedge fund managers.  This article describes the unique tax advantage that is available to owners of sports franchises.  Balmer can save around $1 billion in taxes through that loophole.

The tax loophole allows franchise owners to deduct goodwill from the other taxable income.  Goodwill is the purchase price of the asset less the value of the cash and fixed assets in the LA Clippers.  If it is assumed that the value of the Clippers is around $500 million, and subtract that from $2 billion, Balmer has $1.5 billion of goodwill.  At a reinvestment rate of 7%, that gives him a tax credit of $1 billion that can deducted from his other taxable income over 15 years.  Its certainly one of the factors that influenced his decision.

NBA owners also share in the rights that are sold to media providers.  The NBA just closed a $24 billion deal with ESPN and Time Warner.  NBA games will be available over the Internet from Time Warner's cable operator (Comcast).  The LA Clippers will share in that revenue without having to compete for it.  Balmer purchased an annuity along with the team. 

The NBA deal is not unique.  Media rights for sports rose 18.7% last year.  The NFL just signed a deal with Direct TV for its Sunday Package.  The eight year deal for $12 billion is twice the value of its previous deal.  If one wants to have every Sunday NFL game available for viewing one must have a Direct TV contract.  Media rights have also risen dramatically in England for teams in its top soccer league.  Its a great time to own a sports franchise.  Consumers can't get enough sports on TV and advertiser love to be associated with sports.

Saturday, October 25, 2014

Spending On Frivalous Luxuries Is Not The Reason For Household Budget Problems

Many people believe that we spend too much on unessential luxuries like lattes and that our budgets would be fine if we cut back on foolish spending.  This article tells us why that is not our problem.  Our spending on essentials like healthcare insurance premiums, rent/mortgage payments, education and day care expenses is the problem.  Those items consume most of our budgets and the prices for those necessities have been rising.  For example, our daughter just had her first child.  In order for her to maintain he job as a teacher she needed $2,000 per month for day care.  Many families are faced with the problem of giving up one of the jobs or paying for daycare.

Friday, October 24, 2014

Managing Democracy To Save Plutocracy

Paul Krugman claims that plutocrats only tolerate democracy when it can be made to work for them.  So how do the plutocrats make democracy work for them?  Krugman provides his list of tactics which have been effective for a long time.  He argues that underneath much of political and economic issues that we debate is the more general problem of plutocracy versus democracy.  The plutocrats are small in number but they are organized to protect their interests.  In general, they must convince others that what's good for the plutocrats is good for them.  They are pretty good at this game.

Thursday, October 23, 2014

Robert Samuelson Provides A Lesson On Economics Journalism At The Washington Post

Robert Samuelson writes a regular column on the economy for the Washington Post.  In this article he describes the labor market, which he argues, has been bad for workers because of the Great Recession.  He quotes economists from conservative and liberal think tanks about the decline in unemployment and the lack of growth in wages.  He concludes that it is still not clear whether the damage from the Great Recession is over or whether its effects on the labor market will be more permanent. 

So what's wrong about this rather typical article from Robert Samuelson? He demonstrated his objectivity by quoting from liberal and conservative commentators and the facts that he presented are accurate.  In other words, his article conforms to the standards of conventional journalism.

The major problem with Samuelson's article, and the problem with most conventional journalism, is in the way the problems have been framed by Samuelson.  He argues that the Great Recession is responsible for the poor labor labor market.  Certainly the Great Recession accelerated unemployment, but the problems faced by workers did no begin with the Great Recession.  For example, Samuelson points out that wages have been flat since 2009 when the Great Recession began.  What he doesn't say is that there has almost no real growth in median wages for 30 years.  The labor market has been getting bad for workers since the 1980's; it did not begin with the Great Recession.  Corporations, with the cooperation of government,  have been doing what they can to weaken the negotiating power of workers for a long time.  Globalization along with the weakening of unions has had a powerful effect on wages and job security since the 1980's. This has not only affected unskilled workers, it has also affected skilled professionals in large corporations.  Job security and loyalty to and from the corporation has been seriously eroded.  There are more temporary workers who do not receive healthcare benefits, and defined benefit pension plans have almost disappeared.  The implicit contract between the corporation and its employees that existed prior to the 1980's has been canceled. 

Samuelson concludes his article by asking whether the labor market will recover from the Great Recession.  The problems in the labor market were not caused by the Great Recession and the damages that have been done to labor market are permanent unless the changes to that market that have been made over an extended period of time are altered.  That is unlikely as long as economic journalists like Samuelson define the problem.

A Good Discussion About The Role Of Economics In Society

Jeff Mandrik wrote a book about the pernicious role that economic ideas play in society.  He came up with seven bad ideas the permeate the profession.  Brad DeLong wrote a scholarly response to Mandrik's seven bad ideas.  Brad made some good points but the comments to his post were even better.  This says a lot about the people who read his posts.  They are quite different from those who comment on Paul Krugman's articles in the NYT.  They have thought a lot about the same issues that have been raised about economics.  You can read them and be treated to a grad school level discussion session about economics and its role in society.

The GOP Economic Agenda Does Not Inspire Even Conservative Economists

The GOP economic agenda has not changed over the last 50 years.  They claim that cutting taxes and reducing spending on programs they do not like, along with less government regulation, will create jobs and reduce the budget deficit.  Even conservative economists don't believe that the GOP proposals will create many jobs.  Nobody believes that cutting taxes will reduce the budget deficit.  The best that they hope for the economic agenda is that it does no harm.  Its support for the agenda of the energy industry may create some jobs but it will be harmful for the environment. 

Wednesday, October 22, 2014

Amazon Provides A Valuable Lesson On Cash Flow Versus Net Income

Amazon is regarded as a highly successful company despite low profits.  It is also able to invest in new businesses without going into debt.  This article explains how Amazon does it.  It provides a good lesson on the differences between net income, cash flow and free cash flow.  Amazon generates an enormous amount of free cash flow that is well above its net income.  It uses its free cash flow to fund its investments. 

Its important to understand the cash conversion cycle (CCC) to appreciate how it differs from other highly efficient retailers like Wall-Mart and Costco.  The cycle is calculated by adding days of inventory to days sales outstanding, and subtracting days you take to pay your providers.  Amazon excels at managing its CCC.  It manages inventory well and it gets paid promptly but it really stands out in the days that it takes to pay its providers.  Amazon is in a class by itself along with Apple, they both have negative CCC scores.

Tuesday, October 21, 2014

Managing IBM And Shareholder Value

IBM's stock price dropped 7% after it announced that failed to meet its financial goals.  Actually, IBM's revenue is about what it was it 2008.  It has been maintaining its stock price by financial engineering.  Since 2000 IBM has spent $108 billion on stock buybacks, including $12 billion in the first six months this year.  It has also returned $30 billion to investors via dividends.  Much of this spending has been financed with debt.

Capital spending has been $59 billion and spending on acquisitions has been $32 billion.  It has spent more on maintaining its share price than it has on growing the business.  IBM recognizes that it has to move into new businesses in a rapidly changing marketplace dominated by new technology.  It has been late to the game and its new businesses have not grown fast enough to compensate for the decline in its traditional businesses.  Managing its stock price has not been good for its long term prospects as a leader in its business sector.

New York Fed President Links Financial Stability To A Change In Wall Street Culture

The New York Fed supervises the Wall Street banks.  The President of the New York Fed sent a tough message to Wall Street.  He told them that they have not made the changes that are needed to prevent the next financial crisis.  In essence he told his audience that the goal of financial stability required a serious change in the Wall Street culture.  The banks need to show that they are capable of managing themselves, or there would be pressure to reduce their size and complexity.  He argued that cultural changes are needed to make that happen.  He then described some of the changes that are needed.  His speech provides one of the clearest descriptions of the cultural changes that are required, and what is needed to change the culture, that any Fed supervisor has ever made.  It should be required reading in business courses.

Business Press Has Issues With Shareholder Value Mission

The idea that businesses should be managed primarily to increase shareholder value has been accepted by many business leaders.  There has been a lot of criticism of this idea by those outside of the business community.  This article in Forbes (via Alex Lamb) illustrates how the critique of the shareholder value mission has spread within the business press. 

Monday, October 20, 2014

Why The US and European Economies Are Growing Below Trend

Michael Hudson presents his explanation for below trend growth in the US and Europe.  Many economists assume that the economic growth rate prior to the financial crisis in 2008 is the long term growth rate for the economy.  The expectation is that the economy will return to the trend growth rate as the financial system recovers.  Hudson makes a different argument.  He claims that the growth rate prior to the financial crisis was fueled by debt.  Therefore, the growth rate can only return to trend by resuming debt funded growth.  He believes that this is unlikely.

Central banks have done their best to keep interest rates low but that has not increased investment demand by large corporations.  Hudson claims the F500 corporations in the US invested only 9% of their earnings on capital investment.  The rest was used to fund stock buybacks and dividend payouts.  He argues that this is consistent with corporate compensation systems.  Executives compensated with stock options have a strong incentive to increase the value of their options.  Many corporations have even borrowed money to fund stock buybacks and dividend payouts. 

In theory, low interest rates should encourage business and governments to invest and expand.  It should also encourage consumers to spend.  Instead low interest rates have created asset bubbles.  Moreover,  governments have not been willing to take advantage of low interest rates to build infrastructure.  The volatility that we see in stock markets reflects the concerns that investors have about the willingness of central banks to maintain low interest rates and uncertainties that they have about the global economy.  Europe is in particularly bad shape because many of its banks have been weakened and they have not been able to stimulate growth through credit expansion.
To summarize, Hudson believes that global economic growth fueled by credit growth may have reached its limits. 

How To Succeed Without Trying and How To Fail By Trying Hard

Children born into poverty who work hard and achieve in school have a chance of making it to the upper income bracket.  Their chance of doing so is about the same as that of kids from high income families who did work hard and are considered to be low achievers.  The poor high achievers also have much better chance of remaining in the low income bracket than low achieving kids from wealthy families.  This article explains why that happens in the US and Canada.

What Yale's Endowment Manager Learned From Keynes

The Yale Endowment Fund has been extremely successful.  Pension funds and other endowment funds have attempted to copy the strategies employed by the Yale endowment.  The manager of the Yale Endowment learned a lot from Keynes who managed the Kings College Endowment between 1921 and his death in 1946.  Some of the ideas that were learned from Keynes are described in this article.

College endowments in England were concentrated in real estate and bonds which were considered to be safer than equities.  Keynes preferred investments in equities because the Kings Endowment had a long term time horizon.  Keynes did not believe that it was possible to successfully time the equity market but equities were more liquid than real estate and over the long term they provided a good return.  Keynes learned about the benefits of a long time horizon during the Great Depression.  Keynes held onto his equity portfolio when prices collapsed in 1929 and he reaped the gains when equities recovered in the late 1930's.  Equities were also preferred to real estate because they were more liquid. If cash was needed in an emergency it could be more easily realized with equities.

That brings us to another important point about private equity investments and real estate.  Investors should build a liquidity premium into their strategies.  Illiquid investments should bring a large premium over more liquid investments.  The Harvard Endowment had invested heavily in illiquid private equity investments and hedge funds; it was forced to raise cash at a steep discount in 2008 when it needed funds for other purposes.  The Harvard Endowment lost billions in 2008.

The Yale fund manager also provided a warning to active investors.  He did not believe that most active investors could be successful in timing the equity market.  Like Warren Buffet, he argues that most equity investors should put their savings in low cost index funds that distribute the risk over a broad portfolio and are not actively managed.  That is good advise that is not typically heeded by individuals.  Most individuals put their savings into more expensive actively managed funds.  Typically their net return is lower than it would have been in low cost index funds.

Ireland and England Have New Tax Avoidance Strategy For Corporations

Europe has been trying to limit the ability of nations to compete against other nations by using friendly tax avoidance schemes.  Ireland is ending its "Double Irish" scheme for new firms but it and England have found a new way to race to the bottom.  They are both providing tax advantages to corporations based upon their intellectual property such as patents.  That is unfair to firms that do not have tax advantaged patents but it also shifts the tax burden to firms and individuals who are not in the intellectual property accumulation game.

Saturday, October 18, 2014

Private Equity Agreements With Pension Funds Lack Transparency

Pension funds are major clients of private equity firms.  In order to do business with private equity firms the pension fund managers agree to keep the terms of their agreements secret.  The private equity firms defend the secrecy clause in their agreements by arguing that disclosure would reveal proprietary information that could be used by their competitors.  Pension fund managers comply with the secrecy clause when requests for information are made.  This article is critical of many of the common terms in these agreements that expose investors to excess risk, and protect the interests of the general partners. Apparently, pension fund managers are willing to accept those risks in order to participate in the funds which provided a superior return for the decade beginning in 2004.  They have have not performed better than low cost index funds in the last five years.  In any case, this article provides many insights into how the agreements favor the interests of the general partners over the investors in their funds.

Friday, October 17, 2014

What Is The Market Saying About Debt?

Economists assume that markets usually get the price right.  The market price for US bonds is rising.  That means that the interest rate, which moves in the opposite direction of price, is falling.  The interest rate on ten year treasuries in the US is under 2%.  What is the market telling us about US debt?  It is telling us a couple of things: Investors are not concerned about the ability of the government to service its debt.  Moreover, the market is not worried about inflation.  The bonds would decline in value if inflation increased.  Investors would be receiving negative interest rates if inflation were greater than 2%.  Moreover, the interest rates on home mortgages is based upon the the yield of ten year treasury bonds.  Mortgage rates are falling.  That will stimulate the housing market and it will enable households to refinance their mortgages at a lower rate.  That will reduce interest payments and allow households to spend their money on other needs.

Robert Samuelson argues in this article that market is not getting the price right.  Apparently, he does not believe in the market system.  He must assume that investors do not appreciate the risk that they are taking when they purchase US treasuries.  He has been writing about rising debt and the threat of inflation for the last five years.  Investors are less worried about US debt and the threat of inflation than Samuelson.  He also fails to understand that investors who purchase US bonds receive an asset in return for their payment.  They are doing the virtuous thing and increasing their savings.  The falling price of US treasuries is telling us that the demand for US debt is higher than the supply.  Unfortunately, it is also telling us that the demand for US treasuries is high because investors are concerned about the risk that they perceive in other assets.  That is one of the reasons why the economy has been recovering slowly.  Businesses are not investing their retained earnings in new capital, or in R&D, at the level that is needed to increase employment.  In other words, they are saving too much or they are using their profits for other purposes.  They are sending dividends to households that are not spending it or they are investing in their own stock.  If business does not want to invest in private goods perhaps it is a good time to invest in public infrastructure.

Of course, every nation is not in the same position as the US, and most of the countries in Europe, which can borrow money to make public investments at very low rates.  Apparently, they do not see the opportunity to invest in infrastructure that might produce a return in excess of the interest rate.

Thursday, October 16, 2014

American Democracy In A Nutshell

This article describes the battle over for control of the Senate.  It is primarily about advertising budgets and how they are affecting the polls.  I guess that's all that really matters.  The GOP candidates are focusing their attention on the fact that Obama is not in their party and the Democratic candidate likes something that Obama likes and is not liked by the GOP base.  Many of the Democrats are running away from Obama but that does not leave them with much to say. Which kind of car do you want to buy?

Yoram Bauman's 11 Funniest Papers In Economics

Sometimes a good joke is worth one thousand journal articles.

Wednesday, October 15, 2014

Paul Krugman's Comments On Jean Tirole's Nobel Prize

A lot has already been written about Jean Tirole's research, and Paul Krugman provides a link to some of the comments in his post.  He chose to discuss his own research and how Tirole's work in the area of industrial organization made it easier for him to win his Nobel prize in trade theory.  His work on trade theory suggested that firms benefited from trade because it led to higher returns from economies of scale.  Their cost of production declined in relation to their market size.  This violated the assumption of perfectly competitive markets in which large numbers of small firms competed primarily on price.  It was much easier to build economic models of perfectly competitive markets than it was to model the real world in which economies of scale operated to produce oligopolistic markets where a small number of very large firms dominated most industrial markets.

Krugman argues that Tirole's research on industrial organization was liberating.  However, it left the economics profession with a big problem.  The real economy is oligopolistic but there is no theory of an oligopolistic economy.  Tirole used game theory in an effort to describe how an industry with only two firms might compete with each other.  It is much more difficult to use game theory to understand how industries that consist of several very large firms might compete with each other.  Ordinarily, it would not be in their interest to compete on price.  Price competition would reduce the profitability of the industry.  The beer industry in the US provides an interesting perspective on how the real economy works.  The beer industry was comprised of small firms that competed in local markets.  It was transformed over time into an industry in which a few very large firms dominated a national beer market.  Budweiser gained over 50% of the market and shared that market with a handful of smaller firms.  There is little price competition in the beer market.  Budweiser's economy of scale is in advertising.  Because of its size, its advertising cost per barrel of beer is much lower than any competitors.  It is very difficult for smaller firms to compete on a national scale against Budweiser.  The cost of advertising is a huge barrier to entry into the national market.  Some small firms manage to grow outside of local markets but they often get acquired by the larger firms as they gain market share.  There are exceptions to this rule but the beer market is dominated by a small number of very large firms that do not compete on price.  This is a far cry from the perfectly competitive markets that are idealized in economic theory and sold to the public.  It is OK to talk about market imperfections but the implication is that they should be reduced as much as possible so that the markets can work like they are assumed to work in theory. 

If the global economy is primarily oligopolistic we need to have a better understanding of large large firms and how they compete in their specific industries.  They often use their national governments to help them to grow profitably and they also invest in strategies to reduce their tax burdens.  In fact, they have a common interest in reducing their tax burdens.  They share the cost of influencing government decisions on tax policy.  Firm strategies are also influenced by large investors whose interests may not be consistent with the long term interests of the firm.  We live in very different world than the world that exists in the textbooks.

The Global Economy Six Years After Financial Crisis

This article looks at several markets which indicate how investors are looking at the global economy.  It has been six years since the financial collapse in 2008 and one might have expected the global economy to be in better shape than we find it.

Prices ordinarily rise during a recovery as employment and wage growth leads to an increase in demand.  That has not happened.  Investors are willing to purchase ten year US treasuries that yield only 2.2%.  They are only willing to pay a 1.5% premium for five year treasuries that protect them against the risk of inflation.  In other words, investors are not worried about price inflation.  That means that they still see risk in the global economy.

Prices for several commodities have also been falling.  To some extent that is caused by increases in supply, but it also indicates that demand for many commodities is not increasing.

The US dollar has also increased in value relative to other currencies.  A lot of factors determine the relative value of the dollar but safety is one of them.  The value of the dollar has been driven upwards to some extent because it is regarded as a safe haven in global economy that has several soft spots.

The stock market has appreciated in many regions over the last few years.  That leads many to believe that the economy is in good shape.  Stock prices have risen because corporate profits have been strong during the recovery but they have also increased because the yields on bonds have been very low.  The recent downturn in the stock market may reflect investor concerns about profit growth in a weaker global economy and also a concern about the ability central banks and governments to arrest the decline in prices.  Price deflation is a greater concern than the fear of inflation.

Sunday, October 12, 2014

Inside A Criminal Hedge Fund

This article (via Manan Shukla) in The New Yorker describes one of the schemes that was used by the SAC hedge fund to earn hundreds of millions on a trade that was based upon insider information.  Investors in the hedge fund were able to get a rate of return on their investment that exceeded the market of rate of return because SAC had an "information edge" on other investors.  The focus of the article is on one of the traders that cultivated a relationship with an insider that enabled SAC to capitalize on the information.  He had a record of doing unethical and illegal things to get ahead.  SAC actively recruited traders with that kind of motivation.  Moreover, it had a system that enabled the head of the firm to deny responsibility for the behavior of its traders.  The trader, in this story, ended up in jail, but head of the firm was protected from prosecution by a carefully crafted system that made it possible for him to deny participation in the fraud.

SAC was eventually put out of business but the head of the firm accumulated $9 billion.  He actively trades his own funds in a business organized for that purpose.  Whether and how he might gain a "black edge" that enables him to achieve an above market rate of return is unknown.  However,  there will always be a suspicion that he does not beat the market with genius.  Gaining an information edge is an attribute of the business that he is in.  It is hard to determine whether a "black edge" or a legal edge provides the advantage required to beat other investors in a trade.

Friday, October 10, 2014

Martin Wolf Describes The Global Economy As a "Managed Depression"

Central banks have been trying to manage their way out of economic slumps.  They have been variously successful in preventing an even worse outcome of a global recession and price deflation.  They have resorted to unconventional policies that might have produced inflation and other bad things in ordinary circumstances.  Emerging market economies that have been the engine for growth are now slowing down.  Their customers in rich countries are not spending as much as they had in the past, and they are purchasing fewer natural resources from resource rich nations.  Martin Wolf, writing in the Financial Times, describes this as a "managed depression". He argues that the slump in the EZ is the major problem in the global economy, and he is pessimistic about its ability to deal with the slump in aggregate demand that has been underway for several years.

Its Time To Say Goodbye To Fiscal Hysteria In The US

Paul Krugman points out that the US deficit is 2.8% of GDP.  That is below the statutory level that has been set for the EZ.  That should be good news for the fiscal hawks but its really bad news for them.  That is because they have been using the budget deficit as a justification for cuts in social welfare programs.  They were very vocal when the deficit was higher earlier in the recession.  Not surprisingly, they have been silent about the improvement in the deficit.  The media are part of the problem.  They made the deficit a big deal, but most of them have failed to inform the public about the decline in the deficit.  The great majority of Americans still believe that the deficit continues to rise under Obama.  Unfortunately, the real problems in our economy have ignored because budget deficits were turned into out most important economic problem. 

Thursday, October 9, 2014

In Defense Of The Obama Presidency

Paul Krugman was not an Obama supporter when he campaigned for the Democratic nomination against Hillary Clinton.  He was asked by Rolling Stone to review his presidency.  It was not an easy job.  The far right has been against everything he attempted to do since day one.  Many on the left have also been disappointed by the degree to which his transformational rhetoric exceeded the scope of his accomplishments.  Krugman examines several aspects of his performance and concludes that he has had a successful presidency.  Clearly, it has been much more successful than we would have had if the other side had won.  This is especially the case in foreign policy.  A McCain presidency would have been a global disaster.   Obama's greatest accomplishment was the Affordable Care Act.  A single payer system like Canada's would have been better but that was not politically possible.  Millions of Americans now have access to healthcare and healthcare price inflation has decreased  since the passage of the ACA.  That is a big deal.  In fact, the federal deficit has been reduced dramatically under Obama.  Much of that is the result of declining healthcare costs which are a large part of the federal budget.  Obama, of course gets none of the credit for the shrinking budget deficit.  Most Americans do not even know that it has been substantially reduced.  Most depend upon TV for their information and the talking heads still have a fixation about budget deficits and the need to reduce social welfare spending.  They also do not know that the greatest increases in US budget deficits occurred during the Reagan and Bush presidencies.  They chose to finance tax cuts by increasing government borrowing.

Krugman covers other areas in which Obama accomplished more than one might have expected in the political environment that he faced.  He was not a transformational president, but Krugman argues that he accomplished much more than most of his predecessors.  Historians will give him higher grades than the public opinion polls which have been less kind to him.

Shadow Banking In US Is Only Slightly Safer Than It Was Before The Financial Crisis

The shadow banking system in the US is 180% larger than the traditional banking system.  It is much larger in the US than it is in other nations which rely primarily on traditional banking.  The IMF determined that the shadow banking system in the US, which is only lightly regulated,  still contains the seeds of systemic risk to the financial system.

The shadow banking system contains a large number of institutions that operate like banks.  They borrow money short term and they lend it out to borrowers.  Unlike banks, however, which hold government guaranteed deposits,  they face the equivalent of a bank run.  Furthermore, many of them are not subject to limits on the amount of leverage that they use.  Lehman provided a good example during the financial crisis.  It borrowed money short-term,  and it used mortgage backed securities as collateral for its short term notes.  When its creditors became concerned about the safety of the collateral, they refused to provide the short term loans that Lehman used to finance its operation.  Its liabilities exceeded its assets and it became insolvent. Money market funds also operate like a bank.  They provide a higher rate of interest to depositors and they lend the funds out to borrowers.  One of the largest money market funds was a provider of short term loans to Lehman.  The deposits were not insured and money market funds faced a "bank run".  Around $300 billion was withdrawn from the money market funds which also provide credit to large businesses.  The government had to guarantee the deposits held by money market funds to stop the withdrawals.

The financial crisis in the US, precipitated by the shadow banks, quickly spread to banks in Europe.  Many of the banks purchased the mortgage backed securities from the shadow banks in the US.  They provided an above market rate of return for AAA rated assets.  Moreover, the banks did not have to hold capital against AAA rated securities.  When the market value of those assets declined many banks had to raise capital to cover their loses.  The capital problem was compounded by the decline in value of sovereign debt held by the banks.  Since the debt had a AAA rating they had not reserved capital as cushion against the decline in value of those assets. 

Much has been done in the US to reduce the risk level of the banking system.  Less has been done to reduce the systemic risk in the shadow banking system. 

Wednesday, October 8, 2014

IMF Global Economic Forecast

The IMF's chief economist describes the global outlook by region.  He also outlines the risks to the forecast which is below its previous forecast.

Tuesday, October 7, 2014

The IMF Tells Us How Government Spending On Infrastructure Provides Us With A Free Lunch

The IMF has historically been a promoter of fiscal austerity.  It has now changed its tune.  Under current conditions of weak demand and low interest rates, the IMF shows how one dollar of infrastructure spending can yield three dollars of benefits.  Larry Summers summarizes the IMF proposal and suggests that it disproves one of the eternal bromides found in econ 101 textbooks.  He tells us that free lunches are possible.  The solution will vary across nations, since circumstances differ between nations, but the IMF has become a champion of infrastructure spending.  Politicians who have used budget deficits as a vehicle to reduce the role of government in the economy will not like the IMF's proposal.  They will stick to their conviction that free lunches are not possible.  Curiously, they are reviving their own version of a free lunch.  That is, the belief that a one dollar cut in taxes will increase tax revenues by more than one dollar.  Cutting taxes is a fiscal policy that everyone can love.  Especially when one believes that they will reduce budget deficits.

Special Issue Of RWER On Piketty and Inequality

Piketty's book raised lots of questions about inequality and what might be done about it.  This special issue of the Real-world Economic Review provides an analysis of Piketty's approach to the problem of inequality;  its relationship to economic orthodoxy and other critiques of capitalism, as well as alternative approaches to reducing inequality. 

Secular Stagnation And Fed Policy Problems

This article provides a good definition of secular stagnation.  The Fed has been trying to deal with that problem while it is at the zero lower bound.  It has been using unconventional policies because short term nominal interest rates cant fall below zero.  Japan has been faced with that problem for decades. The question is whether western economies will be constrained by the liquidity trap for a similar period of time.  It is a good lead to the following post which includes a discussion of secular stagnation.

What We Learned From The Financial Crisis

Martin Wolf wrote an impressive book that described the underlying dynamics of the financial crisis.  Paul Krugman took the opportunity to review Wolf's book  in order to add a missing dimension to Wolf description.  He agrees with much of Wolf wrote about the vulnerability of the financial system, and the factors that contributed to its vulnerability.  He takes issue with Wolf's conclusion that we should focus our attention on reforming the financial system in order to reduce the risk of future financial crises. 

Krugman points to two problems that are not addressed by Wolf.  He asserts that most of the advanced economies suffer from a problem of declining aggregate demand.  Larry Summers has called this secular stagnation.  We have secular stagnation when even very low interest rates are unable to produce a full-employment level of demand.  The financial bubbles that we experienced in the US and Europe provided an unsustainable solution to the demand problem.  We have not found a way to provide a sustainable solution.

The second problem that requires more focus is the intellectual shift within economics, and among policy makers, that caused us to unlearn much of what we learned from the Great Depression.  Instead of finding ways to stimulate demand, politicians decided to focus on ways to reduce public debt.  That only made the public debt problem worse in many countries because it reduced aggregate demand and tax revenues.  Its hard to reduce public debt in countries with declining aggregate demand.

There is an interesting graph in Krugman's review that was taken from Wolf's book.  It shows the rapid growth in PRIVATE debt that has created the deleveraging problems that have been undertaken by households and by business.  Wolf used the graph to show that much of private debt increase took place within the financial system.  Leverage was used to bolster financial industry profits and Wolf was primarily worried about excessive leverage in the financial industry that led to a credit crunch.

The unresolved problem that Krugman raises, but does not address with a solution, is the secular stagnation problem.  He was primarily concerned about the misuse of austerity during the recession which only prolonged the recession.  He has been fixated on that issue for the last several years.  Longer term, however, we have to produce a level of aggregate demand provides full employment without reliance on credit and asset bubbles which are not sustainable.

In summary, Wolf does a good job of reviewing the factors that led to the financial crisis and Krugman provides an excellent description of Wolf's analysis.  Krugman also does a good job of describing the intellectual shifts in economics and politics that exacerbated the demand problem that should have been fixed.  We are left, however, with western economies that cannot provide a level of demand that is consistent with full employment.

The Criminalization Of Banking

This article describes another criminal scheme that required collusion among the largest banks in the world.  The colluded in the huge foreign exchange market to skim a fraction off of currency trades.  The Justice Department is using emails between traders to press criminal charges against the traders who worked together to manipulate the prices on currency trades.  This is one many schemes that required traders at large banks to collude.  The traders earned larger bonuses by colluding, but they also contributed bank profits and executive bonuses.  Bankers pay tribute to free market capitalism but they prefer a different system that allows them to earn monopoly profits.  The top executives must know what its traders are doing but they are immune from prosecution. 

Friday, October 3, 2014

How To Jumpstart The European Economy

This article assumes that the EZ economy is in an aggregate demand recession.  It argues that a combination of monetary and fiscal policy is required to reverse the negative trend that is underway.  A failure to do so increases the risk of disintegration in the EZ. 

Fiscal policy should be implemented by a 5% tax cut in the EZ.  Tax cuts work faster than increased government spending but they will also increase budget deficits.  They should be financed by lending from the ECB.  That will lead to a devaluation of the euro and stimulate export demand which will help to reduce budget deficits that result from the tax cut.

This proposal runs counter to the treaty that requires EZ members to bring their deficits down to the required target in the near term.  The major opposition to this kind of solution will be political rather than economic.

Thursday, October 2, 2014

Why Do Nation States Promote Trade Agreements That Reduce National Authority?

The US and many European nations have insisted that international trade agreements include a clause that protects investor rights but undermines the rights of nation states to protect their citizens or the environment.  This article describes the investor rights clause that is loved by Wall Street, but which undermines national efforts to protect their own citizens.  The investor protection clause, which was born during the Reagan Administration, and supported by subsequent administrations, describes the misuse of this clause.  For example,  Swedish energy company is building a coal plant in Germany.  The German government demands that the plant disposes of its waste products so that it does not pollute the Elbe river.  The Swedish energy company is using the investor protection to protect its financial interests in the German plant.  The clause requires that a separate court of three judges  hears its case and decides whether Germany is violation of the investor protection clause.  The Swedish energy company is also taking advantage of the clause to dispute Germany's decision to limit the use of nuclear energy.  In other words, Germany's efforts to protect its environment can be subverted by an independent court that is not under its jurisdiction.  That has led Germany and the European Union to exclude the investor protection clause from the Transatlantic Treaty that is being negotiated.  The Obama Administration opposes that effort.

A similar case involves a tobacco company that opposes the rights of the Australian government to insist that it displays the harmful effects of smoking on its packages.  It is using the investor protection clause to limit the ability of Australia to protect the health of its citizens.  The New Zealand government, which is aware of the dispute in Australia, has been reluctant to protect its citizens by requiring a similar warning on cigarette packages produced by foreign firms.

It is clear why multinational corporations support the investor protection clause.  It increases their freedom to ignore the rights of nation states to impact their investment projects.  Wall Street also strongly supports the clause which enables globalization to proceed without interference from national governments.  Its not clear why democratic states support the clause.

The Very Unequal Growth In Income In The US Since 1980 That Is Poorly Understood

The Occupy Wall Street movement correctly pointed out that the bottom 99% has not seen much growth in their income since 1980.  They focused our attention on the top 1% which has seen its income grow by 175% since 1980.  However, the gap within the top 1% is even greater than the gap between the top 1% and the bottom 99%.  The super rich, or the top 0.01% has seen its income grow by 500% since 1980.  The last three decades has not been good for the bottom 99% which has had almost no growth in its real income.  The new phenomenon, however, has been the emergence of a new class as we entered the "Gilded Age" beginning in 1980.  The economic and political deck was rearranged beginning in the 1980's.  The US is back to where it was in the late 1920's.  It will not be easy to end the new Gilded Age.  The super rich have gained control over the economy and the political system.  It is well defended by its supporters who were able to make it into the top 1%.  That includes the lobby industry in Washington as well economists in the conservative think tanks that have grown up since 1980.  They provide the intellectual justification for the growth in inequality and they attack all efforts by government to end the Gilded Age.  The Hoover Institute recently held a party in which conservative economists made the case for the Gilded Age and attacked government intervention in the new economy that made it possible.  Noah Smith gently criticized one of the speeches at Hoover but his criticism was bounded by a consideration of academic courtesy.

This graph illustrates the pattern of income growth that has created the Gilded Age:

Wednesday, October 1, 2014

Why Deindustrialization Is A Good Thing

This study by the Dallas Fed describes the changes that are taking place in the global economy.  Nations typically move from an agricultural economy to an industrial economy.  Productivity improvements in agriculture allow a nation to supply the necessary food products with a much smaller workforce.  The unemployed farmers move to urban areas and take manufacturing jobs.  Eventually, some of the manufacturing jobs move to countries with lower cost labor.  The industrial sector becomes a smaller part of the economy and the services sector expands.  Most of the advanced economies are in the late stages of this transformation they have become service economies.

We are all familiar with this process.  The real issue is how this process has worked out in the advanced economies.  In theory, low skill manufacturing jobs are lost in this process.  The advanced nations retain higher skilled manufacturing jobs, and the industrial sector increases its consumption of high paying services such as consulting, finance and information technology.  Households increase their spending on high paying services such as education and healthcare and everyone is better off except the low skilled industrial workers who need to upgrade their skills in order to participate in the advanced economy.  The advanced economies are at the top of the pyramid in the "knowledge economy".

This paper describes how many nations have gone through this process and it associates the process with increases in per capita GDP which is typically higher in the more advanced economies.  One of the countries that has gone through this process is Japan.  Its economy was at its apex in the 1980's when it became an exporter of manufacturing products to the America and the rest of the world.  Its transformation into a services economy has not worked according to theory.  Economic growth has declined and it has been in a state of recession for decades.  Much of the western world is having a similar experience.  Managing the transition to a services based economy appears to be more difficult than it is described by the Dallas Fed.