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LQD: Palley - Macroeconomic Causes of the Financial Crisis

by NBBooks Mon Aug 10th, 2009 at 10:01:26 AM EST

A big tip o' the hat to disrael  on DailyKos, who caught the latest from economist Thomas Palley, America’s Exhausted Paradigm: Macroeconomic Causes of the Financial Crisis and Great Recession.  

Palley's introduction sets the hook quite well:      

Most commentary has therefore focused on market failure in the housing and credit markets. But what if the house price bubble developed because the economy needed a bubble to ensure continued growth? In that case the real cause of the crisis would be the economy’s underlying macroeconomic structure. A focus on the housing and credit markets would miss that.

I'm  on the road and running late already, so all I'll do here is vigorously urge everyone to read Palley's article in its entirety. Because until people in power, like Larry Summers, starts referring to the problems and solutions Palley identifies, things will never improve for the vast majority of the world's population, and only the behavior of vampire squids will be richly rewarded.  


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European Tribune - LQD: Palley - Macroeconomic Causes of the Financial Crisis
But what if the house price bubble developed because the economy needed a bubble to ensure continued growth? In that case the real cause of the crisis would be the economy's underlying macroeconomic structure.
Maybe my old diary Musings on the savings-glut theory (Oct 17th, 2008) bear rereading:
We then come to the key of Bernanke's savings glut argument:
In this world of massive savings surpluses in a range of important countries and weak demand for capital from non-financial corporations, central banks ran easy monetary policies. They did so because they feared the possibility of a shift into deflation. The Fed, in particular, found itself having to offset the contractionary effects of the vast flow of private and, above all, public capital into the US.
In other words, to the best of my understanding, because China was hoarding US dollar reserves (and also as a result of the popping of the dot-com bubble), the US economy was in danger of monetary deflation and therefore the Fed had to run an expansionary monetary policy of real negative interest rates which kicked off the credit bubble.

...

So, once we manage to blame the Chinese for Greenspan's 18 months of negative real interest rates around 2003, we can say that

The big global macroeconomic story of this decade was, then, the offsetting emergence of the US and a number of other high-income countries as spenders and borrowers of last resort. Debt-fuelled US households went on an unparalleled spending binge - by dipping into their housing "piggy banks".
Except that the US households didn't go on an "unparalleled" "debt-fuelled" "spending binge". I would argue with Jerome that there was an "unparalleled debt binge" fuelled by the desire to maintain a standard of living in the face of declining real incomes.
The inside quotes are from Martin Wolf in the Financial Times - so I am not sure the "people in power, like Larry Summers" are unaware of any of these things. They'd just rather not do anything about it because it goes against their ideas on how the economy should operate, who should benefit, and what the final outcome of the crisis should be.

The peak-to-trough part of the business cycle is an outlier. Carnot would have died laughing.
by Migeru (migeru at eurotrib dot com) on Mon Aug 10th, 2009 at 10:35:41 AM EST
While the article is good, I must protest at this:

Because until people in power, like Larry Summers, starts referring to the problems and solutions Palley identifies, things will never improve for the vast majority of the world's population

Business as usual, especially during the infamous last 35 years, have meant huge improvement in the standard of living for the vast majority of the global population. That the US middle class is not a part of that vast majority is beside the point.


Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Mon Aug 10th, 2009 at 04:32:07 PM EST
I thought the standard of living rose because of WWII? You know, reconstructrion from scratch and fewer people... The only way is up.

--
$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Mon Aug 10th, 2009 at 11:00:25 PM EST
[ Parent ]
Deconstruction.

I've been doing this for too long.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Aug 11th, 2009 at 01:32:07 AM EST
[ Parent ]
I use my own poverty index, which is the number of apparently homeless I see in the streets. For example, by that measurement poverty has increased in Sweden the last twenty years.

That index might be good in some countries, but it works spectacularily bad in Sweden.

Reason: the vast majority of the homeless in Sweden are insane, or heavily addicted to heavy drugs, or most usuually both (known as "double diagnoses"). Pretty much exactly 20 years ago, the massive mental hospitals were dismantled and these people were kicked unto the streets. Earlier they were just locked up, out of sight, out of mind, living their entire lives in completely separate walled-off communities.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Tue Aug 11th, 2009 at 09:39:58 AM EST
[ Parent ]
Well, the money quote was this:

What this actually shows is China and India making great progress. I've seen the disaggregated data somewhere - can't remember where, though - and if you remove China (who very explicitly didn't follow Washington Consensus policies) and India (who did so only to a lesser degree), you don't see that big an improvement.

All the rest of Rosling's figures are aggregates or averages, which can easily mask worsening conditions for the majority of the population.

The history of psychiatric care in Scandinavia is a story in and of itself. Although I think you are seriously mistaken if you believe that the crazy addicts are the majority of the homeless. You can usually tell the addicts and the drunks, and the ones you see in the streets are most often neither. At least not to a degree that warrants outright hospitalisation.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Aug 11th, 2009 at 09:48:05 AM EST
[ Parent ]
What Roslings data show is not that it's just about India and China (and even if it were, that's were almost half of all people live) but it's also about the Middle East, about south and east Asia and about the Americas. It's about everone except Africa which is terminally sucky. But still, even Africa has been improving.

If you consider the issue of averages vs. medians, that might indeed have a large impact on GDP (as you're taught in junior high), but it's pretty hard to believe the same to be true for health. Average lifetimes can't go from from 40 to 70 years just because a minority suddenly lives for 200 years.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Tue Aug 11th, 2009 at 10:03:12 AM EST
[ Parent ]
What Roslings data show is not that it's just about India and China

But they are the ones that he disaggregates.

(and even if it were, that's were almost half of all people live)

But fortunately they are not run by "people like Summers." They are run by people more like Keynes.

If you consider the issue of averages vs. medians, that might indeed have a large impact on GDP (as you're taught in junior high),

... but which, apparently, most economists have forgotten by the time they make it to their first year of university.

but it's pretty hard to believe the same to be true for health. Average lifetimes can't go from from 40 to 70 years just because a minority suddenly lives for 200 years.

Granted. But, again, not run by "people like Summers."

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Aug 11th, 2009 at 10:55:49 AM EST
[ Parent ]
Starvid:
Reason: the vast majority of the homeless in Sweden are insane, or heavily addicted to heavy drugs, or most usuually both (known as "double diagnoses"). Pretty much exactly 20 years ago, the massive mental hospitals were dismantled and these people were kicked unto the streets. Earlier they were just locked up, out of sight, out of mind, living their entire lives in completely separate walled-off communities.
Gee, sounds like the US, including the closing of the mental hospitals (normally attributed to Ronnie Raygun as governor of California). This was part of a worldwide movement of Deinstitutionalization in the 1960's.

The peak-to-trough part of the business cycle is an outlier. Carnot would have died laughing.
by Migeru (migeru at eurotrib dot com) on Tue Aug 11th, 2009 at 09:49:00 AM EST
[ Parent ]
Ha, Reagan ordered that? Here it was done by the naive bleeding heart social liberals, who thought mental hospitals were evil and inhuman and all kinds of bad. Which they, granted, sometimes were, but by the time they were shut down, the irregulartities had pretty much all been ironed out.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Tue Aug 11th, 2009 at 10:06:01 AM EST
[ Parent ]
In the US the policy was the result of a combination of civil rights activism and right-wing libertarian budget cuts.

The mental hospital situation that the deinstitutionalisation movement (which you claim in Sweden took place 20 years after the US) was responding to is illustrated by stories such as one flew over the cuckoo's nest.

The peak-to-trough part of the business cycle is an outlier. Carnot would have died laughing.

by Migeru (migeru at eurotrib dot com) on Tue Aug 11th, 2009 at 10:16:53 AM EST
[ Parent ]
The Palley paper is beautifully framed and well-supported, but duuh, doesn't everyone in power already know this obvious version of the truth?  They've ignored it for greed related reasons and will continue to do so.

I can swear there ain't no heaven but I pray there ain't no hell. _ Blood Sweat & Tears
by Gringo (stargazing camel at aoldotcom) on Tue Aug 11th, 2009 at 12:02:14 AM EST
When an industrial economy hits its resource limits, there are no longer profitable places for real investment.  How then to make a return on one's money?  Thus is a need created for bubbles and scams, which, formerly a peripheral drag on the economy, acquire respected status as its reason for being.  

It remains awkward and embarrassing when the bubbles pop, but rest assured the right people have already cleaned up.  

The Fates are kind.

by Gaianne on Thu Aug 13th, 2009 at 11:41:48 PM EST
I think you're seeing patterns where there are none. For the last 20 years there have been lots and lots of bubbles, while there have been even more protable places for real investment.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Thu Aug 13th, 2009 at 11:54:57 PM EST
[ Parent ]
For the last 20 years there have been lots and lots of bubbles

But US oil production peaked in the 1970s, over 30 years ago.  That was the writing on the wall--that industrial growth was nearing its end.  The new production that came on line in the 1990s was temporary, and was used to buy time, only.  That time has now been spent.  

So the pressure for bubbles, which indeed have "always" been with us (eg. The Dutch Tulip Bubble, the South Sea Bubble) increased at that time.  

The Fates are kind.

by Gaianne on Fri Aug 14th, 2009 at 01:42:46 PM EST
[ Parent ]
Indeed.  And the opportunities for profitable investments came to involve dismantling US companies and shipping the machine tools, work and jobs to China.  And then actually investing capital in China.  The real estate bubble in the US provided the cash to purchase the goods made in China and almost all of the profits went to the top 0.1% of the population, e.g. the Walton Family and financiers on Wall Street.  So the real estate bubble served to "soak" wealth out of the bottom 97% of the US population.  Now many are left only with mortgages debt that is twice the value of the property against which it is secured.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Aug 15th, 2009 at 12:24:20 AM EST
[ Parent ]
The internet bubble was built on an industry that was providing useful services.  But it possibly turned into a bubble because there were relatively few comparable opportunities for profitable investments.  The real alternative was real estate.

The problem does not involve lack of socially useful profitable investments.  These include wind power, upgraded and electrified rail transport, etc. The problem has to do with the lack of socially useful investments with sufficiently high differential profits. Profit expectations have been calibrated in bubble economies.  Profitable and socially useful investments do not offer the expected 16-18% returns the financial class has come to expect.

The problem is preventing further damage by the financial sector in search of unattainable profit margins while waiting for the profit expectations to renormalize.  These clowns think that the 50% declines we have seen in equity markets are a one of aberration and that "recovery" will be a return to those margins.  Given the debt loads and the resource constraints, such a "recovery" is highly unlikely, IMO.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Aug 15th, 2009 at 12:42:26 AM EST
[ Parent ]
Like Starvid said: Bubbles occur independently of resource shortages.

Resource shortages make the crash worse, because they make every economic policy that does not take them into account work worse. But the Americans were happily inflating disastrous bubbles in the late 1920s, when there was no serious resource constraint on the American economy (as evidenced by the fact that Roosevelt could build the US out of the Depression with off-the-shelf technology and familiar project designs, something Obama couldn't do even if he wanted to). And before that, real estate speculation made a name for itself in California in the 1800s. Not to mention the South Sea Bubble.

Bubbles occur when the gamblers take over the casino. And since the casino is, in the short term, completely detached from the real world, there does not need to be any underlying reason for the bubble in the real economy (although there has to be a plausible-sounding excuse - at least plausible-sounding to the gamblers).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Aug 14th, 2009 at 02:38:36 AM EST
[ Parent ]
investments that produce a material, physical return--not investments that produce financial paper only.  

Real investments depend on real resources.  As real resources become short, real investments come to an end.  

Scams and frauds remain, and indeed come to the fore.  That is in fact what is happenning now.  

The corruption of the US banking system is unprecedented, literally.  This is new, and it is happening for a reason--a structural reason.  It is not a matter of corrupt and greedy people--though we have plenty of those!  The constraints of capitalism itself require the corrupt behavior.  It cannot be otherwise.  

My point, in case you have missed it, is  that Europe is not immune to the effects of this process.  

The Fates are kind.

by Gaianne on Fri Aug 14th, 2009 at 01:52:50 PM EST
[ Parent ]


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