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Where we have been and where we are going

by ARGeezer Wed Apr 14th, 2010 at 04:38:12 AM EST

There is a very insightful, very long guest post in Naked Capitalism:

The Origins of the Next Crisis   Edward Harrison    Naked Capitalism

William White, the former chief economist at the Bank of International Settlements (BIS) gave an important speech at George Soros' Inaugural Institute of New Economic Thinking (INET) conference in Cambridge.  While everyone is casting about for the one magic bullet solution which would have prevented this and future crises, he placed the blame for the credit crisis on short-termism, pointing the finger most notably at economists and their models. White said that the models almost all economists use are `flow' models which leave no room for 'stocks' and thus completely miss unsustainable secular trends.

Video of Wm. White here. (18 minutes.)

In essence, White was saying: "it's the debt, stupid."  When aggregate debt levels build up across business cycles, economists focused on managing within business cycles miss the key ingredient that leads to systemic crisis. It should be expected that politicians or private sector participants worried about the day-to-day exhibit short-termism. But White says it is particularly troubling that economists and their models exhibit the same tendency because it means there is no long-term oriented systemic counterweight guiding the economy.

This short-termism that White refers to is what I call the asset-based economic model. And, quite frankly, it works - especially when interest rates are declining as they have over the past quarter century. The problem, however, is that you reach a critical state when the accumulation of debt and the misallocation of resources is so large that the same old policies just don't work anymore. And that's when the next crisis occurs.

Yves Smith was an invited attendee at the inaugural meeting of George Soros's Institute of New Economic Thinking. Edward Harrison is the author of the blog Credit Writedowns, (come the day we actually have some!) and oft times guest contributor at Naked Capitalism, a seeming kindred spirit and, I suspect, to some extent a collaborator with Yves in developing an understanding what has happened in the economy and in finance and what can be done. He has been over some of the ground covered by William White and here he further develops the explaination of why mainstream economists failed to see the GFC coming:

The concentration of economic models on flow

First, from a post called Why economists failed to anticipate the financial crisis"," I echoed White's sentiments when reviewing a widely read piece by Paul Krugman on why economists failed to anticipate the crisis:

   Paul Krugman is a Keynesian. So, his prescription is fiscal stimulus. Have the government pump money into the economy and it will alleviate some of the pressure for the private sector. There is some merit to this argument on stimulus. Many Freshwater economists say monetary stimulus is what is needed. If the Federal Reserve increases the supply of money, eventually the economy will respond. This is what Ben Bernanke was saying in his famous 2002 Helicopter speech at the National Economists Club.

    Yet, I couldn't help but notice that Krugman mentioned the word debt only twice in 6,000 words. In fact, it is in the very passage above where Krugman uses the term for the only time in the entire article. And here Krugman refers to government debt; no mention of private sector debt whatsoever.  I have a problem with that....

    This economic Ponzi scheme is what I have labeled the asset-based economy. As with all things Ponzi, it must come to a spectacularly bad end. One can only Inflate asset prices to perpetuate a debt-fuelled consumption binge so far. At some point, the Ponzi scheme collapses. And we are nearing that point.  We still have zero rates, massive amounts of liquidity, manipulation of short-term rates, manipulation of long-term rates, and bailouts galore a full 15 months after Lehman Brothers collapsed. This is pure insanity.

    The reason economists failed to anticipate the crisis is because they were fixated on avoiding downturns and driving the economy to unsustainable growth rates by using debt to consume today what will be earned in the future. Debt is the central problem. When debt to income or debt to GDP doubles, triples and quadruples, it says you have doubled, tripled and quadrupled the amount of future earnings you are consuming in the present (see the charts here and here). That necessarily means you will have less to spend in the future. It's not rocket science.(Emphasis added.)

Harrison discusses the charts linked in the preceding paragraph and notes that "Debt levels at the end of Q2 2009 are 357% of GDP, a massive increase from the 160% that prevailed in 1982." He then brings up The Doom Loop, citing Simon Johnson and Peter Boone and, of course, himself:

The Doom Loop of ever lower rates and increased leverage

These are not just increases in relative debt loads. We are talking about debt increasing at a rate out of all proportion to the underlying rate of economic growth. This increase in relative debt burdens is quite unhealthy and has created an ever-lower interest rates to prevent economic calamity followed by an ever-increasing severity of financial crisis, the Doom Loop.

    What is the doom loop?

    It is the unstable, crash-prone boom-bust lifestyle we have now been living for some 40 years, where a cycle of cheap financing and lax regulation leads to excess risk and credit growth followed by huge losses and bailouts. With interest rates near zero everywhere, the doom loop seems to have hit a terminal state where debt deflation and depression are the only end game unless serious reform measures are taken.


    Source: The doomsday cycle, Peter Boone and Simon Johnson

    Because these measures themselves are deflationary and depressionary (with a small-d), in my view, they will not be taken.

Simon Johnson described the Doom Loop using pictures of some of the major players from the latest go round the loop (graphic below).

Johnson sees large too-big-to-fail banks at the heart of the problem. Citigroup has been at the center of every major crisis. That is testament to both how important and how dangerous these companies can be. Clearly, these companies are important. For example, the big six banks (JPMorgan Chase, Wells Fargo, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley) own assets equal to 60% of U.S. GDP where it was 20% just a few decades ago. This makes these organizations too big to fail and affords them an implicit federal backstop which tilts the playing field by translating into cheaper funding costs.

Harrison describes how lower and lower interest rates make increasingly large amounts of debt serviceable, how this leads to a debt servicing mentality and then, amusingly, uses Paul Samuelson's vintage 1948 textbook to show how this is unsustainable:

Today few economists regard Federal Reserve monetary policy as a panacea for controlling the business cycle. Purely monetary factors are considered to be as much symptoms as causes, albeit symptoms with aggravating effects that should not be completely neglected.

By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can encourage an increase in the supply of money and bank deposits. They can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves. Result: no 5 for 1, "no nothing," simply a substitution on the bank's balance sheet of idle cash for old government bonds.

Who knew! Samuelson the seer. He could have been describing our current situation from observation, but was basing this on observations made during the '30s. Plus ça change, plus c'est la même chose.

Harrison then cites Richard Koo's presentation at Soros's Forum on the subject of balance sheet recessions. Koo notes that even with zero central bank interest rates there are no borrowers. Businessmen know they are underwater and use earnings to pay down debt. Zero interest rates are useless as a means of stimulating the economy. This is what he calls "a balance sheet recession. Instead of seeking to make profits, businesses are paying off debt. Growth cannot resume until businesses are solvent and if the government ceases to spend, the economy collapses. Japan has been there.

Harrison concludes thus:  

I see the increase in public sector debt in a balance sheet recession as a socialization of losses.  If you look at any economy that has suffered steep declines in GDP, what we have seen are a reduction in tax revenue, an increase in government spending and bailouts. This is true in Ireland, the UK, and the U.S. in particular. In effect, what is occurring is a transfer of the risk borne by particular agents in the private sector onto the public writ-large.  The magnitude of this risk transfer via annual double digit increases in debt-to-GDP is breathtaking.

Finally, these debt levels are unsustainable for the world as a whole.  Japan has been able to run up public sector debt to 200% of GDP because it alone was in a balance sheet recession and its private sector was willing to fund this debt. But, things are vastly different now. Sovereign defaults are likely. The debt crisis in Greece is a preview of what is to come.  Those debtors which attempt to most increase the risk transfer onto the public will soon find debt revulsion a very real problem.  And what will invariably happen is that a systemic crisis will ensue. Fiscal stimulus is warranted, but deficit spending as far as the eye can see risks a catastrophic outcome. This is a very different world than we lived in during the asset based economy. But it also a different world than Japan has lived in over the last two decades.

There are four ways to reduce real debt burdens:

   1. by paying down debts via accumulated savings.
   2. by inflating away the value of money.
   3. by reneging in part or full on the promise to repay by defaulting
   4. by reneging in part on the promise to repay through debt forgiveness

Right now, everyone is fixated on the first path to reducing (both public and private sector) debt. I do not believe this private sector balance sheet recession can be successfully tackled via collective public sector deficit spending balanced by a private sector deleveraging. The sovereign debt crisis in Greece tells you that.  More likely, the western world's collective public sectors will attempt to pull this off. But, at some point debt revulsion will force a public sector deleveraging as well.

And unfortunately, a collective debt reduction across a wide swathe of countries cannot occur indefinitely under smooth glide-path scenarios. This is an outcome which lowers incomes, which lowers GDP, which lowers the ability to repay. We will have a sovereign debt crisis. The weakest debtors will default and haircuts will be taken.  The question still up for debate is in regards to systemic risk, contagion, and  economic nationalism because when the first large sovereign default occurs, that's when systemic risk will re-emerge globally.

I will be the skunk at the garden party and note that the duration of a balance sheet recession brought on by fraudulent investment activities could be significantly reduced were the guilty prosecuted, the fraudulent debts they created are repudiated, and their net worth clawed back as partial restitution. Unfortunately, this requires prying their hands off of the steering wheel. Does anyone know of an example of a parasite that releases a host in order to prevent the death of the host?

Display:
Where we have been and where we are going | 73 comments (73 topical, 0 editorial, 0 hidden)
Re: Where we have been and where we are going (4.00 / 7)
Hence the name of his blog: Credit Writedowns. The private sector is so deeply in debt that the only ways to deal with it are to either write down or write off the debt, or wait a decade for people to pay it off, accepting the anemic-at-best growth that would come as a result of trying to pay back the debt.

US economic policy since 1980 has been to use debt to replace wages and taxes to maintain prosperity and global domination. That approach seems to have hit its limits, but because the political aspects of this policy are now so deeply rooted in American governments, it's proved unusually difficult to dislodge.

And the world will live as one

by Montereyan (robert at calitics dot com) on Wed Apr 14th, 2010 at 02:49:19 AM EST
Re: Where we have been and where we are going (4.00 / 4)
It's not a rocket science indeed. People like Keen, Hudson obseved well, that crises "coincide" with out-of-proportion debt waves, and they are never solved until sufficient deleveraging.

Minsky was especially right: good times lead to loss of any perspective of appropriate credit levels. Only in really good times massive shifts to speculative financing (just to cover the interest) and even Ponzi financing (when escalating refinancing is necessary) could be "normal". Before long, money concentrates in hands of a small minority, that can naively expect opportunities for double-digit returns forever. The volume of financial claims now exceeds the evaluation of annual globe production at least 4 times. So instead of producing and exchanging happily, the world must be concerned how to return more than it has. The compound interest is ticking regardless of economic and physical limitations.

The debt proportion gets only worse when massive market bets have to be honoured at the expense of taxpayers and society. Money is just wealth vouchers, really. What else a rich boy could do with it?

by das monde on Wed Apr 14th, 2010 at 04:13:34 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 2)
Considering the rate at which we are proceeding, a better title for this post might be "Welcome to the Lost Century!"

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Apr 14th, 2010 at 09:57:52 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 2)
People like Keen, Hudson obseved well, that crises "coincide" with out-of-proportion debt waves, and they are never solved until sufficient deleveraging.

I have been trying to trace the intellectual history of this idea. As far as I can tell the first to clearly state it was Veblen. Then came Fisher (who introduced debt deleveraging as a way to explain the Great Depression) but who apparently was unaware of Veblen's work and so has to be considered an independent discovery.

Then Minsky refers to Fisher and debt deflation, while also giving some credit to Keynes' General Theory, but again he omits Veblen.

Keen is explicitly working on modelling Minsky's framework, and Hudson is also talking in Minskian terms (Ponzi Finance).

The brainless should not be in banking -- Willem Buiter

by Carrie (migeru at eurotrib dot com) on Wed Apr 14th, 2010 at 10:09:01 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 2)
Krugman's beloved Keynesian Baby Sitting Coop model shows that recessions can occur without debt. But debt deleveraging turns out to be such a powerful incentive to "hoard" money.

Largely, I see so-called investments as money hoarding as well. The investors do give away money first, but on balance they ask later much more, eventually leading to recession plights.

by das monde on Thu Apr 15th, 2010 at 02:02:41 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 2)
Repeating myself ad nauseam, "investment" in the secondary markets is not investment, it is speculation. This is because unless a financial asset is purchased at issue it does nothing to change the capitalization of a going concern.

The brainless should not be in banking -- Willem Buiter
by Carrie (migeru at eurotrib dot com) on Thu Apr 15th, 2010 at 11:29:09 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
Except that without the secondary markets to provide liquidity the going concern mightn't have been able to get the capital in the first place.
by Colman (colman at eurotrib.com) on Thu Apr 15th, 2010 at 11:33:23 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 6)
That's Keynes' dilemma
The spectacle of modern investment markets has sometimes moved me towards the conclusion that to make the purchase of an investment permanent and indissoluble, like marriage, except y reason of death or other grave cause, might be a useful remedy for our contemporary evils. For this would force the investor to direct his mind to the long-term prospects and to those only. But a little consideration of this expedient brings us up against a dilemma, and shows us how the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is 'liquid' (though this cannot be true of all investors collectively) calms his nerves  and makes him much more willing to run a risk. If individual purchases of investments were rendered illiquid, this might seriously impede new investment, so long as alternative ways in which to hold his savings are availale to the individual. This is the dilemma. So long as it is open to the individual to employ his wealth in hoarding or lending money, the alternative of purchasing actual capital assets cannot be rendered sufficiently attractive (especially to the man who does not manage the capital assets and know very little about them), except by organising markets wherein these assets can be easily realised for money.


The brainless should not be in banking -- Willem Buiter
by Carrie (migeru at eurotrib dot com) on Thu Apr 15th, 2010 at 11:43:35 AM EST
[ Parent ]
liquidity dilemna (4.00 / 3)
Can't it be solved rather simply with a small transaction tax which changes little to the ability to go out, but limits the extent of speculative movements. If small enough, it will restrain trade but not kill liquidity completely.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Sun Apr 18th, 2010 at 05:56:10 AM EST
[ Parent ]
Re: liquidity dilemna (4.00 / 2)
That would kill the noise trading and program trading, yes. Which would be valuable, but would do little to restrain the wholesale delusion of a genuine speculative bubble. For that, you need targeted policies of moral suasion, precise fiscal intervention and (when the bubble is being financed by increasing debt load for speculators) narrow but heavy-handed monetary intervention.

If prices are going up, Ponzi style, at 5 % a month, the speculator will be entirely unperturbed and only mildly inconvenienced by a transaction charge of 1 %.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun Apr 18th, 2010 at 06:24:31 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 2)
But in non-growing regimes, productive investments become worse than direct hoarding as well. Actual entrepreneurs are ripped off by rentiers (of real estate or capital) just enough to have minuscule margins over alternative pursuits. Like in Henry George's theory, all gains from productivity improvements go to rentiers.
by das monde on Thu Apr 15th, 2010 at 09:26:41 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
Hence the name of his blog: Credit Writedowns

Indeed, and the name of Steve Keen's blog, DebtWatch. Steve was making many of these points about debt levels last year and has graphs showing various debt levels, private, governmental, total, vs. GDP. But I was up way past my bedtime as it was.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Apr 14th, 2010 at 09:56:13 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 3)
Well, as we know the Fed stopped looking at the M3 money supply in 2006. That's another measure that correlates with the total stock of debt.

The brainless should not be in banking -- Willem Buiter
by Carrie (migeru at eurotrib dot com) on Wed Apr 14th, 2010 at 09:51:42 AM EST
Re: Where we have been and where we are going (none / 1)
People get alarmed when they see a "hockey-stick" in an important graph. John Williams had some posts on this subject. Wouldn't want to spook the troops.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Apr 14th, 2010 at 10:00:17 AM EST
[ Parent ]
Re: Make it Five Ways (4.00 / 2)
European Tribune - Comments - Where we have been and where we are going

There are four ways to reduce real debt burdens:

   1. by paying down debts via accumulated savings.
   2. by inflating away the value of money.
   3. by reneging in part or full on the promise to repay by defaulting
   4. by reneging in part on the promise to repay through debt forgiveness

I believe that there is a 'Fifth Way' solution through a new approach to equity, using legal frameworks based not upon Companies but upon partnership principles - although trust law could work after a fashion.

Conventional approaches are aimed at the quantity of legal claims over productive assets, particularly land. A debt/equity swap approach acts upon the quality of claims, by removing the repayment date.

Qualitative Easing, in other words.

.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Apr 14th, 2010 at 10:53:46 AM EST
Re: Make it Five Ways (4.00 / 3)
Since the wealthiest 0.1% of the US population probably hold, directly or indirectly, over 70% of the total debt in the U.S. economy, excluding foreign debt holders such as China, and since they or their representatives are among those who have captured Washington D.C. I am sure they would prefer your solution to my favorite:

I will be the skunk at the garden party and note that the duration of a balance sheet recession brought on by fraudulent investment activities could be significantly reduced were the guilty prosecuted, the fraudulent debts they created are repudiated, and their net worth clawed back as partial restitution.

Even in a partnership relation such as you propose the fraudsters would remain the ones with the claims on wealth. I find this morally repugnant, but then I have found most of what has happened, especially since 1980, morally repugnant. I suppose we could do both. First change the debt into an equity partnership and then prosecute the fraudsters and use clawbacks to finance Bruce's Brawny Recovery and/or buy back shares of the equity partnership, if that seemed desirable. I don't know how that might play out.

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

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Apr 14th, 2010 at 11:27:47 AM EST
[ Parent ]
Re: Make it Five Ways (4.00 / 2)
Since the wealthiest 0.1% of the US population probably hold, directly or indirectly, over 70% of the total debt in the U.S. economy

Well, the private share of the US public debt is quite small, so the wealthiest 0.1% do not own it directly.


source: wikipedia

But, indirectly, since the top 1% own a huge share of the financial wealth, they certainly have a disproportionate influence on the economic and political decision-making.

source:Who Rules America: Wealth, Income, and Power

"Ce qui vient au monde pour ne rien troubler ne mérite ni égards ni patience." René Char

by Melanchthon on Fri Apr 16th, 2010 at 03:51:03 AM EST
[ Parent ]
Re: Make it Five Ways (none / 1)
Considering that much of what is shown as belonging to the Fed, >50%, is "trash" they are holding for TBTFs and that the next largest portion, >30%, of the pie is held by foreign governments and individuals, and the third largest amount is held by state and local governments, over 80% is thereby accounted for. Of that I excluded the portion held by foreigners.

The Fed is subservient to the banks it is supposed to regulate, who are largely owned by those in the very top percentile, so an argument could be made that that money is effectively controlled by the very rich. Depository institutions and insurance companies are disproportionately owned by the very rich and recent events have shown the extent to which the market manipulators can profit from pension fund monies at the expense of the funds, so....

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

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Apr 16th, 2010 at 06:59:51 AM EST
[ Parent ]
Re: Make it Five Ways (none / 1)
This is ownership of US Treasuries, so there is no trash there. I expect that most of that intragovernmental amount is the SS accumulated surplus, so that's actually debt to ordinary Americans.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Sun Apr 18th, 2010 at 05:59:22 AM EST
[ Parent ]
Re: Make it Five Ways (none / 0)
None of the Maiden Lane "facilities" have any Treasuries. I am not certain if or where the GSEs would appear on that pie chart.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Apr 18th, 2010 at 11:11:13 AM EST
[ Parent ]
Re: Make it Five Ways (none / 1)
That chart is about ownership of US Treasuries (who owns them), not about what the public financial institutions own (US Treasuries and other stuff).

Wind power
by Jerome a Paris (etg@eurotrib.com) on Sun Apr 18th, 2010 at 03:13:17 PM EST
[ Parent ]
Re: Make it Five Ways (none / 0)
Funny what your mind will omit!

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Apr 18th, 2010 at 03:37:33 PM EST
[ Parent ]
So, what's the policy narrative here? (4.00 / 4)
What's the recommendation, and why should that recommendation be followed, and whom will benefit most from it, and whom will be burdened by it?

There is a tendency to over-think debt problems, and much of the over-thinking is expended upon trying to fit the issue of too much debt into one's already prescribed political remedies, so that's why it's important to pin down the narratives at play first.  An argument that there may exist a 'global debt crisis' can be used to encourage policymakers to de-prioritize the interests of less well endowed members of society in order to prioritize the interests of people whose livelihoods and power depend much more upon social contrivances such as bond markets, sovereign debt, and private capital markets.  I'm worried that this is precisely how the "global financial system is doomed" narrative will be used.  

There is really nothing mysterious about debt, which is the mirror of credit. An unsustainable level of debt or debt growth just means that people are making more claims upon social resources than can likely ever be met, so some people will fail to live up to their commitments to others, and other people will be disappointed that others failed to deliver the resources that were promised to them.  Big deal. This could become a major social drama or crisis, but it could just as well fizzle away as individuals privately and gradually adjust their expectations regarding their own wealth to more a realistic understanding of the capabilities of their partners to provide the resources that they had previously promised to obtain.

It becomes a crisis if a sufficient mass of political leaders (people with followers) deem it necessary to elevate the debt problem to something requiring substantial applications of political power to resolve in favor of one group of people or another.  So given that there are voices who now advocate the need to do something politically about the "debt problem," it's kind of important to know the details of the policies that those voices are prescribing, if any, and whom will benefit or be burdened by them. It might, after all, be better for more people, particularly the poor or those less dependent upon global capitalism for their lifestyles, to do nothing at all about it. (Or it might not, but that's what we should know about this before advocating something one way or another.)

by santiago on Wed Apr 14th, 2010 at 11:40:26 AM EST
Re: So, what's the policy narrative here? (4.00 / 3)
It becomes a crisis if a sufficient mass of political leaders (people with followers) deem it necessary to elevate the debt problem to something requiring substantial applications of political power to resolve in favor of one group of people or another.

Unfortunately, this seems to be the course taken to date, with bad loans from which Wall Street profited now being transferred to GSEs with taxpayer guarantees. I am all in favor of writing down bad debt and forcing banks to acknowledge the true value of the "assets" on their balance sheets. But very few in Washington have any appetite for this. Almost every action to date has been to hide bad assets, relax accounting standards, bail out the perpetrators and ignore the fraud.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Apr 14th, 2010 at 02:33:39 PM EST
[ Parent ]
Re: So, what's the policy narrative here? (none / 0)
I know what you mean, but I think it is still more ambiguous than that.  For example, did "Wall Street" really profit from the "bad" loans? Or did just some people on Wall Street -- mainly those who repackaged them and re-sold them to other investors as securities profit while many others suffered losses from them? And what about main street?  Did everyone on main street really suffer from the bad loans, or didn't quite a few people obtain loans for properties they otherwise would not have been able to, most of them profiting from them, even if many of them, and others, have ended up losing their homes as a result of the recession?  

Finally, what would have happened and whom would have been hurt most if governments did not bail out the suddenly insolvent banks? Would the crooks that caused the problem really have faced some kind of justice, or would a more complete collapse in lending than what actually occurred have just result in even more innocent bystanders losing their jobs and homes due to an unnecessarily exaggerated economic crisis. Sometimes it's good policy to let crooks off easy --  even with their loot -- in order to save many more people from deprivation.

by santiago on Wed Apr 14th, 2010 at 05:45:11 PM EST
[ Parent ]
Re: So, what's the policy narrative here? (4.00 / 5)
There were, of course, victims and predators on Wall Street and winners and losers on Main Street. Goldman Sachs and J.P. Morgan were highly successful predators. A.I.G., Bear Stearns and Lehman Bros. were unsuccessful would be predators who ended up as victims. The taxpayers as a class are victims via the toxic mortgages stuffed into GSEs and, quite likely, from much of the "trash" the Fed has taken in return for "cash".

On Main Street I was a winner. I bought for 3% down at $2 in '99, sold at $5.6 in late '07 and ended up with no debt, a larger house on 1 1/4 acre in Arkansas free and clear and more than the house cost me in the bank. I could smell the fraud after 2003. Fortunately, I was close to retirement age and had the money to survive until I was 65 and started drawing SS and got Medicare. Even better, I continued to have work in LA through '07 at my consulting rate, even if it cost me more for travel and accommodations. But the GFC trashed my business and I made very little last year. All in all, we have been very fortunate.

Deciding whether to let looters get away with their loot in order to save the innocents would and should be a painful decision, but it was never really made. I have seen little evidence that prosecution of fraud would disrupt the economy. More likely is that it would deter future fraud, but, as yet, it isn't even on the table. However, in the first few days of this week I have seen mention of massive fraud in several mainstream media outlets, including the NBC Nightly News, the New York Times and the Arkansas Democrat Gazette. Possibly some WaMu executives could be charged. That would be a start. But I am not holding my breath.

Were vigorous fraud prosecutions to take down all of the TBTFs it may product some temporary dislocations, but, if done properly, it would also result in writing down much of the bogus debt which is currently strangling the economy and cutting "Wall Street" to a half or a third of its present bloated size would be a net plus for the economy as it would remove a massive parasite from the body politic and economic. It would also make easier instituting needed reforms to redress the current extremes of wealth distribution which are also strangling the economy, IMHO.

The whole GFC could be readily dealt with could we only find a way to bulk erase the poisonous programming that has been written into the popular mind over the last forty years regarding the nature of the society and economy. That legacy is the true problem.

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

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Apr 14th, 2010 at 07:43:45 PM EST
[ Parent ]
Re: So, what's the policy narrative here? (4.00 / 2)
Fraud should always be prosecuted, no ifs and or buts.  But the real crooks -- the ones who are behind the crisis -- are too slick to have done anything truly illegal, mostly because the rules were written by or for them regarding financial deregulation. It wasn't law breakers that caused the crisis.  It was that the laws themselves were created to allow such crises to occur and for many to profit from such conditions.  The real perpetrators are guilty of grave moral failings, not legal ones, for the most part.

And, just as it is often counterproductive during a war to be overzealous of justice during negotiations for peace with perpetrators of great crimes, it would have been wrong for central bankers and government regulators to be threatening private bankers with legal actions when their cooperation was still needed to avert a still wider financial panic. Only now, when the damage has been averted and there is little more that can happen due to bad bankers, some measure of justice can be sought, through courts or through policy changes.

by santiago on Wed Apr 14th, 2010 at 09:23:36 PM EST
[ Parent ]
Re: So, what's the policy narrative here? (4.00 / 2)
It wasn't law breakers that caused the crisis.

Agreed. See this comment and Yves' linked post about Magnetar. If we could get some convictions at the WaMu, Lehman, Bear Stearns, Citi level, or at the level of mortgage brokers and aggregators, then we could at least have the makings of a scandal and could start up the chain. But, to date, there is nothing. TPTB possibly don't want ANY real investigations and prosecutions for fear of things unraveling. I don't know for sure, but strongly suspect that is the case. Perhaps the strategy is to push it down the road until Obama leaves office. It is such bad form, you know, to prosecute the members of previous administrations. Obama has taught us that.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 15th, 2010 at 01:27:41 AM EST
[ Parent ]
how not to be a crook (4.00 / 2)
Dylan Ratigan had a puppet show segment explaining the financial crisis.

Enjoy.

http://www.msnbc.msn.com/id/21134540/vp/36522064#36522064

Wind power

by Jerome a Paris (etg@eurotrib.com) on Sun Apr 18th, 2010 at 06:04:04 AM EST
[ Parent ]
Re: So, what's the policy narrative here? (none / 0)
ARGeezer:
ignore the fraud.

ignore....as in reward?

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Thu Apr 15th, 2010 at 05:03:26 AM EST
[ Parent ]
Re: So, what's the policy narrative here? (none / 1)
Successful fraud is its own reward.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 15th, 2010 at 10:26:44 AM EST
[ Parent ]
Debt and the American Way of Life (4.00 / 6)
.
An excellent article from 2002 with explanation of today's economic and financial collapse due to debt.

The Last Wave by James J. Puplova

National Debt

As the graph of total American debt illustrates, America has now become the largest debtor nation in the world -- a trend that is not sustainable. No nation can borrow its way to prosperity in perpetuity. From our government and corporations to its citizens, debt permeates every sector of the American economy. One of the hallmarks of America's economic boom years during the 80's and 90's was the remarkable change in individual financial behavior. Individuals went from the accumulation of liquid assets to illiquid assets to the addition of liabilities. Mass marketing of debt and the disintermediation of credit in the financial system lessened the appeal of cash with consumers.

Net household liquidity turned negative as individuals transferred liquid cash savings into less liquid securities with stocks, bonds, and mutual funds. The higher returns offered by financial assets made the financial markets that much more alluring to all sectors of society. From senior citizens dependent on investment income to pay bills to younger indebted households looking for higher returns to supplement the lack of savings, financial assets replaced cash. As memories of the depression and post-war hardships faded, a new generation of Americans took to the credit markets like a duck to water.

The thrift-conscious, buy-with-cash culture has disappeared. The revolution in the credit markets, the wave of technological change in the financial industry, and the plethora of financial products and means for borrowing money has been embedded in the American way of life. The willingness with which debt is assumed is one of the more dominant aspects of the American economy. From the ubiquitousness of credit cards, home mortgages, home equity loans, margin debt, to installment debt, credit has securitized and mortgaged the entire asset base of the U.S. economy. We have become our own worst enemy and day after day, we sink deeper in debt.

● Reaganomics

"But I will not let myself be reduced to silence."

Hasbara is a dead language

by Oui (Oui) on Wed Apr 14th, 2010 at 11:46:49 PM EST
[ Parent ]
Re: Debt and the American Way of Life (4.00 / 6)
All of that presumes that a nation as powerful as the US actually has to pay back all of its debt to those who have provided her with credit.  And that's just not true, nor is it consistent with historical precedence for the behavior of states and empires. Following Mancur Olson, we can think of states as the institutional outcomes of conflicts between two categories of bandits -- stationary bandits who rob people within a given geographical domain and mobile bandits, or pirates, who rob people in one place and then move to a different place.  States, he argues, are the outcome of a temporary victory of stationary bandits over mobile pirates (who are now manifest as multinational corporations among other things).  What's interesting with this analogy of political affairs is that it means that this assertion by the author you quote is probably not true:

No nation can borrow its way to prosperity in perpetuity.

If we substitute the word "plunder" for borrow, we see that very strong polities, as well as other powerful organizations of bandits can, and historically do, plunder indefinitely, often only meeting their end when losing contests for power with other similar groups. To believe that a nation cannot borrow indefinitely is to assume that nations and other political groups don't engage in plunder, which just isn't supported by the historical evidence.  

There's nothing, therefore, inherent in the international financial system to prevent a dominant political power such as the US from simply stealing in order to escape debt and manage its multiple constituencies. Only successful political challenges, from within or without, to its power to do that can really prevent the US from perpetually borrowing and plundering forever.

by santiago on Thu Apr 15th, 2010 at 12:18:57 PM EST
[ Parent ]
Re: Debt and the American Way of Life (4.00 / 4)
This is certainly consistent with the history of Rome. In the early days it was farm and market for about a year and ten months, then go plunder one of your neighbors. About every two years the red planet, Mars was in the evening sky--a signal to get ready for war. The genius of Rome was to incorporate the leading citizens of conquered people into the Roman state, thereby expanding the extent and power of the state.

This policy of periodic war and bringing home plunder was the equivalent of always running a significant trade surplus, which gives the government and people all of the good options for the economy, as outlined by Robert Parenteau. (The Romans might not have had economists but they certainly had an economy!)

In the end there was no one left that it made sense to conquer, Rome was a victim of its own success and had to start spending money on defense of its existing empire. This was a lot less profitable. Plus there was no growth. Then Constantine abandoned the troublesome nobility of Rome and the Bishop of Rome and moved his capital to Byzantium, effectively starting again in the richest, most populous part of the old empire. The remnants of the old empire in the west then had 700 years or so to work things out with the Germans, Slavs and Gauls. The Western Europeans took their revenge during the Fourth Crusade with the sack of Constantinople.

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

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 15th, 2010 at 07:54:14 PM EST
[ Parent ]
Re: Debt and the American Way of Life (4.00 / 3)
ARGeezer:
This policy of periodic war and bringing home plunder was the equivalent of always running a significant trade surplus

I don't think so. Running a trade surplus leads to people having your stuff and you accumulating promises. Plunder means you get their stuff and they get nothing. The effects on production and employment of the two should be opposites.

by generic on Thu Apr 15th, 2010 at 08:20:22 PM EST
[ Parent ]
Re: Debt and the American Way of Life (4.00 / 6)
Actually in Roman times plunder meant you got their stuff and you also got them - or some of them, at least.

Ricardo might not have approved - it's not clear how slavery affects comparative advantage - but while the Empire was expanding it was almost a net economic gain for everyone in the newly captured area.

Once people recovered from the immediate loss of losing a year's harvest and having their royalty sold into slavery, it didn't take them long to realise that they now had access to a much bigger trading area.

Even with the punitive corrupt taxation - second only to slavery as a form of tribute - Rome was a huge and very active trading bloc. After the fall it took a millennium for trade to recover to the same levels.

Unfortunately empires happen because they're such an effective way of concentrating and monopolising resources. Free trade is a poor substitute for stealing stuff and using people.

This why empires are the logical consequence of market ideology. They're joined at the hip. Once you have an unregulated competitive market economy, the only way you can avoid self-defeating levels of wealth concentration, political corruption and aggressive imperial plunder is by military force.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Apr 15th, 2010 at 08:58:12 PM EST
[ Parent ]
Re: Debt and the American Way of Life (4.00 / 2)
Leading merchants get incorporated as merchants. Male Nobility gets slaughtered, female nobility, depending on age, possibly had other uses. Titus Andronicus shows some extreme possibilities.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 15th, 2010 at 09:17:49 PM EST
[ Parent ]
Re: Debt and the American Way of Life (4.00 / 2)
You don't need to run a trade surplus if your trading partners are willing to lend you their resources, at effectively negative interest rates, so that you can buy their goods. Lending to the US in dollars only to be repaid at a later date in devalued dollars results in lending at effectively negative interest rates, and the only reason anyone would do that is because they have no other choice -- they have been coerced and plundered by the more powerful partner.  That's the connection between borrowing and plunder in a modern empire.
by santiago on Thu Apr 15th, 2010 at 10:38:10 PM EST
[ Parent ]
Re: Debt and the American Way of Life (none / 1)
This, however, looks only at the stock of finished goods.

If the people who lend money to you at sub-zero interest rates are playing a long chess game and you're playing a short-term next-quarter game, they'll end up with all the productive power, and you'll end up with a structural import dependency.

And the guy with the industrial capacity is the guy with the power. Steelmakers can survive longer without bankers than bankers can survive without steelmakers.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Apr 17th, 2010 at 09:06:51 AM EST
[ Parent ]
Re: So, what's the policy narrative here? (4.00 / 7)
What's the recommendation, and why should that recommendation be followed, and whom will benefit most from it, and whom will be burdened by it?

A key observation might be that this predicament has no easy solutions or levers. Look at the "lost decade" of Japan, the long Great Depression. Governments tried sensible things, people made rational decisions. But the simple fact is: there is a huge volume of nominal indebtedness that presses painfully most people, and takes away all steam out of productive economy. Credit evaluations turned out to be that much of target, massively.

In the second video of the linked Naked Capitalism post, the Japanese guy explains how things are stuck in Japan. Quite possibly, policy makers know this angle of deep recessions well, and they are aware of this helplessness. But they can buy time by throwing theories at us about innovation in capitalism, "monetary phenomena", Central Banking instruments, and what not. As Keynesians observed, the character of recessions have nothing to do with issues of technology, productiveness, competitiveness and other "fundamentals". Technology or asset bubbles, stimulated growths can lead to recessions - but not to help out.

And social issues eventually cannot be avoided in this discussion. Wall Street did not really suffer that much, after all. Most of those guys still wear suits, drive good cars, even if their balances switched to minus a million. They really have special privileges when it comes to enforcement of their contracts and bets. Big investors may be "loosing" millions, but their life is objectively not worse. The situation is: a big majority of people have to work hard for ever smaller rewards (or loose everything they got), while a small minority enjoys all comfort and future credit claims. This is the dead end economy of stifling privileges that classical economists (including Adam Smith) tried to resolve.

by das monde on Thu Apr 15th, 2010 at 02:50:03 AM EST
[ Parent ]
Re: So, what's the policy narrative here? (4.00 / 6)
Systemic fraud leading to a balance sheet recession is an economic problem that has to be solved by legal and political means. Fortunately for Wall Street, the 40 year long effort at indoctrination of the public into their version of "separate spheres" of economics and politics, including the autonomy of economics and its Neo-Classical nature have largely succeeded. It is that purchased consensus that insulates the political dominance they have achieved from assault--that and the fact that, until recently, few people were aware of and even fewer were publicly articulating the nature of this relationship.

Exposure of the relationship between Wall Street and Washington is beginning to seep into the public consciousness. Discussion of the extent of the fraud is beginning in the mainstream media. We may be awaiting a crystallizing moment that will dominate public awareness and lead to serious and determined demand for change. Else it is going to be a long, lost century, if not world.

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

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 15th, 2010 at 10:45:27 AM EST
[ Parent ]
Re: So, what's the policy narrative here? (none / 1)
It becomes a crisis if a sufficient mass of political leaders (people with followers) deem it necessary to elevate the debt problem to something requiring substantial applications of political power to resolve in favor of one group of people or another.

The problem is that the default expectation is that default is unacceptable. In other words, the current status quo is that political power will be applied to resolve the imbalance in favour of the creditors. Which will kill the real economy dead.

If the political consensus were that creditors who extended ill-advised credit just had to suck it up and write off the bad debts as unenforceable, the real economy would not be harmed by the need to de-leverage, because it could all be done with pure balance-sheet operations that don't involve any tangible goods or long-term cash flow commitments.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Apr 17th, 2010 at 08:57:56 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
Krugman:
..you are consuming in the present..

People are not "consuming" with this debt. They are buying "assets."

by kjr63 on Wed Apr 14th, 2010 at 07:38:19 PM EST
Re: Where we have been and where we are going (none / 1)
If they were truly assets, there would not be a problem with the debt.  The sheet would either balance or tip toward the asset side.  The problem is that assets which turn out to have less value than originally believed really are a form of consumption, not investment, causing the balance sheet to tip instead to the liability side, which lets everyone know that some people are going to end up disappointed in their expectations for wealth.
by santiago on Wed Apr 14th, 2010 at 09:28:21 PM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 4)
Jerome has appropriately called these counterfeit assets. They had just about the same effect as would have the introduction of a similar quantity of counterfeit money into circulation and having that counterfeit go undetected for several years. Except here the amount of counterfeit is comparable to or exceeds M1.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 15th, 2010 at 01:41:11 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 3)
If they were truly assets, there would not be a problem with the debt.

On the contrary. Consumption "consumes." So, it "circulates." Consuming debts are not a problem unless there is an inflation. "Assets" instead do not "consume" nor circulate. Asset debts remove money out from circulation and reduce wealth creation.

..The sheet would either balance or tip toward the asset side.

No. It would mean wealth transfer from labour and investment to property.

The problem is that assets which turn out to have less value than originally believed really are a form of consumption, not investment..

No. Consumption and investment are chicken and egg. They are the same thing. Overvalued assets are taxes to wealth creation and reduce circulation. They are lottery tickets.

..causing the balance sheet to tip instead to the liability side, which lets everyone know that some people are going to end up disappointed in their expectations for wealth.

Disappointed in their expectations for wealth extraction.

by kjr63 on Thu Apr 15th, 2010 at 03:39:55 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
You're introducing a lot of alternative ideas and definitions for pretty standard accounting terms here. You might be right, but since your model of how the world works and your alternative definitions of terms don't appear to be the 'standard' ones of common usage (neither Marx nor Milton Friedman, for example, would understand how you're using your terms) you're going to have to be more explicit regarding how you think the world works in order to be compelling.
by santiago on Thu Apr 15th, 2010 at 11:25:00 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
These are not mine.. I believe these are from Adam Smith. Marx would surely agree with these "ideas."

We have three means of production, land, labour and capital. Labour and capital create economic surplus, rents extract from surplus. Problem with Marx is that he thought industrial monopolies will extract all wealth, also rents. But that is not what is happening.

by kjr63 on Thu Apr 15th, 2010 at 03:24:24 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
I think your ideas are in the right direction, and may very well be consistent with how Marx and Smith believed the world worked, but you seem to be attaching meanings to words like "consumption," "asset," "investment," and "circulation" that Marx and Smith, as well as Krugman, would have trouble following without a more explicit explanation from you.  You have a semantic dispute, and not an idea dispute, with Krugman.  I think you and Krugman would probably believe the same things if you both agreed on the same definitions of words, is what I'm saying.  For example, "asset" is an accounting word, referring to the asset side of a double-entry accounting balance sheet that must be balanced against claims by others on the real resource behind the asset, called "liability."  Accounting, however, is just a method for trying to keep people honest with their transactions over space and time, and not anything that is fundamentally connected to the world of real things.  

An asset is a positive entry on a balance sheet and represents a real investment only insofar as that investment has the value that the bookkeepers' ledgers say it does. If someone borrows resources to buy the asset, the loan gets entered as a liability in the books. Lot's of times, people and firms invest in assets with the expectation that their value will be retained or will produce income sufficient to offset the liability of a loan. But when it turns out otherwise, the failed "investment" is the same thing when dealing with real resources as if it had been a consumption expenditure with no expectation for a positive return, just present enjoyment or use value.  That's why Krugman is on target when he uses the word "consumption."  He's referring to what happens to real resources not accounting identities -- the real resources got consumed in the moment and their value is depleted now and not available anymore for producing more real resources, which is going to cause a problem for the poor bankers who lent their wealth and credibility in order to buy the "assets."

by santiago on Thu Apr 15th, 2010 at 03:59:50 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
You make it sound like the bankers are the victims here...

The brainless should not be in banking -- Willem Buiter
by Carrie (migeru at eurotrib dot com) on Fri Apr 16th, 2010 at 02:13:52 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
That's a really good point, but the question is, since the problem is essentially that some borrowers are failing to make good on their obligations to repay their loans (and loans given at historically LOW interest rates, for the most part), WHY aren't bankers the victims here?

To answer this, we have to break out of the rules of the system and account for the fact that bankers are simply more powerful people in society, as a class, than borrowers are, and they are not the victims here precisely because they are the ones who made up the rules that borrowers and themselves must try to follow.  And those rules are what allowed borrowers to be given more credit than was their due, not the borrowers themselves.

by santiago on Mon Apr 19th, 2010 at 07:53:43 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
That and the fact that the bankers helped inflate a property bubble.

If you borrow € 1 mil to buy a house that is really only worth € 0.5 mil, pay off € 0.2 mil out of your ordinary income before going underwater when the price resets to a more realistic value, then you've lost € 0.2 mil relative to the scenario where the housing market didn't suffer from a bubble. Plus the expense of bankruptcy and the inconvenience of foreclosure...

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 20th, 2010 at 06:25:31 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
First i have to say, that Krugman is a nobel price winner i'm an amateur.

Lot's of times, people and firms invest in assets with the expectation that their value will be retained or will produce income sufficient to offset the liability of a loan. But when it turns out otherwise, the failed "investment" is the same thing when dealing with real resources as if it had been a consumption expenditure with no expectation for a positive return, just present enjoyment or use value.  That's why Krugman is on target when he uses the word "consumption."

I don't buy this explanation. Speculative losses on "assets" are "consumption?" Of course Casino needs labour, but that is not not where the money went. This money just circulates in the financial sector from pocket to pocket. Of course one can call this "consumption" from individual's point of view, but they did not "consume" in an economic sense. They gave their money away.

..He's referring to what happens to real resources not accounting identities -- the real resources got consumed..

No real resources were consumed. They just gave their money away. And now it is available to the receiver to be consumed. Nothing happened in the real economy. only the "savings" got reallocated.

..in the moment and their value is depleted now and not available anymore for producing more real resources, which is going to cause a problem for the poor bankers who lent their wealth and credibility in order to buy the "assets."

They don't have the money to produce more real "stuff", but somebody else has. So nothing was "lost," no "surplus" was lost and no surplus was created.

Now the beneficiary of these capital gains goes to the bank and makes a deposit. Bank gives out more loans to cover it's losses and all is well again. As long as there are debtors.

by kjr63 on Fri Apr 16th, 2010 at 03:21:43 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
i add here that with "assets" (in quotation marks) i mean financial assets, not "real" assets like machines or buildings etc. Also financial "assets" are on asset side in the account books.
by kjr63 on Fri Apr 16th, 2010 at 06:46:29 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
Consumption = resources consumed today.  
Investment = resources not consumed today in order to provide more resources tomorrow.
(Contrast investment with Savings, not part of our discussion = resources not consumed today but simply held until tomorrow with no expectation of providing more resources tomorrow.)

Therefore, if a speculative investment goes bad, it is equal to consumption -- it's not providing more resources for tomorrow, and its expenditure precludes other consumption or investment. To illustrate think of the difference, vis a vis the US, between WWII and the Iraq war.  Both involved very significant expenditures of national resources, but only WWII turned out to be an investment because the US won the war at low enough costs to reap the (very significant) economic benefits, repaying its debts in the process very quickly.  In Iraq, although the US has apparently "won" the war, having successfully removed Saddam Hussein from power, the costs turned out to be much  higher than had been anticipated so no economic benefits could be reaped and, unlike WWII, the adventure has effectively prevented other US consumption or investment, which means that expenditures in that war must be categorized as consumption.

So, yes, speculative losses on assets are consumption, even if after the fact, because speculative losses mean that resources are no longer available for other uses or for providing more resources for tomorrow.  An investment that goes bad is a form of consuming, not preserving, economic resources, regardless of the intention when the resources (real or not) were initially expended.

by santiago on Fri Apr 16th, 2010 at 09:55:51 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)

Consumption = resources consumed today.  
Investment = resources not consumed today in order to provide more resources tomorrow.

Consumption = buying produced goods and services.
Investment = buying produced goods and services.
Savings = resources not consumed today in order to provide more resources tomorrow.
Speculation = buying claims on wealth in the hope of "profit."

by kjr63 on Fri Apr 16th, 2010 at 03:23:06 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
That's what I mean.  You're using different definitions of the terms than Krugman (or Marx, Smith, or most anyone else) would use, so you're having just a semantic argument, not an argument over different ideas. Try thinking it through using the more common meanings for the words that I gave above, and I'll think you'll see that you and Krugman are on the same page.
by santiago on Fri Apr 16th, 2010 at 04:04:46 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
Investment = resources not consumed today in order to provide more resources tomorrow.

If we say that investment = savings we are not talking about semantics, we are talking BS. And oh boy, there is a lot of it.

by kjr63 on Sat Apr 17th, 2010 at 12:40:35 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
kjr63:
If we say that investment = savings we are not talking about semantics, we are talking BS.

That's not what santiago said.

by generic on Sun Apr 18th, 2010 at 08:19:29 AM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 3)
Consumption = resources consumed today.  
Investment = resources not consumed today in order to provide more resources tomorrow.

Money | resources. In a functioning monetary economy, money can command resources.

But simply increasing the prices of - say - houses does not (ignoring for the moment any distorted incentives towards new construction) consume any real resources.

So I think you need another term here:

Consumption: Resources consumed today.
Investment: Resources used in ways that increase usable resources at a later date.
Speculation: Making promises about the allocation of resources that are presumed to be available at a later date.

Speculation does no harm (except inasmuch as it can fuel a consumption binge) until it has to be unwound.

This is not simple nitpicking. There is an important difference between consuming resources that you thought you were investing and oversubscribing future resources. While both result in a shortage of resources at some future date, the former wastes resources and sets unrealistic expectations, while the latter only sets unrealistic expectations.

Malinvestment, in other words, causes real damage to the real economy before the problem becomes apparent - while speculative bubbles cause real damage to the real economy mainly or only during the process of bursting the bubble.

This in turn has important policy implications, in that the damage done by a bubble can still be averted (almost) entirely by the time the bubble is discovered, whereas the damage done by real malinvestment is at least partly a done deal by the time you realise that the jig is up.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Apr 17th, 2010 at 09:23:17 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
I think you're right, but there's two other concepts at play here too: risk and credibility.  Risk is the chance of failure, and trying to account for risk is a way of distinguishing between reasonable levels levels of speculation and unreasonable, or unsustainable, levels.  Credibility is the ability of an agent to be trusted by counter-parties, and is, like cash money, used to command resources. Greater credibility provides one with greater power to command resources. The problem is that one can't know with certainty, within a given system, the true credibility of an agent or the true risk of a venture.  This means it's really hard to tell until after the fact whether a bad investment really is bad, or whether a speculative bubble really is a bubble and not just an indication that some resources, such as fossil fuels or habitable space, are getting really scarce during conditions of global economic growth. Hence the old joke about economists correctly predicting 9 of the last five recessions and the tendency to think that naysayers are crying wolf whenever some start to raise alarms about such things.
by santiago on Mon Apr 19th, 2010 at 07:09:58 PM EST
[ Parent ]
Re: Where we have been and where we are going (4.00 / 2)
That's true to an extent. However it is, at least in principle, possible to compute how much prices would have to drop in order to trigger a systemic margin call. Such computations can be compared with historical safety margins, historical price levels and historical intelligence on the increase in volatility as slack decreases.

Such calculations do not and cannot obviate the need to make political decisions about risk. Risk assessment, like discount rates, is inherently a partly political decision - and that's doubly true for systemic risk. But hopefully such calculations can make those political decisions more informed. And certainly, they can remove the plausible deniability of "nobody could have predicted."

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Mon Apr 19th, 2010 at 07:23:18 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
kjr63:
We have three means of production, land, labour and capital.

My analysis is slightly different, and I aim to start pulling together my thoughts  on this, and a political economy/manifesto based on my core assumptions, in a short book beginning next week, when I will be in Norway doing not very much.

In my analysis, there are three means of production:

Location - (3D);

Energy - in static/material and dynamic forms; and

Knowledge - in subjective (between our ears) and objective (data) forms.

All of these have a value in use which may be deployed through the use of legal protocols, which confer rights and obligations in respect of this use value.

These property and contractual rights are the basis of what is known as finance capital and our current system of finance capital is broken:

(a) in Principle - there are two conflicting claims over productive assets in the form of "Equity" (absolute ownership eg freehold, company shares) and  "Debt" (temporary rights to use or usufruct for a defined term);

(b) in Practice - the combination of compounding debt and private property in the commons of land/location has led - once again - to unsustainable concentration of wealth, as it always has for thousands of years, but this time, terminally.

I believe that new protocols and rights are emerging which will resolve existing conflicts, and will form the basis of a non-toxic directly connected 'Peer to Peer' economy.

The above 'reality-based' (I hope) assumptions in respect of factors of production will form the basis for successful consensual collaborative action and implementation of a networked Economy 3.0 if my analysis is correct.

Marx, in his early days foresaw the Abolition of Labour, and the Abolition of the State and the Abolition of Property which would flow from this.

In a post-Industrial decentralised but connected Knowledge Economy (Economy 3.0) the power relationships which enabled the formation and continuation of the existing centralised but connected Economy 2.0 are obsolescent.

The Internet interprets State and Rentiers alike as damage, and routes around them.


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Apr 16th, 2010 at 05:30:02 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
Too bad that i don't have "energy" to focus on your ideas, which always sound interesting. But these are almost the same as the classical factors?

Location - Land
Energy - Capital
Knowledge - Labour

by kjr63 on Fri Apr 16th, 2010 at 06:50:59 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
Unqualified labour is knowledge?

The brainless should not be in banking -- Willem Buiter
by Carrie (migeru at eurotrib dot com) on Fri Apr 16th, 2010 at 06:55:09 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
Some knowledge is tied up in rent extracting patents, copyrights and proprietary knowledge and processes, including the knowledge of how to run a de facto monopoly or a tacit cartel.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Apr 16th, 2010 at 07:06:09 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
That's the goodwill (intangible assets) and is part of the capitalization of a firm.

The brainless should not be in banking -- Willem Buiter
by Carrie (migeru at eurotrib dot com) on Fri Apr 16th, 2010 at 07:09:34 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
I thought goodwill consisted of intangibles. A patent is very tangible.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Apr 16th, 2010 at 12:05:16 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
I see Labour as being a hybrid of:

(a) Energy -  'Manpower' or unqualified Labour;

(b) 'Subjective' Knowledge - the skill, contacts, experience, common sense, intuition, knowledge, wisdom etc etc that sits between our ears and dies with us.

I see 'Objective' Knowledge as being everything recorded in data patterns and representations (including information, software, music video etc etc) and which has a value (which may be spiritual or emotional) in use.

So I guess I would see 'Capital' as being broken down into embedded energy Material form; intellectual capital (capable of being 'enclosed' and owned as IP) and human capital (training and education etc).

The economic definition of 'Land' is currently way more than bare 3D location, and includes natural resources, and radio spectrum among other things.

As I said, I aim shortly to write a fairly short book or 'Mighty Pamphlet', as rg puts it, setting out my take on a 'Reality-based' economics founded upon these assumptions, and a new approach to the legal protocols (finance capital) we use.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Apr 16th, 2010 at 07:08:38 AM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
I think your specifications for energy, capital, knowledge, land, and labor are on target or on the right track.  But unless you do something radically different with them, you might just be heading back to the standard, neoclassical production function , which is:

Y = f(A,K,L),  

meaning output (whatever that might be) is some function of inputs, which in the simplistic, textbook case is just two things -- capital and labor -- mixed together with something called A, technology (or knowledge), but changes or broadening the inputs to include other categories such as expanded definitions of land or objective capital or different kinds of labor in no way changes the fundamental framework of the neoclassical model of Outputs = f(Inputs).

by santiago on Mon Apr 19th, 2010 at 07:39:09 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 1)
That's the autistic version which doesn't accept the existence of the outside world.

A more realistic model accepts that natural resources drive the rest of the economy. And being finite, when the natural resources run out, the economy simply stops working.

y(t) = f(A(t), C, -L) * (R-(g(t))

(L is negative because it's considered a drain on output.)

In fact y(t) feeds back to C via a financialisation multiplier, because capital/debt is considered (spuriously) as the engine that drives the economy and/or the brake that prevents it working.

Even more accurately, as R-(g(t)) tends to zero, C decreases because extraction costs eat into profit.

Putting it all together you get something like

y(t+1) = f(A(t), k*y(t), -L) * (R-g(t))

A lot of economics seem to obsessed with k's irrational gyrations, when it's the other terms that define historical outcomes over long periods.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Apr 19th, 2010 at 08:08:29 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
... which is still just a more detailed specification of the basic neoclassical model:

Real output is a function of real inputs.
 

Everything else is just trying to measure the real inputs and outputs (not a trivial problem at all) and determine what the function really is.

by santiago on Mon Apr 19th, 2010 at 09:20:37 PM EST
[ Parent ]
Re: Where we have been and where we are going (none / 0)
Yes and no.

The neoclassical picture requires a couple of spurious assumptions about the causality - specifically, it requires money neutrality in the long run, which implies a supply-side causality. In the real world, where money is not neutral and "long run" is code for "bullshit," you get a picture where both the supply and demand sides matter.

Though of course that still misses the point that production inherently has a political component, since it is the product of organised human action.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 20th, 2010 at 06:31:19 AM EST
[ Parent ]
Where we have been and where we are going | 73 comments (73 topical, 0 editorial, 0 hidden)


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