Review of Things Said

Martin Wolf has joined the debate between me and Tim on the likely frequency of massive crises.

In the debate between Tim Leunig and Giles Wilkes I am closer to the latter. I think it must be too pessimistic to expect crises like this every ten years. Indeed, that would clearly be intolerable. We would have to move towards balkanised and repressed finance if credit booms and collapses on the present scale were to be expected. It would be far better surely to plan to escape from the present crisis and introduce changes in monetary and regulatory policies that would greatly reduce the risks of an early repeat. If that means more control over finance than before, so be it

I like this analogy between risk financial ideas and building on a floodplain.  The piece makes the same point I bang on about: limit leverage, sweat the details afterwards.

David Smith argues that we should not worry too much about spending cuts hurting the economic recovery:

Over that period, GDP rose £224 billion, just over 20%, in real terms. Government spending rose by just over £50 billion. It contributed only just over a fifth of growth even when ministers were spending fit to bust. This kind of static comparison, more-over, probably overstates the public contribution. Had spending not risen, and the taxes needed to pay for it, private-sector growth could have been stronger.

No.  The prior “good” period was one where finance was doing its job, and less G would not doubt have produced more private spending/investment.  But in a financial/balance-sheet/credit-mechanism depression, the impact of lost government spending might have a large multiplier – nothing else springs in to take it’s place.   But it is certainly very interesting to be reminded that Brown did not take it ALL.

Excellent cartoon showing the rich expropriating themselves

For my birthday today, I got a few antique Punch’s, from the First World War*.  Browsing, I saw this excellent cartoon:


I spent most of Friday celebrating a wedding anniversary in the Conspicuous Consumption capital of the World, aka that bit of London north of the Ritz where the jewelry shops jostle for space alongside absurdly overpriced galleries and rag shops called things like Issey Miyake, Chanel and Ralph Lauren, and where the imposing door staff render the uncertain buyer certain to move on.

We were hoping to find a picture to put up in a space at home, but the prices were lunacy, and clearly a massive reflection of (a) the rent in the West End (beating the hell out of New York’s) and (b) the well-observed need (going back to Veblen) for  the rich to “conspicuously consume”. So a Prada T-shirt needs to cost £300, otherwise it would not indicate how you were a prize fool one a of society’s winners. It’s not because only Prada knows how to put the arm-holes in the right place, or knows how to brief the underpaid workforce to do it really, really carefully.

The whole of that quarter of London is an elaborate and unsuccessful attempt to deny this illusion, but as Punch showed in 1914, the illusion has been understood for centuries. It makes me wonder if the rich are in some way better at expropriating themselves than anyone else: as Will Wilkinson argued in a provocative piece against the cult of inequality, pointing out that the “lived” quality of objects is far closer than the prices would suggest:

You can see leveling in quality across the price scale in almost every kind of consumer good.19 At the turn of the 20th century, only the mega-rich had refrigerators or cars. But refrigerators are now all but universal in the United States, even while refrigerator inequality continues to grow. The Sub-Zero PRO 48, which the manufacturer calls “a monument to food preservation,” costs about $11,000, compared with a paltry $350 for the IKEA Energisk B18 W. The lived difference, however, is rather smaller than that between having fresh meat and milk and having none.

There was a storm of response to this piece: I mentioned some in a post on Freethink.  Just because the rich can be idiots, and miserable idiots at that, in their pointless and impossible quest for relative advantage in display, does not make the underlying wealth inequalities that make it possible any less important – in fact, I left Kensington thinking that luxury taxes had a stronger justification than I had thought.  If one of these impossible to wear shoes were a few hundred quid more expensive, who would lose out?  The higher price would make the sheer physical risk of wearing them still more attractive . . .

*alongside a complete Shelley printed during the same period, an interesting cardigan, and a lie-in past eight-thirty)

Sceptical about Lib Dem VAT-for-Apprenticeships idea

Nick Clegg has announced that what the economy needs is for the VAT cut to be reversed NOW, and the £billion or so be spent on providing paid internships to 16-24 year olds.  In the email, he claims that “Under our plans more than 800,000 young people will be given a leg-up into industry via paid internships.” They have announced it on Lib Dem Voice, too.

I am not a fan.  Here’s why:

– I like the VAT cut.  I’ve blogged on this at Freethink before.  The VAT cut might be working spectacularly well, as the CEBR research suggests.  What is amazing is that we have not really had a retail recession. July’s retail sales are 3.3% above last July’s.   Now, you may be a manufacturing-snob who thinks retail activity does not matter, but since this is a crisis-of-demand recession, the non-collapse of retail sales has probably prevented tens of thousands of real job losses.

– I also like the way the VAT cut is an unselfish act, politically.  It doesn’t come with a big “look what the government’s done for you” tag on it – as the people who sneered at it at the time said, who will notice?  Well, £12bn lower prices, hundreds of pounds through the income effect (hat-tip, Dillow) – it DOES make a difference, it just produces zero political credit.  A selfless act, costing the government billions and the ability to do something far more noticeable, spectacular and PR-easy . . .

– . . . . like promising to ‘save’ tens of thousands of youths through your own whizzy idea.  Face it – if this were possible, Brown would have announced it, and re-announced it, thousands of times over the last few years.   NEETS have been a problem for longer than this recession.  If in a booming economy it was not possible or desirable to bribe people to take on employees of some sort that they would not have wanted without the bribe, then why should it be possible now? Normally, only the likes of Brown think they can plan things so cleverly from the centre . . .

–  which is what bothers me the most about it.  It smacks of central-planning-fabian thinking – jumping into the youth employment market with a big central scheme that promises everything from skills for kids to green-infrastructure.

Do you think that having this on the CV will really look good for the kids somehow taken on?  With the past history of YTS kids and all its successors, I suspect not.  Alison Wolf, who is great, thinks such schemes  have not worked.  Nick has highlighted a problem – good – but let’s not go thinking that a few central government schemes will solve it so cheaply.

I rate Nick highly, so this is all kindly meant.  There are no easy answers here. VAT cuts have done the trick -let’s keep them during this fragile recovery.

Stuff I’m reading

Sandwiched between my tenth anniversary and 37th birthday, it’s a real divorce risk to be sitting here on a blog, just as the third child has finally stopped wailing in his cot.   I get something like 90 minutes to read before the reality of being a father of three comes crashing home.

Right now: “The Great Depression (Bernanke)” – hard but good, with both models and regressions to justify his theories.  Background for a forthcoming piece on QE, it needs a double arpeggio to be anywhere near comprehensible.   The really key take-away is the independent effect of banking crises on output, demand, etc: they are not just an epiphenomenon that can be entirely explained by a contracting money supply – they help accelerate that fall in money, and ought to be independently countered.  Take that, Scott Sumner.

Keynes by Peter Clarke – light stuff so far.  Expecting Skidelsky to have more to it.  I’ll review it properly later.

Finally finished Homicide by David Simon.  Pretty bleak, full of wit, and an entirely different world to ours.  Imagine: 20 cops, each having to take on about 15 murder cases a year. forced to drop cases if they don’t look soluble after a few weeks.

And I feel I’ve got to keep going at the Cochrane-Krugman fight, now being introduced by the much more mellow Nick Rowe.

Reading is my compulsion, major hobby and the plague of my peace of mind: the mental image of a looming library of unread, essential books has been with me for as long as I can remember – back at least to the 1994 Cheltenham Festival of Literature, where I worked unpaid in my first attempt to get near publishing.  I used to be terribly bothered by my inability to summon quotes from whatever I’ve read, until I came across this quote:

Misquotation is, in fact, the pride and privilege of the learned. A widely- read man never quotes accurately, for the rather obvious reason that he has read too widely.

Too right.  The man who’s read nothing but the New Testament can no doubt rattle off many bits of it at will.  Not if he’s had the openmindedness to read loads of other stuff as well.

How often will financial collapses happen?

By email, and now on the Wolf Forum, Tim Leunig and I have had a running debate about how frequently we should expect fiscal collapses of the sort we’ve recently seen.

Tim’s view – which you can read on that link – is that they may take place every 10 years – in which case the government needs to plan for a huge fiscal surplus in the good years to make up for the bad.

I pulled out a log of Angus Madison data to show that since 1920, the non-War years have seen 3% falls about one in every 50 (going off Western European countries).  So 1 in 10 seems a tad bearish.

But it is not that straightforward, as different historical epochs produce different conditions.  Inflation – a favourite cause of Tim’s – was a predominant feature of the post War period.  Low inflation may mean more asset booms, financial volatility, panic, collapsing fiscal revenues.

I’m more optimistic – follow the reasons on the Wolf Forum, but basically because I have a liberal belief in institutional change and learning improving economic outcomes over time.  But Malthusian and geopolitical developments can derail the greatest optimist.

S&P – conspiracy or cockup?

Paul Bickerstaffe drew my attention to an extraordinary S&P trampoline downgrade and upgrade again . ..  after arguing, I resorted to the sort of cheap sarcasm that can unfortunately close down interesting arguments.

I still think the idea that such a blatant movement from the highest rating to one of the lowest can only be cockup, not conspiracy.  If there was a plot to put terrible securities into a government/tax-payer protected haven, then you would choose a target less conspicuous than something recently downgraded past junk.  Paul, IMHO, overestimates the perfidy, and underestimates the potential incompetence, of staff at S&P: rating thousands of tranches of difficult RMBS etc, with all the problems of asymmetric information/lemons etc that goes into it, is never easy.

But there are serious reasons to believe that finance, as a system, exerts a destabilising, corrupting pull over its regulatory environment, and the payoffs that it accrues.   You don’t have to be a Marxist to believe this possible, just stop short of IEA-style right wing idealism about markets.   Simon Johnson, ex-IMF chief economist, has put this powerfully himself.  (this has been such a continuous refrain at the BaselineScenario as to make the place quite dull at times).

Banking profitability is too high. Efforts to fix finance might stop this. Bankers are going to lobby to keep it high,. and have powerful voices I’ll accept that, and am happy to write about it when it’s a factor.  But behind the scenes deals to lie about debt-ratings – nah.

Hubble discovers: it’s big

From the Big Picture

This is what happens when Hubble looks at a pinprick of the sky for two weeks
This is what happens when Hubble looks at a pinprick of the sky for two weeks

This picture contains literally thousands of galaxies, each home to billions of stars.  It is the area covered by a match-head, held at arm’s distance to the sky.

The author of the God Blog,  in The New Statesman, raised the subject of science and religion being in conflict.  I used to think them irreconcilable, till I started thinking about this picture.  Surely an important tenet of any serious religion is man’s utter inability to grasp the universe. Science helps us understand, and also assures us that we can never truly understand, so small are our limits.

Tobin taxes aren’t democratic?

Well, that seems to be the odd angle that Chris Dillow comes from.  I’ve commented: I share his opposition to the tax, though it’s not because I think that there is a logical leap between taxing transactions and denying people the vote.   Instead,  on CommentIsFree I had already enlarged on the the point Chris makes at the end.  Transaction taxes do nothing to address the real problem of the crash: the leverage. (in fact, since illiquidity was a key mechanism by which the deleveraging began, further taxing liquidity would hardly have helped an orderly process).

Everything else is incidental, oblique to the main issue, or epiphenomenal.  Leverage.  A later post will expand on this.

No, Osborne is NOT our saviour

I’ve commented on this thread* at Liberal Conspiracy about George Osborne being the reason we can all breathe easily about the debt – and, more importantly, that he is why the markets and the credit rating agencies are breathing easily, and not burdening us with horrible interest payments.

It follows from this article by the Telegraph’s Ben Brogan.  So, rather than taking the wind out of Conservative sails, the Moody’s debt upgrade is proof that Conservative debt-allergy was in fact good for Britain all along.  Perhaps a slogan for the next election: “Our opportunistic panic about debt has saved Britain.”

Of course, this is nonsense, and as I explain in the comment, there are many sound reasons that the gilt markets are not taking fright.  In particular, Britain has a political system that is good at taking nasty decisions in a pinch – Jenkins 1969, Healey 1976, Howe, Clarke – all managed it, and gilt investors know it.

Further criticisms of Tory policy in the bust – and cautious support for Labour’s – can be found in A balancing act, which is attracting continued interest from various political types that we know at CentreForum.  It is not uniformly uncritical of Labour: the boom era fiscal behaviour was badly flawed and hubrisistic.

What most amazes me about Conservative attitudes to debt is the sheer inconsistency.  I wrote on Freethink about the bizarre, self-damning nature of Cameron’s debt warnings.  They have also said “let the automatic stabilizers operate” – but that is 90% of the fiscal swing (the rest is banking rescue, which they support).  They are all over the place.  Ordinarily, I would agree that the markets would take some comfort from a future Tory administration – but one with this confused record, I’m not sure.

*there’s also underneath a slightly less highbrow argument about whether, because the ratings agencies are culprits in the credit crunch, their words on sovereign default risk are worth f-all anyway.  I think this is  polemical paranoia, but this is the blogosphere, it’s a free world . . . .

Musing on Iceland’s Littleness

(from Monday, 31 August 2009 17:14)

[I haven’t read the classic texts (Robert Mundell, for example) on currency theory, so this is very much busked from my own instinctive market understanding. For what it’s worth.]

My letter to the FT, published 31st August, argued that whatever grim future awaits Iceland holds no auguries for Britain or other advanced nations.  There’s a basic mistake easily made when trying to interpret ‘big’ situations (say: whether the market will be repulsed by the USA’s debt) with ‘little ones’ (whether a stranger would lend you a fiver): certain rather important features of an economic situation cannot be abstracted away simply by dividing through by GDP.  Some things change a lot with size.

And so predicting the future of the advanced nations on the basis of what happens next to Iceland is rather like looking at the London Borough of Lambeth and extrapolating from there to EU nations.  If Lambeth had a currency  . . .

What are the differences? The most important is surely the ability to borrow in your own currency.   If you are America, and, say, 20% of the world’s transactions take place in dollars, there will be a lot of people who actually need instruments denominated in your currency, in order to hold said dollars in a profitable, secure way while waiting to use them: they may be waiting many years, or just a few days.  Hence you get stories like this: foreigners snapping up US dollar debt despite its growing supply.

Now imagine that Lambeth decided to issue its own currency, Florins*. Population, 272,000 – about the same as Iceland’s. In order to get people to put money into Florins, they’d need a high interest rate – again, like Iceland‘s. Of course, if the exchange rate gets stronger, investors in Lambeth Florins are on a winner – high interest rates on their cash, low rates on their borrowings, increased capital value.  But despite this, Lambeth would be highly likely to need to borrow to a great extent in foreign currency – sterling, dollars, euros.   Moreover, in order to maintain convertability, Lambeth would have to keep a store of foreign currency.  So maintaining confidence in the ‘world’ market would remain critical.

This is where it gets precarious. No matter how prosperous Lambeth may be – as an economy, it produces around £5-7bn, is my guess (confirmed here), the worldwide demand for things made in Lambeth is pretty small.  Moreover, the things that Lambeth needs, from the cars they drive in, the petrol in the tanks, the food on the shelves – is pretty much all made overseas. The services are probably a different matter: the haircuts come with “made in Lambeth” – but the banking, telephone, etc are all likely to be foreign-produced as well.  Note that even if Lambeth is running a comfortable export-surplus on the current account, it would need a ready store of liquid foreign currency just to feed its people.

But what happens if Lambeth gets into debt problems – say, invests in a massive entertainment complex that goes twice over budget, or bids unsuccessfully for the World Cup?  It has no federal help from the London government.  With all those debts in foreign currency, it has to somehow extract a ‘surplus‘ from its captive population of Lambeth taxpayers, to produce enough exportable-stuff for the foreigners to be satisfied. Even if it were producing a current-account surplus, investor nervousness would be very likely to take hold on any excuse – because, at just 0.5% of the UK economy (and therefore 0.01-0.02% of world GDP), investors would feel little need to hold Florins, and plenty of reasons to fear looking stupid if they were caught in possession of a lot of them.

Moreover, the smaller the country, the easier it is for people to leave.  Few of them would want to remain in ‘debt-slavery’ (see this Iceland story).  And the more people leave, the higher the burden on those left behind, the greater the chance of default – a continuous self-fulfilling spiral.   Why would people stay around to pay massive taxes, when the next-door authority, Wandsworth, might be willing to entice the really productive individuals to move across the border?  (this is happening with Nevada and California).

How is it different for big countries? The emigration risk is surely lesser – the larger the country, the less the “rest of the world” can compete with it as a place to stay.  Then, even those in deficit, investors need to have a position in large country currencies because of their size relative to GDP.  The US, still by far the world’s biggest manufacturing nation, is in this position.

Savings, moreover,  have to go somewhere. There is a real demand for safe investments, the payoffs from which are in a currency that has things you need.  Pension funds don’t have to go into tiny countries’ currencies, unless they have some unique resource – unlikely.  Small country currencies can be substituted.   Then there is also liquidity. If you are small, markets never really reach critical mass and so trading in and out of your position is really expensive – and in a crisis, risky.

I also think that some coordination issues work against small countries.  Confidence is self-fulfilling.  Imagine a game** in which, so long as 76% of the players stay in the game, they earn 1 point per round.  If a player drops out, it gets 0 points – but if it stays in and 25% or more drop out, it gets minus 10.  Now, first imagine there are 100,000 players.  Each start with “confidence”  – earning 1 every round.   You could imagine them keeping confidence for many rounds. But now imagine there are four people.   It only takes one to drop out for the others to all lose out.  Even an accidental leaving could bring the game into negative territory. Knowing this, all the players are likely to be quick to leave. I strongly suspect that this sort of psychology takes place in small-currency situations.

Ultimately, this leaves all small countries as ‘takers’ in the world macroeconomic scene. Their fiscal stimuli leak abroad.  They have to accept whatever world interest rates tell them.  Finally, the self-fulfilling lurches in investor confidence can throw them up and down.  No wonder they queue up to join the Euro – even if it means terrible austerity for small countries like Ireland that get in and then screw up.

So – what a long-winded post – there is nothing strange or unfair or suspicious about small countries with weak, uncertain currencies getting very different treatment from markets than strong countries.  (Compare IMF advice in 2008 to their form in the 1997 Asian crisis.  Interestingly, Professor Wade has written on the 1997 crisis – clearly in no need of a lecture from me on this subject).  There is huge inefficiency and risk in trying to run your own small country currency.  Which is why I find Hayek’s competing currencies idea ultimately implausible – they have to be big to avoid real problems.

These inefficiencies render macroeconomic extrapolation from the small to the large almost meaningless.  In fact, the same gales of speculation that drive money away from the likes of Iceland are able to sustain the USA and UK in their emergency fiscal straits.

PS: Campbell’s Soup is now as credit-worthy as the US government.  Discuss.  I think this is not as mad as it sounds.  Campbell’s soup are not issuing their own currency.  They have a reliable franchise, don’t depend on getting Congressmen to agree to raise revenues, and are not obliged to fight a war in Afghanistan or fund Medicare. As far as I know.

*Mad?  Tell the people of Lewes

**I doubt I invented this, but can’t find a source in a rush at 10:30pm.

Since writing this blog post, I have had more thoughts on the “confidence” game scenario.  Now imagine that several simultaneous versions of this game are taking place in a room.  In one corner of the room, there are 100 people playing, and they are consistently scoring 97-99% “confidence” – so that people who join that game are very likely to score 1 point per round.   Then in another corner, is another game with just ten people.  They keep struggling around 7-8, with dives down to zero as people lose confidence.  Obviously, given the choice, you’d head off for the first game.

So what do the people running the second game do?  They would probably increase the payoffs for staying.  Which means  . . . increasing the interest rate.  This is exactly like choosing between investing in dollars and Icelandic Krona