The Slack Wire

Krugman and China

So, what’s he on about?

There’s a lot of heat, but surprisingly little light. Is the objection to the renminbi peg as such, or is it just he thinks a different peg would be better? Better for who — the US, China, the world? Why is he so sure that the current account imbalance between the US and China is due to the peg? And what general principles for currency value and trade flows, if any, underwrite the argument in this specific case?

One thing he’s got right, at least — the US current account deficit with China is big. The US c.a. deficit in January was about $40 billion, or 3 percent of GDP. (That’s down from 5 percent of GDP in 2008, and 7 percent in 2005-06.) China accounted for $18 billion of that ($17 billion if you include Hong Kong, with which the US runs a surplus), or about 40 percent of the total. At the height of the c.a. deficit, in mid-2006, China accounted for about a third of it. The rise in China’s share is largely accounted for by the fall in oil prices; in recent years China has consistently accounted for about half the non-OPEC deficit. So if you are worried about the current account deficit, you should worry about the deficit with China.

But should you worry about the current account deficit? And does worrying about the deficit with China mean worrying about Chinese “manipulation” of the renminbi?

To take the second question first, it’s far from clear that the currency peg is responsible for the deficit. One reason the US deficit with China is so big is that US trade with China is so big — China is by far the largest recipient of US exports outside of North America. Yes, China’s exports to the US are four times greater than its imports from the US, an outlier among major trade partners, but countries like Germany, Japan and India regularly see ratios in excess of two to one, and their currencies float freely. So at the least, it’s clearly not true that laissez-faire in the foreign exchange markets guarantees balanced trade — which would be a strange thing for Krugman to believe in any case.

But of course, it could be true that the vagaries of the foreign-exchange markets, demand for US assets, or government policy can all keep a currency away from its trade-balancing level. So set aside the loaded language of manipulation, which suggests there is something inherently immoral or dishonest about currency pegs — which have, after all, been the norm in international trade for much longer than floating currencies, and are used by lots of other countries beside China today. Is it the case that a higher renminbi would narrow the US deficit with China?

There is a long tradition, going back at least to Keynes, that doubts whether trade flows are sufficiently responsive to exchange rates to make them an effective way of achieving balanced trade.[1] In the short run, the elasticity pessimists are clearly right that income changes, not exchange rates, are the decisive influence on trade — casual examination of the trade statistics shows that exports to and imports from any given country tend strongly to move together, whereas they should move in opposite directions if exchange rates were dominant. Nor is this surprising — in the short run most trade is contractually committed; over the medium run market share is expensive enough that sellers absorb some part of exchange rate movements in profit margins rather than adjusting prices, and even when prices do adjust few close substitutes are available for many traded goods, especially intermediate goods. Thus the familiar J-curve, where the short- or medium-run effect of an exchange rate change is in the “wrong” direction.

But in the long run, surely, prices are decisive? Maybe, maybe not. Krugman brings up “the smaller East Asian nations in the aftermath of the 1997-1998 crisis” as if they were an obvious case of exchange rate effects. It is true that those countries did devalue their currencies during the crisis, and did see sharp improvements in their current account in the following years. But they didn’t just devalue; they also saw dramatic falls in domestic income and consumption. How do we know if it was the devaluations or the contractions that led to the improved trade balances? Well, take Indonesia and Korea as examples (I pick them because they are in the OECD international trade database.) In both, the improvement in the current account balance (from a $250 million to a $2.7 billion surplus 1996-2000, and from a $2.4 billion deficit to a $3 billion surplus 1996-98, respectively) came entirely from declining imports. Indonesian exports were no higher at the end of 1999 than at the beginning of 1997 — but imports had fallen by half. That looks a lot more like an income effect than a price effect to me.

Still, in the very long run exchange rates presumably do have a major effect on trade flows. But it matters how long the long run is. If the problem with the current account deficit is its anti-stimulus effect, and not the broader “global imbalances,” then a solution that only helps five years from now, and makes things worse in the next year or two, is no solution at all. (Someone should ask Prof. Krugman how long he thinks it would take for a renminbi revaluation to have a net positive effect on the US current account.) But set that aside. Let’s say that a change in Chinese policy would lead to a higher renminbi, and that that would narrow the US deficit with China, and fast enough to work as fiscal policy. Should we care? And does the answer depend who “we” are?

The simplest way of looking at the demand effects of the deficit is that every dollar of “anti-stimulus” in the US is balanced by a dollar of stimulus in China. And to be honest, it’s hard to find much beyond that simple level in Krugman’s stuff on China. He seems to be saying the reniminbi should be revalued so that the US gets more, and China less, of a fixed pool of global demand. Now, I am not as allergic to mercantilist-type arguments as most people. But why on the world should China go along with this? And why, from behind the veil of ignorance, should we-in-general want them to? [2]

In a recent blog post, Krugman had an interesting answer to this question — interesting because it’s so clearly wrong. He writes, “the global macro aspects of the situation are reminiscent of the late 1920s, when the US was simultaneously insisting that European nations repay their dollar debts and that they not be allowed to export more to earn the dollars. That didn’t end well.” There are two key differences, ,though. First, China accepts payment in dollars — it doesn’t insist on its own currency.[3] And second, China has no problem exporting capital to match its current account surplus, unlike the US in the 20s, when our surplus was offset by politically contentious loans related to WWI reparations and highly unstable private flows. These two factors mean that while debtors then found themselves forced to accept domestic deflation and contraction, the US is under no corresponding pressure. As long as China is willing to finance the US deficit with low-interest loans to the US, the deficit need have no negative effects for this country; and as soon as they stop financing it, it will go away — as Krugman rightly stresses, China’s trade surplus and capital exports are two sides of the same coin.

Let’s take a step back.

Imagine that China appeared out of the blue one day and began selling stuff to the US. But instead of buying stuff in return, they simply lend their dollar earnings to the US government, i.e. bought Treasury bonds. This reduces demand for producers of US goods. But now suppose the US government increases its total borrowing by the amount of the Chinese bond purchases, and uses the increment for domestic purchases. Supply and demand for bonds among non-China buyers are unchanged, so there is no reason for interest rates to move. The stimulus of the additional government spending exactly offsets the anti-stimulus of the Chinese imports, so there is no inflation. And the offsetting goods and capital flows between the US and China mean there is no pressure on the dollar. At the end of the day, domestic output and employment are unchanged, and domestic consumption is increased by the amount of Chinese imports. In short, to exactly the extent that the imbalance with China reduces private domestic demand, it removes the constraints on expansion of public domestic demand.[4] This is the fundamental difference between the position of the US today and the position of countries on the gold standard or equivalent systems, as in the 1920s. In the latter case there is no mechanism to guarantee offsetting capital flows to trade imbalances, so countries can find themselves facing a foreign exchange constraint on output and growth.

And now we are coming toward the point of this very long post. Krugman calls Chinese capital exports “artificial,” by which he means — well, what, exactly? That they are undertaken by government? that they are not motivated by returns? that they correspond to a big current account surplus? It isn’t clear. Nor is it clear what he thinks a world of “natural” flows would look like. More balanced trade overall? or just a more favorable balance for the United States? And finally, why should we support a policy whose benefits to American workers are offset by costs to (much poorer) workers elsewhere?

Let’s turn back to that previous era of global imbalances, the 1920s and 30s — whose lessons, I think, Krugman gets wrong. It’s well known that when countries left the gold standard and devalued their currencies, their economic performance dramatically improved. But was this from the stimulus of an improved current account,as Krugman imagines the US would enjoy following a renminbi revaluation? Not at all. As Peter Temin and Barry Eichengreen both emphasize, countries that devalued did not, on balance, experience any improvement in their current account at all! Rather, the devaluations allowed them to achieve the same external balance at a higher level of income. Removing the foreign exchange constraint allowed national governments to take much more aggressive steps to boost domestic demand — mainly through looser monetary policy once central banks no longer had to defend the peg to gold. In effect, going off gold enabled a movement from a low-employment to a high-employment equilibrium by allowing countries to reflate one at a time, instead of needing a coordinated expansion; but trade flows at the beginning and end of the process were basically the same.

The key point is that what matters is not the balance of trade between any particular countries, but the presence or absence of a foreign exchange constraint. If a country can offset adverse movements in its current account with expansions of public, or private, domestic demand, i.e. if a worsening current account is reliably offset by capital inflows or if it can settle international claims in its own currency (of course both are true of the United States), then deficits need have no effect on output or employment. But some countries must restrict domestic demand to keep any current account deficit at a level they can finance; adverse movements in those countries’ current account reduce output and employment without any corresponding gains elsewhere. Thus the deflationary bias of the gold standard. This was the decisive consideration for Keynes in the design of postwar international financial arrangements: No country should be prevented from pursuing full employment by a foreign exchange constraint. [5]

So where does that leave us? A new international financial architecture isn’t on the menu (and doesn’t seem to interest Krugman, anyway; for him the problem is all China.) But under the current system, it’s clear that the highest level of output and employment will be achieved if a simple condition is met: current account deficits are run by countries that can most easily finance them. Countries that can easily attract capital inflows and issue liabilities in their own currency should have exchange rates that result in deficits at full employment; countries without those characteristics should have “undervalued” exchange rates so they run surpluses at full employment. This preserves the flexibility of every country to manage domestic demand to preserve full employment. Expansionary fiscal or monetary policy leads to adverse movement of the current account. It’s no problem if this increases the deficit for countries that can finance a deficit, but for others this will rule out expansion unless they start from a position of surplus. And indeed this was one of the lessons of the Asian crisis — countries that found they could no longer count on private capital flows concluded they need to run large current account surpluses to ensure that their growth was not choked off by foreign exchange constraints.
Given that the US issues the global reserve currency, a world with a large US current account deficit will almost certainly see higher and more stable output than one in which the US current account is balanced. And given that the US does not face a foreign exchange constraint, our unemployment can’t be blamed on the Chinese – they’re not holding back domestic demand here.
Krugman is a smart guy: why doesn’t he recognize this? The answer, I think, goes back once again to Keynes. In chapter 23 of the General Theory, he writes:

When a country is growing in wealth somewhat rapidly, the further progress of this happy state of affairs is liable to be interrupted, in conditions of laissez-faire, by the insufficiency of the inducements to new investment. Given the social and political environment and the national characteristics which determine the propensity to consume, the well-being of a progressive state essentially depends, for the reasons we have already explained, on the sufficiency of such inducements. They may be found either in home investment or in foreign investment… Thus, in a society where there is no question of direct investment under the aegis of public authority, the economic objects, with which it is reasonable for the government to be preoccupied, are the domestic rate of interest and the balance of foreign trade.

Before the 20th century, there was “no question of direct investment under the aegis of public authority” simply because the public sector — apart from the military — was very small. Of course that’s not the case today – no technical reason why federal spending couldn’t increase by 10 percent of GDP if need be. The obstacles are political – as Krugman acknowledges when he stipulates that the Chinese surplus matters because in its trade partners, “both central banks and governments are unable or unwilling to pursue sufficiently expansionary policies to eliminate mass unemployment” (my emphasis).
The unwillingness of the US to pursue sufficiently expansionary policies is not a fact of nature. Given that unwillingness, Krugman (and Dean Baker, etc.) may be right that an improvement in the US current account is the most practical way to boost US demand – even if they exaggerate how quickly and reliably exchange rate changes will deliver it. But it’s neither a necessary nor a particularly good way of achieving this. The real problem is the inability of the US financial system to channel savings into productive investment, and the unwillingness of the state to step in in its stead. Too bad folks like Krugman are trying to shift the blame to China.

[1] Formally, Keynes and post-Keynesians like Davidson doubt that the Marshall-Lerner-Robinson condition is satisfied, i.e. that the elasticity of imports and exports with respect to exchange-rate changes sum to at least one.

[2] He actually does answer this question with respect to China, sort of. Might makes right: “Because the United States can get what it wants whatever China does, the odds are that China would soon give in.”

[3] In the real world the problem is that US government borrowing did not increase by as much as the capital inflows from China, with the result that Chinese purchases of Treasurys drove down the yield and forced more return-sensitive investors to look for similar assets elsewhere — thus the demand for asset-backed securities. This point is made by Perry Mehrling and by Daniel Gros. Neither draws the logical conclusion that the financial crisis might have been averted if the federal government had only borrowed more. Topic for another post.

[4] Countries other than the US are in more the gold-standard situation — they face the problem of earning the dollars to cover their deficit with China, or euros for their deficit with Germany.

[5] Since he doubted the effectiveness of exchange rates to provide the needed flexibility, the key goal for him was an automatic mechanism to provide the offsetting capital flows to deficit countries, without depending on either private investors or the governments of surplus countries.

Stein’s law modified

Krugman cites it: If something can’t go on forever, it will stop. True.

Also true:

Even if something can go on forever, it will stop eventually.
Even if something can’t go on forever, it can go on for a very long time.

One might say the difference between these corollaries and Stein’s original is the difference between a real-world, historical approach to macro and the equilibrium approach of the mainstream. Fresh or salty, it’s all water “when the storm is past and the ocean is flat again…”

Marx and the crisis: missing or just missed?

Over at Crooked Timber, John Quiggin suggests that Marxian analyses of the economic crisis have been MIA. So, for the record:
Chris Rude, The World Economic Crisis and the Federal Reserve’s Response to It: August 2007-December 2008Jim Crotty, Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’David Kotz, The Financial and Economic Crisis of 2008: A Systemic Crisis of Neoliberal CapitalismErdogan Bakir and Al Campbell, The Bush Business Cycle Profit Rate: Support in a Theoretical Debate and Implications for the Future
Engelbert Stockhammer, The finance-dominated accumulation regime, income distribution and the present crisisCostas Lapavitsas, The Roots of the Global Financial Crisis and Financialised Capitalism: Crisis and Financial Expropriation
Gerard Duménil and Dominique Lévy, The Crisis of Neoliberalism and U.S. HegemonyAnwar Shaikh on Marx and the crisis (video)Rick Wolff, Economic Crisis from a Socialist Perspective
Robert Brenner, What Is Good for Goldman Sachs Is Good for America: The Origins of the Current CrisisJohn Bellamy Foster and Harry Magdoff, Financial Implosion and Stagnation: Back To The Real Economy

Two, three, many Ecuadors

I had no idea that Ecuador had defaulted on its debt.

Felix Salmon’s Reuters piece is fascinating, not least for the tone of astonishment that “the country has won and the private sector has lost.” Aren’t small open countries like Ecuador helpless in the face of the mighty capital markets? Not at the moment:

[President Rafael] Correa didn’t pull the trigger until he could see the whites of his opponents eyes: he announced that he was defaulting on the 2012 global bonds at exactly the time that three huge hedge funds, which held Ecuador’s debt, were being forced by their prime brokers to liquidate their holdings. As a result, the selling pressure on Ecuadorean bonds sent them tumbling from the 70s to the 20s almost overnight.

They would have fallen further, into the waiting arms of a small army of hungry vulture funds… But then Ecuador pulled its next smart stunt: it used Banco del Pacifico, a large Ecuadorean bank, to start buying bonds at levels above 20 cents on the dollar. That was just high enough that the vultures didn’t want to amass a large position, and ensured that any future restructuring would face little organized opposition just because Ecuador’s bondholders were so fragmented. … And its final clever step was not to put forward a take-it-or-leave-it offer, as Argentina did, which would allow bondholders to agitate for a mass “no” vote. Instead, they just asked bondholders to name their price. Of course that’s what the bondholders did. None of them wanted to be left as holdouts.

The lack of solidarity among bondholders is noteworthy here (a group of disgruntled bond owners uses, telling if a bit comically, the slogan “United We Stand.”) Game theory might explain why most bondholders would take the country’s offer, but one suspects that in a different political conjuncture the game would work differently.

Also noteworthy is this: “Ecuador hasn’t been able to issue debt in years, so losing access was no big deal for Ecuador, as it would be for most other countries.” But why on earth should any country keep paying tribute to foreign bondholders if it won’t be seeing any more capital inflows?

Of course, Salmon might be wrong — which makes the case for default stronger, if anything. According to Marc Weisbrot, S&P raised the country’s bond rating following the default, and the price of non-defaulted government bonds rose sharply: “The debt reduction appears to have convinced foreign investors that Ecuador’s ability to repay its non-defaulted debt has increased.” It would be interesting to try to generalize this point. Even if you ascribe much more in the way of rational expectations to international lenders than I would, there is clearly some level of debt which is too high to be realistically serviced; in that case, repudiating some or all of the existing debt clearly improves repayment prospects for future debt.

On balance, despite all the huffing and puffing you hear in cases like this, it’s not clear that default has any repercussions on access to foreign loans. Jeffrey Sachs and Erika Jorgenson have an interesting paper that looks at the subsequent experience of Latin American countries that did, or did not, default on their debt in the 1930s. They find that “reputational effects on future access to credit … were low, so low as to be negative. … the costs of default in terms of future external financial flows were negligible. When the countries returned to international capital markets in the 1950s, no apparent systematic differences between the defaulters and nondefaulter emerges.”

Most likely the same will turn out to be true here: Post default, the income of a few wealthy bondholders will be a bit lower, the income of the citizens of Ecuador (or at least the government) will be a bit higher, and Ecuador’s capacity to borrow internationally will be unchanged.

Toward the end of his piece, Salmon quotes someone from Greylock Capital worrying that “as much as we can say this is an outlier, any country which runs into trouble has a great blueprint now of how to do it.” Let’s hope so!

Health bill thoughts

Short version: It’s an expansion of Medicaid, with some doodles in the margin.

Longer version:

Today, the US has the world’s highest medical spending and poor-to-mediocre health outcomes. It’s the only rich country where health coverage is provided by private insurers; where most people’s coverage is linked to their jobs; with a large number of people without health insurance; where millions of people lack any health coverage; and where medical problems often mean financial catastrophe. When this legislation is fully phased in, by 2016 or so … it still will be.

We know what the bill won’t do: fundamentally change the structure of health coverage and finance. But what will it do? My own bottom line is, Enough to be worth passing.

The bill’s provisions break down into half a dozen major categories: (1) new insurance regulations; (2) health insurance exchanges; (3) individual and employer mandates; (4) Medicaid expansion; (5) Medicare (and Medicaid) spending cuts; (6) tax on high-cost insurance policies, plus a bunch of other smaller taxes; and (7) a grab bag of experimental measures to improve the efficiency and quality of health care. And then there’s the provision that’s not there, (8), the public option. There are serious questions about the logic and impact of most of these provisions, many of which I have not seen analyzed seriously. As time and inclination permits, I’ll dig more into the most glaring ones. The bottom line, per the CBO, is that the uninsured would fall from 19 percent of the population today to 8 percent after 2015. [1]

I was thinking of walking through the major provisions of the bill one by one. But you can find that elsewhere. (Start here.) I might come back and write up a full summary, but in the meantime, I want to flag a half dozen important issues and questions that I haven’t seen discussed much elsewhere.

1. The individual mandate — is it really necessary to make community rating and related regulations work?
2. the distribution of new Medicaid spending, which is highly unequal between states.
3. The cuts in DSH payments, which could be catastrophic for some urban hospitals.
4. The crazy-quilt employer mandate.
5. Why the public option mattered.
6. How meaningful in practice are the limits on out-of-pocket costs, premiums, and medical loss ratios?
7. How much do insurance companies gain?

There are a couple other issues that have gotten a bit more discussion, where I don’t think I have anything much to add.

First, what is the role of insurance companies under this system? It seems they no longer have access to the two main choice variables on which they maximize profits currently: the terms on which they offer coverage, and the mix of benefits they will pay for. If they must offer policies on publicly-fixed terms with a publicly-set package of benefits, there’s no margin left for them to operate on. (Which doesn’t mean they won’t be profitable, just that their profit will depend on federal policy, not on factors under their direct control.) Two possibilities here: First, they will find ways to continue selecting healthier populations and limiting payments; the medical loss ratio restrictions won’t bind; in short, the status quo. Second, the insurance companies become essentially vestigial, simply taking a cut off the top of what is basically a public system. Purely parasitic insurance isn’t something anyone would propose, but it does have to be admitted it’s an improvement on insurance companies that take their cut and try to increase it by denying people health coverage.

Anyway, this is looking at the bill through the lens of universal reform — what is the logic of the system it creates? Whereas it plainly isn’t fundamental reform, and it doesn’t create a system with any particular logic, just tweaks the system that’s formed itself willy-nilly.

Second, the abortion restrictions. It’s clear that for some women, the bill will actually make things worse — it will restrict abortion coverage compared with the status quo. How much, for how many? I don’t know. But I did want to flag this lovely quote from The New Republic: “Poor people pay surprising amounts for cell phones and cable TV. They can be surprisingly resourceful in paying for abortions, too.”

[1] Also, at The New Republic, Jonathan Cohn writes, “For nearly a hundred years, the political system has been debating whether access to basic medical care should be a right all citizens enjoy. When reform passes, the political system will finally render its verdict: ‘yes.'” But 92% — or even 94%, if you don’t count undocumented immigrants — is not “all”. This kind of dishonest rhetoric has been all too common among those defending the bill.

How biologists think about genes

From Tangled webs: Tracing the connections between genes and cognition, by Simon E. Fisher:

The deceptive simplicity of finding correlations between genetic and phenotypic variation has led to a common misconception that there exist straightforward linear relationships between specific genes and particular behavioural and/or cognitive outputs. The problem is exacerbated by the adoption of an abstract view of the nature of the gene, without consideration of molecular, developmental or ontogenetic frameworks. … Genes do not specify behaviours or cognitive processes; they make regulatory factors, signalling molecules, receptors, enzymes, and so on, that interact in highly complex networks, modulated by environmental influences, in order to build and maintain the brain. …

What is a gene? Answering this question is far from trivial, but a useful operational definition might be ‘‘a stretch of DNA whose linear sequence of nucleotides encodes the linear sequence of amino acids in a specific protein’’. … It is important to realise that the appearance and biology of a mature organism is the result of a complex series of ontogenetic events unfolding over time, moderated by environmental and stochastic influences. Genomes are much more like knitting patterns or recipes than blueprints (although even the former are poor analogies for the peculiarities of the genome). …

The apparent ease of correlating genotype with phenotype without reference to molecular/developmental mechanisms promotes an erroneous impression of neurogenetics; one in which individual genes are able to mysteriously control specific behaviours or cognitive abilities, leading to talk of ‘‘language genes’’, ‘‘smart genes’’, ‘‘gay genes’’, ‘‘aggressive genes’’ and so on. It is indisputable that variations of gene sequence can contribute to variability in cognitive abilities and personality traits (sometimes in a dramatic manner) and that apparently straightforward genotype-phenotype correlations can sometimes emerge in our datasets. But the simplicity of these relationships is merely an illusion; genes do not (and indeed can not) specify particular behavioural outputs or cognitive processes, except in the most indirect way. … The gross activities of the human brain are the products of a complex interplay between factors at multiple levels; be they genetic, cellular, developmental, anatomical, or environmental, and the routes linking genes to cognition will inevitably be tortuous…

… the gap between genes and cognition can only be bridged by a thorough systems biology account of brain development and function. Even pure candidate gene approaches can be victims of the ‘‘abstract gene’’ perspective. In many cases, when researchers find statistical evidence to support association between a particular variant of a gene and a common trait, it is erroneously assumed on the basis of this that the variant is likely to be causative and that there is a simple pathway connecting gene to trait. … There is a large gulf between finding statistical evidence for a genotype-phenotype correlation and demonstrating a convincing causal relationship…

There is no doubt that the gene known as FOXP2 is relevant to linguistic ability. However, any characterisation of this as a ‘‘gene for grammar’’ clearly becomes untenable once we are able to view it within a more complete biological framework. … Reduced amounts of functional FOXP2 protein can lead to disordered brain development or function, in a manner that primarily interferes with speech and/or language abilities. … this is emphatically not the same as saying that FOXP2 is a ‘‘gene for speech’’ or a ‘‘gene for language’’… FOXP2 [also] regulates key pathways in the developing lung, heart and gut. …. The recycled use of the same regulatory factors to control multiple pathways in different developmental contexts is a common feature of complex biological systems; it is rare to find a transcription factor that has an exclusive role specific to only one context. Thus, calling FOXP2 a ‘‘language gene’’ makes no more sense than referring to it as a ‘‘lung gene’’… the data on FOXP2 from molecular and developmental biology confounds any expectations that one might have for a hypothetical ‘‘language gene’’; and the reason for this is that this entire concept is flawed, being rooted in an abstract view of the nature of the gene. …

Credit and car sales

Here’s another one for the file on credit availability and the downturn: How much has tighter financing contributed to the decline in car sales?

The conventional view is that auto sales, like other categories of consumer spending, have been sharply and directly reduced by the financial crisis. From today’s Wall Street Journal:

The hardest-hit markets since the crisis were ones at the heart of the financial problem — the “securitization” markets where loans for everything from mortgages to credit-card debt get sliced up and repackaged into complex securities.

The size of the market for securities backed by loans tied to homeowners’ equity has shrunk more than 40% since the second half of 2007. The market for securities backed by auto loans has shrunk 33%…

These securitization markets provided as much as 50% of consumer lending in the years leading up to the crisis, says Tim Ryan of the Securities Industry and Financial Markets Association, a financial-industry trade group. “Without [the securitization markets], it’s very difficult to replicate the amount of money moving into the economy,” he says.

I’ve been skeptical about this story in general, but let’s see how it holds up in this case. (Click the graph to make it readable; I’m still figuring out the mechanics of blogging.)

The top panel shows the real interest rate on new car loans, the second shows the average loan-to-value ratio, and the bottom shows monthly auto sales in millions, at a seasonally-adjusted annual rate. (Source: Table G.20 from the Flow of Funds; BEA via FRED.) The vertical lines mark business cycle peaks. To make the argument clear, here are the same graphs for just the past two years. The gray area in this one shows when the “Cash for Clunkers” program was in effect.

We see a few things here. First, while auto financing clearly did get tighter as measured both by interest rates and loan-to-value (the latter is a measure of credit availability), the decline in sales started first. Sales were already falling by the end of 2007, while there’s no sign of tighter credit until August 2008. So while the collapse of the secondary market for securitized auto loans may indeed have caused lenders to tighten their standards, it’s not clear that this was a major factor in reducing sales. Further evidence on this point: Auto credit tightened just as much in 2003-04, with no effect whatever on sales.

Second, while lending standards relaxed this past spring (the bailouts worked), easier credit didn’t get people into the dealerships. The spike in sales this summer was all about cash for clunkers; once that ended, sales collapsed, even though interest rates remained extremely low and credit availability, as measured by the loan-to-value ratio, remained fairly high (lower than in the 2000s, but similar to the 90s.) Interestingly, dealers seem to have tightened credit standards during the period of heightened demand in July and August; in this case, the real dog was wagging the financial tail.

So as far as cars go, we can conclude: The credit crisis may have contributed to the decline in real activity, but it wasn’t the sole or the decisive cause. And now that sales have collapsed, there’s no reason to think that credit conditions are what’s holding them down. If you want to support the auto industry, give people money to buy cars (or retrofit car factories to build windmills). Don’t try to revive the market for securitized auto loans.

Quoted for truth

“You can’t completely trust anyone who’s not a communist,” says Jim Crotty.

No you can’t — except one is often inclined to let the trust extend a generation down. Case in point: A. Hiring A. was, for better or worse, probably my biggest single contribution to the Working Families Party in my five years there. But the guy was a puzzle — his vibe was pure corporate-pragmatic — “we don’t really believe our own propaganda, do we?” he’d say — and yet he’d left a successful and presumably lucrative career in business (he’d been, inter alia, general counsel at the teen clothing chain Delia’s) to do grunt work in left-wing politics. And he was good at it!

So, a puzzle. So one day, driving back from Albany, E.B. and I started asking him about his background, where his politics came from. And come to find out, A.’s father was a Chilean communist, who’d fled the country after the coup against Allende. We looked at each other as if to say: Well, now it makes sense.

(EDIT: Names changed to abbreviations because these folks still work in politics and possibly don’t want to be outed as crypto-commies. Lame, I know.)

Getting it wrong on credit conditions

I’ve been obsessed for a while with the idea that credit availability is a much smaller factor in the current downturn than is widely believed — that the focus on bank balance sheets as a key constraint on output and employment is a symptom of the intellectual capture of economic discussions by Wall Street.

Here’s a perfect example from the generally good Gretchen Morgenson of the Times. Morgenson writes:

All that debt overhanging consumers and organizations is the pivotal reason we are still seeing a free fall in bank lending. And small businesses, which account for half of all jobs in this country, are taking the brunt of this credit contraction. Smaller banks are especially worried about their own balance sheets and aren’t making loans. This puts small businesses ­ important engines of growth ­ squarely on the brink.

In its survey, the [National Federation of Independent Businesses] asks small businesses how easy it is for them to get loans. The most recent data shows that credit tightness peaked earlier this fall ­ the worst levels in 23 years, Mr. Shepherdson says. Although credit continues to remain troublingly hard for small business to come by, that phenomenon is a largely untold story.

So let’s take a look at what that NFIB report actually says. Yes, on p.12-13 it reports that the net percent reporting easier credit conditions was -14 percent in October, compared with just -4 percent five years ago; in July, the percent saying they had satisfied their borrowing needs over the past three months bottomed out at 29%, with 10% saying their borrowing needs were not satisfied. (The balance didn’t need to borrow.)


Turn to p. 14 and you see that the interest rate paid by small business on short-term loans was 6.0%, down from 9.5% in May 2007. On p.6, we learn that of the half of small business owners who report lower earnings this month, 62% say it’s because of reduced sales and another 8% to price cuts; only 13% cite rising costs, including labor, materials, taxes, and regulatory costs as well as finance costs. And then on p. 18 they ask small biz owners what is their most important problem. Sales, 33%; taxes, 22%; government regulation, 11%; competition from big business, 6%; and finally financing, tied with cost and and quality of labor at 4%. Compare this to the early 80s, when nearly 40% cited financing as their single most important problem.

Here’s how the NFIB itself summarizes these findings:

Overall, loan demand remains weak due to widespread postponement of investment in inventories and record low plans for capital spending. In addition, the continued poor earnings and sales performance has weakened the credit worthiness of many potential borrowers. This has resulted in tougher terms and higher loan rejection rates (even with no change in lending standards), and there is no rush to borrow money … It sounds like the Administration thinks the reason small firms are not hiring is that they are not able get credit. Although credit is harder to get, ‘financing’ is cited as the ‘most important problem’ by only four percent of NFIB’s hundreds of thousands of member firms. … Record low percentages cite the current period as a good time to expand, more owners plan to reduce inventories than to add to them, and record low percentages plan any capital expenditures. In short, the demand for credit is in short supply and failing to understand the more major problems facing small business leads to bad policy. … What small business needs is customers.

Gretchen Morgenson is one of the better business reporters out there, as far as I can tell. So how could she take a report that explicitly says that credit availability is not a major problem for small businesses and turn its findings around 180 degrees? And of course, this has implications for the shaping of policy. The NFIB’s story leads to the conclusion that what’s needed is government action to raise final demand. But in Morgenson’s version, it turns into an argument for further capital injections into the banking system instead. That’s how strong is the intellectual hegemony of finance. Stories that don’t end with the moral “… and so banks need more money” just do not get told.

GDP skepticism from the Fed

Interesting article by Bart Hobijn and Charles Steindel of the New York Fed, on alternative measures of GDP growth.

They make adjustments for three familiar problems — the non-inclusion of household labor, the calculation of government output as equal to cost, and the treatment of R&D (and other “intangible capital”) spending as an intermediate rather than capital good. The first issue is self-explanatory; the second is equivalent, for purposes of measuring growth, to an assumption of constant productivity in government; and the third means that R&D expenditures are not counted in final output. Hobijn and Steindel adjust for these problems by adding R&D-type expenditures to GDP; assuming that about one-quarter of women’s wages represents the market value of foregone household labor (don’t ask me how they came up with that number, or how they decided that men’s household labor has no value); and assuming that government productivity grows at the same rate as for the nonfarm business sector.

Their results? For 1983-2003, the adjusted and published series correlate almost exactly (0.99) at an annual level. (This isn’t surprising given how the adjusted series is constructed.) But over time, the divergence is significant — the upward adjustments for government productivity and the faster growth of R&D expenditures compared with GDP outweigh the downward adjustment due to a rising proportion of women in the workforce. So annual growth over those two decades runs about 0.5 percentage points, or 15 percent, higher with the adjusted series than with the published one. That’s not a trivial difference.

This is obviously of interest to anyone working on constructing alternative measures of GDP. But to me it raises bigger conceptual questions (questions that Hobijn and Steindel don’t get into, of course, since being mainstream guys they’re chasing the mirage of “welfare”). If short-term fluctuations are robust to alternative measurements but long-term growth is not, shouldn’t quantitative economics focus on the former? Is there a firm conceptual basis for talking about long-term growth as something we can even measure at all? Or was Keynes right when he said,

To say that net output to-day is greater, but the price-level lower, than ten years ago or one year ago, is a proposition of a similar character to the statement that Queen Victoria was a better queen but not a happier woman than Queen Elizabeth — a proposition not without meaning and not without interest, but unsuitable as material for the differential calculus.