Tag: finance is fraud

At Barron’s: Are Low Rates to Blame for Bubbles?

(I write a monthly opinion piece for Barron’s. These sometimes run in the print edition, which I appreciate — it’s a vote of confidence from the editors, and means more readers. It does impose a tighter word count limit, though. The text below is the longer version I originally submitted. The version that was published is here. All of my previous Barron’s pieces are here.)

The past year has seen a parade of financial failures and asset crashes. Silicon Valley bank was the first bank failure since 2020, and the biggest since 2008. Before that came the collapse of FTX, and of much of the larger crypto ecosystem. Corporate bankruptcies are coming faster than at any time since 2011.  Even luxury watches are in freefall. 

The proximate cause of much of this turmoil is the rise in interest rates. So it’s natural to ask if the converse is true. Is the overvaluing of so many worthless assets  – whether through bubbles or fraud – the fault of a decade-plus of low rates? For those who believe this, the long period of low rates following the global financial crisis fueled an “everything bubble”, just as the earlier period of low rates fueled the housing boom of the 2000s. The rise of fragile or fraudulent institutions, which float up on easy credit before inevitably crashing back to earth, is a sign that monetary policy should never have been so loose. As journalist Rana Foorohar put it in a much-discussed article, “Keeping rates too low for too long encourages speculation and debt bubbles.”

You can find versions of this argument being made by  prominent Keynesians, as well as by economists of a more conservative bent. At the Bank for International Settlements “too low for too long” is practically a mantra. But, does the story make sense?

Yes, low interest rates are associated mean high asset prices. But that’s not the same as a bubble.To the extent an asset represents a stream of future payments, a low discount rate should raise its value. 

On the other hand, asset prices are not just about discounted future income streams; they also incorporate a bet on the future price of the asset itself. If a fall in interest rates leads to a rise in asset prices, market participants may mistakenly expect that rise to continue. That could lead to assets being overvalued even relative to the current low rates.

Another argument one sometimes hears for why low rates lead to bubbles is that when income from safe assets is low, investors will “reach for yield” by taking on more risk, bidding up the price of more speculative assets. Investors’ own liabilities also matter. When it’s cheap and easy to borrow, an asset may be attractive that wouldn’t be if financing were harder to come by.

But if low interest rates make acquiring risky assets more attractive, is that a problem? After all, that’s how monetary policy is supposed to work. The goal of rate cuts is precisely to encourage investment spending that wouldn’t happen if rates were higher.  As I argued recently, it’s not clear that most business investment is very responsive to interest rates. But whether the effect on the economy is strong or weak,  “low interest rates cause people to buy assets they otherwise wouldn’t” is just monetary policy working as intended.

Still, intended results may have unintended consequences. When people are reaching for yield, the argument goes, they are more likely to buy into projects that turn out to be driven by fraud, hype or fantasy.

Arguments for the dangers of low rates tend to take this last step for granted. But it’s not obvious why an environment of low yields should be more favorable to frauds. Projects with modest expected returns are, after all, much more common than projects with very high ones; when risk-free returns are very low, there should be more legitimate higher-yielding alternatives, and less need for risky long shots. Conversely, it is the projects that promise very high returns that are most likely to be frauds  — and that are viable at very high rates.

Certainly this was Adam Smith’s view. For him, the danger of speculation and fraud was not an argument for high interest rates, but the opposite. If legal interest rates were “so high as 8 or 10 percent,” he believed, then “the greater part of the money which was to be lent would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people … would not venture into the competition.” 

The FTX saga is an excellent example. At one point, Sam Bankman-Fried—a projector and prodigal if ever there was one—offered as much as 20% on new loans to his hedge fund, Alameda, according to The Wall Street Journal. It wouldn’t take low rates to make that attractive — if he was good for it. But, of course, he was not. And that is the crux of the problem. Someone like Bankman-Fried is not offering a product with low but positive returns, that would be attractive only when rates are low but not when they were high. He was offering a product with an expected return that, in retrospect, was in the vicinity of -100 percent. Giving  him your money to him would be a bad idea at any interest rate. 

We can debate what it would take to prevent fraud-fueled bubbles in assets like cryptocurrency. Perhaps it calls for tighter restrictions on the kinds of products that can be offered for sale, or more stringent rules on the choices of retail investors. Or perhaps, given crypto’s isolation from the broader financial system, this is a case where it’s ok to just let the buyer beware. In any case, the problem was not that crypto offered higher returns than the alternative. The problem was that people believed the returns in crypto were much higher than they actually were. Is this a problem that interest rates can solve?

Let’s suppose for the sake of argument that it is. Suppose that without the option of risk-free returns of 3 or 4 or 5 percent, people will throw their money away on crazy longshots and obvious frauds. If you take this idea seriously, it has some funny implications. Normally, when we ask why asset owners are entitled to their income in the first place, the answer is that it’s an incentive to pick out the projects with the highest returns. (Hopefully these are also the most socially useful ones.) The “too low for too long” argument turns this logic on its head. It says that asset owners need to be guaranteed high returns because they can’t tell a good project from a bad one.

That said, there is one convincing version of this story. For all the reasons above, it does not make sense to think of ordinary investors being driven toward dangerous speculation by low interest rates. Institutions like insurance and pension funds are a different matter. They have long-term liabilities that are more or less fixed and, critically, independent of interest rates. Their long investment horizons mean their loss of income from lower rates will normally outweigh their capital gains when they fall. (This is one thing the BIS surely gets right.) When the alternative is insolvency, it can make sense to choose a project where the expected return is negative, if it offers a chance of getting out of the hole. That’s a common explanation for the seemingly irresponsible loans made by many Savings & Loans in the 1980s—faced with bankruptcy, they “gambled for resurrection.” One can imagine other institutions making a similar choice.

What broke the S&Ls in was high rates, not low ones. But there is a common thread. A structure set up when interest rates are in a certain range may not work when they move outside of it. A balance sheet set up on the basis of interest rates in some range will have problems if they move outside it. 

Modern economies depend on a vast web of payment expectations and commitments stretching far into the future. Changes in interest rates modify many change of those future payments; whether upward or downward, this means disappointed expectations and broken commitments. 

If the recent period of low rates was financially destabilizing,  then, the problem wasn’t the not low rates in themselves. It was that they weren’t what was planned on. If the Fed is going to draw general lessons from the bubbles that are now popping, it should not be about the dangers of low rates, but that of drastic and unexpected moves in either direction. 

What Is the Stock Market For?

Elon Musk’s pending purchase of Twitter is an occasion for thinking, again, about what function stock markets perform in modern capitalism.

The original form of wealth in a capitalist society is control over some production process. If you become a wealthy capitalist, what this means at the outset is that you have authority over people engaged in some particular form of productive activity. Let’s say a group of people want to get together to make steel, or write some computer code, or serve a meal, or put on a play: The armed authority of the state says they cannot do it without your ok.

That property rights are fundamentally a legally enforceable veto over the activity of others is one of the first points you get from legal analysis of property. “The essence of private property is always the right to exclude.” What makes capitalist property distinct is that it is a right to exclude people specifically from carrying out some productive activity, and is linked in some way to the concrete means of production employed. 

As a capitalist, you are attached to the production process you have property rights over.1 Now, you may be happy with this situation. You are a human person as well as a holder of property rights, and you may feel various kinds of personal affinity with this particular process. You may have some knowledge, or social ties, or other property claims that make this process a particularly suitable form for your wealth; or you may simply regard this as a more promising source of money income than the alternatives. 

Then again, you may not be happy; you may not want to be attached to this particular process. There are risks associated with both an enterprise as a social organism, and with the kind of activity it is engaged in. (The steel mill may burn down, or be taken over by the workers; steel may be replaced by alternative materials or cheaper imports.) Ensuring that the process remains oriented both to its own particular ends and to producing an income for you requires active engagement on your part; you may be unsuited to carry this out, or just get tired of it. And even if your ownership rights generate a steady flow of income for you, the rights themselves cannot be easily converted into claims on some other part of the social product or process. (You can’t eat steel.) So you may wish to convert your claim on this particular production process into a claim on social production in general.

In the US context, this is especially likely at the point where the owner dies or retires. For Schumpeter, the ultimate ambition of business owners was “the foundation of an industrial dynasty”, “the most glamorous of .. bourgeois aims”. But in the US, at least, the glamor seems to have faded.2 Heirs may not be interested in running the business, or competent to do so. There may be several of them, or none. And a curiously persistent monarchical principle generally precludes looking outside the immediate family for a successor.

At some point, in any case, the holder of ownership rights over an enterprise will no longer be in a position to exercise them. At this point, the business might shut down. Before the modern corporation, this was the normal outcome:  In early-modern England, “The death of the master baker … ordinarily meant the end of the bakery.” This will often still happen in the case of small businesses, where the value of the enterprise is tightly linked to the activity of the owner themself. This is fine when the productive capacity of the economy is widely dispersed in the brains of the individuals carrying out, and in tools that can be owned by them. But once production involves large organizations with an extensive division of labor, and means of production that are too lumpy for personal ownership, some means has to be found for the organization to continue existing when the individual who has held ownership rights over it is no longer willing or able to.

The stock market exists in order to allow ownership rights over particular production process to be converted into rights to the social product in general. 

This is true historically. In the great wave of mergers in the 1890s that established the publicly-owned corporation as the dominant legal form for large industrial enterprises in the US, raising funds for investment was not a factor. As Naomi Lamoreaux notes, in a passage I’ve quoted before, “access to capital is not mentioned”  in contemporary accounts of the merger wave. And in the hearings by the U.S. Industrial Commission on the mergers,  “None of the manufacturers mentioned access to capital markets as a reason for consolidation.” The firms involved in the first mergers were normally ones where the founder had died or retired, leaving it to heirs “who often were interested only in receiving income.” The problem the creation of the publicly-traded corporation was meant to solve was not how to turn widely dispersed claims not he social product in general into claims on means of production to be used in this particular enterprise, but just the opposite: How to turn claims on these particular means of production into claims on the social product in general.

The same goes for today. We already have institutions that allow claims on the social product to be exercised by entrepreneurs on the basis of their plans for generating profits in the future. These include banks and, in favored sectors, venture capitalist funds, but not the stock market. The stock market isn’t there for the enterprise, but those with ownership claims on it.

The purpose of a stock offering is to allow those who already hold claims against the enterprise (early investors, and perhaps also favored employees) to swap them out for general financial wealth. This is why IPO “pops” — immediate price rises from the offering price — are considered a good thing, even though, logically, they mean the company raised less money than it could have. The pop makes the stock more attractive to the investors who will be buying out the insiders’ stakes down the road. The IPO is for the owners, not for the company. Or as Matt Levine puts it, “the price of the IPO is less important than the insiders’ ability to sell stock at good prices in the future.” 

As I’ve argued before, converting the surplus generated within the firm into claims on the social product in general  is fundamental to the capitalist process as production itself. It’s also an integral part of capitalist common sense. As any guide for budding entrepreneurs will remind you, “It’s not enough to build a business worth a fortune. You also need a way to get your money back.” 

Now, in principle this goal could be achieved in other ways. Money itself is a claim on general social product — that is one definition of it. When Antonio’s ships are safely come to road, his venture is concluded and his whole estate is available to meet his obligations. This is sufficient for merchant capital in early-modern Venice – its self-liquidating character means that no additional mechanisms are needed to turn claims on concrete commodities back into money.

Ongoing enterprises cannot be liquidated so easily. And money is liable to delink from productive economy over longer periods – what one wants is something with the safety, liquidity and non-need for management of money, but which maintains a proportionate claim on the overall surplus. Government bonds are an obvious choice here. They offer a claim on productive activity in general, or at least that part of it which is subject to taxation.

This possibility is worth pausing over. Historically, this was one of the most important ways for holders of claims against particular production processes to turn them into claims against society in general. The “rent” in rentier refers originally to the interest on a government bond. Government bonds as alternative to stock ownership also calls attention to the fundamentally political character of this transaction. For the capitalist to be able to give up their direct control over a production process in return for a proportionate share of the overall social product, someone else needs to oversee the collection of the surplus. And that someone needs to be accountable to wealth owners in general. There is an important affinity between finance and the state here.

Alternatively, partnership structures allow for the human owners to turn over while ownership as such remains tied to the particular enterprise. 3 Universal owners are another route. If Morningstar or Blackstone owns all the corporations, it’s redundant for them to do so in the form of stock. They could just own them directly. Many startups today have their liquidity moment not by issuing stock but being bought by a larger competitor. One could imagine a world where a startup that is successful enough is bought up by a universal index-slash-private equity fund, without the intermediate step of issuing stock. 

Another possibility, of course, would be for the founder to give up their ownership rights and the company then just not to have owners. Wikipedia is a thing that exists; Twitter could, in principle, have a similar structure. I admit, I can’t think of many similar examples. When Keynes talked about corporations “socializing themselves”, this didn’t entail a change in legal structure; the shareholders continued to exist, but just were increasingly irrelevant. Plenty of rich people do leave some fraction of their wealth to self-governing charities of one sort or another, but this is their financial wealth, not the businesses themselves. The closest one gets, I suppose, is when someone leaves real estate to a conservation or community land trust.

Back in the real world, these other models of transition out of personal ownership are either nonexistent, or else confined to narrow niches. What we have is the stock market. Fundamentally, this is a way for owners of claims against production processes to pool them — to trade in their full ownership of a particular enterprise for a proportionate share of ownership in a broad group of enterprises. This was more transparent in the trust structures that preceded the development of publicly traded corporations, which were explicitly structured as a trade of direct ownership of a business for a share in a trust that would own all the participating businesses.4 But the logic of the public corporation is the same.

This is why shareholder protections are so critical. They’re often framed as protections for small retail investors. But the real problem they are addressing is mutual trust among owners. The pooling of claims works only if their holders can be reasonably confident that they’ll continue receiving their income even as they surrender control over production.

You’ll have noted that I keep using obtuse terms like “holders of property claims against the corporation” instead of the more straightforward “owners”. This is necessary when we are discussing shareholders. It is not the case, as more familiar language might imply, that shareholders “own” the corporation. One of my favorite discussions of this is an article by David Ciepley, which observes that many of the features of the corporation are impossible to create on the basis of private contracts. Limited liability, for example — there is no private contract a group of property owners can sign among themselves that will eliminate their liability to third parties for misuse of their property.

If we take a step back, it is obvious that the relationship of shareholders to the corporation is something other than ownership. Just think about the familiar phrase, separation of ownership from control — it is an oxymoron. What, after all, is ownership? The old books will tell you that it is a set of control rights — jus utendi, jus disponendi, and so on. Ownership without control is ownership without ownership. 

The vacuity of shareholder “ownership” can be glossed over most of the time, but becomes salient in takeovers and governance questions in general.5   Dividends and other payments can be subdivided arbitrarily, but decisions are discrete and control over them is unitary. Either Elon Musk buys Twitter, or he does not. Yes, there are votes, but someone still sets the terms of the vote, and 51% is as good as 100%.6 This is the contradiction that shareholder protections are meant to paper over. The publicly owned corporation allows business owners to pool their claims on the income of their respective companies. But it is not possible to share control over the businesses themselves. So the board – which actually does controls them — is instructed to act “as if” the shareholders did. 

All of this is visible by contrast in Elon Musk’s purchase of Twitter, which reverses the usual logic of shareholding. He is trading in a claim on the general social product (or on Tesla, but it has to be cashed in first) into a claim on the specific activity organized via Twitter. He wants Twitter itself, not the stream of income it generates. He wants to turn his share of Twitter’s (so far nonexistent) profits into control over the substantive production process it is engaged in. Twitter for him is a source of use-value, not exchange-value. In this specific transaction, he is acting not as a capitalist but as a feudal lord. (Italics for a reason. One of the many mistakes we can make on these tricky questions is to treat terms like “capitalist” as if they described the essential nature of a person or organization, something that one either is or isn’t. Whereas they are ways of organizing human activity, which one can participate in in one context but not in another.)

The tension between the social production processes over which property claims are exercised, and the specific people who exercise them and the means by which they do so, is easy to lose sight of. It’s natural to abstract from these questions when you’re focused on other questions, like the conflict between capital — whoever exactly that may be — and the human beings who more directly embody labor. In Volume 1 of Capital, the capitalist is simply the personification of capital, and there are good exposition reasons for this.7

It’s in Volume 3 — truly the essential reading on this topic — that Marx directly takes on the conflation of social relations with concrete things. In a blistering passage in chapter 48 he attacks the identification of the real conditions of production with the incomes that are received from them, as if for example land — the natural world — existed only insofar as it is a source of rent for the landlord. This is “the complete mystification of the capitalist mode of production, the conversion of social relations into things, … It is an enchanted, perverted, topsy-turvy world, in which Monsieur le Capital and Madame la Terre do their ghost-walking as social characters and at the same time directly as mere things.” This mystification is alive and well in modern discussions of economics, where ownership of claims against a thing are constantly confused with being the thing. The ubiquitous language of payments to capital (or factor payments) is an obvious example, in which a payoffs to whatever private rights-holder you need permission from to use a machine, are imagined as payments to the machine itself. 

This is not just a matter of verbal ambiguity. It leads to completely wrong conclusions when transactions involving ownership claims on something are confused with transactions involving the use of the thing. For example, you sometimes hear housing activists say that investor purchases will drive up the cost of housing. This sounds reasonable – but only because the word “housing” is being used in two different senses. Ownership of a house, and living in a house, are not competing uses, they exist on entirely separate levels. We may object for various reasons to ownership of homes by large investors rather than owner-occupiers or small landlords (or we may not). But this shift in ownership claims has no effect on the amount of space available for people to live in.

Coming back to the stock market, the confusion comes from mixing up transactions and institutions intended to shift ownership rights over the enterprise with solutions to the financing needs of the enterprise itself. The terms of the twitter deal seem to be: The bankers will get $2 billion per year, half from Musk, half from Twitter. Current Twitter shareholders get a one-time payment of $54 per share, which they may or may not be happy with.8 Twitter as an enterprise — and its employees and users — get nothing from the transaction at all. The company ends up owing $13 billion in additional debt, which finances nothing.

On one level, this is just what the stock market, and finance more generally, do: They change asset and liability positions around, without necessarily implying any changes in the substantive activities that those positions give rights over and which generate the incomes that go with them. As Perry Mehrling likes to point out, the biggest single transaction for most families is the purchase of a home, which doesn’t even show up in the national income and product accounts. But on another level, again, in the specific trade here — away from liquidity and general financial claims toward a more direct relationship with a particular production process — is the opposite of what the stock market usually facilities. Musks’s purchase of Twitter is, precisely, a form of de-financialization.  

On some level I suppose all this is obvious. Everyone understands that this a transaction between various groups of holders of financial claims against Twitter — Musk, the board on behalf of the existing shareholders, the banks— to which Twitter-the-enterprise is not a party at all. But coverage tends to treat this as a problem only insofar as Twitter is special, the “digital town square”. In weighing the deal, the Times sniffs, the board “might as well have been talking about a tool-and-die manufacturer.” Any conflict between relations of production and relations of ownership is, evidently, only a problem when what is being produced are 280-character messages.

At this point, I suppose, I should denounce Elon Musk’s purchase of Twitter. But honestly, I’m not convinced it will make much difference one way or another. 

For me personally, Twitter has been a good outlet.  It connects me with journalists, political people, potential students, and other folks I want to communicate with more effectively than any other platform. It’s a gratifyingly horizontal — anyone who has something to say is on the same level. I’d be sorry if it no longer existed in its current form. But I’m not sure any of its good qualities come from who exactly exercises a claim on whatever profits it may generate.

Do you think that any of Twitter’s positive qualities emanate from the particular individuals who’ve owned it, or “owned” it? Jack Dorsey seems like kind of a nut; if the platform works, it’s in spite of him, not because of him. The current gaggle of suits on the board don’t see to have much hands-on involvement one way or another. The people who do the actual work of maintaining the platform obviously take their jobs seriously. I have no idea who exactly they are, but I have a lot of respect for them. I expect they’ll continue doing their job, whoever is appropriating the surplus.  

To say that having Elon Musk own a company is a central, transformative fact about it – for good or for ill — is to buy into the narcissistic worldview of the masters of the universe. I would rather not do that. Indeed, the idea that who owns a business and how it operates are inseparable, is more or less exactly the position I’m arguing against in this post.

The question of who owns a company is a distinct question from what it does or how it is run. Not entirely unrelated, to be sure — but to think about how they are connected, we first have to recognize that they are not the same.

The Class Struggle on Wall Street: A Footnote

Remember back at the beginning of February when the stock markets were all crashing? Feels like ages ago now, I know. Anyway, Seth Ackerman and I had an interesting conversation about it over at Jacobin.

My rather boring view is that short-term movements in stock markets can’t be explained by any kind of objective factors, because in the short run prices are dominated by conventional expectations — investors’ beliefs about investors’ beliefs… [1] But over longer periods, the value of shares is going to depend on the fraction of output claimed as profits and that, in general, is going to move inversely with the share claimed as wages. So if working people are getting raises — and they are, at least more than they were in 2010-2014 — then shareholders are right to worry about their own claim on the product.

One thing I say in the interview that a couple people have been surprised at, is that

there has been an upturn in business investment. In the corporate sector, at least, business investment, after being very weak for a number of years, is now near the high end of its historical range as a fraction of output.

Really, near the high end? Isn’t investment supposed to be weak?

As with a lot of things, whether investment is weak or strong depends on exactly what you measure. The figure below shows investment as a share of total output for the economy as a whole and for the nonfinancial corporate sector since 1960. The dotted lines show the 10th and 90th percentiles.

Gross capital formation as a percent of output

 

As you can see, while invesment for the economy as a whole is near the low end of its historic range, nonfinancial corporate investment is indeed near the high end.

What explains the difference? First, investment by households collapsed during the recession and has not significantly recovered since.  This includes purchases of new houses but also improvements of owner-occupied houses, and brokers’ fees and other transactions costs of home sales (that last item accounts for as much as a quarter of residential investment historically; many people don’t realize it’s counted at all). Second, the investment rate of noncorporate businesses is about half what it was in the 1970s and 80s. This second factor is exacerbated by the increased weight of noncorporate businesses relative to corproate businesses over the past 20 years. I’m not sure what concrete developments are being described by these last two changes, but mechanically, they explain a big part of the divergence in the figure above. Finally, the secular increase in the share of output produced by the public sector obviously implies a decline in the share of private investment in GDP.

I think that for the issues Seth and I were talking about, the corporate sector is the most relevant. It’s only there that we can more or less directly observe quantities corresponding to our concepts of “the economy.” In the public (and nonprofit) sector we can’t observe output, in the noncorproate sector we can’t observe profits and wages (they’re mixed up in proprietors income), and in the household sector we can’t observe either. And financial sector has its own issues.

Anyway, you should read the interview, it’s much more interesting than this digression. I just thought it was worth explaining that one line, which otherwise might provoke doubts.

 

[1] While this is a truism, it’s worth thinking through under what conditions this kind of random walk behavior applies. The asset needs to be and liquid and long-lived relative to the relevant investment horizon, and price changes over the investment horizon have to be much larger than income or holding costs. An asset that is normally held to maturity is never going to have these sort of price dynamics.

Links for October 14

Now we are making progress. This piece by CEA chair Jason Furman on “the new view” of fiscal policy seems like a big step forward for mainstream policy debate. He goes further than anyone comparably prominent in rejecting the conventional macro-policy wisdom of the past 30 years. From where I’m sitting, the piece advances beyond the left edge of the current mainstream discussion in at least three ways.

First, it abandons the idea of zero interest rates as a special state of exception and accepts the idea of fiscal policy as a routine tool of macroeconomic stabilization. Reading stuff like this, or like SF Fed President John Williams saying that fiscal policy should be “a first responder to recessions,” one suspects that the post-1980s consensus that stabilization should be left to the central banks may be gone for good. Second, it directly takes on the idea that elected governments are inherently biased toward stimulus and have to be institutionally restrained from overexpansionary policy. This idea — back up with some arguments about  the“time-inconsistency” of policy that don’t really make sense — has remained a commonplace no matter how much real-world policy seems to lean the other way. It’s striking, for instance, to see someone like Simon Wren-Lewis rail against “the austerity con” in his public writing, and yet in his academic work take it as an unquestioned premise that elected governments suffer from “deficit bias.” So it’s good to see Furman challenge this assumption head-on.

The third step forward is the recognition that the long-run evolution of the debt ratio depends on GDP growth and interest rates as well as on the fiscal balance. Some on the left will criticize his assumption that the debt ratio is something policy should be worried about at all — here the new view has not yet broken decisively with the old view; I might have some criticisms of him on this point myself. But it’s very important to point out, as he does, that “changes in the debt ratio depend on two factors: the difference between the interest rate and the growth rate… and the primary balance… The larger the debt is, the more changes in r – g dwarf the primary balance in the determination of debt dynamics.” (Emphasis added.) The implication here is that the “fiscal space” metaphor is backward — if the debt ratio is a target for policy, then a higher current ratio means you should focus more on growth, and that responsibility for the “sustainability” of the debt rests more with the monetary authority than the fiscal authority. Admittedly Furman doesn’t follow this logic as far as Arjun and I do in our paper, but it’s significant progress to foreground the fact the debt ratio has both a numerator and a denominator.

If you’re doubting whether there’s anything really new here, just compare this piece with what his CEA chair predecessor Christina Romer was saying a decade ago — you couldn’t ask for a clearer statement of what Furman now rejects as “the old view.” It’s also, incidentally, a sign of how far policy discussions — both new view and old view — are from academic macro. DSGE models and their associated analytic apparatus don’t have even a walk-on part here. I think left critics of economics are too quick to assume that there is a tight link — a link at all, really — between orthodox theory and orthodox policy.

 

Why do stock exchanges exist? I really enjoyed this John Cochrane post on volume and information in financial markets. The puzzle, as he says, is why there is so much trading — indeed, why there is any trading at all. Life cycle and risk preference motivations could support, at best, a minute fraction of the trading we see; but information trading — the overwhelming bulk of actual trading — has winners and losers. As Cochrane puts it:

all trading — any deviation of portfolios from the value-weighted market index — is zero sum. Informed traders do not make money from us passive investors, they make money from other traders. It is not a puzzle that informed traders trade and make money. The deep puzzle is why the uninformed trade, when they could do better by indexing. …

Stock exchanges exist to support information trading. The theory of finance predicts that stock exchanges, the central institution it studies, the central source of our data, should not exist. The tiny amounts of trading you can generate for life cycle or other reasons could all easily be handled at a bank. All of the smart students I sent to Wall Street for 20 years went to participate in something that my theory said should not exist.

At first glance this might seem like one of those “puzzles” beloved of economists, where you describe some real-world phenomena in terms of a toy model of someone maximizing something, and then treat the fact that it doesn’t work very well as a surprising fact about the world rather than an unsurprising fact about your description. But in this case, the puzzle seems real; the relevant assumptions apply in financial markets in a way they don’t elsewhere.

I like that Cochrane makes no claim to have a solution to the puzzle — the choice to accept ignorance rather than grab onto the first plausible answer is, arguably, the starting point for scientific thought and certainly something economists could use more of. (One doesn’t have to accept the suggestion that if we have no idea what social needs, if any, are met by financial markets, or if there is too much trading or too little, that that’s an argument against regulation.) And I like the attention to what actual traders do (and say they do), which is quite different from what’s in the models.

 

Yes, we know it’s not a “real” Nobel. So the Nobel went to Hart and Holmstrom. Useful introductions to their work are here and here. Their work is on contract theory: Why do people make complex ongoing agreements with each other, instead of just buying the things they want? This might seem like one of those pseudo-puzzles — as Sanjay Reddy notes on Twitter, the question only makes sense if you take economists’ ideal world as your starting point. There’s a whole genre of this stuff: Take some phenomenon we are familiar with from everyday life, or that has been described by other social scientists, and show that it can also exist in a world of exchange between rational monads. Even at its best, this can come across like a guy who learns to, I don’t know, play Stairway to Heaven with a set of spoons. Yes, getting the notes out takes real skill, and it doesn’t sound bad, but it’s not clear why you would play it that way if you weren’t for some reason already committed to the gimmick. Or in this case, it’s not clear what we learn from translating a description of actual employment contracts into the language of intertemporal optimization; the process requires as an input all the relevant facts about the phenomenon it claims to explain. What’s the point, unless you are for some already committed to ignoring any facts about the world not expressed in the formalism of economics? This work — I admit I don’t know it well — also makes me uncomfortable with the way it seems to veer opportunistically between descriptive and prescriptive. Is this about how actual contracts really are optimal given information constraints and so on, or is it about how optimal contracts should be written? Anyway, here’s a more positive assessment from Mark Thoma.

 

Still far from full employment. Heres’ a helpful report from the Center for Economics and Policy Research on the state of the labor market. They look at a bunch of alternatives to the conventional unemployment rate and find that all of them show a weaker labor market than in 2006-2007. Hopefully the Clinton administration and/or some Democrats in the Senate will  put some sharp questions to FOMC appointees over the next few years about whether they think the Fed as fulfilled its employmnet mandate, and on what basis. They’ll find some useful ammunition here.

 

Saving, investment and the natural rate. Here’s a new paper from Lance Taylor taking another swipe at the pinata of the “natural rate”. Taylor points out that if the “natural” interest rate simply means the interest rate at which aggregate demand equals potential output (even setting aside questions about how we measure potential), the concept doesn’t make much sense. If we look at the various flows of spending on goods and services by sector and purpose, we can certainly identify flows that are more or less responsive to interest rates; but there is no reason to think that interest rate changes are the main driver of changes in spending, or that “the” interest rate that balances spending and potential at a given moment is particularly stable or represents any kind of fundamental parameters of the economy. Even less can we think of the “natural” rate as balancing saving and investment, because, among other reasons, “saving” is dwarfed by the financial flows between and within sectors. Taylor also takes Keynes to task (rightly, in my view) for setting us on the wrong track with assumption that households save and “entrepreneurs” invest, when in fact most of the saving in the national accounts takes place within the corporate sector.

 

On other blogs, other wonders:

At Vox, another reminder that the rise in wealth relative to income that Piketty documents is mainly about the rising value of existing assets, not the savings-and-accumulation process he talks about in his formal models.

Also at Vox: How much did Germany benefit from debt forgiveness after World War II? (A lot.) EDIT: Also here.

Is there really a “global pivot” toward more expansionary fiscal policy? The IMF and Morgan Stanley both say no.

Another one for the short-termism file: Here’s an empirical paper suggesting that when banks become publicly traded, their management starts responding to short-run movements in their stock, taking on more risk as a result.

Matias Vernengo has a new paper on Raul Prebisch’s thought on business cycles and growth. Prebisch would be near the top of my list of twentieth century economists who deserve more attention than they get.

I was just at Verso for the release party for Peter Frase’s new book Four Futures, based on his widely-read Jacobin piece. I don’t really agree with Peter’s views on this — I don’t see the full replacement of human labor by machines as the logical endpoint of either the historical development of capitalism or a socialist political project — but he makes a strong case. If the robot future is something you’re thinking about, you should definitely buy the book.

 

EDIT: Two I meant to include, and forgot:

David Glasner has a follow-up post on the inconsistency of rational expectations with the “shocks” and comparative statics they usually share models with. It’s probably not worth beating this particular dead horse too much more, but one more inconsistency. As I can testify first-hand, at most macroeconomic journals, “lacks microfoundations” is sufficient reason to reject a paper. But this requirement is suspended as soon as you call something a “shock,” even though technology, the markup, etc. are forms of behavior just as much as economic quantities or prices are. (This is also one of Paul Romer’s points.)

And speaking of people named Romer, David and and Christina Romer have a new working paper on US monetary policy in the 1950s. It’s a helpful paper — it’s always worthwhile to reframe abstract, universal questions as concrete historical ones — but also very orthodox in its conclusions. The Fed did a good job in the 1950s, in their view, because it focused single-mindedly on price stability, and was willing to raise rates in response to low unemployment even before inflation started rising. This is a good example of the disconnect between the academic mainstream and the policy mainstream that I mentioned above. It’s perfectly possible to defend orthodoxy macroeconomic policy without any commitment to, or use of, orthodox macroeconomic theory.

 

EDIT: Edited to remove embarrassing confusion of Romers.

Links for September 23

I am going to strive to make these posts weekly. People need things to read.

 

The trouble with macro. I haven’t yet read any of the latest big-name additions to the “what’s wrong with macroeconomics?” pile: Romer (with update), Kocherlakota, Krugman, Blanchard. I should read them, maybe I will, maybe you should too. Here’s my own contribution, from a few years ago.

 

Tankus notes. You may know Nathan Tankus from around the internet. I’ve been telling him for a while that he should have a blog. He’s finally started one, and it’s very much worth reading. I’m having some trouble with one of his early posts. Well, that’s how it works: You comment on what you disagree with, not the things you think are smart and true and interesting — which in this case is a lot.

 

The shape of the elephant. Branko Milanovic’s “elephant graph” shows the changes in the global distribution of income across persons since 1980, as distinct from the more-familiar distribution of income within countries or between countries. The big story here is that while there has been substantial convergence, it isn’t across the board: The biggest gains were between the 10th and 75th percentiles of the global distribution, and at the very top; gains were much smaller in the bottom 10 percent and between the 70th and 99th percentiles. One question about this has been how much of this is due to China; as David Rosnick and now Adam Corlett of the Resolution Fondation note, if you exclude China the central peak goes away; it’s no longer true that growth was unusually fast in the middle of the global distribution. Corlett also claims that the very slow growth in the upper-middle part of the distribution — close to zero between the 75th and 85th percentiles — is due to big falls in income in the former Soviet block and Japan. Initially I liked the symmetry of this. But now I think Corlett is just wrong on this point; certainly he gives no real evidence for it.  In reality, the slow growth of that part of the distribution seems to be almost entirely an artifact due to the slow growth of population in the upper part of the distribution; correct for that, as Rosnick does here, and the non-China distribution is basically flat between the 10th and 99th percentiles:

Source: David Rosnick
Source: David Rosnick

Yes, there does seem to be slightly slower growth just below the top. But given the imprecision of the data we shouldn’t put much weight on it. And in any case whatever the effect of falling incomes in Japan and Eastern Europe (and blue-collar incomes in the US and western Europe), it’s trivial compared to the increase in China. Outside of China, the global story seems to be the familiar one of the very rich pulling ahead, the very poor falling behind, and the middle keeping pace. Of course, it is true, as the original elephant graph suggested, that the share of income going to the upper-middle has fallen; but again, that’s because of slower population growth in the countries where that part of the distribution is concentrated, not because of slower income gains.

It’s important to stress that no one is claiming that Branko’s figures are wrong, and also that Branko is on the side of the angels here. He’s been fighting the good fight for years against the whiggish presumption of universal convergence.

 

Equality of opportunity and revolution. Speaking of Branko, here he is on the problem with equality of opportunity:

Upward mobility for some implies downward mobility for the others. But if those currently at the top have a stronghold on the top places in society, there will no upward mobility however much we clamor for it. … In societies that develop quickly even if a lot of mobility is about positional advantages, … it can be compensated by creating enough new social layers, new jobs and by making people richer. …

In more stagnant societies, mobility becomes a zero-sum game. To effect real social mobility in such societies, you need revolutions that, while equalizing chances or rather improving dramatically the chances of those on the bottom, do so at the cost of those on the top. … The French Revolution, until Napoleon to some extent reimposed the old state of affairs, was precisely such an upheaval: it oppressed the upper classes (clergy and nobility) and promoted the poorer classes. The Russian revolution did the same thing; it introduced an explicit reverse discrimination against the sons and daughters of former capitalists, and even of the intellectuals, in the access to education.

I think this is right. The principle of equality of opportunity is incompatible, not just practically but logically, with the principle of inheritance. The only way to realize it is to deprive those at the top of their power and privileges, which by definition is possible only in a revolutionary situation. This is one reason why I have no interest in a political program defined, even in its incremental first steps, in terms of equality of income or wealth. The goal isn’t equality but the abolition of the system which makes quantitative comparisons of people’s life-situations possible.

The post continues:

There is also an age element to such revolutions which fundamentally alter societies and lift those from below to the top. The young people benefit. In a beautiful short novel entitled “The élan of our youth” Alexander Zinoviev, a Russian logician and later dissident, describes the Stalinist purges from a young man’s perspective. The purges of all 40- or 50-year old “Trotskyites” and “wreckers” opened suddenly incredible vistas of upward mobility for those who were 20- or 25-year old.  They could hope, at best, to come to the positions of authority in ten or fifteen years; now, that were suddenly thrown in charge of hundreds of workers, became chief designers of airplanes, top engineers of the metro. What was purge and Gulag for some, was upward mobility for others.

As this suggests, the overturning ofhierarchies didn’t stop with the revolutions themselves — that was the essential content of the various purges, to prevent a new elite from consolidating itself. I’ve always wondered how much vitality revolutionary France and Russia gained from these great overturnings. There are an enormous number of working-class people in our society, I have no doubt, who would be much more capable of running governments and factories, designing airplanes and subways, or teaching economics for that matter, than the people who get to do it.

 

We simply do not know — but we can fake it. Aswath Damodaran has a delicious post on the valuations that Elon Musk’s bankers came up with to justify Tesla’s acquisition of Solar City. The basic problem in these kinds of exercises is that the same price has to look high to the shareholders of the acquired company and low to the shareholders of the acquiring company. In this case, the Solar City shareholders have to believe that the 0.11 Tesla shares they are getting are worth more than the Solar City share they are giving up, while the Tesla shareholders have to believe just the opposite — that one Solar City share is worth more than the 0.11 Tesla shares they are giving for it. You can square this circle by postulating some gains from the combination — synergies! efficiencies! or, sotto voce, market power — that allows the acquirer to pay a premium over the market price while still supposedly getting a bargain. Those gains may be bullshit but at least there’s a story that makes sense. But as Damodaran explains, that isn’t even attempted here. Instead the two sets of advisors (both ultimately hired by Musk) simply use different assumptions for the growth rates and cost of capital for the two companies, generating two different valuations. For instance, Tesla’s advisors assume that Solar City’s existing business will grow at 3-5% in perpetuity, while Solar City’s advisors assume the same business will grow at 1.5-3%. So one set of shareholders can be told that a Solar City share is definitely worth less than 0.11 Tesla shares, while the other set of shareholders can be told that it is definitely worth more.

So what’s the interest here? Obviously, it’s always fun to se someone throwing shoes at the masters of the universe. But with my macroeconomist hat on, the important thing is it’s a snapshot of the concrete sociology behind the discounting of future cashflows. Whenever we talk about “the market” valuing some project or business, we are ultimately talking about someone at Lazard or Evercore plugging values into a spreadsheet. This is something people who imagine that production decisions are or can be based on market signals — including my Proudhonist friends — would do well to keep in mind. Solar City lost money last year. It lost money this year. It will lose money next year. It keeps going anyway not because “the market” wants it to, but because Musk and his bankers want it to. And their knowledge of the future isn’t any better founded than the rest of ours. Now, you could argue that this case is noteworthy because the projections are unusually bogus. Damodaran suggests they aren’t really, or only by degree. And in any case this sort of special pleading wouldn’t work if there were an objective basis for computing the true value of future cashflows. I suspect it was precisely Keynes’ experience with real-world financial transactions like this that made him stress the fundamental unknowability of the future.

 

Uber: The bar mitzvah moment. While we’re reading Damodaran, here’s another well-aimed shoe, this one at Uber. As he says, pushing down costs is not enough to make profits. You also need some way of charging more than costs. You need some kind of monopoly power, some source of rents: network externalities; increasing returns, and the financing to take advantage of them; proprietary technology; brand loyalty; explicit or implicit collusion with your competitors. Which of these does Uber have? maybe not any? Uber’s foray into self-driving cars is perhaps a way to generate rents, though they’re more likely to accrue to the companies that actually own the technology; I think it’s better seen as a ploy to convince investors for another quarter or two that there are rents there to be sought.

Izabella Kaminska covers some of the same territory in what may be the definitive Uber takedown at FT Alphaville. Though perhaps she focuses overmuch on how awful it would be if Uber’s model worked, and not enough on how unlikely it is to.

 

On other blogs, other wonders. 

San Francisco Fed president John Williams writes, “during a downturn, countercyclical fiscal policy should be our equivalent of a first responder to recessions.” Does this mean that MMT has won?

Mike Konczal: Trump is full of policy.

My friend Sarah Jaffe interviews my friend Vamsi, on the massive strikes going on in India.

The Harry Potter books are bad books and and have a bad, childish, reactionary view of the world. So does J. K. Rowling.

The Mason-Tanebaum household has its first byline in the New York Times this week, with Laura’s review of the novel Black Wave in the Sunday books section.

 

 

Only the Debt Is National

Imagine this set of transactions.

1. A bank in rich country A makes a loan of X to the government of poor country B. Let’s say for concreteness that A is the United States, B is Nigeria, and X is $1 billion. So now we have a liability of $1 billion of the Nigerian government to the US bank, and deposit of $1 billion at the US bank owned by the government of Nigeria.

(Nigeria might just as well be Egypt or Mexico or Argentina or Greece or Turkey or Indonesia. And the United States might just as well be Germany or the UK. )

2. The deposit at the bank is transferred from ownership of the government to ownership of some private individual. It’s easy to imagine ways this can be done.

3. The residents of Nigeria, via their government, still have a liability of $1 billion to the bank, obliging them to make annual payments equal to the interest rate times the principal. In this case, let’s say the interest rate is 5%, so debt service is $50 million.

4. The payments can be met by running an annual export surplus of $50 million. As long as this $50 million annual payment is maintained, interest payments can be made and the principal rolled over; the debt will remain forever.

5. The private individual from step 2 moves from Nigeria to the United States, eventually becoming a citizen there.

The result of this: a family in the United States has wealth of $1 billion (plus whatever they already had, of course). Meanwhile, the people of Nigeria make payments of $50 million each year to the United States forever, in the form of uncompensated exports. In their important book Africa’s Odious Debts and related work, Boyce and Ndikumana demonstrate that this story describes much of sub-Saharan Africa’s foreign debt. It applies elsewhere in the world as well.

I wonder how various people evaluate this scenario. Do we agree there is something wrong here? And if so, what, and what is the solution?

The orthodox view, as far as I can tell, is: what’s the problem? People should pay their debts. Nigeria (or Argentina etc.) is a person, it has borrowed, it must pay. The fact that some private individual chooses to hold their wealth in one country rather than another has nothing to do with it.

More generally, the dominant view today is that the ability to carry transactions like those describe above is an unmixed blessing; in fact it’s the whole point of the international system. The three pillars of the European union are free movement of people, free movement of goods, and free movement of finance.  Argentina’s Macri is hailed as a hero — by Obama among others — for removing capital controls.  If you are committed to capital mobility, then it’s hard to see where the objection would be. Third World governments and New York banks are consenting adults and can contract on any terms they choose. And of course the fact that a possessor of wealth happens to be located in one country cannot, in a liberal order, be an objection to them owning an asset somewhere else.

Maybe it’s the last step that is the issue? Outside of Europe, the free movement of people does not have the same place in the economic catechism as the free movement of money or goods. And even in Europe it’s a bit shaky. Still, most governments are happy enough to welcome rich immigrants. (A few months ago, my FT dislodged a glossy pamphlet, a racially ambiguous woman in a bikini on the cover, advertising citizenship by investment in various Caribbean countries.)  This post was provoked by a Crooked Timber post by Chris Bertram; I’d be curious what he, or other open-borders advocates like my friend Suresh Naidu, would say about this scenario. Does an unrestricted right of human beings to cross borders imply an unrestricted right to transfer property claims across them also?

If the solution is not limits on movement of people, perhaps it is limits on cross-order transfers of financial claims, that is, capital controls. This used to be common sense. It’s not entirely straightforward where capital controls would operate in the sequence above; the metaphor of “capital” as a substance that moves across borders is unhelpful. But in some way or other capital controls would prevent the individual in country B from coming into possession of the bank deposit in country A.

There are two problems with this solution, one practical and the other more fundamental. The practical problem is that many routine transactions — payment for imports say — involve the creation of bank deposits in one country payable to some entity in another. It is hard to distinguish prohibited financial transactions from permitted payments for goods and services — and as Boyce and Ndikumana document, capital flight is usually disguised as current account transactions, for instance by over-invoicing for imports. Eric Helleiner [1] quotes Jacob Viner: “Because of the difficulty of distinguishing between capital account and current account transactions, capital controls could be made effective only by ‘censorship of communications and by crushing penalties for violation.'” [2]

The more fundamental problem is that these transactions — and capital flight in general – may be perfectly legal by the rules in force when they take place. Or if formally illegal, they are usually carried out by high government officials and/or members of the country’s elite. So the government of the poor country is unlikely to aggressively apply any restrictions that do exist. A subsequent government might well feel differently — but what claim do they have on a private bank account in a foreign country?

The problems with making capital controls effective were recognized clearly in the runup to Bretton Woods. In White’s 1942 draft for the agreements — again quoting Helleiner — “governments were required (a) not to accept or permit deposits or investments from any member country except with the permission of the government of that country, and (b) to make available to the government of any member country at its request all property in form of deposits, investments or securities of the nationals of the member country.” Even this wouldn’t be enough, of course, in the case where the wealthowner ceases to be a national. And it might not help in the case of a corrupt government that doesn’t want to repatriate private funds — though it might, if (as was also discussed) countries with balance of payments problems were required to draw on foreign exchange in private hands before being granted official assistance. In any case, it seems challenging to impose effective capital controls without granting the government control of all foreign assets — which will often require the cooperation of the country where those assets are held.

Needless to say nothing like this was included in the Bretton Woods agreements as signed. The US government would not even accept its allies’ pleas to assist in repatriating flight capital to help with the acute balance of payments difficulties following the war. Now it’s true, Second Circuit Judge Griesa recently claimed even more extensive authority that the government of Argentina would have had under White’s proposals, seizing the US assets of third parties who’d received payments from the Argentine government. But that was strictly to make payments to creditors. No such access to foreign assets is generally available.

This situation can arise even if governments themselves don’t even have to borrow abroad. As we recently saw in the case of Ireland, a government can strictly limit its debt and still find itself with unmanageable foreign liabilities. If private institutions — especially banks, but potentially nonfinancial corporations as well — borrow abroad, government that wishes to keep them operational  in a crisis may have to assume their liabilities. Or at least, they will be strongly urged to do so by all the guardians of orthodoxy. What, are you going to just let the banks fail? Meanwhile, any foreign claims generated by the activities of the banks before they failed are out of reach.

Financial commitments create obligations; when circumstances change, sometimes they can’t be met. Someone isn’t going to get what they were promised. In modern economies, the state (often in the guise of the central bank) steps in to assume or redenominate claims, to impose an ex post consistency on the inconsistent contracts signed by private agents. But with foreign-currency commitments to foreigners the authorities’ usual tools aren’t available. And just as important, there are other authorities — the ECB in the case of Greece, the US federal court system in the case of Argentina — that are ready to use their privileged position in the larger payments system to enforce the claims of creditors. In effect, while domestic contracts are always subject to political renegotiation, foreign contracts are — or can be made to seem — objective fact.

What we’ve ended up with is a situation in which private parties have an absolute right to make whatever financial commitments they choose, and national governments have an absolute duty to honor the resulting balance sheet commitments. Wealth belongs to individuals, but debt belongs to the people. They are bound by past government commitments forever.

Or as Marx observed, “The only part of the so-called national wealth that actually enters into the collective possession of modern peoples is their national debt. …in England all public institutions are designated ‘royal’; as compensation for this, however, there is the ‘national’ debt. ” 

 

 

[1] The Helleiner book, along with Fred Block’s Origins of International Economic Disorder, is still the best thing I know on the evolution of international monetary arrangements since World War II. Has anything better been written in the 20 years since it came out?

[2] This brings out two general points on financial regulation that I’d like to develop more. First, it is one thing to establish different rules for different kinds of activity, but the classification has to actually match up with the legal and accounting categories in which actual economic transactions are organized. The category of “banks” is a currently relevant example. This is part of the larger issue of what I call the money view, or economic nominalism — we need a perspective that regards money payments and the labels they bear as fundamental, rather than seeing them as reflections of some underlying structure. Second, and relatedly, it is hard for individual regulations to be effective in a setting in which anything that is not explicitly forbidden is permitted, since for any regulated transaction there will normally be unregulated ones that are economically equivalent.

Links for April 21

 

The coup in Brazil. My friend Laura Carvalho has a piece in the Times, briefly but decisively making the case that, yes, the impeachment of Dilma Rousseff is a coup. Also worth reading on Brazil: Matias Vernengo, Marc Weisbrot and Glenn Greenwald.

 

The bondholder’s view of the world.  Normally we are told that when interest rates on public debt rise, that’s a sign of the awesome power of bond markets, passing judgement on governments that they find unsound. Now we learn from this Bloomberg piece that when interest rates on public debt fall, that  too is a sign of the awesome power of bond markets. Sub-1 percent rates on Irish 10-year bonds are glossed as: “Bond Market to Periphery Politicians: You Don’t Matter.” The point is that even without a government, Ireland can borrow for next to nothing. Now, you might think that if the “service” bond markets offer is available basically for free, to basically anyone — the takeaway of the piece — then it’s the bond markets that don’t matter. Well then you, my friend, will never make it as a writer of think pieces in the business press.

 

The bondholder’s view, part two. Brian Romanchuk says what needs to be said about some surprisingly credulous comments by Olivier Blanchard on Japan’s public debt.

Anyone who thinks that hedge funds have the balance sheet capacity to “fund” a G7 nation does not understand how financial markets are organised. There has been a parade of hedge funds shorting the JGB market (directly or indirectly) for decades, and the negative yields on JGB’s tells you how well those trades worked out.

 

The prehistory of Trumpism. Here is a nice piece by my University of Chicago classmate Rick Perlstein on the roots of Trump’s politics in the civil-rights-backlash politics of fear and resentment of Koch-era New York. (Also.) I’ve been wishing for a while that Trump’s role in the Central Park Five case would get a more central place in discussions of his politics, so I’m glad to see Rick take that up. It’s also smart to link it to the Death Wish/Taxi Driver/Bernie Goetz white-vigilante politics of the era.  (Random anecdote: I first saw Taxi Driver at the apartment of Ken Kurson, who was at the U of C around the same time as Rick and I. He now edits the Trump-in-law owned New York Observer.)  On the other hand, Trump’s views on monetary policy are disturbingly sane:

“The best thing we have going for us is that interest rates are so low,” says Trump, comparing the U.S. to a homeowner refinancing their mortgage. “There are lots of good things that could be done that aren’t being done, amazingly.”

 

The new normal at the Fed. Here’s a useful piece from Tracy Alloway criticizing the idea that central banks will or should return to the pre-2008 status quo.  It’s an easy case to make but she makes it well. This is a funny moment to be teaching monetary policy. Textbooks give a mix of the way things were 40 years ago (reserve requirements, the money multiplier) and the way things were 10 years ago (open market operations, the federal funds rate). And the way things are now? Well…

 

Me at the Jacobin. The Jacobin put up the transcript of an interview I did with Michel Rozworski a couple months ago, around the debates over potential output and the possibilities for fiscal stimulus. It’s a good interview, I feel good about it. Now, Noah Smith (on twitter) raises the question, when you say “the people running the show”, who exactly are you referring to? It’s a fair question. But I think we can be confident there is a ruling class, and try to understand its intentions and the means through which they are carried out, even if we’re still struggling to describe the exact process through which those intentions are formed.

 

Me on Bloomberg TV. Joe Weisenthal invited me to come on “What’d You Miss” last week, to talk about that BIS paper on bank capital and shareholder payouts. Here’s a helpful post by Matthew Klein on the same topic. And here is the Fed paper I mention in the interview, on the high levels of bank payouts to shareholders during 2007-2009, when banks faced large and hard to predict  losses from the crisis and, in many cases, were simultaneously being supported in various ways by the Fed and the Treasury.

 

“Brazil in Drag”: Hyman Minsky on Donald Trump

Via Nathan Cedric Tankus, here is a recent JPKE article by Kevin Capehart on a 1990 lecture by Minsky that uses Trump as a case study of asset market bubbles in the 1980s. The lecture is fascinating, and not just as an odd historical artifact.

Here is what Minsky says about Trump:

One of the puzzles of the 1980s was the rapid rise in the financial wealth of Donald Trump, author of The Art of the Deal… Trump’s fortune was made in real estate. Many large fortunes have been made in real estate, since real estate is highly leveraged. Two factors made Trump somewhat unique — one was the he developed a fortune in the period of high real interest rates, and the second was that the cash flows on most of Trump’s properties were negative.

Trump’s wealth surged because the market value of his properties — or at least the appraised value — was increasing faster than the interest rate. Trump obtained the funds to pay the interest on his outstanding loans by increasing the draw under what in effect was a home equity credit line. The efficiency with which Trump managed these properties was more or less irrelevant — hence Trump could acquire the Taj Mahal in Atlantic City without much concern about the impacts on the profits of the two casinos he already owned. Trump was golden — he had a magic touch — as long as property prices were increasing at a more rapid rate than the interest rate on the borrowed funds.

The puzzle is that the lenders failed to recognize that the arithmetic of his cash flows was virtually identical with that of the developing countries [discussed earlier in the lecture]; in effect Trump was Brazil in drag. In the short run Trump could make his interest payments with funds from new loans — but when the increase in property prices declined to a value below the interest rate, Trump would become short of the cash necessary to pay the interest on the outstanding loans.

The increase in U.S. real estate prices in the 1980s was regional, and concentrated in the Northeast and in coastal California. … Real estate prices dipped in the oil patch, climbed modestly in the rust belt, and surged in those areas that benefitted from the rapid increases in incomes in banking and financial services — sort of a derived demand from the financial success of Drexel Burnham. In effect, those individuals with high incomes in financial services — and with the prospect of sharp increase in incomes — set the pace for increases in real estate prices.

Trump’s cousins were alive and well and flourishing in Tokyo, Taipei and Seoul especially in the second half of the 1980s. The prices of equities and real estate were increasing because they were increasing…

In any market economy the price of real estate will tend to reflect both its rental return and the rate of return on the riskless bond. … The price of land rises and the price of land sometimes falls — the relevant question is whether the anticipated increase in the price of land is sufficiently higher than the interest rate on bonds to justify a riskier investment.

….

The key question is why so many varied bubbles developed in the last several decades. The most general answer is that sharp changes in inflation rates and interest rates led to extremely volatile movement in asset prices. And once these price movements begin, then on occasion momentum may develop and feed on itself — at least for a while.

So in Minsky’s version of The Art of the Deal, there are three things you need to get rich like Trump. First, be an investor in NYC and New Jersey real estate in a period when land prices are rising rapidly there relative to the rest of the country. Second, be highly leveraged. And third — and this is critical — convert your equity to cash as quickly as possible to protect yourself from the post-bubble fall in prices. Picking the right individual properties doesn’t matter so much, and managing the properties well doesn’t matter at all.

In this analysis, the repeated bankruptcies of Trump-controlled properties don’t undermine his claims of business success, nor are they just an incidental footnote to it; they are an integral part of how he got so rich. Because the flipside of extracting cash from his properties through “what was in effect a home equity credit line” is that there was less equity left for the entity that actually owned them.

The trick to making money in an asset bubble is to cash out before it pops. Doing this by selling at the peak is hard; you have to time it just right. It’s easier and much more reliable to cash out the capital gains as they accrue; that just requires some way of moving them to a different legal entity. The precedent for Trump, in this reading, would be the utility holding companies that played such a big part in the stock market boom of the 1920s and were such a big target for regulation in the 1930s. Another parallel would be today’s private equity funds. To the extent that the funds cash out via so-called “dividend recapitalization” (special dividends paid by the acquired company to the PE fund) rather than eventual resale, an acquired company that doesn’t end in bankruptcy is money left on the table. It’s interesting, in this context, to think about Romney and Trump as successive Republican nominees: They may embody different cultural stereotypes (prissy Mormon patriarch vs womanizing New York vulgarian) but fundamentally they are in the same business of financial value extraction.

What Is Foreign Investment For?

The top of the front page in today’s Financial Times shows Steve Forbes’ scowling face with the caption, “We want our money!” Really, that should be there every day — it could be their new logo.

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Further down the page, the big story is the election of the opposition candidate Mauricio Macri as president of Argentina. I’ll wait to see what Marc Weisbrot has to say before guessing what this means substantively for the direction of the Argentine state. What I want to call attention to now is the consistent theme of the coverage.

The front page headline in the FT is “Markets cheer Argentina’s new order”; the opening words of the article are “Investors hailed the election of Mauricio Macri….” After mentioning his call for the leaders of Argentina’s central bank to step down — the apparent unobjectionableness of which is evidence on the real content of central bank “independence” — the first substantive claims of the article are that “markets reacted positively” and that “Macri has promised to eliminate strict exchange controls” — evidently the most important policy issue from the perspective of the FT reporter.

Over the fold, we learn again that “Investors yesterday cheered the election of Mauricio Macri”; that “dollar bonds issued by Argentina … extended their winning streak”; and that “markets have hoped for an end to ‘Kirchnerismo’.” The only people quoted in the article other than Macri himself are three European investment bankers. One says that “Macri understands what the country needs to do to regain the confidence of international investors and get the country back on its feet” — presumably in that order. Another instructs the new government that “Argentina must normalise relations with the capital markets and start attracting the all- important foreign investors”.

The accompanying think piece explains that among the “most pressing issues” for Macri are that “the country is shut out of international markets by its long court case with holdout creditors” and that “the economy suffers from a web of distortions, including energy subsidies that can shrink a household’s monthly energy bill to the price of a cup of coffee.” (The horror!) It emphasizes again that Macri’s only firm policy commitment at this point is to remove capital controls, and suggests that “Argentina will need to have recourse to multilateral financial support.” The conclusion: “The biggest area where Macri needs to effect change is the investment climate. Investors have cheered his rise … but Mr Macri’s job is to convert Argentina into a destination for real money investment rather than hedge fund speculation … a decisive change for a country that … is unique in having lost its ‘rich nation status’.”

So that’s the job of the president of Argentina, making the country a destination for real money. Good to have that clear!

Now, you might say, if you don’t want to read every story through the frame of “Is it good for the bondholders,” then why are you reading the FT? Fair enough — but the FT is a good newspaper. (The Forbes story is fascinating.) Anyway, it’s worth being reminded every so often that in the higher consciousness of the bourgeoisie, nations and all other social arrangements exist only in order to generate payments to owners of financial assets. [1]

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The question I’m interested in, though, is the converse one — are the bondholders good for Argentina? The claim that foreign investors are “all-important” is obviously an expression of the extraordinary narcissism of finance. But is there a rational core to it? Are foreign investors at least somewhat important?

This is a question that critical economists need to investigate more systematically. Even among heterodox writers, there’s a disproportionate focus on the development of the financial superstructure and the ways in which it can break down. [2] The importance of this superstructure for the concrete activities of social production and reproduction is too often taken for granted. Or else we make the case against free cross-border financial commitments too quickly, without assessing what might be the arguments for them.

So, concretely, what is the benefit to Argentina of regaining “access to the markets,” to enjoying the goodwill of foreign investors, to being a destination for real money? To answer this properly would involve citing lots of literature and looking at data. I’m not going to do that. The rest of this post is just me thinking through this issue, without directly referring to the literature. One result of this is that the post is too long.

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Let’s start by distinguishing foreign direct investment (FDI) from portfolio investment.

The case for FDI is essentially that there are productive processes that can be carried out successfully only if owned and managed by foreigners. Now, obviously there are real advantages to the ways in which production is organized in rich countries, which poorer countries can benefit from adopting. But the idea that the only way this technical knowledge can reach poorer countries is via foreign ownership rests, I think, on racism, that simple. The claim that domestically-owned firms cannot adopt foreign technology is contradicted by, basically, the entire history of industrialization.

A more plausible advantage of foreign ownership is that foreign companies have more favorable access to markets and supply networks. It would be at least defensible to claim that Polish manufacturing has benefited from integration into the German auto industry — not because German management has any inherent superiority, but because German car companies are more likely to source from their own subsidiaries than from independent Polish firms. I don’t see this kind of argument being made for Argentina. When we hear about “regaining the confidence of international investors,” that pretty clearly means owners of financial wealth considering whether to include Argentine assets in their portfolios, not multinational corproations considering expanding their operations there. In other words, we are interested in portfolio investment.

So what are the benefits that are supposed to come from attracting portfolio inflows? I wonder if the people quoted in the FT piece, or the author of it, ever even ask this question. This may be a case where the debate over what “capital” means is not just academic. If financial wealth is conflated with concrete means of production, then it’s natural to think that the goodwill of the owners of the first is all-important, since obviously no productive activity can take place without the second. But purchasers of Argentine stocks and bonds are not, in fact, providing the country with new machines or software or engineers or land. (For this reason, I prefer to avoid the terms “capital flows” and “capital mobility”.) What then are the bond buyers providing?

Macroeconomically, it seems to me that there are really only two arguments to be made for portfolio inflows. First, they allow a current account deficit to be financed. Second, they might allow the interest rate to be lower. Beyond macro considerations, we might also want to keep international investors happy because of their political influence, or because they control access to the international (or even domestic) payments system. And of course, if a country is already committed to free financial flows then this commitment will only be sustainable if net financial inflows are kept above a certain level. But that just begs the question of why you would make such a commitment in the first place.

Let’s consider these arguments in turn.

‘The first benefit, that portfolio inflows allow a country to have a deficit on current account, is certainly real. I think this is the only generally credible macroeconomic story for the benefits of capital account liberalization.

In a world with no international financial flows, countries would have to a balanced current account (or in practice balanced trade, since most income flows are the result of past financial flows) in every period. But there might be good reasons for some countries. to have transitory or persistent trade imbalances If a country’s trade balance moves toward deficit for whatever reason, the ability to reduce foreign assets and increase foreign liabilities allows the movement back toward balance to be deferred. If faster growth would lead to higher import demand (which cannot be limited otherwise) or requires specific imported intermediate or capital goods (that cannot be financed otherwise) then the foreign exchange provided by portfolio inflows can allow faster growth than would otherwise be possible.

There are good reasons to be skeptical about the practical value of portfolio inflows as finance of current account deficits. But there’s nothing wrong with the argument in principle. If that is the argument you are making, though, you have to be clear about the implications.

First, if this is your argument, then saying that Argentina has suffered because of its lack of access to foreign capital markets, is equivalent to saying that Argentina suffered because of its inability to run a trade deficit. I don’t think this is what people are saying — and it would not be plausible if they were, since Argentina has had a large trade surplus over the whole Kirchner period. No help from foreign investors would have been needed to reduce that surplus.

Second, if the benefit of portfolio flows is to finance current account imbalances, then only the net flows matter. There is no purpose to the large offsetting gross flows — you could just as well have the central bank alone borrow from abroad, and then sell the resulting foreign exchange at the market price (or distribute it in some other way). That would deliver all the macroeconomic benefits of international financial flows and avoid one of the major costs — the central bank’s inability to act as lender of last resort or resolve financial crises when financial institutions have liabilities that cannot be settled with central bank’ money.

Again, the only unambiguous macroeconomic reason to support capital-account liberalization, or to make attracting portfolio inflows a priority, is if you want to see larger current account deficits. In an undergraduate textbook, this is the whole story — to say that international lending permits countries to substitute present for future expenditure, or to raise investment above domestic saving, are just different ways of saying it permits current account deficits. If you think larger current account imbalances are unnecessary or dangerous, then, it’s not clear what the macroeconomic function of portfolio investment is supposed to be. The only thing that portfolio investment directly provides is foreign exchange.

The second possible macroeconomic benefit is that foreign portfolio investment allows the interest rate to be lower than it otherwise could be. This is certainly possible as a matter of logic. Let’s imagine a firm with an investment project that will generate income in the future. The firm needs to issue liabilities in order to exercise claims on the labor and other inputs it needs to carry out the project. Wealth owners must be willing to hold the liabilities of entrepreneur on terms that make the project viable; if they demand a yield that is too high, the project won’t go forward. But there may be some foreign intermediary that is both willing to hold entrepreneur’s liabilities on more favorable terms, and issues liabilities that wealth owners are more willing to hold. In this case, the creation of financial claims across borders is a necessary condition for the project to go forward. Note that this case covers all the macroeconomic benefits of diversification, risk-bearing, etc. — the ability to hold an internationally diversified portfolio may be very valuable to wealth owners, but that matters to the rest of us only insofar as that value allows real activity to be financed on more favorable terms.

That story makes sense where there is no domestic financial system, or a very underdeveloped one; it’s a good reason why financial self-sufficiency is not a realistic goal for small subnational units. But it’s not clear to me how it applies to a country with its own banking system and its own central bank. Is it plausibly the case that in the absence of financial flows, the Argentine central bank would be unable to achieve an interest rate as low as would be macroeconomically desirable? Is it plausibly the case that there are productive enterprises in Argentina that are unable to secure domestic-currency loans from the local banking system even given expansionary policy by the central bank, but would be able to do so from foreign lenders?  [3]

If this is your argument, you should at least be able to identify the kinds of firms (or I suppose households) that you think should be borrowing more, are unable to secure loans from the domestic banking system, but would be able to borrow internationally. (Or that would be able to borrow more from domestic banks, if the banks themselves could borrow internationally.)

It’s hard for me to see how a reasonably developed banking system with a central bank could be constrained in its ability to provide domestic-currency liquidity by a lack of portfolio inflows. And I doubt that’s what the gentlemen from Credit Suisse etc. are saying. On the contrary, the usual claim is that portfolio flows reduce the feasible range of domestic interest rates. Of course the people saying this never explain why it is desirable — the ability to conduct financial transactions across borders is just presented as a fact of life, to which policy must adapt. [4]

In any case, my goal here isn’t to dispute the arguments for the importance of portfolio inflows, but to clarify what they are, and their logical implications. Do you think that the benefits of portfolio flows are that they finance current account deficits and allow easier credit than the domestic bank system could provide? Then you can’t, for instance, turn around and blame the euro crisis on current account deficits and too-easy credit. Or at least, you can’t do that and still hold up “free movement of capital” as one of the central virtues of the system.

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There are two other non-macroeconomic arguments you sometimes hear for the importance of foreign investors, focused less on what they offer than with what they can threaten. First, the political importance of international creditors in the US and other states may allow them to use the power of those states against government they are unhappy with.

Historically, this is the decisive argument in factor of keeping foreign investors happy. Through most of the period from the 1870s through the 1950s, the possible consequences of a poor “investment climate” included gunboats in your harbor, the surrender of tariff collection and other basic state functions to creditor governments, military coups, even the end of your national existence. [5] (Let’s not forget that the pretext for the war in which the United States claimed half of Mexico’s territory was the mistreatment of American businessmen there.)

That sort of direct state violence in support of foreign creditors has been less common in recent decades, though of course we shouldn’t exclude the possibility of its revival. But there are less overt versions. The extraordinary steps taken by the Judge Griesa on behalf of Argentina’s holdout creditors go far beyond anything the investors could have done on their own. If the point of the FT pieces is that Argentina needs to settle with its creditors because otherwise it will face endless, escalating harassment from the US legal system, then they may have a point. I’d just like them to come out and say it.

A related argument is that failure to get on good terms with finance as a cartel of asset owners, will mean loss of access to finance as a routine service. The version of this you hear most often is that defaulting on or otherwise annoying foreign investors will result in loss of access to trade finance. So that even if the country has a current account in overall balance, its imports and/or exports will be restricted by a sudden need to conduct trade on a pure cash basis. I’ve seen this claim made much more than I’ve seen any evidence for it — which doesn’t mean it’s wrong, of course. But who are the providers of trade finance? Are they so resolutely class-conscious that they would refuse otherwise profitable transactions out of solidarity with their investor brethren? It doesn’t seem terribly likely — if foreign investors are willing to continue buying sovereign bonds post-default, as they unequivocally are, it’s hard to see them refusing this basic financial service to private businesses. Or coming back to Argentina, is there any evidence that the demand for Argentine exports was reduced by the default, or that Argentina was unable to convert its foreign exchange earnings into imports because foreign exporters couldn’t finance the usual 60- or 90- or whatever-day delay before receiving payment?

Another version of this argument — which Nathan Cedric Tankus in particular made in the case of Greece — is that a country that breaks with its creditors will lose access to the routine payment system — credit cards and so on — since it is all administered by foreign banks. In the case of a eurosystem country this may have some plausibility, at least as an acute problem of the transition — over a longer term, I can’t see any reason why this is a service that can’t be provided domestically. But leave aside how plausible they are, let’s be clear what these claims mean. They are arguments that foreign investors matter not because of anything of value they themselves provide, but because of their ability to provoke a sort of secondary strike or embargo by other segments of finance if they don’t get what they want. These are political arguments, not economic ones. In the longer view, they also support Keynes’ argument that finance should be “homespun” wherever possible. If trade finance really is so critical, and so readily withdrawn, wouldn’t it be wise to develop those facilities yourself?

The final argument is that, if you have committed yourself to permitting the free creation of cross-border payment commitments, you will be unable to honor those commitments without a sufficient willingness of foreign units to take net long positions in your country’s assets. [6]

This one is correct. If, let’s say, banks in Argentina have accumulated large foreign currency liabilities (on their own, or more likely, as counterparties to other units accumulating net foreign asset positions) then their ability to meet their survival constraint will at some point depend on the willingness of foreign units to continue holding their liabilities. And unlike in the case of a bank with only domestic-currency liabilities, the central bank cannot act as lender of resort. In other words, the central bank can always maintain the integrity of the payment system as long as its own liabilities serve as the ultimate means of settlement; but it loses this ability insofar as the balance sheets of the domestic financial system includes commitments to pay foreign moneys. [7]

This, probably, is the real practical content of stories about how important it is to maintain the goodwill of footloose capital. If you don’t honor your promises to foreign investors, you won’t be able to honor your promises to foreign investors. The weird circularity is part of the fact of the matter.

 

[1] Needless to say, not every political development is covered this way. The fact that the bondholder’s view of the world so dominates coverage of Argentine politics is evidently related to the specific way that Argentina is integrated into the global circuits of capital.

[2] I really wish people would stop talking about “the crisis” as some kind of watershed or vindication for radical ideas.

[3] I emphasize domestic currency. Of course domestic banks cannot provide foreign -currency loans. But again, this is only a macroeconomic issue if the country is running a trade deficit. Otherwise, the foreign exchange needed for imports will, in the aggregate, be provided by exports. The same goes for arguments that portfolio flows allow the central bank to target a lower interest rate, as opposed to achieving one.

[4] It would be worth going back and seeing what positive arguments the original framers of the policy trilemma made in favor of “capital mobility.” Or is it just treated as unavoidable?

[5] In the 19th century, “default might even be welcomed as a way of enhancing political influence.”

[6] It would be more conventional to express this thought in the language of capital mobility or international financial flows, but I think the metaphor of “capital” as a fluid “flowing” from one country to another is particularly misleading here.

[7] The capacity of the central bank to maintain payments integrity by substituting its own liabilities for impaired institutions’ is preserved even in the case of foreign-currency liabilities insofar as the central bank’s liabilities are accepted by foreign units. So the development of unlimited swap lines between major central banks represents, at least potentially, an important relaxation of the external constraint and a closer approximation of at least the rich-country portion of the global economy to an ideal closed economy. I’m glad to see that the question of swap lines is being taken up by MMT.

Lessons from the Greek Crisis

The deal, obviously it looks bad. No sense in spinning: It’s unconditional surrender. It is bad.

There’s no shortage of writing about how we got here. I do think that we — in the US and elsewhere — should resist the urge to criticize the Syriza government, even for what may seem, to us, like obvious mistakes. The difficulty of taking a position in opposition to “Europe” should not be underestimated. It’s one of the ironies of history that the prestige of social democracy, earned through genuine victories by and for working people, is now one of the most powerful weapons in the hands of those who would destroy it. For a sense of the constraints the Syriza government has operated under, I particularly recommend this interview with an unnamed senior advisor to Syriza, and this interview with Varoufakis.

Personally I don’t think I can be a useful contributor to the debate about Syriza’s strategy. I think those of us in the US should show solidarity with Greece but refrain from second-guessing the choices made by the government there. But we can try to better understand the situation, in support of those working to change it. So, 13 theses on the Greek crisis and the crisis next time.

These points are meant as starting points for further discussion.  I will try to write about each of them in more detail, as I have time.

Continue reading Lessons from the Greek Crisis