On the Soapbox

Bernanke on 60 Minutes

Sunday, March 15, 2009
Keywords: Economics

The Ben Bernanke interview on 60 Minutes tonight was enjoyable, in part because it's one of those rare instances where the media coverage of the current crisis is actually accurate and decent. There were four points in particular that I found delightful.

First, in a very subtle and coded way, he said that he was opposed to letting Lehman go, and that the fault for that lay with Hank Paulson. He did this by noting that the Fed did not act because the Fed did not have the power to act, the subtle implication of which was that the ball was in Treasury's court (for the dissolution of Bear Stearns, the Fed had a very ad hoc approach that involved acting through an intermediary). Many have attributed the Lehman misjudgment to Paulson's ideology, and it's comforting to know that at least the Fed was on the right track.

Second, Bernanke spoke of the need to stabilize and recapitalize the financial system as a prerequisite for recovery. This is a point that far too many people, especially those in the media, miss. It's reassuring to know that the Fed Chairman recognizes the importance of this, especially given how pitiful the Obama administration's plans on this front have been (I suspect in part due to political considerations, as Republicans seem to be even more blind to this).

Third, Bernanke spoke of the need to grant the Fed more powers, and he also spoke of the need for an easier way for the government to "wind down" financial institutions. Although Bernanke does not say this in the interview, the Fed, being an independent institution immune to political bickering, has done the most in this crisis, often finding creative ways to step beyond its normal boundaries. When this history of this crisis is written years down the road, I doubt many will find fault with the Fed's response. But it still has its limits: it did not have the authority to stop Lehman's collapse, for example. And asking for an easier way to "wind down" bad institutions is just a subtle way of saying, "in the future, we need a way to temporarily 'nationalize' and clean up institutions without having to subject the economy to the uninformed and idiotic bickering of politics"--basically, to expand the ability to do FDIC-like interventions.

Finally, when asked about the causes of this, Bernanke homed in on what I have long thought to be the true root cause of the crisis: a savings glut. Too many people focus on the housing bubble, on derivatives, on Wall Street greed, etc. But while all of these things are relevant and have contributed to the formation of the crisis, they are not the root causes. The problem, as Bernanke puts it, is the massive inflow of capital ("savings") from "China, East Asia, and oil-producing countries" over the past decade or so. An excess of capital without a good place to go is how we form bubbles. This is what happened with the stock market bubble of the 1920's, with Japan's real estate bubble of the 1980's, and with the global real estate asset bubble. If we had tougher mortgage regulations and better bankers, we may have avoided a mortgage bubble, but with all that capital sloshing around, if it wasn't going to be a mortgage bubble, it would have been some other bubble that would have formed and bust, which is why I put the primary blame on the savings glut.

Not only is this one of those extremely rare situations where the large capital inflow is mentioned in the media, it's also a rare situation where China is singled out by name. If there is any single entity that deserves the most blame, it would be China. Normally, when there is a trade imbalance, the exporting country's currency will appreciate in value, making it cheaper for them to import and more expensive for them to export, and this is the market's way of naturally correcting trade imbalances. But the Chinese government manipulates its currency by sending Dollars back to the US (and Euros back to Europe). This keeps the RMB undervalued (which, BTW, hurts the average Chinese citizen) and ensures that Chinese exports are artificially cheap, thus sustaining the trade imbalance. One devastating side effect of this is that by trying to hold down the RMB and prop up the Dollar and Euro, China was also helping create an imbalance of capital flows, which is the cause of the excess bubble-forming savings that flooded Europe and the US. Of course, China was not the only country at fault, but it was probably the biggest. I can only hope that when this is all over, the West will take a harder stance on China's undervalued currency (by the IMF's purchasing power parity estimates, the RMB is nominally valued at half of its true value).

Edit: Fixed link... again.

This entry was edited on 2009/03/15 at 23:05:42 GMT -0400.

Hoover, version 2

Sunday, March 8, 2009
Keywords: Politics, Economics

The words of John Boehner, leader of the House Republicans:

American families are tightening their belts. But they don't see government tightening its belt.

The very reason why people are being forced to "tighten their belts" is because everyone is trying to do some belt-tightening. I find it incredible--stunning, even--that these Republicans cannot grasp the concept that Alice cannot save money unless Alice gets money to save (i.e., Bob needs to buy goods and services from Alice), which is not going to happen if Bob is trying to save money at the same time (which is also a doomed endeavor since Alice is also trying to stockpile money and will not buy from Bob). It is like the economic equivalent of the conservation of momentum: any amount of savings (consider it a "surplus" budget) must necessarily be balanced by an equivalent amount of "deficit" elsewhere, and because everyone has been spooked into saving, the government must embark on deficit spending to counteract this, or else we will be repeating the mistakes that another Republican made 80 years ago.

Boehner has gone as far as push a vote to freeze government spending for the year (the measure failed, but it did get the vote of every House Republican). I sincerely hope that the Republicans are merely engaging in political theatrics, knowing that their destructive policies cannot be passed, since the alternative--that they actually believe that freezing spending will help--is a terrifying prospect.

Another common Republican refrain is that public spending will crowd out private investment and thus worsen the problem. In a recent (and very popular) op-ed in the Wall Street Journal, we hear this tired old line:

[Taxes will] reduce incentives for our most productive citizens and small businesses to work, save and invest ...

I doubt very much that there is any shortage of an incentive to work in this recession; the labor market is very much a buyer's market right now. As for saving and investing, while this argument may hold some water during good times when the economy is running at capacity, the problem of a recession is that we are underutilizing capital due to slackening demand. Both physical and human capital--e.g., factories and talent--are being idled, and the very notion that the solution to underused capacity and idled capital stock is to increase capacity and capital stock is absolutely ridiculous.

Finally, Republicans are fond of raising fears about the effects of high government debt. What they (and the media) fail to mention is that, while our public debt is at historically high levels in nominal terms, our public debt as a percent of GDP is very low: approximately 40%. In contrast, following the Second World War, our public debt as a percent of GDP was nearly 110% and yet we experienced a long post-war economic boom. For further perspective, consider that Canadian, German and French public debt currently exceed 60% of their GDPs, Italian public debt exceeds 100% of their GDP, and Japanese public debt is currently at 170% of their GDP. Aside from a failure to put things into perspective, people also confuse private debt (mortgages, credit card debt, etc.) and public debt (government borrowing). Our problem now (and our problem at the start of the Great Depression) is that private debt had grown to unhealthy levels. While we can all agree that a high level of public debt is undesirable, it is less undesirable than high levels of private debt. Increasing public debt through government spending is an effective way to reduce private debt (think of it as a transfer from private debt to public debt: government spending creates the paychecks necessary for people to pay down their debt), which is the way to dig out of this crisis. This is how we dug out of the Great Depression--the "high" levels of public debt following the war was matched by substantially lower private debt--and this is what needs to be done again today.

The Republican opposition--driven by ideology instead of a pragmatic application of basic economic principles--is harmful in two ways: first, this high amount of political pushback makes it difficult for government to do what needs to be done, and second, the Republicans are destroying themselves, and as much as liberals may rejoice at the spectacle of the latter, a one-party system is not healthy in the long-run.

This entry was edited on 2009/03/08 at 22:45:39 GMT -0400.