Thoughts of an unserious economist

William Pesek writes:

No serious economist thinks Japan is going to crash.

This charming little argument from intimidation reminds me of the endless parade of pundits proclaiming that all the "serious" people supported the War in Iraq. Or, for that matter, all the "serious" mockery of housing bubble predictions.

It seems most people fall into a fallacy encouraged by standard macroeconomic thinking that savings automatically produces something useful and that all "productive capacities" are equally good. All investments are particular - they are to make or do something. Market action equalizing marginal benefit *normally* produces a very good set of particular investments so it's an acceptable approximation to view any investment as equally good. But markets do fail, and they can also be distorted. If this happens the investment is wasted - perhaps partially; perhaps totally.

Japan has a huge productive capacity, but if that productive capacity is for export products that nobody will buy for years, then it's virtually worthless - regardless of how much people thought it was worth last year, or the effort put into creating it. Likewise Japan's vast savings, insofar as they own worthless productive capacity or assorted foreign bonds that can't be paid, are also worthless.

If Japan's exports continue down 35% they will crash. Hard. Are the "serious" economists going to be wrong again?

So is it insider trading?

An important point from Clusterstock:

Side note: if the government officials have been consulting with banking heads about the bad bank, and we hope they have been, does it count as insider trading when the banking chiefs buy their own stock?

This is a reference to large insider purchases by Dimon and Lewis of JPM and BoA. It's particularly interesting that both bought shares at the same time.

I have one disagreement with Clusterstock: This is not a side note. Not to say that Dimon and Lewis are necessarily guilty; but if they are this is a very big deal. This harkens back to a point I made about the Citi bailout: the connections between bank regulators and the banks are so strong that the incentives and opportunities for corruption are unbearable. Even apart from solvency issues, the banks (at least the big money center banks) have to be nationalized for governance issues while we figure out how to solve these problems.

A disturbing aspect of Obama's economic plan

There's nothing on mortgages, foreclosures, bank management, bailouts, deriivative tangles, SIVs, or any of the other financial issues dragging us into depression. This site came up as soon as Obama assumed the presidency and doesn't appear to be pulling punches, as Obama did during the transition. Other issue pages put forward a clear, if somewhat mild, center-left agenda in basic agreement with his campaign promises. So Obama has at least not yet figured out how to address the real economic problems, not even to the point of putting out an outline.

These problems are thorny but they will not wait. It's very concerning that Obama does not yet have a road map he's willing to publish, and possibly no road map at all.

Me too!

Felix Salmon wrote a great piece on Why Nationalization is the Best Alternative. It's been mentioned by Krugman, and in several comments threads. I don't have a great deal to add at the moment but it's well worth a read.

The stimulus plan: useful, but misses the point.

The House Democrats have released a first draft of their stimulus plan. It's a mix of relief (medicare/unemployment) and infrastructure investment. With current bond rates, those are good ideas; but what we will need most are employment projects and there's not a whole lot of jobs here. Most proposals are capital-intensive. It's a good idea to do capital-intensive infrastructure when rates are low; but that won't help most people in fear of losing their jobs.

What I would add to the program is jobs-related programs. Do things that aren't done now, at least not enough, which don't require much skill or physical prowess, and which pretty much everybody likes. My initial ideas would be cleaning public spaces (especially of grafitti), neighborhood patrols, landscaping, ecological restoration (wetland recreation, elimination of invasive species), and public art. Not only would this make the country a nicer place, those kinds of activities feel constructive to the worker and make for good temporary work where the pay needs to be low.

4 million people at $8/hour is 64 billion a year, which is smallish compared to this overall proposal or to the TARP. In addition to the direct benefits, if we make it clear that we *aren't* going to get depression-level unemployment then other stimulus proposal can be addressed level-headedly without the kind of panic that was used to shove through the TARP.

Reforming the Federal Reserve

The policy responses to the current crisis have exposed some bad governance problems with the Federal Reserve. Like most central banks, the Fed is fairly independent, and needs to be as otherwise there are massive incentives for electorally directed manipulation of the money supply. However, in the current crisis the Fed has used its independence to provide massive benefits to private interest, most notably with with Citibank bailout, ultimately from the pocketbook of the taxpayer.

Clearly it's totally unacceptable for any institution to effectively give hundred of billions of taxpayer money with no effective control. We'll pay for years covering the past year of thinly disguised giveaways. However, we don't want to put the Federal Reserve under the direct control of the President due to the need for independence.

To solve this dilemma, I have a simple proposal: the Federal Reserve will only be allowed to own debt explicitly guaranteed by the federal government. It will not be authorized to make any guarantees of any other assets, or to participate in any derivatives. It may make loans only when suitably collateralized by government-guaranteed debt. If the Fed needs to operate a discount window, it must first get guarantees from the political system, so it will no longer be able to effectively give away money without taxpayer control.

The Federal Reserve will still be able to control the money supply but it will only be able to use use its implicit call on taxpayer money to benefit government-guaranteed entities, which is restrictive enough. I think this proposal provides leeway for the Federal Reserve to perform its monetary function with adequate interference while ensure that benefits from government granted authority are controlled by Congress and the Executive branch.

What does it take?

Right now the world faces a real risk of economic disaster, quite possibly a depression, as a result of a credit bubble set off by insanely low interest rates in 2001-2005. This is no surprise; if you set the price for something (credit in this case) you get overconsumption and efficiency losses; when the item in question (credit) is the most important single element of the economic system the waste has particularly dire results. Now Germany's finance minister blandly observes this obvious fact we are so painfully being reminded of.

And Paul Krugman finds this objectionable?

Seriously, what does it take for economists to accept basic economics? Mad Max?