Look for shocks

Baseline Scenario succumbs to its bias, and gets the causality wrong.

So there are two possible reasons why these people make the top 1 percent. One is that they are talented, hardworking people who succeed (financially) despite what they majored in—but then why are talented, hardworking people overrepresented in these majors? The other is that they are children of the elite who go to elite schools, study whatever they feel like, and succeed because of their upbringing and connections. (The reasons are not mutually exclusive.) Given the increasing evidence that America, the land of opportunity, is actually one of limited social mobility, I think we can’t overlook the latter explanation.

If talent and a strong work ethic is heritable, through genetics or upbringing or some combination of the two, then one would expect limited social mobility.

The real test of social mobility in a system is how it responds to shocks. Say, someone who is lazy and an idiot is born into Bill Gates' family. He might be wealthy, but what would his income be? Or suppose a hard working genius was born to a poor family in New York? Would they be left to languish, or would they be successful?

What Google cannot help you with

Google's PageRank algorithm is good at goal directed queries -- "flowers", "cheap airline tickets", or "nearest library". It is not good at non-directed queries, like "funny", "inspirational", "entertain me".

Facebook is great at entertaining people who have no goal cheaply. Instead of making content like TV stations do, it just parades photos of your friends, which are very entertaining because they are your friends. If you want to waste time, Facebook is the place to go (and this is why social games on Facebook are so inane, but also so successful).

This new Google ad is interesting because the queries are exactly the type of queries that Google was bad at, but Google+ hopes to be better at.

"Awesome things you can do with a paperclip"
"Awesome things you can do"
"Awesome things"

Delicious was actually great at this, back when it was a live product. TechCrunch doesn't get it at all.

Building Credit

Megan McArdles has a number of good posts about credit unions, and how they help (or don't) build credit.

When I graduated from college, I had a well paying job, was living in New York, but had no credit history. I was a foreigner, and had used my parent's credit card in college, so although I had reasonable income, debt etc. I could not get a credit card of my own.

I ended up getting a secured card from Capital One, with ruinously high fees, and I had to send in a check for $200 (which was the limit on that card). Using the card for convenience, my credit score improved, and I switched to a regular Visa card a few months later.

I don't know what the details are with the teacher in Megan's examples, but I would like to add that there are lots of instruments out there that seem (and are) pretty awful deals, but once you start borrowing and paying back, you build credit very quickly and don't need to stay in those products long.

RIP: Kodak

Kodak seems to be filing for Chapter 11 bankruptcy.

The thing is, that Kodak was well aware of the digital photography revolution, and launched digital cameras as well as online photo sharing sites etc. But more focused consumer electronics companies won in digital cameras, and more focused online photo sites won in the upload and print business. (Although I think Facebook is now the biggest photo serving service in the world).

I don't think it's right to criticize Kodak for not innovating. Companies are very specialized to do a particular thing, and when that thing is no longer valuable, it's very difficult to re-deploy those assets to do some different thing.

Not understanding banking is an impediment to regulating banks

MacroResilience demonstrates why not understanding banking is an impediment to regulating banks:

Amar Bhide’s idea essentially seeks to turn back the clock and forbid much of the innovation that has taken place in the last few decades... But it is not enough to mitigate the moral hazard problem... Let us assume that banks can only take deposits and make loans to corporations and households... Banks can simply lend to other firms that take on negatively skewed bets. You may counter that banks should only be allowed to lend to real economy firms. But do we expect regulators to audit not only the banks under their watch but also the firms to whom they lend money?

In a word--yes!

First, bank lending is capital constrained (not reserve constrained), so limits to leverage (especially derivatives, which hide leverage very well) are at the very core of regulation. When a bank makes a loan, the impact of that balance sheet expansion must be risk weighted. So, buying US Treasuries -- go nuts! Buying anything else -- you'll hit your cap earlier.

And yes, this means that regulators need to look at the loans banks are making. In fact, regulators cannot regulate without looking at the loans banks are making. This is baked into the Basel accords that specifically risk-weight capital requirements.

Second, if banks were also required to keep all their loans on their books, then they would have an incentive to make good credit decisions, something they are not motivated to do if they can offload risk to third parties.

Third, if counterparties failed, loans went bad, and banks went under, so long as the Fed gave the bank open access to the discount window and didn't shut it down when it fell under it's capital requirements, a bank with a negative equity position can continue to clear checks.

But, if you believe "unless short-term deposits are deployed to match long-term investment projects" then these regulatory options are inconceivable.

Mosler makes the Economist

Warren Mosler has made it into the Economist. Nice way to end the year!

People thought that blogs would replace journalism--and that isn't true. But blogs are influential because journalists read blogs. They need to feed the Beast, and they Google just like you or I. MMT's influence in the blogosphere can rival that of the academy, and seeing Warren in the Economist is proof of that.

It's unsurprising that Market Monetarism gets the kindest write-up as it is essentially orthodox Monetarism taken to its logical extreme. This is great, because it makes the absurdities clearer:

In pursuing this target, the central bank would use many of the same tools as today: tweaking the short-term interest rate and, when that reaches zero, increasing NGDP by printing new money to buy more assets (ie, quantitative easing). And the very creation of the NGDP target would make such intervention more effective, Mr Sumner says. If people expect the central bank to return spending to a 5% growth path, their beliefs will help get it there. Firms will hire, confident that their revenues will expand; people will open their wallets, confident of keeping their jobs. Those hoarding cash will spend it or invest it, because they know that either output or prices will be higher in the future.

Confidence fairies and more quantitative easing. Ho hum.

Merry Christmas

Merry Christmas, all!

I must confess, I have yet to go through all the excellent comments folks left on the last few posts. But I will. I am also hesitant to post anything new until I have absorbed all the thought that folks shared. Unfortunately, this may take a while.

One point I will add, though, is that I think attempts to pin the failure of MMT to spread (Steve Keen, Steve Keen! seems to be doing better) on politicians is misplaced, as are attempts to make it easier to understand to laymen, and attempts to reconcile it with standard macro.

This stuff is technical, and on technical material like this the government takes its marching orders from the University. If Obama or Paul or Cain or whomever were to take to the podium and begin spouting MMT he would be a laughing stock before the ink on Paul Krugman's takedown column was even dry. The Fed and the Treasury are staffed by guys who learned from the same textbooks written by professors at Harvard or Princeton. A populist movement to take over the academy in this day and age is ludicrous, it ain't 1968 and it ain't going to be.

This, incidentally, is the problem OWS has.

Secondly, while making MMT easier to understand is a laudable goal, the outcome of this will be to win over Austrians, the other leading candidate for a "people's economics". This will not help in the Academy, but it will fill the blogosphere with semi-correct rantings and it will make Austrians really mad.

Finally, the history of paradigm shifts in the Academy is well documented, and they have always happened via dead bodies, never by the future playing nice with the past. When something is true, that is enough.

Steve Keen on Hardtalk

I don't much like Steve Keen because, although he gets private credit creation correct ("banks create money out of thin air by making loans that then create deposits") he does not get public debt creation correct ("federal deficits create the private sector net financial assets which can then be used to "buy government debt"). How you can understand horizontal money without understanding vertical money is beyond me, but there you go.

Anyway, here is a transcript of Steve on "Hardtalk" -- so, good for Steve for getting on the BBC!

At times, it seems like the understands vertical money:

SK: I wouldn’t say it was a case of making a choice between one individual and another. It has to be a systemic process by which we reduce the level of debt-finance money in the economy and increase the amount of government-created money. Because we have two sources of money in a capitalist economy. The banks can create money by extending loans. The government creates money by running a deficit. Now back in the early 60s the ratio of government created money to the overall money supply was 15%. It’s fallen so far that we’ve got an entirely debt-based system which has driven speculation. We need to create the government money to balance out the credit. So I’d actually have a government creation of money system approach to try to rebalance the system and reduce the private debt.

HT: The government, the central bank, prints money to pay off people’s debts? What I’m wondering is, you say, “Write off debts.” And it’s basically private debt that you want written off. Mortgages, companies’ debt. How is that working?

SK: We’d have to give the money to the debtors rather than to the creditors. If you look at what’s been happening in the last three or four years, all the rescues Bernanke has done, the banks around the world have done, have been to give money, to create money and give it to the banking sector in the belief the banking sector will lend to get the economy starting again. Now that is bizarre because we know one reason they won’t lend is they’ve lent too much already. So all that money has been ineffective.

It is true that the Govt creates money by running a deficit, and that stimulus needs to focus on giving money to households. But from here, why is the solution not to have bigger deficits based on spending/taxation policy that increases household savings?

To Read:

Scott Fullwiler:Modern Monetary Theory—A Primer on the Operational Realities of the Monetary System

Marc Lavoie:The monetary and fiscal nexus of neo-chartalism: A friendly critical look

From the comments: technical details on MMT

In a recent post I said that

A country that runs a fiat currency doesn't "borrow", it prints and unprints money whenever it spends and taxes. If it issues bonds, it is to change the term structure of extant pre-printed currency, not to print more, or "sterilize" outstanding money.

This is technically not true, as was pointed out in comments by JKH. The comments are now about 100, so I wanted to pull out this point.

I've found that the greatest challenge in understanding MMT, or getting someone else to understand it, is that our heads are filled with lots of preconceived notions that limit our ability to see things from a new perspective. As Chuck Norris would say "you cannot fill a cup that is already full".

So I exaggerate and say that a government neither has nor does not have money, and that all spending is printing, all taxing unprinting, so shock the system out of its current paradigm into the new one. Maybe it works for some, maybe it doesn't. I found this helpful in making the leap, but it may not work for others. YMMV.

Technically, the central bank is the currency issuer, while the Treasury is just a user like everyone else. So now the question becomes, to what degree is the central bank part of the Government, and even if the central bank is ultimately a creature of Congress (in the US) then Congress needs to actually enact legislation that would combine the CB and Treasury functions to make the Federal Government proper a true "currency issuer".

Thanks to everyone, but JKH especially, for their comments.

Between Depression and Hyperinflation

Contra Megan, there is a middle ground between a Depression and Hyperinflation:

But it is not true that loads of debt is just fine as long as you're borrowing in your own currency, except in the trivial sense that a government which borrows in its own currency can always resort to hyperinflation. This is rather like saying, "Don't worry about that cancer--you can always shoot yourself!" If you take too much advantage of the benefits of borrowing in your own currency, pretty soon you have trouble borrowing in your own currency, which means that practically, the distinction is not necessarily as strong as some people pretend.

This is the conventional wisdom, believed by Austrian, Paul Krugman, and Greg Mankiw alike. A country that runs a fiat currency doesn't "borrow", it prints and unprints money whenever it spends and taxes. If it issues bonds, it is to change the term structure of extant pre-printed currency, not to print more, or "sterilize" outstanding money.

Too much printing can generate hyperinflation, but too little printing leads to low aggregate demand, unemployment, and lost real resources -- the very thing a country should be looking to maximize.

Bluff called -- no deal

The Supercommittee seemed not to reach any deal on debt. The question now is, will the automatic austerity measures go into full force, or will the Government find some way to defang them?

A New Deal for Europe

During the Great Depression, the New Deal represented a dramatically different sovereign structure in the US than what had existed before. Individual states--who had given up monetary sovereignty long ago--gave up political sovereignty as Academics joined forces with national politicians to run America.

The days of corporate paternalism and local politics was over.

I don't know how much State level resistance there was to this takeover. I'm guessing that your average unemployed worker didn't think much of his local politicians, and may have believed that the wise technocrats in DC were going to usher in better governance, and a better life. Maybe local politicians saw this centralization as a meal ticket to plummer plum jobs, and even more opportunities for power. Or maybe people saw it as a dreadful curtailment of States rights and fought against the changes. I don't know.

Nevertheless, I see parallels to this and the situation in Europe right now, as member nations, who gave away their monetary sovereignty when they joined the Eurozone, are now losing their political sovereignty as well and don't seem to have any desire to go back to their old currencies or their old politicians. I think Italians and Greeks would rather be ruled by Germans, they just want the Germans to be less stingy.

The Greek Central Banks wants to stay in the Euro

Greece will stay in the Euro and tolerate high unemployment for no reason because the Greek Central Bank wants to remain chained to the European Central Bank.

Greek central bankers, just like all central bankers, went to the same economics programs and learned the same nonsense about how deposits create loans, and how governments must tax in order to spend. Even if Greek wanted to go back to the drachma, I don't think there's anyone in Greece capable or interested in actually running a sovereign currency. Why bother when you can't tell the difference anyway?

Both Monti and Papademos look to be corporate liberal internationalists of the kind that in the U.S. end up in the Treasury Department. Papademos went to college and grad school at MIT and taught economics at Columbia from the mid-70s to the mid-80s. He even served as senior economist for the Federal Reserve Bank of Boston in 1980. Returning to Greece in 1985 to work as chief economist of the Bank of Greece, he rose to the post of the bank’s Governor; then served as Jean-Claude Trichet’s chief deputy at the European Central Bank from 2002 to 2010, returning again to Greece in 2010 to become an economic adviser to Prime Minister George Papandreou.

Monti went to college in Italy, but completed his graduate studies in economics at Yale, where he studied under James Tobin (which I suppose increases the chances that he supports a financial transaction tax). He was an economics professor and university administrator in Italy from 1970 through 1994, then was appointed to the European Commission, where he was handed various economic portfolios, including those on financial services and competition.

Where is their Financial Bismarck? How could such a man survive grad school?

Economists don't understand accounting

I don't much like Steve Keen, because while his understanding of private sector credit expansion is good, he does not understand how an out-of-sector source is needed for private sector net (not gross) financial assets. In other words, he does not understand how the Government is a currency issuer.

Nevertheless, this observation from a recent talk he gave is interesting:

One part of the discussion that I found quite notable was that, even after showing empirical evidence on the impact that rising and then falling private debt had on the economy both now and during the Great Depression, I couldn’t convince several of the academics in the audience of the importance of private debt: they kept coming back to “one person’s debt is another person’s asset, therefore the level of debt doesn’t matter”. They therefore argued vehemently that the distribution of debt was important, but its aggregate level was irrelevant.

This is the core miscomprehension about debt that economists have. They see bank debt as the same as personal debt -- if I lend $10 to you, then I do not have $10 to spend myself, so the aggregate level of spending money available is unchanged.

However, bank lending does not work like this. If a bank lends $10, the $10 gets deposited in some other bank and is therefore available to lend again, limited only by capital requirements. In this sense, one person's asset is not another person's liability, and the total (gross) quantity of financial assets can expand and contract, while the total (net) quantity of financial assets remains the same.

The latest stupidity: NGDP

The latest dumb idea circulating the orthodox economics blogosphere is NGDP targeting. In this scheme, the Fed, instead of saying "inflation is too high" or "employment is too low" instead says "we want NGDP to be x%". After this proclamation, the economy will start growing at the required rate to hit the declared NGDP target.

Magic, no?

So, what will the Fed do if the economy doesn't suddenly start growing? They will buy more and more Government debt, driving the interest rate further and further out the yeild curve to zero.

"But isn't that just quantitative easing?" you ask.

It is.

"Isn't the Fed doing that now?" you ask.

It is.

"So, what's the difference?"

There is none. But if you believe monetary policy is effective, and you live in a world where it clearly isn't being effective, you've got to do something.

In my view, the Fed fully knows that the economy is growing too slowing and unemployment is too high. They've done everything in their arsenal by bringing the Federal Funds rate to zero, and have gone a step beyond by bringing longer term rates down to zero as well. None of it is working, because changing the duration of outstanding Government debt does not solve the problem of an undercapitalized private sector. The economy needs a larger deficit to start growing again, but economists don't understand accounting, and so do not understand sectoral balances etc.

MMT understands this dynamic very well, and need give no quarter to orthodox macroeconomics, just as oxygen need give no quarter to phlogiston.

Ages ago I read some book on the sociology of philosophy, and the big lesson in it was how all the philosphers you read about knew one another, either directly or indirectly, and how ideological movements compete with one another. If your school of thought is ascendent, then you gain fame by forming a (hopefully) ascendent spliter group. If your school is in decline, you build bridges with those who might think a little different to try and build a bigger tent. And if you are on the outside, you should just be a crank and attach the most dominant group around to try and get their attention, and have them give you credibility by engaging.

The NGDP crowd is a splinter group off orthodox macro. MMT are the cranks. They will not win through accomodation.

Occupy Wall Street

Occupy Wall Street is like a Rorschach test -- people read into it what they want.

A particularly fanciful take on this is from Venkatesh Rao, whose excellent blog I would recommend, but difficult book I might not. (Venkatesh -- if you ever read this, please do not judge the prior comment to harshly. It's more a reflection on the extremely high quality of the blog and the very difficult task you set yourself in the book, not an absolute judgment).

I was not familiar with Sterling's talk at PopTech, so "favella chic" and "dark euphoria" were new to me, and I'm grateful for the introduction.

Rao says, reasonably, that

I am surprised by the number of commentators who have switched from being dismissive to taking it seriously, simply because the thing has grown bigger and angrier, and we happen to be in the run-up for a Presidential election. Call me a cynic, but I don’t think the growth of the movement means squat. Here’s why.

Here's the "here's why", and at this juncture we part company:

It does not matter how many people demonstrate and pour out into the streets. This is not a problem that can be solved by industrial-age collective action models because the problem is the end of the industrial age. One side has collected the trophy and left the field, the other side is still on the field, trying to convince itself the game is still going on. The winners, and ahead-of-the-curve losers, are already setting up the playing field for the new game.

The problem is not the end of the industrial age, the problem is a lack of aggregate demand. We have a lack of aggregate demand because finance is mismanaged, both at the industrial level ("Finance industry") and at the Governmental level ("deficit spending" and "financial regulation"). The reason that finance is systemically mismanaged is because the academic paradigm of finance is simply wrong. Economics professors are not good at accounting, they consider it beneath them, so they simply do not know that their macroeconomic models do not follow double-entry bookkeeping and are therefore wrong.

Accountants don't notice that macroeconomics is wrong because they imaginationless grinds.

Venkatesh ends with

"[expect] a reboot the likes of which we haven’t seen since 1776.

Fasten your seat-belts. It is going to get far uglier than the #OccupyWallStreet gang realize."

Maybe, but maybe not. We have a vision of our future, and it's Japan, which never restored aggregate demand after their credit bubble popped in the mid 80s. Does modern day Japan strike you as having experienced a reboot, the likes of which we haven't seen since 1776? When you sip your Daiginjo-shu in Tokyo, are things really all that ugly?

OWS is better thought of as a popular protest, some of which is genuinely seeded by popular disgust with the financial industry and it's government compatriots, and some of which is engineered by reporters, academics, and left wing policy entrepreneurs who want a more Communist version of the Tea Party. The problem is, that this faction has already won--first in the 30s, and then again in the 60s. This, my friends, is the smell of victory.

Nonsense from Meeker

I won't comment on the rest of Meeker's presentation (which was fine but banal--how did Meeker manage to do so well while Blodget flamed out??) but I will draw attention to this slide on America's income statement:



I'm not picking on Meeker here, it is normal and natural to think about a currency issuer's finances the same way one of think of a household if that's the frame supplied by the community of interpretation (to use a Stanley Fish phrase). So, ignore the stock flow inconsistency etc. of the slide and reflect on the fact that, quibbles aside, there's nothing here that Paul Krugman wouldn't sagely nod his head at.

I spoke too soon: Netflix

Seems like Reed has decided to take back his decision to split Netflix into a video streaming business (the future) and a DVD by mail business (the legacy).

I wonder why he changed his mind. I thought the decision to split the company was excellent.

Recapitalize the non-Govt Sector, not the Financial Sector

When you have a credit bubble -- ie. banks make loans that do not get paid back -- then the subsequent credit bust de-capitalizes banks (as they must write down assets and equity) constraining their ability to lend anew.

As the non-government sector needs additional financial assets to grow, if banks cannot lend (capital constrained) then the economy as a whole starts to trouble.

This, in a nutshell, is where the "Too Big to Fail", "We Must Bail Out the Banks" argument comes from, and it is true, as far as it goes.

Nevertheless, there is more to the story. First, if banks were making loans that did not get paid back, then they were not doing their primary job which is to make good credit decisions. Bad credit decisions should be punished, and the owners and operators of such companies should be fired and/or wiped out. This is how markets work. Rewarding such behavior only encourages more bad practices in the future, and people (rightly) start to wonder why we have a financial system at all.

Second, if banks fail, that contraction in private financial asset growth can be balanced by "capitalizing" the rest of the non-Governmental sector directly (through some combination of tax cuts and spending increases -- whatever increases the deficit). Since economists at Harvard and Princeton do not understand that the Government is the sole creator of net financial assets (equity) for the private sector, they do not know that this policy lever is on the table. So we are where we are.

From Macroeconomic Resilience

My policy proposal has three legs all of which need to be implemented simultaneously:

* Allow Failure: Allow insolvent banks and financialised corporations to fail.
* The Helicopter Drop: Institute a system of direct transfers to individuals (a helicopter drop) to mitigate the deflationary fallout from bank failure.
* Entry of New Banks: Allow fast-track approvals of new banks to restore banking capacity in the economy.

The argument against allowing bank and corporate failure is that it will trigger off a catastrophic deflationary collapse in the economy while at the same time crippling the lending capacity available to businesses and households. The helicopter drop of direct transfers helps prevent a deflationary collapse and the entry of new banks helps maintain lending capacity thus negating both concerns.