Tuesday, June 30, 2009

Global Savings Glut

Brad Setser has a good point on the Global Savings Glut controversy. How anyone can still give any credence to this notion is beyond me. How on earth can "excess savings" trigger massive de-leveraging?
Few topics are quite as polarizing as the “savings glut.” The very term is often considered an attempt to shift responsibility for the current crisis away from the United States.

That is unfortunate. It is quite possible to believe that the buildup of vulnerabilities that led to the current crisis was a product both of a rise in savings in key emerging markets, a rose that with more than a bit of help from emerging market governments – produced an unnatural uphill flow of capital from the emerging world to the advanced economies, and policy failures in the U.S. and Europe.
I can see how this idea might seem plausible in 2005. But in 2009 the fact that it is nonsense is quite clear.

By accounting, an increase in surplus (savings) in one area must be matched by an decrease in savings (deficit) in another area. Every asset must have a liability. So, it is true by accounting that an increase in debt in the West must have had an increase in surplus elsewhere (China, oil exporters) but events have made the causality clear: Western debt drove surpluses elsewhere. Private sector debt, unlike public sector debt, must be financed out of income, and it is clear the US debt levels cannot be supported by current levels of income. The credit expansion that fueled this increase in debt was bogus, banks stopped lending money and instead gifted it. China can impoverish it's people and trade their income (output) for US dollars (FX savings) to whatever degree it wants. This benefits the US, but does not work well for China. It is, however, sustainable, and it it unwinds it will only be good for China. But debt that cannot be serviced out of income will catastrophically collapse.

Sunday, June 28, 2009

Smartest man at Chicago

Great interview of Kevin Murphy, the smartest person I met at Chicago (and that's saying something). Every time I listen to him, I learn something new. Latest learning (re: healthcare):
What really does matter is the cost of treatment. If treatment costs are $10 trillion, the project has a negative net present value even if the research is free. With $2 trillion in treatment costs, the net gain from success is $3 trillion, so that we would get a good return even if the probability of success was one in 30. So when you think about research, it’s not the dollars you spend that matter—what matters is the cost of implementing the treatment that might be discovered. The downside to research is not failure, but unaffordable success.

I think the following message comes out of that exercise: Cost containment and health progress are complementary. That is, if we can control costs, that makes research a much more attractive option.

Friday, June 26, 2009

New Deal 2.0

I liked this article which points out that the Obama administration has transfered money to rich bankers, when it should be transferring money to households.
State and local governments have been forced into draconian budget cuts, firing workers who are among the most reliable in making their mortgage payments–when they have jobs: firemen, policemen, teachers, civil servants.

Yet the Obama administration won’t spend even a small fraction of what it has wasted on the banks to cover state shortfalls. The guarantee of $5.5bn in short term notes for California was deemed to be fiscally irresponsible, yet hundreds of billions have already been allocated to the likes of Citigroup, AIG, and Goldman Sachs, all of whom have already beefed up salaries and bonuses as they emerge from the embrace of the federal government.

Good for the banks, bad for the economy

Banks are also benefiting from lending programs that effectively allow them to borrow at zero and reinvest in Treasuries at around 3%. A bank doesn’t have to do anything to make money. The banks’ return on equity is going to be very good. They are going to be able to restore their finances.

While this is good for banks, is it good for anyone else? The problem is the government’s “free money” program means banks have little or no incentive to do any actual lending. Combined with rising unemployment and the ongoing housing crisis, this means any recovery is likely to be muted, at best, especially given the ongoing weakness in the real estate market.
Giving money to banks does not help fund higher consumer savings and support aggregate demand. The increase in household savings, and subsequent fall in aggregate demand, is what is driving the recession. Thank goodness for unemployment -- that's the only thing driving the Federal deficits needed to fund private savings and stabilize AD, but unfortunately, at a low level. The Obama administration could have taken a "float all boats" approach by cutting payroll tax, and funding private savings that way, but instead chose to enrich bankers and put labor on sale. Banks are pro-cyclical, a strengthening economy will get them to lend, nothing else.

...Except maybe for Federal dictat. Nice post on how the 1970s Community Reinvestment Act, and subsequent legislation and regulatory enforcement, contributed to the housing bubble after all. At the time, I'm sure no one understood how the pieces would come together and create this disaster. Same thing is happening now.

There is all this confusion about banking which I do not understand. I would have thought that this crises would make certain point completely obvious:
(1) Banks are pro-cyclical, the amplify what's going on in the broader economy, not drive it
(2) The liability side of a bank's balance sheet is no place for market discipline
(3) Financial regulation fails
(4) Banks should focus on making loans that will be paid back (credit risk)
(5) Banks are public-private partnerships
(6) The current banking system net destroys value

From this, the core of a new banking structure seems straightforward. The Obama administration does not realize any of 1-6.

Wednesday, June 24, 2009

Why Japan has spent a generation in the doldrums

From The Times:
With recovery elusive, a population doddering into old age and perhaps a decade of deflation in prospect, Japan may start mulling the most radical monetary policy of all — the abolition of cash.

Unorthodox, untried and, said one Bank of Tokyo Mitsubishi strategist, “in the realms of economic science fiction”, the recommendation has nevertheless begun floating around Tokyo’s corridors of power and economists have described Japan as particularly suitable as a testing ground.
If you want to witness the lunacy of monetarism, this is it. The argument goes like this: monetary policy is zero bound since you cannot have negative interest rates, people will just switch out into cash. Therefore, if we eliminate cash and force all money to be held electronically, we can decrement accounts and have negative rates.

It's utter rubbish. Suppose your dollar account was being decremented, and you were not allowed to hold dollar bills. Would you begin spending, or would you rush your savings into another currency, or maybe even gold?

A high savings rate means that the Government can buy more economic output without having to sterilize that fiscal action through taxation. The real question isn't why does Japan have cash, it's why does Japan bother to tax? Answer: it has no clue what it's doing.

Monday, June 08, 2009

How Investment Creates Savings

In the standard identity, Savings (S) = Investment (I). The typical causality associated with this: people save, and those savings are parceled out as investment, comes from the gold standard world and, as such, is non-operative in today's fiat world.

It took me a long time to think through why this was the case, but you can see me work through it in this old Interfluidity comments thread.


1. In a given period, an economy produces a certain amount of stuff. This quantity of stuff is that economy's real income.

2. Some of that production (real income) is consumed in the same period. The rest of it is not consumed, and is, instead saved/invested.

3. If you look at it in nominal terms, then income not spent is saved. If you look at it in real terms, production rolled over to be available for consumption in the next period (either in capital stock, or inventory) is investment. Thus savings and investment and flip sides of the same coin. If you don't consume all of your real output in a given period, then someone, somewhere, must have consumed less than they produced (saved). Real investment is recorded as nominal savings. Savings is how we account for real production that's been made available (via investment) for a subsequent period.