Category / Economic History

by Oisín Gilmore

SOME NOTE ON DEAN BAKER’S “FALSE PROFITS”

Recently, in response a request for “resources for understanding the economy”, I recommended a few books. The request was as follows:

The actually existing one I mean, the global economy and the US economy, not like general principles such as surplus value and exploitation, but what’s really been going on recently-ish…. I feel really under-equipped in terms of knowledge about the economy and about how to find out more about the economy – from basic stuff like where do most people work, up to things that feel more confusing like what’s a derivative, how does currency trading work, etc. Can folks recommend me like 1-3 good sources for getting a grasp on some of this? The shorter the better. 

And my response was:

1-3 good sources is pretty difficulty because you’ve cast a very wide net. As a rule of thumb…you are much better off reading economics that does not come from the far left. But after thinking about this while i cook lunch I think I am actually going to recommend you some left wing books.

So two books by Dean Baker The United States Since 1980 and False Profits: Recovering from the Bubble Economy (Haven’t actually read this yet though)

One by Andrew Glyn Capitalism Unleashed

And one by Paul Krugman’s The Return of Depression Economics and the Crisis of 2008

i.e. basically books by social democrats. The far left is shit at economics. (Although Glyn was on the far left, but exceptions rules all that.)

A lot of people have asked me for recommended reading on the economy recently and I think my above recommendations are pretty good. Dean Baker’s books are quite US-centric but still well worth a look considering a) the central role the US plays in the world economy and b) very little is being written about the EU/Irish/Western economy.

However, as I said in my response, I hadn’t actually read Baker’s book “False Profits” so I perhaps shouldn’t have recommended it. But I read it this morning and am now pretty happy recommending it. Anyway, the point of this blog post is basically to note down some issues with the book while its still fresh in my head.

As is my wont, I’m going to begin polemically by responding to Brad DeLong’s blog post I Need to Review Dean Baker’s “False Profits”. DeLong writes:

I really need to get started on this…

The first two paragraphs:

Dean Baker is one of the very few economists to have gotten things right in the mid-2000: to have not only recognized the housing bubble, but to have predicted that it would produce big trouble for the economy as a whole. Now he has produced his book on the financial crisis, False Profits. Given the sales of all the books by all the people who did not predict that the housing bubble would have big bad consequences for the economy as a whole, everybody who has bought even one of those other books is under a strong moral obligation to buy Dean Baker’s book and to read it was very close attention. And they will all profit substantially from doing so.

But let me start by saying how I disagree with the book. I think that its story of the linkages between our current crisis and Federal Reserve policy is significantly overstated. Its argument about how excessively-low interest rates caused the housing bubble is exaggerated. I think that its belief that the Federal Reserve could have taken much more action to curb the housing bubble while is underway is also exaggerated, and does not recognize the very real constraints that the Federal Reserve works under and all but ignores the costs of austerity. And it overstates the strength of the links between the housing bubble and the housing crash on the one hand and our current situation of macroeconomic despair on the other.

I’m pretty much onside with DeLong here. I don’t think that you can reduce the crisis to failings by the Fed to the extent that Baker does. Baker writes in paragraph 1, page 1: “The basic story of this economic collapse is very simple. The Federal Reserve Board, guided by its revered chairman, Alan Greenspan, allowed an $8 trillion housing bubble to grow unchecked.” I don’t think it is that simple. Paul Krugman lists six possible explanations of the crisis in his Minsky Lecture “Six Doctrines in Search of a Policy Regime”

– Size: Our largest financial institutions have just gotten too big – Shadows: The rise of shadow banking, institutions that fulfill banking functions but evade the regulatory regime, has undermined stability – Opacity: We’ve come to rely on complex financial instruments that neither regulators nor the private sector – Predation: Financial firms deliberately misled consumers and investors – Government intervention: Public policy pushed lenders into making bad loans, especially to the poor – Monetary mismanagement: The Fed did it by keeping interest rates too low for too long, and/or policymakers panicked in 2008 and spooked the markets

While, I don’t find Krugman’s dismissal of reason 1, 5 and 6, I also think that Baker basing his entire explanation on reason 6 ‘Monetary mismanagement’ is too much. However, DeLong isn’t being fair to Baker is saying that he reduces it to not increasing the interest rate in time. If that was Baker’s argument both DeLong and Krugman would have a point. Neither the argument that interest rates were too low before the crisis, nor that increasing interest rates more in 2004/2005 would have prevented the crisis are arguments I find persuasive.But Baker doesn’t argue that, rather he argues that “the Fed could have issued clear warnings about the existence and danger of the bubble.” (p.36) He argues the Fed should have pressed “the case everywhere for the existence of a housing bubble”. Along with that he says that “the Fed could also have used its regulatory authority to crack down on the proliferation of bad loans” by for example issuing mortgage guidelines (p.37) that were promised since the 1990s but weren’t finalized until 2008. He argues that if that doesn’t work, the fact that the Fed is pursuing a clear and committed strategy to burst the housing bubble would mean that if it came to increasing the interest rate, any increase would have an amplified effect. (p.38) This is a much stronger argument than simply saying that the Fed should have increased the interest rate; the opinion that DeLong attributes to Baker.

However, Baker’s take on the effect of interest rates on the housing bubble is kind of confused/confusing. He actually explicitly rejects the argument that the housing bubble was fuelled by low interest rates (pp.25-26). He says that “Historically, housing prices have not been that sensitive to interest rates” (p.25). But later he argues that there was a surge in housing demand after the 1981-82 recession caused by the Fed cutting interest rates. He writes: “the Fed held the key to reviving the economy. When it did so, by lowering interest rates, it kicked off a huge surge in car purchases and home buying because substantial demand had built up during the recession.” (p.40) The is a bit of a contradiction here. If lower interest rates increase the demand for houses then, ceteris paribus, the price of houses should increase i.e. housing prices should be sensitive to interest rates. There is a way to square this circle which is to argue that interest rates cause a rise in the supply of housing equivalent to the rise in demand. I can think of some reasons that that might be the case and Baker does have a strong argument that an increase in demand relative to the supply of housing was not the cause for rising house prices. He points out that neither income nor population were growing sufficiently to fuel the growth in demand, nor was supply constrained. The 2002-2006 building rate was at a record rate, rental vacancies were increasing throughout the period and ownership unit vacancies increased towards the end of the period. However, I’m filling in the blanks here. It would have been better if he had explained how and why low interest rates increase housing demand but not house prices.

Moving on from chapters 1 and 2, to chapter 3 “The Terrible Tale of the TARP”. In this he argues strongly that the TARP was a bad policy. The TARP, I thought until reading this, was basically like a better designed NAMA. My thinking here was that NAMA agreed to purchase bad assets above their market value in order to recapitalise the banks, whereas the TARP planned to buy bad assets at market value. However, as Baker points out, there was no point to purchasing assets at market value. Doing this did not recapitalise the banks it merely changed the composition of its assets. He says that what Paulson ended up doing then was simple giving capital to the banks and not purchasing the ‘bad assets’ at all. To be honest I hadn’t come across this argument before. I found it really interesting and its something I’m going to follow up on.

In chapter 4 he argues that the housing bubble is still being propped up. In chapter 5 and 6 he discusses the financial stimulus. In chapter 5 he argues that the stimulus was necessary and too small. This includes a humorous analogy, he writes: “the last senators who were pulled on board behind the stimulus were proud of the fact that they had reduced its size. The whole point of stimulus is to spend lots of money; reducing the size of a stimulus package is a bit like finding a shortcut on your jogging route. It might be possible, but whats the point? Instead of expressing ridicule, many in the media applauded these senators for being fiscally responsible.” (p.109) Chapter 6 describes other possible expenditures that could be included in a further stimulus. This is probably the least interesting chapter. I’m sure we can all think of useful things the government could spend money on.

Chapter 7 is on reforming the financial system. In it he argues for two reforms. Firstly, he argues for restructuring the Federal Reserve system to take it out of the control of private finance and put it more under public control.This issue is what I’m doing my PhD on and it is not as simple as Baker suggests it is. Yes changing the appointment system of the federal reserve so as to make it so as that private banks aren’t electing their regulators is obviously a good idea, but… placing the federal reserve under more public scrutiny and control is difficult. Democratising capitalism destabilizes capitalism. I don’t want to pull the revolution rabbit out of the economics hat here, but there is a fundamental incompatibility of a publicly controlled economy and a free market economy.

His second proposal is to introduce a financial transaction tax, this is similar to the idea of a Tobin tax or more recently and more idiotically named the ‘Robin Hood Tax’. However, his discussion of this raises two very interesting points that I didn’t know. 1.) The UK has a financial transaction tax on London Stock Exchange. 2.) The LSE tax raises £4 billion pounds annually. I thought that any tax on financial transactions would not really raise all that much. I viewed the tax as basically being a disincentive to speculation not as a realistic revenue raiser. It would seem that it is!

Baker also argues for some other financial reforms. He argues for dealing with derivatives by making all derivatives exchange traded, regulated by the exchange and that any customized derivative would have to go through the bother of getting the customized derivative on the exchange before it could be sold.This he argues would result in the standardisation of derivatives and thereby in their decreased opacity. He also argues for ratings agencies being employed by exchanges and not by firms. This would change the incentive structure for ratings agencies and would stop them giving large firms the ratings they want, because they would no longer be directly employed by those firms. Apart from sounding like a pretty good idea, this is interesting because 1. I didn’t know that rating agencies were directly employed by firms 2. Baker doesn’t even bother arguing that ratings agencies were giving firms the ratings they wanted, he just takes it as a given. If ratings agencies were doing this is is serious, I imagine illegal and if so people should go to jail over it.

The book ends with chapter 8 appealing to reader to remember that the people arguing that workers should pay with unemployment for the crisis are the people who created the crisis. (How true that is I’m not really too sure.)

by Oisín Gilmore

NOTE TO SELF READ THESE

Basically just noting these articles to myself and anyone else who might be interested. Both were published over the last month. One of the recent past one on the rather distant past.

Three million Trotskyists? Explaining extreme left voting in France in the 2002 presidential election

In the first round of the 2002 French presidential election, three million voters (10.4 per cent of the national vote) supported Trotskyist candidates. This unprecedented electoral result has received little academic attention. This study aimed to identify the strongest socio-demographic and attitudinal predictors of support for the new extreme left in 2002. A multivariate framework was applied in a series of models, using data from the 2002 French Electoral Panel. The study also aimed to understand the rise of the Trotskyists in the context of broader social and political developments. The analysis was grounded in series of hypotheses constituting a model of class voting in postindustrial France. Overall, the analysis tended to confirm the predictions of the model, with younger voters at the lower end of the service sector being the most likely to support the three Trotskyist parties. With regard to attitudes, opposition to economic liberalism proved the strongest single predictor of Trotskyist voting, followed by liberal attitudes on cultural issues, political distrust and political disengagement. However, in terms of economic attitudes, Trotskyist voters still came out as surprisingly close to mainstream left voters. In conclusion, it is argued that models of class voting should reconsider the political role of social class in a postindustrial context, and pay particular attention to the trajectories of different classes over time in terms of changing employment conditions and life chances in order to understand how class is likely to shape party preferences.

Black man’s burden, white man’s welfare: control, devolution and development in the British Empire, 1880-1914

This article organizes an economic analysis of the effects of colonial rule on capital market access and development. Our insights provide an interpretation of institutional variance and growth performance across British colonies. We emphasize the degree of coercion available to British authorities in explaining alternative set-ups. White colonies, with a credible exit option, managed to secure a better deal than those where non-whites predominated, for which we find evidence of welfare losses.

by Oisín Gilmore

KRUGMAN AND OTHERS ON DEBT

Yet another great post by Paul Krugman on the significance of rising debt levels. First here’s the image that went with the post:

And now the post itself:

Earlier this week I gave a talk about the state of the crisis at Princeton’s Plasma Physics Lab, and one audience member asked a really good question: if the problem is that interest rates are at the zero lower bound, why should we worry about government borrowing? After all, doesn’t that mean that the government can borrow at a zero rate?

Now, part of the answer is that you really don’t want governments financing themselves largely with very short-term debt — that makes them too vulnerable to liquidity crises. But even long-term rates are low — the real interest rate on 10-year bonds is below 1.5 percent.

And if you do the arithmetic of debt service, that really does seem to suggest that debt isn’t a problem. To stabilize the real value of debt, all the government has to do is pay the real interest on it. So suppose that we add debt equal to 100 percent of GDP, which is much more than currently projected; servicing that debt should cost only 1.4 percent of GDP, or 7 percent of federal spending. Why should that be intolerable?

And even that, you could argue, is too pessimistic. To stabilize the debt/GDP ratio, all you need is to pay r-g, where r is the real interest rate and g the economy’s real growth rate; and right now r-g looks, ahem, negative.

And this benign view of debt isn’t just hypothetical: countries have, in reality, run up immense debt/GDP ratios without going insolvent: see the history of Britain, above.

So what’s the problem? Confidence. If bond investors start to lose confidence in a country’s eventual willingness to run even the small primary surpluses needed to service a large debt, they’ll demand higher rates, which requires much larger primary surpluses, and you can go into a death spiral.

So what determines confidence? The actual level of debt has some influence — but it’s not as if there’s a red line, where you cross 90 or 100 percent of GDP and kablooie; see the chart above. Instead, it has a lot to do with the perceived responsibility of the political elite.

What this means is that if you’re worried about the US fiscal position, you should not be focused on this year’s deficit, let alone the 0.07% of GDP in unemployment benefits Bunning tried to stop. You should, instead, worry about when investors will lose confidence in a country where one party insists both that raising taxes is anathema and that trying to rein in Medicare spending means creating death panels.

This is important. In particular given what is being said by the likes of George Osborne:

No one doubts that there were massive failures of financial regulation over the last decade.

No one seriously defends the fiscal rules, once spelt out in a Mais Lecture like this, which proved unable to prevent the Government running a budget deficit at the peak of the boom.

But we will not draw all the right lessons for the future unless we understand the deep macroeconomic roots of the crisis.

Much has already been written about what went wrong.  Much more is yet to be written.

Perhaps the most significant contribution to our understanding of the origins of the crisis has been made by Professor Ken Rogoff, former Chief Economist at the IMF, and his co-author Carmen Reinhart.

In a series of papers and now a book, they have demonstrated in exhaustive historical and statistical detail that while it always seems in the heat of the crisis that ‘this time is different’, the truth is that it almost never is.

As Rogoff and Reinhart demonstrate convincingly, all financial crises ultimately have their origins in one thing – rapid and unsustainable increases in debt.

As they write, “if there is one common theme… it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks that it seems during a boom.”

So while the specific financial innovations and failures of regulation that contributed to the credit crunch were new, the underlying macroeconomic warning signs were depressingly familiar from many dozens of crises in the past.

In this context, all the signals were flashing red for the UK economy: a rapid increase in household and bank balance sheets, soaring asset prices, a persistent current account deficit, and a structural budget deficit even at the peak of the boom.

Our banks became more leveraged than American banks, and our households became more indebted than any other major economy in history.

And in the aftermath of the crisis our public debt has risen more rapidly than any other major economy.

So while private sector debt was the cause of this crisis, public sector debt is likely to be the cause of the next one.

As Ken Rogoff himself puts it, “there’s no question that the most significant vulnerability as we emerge from recession is the soaring government debt. It’s very likely that will trigger the next crisis as governments have been stretched so wide.”

The latest research suggests that once debt reaches more than about 90% of GDP the risks of a large negative impact on long term growth become highly significant.

As is clear, Krugman is refering to the now bandied around figure that once debt goes over 90% trouble arises. But as is even clearer from the graph above, this simply doesn’t apply when there is confidence that this debt will get paid off. So where does this figure come from. Essentially it has arisen from the very impressive work of Reinhart and Rogoff. I read Reinhart and Rogoff’s book and that 90% figure didn’t jump out that strongly, nor did the book seem to give strong support for the Conservative/Fianna Fail commitment to cuts regardless of consequence. So I was a bit surprised when I say Ken Rogoff name onthat letter to the Sunday Times, which ostensibly supported Osborne’s proposals.

I think I was right to be surprised given that Reinhart and Rogoff wrote an article for the FT at the end of January arguing that:

Given these risks of higher government debt, how quickly should governments exit from fiscal stimulus? This is not an easy task, especially given weak employment, which is again quite characteristic of the post-second world war financial crises suffered by the Nordic countries, Japan, Spain and many emerging markets. Given the likelihood of continued weak consumption growth in the US and Europe, rapid withdrawal of stimulus could easily tilt the economy back into recession.

And given that Reinhart and Rogoff’s work is being used by the likes of Martin Wolf to argue in favour of continued stimulous. Wolf points out that Reinhart and Rogoff have shown that you the debt almost alwaysincreases during a recession:

In their work on the history of financial crises, Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University note that “the real stock of debt nearly doubles” in crisis-hit countries.*

Perhap’s as  leftfootforward argues the letter to the Sunday Times actually was not in support of Osborne. The letter does state that

The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery.

Regardless, not to disparage Ken Rogoff, but as Osborne is clearly arguing from autority here. ‘If the former chief economist of the IMF says it is must be true.’ He should perhaps listen to a former chief economist of the World Bank who recently gave his opinion of Osborne’s policies:

On the suggestion, put about by George Osborne, among others, that Britain is at risk of default: “I say you’re crazy — economically you clearly have the capacity to pay. The debt situation has been worse in other countries at other times. This is all scaremongering, perhaps linked to politics, perhaps rigged to an economic agenda, but it’s out of touch with reality. One of the advantages that you have is that you have your own central bank that can buy some of these bonds to stabilise their price.”

by Oisín Gilmore

KEYNES’S QUOTES

There has been a bit of a resurgence in interest in Mr Keyne’s recently. There was a brief article in Time a few weekd back on this. I liked the quote from Robert Lucas, perhaps the most important economist since Keynes and certainly NOT a Keynesian: “I guess everyone is a Keynesian in a foxhole”.

Also interesting was that it cleared up what I’d heard before but wasn’t sure about. It was Miton Friedman, the reason there is a ‘perhaps’ in the above sentence, who said ‘We are all Keynesians now’ not Nixon.

…A few pages later came the now famous quote from economist Milton Friedman: “We are all Keynesians now.” Friedman later objected that it was taken out of context–all he meant was that everybody used Keynesian language and concepts. But the phrase stuck. It’s often attributed these days to Republican President Richard Nixon, but what Nixon actually said, in 1971, was the less expansive “I am now a Keynesian.” …

by Oisín Gilmore

EP THOMPSON DOESN’T LIKE SHIT

Okay I’ve promised myself I’m going to read The Poverty of Theory by EP Thompson, if only to read this quote in context:

We might define the present situation more precisely if we employed a category found frequently in Marx’s correspondence with Engels, but a category which evaded Althusser’s vigilant symptomatic scrutiny. All this ‘shit’ (Geschichtenscheissenschlopff) in which both bourgeois sociology and Marxist structuralism stand up to their chins (Dahrendorf beside Poulantzas, modernization theory beside theoretical practice) has been shat upon us by conceptual paralysis, by the dehistoricising of process and by reducing class, ideology, social formations, and almost everything else, to categorical stasis… .the systems-analyses and structuralisms. . .the econometric and cleometric groovers – all of these theories hobble along programmed routes from one static category to the next. And all of them are Geschichtenscheissenschlopff,unhistorical shit.

by Oisín Gilmore

KEVIN O’ROURKE, WHAT A LAD

Okay well I’ve banged on to Fergal about this before. But…….. Fergal, is a blogger on this blog but who doesn’t blog so probably can’t be called a blogger, or at least not on this blog. I suppose this make Fergal abit like Peter Piper who picked a peck of pickled peppers, A peck of pickled peppers Peter Piper picked. If Peter Piper picked a peck of pickled peppers, How many pickled peppers did Peter Piper pick?

Anyway, I banged onto Fergal about this before, but it really irritates me the way that the left ignores most of economic history. It irritates me that we only pay attention to people like Robert Brenner or Giovanni Arrighi when there are better economic historians out there. (The only reason we are attracted to Arrighi (the maoist) and Brenner (the trot) is because they are – at least – marxist. I don’t find this good enough.) I’ve used Dublin’s own Kevin O’Rourke as an example of a non-socialist economic historian who the left should be reading. And low and behold, in the most recent NLR

Mind you my words are tasty so I dont mid eating them that much. To be honest I’d like more. So please more of this. More engagement with mainstream economic history please!

by Oisín Gilmore

FAREWELL TO THE WORKING CLASS . . . IN 1930’S GERMANY.

I’m making my way through Adam Tooze’s acclaimed, but very, very long ‘The Wages of Destruction: The Making & Breaking of the Nazi Economy’. When, on p.144 I came across the rather amuzing passage:“In 1939 only 30,000 male school leavers entered the workforce as unskilled labourers, as compared to 200,000 in 1934. For many working-class families, the 1930s and 1940s were a period of real social mobility, not in the sense of an ascent into the middle class, but within the blue-collar skilled hierarchy, prompting one author to speak of the ‘deproletarianization’ of the German working class.”

I hear that in the 1950s Germany wage-labour still existed. Though, I’m happy to be corrected.