Via FT:
We can make four obvious replies to Mr Wen. First, whatever the Chinese may feel, the degree of protectionism directed at their exports has been astonishingly small, given the depth of the recession. Second, the policy of keeping the exchange rate down is equivalent to an export subsidy and tariff, at a uniform rate – in other words, to protectionism. Third, having accumulated $2,273bn in foreign currency reserves by September, China has kept its exchange rate down, to a degree unmatched in world economic history. Finally, China has, as a result, distorted its own economy and that of the rest of the world. Its real exchange rate is, for example, no higher than in early 1998 and has depreciated by 12 per cent over the past seven months, even though China has the world’s fastest-growing economy and largest current account surplus.
Do these policies matter for China and the world? Yes, is the answer. Mark Carney, governor of the Bank of Canada, notes in a recent speech, that “large and unsustainable current account imbalances across major economic areas were integral to the build-up of vulnerabilities in many asset markets. In recent years, the international monetary system failed to promote timely and orderly economic adjustments.” He is right.
Read the full article here
Via The Economist:
People nevertheless use the stockmarket as a barometer of economic health. So a rise in equity markets can be (and has been) seen by governments and central bankers as evidence that the economy is headed in the right direction. That can lead to policy mistakes, such as a lax monetary stance, and further irrational exuberance.
Housing is more complicated than the stockmarket since people get utility from their homes (shelter, relaxation) while simultaneously treating them as assets. Even so, a rise in house prices that outpaces GDP growth does not make a society richer. Instead, all that is achieved is a transfer of wealth from first-time buyers to retirees exiting the property market.
In theory house prices can rise faster than GDP for a while if citizens decide to devote more of their incomes to housing services (for example, they may prefer a bigger flat to a bigger car). In practice it is hard to disentangle such structural shifts from the speculation that is prominent in all property booms.
It is the link between speculation and asset prices that explains this crisis. The ability to borrow money to buy assets fuelled the rise in asset prices. And the wealth effect of higher prices persuaded those in English-speaking countries to borrow money to sustain consumption.
Not long ago the BBC transmitted a programme about credit-card use. One man said he felt “wealthier” because he was given a credit-card limit of £5,000 ($8,000). Of course, once he used the card he was poorer. Not only did he have to repay the £5,000, but he had to service a double-digit interest rate as well. Similarly those who buy an overvalued asset with borrowed money have not made themselves richer but poorer.
Read the full article here
If you are not only looking for a good read, but one that is also relevant to our current economic situation, then I would recommend Where Keynes Went Wrong: And Why World Governments Keep Creating Inflation, Bubbles, and Busts. You hear a lot about Keynes now days, especially from Paul Krugman. But what did Keynes actually say and should we be relying on his policies.
From the Product Description:
In responding to the financial crash of 2008, both the Bush Administration and the Obama Administration have relied on prescriptions developed by John Maynard Keynes, the most important economist since Marx. But should we be relying on Keynes? What did Keynes actually say? Did he make his case? Hunter Lewis concludes that he did not. If Keynes was wrong then so are the economic policies of virtually all world governments today.
Robert Blumen from Mises.org has a mini-review of the book. Below is an excerpt:
This book fills a missing niche in the literature: a debunking of Keynes for the general reader. I believe that this book would also be useful as a supplement in a macro course. But its most important contribution in my view is that it demystifies Keynes. The ideas in The General Theory form the foundation of modern macro-economics, which is the basis for the modern practice of central banking and pretty much all monetary policy around the world. What I mean by the mystification of Keynes is that, because his theories are so long-established and deeply embedded in academic economics, government, and the public consciousness, it is difficult not to think that there must be something really deep and profound there. Upon reading Lewis’ book, it is somewhat shocking to see how weak his arguments are and how poorly they stand up to any kind of logical examination.
The Economist has two articles you should read in this week’s magazine. The first one is “Making Fiscal Policy Credible: Bind Games“. Below is an excerpt:
In America worries about the dollar’s international status and the appetite of Asian central banks for Treasury bonds may yet spur a consensus on the need for a binding fiscal framework. The rise in gold prices to above $1,000 an ounce this week reflects both fears for the dollar and concerns about the possible consequences for inflation of rising public debt.
What America needs is fiscal projections that say something about how and when deficits will be tamed, says Eric Leeper of Indiana University. That sort of detail would help taxpayers and bondholders to form views about future policy. As with monetary policy, fiscal policy works more effectively when people know what to expect, says Mr Leeper.
The other one is “The Financial Industry: Unnatural Selection“. Here’s an excerpt:
But the dramatic changes in the pecking order mask a lack of more profound change in the system of finance itself. Lehman aside, no big firms have been allowed to fail (as they would have done, unaided). Thanks to state aid, the law for big firms today is what Gordon Gekko, the red-blooded villain of the film “Wall Street”, dubbed “survival of the unfittest”.
Indeed, taken together, financial firms have not even really got smaller. Exclude “useful” loans to the real economy, and over the past year the remaining underlying risk-adjusted assets of the nine biggest investment banks worldwide have been broadly flat. Statistical measures of the maximum trading losses these firms could face on those positions suggest that, in aggregate, they are taking more risk. Their combined balance-sheet is 40% bigger today than in mid-2005. And all this has been amplified into public outrage by the foolish decision to pay out bumper bonuses again.
…No one should pretend that banking is an industry where pure natural selection takes place. But as guarantees, both explicit and implicit, are withdrawn, the hope is that self-discipline will be imposed on banks, not just swathes of new regulation. There are signs that riskier banks are already paying more to finance themselves. This differentiation must be promoted, so the weak and reckless are gradually forced to shrink and live within their means—and not off taxpayers’ largesse.
Dirk Bezemer discusses his interesting new paper in the Financial Times. The paper presents evidence that accounting (or flow-of-fund) macroeconomic models helped anticipate the credit crisis and economic recession.
You can read the paper here.
Below is an excerpt from the Financial Times article:
From the beginning of the credit crisis and ensuing recession, it has become conventional wisdom that “no one saw this coming”. Anatole Kaletsky wrote in The Times of “those who failed to foresee the gravity of this crisis” – a group that included “almost every leading economist and financier in the world”. Glenn Stevens, governor of the Reserve Bank of Australia, said: “I do not know anyone who predicted this course of events. But it has occurred, it has implications, and so we must reflect on it.” We must indeed.
Because, in fact, many had seen it coming for years. They were ignored by an establishment that, as the former Federal Reserve chairman Alan Greenspan professed in his October 2008 testimony to Congress, watched with “shocked disbelief” as its “whole intellectual edifice collapsed in the summer [of 2007]”. Official models missed the crisis not because the conditions were so unusual, as we are often told. They missed it by design. It is impossible to warn against a debt deflation recession in a model world where debt does not exist. This is the world our policymakers have been living in. They urgently need to change habitat.
I undertook a study of the models used by those who did see it coming. They include Kurt Richebächer, an investment newsletter writer, who wrote in 2001 that “the new housing bubble – together with the bond and stock bubbles – will [inevitably] implode in the foreseeable future, plunging the US economy into a protracted, deep recession”; and in 2006, when the housing market turned, that “all remaining questions pertain solely to [the] speed, depth and duration of the economy’s downturn”. Wynne Godley of the Levy Economics Institute wrote in 2006 that “the small slowdown in the rate at which US household debt levels are rising resulting from the house price decline, will immediately lead to a sustained growth recession before 2010”. Michael Hudson of the University of Missouri wrote in 2006 that “debt deflation will shrink the ‘real’ economy, drive down real wages, and push our debt-ridden economy into Japan-style stagnation or worse”. Importantly, these and other analysts not only foresaw and timed the end of the credit boom, but also perceived this would inevitably produce recession in the US. How did they do it?
Central to the contrarians’ thinking is an accounting of financial flows (of credit, interest, profit and wages) and stocks (debt and wealth) in the economy, as well as a sharp distinction between the real economy and the financial sector (including property). In these “flow-of-funds” models, liquidity generated in the financial sector flows to companies, households and the government as they borrow. This may facilitate fixed-capital investment, production and consumption, but also asset-price inflation and debt growth. Liquidity returns to the financial sector as investment or in debt service and fees.
It follows that there is a trade-off in the use of credit, so that financial investment may crowd out the financing of production. A second key insight is that, since the economy’s assets and liabilities must balance, growing financial asset markets find their counterpart in a growing debt burden. They also swell payment flows of debt service and financial fees. Flow-of-funds models quantify the sustainability of the debt burden and the financial sector’s drain on the real economy. This allows their users to foresee when finance’s relation to the real economy turns from supportive to extractive, and when a breaking point will be reached.
Ambrose Evans-Pritchard of the Telegraph writes that deflation is spreading from the core of the global system to the most unexpected regions of the world. It has even reached Latin America. Prices are sliding in Peru, Chile, Colombia, Paraguay, Bolivia, Ecuador, Guatemala, and El Salvador, to the consternation of everybody.
You can read the article below:
Enough of the world has already fallen so far into pre-deflation conditions that any misjudgment by the big central banks from now risks setting off a chain-reaction that may prove very hard to stop.
CPI inflation has dropped to –2.2pc in Japan (a modern record), -2.1pc in the US, -1.8pc in China, -1.4pc in Spain, -0.7pc in France, and -0.6pc in Germany.
This was not anticipated by the authorities anywhere, so we should be wary of their assurances now that we face nothing more than a brief dip in prices before rising energy costs bring inflation back into familiar and safe territory. No doubt prices will rebound as the “base effect” of oil prices kicks in. But by how much; for how long?
The sum of economists in the world (outside Japan) familiar with the cultural and psychological dynamics of deflation can fit into one London bus, and most are historians of the 1930s.
If PIMCO guru Bill Gross and hedge fund manager Paul Tudor Jones are right in fearing that the US economy will tip back into a “W-shaped” recession as the sugar rush of fiscal stimulus fades, we may wake up to find that we have baked deep deflation into the pie for 2010 and 2011. The G20′s talk of “exit strategies” and rate rises will seem surreal.
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Paul Krugman wrote a lengthy piece in the New York Times Magazine today. It is a very hard critique and analysis of the failure of current macro and financial economic thought, which didn’t even come close to predicting the current financial malaise. I don’t agree with all of it, particularly his love affair with Keynesian economics. But it is still very worthy of your time and a recommended read. A point where I agree with Krugman: the failure of EMH.
Below is an excerpt:
As I see it, the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth. Until the Great Depression, most economists clung to a vision of capitalism as a perfect or nearly perfect system. That vision wasn’t sustainable in the face of mass unemployment, but as memories of the Depression faded, economists fell back in love with the old, idealized vision of an economy in which rational individuals interact in perfect markets, this time gussied up with fancy equations. The renewed romance with the idealized market was, to be sure, partly a response to shifting political winds, partly a response to financial incentives. But while sabbaticals at the Hoover Institution and job opportunities on Wall Street are nothing to sneeze at, the central cause of the profession’s failure was the desire for an all-encompassing, intellectually elegant approach that also gave economists a chance to show off their mathematical prowess.
Unfortunately, this romanticized and sanitized vision of the economy led most economists to ignore all the things that can go wrong. They turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation.
It’s much harder to say where the economics profession goes from here. But what’s almost certain is that economists will have to learn to live with messiness. That is, they will have to acknowledge the importance of irrational and often unpredictable behavior, face up to the often idiosyncratic imperfections of markets and accept that an elegant economic “theory of everything” is a long way off. In practical terms, this will translate into more cautious policy advice — and a reduced willingness to dismantle economic safeguards in the faith that markets will solve all problems.
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Tags: ben bernanke, derivatives, economy, EMH, federal reserve, great depression, inflation, keynes, keynesian, paul krugman
economy, EMH, global economy | Graham | 
Saturday, September 5, 2009 11:51 am | 
Comments (1)
I read this very insightful article on Russia and Putin a couple of weeks back in the Financial Times. I was reminded of it yesterday when I was reading how Putin tried to present a nuanced view of the 1939 Soviet invasion of Poland, during ceremonies marking the 70th anniversary of the second world war’s outbreak. It was very typical of Putin. So I did a quick search on FT and found the article that I read a couple of weeks ago. It’s a short read and well worth your time.
A friendless Russia is held hostage to Putin’s vanity
By Philip Stephens
The conventional story about Russia has been one of power reclaimed after the fall to chaos during the 1990s. Oil, gas and autocracy have restored it to the ranks of world powers. Some of the more hyperbolic commentary has gone so far to say that, along with China, Moscow has created an entirely new model to challenge western liberalism.
Yet what most strikes me about Russia is its isolation. For all its resurgent hydrocarbon revenues and its considerable, albeit residual, military power, Moscow is essentially friendless. As for a superior system of capitalism, when was the last time you heard an international politician of any consequence hold up Russia as their chosen paradigm?
Moscow can claim the odd loyal acolyte, sure. Many of the former Soviet republics among its neighbours judge it wise to stay on side with the present regime. Last year’s Russian invasion of Georgia served, in Voltaire’s famous phrase, “pour encourager les autres”. Beyond the post-Soviet space, mavericks such as Venezuela’s Hugo Chávez see some advantage in travelling in Moscow’s slipstream.
But look for eager and willing allies – governments and peoples that feel an instinctive affinity with today’s Russia or who see in its society something to borrow for themselves – and, well, Moscow is out there on its own. To put it another way, what country in the world wants to be more like Russia? I cannot think of a shorter list.
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