Not so when the word is nationalization.

From Bob McTeer:

“Nationalizing” Banks

"Sticks and stones may break my bones, but words will never hurt me."

Not so when the word is nationalization. That word appears to have trimmed a few more percentage points off the stock averages in the past few days.

The remarkable thing is that people seem to have no idea what nationalizing means, much less agree on its meaning. After listening carefully, I've decided that it has no special new meaning or relevance, but that the word itself is toxic.

In modern banking history, a failed or insolvent bank is taken over by its insurer, the FDIC, while a private sector purchaser is sought. Or, probably more likely these days, the FDIC finds a buyer prior to closing the bank along with the bank's primary regulator. In the first instance, one can say that the bank is temporarily nationalized-taken over by a government agency. Under the doctrine of "early intervention" or "prompt corrective action," the FDIC may find a buyer or it may "nationalize" the bank before it runs out of capital, i.e., while it is still solvent but expected to be insolvent before long.

My point is not whether the word "nationalization" fits or doesn't fit the circumstances; my point is simply that people are just using a new word (in this context) for a familiar action. The word frightens because it is usually associated with socialism, but it's just a new label for old wine.

If a couple or more of very large banks run out of capital at about the same time, whether in reality, or as a result of mark-to-market accounting, it would probably take a while for the FDIC to "resolve" them. During that period, the banks would probably be under the FDIC's (the government's) jurisdiction. One could call that nationalization, but it's never been called that before, and calling it such now is doing real damage. Now is a time for watching our words and showing some restraint.

Me:

1. Don the libertarian Democrat Says: Your comment is awaiting moderation.
   February 23rd, 2009 at 2:30 pm

   “One could call that nationalization, but it’s never been called that before, and calling it such now is doing real damage. Now is a time for watching our words and showing some restraint.”

   I agree with you that it’s nothing new, but I insist on calling it nationalization, precisely because it’s terrifying everyone. That’s how moral hazard works. Fear. I don’t want anything happening like this again. Apparently calling banks “Too Big To Fail” doesn’t scare anybody.

   We have a welfare state. Since I don’t know what Socialism is any more for many people, I’ll just say that I have seen reports that even in Eastern Europe, with its problems, most people believe that our free market/government systems are going to remain in some form. My fear is nationalism, not socialism.

   Also, if precision of speech is important, I wouldn’t go around calling what we have a free market, but that’s just me.

"The lesson is simple: Don't count jobs; make jobs count."

And again:

"Jobs: Not a Proper Goal of Public Policy

In my previous piece I focused on a simple trap that we all fall into when we count what happens (jobs) but forget to count what doesn't happen (other jobs). We forget to net it out.

In this piece, also mercifully short, I hope, I would like to make the case that "job creation" is not a worthy goal of economic policy anyway. Sure, we want jobs for everybody who wants one, but jobs should come as a by-product of producing something or providing a service that is needed. Focusing on the job per se, rather than on what is produced with the job, leads to waste. There is always more work to be done than there are people able and willing to do it. It is the work that should drive the process; not just a job for a job's sake.

Some examples will make this obvious. The government could create enough jobs to achieve full employment by having the previously unemployed dig holes on Monday, Wednesday and Friday and fill them up on Tuesday, Thursday and Saturday. Or, in my long-time favorite example, if you want more jobs, replace the heavy equipment on a construction site with shovels. If that doesn't do it, replace the shovels with spoons. Silly? Sure, but not much sillier that some of the rhetoric we take all too seriously.

When we say we have to "create jobs," we are setting ourselves up for a misallocation of scarce resources and a sub optimization of our economic efficiency. When we say that, we imply that there are just so many jobs to go around and we need to find and fill them. Pretty soon that kind of thinking leads us into the French fallacy of spreading a given (fixed) amount of work among more workers by shortening the legal work week. Only so much work to be done; let's spread it out.

Don't forget that the demand for workers will increase with the work being done. Don't forget Say's Law, "Supply creates its own demand." We sometimes forget it in times like this because we get caught up in Keynes' Law, "Demand creates its own supply." Come to think of it, neither law is a rationale for wasting good workers by putting them in sup-optimal jobs. The lesson is simple: Don't count jobs; make jobs count."

Me:

1. Don the libertarian Democrat Says: Your comment is awaiting moderation.
   February 20th, 2009 at 5:55 pm

   Here I agree with you. It has to matter how the money is spent, otherwise, why even bother creating jobs? Just give people money to live. In fact, from my point of view, social safety net spending works the best, since it has to be spent. After all, it’s given to people who, theoretically at least, need it to survive, and so have to spend it, and on things essential to the economy at that.

   Infrastructure is purportedly an investment. In other words, it will more than pay for itself in the future by facilitating some business or civic function or both. If it turned out be heavily siphoned off into fraud, or spent in a way that led to enormous cost overruns in the future, wouldn’t we be angry? Otherwise, why not run a big Ponzi Scheme instead? They certainly seem to attract investors.

   From my point of view, there is a good argument, in general, to borrow for investment, so that, in a time of necessary borrowing ( This is what I call the current situation. Not necessary spending. After all, you could spend without borrowing. ), some money for infrastructure makes sense. I simply thought that $100 Billion made more sense, since I do worry about things like waste and fraud, especially under crisis conditions.

   So, I agree with you. The argument is intentionally fuzzy. We want to spend money on infrastructure as an investment, but we don’t want to observe the normal precautions we take concerning it, because we’re in a hurry to spend. This is not a good argument, and neither is the argument that it doesn’t matter what the spending is for.

The economy of the future will just be a little less productive and a little more sluggish than it would have been. Less will be seen in the future.

From Bob McTeer:

"Stimulus and Job Creation

Not Necessarily the Same Thing

Once again I'm going to be brave and state the obvious and run the risk of a "Duh" response. While my point is embarrassingly obvious, I haven't heard anyone make it during the debate on the recently passed stimulus package.

Money spent, even new money spent, on a given project or cause is much more likely to cause a diversion or reallocation of employment than to cause a net increase in employment.

As explained in my Broken Window Fallacy, when a baker has to spend money for a new window because teenagers threw a brick through the old one, he does create additional business for the window repair man, who will likely spend the proceeds on something else, and so on. The broken window does create new spending, and, perhaps, even additional employment. However, the benefits of this new spending are likely to be offset by the money not spent on something else had the window not been broken. That spending would also have led to further spending. The broken window diverted spending and reallocated the benefits, but didn't create net new spending or employment.

Substitute for the broken window the various and sundry new spending projects included in the huge stimulus package. They will result in new business for some, and perhaps even some new employment, but not necessarily any net new employment. Workers used on new projects are likely to be the same workers that would have worked on other similar projects in the same field. The workers on the new projects will be counted and added to the ranks of the newly employed; the same workers won't be subtracted from other projects because the other projects didn't materialize. As Frederic Bastiat would have put it, it's the difference between the seen and the unseen. The seen get counted; the unseen don't.

As the debt piles up, the government programs that don't get funded in the future because of the higher cost of servicing the debt won't be counted either. Those forgone programs of the future won't be counted as a cost of today's stimulus because they won't be seen either. The economy of the future will just be a little less productive and a little more sluggish than it would have been. Less will be seen in the future."

Me:

1. Don the libertarian Democrat Says:
   February 19th, 2009 at 11:21 am

   “The workers on the new projects will be counted and added to the ranks of the newly employed; the same workers won’t be subtracted from other projects because the other projects didn’t materialize.”

   This sounds like your saying that, if the local government builds a courthouse, I won’t be able to find workers to build my grocery store. That can’t be right. What am I missing?

I'm going to belabor the obvious here. I hate to do it, but somebody needs to and nobody else is:

From Bob McTeer's blog:

Rescues and Stimulus

I'm going to belabor the obvious here. I hate to do it, but somebody needs to and nobody else is:

*Calling something a stimulus package doesn't make it one. This one doesn't come close. Read it here.

*If you are headed in the wrong direction, speed is not your friend. Neither is size.

*The rescue of financial institutions is more urgent than a stimulus package and less expensive to taxpayers.

*Illiquid assets can be purchased, held, and later resold, possibly at a profit, while money spent is money gone. One is "investment;" the other is spending.

*Money spent with borrowed money raises future interest costs to future taxpayers.

*Rescue investing by the Fed and Treasury probably provide more stimulus than stimulus spending helps the financial system.

*You don't have to have a stimulus package to get stimulus. The recession is triggering automatic stabilizers - more spending and lower tax payments. The budget deficit is growing rapidly without a stimulus bill.

*Since the beginning of September, Fed operations have speeded up the growth of bank reserves and money. As velocity normalizes, much stimulus will be unleashed. The trick will be winding it down.

*Tax-rate cuts would result in immediate reductions in withholding and impact the economy faster while letting the public allocate their own funds.

*"Buy American" provisions are crazy. Has anyone heard of Smoot-Hawley? Do we not understand retaliation?

*Did someone say Davis-Bacon would apply to construction contracts? The best I can say about it is that it's well named.

*This is no time to poke a stick in our biggest international creditor's eye.

*What some people are calling "manipulation" used to be the official policy of the U.S. and other countries under Bretton Woods.

*I see that while we were focused on these issues, the trial lawyers just got a whole new playing field - equal pay."

Me:

1. Don the libertarian Democrat Says: Your comment is awaiting moderation.
   January 31st, 2009 at 1:57 am

   Here’s my plan, just so you know where I’m coming from:
   1) $100 Billion Infrastructure ( In order to show that we have the confidence to invest in the future )
   2) $100 Billion Tax cuts targeted toward investment ( To attack the fear and aversion to risk )
   3) $200 Billion Sales Tax decrease or Payroll Tax decrease which will be phased out ( To battle the possibility of Debt-Deflation )
   4) Social Safety Net spending, which I’m assuming that you’re calling automatic stabilizers
   Now, you seem to believe that 1 is bogus. Infrastructure cannot be considered an investment. I find this view strange. If you do consider it so, surely then some part of it you agree with. How much?
   The plan has tax cuts and increases in 4 which I approve of. Now, I have to assume that your main objection is 1. But is that enough to vote down a compromise bill? It’s not my plan, but I would have voted for it.
   As for the real stimulus, I would use monetary policy. I happen to be a follower of Irving Fisher, although I am more behaviorally oriented. But I’m bewildered by the idea that this plan has nothing good in it for the GOP. I simply don’t credit that view. It’s bad faith. At most, some of 1 is a bother to them. But how much and where? And what would a compromise be? I guess that compromise is very bad in the GOP’s eyes. Let me quote my hero Burke:

   “All government, indeed every human benefit and enjoyment, every virtue, and every prudent act, is founded on compromise and barter. ”

   Too bad there are no Burkeans in the GOP.

"But for now at least you have the means to understand what money supply is and how it is measured"

Another nice resource post from Jesse's Cafe Americain:

"Money Supply: A Primer

You walk into a Merchant and a sign says, "All Items on Sale Today for Cash Only No Credit."

You are interested in purchasing an item. The Merchant, being a crafty sort asks "How much money do you have to spend(in US dollars)?"

How would you answer that if you are being truthful?

You might start by looking into your wallet and pockets, and counting all the cash and coins you have with you at that moment.

M0: Monetary Base

This is equivalent to the monetary base, or M0. It is money you have that is immediately available requiring no change or conversion. There is very little risk to the merchant, unless it happens to be counterfeit which is easily verified.

"Not enough" says the Merchant. "I am sorry, but do you have more?"

M1

Then you remember that in addition to cash, you have your checkbook with a current balance in it, and a debit card to an account you maintain in a local bank, but with no overdraft or lines of credit provisions.

That plus the currency in your pockets is M1. See the difference? You do not have ALL your money in your pockets for immediate presentation, but with a little transactional effort the money is readily available and it is inherently your money, it belongs to you. It is just being held elsewhere besides your pockets and wallet. The merchant assumes a little more risk, but he can quickly call your bank to verify that the funds are available for the check, and the debit card is even more mechanized. More risk, a little more delay, but almost as 'good as cash.'

"I am sorry sir," says the Merchant, "but this is still not enough to exchange for such a valuable object as I have for sale here."

M2

You think about it, and remember that you have a savings account across the street at the bank, and a money market fund at your brokerage office next door, that have more of your money on deposit. You have no cards for those accounts, but it would be an easy thing to walk next door or across the street and obtain the cash.

This is M2. There is a more complex transaction involved, since the transfer is not electronic as in the case of a debit card, and you must leave the store to obtain the money in the form of currency unless they bring it over to you. But it is your money that is available to you on demand. There is a small amount of risk of your bank not being solvent when you need the money, but these are slight inconveniences compared to the safety of not carrying around large sums of money that earn no interest in the form of cash.

"I am so sorry," says the Merchant. "But this item is far too valuable to part with for such a sum as you have offered."

M3

You think about it, and remember that you have a large Certificate of Deposit at the bank across the street that matures in one year. There is a small penalty if you redeem it today to receive your money since you promised it to them for a time in exchange for a specific return, and you must fill out some paperwork, but it is still your money. It involves no sale of an asset or conversion.

That is M3. It involves money that is still yours without borrowing, but has additional conditions set up on it for its retrieval.

One could make the case, and perhaps appropriately so, that while certificates of deposit with a term contract that might effect their value are money, they are not readily available money since the terms of the CD's may differ greatly. They are not 'liquid' and the value before maturity is not always certain due to a penalty.

MZM

If one takes all the things we describe as M2, but takes out the time deposits or certificates of deposit, and includes ALL money market funds, that is what the Fed considers to be the broadest measure of liquid money, or Money of Zero Maturity (MZM). "Zero maturity" means that the money is not tied up for a period of time to mature to its full value.

Are credit cards or loans Money? No,those are all forms of borrowing something that is not yours that you promise to return with conditions. You are receiving money that was not yours.

Credit Is Not Money.

Credit, or debt, is the 'potential' for money, a way of receiving it.

Whether water is held in a canteen, a well, a cistern, or a private lake, it is still water and it is yours if you own it. So too money is still money if it is yours, no matter under what conditions you hold it or save it for your use.

The cloud of credit, or debt depending on your perspective, is the potential for money as it is defined in our economy. It is a source of money. At a given point in time, you either have the money as your property or you do not.

But the source is not the money itself, and the source can be different and can change over time. In our society borrowing is so common and so technologically convenient that there is little difference in most people's mind between credit and money.

But the difference is that if you spend real money, you incur no obligation for it in the future. You receive no payment request from another at the end of the month.

That is what money is, at least in our economy, and the various measure of money as it is held and shifts through the economy and a variety of transactions, where it flows and rest in pools, and moves again. A measure of the money supply is a snapshot in time.

How money increases or decreases, and how it is stored or held, is a significant indicator of economic activity for those who study such things. It is also significantly affected by custom, technology, and the prevailing mood and perception of the public.

The best and broadest measures of money supply are either MZM, or M2, now that M3 is no longer being reported by the Fed. This can easily be seen from the illustrations.

As springs feed into brooks, and brooks streams, and streams into rivers, and rivers into lakes, so the money supply components change in size and shape over time as money flows from its various sources. The speed of the flow is the 'velocity of money' and as one can easily understand that flow will have a different force and speed depending on when you measure it, and whether you are measuring one of the streams or a major river.

People often prefer to jump into discussions and turn them into debates (arguments) with hair-splitting definitions (what is 'control' of the money supply) and red herrings (why does a dollar cross the road?) before defining any terms or facts and setting some boundaries for the analysis, because their goal too often is not understanding, but to promote some theory or point of view. 'Winning the argument' is their objective, not a search for the truth.

Money is the instrument of the official economy. This gives money a certain arbitrariness over time because, after all, it is the product of a committee. Official money is the creation of government, managed by its agents, validated by the people who use it.

Official money rises and falls from favor to disfavor, as do governments. What if you were a citizen of Zimbabwe? Or the US in the 1860's? Or Germany in 1922? How would you feel about your official money then? Why is it different for you now? What would change your opinion?

What is the 'natural growth rate' of the money supply? Zero?

The discussion of how money supply increases, and who or what determines the supply, and what an appropriate level of growth would be is a matter for discussion on another day. So too is the strange phenomenon of 'natural forms of money' that keep turning up in every era and nearly every society.

But for now at least you have the means to understand what money supply is and how it is measured, and how it is different from potential money, or credit, the representations of money, and asset stores of wealth."

Now David Friedman, with a good resource post:

"The Price of Money and Other Errors

It is common for people who think they understand economics to describe the interest rate as the price of money. If it were true, then printing more money would lead to lower interest rates, and many of the same people think it does.

The next time someone tells you that the interest rate is the price of money, ask him what he thinks a reasonable interest rate is and offer to buy some money from him—at ten cents on the dollar if the rate he suggests is ten percent. As that example illustrates, the interest rate is not the price of money. The price of money is what you must give up to get it. If apples cost fifty cents each, the price of money is two apples. More generally, the price of money is the inverse of the price level—when prices are high, that means that money is not worth very much.

The interest rate is the rent of money measured in money. Suppose you borrow a hundred dollars at ten percent. If the price of a dollar is two apples, you are borrowing the price of two hundred apples and paying the price of twenty apples a year in interest. If the money supply doubles, prices double, including the price of an apple, you are borrowing the price of a hundred apples and paying the price of ten apples a year in interest. If you prefer, you could do the same real transaction as before by borrowing two hundred dollars and paying twenty dollars a year interest, still at ten percent.

As this example suggests, there is no connection between the amount of money in circulation and the interest rate. There is a connection between the rate of change of the amount of money in circulation and the interest rate, but it goes in the opposite of the direction implied by the error I am discussing. When the money supply is increasing and prices are rising, nominal interest rates are high, not low, because lenders must be compensated for the fact that they will be paid back in dollars worth less than the ones they lent.

Much of the confusion here comes from the multiple meanings of the term "money." When we say someone has lots of money, we don't usually mean that he has a lot of green paper or a large balance in his checking account; we mean that he is wealthy. His wealth might be in money, it might be in valuable real estate, it might be in stocks and bonds. If there is lots of money in that sense—more precisely, if lots of people have wealth they would like to lend out—that will tend to lower interest rates. But that has nothing to do with the amount of money in circulation.

What brings up this particular confusion at the moment is the attempt to link the current crisis with the events that led to the Great Depression. Those events produced a sharp drop in the money supply, due to banks going broke and depositors either losing or withdrawing their deposits. Given the nature of a fractional reserve system, replacing a mix of currency and deposits with just currency reduces the total amount of money in circulation, in that case by a lot. The problem could have been prevented if the Federal Reserve System had kept those banks from failing, which was part of the purpose it had been set up for, a purpose that had been served earlier by the private arrangements among banks that it effectively replaced( A GOOD POINT ).

That series of events cannot happen now because the FDIC insures bank deposits( TRUE ). What we are observing is not a drop in the money supply. It is a loss of wealth, as firms discover that their assets, in particular mortgages and securities backed by mortgages, are worth less than they thought. That explains why the proposed bailout is enormously greater than would be required to prevent a run on bank deposits( TRUE. BUT NOT A CALLING RUN. ). $700 billion is roughly half the total money supply of the U.S. (M1—currency plus checking accounts and similar assets)--and about half of that is currency, which isn't going to vanish whatever happens to the banks. The total wealth of the economy is enormously greater than the total amount of money in the economy, and the bailout is a response not to a reduction in the amount of money but a reduction in the amount of wealth.

That also explains why the bailout has very little to do with preventing another Great Depression. The U.S. money supply at the moment is at or near its all time high, and it is hard to see how anything likely to happen, with or without a bailout, will reduce it by much. The mechanism that set off the Great Depression isn't happening.( I AGREE )

What is happening is the failure of lots of firms. The failure of a firm doesn't wipe out wealth, except to the extent that the firm itself—its firm culture, web of relationships and such—has some value. When a firm fails, that is at least some evidence that that value was negative, which is why nobody chose to buy out the firm and keep it going. The ordinary assets of the firm—its buildings, land, stocks, bonds, mortgages, and whatever it owns—don't vanish when the firm fails, they get sold to someone else.

The bailout is not a way of preventing the loss of value. The loss (or transfer) of value occurred when people made bad mortgage loans( TRUE ). What happened more recently was the recognition of that loss. All the bailout can do is to shift( SOME OF THE ) the loss from some people to others, from the stockholders and creditors of firms that are now effectively bankrupt( THESE BUSINESSES I AGREE ) to the taxpayers( I AGREE ).

All of which comes back to confusion over the meaning of "money."

Now, Bob McTeer:

"Is the Fed Printing Too Much Money?

For as long as I can remember people have referred to the Fed printing money-usually when they disapprove. The implication is that printing money is inflationary.

I've always assumed that those who use that terminology understood that "printing money" shouldn't be taken literally. Nowadays, I'm not so sure. Several financial talking heads I've heard recently sound like they mean it literally. Often the context has been whether the Fed might buy longer-term treasuries.

While most of you know this, I feel compelled to point out that the Fed doesn't literally print money. That is done by the Bureau of Engraving and Printing, which is under the Treasury Department. The amount of printed or paper money that gets into circulation is not determined by the Bureau, the Treasury, or the Fed. It is determined by the preference of the public for holding currency as opposed to deposit accounts in financial institution.

If the public collectively decides it wants to hold more of their money in the form of currency-as they normally do as the Christmas season approaches-they simply cash more checks at their banks and take the currency. The proportion of the money supply (however we define it) held in paper money rises relative to the proportion held as deposits. More checks cashed at banks are paid for by the public with deposit balances. The banks will, in turn, order more currency from the Federal Reserve, paying for it by drawing down their reserve balances on deposit at the Fed. When the Fed's own inventory of currency gets low, it orders more from the Bureau of Engraving and Printing and pays for it by increasing Treasury deposits at the Fed. So the amount of currency printed is up to the public.

I should mention that when paper money gets too worn or damaged, the Fed destroys it and replaces it with new inventory from the Bureau. That means there is a relatively steady printing of new currency even when the total money supply-currency plus certain deposits-isn't growing rapidly.

The Fed influences the creation of money while the public determines the portion to be held in currency. Substituting "creating money" for "printing money" would correct many assertions that are made. However, the term "creating money" may also be misunderstood by those who aren't familiar with the process.

The Fed normally "creates money" by buying short-term government securities in the open market. The seller of the government securities gives up the securities and gets more deposits in his bank. He traded one asset for another. The banks owe more deposit liabilities to their customers, offset by more reserve deposits at the Fed-when it deposited the check received from its customer. The Fed has more government securities on the asset side of its balance sheet offset by more reserve liabilities owed to the banks. Everybody's balance sheet balances. New money was created in the process, but no net new assets or wealth. New money was created-not printed. If its growing deposits (money supply) causes the public to rebalance into more currency, more money might then be "printed," but it will be paid for with deposit money."

All three of these posts provide clear explanations and should be kept.

The question of whether the Fed is creating too much money these days is a different question to be dealt with separately."

"but the critics never mention the reason for the low rates nor their benefits."

Bob McTeer takes the blame for turning the water on in the Spigot Theory, which I don't credit:

"When recession becomes an issue, as it now is, the remedy involves increasing total spending, or aggregate demand, to match the capacity of the economy to produce goods and services at full employment( TRUE ).

One way to view aggregate demand is by its spending components such as consumption, investment, and government spending. This "Keynesian approach facilitates a focus on fiscal policy( TRUE ).

An equally valid approach that highlights monetary policy is to treat aggregate demand as the money supply (M) times its velocity (V). MV gives you the same spending totals as above( YES ).

A third approach, rarely used, is productivity (output per hour worked) times the number of hours worked. That too gives the same result. It's like describing the same thing in different languages.( OK )

Productivity growth came into prominence in the late 1990s because its acceleration had very positive results. It enabled employers to give pay increases without increasing their unit labor costs. That permitted an easier monetary policy with less worry about inflation. We had faster growth with falling inflation( YES ).

Remarkably, faster productivity growth continued as we climbed out of the recession in 2002. That was a mixed blessing since business expanded with little or no expansion in employment. Rising output coinciding with rising unemployment led to the term "jobless recovery."( YES. THAT'S SOMETIMES AN ODDITY OF AN INCREASE IN PRODUCTIVITY )

While rising productivity was increasing our standard of living, it also depressed employment growth, which is probably not a desirable tradeoff when the economy is weak( I AGREE ). Rising employment spreads the benefits of growth more widely( YES ).

As 2002 progressed, the recovery sputtered and a double dip recession threatened. Falling inflation threatened to morph into actual deflation. Fear of deflation, was the main reason the Greenspan Fed allowed the Federal funds rate to go so low, eventually reaching one percent. Alan Greenspan is routinely blamed for those low interest rates fueling the housing boom, but the critics never mention the reason for the low rates nor their benefits( TRUE. SAME PLAN AS THIS TIME ).

Whether the policy was justified or not, I left my fingerprints at the scene. At the September 2002 FOMC meeting, I dissented, along with Governor Ned Gramlich, in favor of reducing rates. We didn't prevail at that meeting, but the vote to ease was unanimous at the next meeting, on November 6.

I wrote the following rational for the minutes, which are now public:

Messrs. Gramlich and McTeer dissented because they preferred to ease monetary policy at this meeting. The economic expansion, which resumed almost a year ago, had recently lost momentum, and job growth had been minimal over the past year. With inflation already low and likely to decline further in the face of economic slack and rapid productivity growth, the potential cost of additional stimulus seemed low compared with the risk of further weakness.

So, you see, it wasn't Chairman Greenspan's fault. It was mine."

I would have voted with McTeer. But, as I say, I don't hold Low Interest Rates as the cause of our crisis. My main complaint against Greenspan is not recognizing problems and voicing concerns about them. He was too much of a cheerleader for some dubious views about current Political Economy.

"But the international-based capital regulations opened loopholes that banks could drive a truck through. "

Arnold Kling also read the paper by Brunnermeier, so read his analysis, which is interesting as always. Here's a comment I really like:

"My opinion continues to be that you cannot prop up until you clean up. The first order or business is to shut down the weakest institutions. Only then should you look around and decide about capital injections and bailouts. We don't need a chief rescuer. We need a head janitor. Think of the financial sector as a bunch of dishes sitting on shelves during an earthquake. Bernanke and Paulson are running around trying to hold the shelves in place. I think we would be better off letting a lot of the dishes fall and then tossing them into the trash. You can understand why my view could be unpopular, and it also could be wrong. But so far, the stock market isn't telling me that Bernanke and Paulson are right."

Now, I understand that, at some point, we have to do this. My rationale for supporting a Swedish Type Plan was for the government to take over these banks, and either kill them, or refit them for private service. I still believe that this plan would have been cleaner in a whole, by now obvious, number of ways.

However, now we are dealing with Bagehot on steroids, as I think Bob McTeer said. In terms of Political Economy, we have a new administration coming in. So, I can see Kling's point as the goal, but I simply think that, in terms of Politics and Political Economy, it's going to continue to be a very messy cleanup. I include the auto makers in this.

Please remember that, for me, we are mainly combating fear and aversion to risk, and so we will have to make concessions to the realities of taking on these powerful forces, and understand that sensible economic and political points might have to be breached in order to get through this. None of this means that we change our basic understandings of economics and politics, which, for any libertarian, means a focus on individual liberty.

"John Maynard Keynes called it the Paradox of Thrift, but most economists I know don't talk about it much for fear of being labeled a Keynesian."

I can think of worse things to be called. In fact, I've been called them. Repeatedly. Bob McTeer on The Paradox Of Thrift:

"The economy is facing quite a dilemma-or paradox. Actually, John Maynard Keynes called it the Paradox of Thrift, but most economists I know don't talk about it much for fear of being labeled a Keynesian. The paradox is this: most of us need to save more, i.e., consume less of our disposable income. Yet, if all or most of us try to save more at the same time, income will fall. The paradox comes in because out of the lower income we will likely end up saving less, not more.

The problem for the economy is this: consumption makes up about 70 percent of total spending, and consumption has been supporting the economy for years even though the personal saving rate is close to zero. The reason is that individual consumers who have experienced capital gains in their homes and in their stock or mutual fund portfolios (including those in their pension funds, 401Ks, IRAs, and the like) have thought of those capital gains as saving and thus have been willing to consume virtually all of their current income. (This is legit for individuals, but not for the nation as a whole since resources aren't being made available by capital gains.)"

Now, I see this as a problem of incentives for individuals, not a paradox. The incentives must be re-balanced to motivate individuals to spend and invest.

Here's my response:

Don the libertarian Democrat Says:

1. November 12th, 2008 at 9:29 pm

   “Second, and perhaps more important, “savings” represent loanable funds; an increase in the supply of loanable funds tends to lower interest rates and stimulate borrowing, so a decline in consumable goods with a short time horizon is offset by an increase in production in sectors with longer time horizons. For example, the demand for personal electronics might decline, but the demand for such things as real estate would be stimulated by favorable borrowing conditions.”

   I was going to write this, but Wikipedia says it better than I would have. During a recession, one can pass laws to increase long term investment and infrastructure spending, using tax breaks or government investment.

   As well, use loans and spending to help people start businesses. I actually started a business during a recession as I recall. I got a great deal on my rent at the time.

   By giving benefits to people who aren’t able to spend, with targeted tax cuts and investment, saving can be a good thing at all times. Of course, as a follower of Maimonides, moderation in most things is the wise course.

   The Paradox of Thrift seems more a problem of group versus individual behavior, which can be overcome with countervailing incentives for individuals.

"who represent competing strains of Democratic economic thought": I'm A Sort Of Non-Competative Strand

Yesterday Free Exchange commented on the post by Robert Rubin and Jared Bernstein about interest and debt, and how they are viewed in the Democratic Party. My party. Now, you might well ask where I fit in, but I've about 600 posts now trying to answer that, so let's move on:

"ROBERT RUBIN and Jared Bernstein are two left-leaning economists (both of which have advised Barack Obama) who represent competing strains of Democratic economic thought. Mr Rubin, Treasury secretary under Bill Clinton, was known as an economic centrist—pushing free trade and fiscal responsibility. Mr Bernstein is a more progressive economist, who has emphasised international labour standards and a robust social safety net.

Today, the New York Times published an opinion column co-written by Mr Rubin and Mr Bernstein. It lays out the broad areas of agreement between the two men which, one assumes, hints at what might emerge from an Obama administration. It's not particularly scary stuff—short-term stimulus, infrastructure investment, long-term fiscal discipline, sympathetic labour policies, and a trade policy that seeks to protect workers but not jobs or industries. A change in direction, to be sure, and one that deserves vigilant oversight, but not a new social democratic state."

Now, I didn't respond to this column because I also didn't see it as particularly scary or even interesting. It dealt at the level of nostrums. I'm more on Rubin's side, but I actually am concerned about Bernstein's concerns.

"What's most interesting to me are the areas where the two authors are forced to concede disagreement. One of these issues—the effect of long-run deficits on interest rates and economic growth—is one of the most contentious areas of debate for lefty economists. The authors write:

One of us (Mr. Rubin) views long-term fiscal deficits — in combination with a low national savings rate, large current account deficits and foreign portfolios that are heavily over-weighted in dollar-dominated assets — as a serious threat to long-term interest rates and our currency and, therefore, to our economic future. The other views these economic relationships as much weaker.

This is the view that shaped Clintonian deficit reduction. It also angered many Democrats, who would have preferred that increased revenues be used for a health insurance solution or public investments. Mr Rubin's position strikes me as fairly orthodox. The thing is, I'm not sure that it makes sense in light of recent events. A lot of people expected a dollar run to precipitate crisis. Instead, crisis precipitated a dollar boom."

Again, here I'm on Rubin's side. But I see the problem.

"And now, Calculated Risk is arguing that declining American deficits might result in higher long-term interest rates. Why? A reduction in the current account deficit would trim growth in foreign central bank investment in dollar-denominated assets, pushing up interest rates. In short, so long as Bretton Woods 2 held up, American deficits meant low interest rates. Only when that financial system comes apart can we expect Mr Rubin's conditions to obtain.

Mr Rubin was right about interest rates given that he was in a certain financial equilibrium, but he was wrong about which equilibrium he found himself in. Given Bretton Woods 2, and the resulting ability to borrow cheap, America should have borrowed heavily and ploughed Chinese capital into long-term domestic investments. By instead running a surplus, Mr Rubin simply made easy credit available to the private sector which, understandably, poured that credit into heavy consumption and investment in non-tradable sectors (like housing!) which weren't rendered comparatively unattractive by Chinese currency policies."

I saw the Calculated Risk post as well, and it bothered me. ( but see Setser here )

"So which should America choose moving forward? For the moment, the risk of a dollar collapse seems low, and the need for deficit spending appears high. Beyond that, we must see whether China will continue to finance American borrowing, or if China will allow domestic spending to flourish by letting the RMB appreciate. Increasingly America is learning that neither its monetary policy or its fiscal policy is as independent of international forces as it believed."

So, this really is food for thought. I agree with:

1) Risk of dollar collapse is low ( I also agree with 'seems' )

2) That's why I accept some deficit spending in the short term and a stimulus plan.

Where to go from here. Let me utter some nostrums:

1) A banking system based on Bagehot's Principles

2) Reducing government spending

3) Lower debt

4) A slight budget surplus or debt in normal times

5) Lower taxes, and fairer and more efficient taxes

I fear:

1) Inflation

But I have to admit, all these gyrations are making things hellishly complicated.

However, this post by Bob McTeer seems to echo more or less the same view, although I would disagree with him on some specifics:

"The most important near-term thing you could do to reassure financial markets and quell the turmoil is to announce early that you don't intend to eliminate President Bush's marginal tax-rate cuts. If you can't go that far, keep the adjustments as small as possible and announce your intentions to be moderate early. A little bad news early is better than great uncertainty and expecting the worse. ( I'm fine with small adjustments )

You have an education job to do. You must be able to articulate clearly how high tax rates on capital (capital gains, dividends, corporate taxes, the death tax, etc.) diminishes the demand for labor and keeps wages from rising. ( I agree )

While tax-rate increases are bad anytime, they are particularly bad in a recession. The timing couldn't be worse for a tax increase. ( I tend to agree, but the debt bothers me more )

Energy limitations must be attacked on all fronts: drill, drill, drill, nuclear, clean coal, wind, solar, and so forth. Don't push for energy independence; push for less energy dependence. ( I sort of agree, but have more environmental concerns )

Everyone knows that exports create jobs, but few focus on imports, which represent the gains from trade. Help educate people on the benefits of low prices via imports. ( I agree, basically )

Don't overdo the regulatory reaction to the current financial crisis. Another Sarbanes-Oxley is the last thing we need." ( I agree )

In other words, while things are in flux, let's stick to our general principles, while confronting reality and bending them where necessary. But like Becker and McTeer, I agree that we don't want to kill the goose that laid the golden egg.

As to Rubin and Bernstein, I'm not that bothered by either of them. I see them as sensible people. I've no fear of some massive economic shift. There will be tinkering, but tinkering can often be wise.

Jane Bryant Quinn Makes Better Sense Than Me, As If You Didn't Know That

Jane Bryant Quinn makes some good points, echoing McTeer and making the point that the deficit is not terrible as yet:

"Isn't any increase in the deficit a bad idea?

Not when the country stands on the brink of a financial disaster. Besides, the deficit -- although large in dollars -- isn't a problem at the moment, says economist Irwin Kellner of Dowling College in Oakdale, New York. It amounts to about 2 percent of the economy, well below the 6 percent deficits of the early Reagan years or 4.5 percent in the early Clinton years. The deficit will rise as the recession advances but not primarily because of the rescue activities.

Is the bailout inflationary?

No. When the Treasury sells securities to the public, it's neither inflationary nor deflationary. You are simply using money that otherwise might be invested elsewhere and investing it in government securities, instead.

The Federal Reserve, which manages inflation, is making short-term loans to financial institutions that can't borrow elsewhere. It can lend without limit. The institutions put up various types of collateral and the loans are expected to be paid in full.

The Fed earns interest on these loans, typically 2.25 percent but sometimes higher -- so it's making money. It will also buy short-term commercial paper from corporations. That earns interest, too, which will help cover losses if any of the paper goes bad.'

Read the whole post.

I wish I was as sanguine. I worry about inflation and the deficit down the road, but, given where we are, I suppose I'm going to be in the minority.

No Current Problem With Inflation

Bob McTeer explains why inflation is not an imminent or the most important threat for the Fed to deal with:

"Even if money growth had been faster and long-term interest rates lower than they have been, I doubt that inflation would accelerate under present circumstances of slowing economic growth and the freezing up of credit markets. In my opinion, a deceleration of inflation is more likely than acceleration, and the decline in oil and other commodity prices may be the early signs of disinflation. The Fed seems vindicated in its belief that the weakening economy would help restrain inflation while it concentrated on actions to unfreeze credit markets and sustain the real economy."

McTeer know a hell of a lot more than me, but I can't but help seeing inflation in our future.

McTeer Calls It

From the Washington Post:

"The Federal Reserve and a consortium of European central banks today announced a half apercentage point reduction in a key interest rate, a coordinated effort to stave off an economic slump even as they continue struggling to tackle a crisis in global financial markets. "

From the NY Times:

"Central banks around the world cut short-term interest rates by up to half a percent on Wednesday after investors across Asia and Europe unleashed waves of sell orders onto already depressed stock exchanges."

It seems like they listened to Bob McTeer, and not William Gross on the amount of the cut.

McTeer On A Rate Cut

Bob McTeer comes out for a rate cut, which is a change in his thinking:

"However, given the recent worsening in the credit freeze and its spread to Europe, I have changed my mind. The European Central Bank has been in denial, in my opinion, even given its single inflation mandate. ECB easing is overdue and a coordinated rate cut with the Fed, the Bank of England, the Bank of Canada and perhaps others participating would likely have a major impact, albeit primarily psychological.

If the Fed initiates a coordinated rate cut of 50 basis points, it will give the ECB cover to do what it should have done already. It would also give the Fed's cut more bang for the buck. After all, given the way things are going in the markets, what do we have to lose?"

Add McTeer and Gross, and you've got two intelligent people calling for a cut, although they seem to differ on the amount.