"As was the case in the 1930s, we also have a choice"

Martin Wolf on Keynes on the FT:

"We are all Keynesians now. When Barack Obama takes office he will propose a gigantic fiscal stimulus package. Such packages are being offered by many other governments. Even Germany is being dragged, kicking and screaming, into this race.

The ghost of John Maynard Keynes, the father of macroeconomics, has returned to haunt us. With it has come that of his most interesting disciple, Hyman Minsky. We all now know of the “Minsky moment” – the point at which a financial mania turns into panic.

Like all prophets, Keynes offered ambiguous lessons to his followers. Few still believe in the fiscal fine-tuning that his disciples propounded in the decades after the second world war ( TRUE ). But nobody believes in the monetary targeting proposed by his celebrated intellectual adversary, Milton Friedman, either( TRUE ). Now, 62 years after Keynes’ death, in another era of financial crisis and threatened economic slump, it is easier for us to understand what remains relevant( I SAY USEFUL ) in his teaching.

I see three broad lessons.

The first, which was taken forward by Minsky, is that we should not take the pretensions of financiers seriously. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” Not for him, then, was the notion of “efficient markets”( I AGREE ).

The second lesson is that the economy cannot be analysed in the same way as an individual business. For an individual company, it makes sense to cut costs. If the world tries to do so, it will merely shrink demand( AS A WHOLE, I CAN UNDERSTAND THIS ). An individual may not spend all his income. But the world must do so( TRY TO ).

The third and most important lesson is that one should not treat the economy( ECONOMICS IS FINE HERE ) as a morality tale( HERE I DISAGREE COMPLETELY. MORALITY IS PART OF POLITICAL ECONOMY ). In the 1930s, two opposing ideological visions( THERE WERE OTHERS, THANKFULLY DEFEATED ) were on offer: the Austrian; and the socialist. The Austrians – Ludwig von Mises and Friedrich von Hayek – argued that a purging of the excesses of the 1920s was required. Socialists argued that socialism needed to replace failed capitalism, outright. These views were grounded in alternative secular religions: the former in the view that individual self-seeking behaviour guaranteed a stable economic order(I DON'T AGREE WITH HIM HERE. VON MISES CRITIQUE OF SOCIALISM WAS MORE THAN A MORALITY TALE, AND SO WERE HAYEK'S VIEWS ABOUT THE MARKET AND THE DANGERS OF TOO MUCH STATE CONTROL); the latter in the idea that the identical motivation could lead only( IT WAS THIS MECHANISTIC APPROACH TO POLITICS AND POLITICAL ECONOMY THAT MADE MARXISM, FOR EXAMPLE, NOT SUITABLE FOR HUMAN CONSUMPTION ) to exploitation, instability and crisis.

Keynes’s genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge( WRONG ). He wished to preserve as much liberty as possible( I AGREE. AS DO I. ), while recognising that the minimum state( HERE I DISAGREE ) was unacceptable to a democratic society with an urbanised economy( I CAN FORESEE A TIME OF LESS GOVERNMENT INVOLVEMENT, BUT THIS IS CURRENTLY TRUE ). He wished to preserve a market economy, without believing that laisser faire makes everything for the best in the best of all possible worlds( I WOULD SEEM TO AGREE WITH HIM ).

This same moralistic debate is with us, once again. Contemporary “liquidationists” insist that a collapse would lead to rebirth of a purified economy( COMPLETELY UNBURKEAN ). Their leftwing opponents argue that the era of markets is over. And even I wish to see the punishment of financial alchemists who claimed that ever more debt turns economic lead into gold( I WOULD LIKE TO SEE THE PUNISHMENT OF CRIMINALS ).

Yet Keynes would have insisted that such approaches are foolish. Markets are neither infallible nor dispensable( TRUE. THEY ARE USEFUL. ). They are indeed the underpinnings of a productive economy and individual freedom( TRUE ). But they can also go seriously awry and so must be managed with care( TRUE ). The election of Mr Obama surely reflects a desire for just such pragmatism( TRUE ). Neither Ron Paul, the libertarian, nor Ralph Nader, on the left, got anywhere( TRUE ). So the task for this new administration is to lead the US and the world towards a pragmatic resolution of the global economic crisis we all now confront.( I AGREE )

The urgent task is to return the world economy to health.

The shorter-term challenge is to sustain aggregate demand( YES ), as Keynes would have recommended. Also important will be direct central-bank finance of borrowers( YES ). It is evident that much of the load will fall on the US, largely because the Europeans, Japanese and even the Chinese are too inert, too complacent, or too weak( TOO MUCH BEGGARING ON THEIR PART ALREADY ). Given the correction of household spending under way in the deficit countries( SPENDER COUNTRIES ), this period of high government spending is, alas, likely to last for years( BTREATHE DEEPLY MATE ). At the same time, a big effort must be made to purge the balance sheets of households and the financial system. A debt-for-equity swap is surely going to be necessary( IT WON'T NEARLY BE AS LARGE AS HE THINKS. TOO MANY PEOPLE WANT THE OLD SYSYEM BACK. IT SUITS US. ).

The longer-term challenge is to force a rebalancing of global demand. Deficit( SPENDER ) countries cannot be expected to spend their way into bankruptcy( TRUE ), while surplus ( SAVER )countries condemn as profligacy the spending from which their exporters benefit so much( THAT'S WHY THEY'RE STRUGGLING TO KEEP THIS SYSTEM ). In the necessary attempt to reconstruct the global economic order, on which the new administration must focus, this will be a central issue. It is one Keynes himself had in mind when he put forward his ideas for the postwar monetary system at the Bretton Woods conference in 1944.

No less pragmatic must be the attempt to construct a new system of global financial regulation and an approach to monetary policy that curbs credit booms and asset bubbles( WE'LL TRY ). As Minsky made clear, no permanent answer exists( TRUE ). But recognition of the systemic frailty of a complex financial system would be a good start( OK ).

As was the case in the 1930s, we also have a choice: it is to deal with these challenges co-operatively and pragmatically or let ideological blinkers and selfishness obstruct us ( I AGREE ). The objective is also clear: to preserve an open and at least reasonably stable world economy that offers opportunity to as much of humanity as possible( I AGREE ). We have done a disturbingly poor job of this in recent years. We must do better. We can do so, provided we approach the task in a spirit of humility and pragmatism, shorn of ideological blinker. ( WE GET THE POINT )

As Oscar Wilde might have said, in economics, the truth is rarely pure and never simple. That is, for me, the biggest lesson of this crisis. It is also the one Keynes himself still teaches( I AGREE )."

He gets a bit simplistic, but I generally agree with what he's saying, except for the fact that, long term, I believe that less government with a growing and balanced economy is possible. Keynes view is still too rooted in the 30s to be of major use to us undigested, and is much too pessimistic and mechanistic, as that era tended to be. Again, Political Economy and Politics are underpinned by the context and presuppositions of the time.

What Keynes offers us is a little useful wisdom and a narrative of perceived success at helping the world out of a crisis, which goes a long in times like these.

"In any case, the Fed’s move pushes us in the definite direction of higher global inflation. "

Simon Johnson is a member of the "Helicopter Club" on The Baseline Scenario":

"The Federal Reserve’s announcement yesterday makes it clear that we should see its leadership as radical incrementalists ( PRAGMATISTS ). They will move in distinct incremental steps, some small and some larger, but they will do whatever it takes to prevent deflation ( KITCHEN SINK ). And that means they will do what it takes to make sure that inflation remains (or goes back to being?) positive ( DEBASE THE CURRENCY ). If they need to err on the side of slightly higher inflation, then so be it. This is pretty radical (and a good idea, in my opinion.) ( SIR, I AM NOT A RADICAL )

What effect does this have on the rest of the world? Well, if your central bank now sits idly by, most likely you will experience an appreciation of your currency relative to the US dollar. (The caveat, of course, is that if you have a new major domestic disruption in your banks, or another member of your currency union runs into refinancing trouble, you could still experience a depreciation.)

Who is willing to experience a significant appreciation in a slowing global economy, with exporters everywhere already clamoring for assistance? Most central banks will be pressed hard to ease further, either with interest rate cuts or their own version of “quantitative easing” (known as printing money to you and me) ( THAT'S WHAT THEY SHOULD DO ). What happens within the eurozone will, in this context, be fascinating - who will support the Germans in arguing that monetary policy should remain relatively tight? ( DON'T GET ME STARTED ON GERMANY ) What happens if the Germans lose this argument at the level of the European Central Bank’s Governing Council? ( I BELIEVE THAT'S WHAT WE WANT )

In any case, the Fed’s move pushes us in the definite direction of higher global inflation. This is better than the alternative of falling wages and prices, but it comes with risks ( AGREED ). Will we be able to control this inflation now or in the near future? ( A ROUGH RIDE AHEAD. BUCKLE UP ) What are the consequences of inflation during a severe global recession - which seems unavoidable, even if the Obama Administration has all possible dimensions of expansionary policy firing on all cyclinders right away ( BLASTOFF! ) (this was the point in our latest baseline scenario)."

I've already said that, for this to truly work well, other countries should debase the currency as well, although how much will vary for each country as we go along.

Here's a clip from a movie that contains my favorite use of the word "Blastoff!". By the way, Slim Pickens is from my home town:

"If those models worked, we wouldn't be where we are now. "

Arnold Kling with a good post:

"James Hamilton writes,

Will [purchases of mortgage securities and other assets by the Fed] succeed if we just do it on a sufficiently large scale? I'm not at all convinced that it would. Our standard finance models treat interest rate spreads as governed primarily by fundamentals such as default risk and only secondarily by the volume of buyers or sellers.

Oh, please. "Our standard finance models" have absolutely nothing to say about crazy de-leveraging. If those models worked, we wouldn't be where we are now.( HOW TRUE )

If the Fed brings the parrot back to life, and mark-to-market accounting of mortgage-backed securities and other non-Treasury bonds starts making bank balance sheets look stronger rather than weaker, the de-leveraging process could be interrupted or even reversed.

There are worrisome excesses in the real economy--too many houses, too many shopping malls. But if the Fed has managed to pull the financial sector out of its de-leveraging death spiral, we can look forward to a finite recession, which would be a lot better than Great Depression II."

That's about it. We're doing the best we can, but nothing is certain, or written. We could call this "Trial And Error", "The Kitchen Sink", or "Pragmatism". I like the last one because it sounds philosophic and has associations with an American Philosophical Movement.

"The Fed will continue to make it up as it goes"

I read the FOMC Statement and was going to scan what there was to scan, but this redaction by David Merkel on the Aleph Blog is fun, and, he disagrees with me:

"Redacted FOMC Statement

The Federal Open Market Committee decided today to lower its establish a target range for the federal funds rate 50 basis pointsof 0 to 1/4 percent.

The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters to levels consistent with price stability.

Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee Federal Reserve will monitor economic and financial developments carefully and will act as needed to promoteemploy all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice ChairmanChristine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 5075-basis-point decrease in the discount rate to 1-1/4/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

The Upshot

• We’re done with Fed Funds in entire. ( GOOD. IT WAS WORTH A SHOT )
  
• On to quantitative easing. (Japan had the advantage of running a current account surplus… how will it work for us with a deficit?) ( PICK UP THE PACE )
  
• The princely rate of 1/4% gets paid on all reserve balances at the Fed, both required and excess. ( HIGHLY COMICAL )
  
• The Fed is looking at deflation, not price stability. ( AS IT SHOULD )
  
• The Fed will possibly invest more into long Treasuries, with uncertain prospects. ( LIFE IS UNCERTAIN )
  
• The Fed will continue to make it up as it goes, and keep expanding its balance sheet, adding liquidity where it wills, and replace functions of the private lending markets in the name of fixing the lending markets. ( THAT'S ABOUT IT. ONLY, THE PRIVATE LENDING MARKETS WANT HELP. THEY PAID FOR IT, AND THEY'RE GETTING IT. WHAT WORRIES THEM IS BEING LEFT ON THEIR OWN )

Oddly, I believe that my plan is more likely to get us to where he and I both want to go.

" Now how do you organise a new French Revolution? "

Bronte Capital and John Hempton also get it:

"Credit Agricole SA is a bank which obsesses me – and on which I have lost some loot.

The problem is that it is a bank with very good bits and very bad bits. And the good bits are excellent (and mostly outside Paris) – and the bad bits are atrocious.

Charlie Munger observed that if you mix turds with raisins you still have turds. Charlie was right and it shows in Credit Agricole SA’s stock price.

The bank is controlled by a bunch of regional mutual banks who – for reasons that are not apparent to me – have never got around to closing the bad bits. Those regional mutuals are in turn controlled by five million voting mutual certificate holders – a reasonable proportion of French households.

The super-bad bit is their investment bank. It’s a mathematical finance type investment bank in the French mould. As has been noticed by more than a few people – the market recently has not been too kind to mathematical finance.

I just want to extract the results – quarterly – for just investment banking business. Please click for detail...

These numbers really deserve looking at. The first observation is that revenue can go very strongly negative at an investment bank. That is nothing that Lehman et al have not discovered before – but the trading revenue was negative for several quarters in a row. You might conclude the traders were not much better as traders than say the average French farmer.

The second thing is that the costs line doesn’t seem to move much. Now when I was young and naïve – say 2006 – I thought the investment banks would have a very rough trot – but that the staff would take a fair bit of it in the hip-pocket. The argument being that the very high salaries were at risk – and you could at least assume that when time got rough for an investment bank the staff would be paid salary without bonus. Capital risks were lower than it would appear because at least variable expense would go close to zero.

Now I read lots of stories about how children are getting less allowance due to the credit crisis. Such stories always seem to wind up high in big-media’s “most read” and “most emailed” lists. And that is only because we – dear readers – are doing it to our own kids.

And if it is good enough for our kids it is surely good enough for our investment banker!

Anyway – it is noted that Wall Street bonuses remain stubbornly high – but this is France with all its equality and fraternity. And they can’t control this crap either.

But with numbers like these – if the investment bank were not owned by the rich French parent (Credit Agricole SA) then it would be bust – and the children (sorry investment bankers) would be out on the street.

But bust is better than it would have been in 1792. In those days – faced with a class as egregiously and hypocritically greedy as investment bankers they would have set up the guillotine in the Place de la Concorde and we would be treated to the public spectacle of mass beheadings.

These days of course it is easier. The French farmers and middle class all have a vote – its their mutual share. Executing a vote may be less grizzly than executing investment bankers – but it might be just as effective (though somewhat less theatrical).

Now how do you organise a new French Revolution?"

Hempton's not far wrong. Now you know why I sound like a certain Whig who's trying to prevent himself from having to write a book about Major Social And Economic Changes wrought by this crisis. Only, in this case, I'm getting more help from my own party than the opposition. This need not happen. It's a remote possibility as of now.

A True Burkean would be thinking about the Pragmatic and Effective Policy Decisions that will allow us to keep our system intact, and yet deal with the crisis before us. Paradoxically, we need more government intervention in the short run to prepare the possibility of less government intervention in the future. We also, and I know I'm sounding Quixotic here, need to root out Fraud, Negligence, Fiduciary Mismanagement, and Collusion, and deal with it strictly and publicly, in order to forestall a collapse in the belief among many voters that this system is worth preserving, and that this presevation will not come at their expense.

Do I agree with everything Burke says? No. I see him as a Whig with a distaste for Radical Change, which often strays very far from its stated goals. So say I. Political Economy and Politics dictate that we deal with this crisis in a way that both appears and is benefitial to all parts of the citizenry. I'm fine with looking towards Keynes for help, but a quick but focused glance towards Burke is seldom, if ever, amiss.

"Walter Bagehot. “The business of banking,” he wrote, “ought to be simple: if is hard, it is wrong”.

Yesterday, I disputed the notion that Low-Information Assets allow more Trust than High-Information Assets. I said that Trust, which Banks need to survive, is never to be taken for granted, and that investors always need to be aware of a Bank' s financial status. Here's Tony Jackson in the FT:

"What are banks for? In normal times, the question would seem redundant. But, with the banks now drifting rudderless in a sea of popular resentment, the answers are alarmingly vague.

Precisely to whom do banks owe their first duty of care? Is it to their shareholders, their depositors or their borrowers? Or all of those?

The thought was partly prompted by a recent letter to this paper from a retired British banking grandee, Sir Ronald Grierson. “A bank is a bank,” he wrote, “and, if the security of its depositors is not its main concern, it should be required to adopt another name. Members of the public are entitled to take this for granted.”

I do not agree with this. We have just learned that such an attitude is not wise. But, together with this notion of Low-Information assets engendering more Trust, I can already see where many of us went wrong.

"Under UK law as it presently stands, Sir Ronald is, strictly speaking, wrong about that. At present – though this is to change – a UK bank is just another company. As such, its primary duty is to its owners."

Is this a surprise?

"More of that in a moment. First, how has the banks’ duty to shareholders been discharged in practice?

In two words, stunningly badly. UK bank shares are almost all below their level of five years ago, in most cases disastrously so. Many may never recover previous peaks."

Job well done.

"To be fair, shareholders sometimes tried to exercise their own duty of control, if ineffectually. For years, they resisted the acquisitive ambitions of Royal Bank of Scotland, only to lose their resolve at the top of the cycle. RBS’s resulting ABN Amro purchase is one main reason for its subsequent collapse into state ownership."

Job well done.

"The same recklessness characterised many borrowers. A depressing number of now-bankrupt companies made big debt-financed acquisitions at the peak of the boom. Others, such as Chrysler and EMI, are in crisis because the banks lent vast sums at the last minute to an equally reckless private equity industry."

Job well done.

"So, in general, you might think, let the borrower beware. The snag is, of course, that too much lending leads inevitably to too little, thus posing systemic threats to the economy – a problem now being urgently addressed by various governments."

If it's inevitable, how come people seemed unprepared? Of course, I don't believe that many were that surprised.

"Nor are all borrowers in the same category. I recently found myself perusing the personal ads on a supermarket notice board in the English Midlands. A striking number were for “house sharing” – seeking other families to move in and share the financial burden.

There is the plain sense here of a duty foregone. Most people know little or nothing of finance. But banks are accredited experts. If a bank says you are good for a loan, it is putting that expertise into practice.

To borrow Sir Ronald’s phrase, you are entitled to take that for granted. And, if the result is a choice between sharing your home with strangers or losing it, you are entitled to feel aggrieved."

You cannot take anything for granted. You should assess the competence of the bank that you put money in, or borrow money from. You are legally and morally entitled to your business with the bank being on the up and up.

"Let us now revert to the depositors. It might seem extraordinary that the UK has no special provisions to protect them from collapse, as opposed to insuring them after it. Most other countries, from the US and Japan to Mexico and South Korea, have had such provisions for many years."

I'm assuming he means the FDIC. Can we imagine how much worse this crisis would be without it? I assume that many free market followers would end it, although I don't hear many calling for it in this crisis.

"The usual method is a so-called “resolution regime”, whereby, if a bank seems in danger, the state intervenes and takes it into protection. It is then sold on, usually to a healthier bank. The implicit assumption is that the interests of depositors trump those of shareholders or creditors."

I believe that this is true.

"In the UK, as Sir Ronald also observed, that task was performed by the Bank of England until its independence in 1997. In the ensuing reshuffle of responsibilities, that part got left out. It is now being reinstated under legislation due for completion in February. But it took the collapse of Northern Rock to bring it about."

I believe that we have that here.

"This is the more extraordinary because, as Professor Julian Franks of the London Business School observes, the UK has had just such a regime for its utilities ever since they were privatised in the 1980s. And a bank is nothing if it is not a utility.

Both the electricity and water regulators, for instance, have powers of last resort to protect customers. If an electricity supplier goes bust, the regulator takes it over and sells it on. This happened in October to a small supplier with some 40,000 customers, Energy4Business. There was no fuss, no publicity. It was routine."

Are Banks like a Utility?

"This all leaves a worrying sense of muddle. In both the UK and US, the response of the authorities to the banking crisis has been piecemeal and uncertain, at least partly because there is no clear sense of priorities. It all badly needs sorting out."

This is true. There is a difference between Pragmatism and Trial and Error, and lurching backwards and forwards in a manner that signals unpreparedness and incompetence.

"Let the last word on this go to the Victorian banker and commentator Walter Bagehot. “The business of banking,” he wrote, “ought to be simple: if is hard, it is wrong”.

Ditto for the legal framework. Lawmakers take note."

As per usual, Bagehot is correct, and his statement is simply a version of Searle's Sagacity.

Forget Hostlity

From the NY Times:

"It also raises questions about whether the administration’s deep philosophical hostility to government ownership in private companies aggravated the financial crisis by delaying rescue action."

A big yes. Hey, I'm philosophically against it, but I believe in dealing in the real world.

"As recently as late September, the idea of letting the government acquire part of the banking system had been unthinkable in the Bush administration. To many officials, such intervention seemed like a European-style government intrusion in the marketplace."

As if the intrusion hadn't already begun and was expected.

Terry Michael On Sen. Biden

Here is Terry Michael on the choice of Sen. Biden by Sen. Obama:

"For free market and free mind types resigned to the political system we've got, not the one we want, Sen. Barack Obama's (D-Ill.) cynical choice of Sen. Joe Biden (D-Del.) as his number two sends a serious wake-up call. Never place much faith in a politician with no discernible political philosophy."

I disagree. Sen. Obama needs someone who can take on Sen. McCain on the war in Iraq from the point of view of someone who initially supported the war. In other words, Sen. Biden needs to convince moderates who initially supported the war and who now are worried about pulling out, that Sen. McCain has and would continue an egregious war policy.

There are other reasons to choose Sen. Biden as well, which I will detail later. As for Sen. Biden being a Libertarian Democrat, Michael has a point. However, Sen. Obama, in my opinion, does lean towards my position. His choice was not cynical, but pragmatic, and I see the pragmatism, where Michael does not.