Wednesday, October 7, 2009

The Greenspan Moment?

Paul McCulley of PIMCO coined the term Minksy Moment to describe the point in a credit cycle or business cycle when investors have cash-flow problems due to spiraling debt they've incurred in order to finance their speculative investments. It's at this point that mass sell-offs begin due to the fact that nobody else can be found to bid at the current high prices. The collapse of the housing bubble in 2007 is a perfect example of a Minsky Moment.
A Minsky Moment is a nice description of how a bubble collapses. But after the financial crisis happened in 2008, I believe there should be another "moment" named: it's the moment that policy makers, economists, bankers and politicians forget how fragile all economies are. It's the moment they forget the lessons of history (and all the bubbles from Tulip Mania to the dot-com crash). It's at this point, when the regulations put on the financial industry by the survivors of previous panics, are unwound. It's the point at which a new generation--which has enjoyed the long-run economic benefit their ancestors helped ensure--end up making the same mistakes their grandparents and great-grandparents made. It's the moment at which people arrogantly believe that monetary policy (or some other force) can stave off depressions. It's the moment that arrogance overtakes rational economic analysis (and knowledge of history). Going forward, I propose this moment be called the Greenspan Moment.
50-years after the Great Depression (from 1931-1981) the country experienced another major financial crisis (the S&L scandals). 70-years after it, politicians repealed Glass-Steagall. And 80-years after it, the country stood on the precipice of another depression.
Will this happen in the future?
Looking back at all the financial panics and crashes in history, I'm guessing yes. We can expect Ben Bernanke to be very heavy-handed with monetary policy in the future. He'll do his level best to control asset bubbles and dampen irrational exuberance. There will be new financial regulations instituted such as counter-cyclical leverage ratios at banks. Bernanke's eventual successors will probably also have lived through the Great Recession and they'll continue the vigilance against asset bubbles, shadow banking and deregulation. But then, at some point in the future (50- or 60- or 80- or 100-years from now) there will be a Greenspan Moment. It will be the moment when the lessons are forgotten, regulations are relaxed and the next crisis happens. Mark my words it will happen. And it needs a name. I only hope that, after the next Greenspan Moment, celebrated economists don't once again forget the lessons of Keynes and fiscal spending.

Tuesday, October 6, 2009

Stimulus Questions

Nobel Prize-winning economist Paul Krugman recently opened up his blog for questions from the readers. He answered a few and the entire Q&A is online and it's educational for those who have questions about the stimulus, the recession, health care, etc. He's a smart man, and his answers are obviously well-thought out and intelligent. Go read what he wrote.
But, unfortunately for me, he didn't answer the question I asked, so I asked my question again, but this time I asked it in the comments section of Brad DeLong's blog (Professor DeLong is an equally intelligent economist) but alas, no answer, yet.
So I suppose I'll write my question(s) here and see if anybody stumbles across it in the future and can shed light on some of these issues for me.
Firstly, regarding the stimulus: Government spending in WWII is what pulled the United States out of the Great Depression. It proved Keynes correct and validated most (if not all) of his theories that fiscal policy could fill the output gap between real GDP and potential GDP during a recession (or depression). However, the world looks very different today than it did in the 1940s and I'm not concerned about the short-run equilibrium of AS-AD or of the effects of the stimulus on real GDP. My questions concern the Long Run Aggregate Supply Curve (Potential GDP).
The "stimulus" of WWII set the stage for long-run economic prosperity in the United States, but the postwar boom here was also fueled by interest payments the United States received from England and Germany. In fact, there was interest earned on interest in some cases, as we loaned money to Germany who had to pay war reparations to England who was in debt to the United States. In addition to these interest payments from other countries, the debt that funded WWII's spending was largely internal debt--meaning the United States went into debt to its own citizens for the most part. But now, however, there is a much larger percentage of US debt owned by sovereign funds (some estimates claim sovereign purchases of US debt has reached nearly 40%).
In the end, my questions are: What does this mean for the long-term recovery? Will potential GDP be lower because a large portion of government debt is given to foreign countries? Does this lower "I" or "G" or neither? Does it matter? Will the new, lower LRAS slow immigration and investment in the US and re-direct capital and resources to growing economies? Will the US, after this collapse, emerge from the crisis much the same way England did from WWII--meaning a sort of economic decline that lasts for a decade or more, accompanied by eventual replacement as the world's economic superpower, while foreign countries like China and India rise? Did Christie Romer include the sovereign purchases of our debt and the interest-on-interest we earned after WWII in her multiplier calculations for the ARRA? Is there an automatic offset to the sovereign funds and interest-on-interest by the TYPE of spending in the ARRA?
What I mean by that is: Keynes proposed that stimulus spending should be spent on useful things if possible, but completely wasteful things if necessary. He proposed burying money in mineshafts so that workers would be hired to dig it out. And WWII's stimulus spending was really no different than wasteful spending because in the end, as Bruce Bartlett so aptly put it:
"WWII proved to be an effective stimulus that, economically speaking, consisted of 100% waste. If the war hadn't broken out, the US could have enjoyed the same economic benefit of the stimulus by building all the tanks, planes and bombs and simply dumping them into the ocean."
So, will there be natural offsets in the ARRA on the "interest and sovereign fund" issues because of economically useful stimulus spending? And, again, how much of this was calculated by the ARRA's creators? And, finally, as I asked Dr. DeLong... what is the air-speed velocity of an unladen swallow?

Monday, October 5, 2009

Reaching Escape Velocity?

As I'm currently out of work, I went to the annual CFA networking day here in Philadelphia, last Friday. Most of the exhibitors said they were currently only hiring "replacements" (people who had retired, moved on, etc.) so it wasn't a great day for me professionally so, as usual, I was more interested in the speakers and the panel discussions.
The keystone speaker this year was Tony Crecsenzi, Senior VP at PIMCO. He began his speech by talking about the economy and the chance that it will reach escape velocity from the recession by 2011. He outlined the pros and cons of the Fed's actions, the TARP and what effects the stimulus will have, all without giving his opinion. Then he asked for a show of hands from the audience (about 250 CFA Charterholders and Candidates) if they thought the economy would reach escape velocity by 2011 without further stimulus. Only two people said yes, the rest of us said no--that we'll need more stimulus.
This may, or may not, be surprising to most people, but it was surprising to me. Most of the CFAs and MBAs I know are fiscal conservatives--typically against government spending. However, CFAs are usually more quantitative in nature, with a higher degree of financial literacy than most (even over MBAs) so perhaps they understand the economy in a much more detailed way than the average financial industry worker.
Crescenzi finished his speech by highlighting a drag he forsees on the growth of the economy in 2010 and 2011 -- the expiration of the Bush tax cuts -- and perhaps a bright spot for further stimulus. Without further stimulus, he believes the economy won't reach escape velocity by January 1, 2011 (when the Bush tax cuts expire). But the mid-term elections (he believes) typically see the ruling party lose seats in Congress. With the economy still dragging by then, the tax cuts will have to be extended (an unfavorable proposition for Democrats) so perhaps it will force them into action on a second round of stimulus. Well, fingers crossed I guess. I need a job sometime before 2011.
Here are the guts of Crescenzi's speech if you're interested.