Quote of the year - 2008 - End or replace capitalism in 2009?

"I've abandoned free-market principles to save the free-market system,"
US President George W. Bush told CNN television on December 16th, saying he had made the decision
"to make sure the economy doesn't collapse."

NEXT?

A remarkable achievement

If a Pigouvian tax, then a Tobin Tax

What we read on Greg Mankiw's Blog: Chu and Pigou is very promising. Particularly so if the next US Energy Minister said :"Somehow we have to figure out how to boost the price of gasoline to the levels in Europe". It is now quite clear that there is a compelling economic and logic case for applying this kind of Pigouvian taxes in the United States. They could also contribute to stabilize the energy markets promoting alternative energies and redistributing surpluses and savings, via reduced demand, from oil producers to consumers. On the other hand, just in July 2008 a price of oil at 150$ was factored in, with Goldman Sachs also predicting 200$, thus there is scope and room for a Pigouvian tax or import tariff up to the difference between the July and the present oil price. I am not personally convinced of any argument that oil market prices are established on the basis of supply/demand balance and all predictions are meaningless or biased. Nowadays' oil price is probably more than 60% pure speculation and manipulation.
To the extent that a Tobin Tax on speculative and derivatives financial transactions (currencies, CDS, CDO, etc.) could also be considered a Pigouvian tax levied to correct the negative externalities of some financial market activities and products, including Ponzi schemes, I think there is much scope, particularly in the United States, to take on the old proposal of Nobel Prize James Tobin. As we cannot afford to backslide to the voracious, "polluting" ways of financial markets and innovation as it did in the 1990-2000s, a financial transaction tax has several advantages and under the present circumstances I would not recommend it to make it that modest.
It goes without saying that revenues from Pigouvian and Tobin taxes could offset other tax cuts or government spending to help redistribution of income and restructuring of the economy.

The recession uncovers what auditors can't

While reading about Bernie Madoff's gigantic Ponzi scheme, it appears that if the financial crisis had not prompted a mass of Madoff investors to withdraw their money all at once, it likely would have gone undetected for some more time. This is exactly the same process that the banking and financial system is undergoing. It is called technically deleveraging but it is actually the unwinding of the Ponzi finance.
You can see this from another point of view: the overproduction of money. This means that there has been some an excess of money creation. Part of the money is simply "fake" and part is what, in his testimony in 2005 (start of the bubble?), Alan Greenspan defined as "excess of global intended saving over intended investment. This configuration is equivalent to an excess of the supply of funds relative to the demand for investment. What is unclear is whether the excess is due to a glut of saving or a shortfall of investment." Nowadays one thing is becoming clear: either it be fake money or saving glut some people do not know where to put the money to be productive. Yet, the creation of money from money, or similar kind of leverages and multipliers, is unsustainable. The sooner the recession uncovers it all, the better. It's a pity that on this, there is not yet a consensus among economists, auditors, regulators, lawmakers, etc.

Economics for Joe the plumber

The Phillips machine explains the functioning of the economy from a plumber's point of view. Economists debates on the liquidity trap, which means that the valve of interest rates is completely open (nominal interest rates close or equal to zero) but the tank of surplus balances is either pretty empty or balances are kept idle. They debate on the multiplier effect of government spending, which means that the valve N°5 is to be opened while the tank of government balances is empty. In order to have bigger spending effect, pipe and valve could be modified to have more pressure so that working balances N°1 could be filled in quicker. Taxation N°4 could also be revised and valve closed but there is a risk that consumption, which is a big pipe built of debt, will not increase as households pay down some debt or money flow to savings N°6. Economists cannot reach a consensus on the type of valves and pipes to be used, changed or opened. Yet the pump on N°3 is broken and unemployment is rising thus reducing the flow of money from income. As the flow of money begins in the big tank at the bottom N°1, somebody is simply suggesting to print money straight away injecting it into the system. This may create some problems in the tank of foreign owned balances N°9 where things are complex as Chinese, Japanese and Germans supply this kind of tanks.
In the meantime somebody, running some Ponzi schemes, is siphoning money directly from 6° and the surplus balances tank.

The end of capitalism: Ponzi and Marx are still alive

While reading this A $50 Billion Fraud? So Where is the Money? or this Stiglitz: Don't Bail Out Incompetence, I wonder what Ponzi and Marx have in common. I think that both interpreted the capitalism and both can explain what is happening during these financial crisis and recession. Professor and Nobel Stiglitz makes a clear case of no bailout for automakers. Professor Zingales made a similar case for banks. Both are cases of overproduction: cars, which market demand cannot absorb and money, whose derivative products are being deleveraged in a pattern similar to a Ponzi scheme.
Most people are discussing about the politics and the economics of fiscal stimuli and bailouts pursuing actually a political agenda or sticking to some schools of thought. We have economists still debating nothing better than Keynes and multipliers effects or whether financial innovation is good. They look to the past for ideas or they try to convince readers on what is theoretically good, which unfortunately does not work in practice particularly among, some irrational, human beings. Pragmatism is not really around and it's difficult to admit past mistakes. Very few dare to admit an inconvenient truth: the system does not work if you always privatize profits and socialize losses and inequality rises. It's a major capitalism's flaw to be fixed to avoid Ponzi schemes and Marxist overproduction crisis. Hopefully the Ponzi Finance will not get another bailout. It's true that the time has come to save capitalism from the capitalists, incompetence and frauds.

Economics of bailouts: the case of Parmigiano Reggiano

I do not know the intentions of Prof. Greg Mankiw's post: Bailout, Italian-style. He has already received an immediate and strong reaction here, which I can somehow share.
Perhaps the case of Parmigiano would need a dissertation thesis. On the other hand bailouts are nowadays very much in fashion, particularly in the United States and for every economic sector. I will avoid entering here the debate and economics of bailouts. A lot can be read on econblogs.
I note that what Prof. Mankiw is suggesting for the Parmigiano could also apply to United States' automakers which happen to have just received a bailout. Prof. Mankiw had to be more explicit in his conclusion. Indeed that is what economists are forecasting for the auto industry, where you have overproduction or production of cars the market is not buying anymore. The same logic might apply to banks (money and derivatives producers?), which again were bailed out. Yet, when an economist reads the case of Parmigiano carefully in its original text here, the difference between the Parmigiano industry and its market and the car or bank industries should be noted. I am sure Prof. Mankiw could elaborate on that. Next time an economist wants an interesting case of bailout Italian style, I would suggest to study the case of Alitalia airline. Its approach is similar to the one used for banks in the United States: call your friends and use taxpayers money without accountability and transparency.

What is a moral issue? Philosophers vs. economists

Philosophers and economists continue to debate whether this crisis can be construed as a moral, an accounting/mathematics or a regulation issue. The full debate can be also read here. The answer could be simple if you think that living on debt or making money from money are moral issues. These issues were definitely addressed by Marx, who considered making money from money a flaw inherent to capitalism which would lead to its collapse, and by the Islamic religion and banking whose best known feature is the prohibition on interest rate. Yet, the debate could end up in trying to set boundaries in what is morally, or financially, acceptable or in trying to treat the crisis as if it is the chicken/egg issue about free markets ideology corrupting the human being or vice-versa using finance as a bypass product.
The inconvenient truth of the matter is that while philosophers (and economists) try to interpret this crisis, the real change has yet to come as we continue to make a distinction between economic-financial matters and moral matters with hindsight. Opposing those matters may make things more complicate and tend to create problems rather than solve them. In trying to fix this crisis we should be a bit more forward-looking and holistic. Yet, these days economists seem to be oriented too much to the past and their schools of thought.

ALCHEMISTS OF GLOBAL FINANCE

The alchemist used to make gold from base, shoddy, metals like lead. The alchemists of global finance try to turn debt into gold and make a profit. Their mistake is to transform greed into a mathematics model without seeking help from behavioral economics, which studies irrationality of investors’ decision making and doubt of many “intelligent agents”.
It is fair to say that if the transmutation into gold does not succeed alchemists can be considered fakers, con artists or counterfeiters. There might be also some elements of fraud with some consideration of the "too big to jail". Under these circumstances Professor Nassim Nicholas Taleb has a point in trying to recall some accountability of the too many bystanders to this financial crime. On the other hand the recession is now uncovering what auditors and rating agencies did not while too many bystanders still watch.

Read also "The pretence of knowledge": "This failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences."

The inconvenient truths of some economists

Professor Stiglitz is telling us some inconvenient truths about this crisis and its origin. Do we have a Prof. Stiglitz in Europe? No, that I am aware of. Do we also need him in Europe? I think so. And there is a country in Europe which should listen more to some international economists: that's Italy a country where we have too often, like in the United States, "the suppression of scientific evidence and the perpetuation of misinformation". We do not have in Europe either an environmentalist like Lester Brown, founder and president of the Earth Policy Institute, who is also reminding us that more should be done and quicly, which means that Italy should stop to be contrarian. The recession uncovers what Governments hide while markets should be forced to tell the truth as well.

Summary of inconvenient truths of this crisis - Part IV

This crisis is showing few paradoxes and a number of trade-off situations:

- Money is being pumped into the economic and financial system via bailouts and fiscal stimuli basically to save jobs and prevent unemployment to raise. The paradox is that those sectors we are bailing out or pumping the money in are laying off anyway. There is here a case here for better targeting and cost-benefit analysis of the the money being spent on. Where should we spend on?
- Central banks are also pumping money but being the liquidity trap actually a debt trap, money is being absorbed by deleveraging and savings to pay back debts.
- The Keynesian arithmetic of fiscal stimuli needs to be worked out thoroughly. There is always a domestic and an international constraint as resources are scarce. Financial markets absorption capacity of debt is limited and risk-aversion is taking its toll. If all countries are engaging fiscal stimuli at the same time and financial markets cannot absorb the increase in public and private debt, the rate of return on investments needs to be higher or a risk-premium is being charged. Again, the question is where government spending should go (investment or expenditure) under constraints and what the plan is to pay the debts back.
- Since resources are scarce and there are domestic and international balances constraints, it would be desirable to have some conditionalities to be applied and regulations to be enforced beforehand in the relevant sectors (banks, automakers, housing, etc.).
- There is increasing economic and logic cases to have Pigouvian and Tobin kinds of taxes. China and US could implement them.

EUROPEAN MARKET TALK: 10-Yr Italy BTP-german Bund Spread Leaps To 137 Bps

While I am writing we have the Italian Economy Minister Tremonti on national TV talk-show saying that Italian economic fundamentals are sound and Italy is strong. The tele-shopping like show goes on inviting people to buy CCT and BOT, that is Italian treasuries. Why should a Minister of Economy ever do that? As a matter of fact, the day before another minister of the same Government is reported to have said that there is a risk of default due to the high level debt.
Today pressure has intensified on the yield spread between 10-year Italian treasury bond, BTP, and German bunds, widening to 137 basis points that is 1,37%. Under normal circumstances and in the past such a spread used to be 20-30 basis point. Here is a table showing the recent trend of such a spread. This means that this situation costs to Italian taxpayers over 15 billions euro more than in normal circumstances, thus not benefiting entirely of the lower rates set by ECB.
The spread is normally lifted by investors' aversion of lower-rated euro-zone debt and it also shows some supply pressure and competition in the bond markets at a time when countries are concurrently running fiscal stimuli under defit and high debt/GDP ratios.
Moreover major european government 5-yr Credit Default Swap, that is the cost of insuring against some major European governments defaulting on their debt are hitting fresh records. Today, after ECB rate cut , the five-year Italian government CDS rose to a record 184.1 bps or 3-4 times higher than Germany, France or US. Here is its trend.
Few weeks ago Paul Kedrosky drew our attention to the fact that Italy is in the Top 20 CDS by Net Exposure, actually in the second place. The situation has worsened in the week ending November 28th.
I do not know what all this means exactly but I fear self-fulfilling expectations. Italian ministers are not very reassuring, on television and with their economic and fiscal policies.

Summary of inconvenient truths of this crisis - Part III

Have we followed this in Europe?
a) This is what they got in the United States and led to the crisis: "the suppression of scientific evidence and the perpetuation of misinformation",
b) While in finance they got: no "debt limits and capital reserves needed for a rainy day".This decision, a real event described in the New York Times, freed billions to invest in complex mortgage-backed securities and derivatives that helped to bring about the financial meltdown in September. In the script, the next scene will be the one in which number-savvy specialists that Wall Street has come to know as quants consult with their superiors about implementing the regulatory change. These lapsed physicists and mathematical virtuosos were the ones who both invented these oblique securities and created software models that supposedly measured the risk a firm would incur by holding them in its portfolio. Without the formal requirement to maintain debt ceilings and capital reserves, the commission had freed these firms to police themselves using risk tools crafted by cadres of quants".

What does it happen if you make a+b? Irrational self-destructing agent?

Summary of inconvenient truths of this crisis - Part II

- There is an increased need for transparency and disclosures from banks, including central banks, activities. The case for opening the books of FED central bank here and here. I still contend that more should be done at European level as well.
- When all countries are trying to solve their own problems at the same time and resources are scarce, there is an increased risk of beggar-my-neighbour policies and incentive to free-ride on other countries' fiscal stimuli. Maybe there is a strong correlation between domestic banks' problems and fiscal stimulus approaches behind what is perceived as free-riding.
- Big stimuli when resources are scarce and countries have high private and public debts will have effects in the currency markets. Some countries may or will be obliged to export their own crisis. There is a temptation to be bearish on their currency. Is it the Dollar or the Euro in peril? Some believe that China will decide. Hopefully not alone.

Philosophers or Economists? They puzzles

There are days when economists prefer to be philosophers or simple supporters of different schools of thought. Econblogger Winterspeak.com summarizes this situation in his article here . Economists debate is open, narrative and backward-looking. It looks a puzzle. It's a pity that we cannot do anything better than looking to the past and died economists to interpret the present crisis. Some feel a bit guilty and get confessing their sins of bad forecasting here and there. Others get into a nice Cassandra hunt, which does not show many European ones. We all know that economists are not forecasters as normally if they tell you how much they do not tell you when or vice-versa. Is this crisis too bad for economists but good for philosophers? It would be better and more interesting to hear from those economic and financial advisers who got it wrong but are now willing to be held accountable and tell us the true story. Unfortunately the recession and the financial crisis effects are telling Main Street what Wall Street and those economists, advisers and managers do not want to tell, the true story, which can be made of sins and not fatal flaws. An old accounting say reminds that recession "uncovers what auditors can't". It would be better if this process had maximum transparency and disclosures, not only of balance sheets. I wonder where we are in Europe in this respect.

Liquidity Trap, Debt Trap or overproduction crisis?

Looking and reading carefully this stripe at Greg Mankiw's Blog: Sounding like an Economist, do you think there is a liquidity trap (Keynes), a debt trap (United States) or an overproduction crisis (Marx)?