20 July 2013

The Night They Raided Minsky's

Not for the first time, the NYT editors let two of their fair haired boys (Krugman and Norris) collide. The point of collision: one Hyman Minsky. Here's the wiki, if you've never heard of him. It's a decent read.

I'll start with the Norris piece, since it relies more heavily on Minsky than Krugman's off-hand reference. Norris sets out to show that Bernanke got it wrong by not anticipating the Great Recession:
... what it got wrong: policies that allowed the dangerous imbalances to grow and bring on the crisis.

Now, that assumes that the Fed/Bernanke could have shunted the train off to a safe siding, as one routinely saw in the Perils of Pauline movies. Well, may be not. It is true that the Giant Pool of Money is still looking to beat the interest rate, and it is true that this is what has propelled the stock market. It that such a bad thing? Your typical Right Wingnut congressman says so:
[Jeb Hensarling, the Texas Republican who is chairman of the House Financial Services Committee] was upset that the "Federal Reserve has regrettably, in many ways, enabled this failed economic policy through a program of risky and unprecedented asset purchases."

Such an ingrate. Big Ben has enriched his constituents (not his district, but the banksters), and still he complains. It's worth noting that in decades past, there was an intense debate on how to fund capitalists. In the US, the typical method was through equities; while in Europe it was debt (bonds). What Hensarling is promoting is a preference for debt. Why would anyone do that? Well, it's simple: if one holds a large sum of moolah, then one likely has more money than one needs, but paranoia sets in. Buying equities leaves one subject to the vagaries of traders; one's income is in the form of capital gains, and therefore vulnerable to the whims of Mr. Market. On the other hand, holding bonds guarantees one income on the coupon (more or less guaranteed). The value of the bond will fluctuate, of course, but that doesn't affect the income stream. Barring total collapse, of course.

Norris spends much of his piece quoting Bernanke, and this is some of that:
Then Mr. Bernanke pointed to "another counterproductive doctrine: the so-called liquidationist view, that depressions perform a necessary cleansing function." That was the view pushed in the early 1930s by Andrew Mellon, the Treasury secretary, to such an extent that it angered even President Herbert Hoover, who did not, however, seem to think he could overrule the secretary. Now the comments could be read as a reproach to those, in the United States and Europe, who push for austerity above all else.

I suppose as one gets older, and Mellon was in his 70s when the Great Depression hit, enemas seem necessary; especially when medicine was primitive. We don't need no economic enemas.

Here is where Norris, otherwise a wise man, goes off into the weeds:
The intellectual framework it used simply could not cope with the idea that financial stability can itself become a destabilizing factor, as investors and bankers conclude that it is safe to take on more and more risk.

He's concluded that the financial world, up to 2003 (to pick a date for the beginning of Viagra at The Home) was somehow stable. Nothing could be less true. Income concentration was revving up. Median income was reversing from the positive trend under Clinton. Thus, the middle class looked to home equity raises (almost wholly unearned) to fund consumption. With Greenspan's cratering of interest rates and real estate appreciation that followed, the die was cast.

"Improved assessment and pricing of risk, expanded lending to households without strong collateral, more widespread securitization of loans, and the development of markets for riskier corporate debt have enhanced the ability of households and businesses to borrow funds," [three Fed economists, Karen E. Dynan, Douglas W. Elmendorf and Daniel E. Sichel] wrote. "Greater use of credit could foster a reduction in economic volatility by lessening the sensitivity of household and business spending to downturns in income and cash flow."

What those Fed economists were engaging in is cognitive dissonance: they were hailing as positive the very machinery which would ignite the Great Recession. What Bernanke and Norris ignore, if they even yet realize it, is that the search by middle class households for funds to maintain their position in the consumption distribution was what propelled the collapse. Now, if China hadn't been generating great quantities of moolah at just the moment that Greenspan chucked his hail mary pass (crashing interest rates, since Dubya wouldn't countenance fiscal policy), things would have turned out rather differently. And they likely will.

While quants (monetarists, all) look at numbers to divine the future, looking at the wrong numbers leads to wrong answers. Bernanke, and Norris, look at the wrong numbers.

The Fed chairman conceded that "one cannot look back at the Great Moderation today without asking whether the sustained economic stability of the period somehow promoted the excessive risk-taking that followed. The idea that this long period of calm lulled investors, financial firms and financial regulators into paying insufficient attention to building risks must have some truth in it."

Again, and I repeat, the calm was *an illusion*. Professional economists, nearly all, looked at the numbers which they traditionally looked at, and in the traditional manner. M1 and U3 (and not, devil be damned, U6) and so on. Few looked at the driving force of the US economy: the middle class consumer and where his/her income came from and what the dynamics of that income was/is. Look at that number, especially today, and one sees not calm but a duck: placid above the water line, and chaotic below. Some understood that median income was in the toilet since Reagan, but the data weren't part of the regular data stream, and easily ignored. Means (averages) were almost always cited, even though it is well known in both economics and quants that income (and wealth) are highly right skew, and that mean income (typically, GDP per capita) is a lousy (way too optimistic of equality) descriptor of central tendency.

At this point in the narrative, Minsky (in a ghostly fashion) enters, stage left. His voice is in the body of an Australian economist, Steve Keen. The year is 1995. For review: Clinton had begun to reverse the Reagan/Bush assault, and life was looking up for the middle class. It was a hopeful time.
Eventually, the income-earning ability of an asset would seem less important than the expected capital gains. Buyers would pay high prices and finance their purchases with ever-rising amounts of debt.

Note that this was a decade before the Giant Pool of Money had been spotted. But the key idea is the same: asset appreciation (whether real or nominal) would eventually overwhelm coupons. What isn't mentioned: the savers and borrowers weren't in the same countries; the moolah, that debt, had to come from somewhere. If Minsky/Keen were correct, then the rational actor would never offer up moolah as debt to others, but use that moolah to buy equities. That matters. There must be one or both of two conditions: asymmetric information (savers don't know) or asymmetric policy (savers can't shop). Norris references a critique of Minsky by Bernanke:
They had, Mr. Bernanke wrote, "argued for the inherent instability of the financial system but in doing so have had to depart from the assumption of rational economic behavior." In a footnote, he added, "I do not deny the possible importance of irrationality in economic life; however it seems that the best research strategy is to push the rationality postulate as far as it will go."

Again, looking at the traditional numbers in a traditional way. Yet, by now one hopes, quants/economists/policy wonks understand that what compelled the Great Recession wasn't a financial panic of the previously traditional type nor was it the product of irrationality. Everyone was rational, responding to incentives that bolstered self interest. What was irrational was establishing/distorting the incentives; this is policy, immune to quants. With Greenspan having crashed interest rates, and all that moolah looking for higher returns (at no risk), standard (or so-called, anyway) vehicles were created. Severely bending the rules of creation in order create sufficient vehicles was the problem. Boatloads of moolah from China (or manna from heaven?) had no precedent; we're still living with it, although China appears to be internalizing the positive feedback loop that used to include the US housing market. Declining median income, without depression or recession, was also without precedent. Using that Giant Pool of Money to pay for the kids braces was a no brainer. The house would generate enough moolah until the cows came home. Or is it, the chickens came home to roost? It entered on little cat feet (extra points for that allusion), one tiny step at a time over a generation. OK, enough barnyard metaphors.

What neither Minsky nor Keen appeared to know in 1995 was that the center of the middle class was being crushed; the process had been pedal to the metal since the PATCO strike, 1981. The financial numbers would make less and less sense as time went on. They make even less sense now. While the standard unemployment number seems to have settled at a barely tolerable number, the gross ratio of employed to population remains near a post WWII low. That ain't a harbinger of glory.

In sum, Bernanke, Norris, Minsky, and Keen (the latter less culpable in 1995) are missing the point. A structural change has been progressing (or regressing, depending on one's point of view) since Carter; he declared war on Federal employment before Reagan did. I was there. I had to re-apply for my position which had been officially made redundant, as did all of my colleagues. Not all Democrats are bleeding heart liberals.

That's it for Norris and Minsky. Now for Krugman.

He invokes Minsky at the end of his column, thus:
Unfortunately, these aren't ordinary times: China is hitting its Lewis point at the same time that Western economies are going through their "Minsky moment," the point when overextended private borrowers all try to pull back at the same time, and in so doing provoke a general slump. China's new woes are the last thing the rest of us needed.

That Lewis point? He begins,
All economic data are best viewed as a peculiarly boring genre of science fiction, but Chinese data are even more fictional than most.

As I've written many times: macro data is wonky, built from sampling, and all too infrequent censuses. Policy trumps data at the macro level in any case: policy is designed to reward friends and punish enemies, and data be damned. Since policy is determined by what friends demand, rather than any rational exercise, it's always correct. So far as the policy maker is concerned.

So, Krugman goes over the problem mentioned here rather a lot: the unsustainability of China's income distribution. He invokes another ancient economist W. Arthur Lewis, who proposed
... that countries in the early stages of economic development typically have a small modern sector alongside a large traditional sector containing huge amounts of "surplus labor" -- underemployed peasants making at best a marginal contribution to overall economic output.

This is the traditional American explanation, overlaid on China. I'm not sure I believe it, but that's secondary to Krugman and Lewis. Whether labor moves to cities/factories either willingly or by force, incomes that don't rise are incomes that don't sustain capital. China is an odd sort of industrial exporter. In times past, export economies were small relative to shipped-to markets. That's what made the gag work: capital relocated to small, preferably dictatorial, locations with cheap labor and sent goods to large economies with moolah. The factories of New England were moved to the more receptive South, and sold to wealthier Northeners. China, if it wished to, has no need for Western markets. Nixon went to China to exploit all those soon to be consumers. That was nonsense, of course. He went there to get access for capital to unlimited cheap labor. And it sort of worked. The problem is that he and successive Right Wingnuts have succeeded in killing the necessary other half of the process (aka, The Golden Goose), the money filled consumer. No consumer, no sales, no profit, no capital. A question of balance.

China faces a problem. Without a robust set of importing countries (which soaked up China's exports and excess savings with CDOs and such, that damn Giant Pool of Money just won't go away), its export based industrialization is in trouble. It's only hope is domestic (organic) growth. Reporting over the last year or so on the reliance on real estate, residential and commercial, for capital placement should unnerve the doyens in Beijing. As I said, they've internalized The Great Recession. If empty apartment buildings are strewn about, one might infer that capital allocation in China is seriously out of whack. No one seems to be able to put that Giant Pool of Money to productive use. Recall what's been said here about capital payback. Real returns are declining. Capital is losing its value. Oops.

China, the US, the EU all share the same problem: "rebalancing". Also known as, income redistribution. The Austrians must be turning over in their graves. Even the vampire ones that still show up on late night cable "news" programs.

In both Norris and Krugman are swipes at consumerist US middle class; but that's stupid. Without a robust middle class with most of GDP, there's no way for capital to earn a return. It's a zero sum game. US corporations continue to generate ever higher profits, and used said profits to buy up competitors, mostly, rather than make physical investment. In other words, the US division betwixt investment and consumption is arguably still not enough consumption; moolah that is "invested" isn't really. Micro (individual corporation) growth through acquisition is a wash at the macro level, at best. It's nothing to base policy on.

So, there you have it. A raid on Minsky.

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