Archive for September, 2011

The Biggest Speculative Bubble of All

L. Randall Wray | September 22, 2011

(Cross posted from EconoMonitor)

Back in fall of 2008 I wrote a piece examining what was then the biggest bubble in human history:

Say what? You thought that was tulip bulb mania? Or, maybe the NASDAQ hi-tech hysteria?

No, folks, those were child’s play. From 2004 to 2008 we experienced the biggest commodities bubble the world had ever seen. If you looked to the top 25 traded commodities, you found prices had doubled over the period. For the top 8, the price inflation was much more spectacular. As I wrote:

According to an analysis by market strategist Frank Veneroso, over the course of the 20th century, there were only 13 instances in which the price of a single commodity rose by 500 percent or more. For example, the price of sugar rose 641 percent in 1920, and in the same year, the price of cotton rose 538 percent. In 1947, there was a commodities boom across three commodities: pork bellies (1,053 percent), soybean oil (797 percent), and soybeans (558 percent). During the Hunt brothers episode, in 1980, silver prices were driven up by 3,813 percent. Now, if we look at the current commodities boom, there are already eight commodities whose price rise had reached 500 percent or more by the end of June: heating oil (1,313 percent), nickel (1,273 percent), crude oil (1,205 percent), lead (870 percent), copper (606 percent), zinc (616 percent), tin (510 percent), and wheat (500 percent). Many other agricultural, energy, and metals commodities have also had large price hikes, albeit below that threshold (for the 25 commodities typically included in the indexes, the average price rise since 2003 has been 203 percent). There is no evidence of any other commodities price boom to match the current one in terms of scope.

Now here’s the amazing thing about that bubble. The staff of Senator Joe Lieberman and Representative Bart Stupak wanted to know whether the bubble was just due to “supply and demand”. Relying on the expertise of Frank Veneroso and Mike Masters (two experts on the commodities market), I was able to conclude beyond any doubt that it was a speculative bubble driven by a “buy and hold” strategy adopted by managers of pension funds. Hearings were held in Congress, with guys like Mike Masters testifying as well as representatives from the airlines and other industries.

The pension funds panicked, realizing that their members would hold them responsible for exploding prices of gasoline at the pump. Pension funds withdrew one-third of their funds and oil prices fell from about $150 per barrel to $50. If you want to read the detailed analysis, go to my paper cited above—it has to do with commodities indexes, strategies pushed by your favorite blood sucking vampire squid (Goldman Sachs), and futures contracts. It gets wonky. To make a long story short, the bubble ended in fall of 2008.

But then the crisis wiped out real estate markets and the economy. Managed money needed another bubble. They whipped up irrational fears of hyperinflation that supposedly would be caused by Helicopter Ben’s QE1, QE2, and the newly announced QE3. Better run to good “inflation hedges” like gold and other commodities. That did the trick. The commodities speculative bubble resumed.

And boy, oh boy, what a boom. continue reading…


Irving Fisher would have supported QE

Thorvald Grung Moe | September 21, 2011

If you haven’t already read Fisher’s 1933 article “The Debt-Deflation Theory of Great Depressions,” read it today. It contains his theory of booms and busts that later inspired Hyman Minsky to develop the Financial Instability Hypothesis (HM duly acknowledged his debt to Fisher in his 1986 book).  Fisher’s article is unfortunately becoming more relevant by the day.

Fisher notes that the two dominant factors in all great booms and depressions are over-indebtedness and deflation. Over-investment and over-speculation with borrowed money are at the heart of the crisis. Once in a crisis, it is very hard to get out again, especially when prices start to fall (deflation). The typical reaction is to liquidate positions and repay debt. But when this becomes a generalized response to the crisis “the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe.” (p. 344)

But, according to Fisher, it need not be this way: “it is always economically possible to stop or prevent a depression simply by reflating the price level up to the average level at which outstanding debts were contracted … and then maintaining that level unchanged.” (p. 346). He notes that since the crisis is man-made, we should not leave the solution of the crisis to nature (i.e. through bankruptcies). However, “if our rulers should still insist on leaving recovery to nature and should still refuse to inflate in any way, or vainly try to balance the budget or discharge more government employees, they would soon cease to be our rulers. For we would have insolvency of our national government itself, and probably some form of political revolution without waiting for the next legal elections.” (p. 347)

Fisher was so concerned about the economic situation at the time that he even wrote a letter to President Roosevelt stating his views on what should be done to get out of the crisis: continue reading…


Not Just a Greek Problem

Michael Stephens |

Dimitri Papadimitriou was interviewed for Ian Masters’ “Background Briefing” segment regarding Greece’s place in the eurozone debt crisis, the inevitability of default (“… it’s going to happen much sooner than we think”), and other issues.  Listen here.


The End (of the Euro) Is Near

Michael Stephens | September 19, 2011

Dimitri Papadimitriou writes in the Huffington Post about two different “endgame” scenarios for the euro:

The collapse of the euro project will break in one of two ways. Most likely, and least desirable, is that nations will leave the euro in a coordinated dissolution which might ideally resemble an amicable divorce. As with most divorces, it would leave all the participants financially worse off. Wealthier countries would be back to the kinds of tariffs, transaction costs, and immobile labor and capital that inspired the euro in the first place; poorer nations could kiss their subsidies, explicit and implicit, good-bye.

Less likely, but more desirable, would be a major economic restructuring leading towards increased European consolidation. The EFSF — the European Financial Stability Facility, which is the rescue fund of the European Central Bank — has access to €440 billion. Thus far, the real beneficiaries of the EU bailouts have been the banks that hold all the debt (you haven’t seen this movie before, have you?).

But with some restructuring and alteration of regulations, that wouldn’t need to be the case. The doomed rescue plans we’re seeing don’t address the central problem: Countries with very different economies are yoked to the same currency. Nations like Greece aren’t positioned to compete with countries that are more productive, like Germany, or have lower production costs, like Latvia. Any workable plan to save the euro has to address those differences.

Papadimitriou goes on to outline what an ideal restructuring might look like.

Previous posts on this issue can be found here, here, and here.


Conventional approach to central banking needs revision

Thorvald Grung Moe | September 16, 2011

Brookings issued a report yesterday, called Rethinking Central Banking, by a group of high-profile economists including Eichengreen, Rajan, Reinhart, Rogoff and Shin. The group – called the Committee on International Economic Policy and Reforms – argues that the conventional approach to central banking needs to be rethought. The neat separation between price stability and other objectives is no longer feasible. The group wants central banks to adopt an explicit financial stability objective, expand their macro-prudential toolkit, and use monetary policy if needed to support financial stability: “If, in the interest of financial stability the central bank sets policies that could result in deviations from its inflation target, then so be it.” (p. 30) They also support the use of capital controls to stem short-term speculative capital flows, and call for more cooperation and coordination between systemically significant central banks.

These policy prescriptions are not radical or new. Much of the ongoing debate in Basel and Washington is focusing on just how to develop these new macro-prudential policies. What is noteworthy with the report, though, is their acknowledgment of weaknesses in the prevailing paradigm. They note that:

  • Central banks have allowed credit growth to run free (p. 6)
  • International capital markets are destabilizing (p. 21)
  • Interest rates affect financial stability and hence real activity (p. 12)

This is significant, since it undermines some of the cornerstones of the current paradigm for (flexible) inflation targeting. As the report notes, “the traditional separation, in which monetary policy targets price stability and regulatory policies target financial stability and the two sets of policies operate independently of each other, is no longer tenable.” This will hopefully lead to more pragmatic and less dogmatic policy making in the future. How the new framework will affect the current preoccupation with DSGE modeling in central banks is, however, not discussed in the report.

Breaking out of the current paradigm will take time, though. continue reading…


A Graphical Play in Three Acts

Michael Stephens | September 15, 2011

Since graphical information manages to fail less spectacularly at getting people to change their minds, here are three graphs; one addressing what we ought (not) to do, one addressing what we are doing, and the other what we can do.

The first comes from the IMF, compiling 30 years of evidence showing that fiscal contraction reduces both employment and incomes:

The second is a graph of changes in government purchases of goods and services in the US, showing dramatic fiscal contraction in a very crucial part of government spending:

The third is a graph of the real rates on 5-year Treasuries, showing that the federal government can borrow at negative real rates to reverse the above fiscal contraction:

I’d like to say more, but the research suggests that doing so in non-graphical form might be counterproductive.


The power of moral framing

L. Randall Wray | September 14, 2011

Here is an excerpt from the most important article you will read this year, by George Lakoff:

Here’s how public intimidation by framing works.

The mechanism of intimidation is framing, not just the use of words or slogans, but rather the changing of what voters take as right as a matter of principle. Framing is much more than mere language or messaging. A frame is a conceptual structure used to think with. Frames come in hierarchies. At the top of the hierarchies are moral frames. All politics is moral. Politicians support policies because they are right, not wrong. The problem is that there is more than one conception of what is moral. Moreover, voters tend to vote their morality, since it is what defines their identity. Poor conservatives vote against their material interests, but for their moral identity.

All language activates frames in the brain. Conservative language activates conservative frames, which activate conservative moral worldviews in the brains of those who hear the language. The more those frames are activated, the stronger the conservative moral views get in people’s brains.

Please go to this link, read the article, and then we will discuss it.  (Continued at EconoMonitor…)


UK report proposes ring-fencing of retail banking

Thorvald Grung Moe | September 13, 2011

The final report from the Independent Banking Commission (IBC), otherwise known as “the Vickers report,” was published yesterday. There are no big surprises here, and the share prices of UK banks actually increased somewhat. The report supports and strengthens the Basel proposals already underway, and maintains its previous proposal to “ring-fence” the retail part of the larger UK banks. This will “narrow” the banks, although it remains to be seen how much narrower they will be (e.g. the banks can decide whether to keep banking services for large corporations inside or outside the ring-fence).

According to the proposal, UK banks will have to put their retail operations in legally separate entities that are well capitalized and can run independently of the rest of the financial group. Investment banking will be conducted outside the fence and should—in principle—be allowed to fail without government intervention (not so likely, according to the Economist).

As usual, however, “the devil is in the details,” as the US Treasury has discovered as it tries to implement its own ring-fence proposal—the “Volcker rule.” The WSJ reported yesterday that efforts to flesh out the Volcker rule, to define what is proprietary trading, have been delayed beyond the October deadline. Interestingly, the US approach is to give a positive definition to non-permissible trading activities, whereas the UK is trying to achieve the same objectives by defining the permissible retail part of the bank. Neither is easy.

A more radical proposal would be to narrow the retail bank 100%, e.g. to limit the investments of the retail bank to only government securities. This is the well-known Chicago plan from the ‘30s proposed by Henry Simons and Irving Fisher, among others (for an excellent overview of the proposal and its history, see the Levy Public Policy Brief no. 17, 1995 “Narrow Banking Reconsidered” by Ronnie Phillips). This would insulate vital banking services (an important objective for the IBC) but perhaps compromise the underwriting function of the banking system. As Hy Minsky wrote in 1992: “The 100% money proposal is losing sight of the main object: The capital development of the economy” (Levy WP no. 69, p. 36).

Recognizing that the role of banks is not primarily the intermediation of funds between savers and investors, but providing essential working capital for production stretched out in time, Minsky would rather see the widespread use of small “universal banks”—Community Development Banks—that could combine retail payment services with extending loans to small and medium-sized businesses.

Whether the UK proposal can pave the way for more community banking remains to be seen. There is a definite risk that the proposals will have been forgotten by the time of implementation—i.e. 2019.

Editor’s Note:  continue reading…


The American Bits and Pieces Act

Michael Stephens | September 12, 2011

The AJA is DOA.  Via Politico:  “House Republicans may pass bits and pieces of President Barack Obama’s jobs plan, but behind the scenes, some Republicans are becoming worried about giving Obama any victories — even on issues the GOP has supported in the past.”

For Thomas Masterson’s extensive treatment of the proposed American Jobs Act (“equal parts weak tea and bitter pill”), see here.

Update: 50% DOA.  Or as Miracle Max put it:  “Whoo-hoo-hoo, look who knows so much. It just so happens that your friend here is only mostly dead.”


Off the Charts

Michael Stephens |

“Through several recessions and recoveries, inflation-adjusted GDP rose almost in tandem with a line of predicted growth expectations. But in November 2007, something changed. Real GDP dropped down from what was expected by more than 11 percent, and, as this summer’s data has shown, it hasn’t returned to its pre-recession trend. The unusual slump has provoked a stream of commentary that attempts to define the problem, but it hardly matters whether the downturn is identified as the second dip of a ‘double-dip’ recession, a continuation of the ‘Great Recession’, a fast-moving slowdown, a slow nosedive, a long-term stall-out, or a confirmation that the economy has entered a Japanese-style ‘lost decade’. Growth during the 21st century is following a different trend line than it did in the 20th, and employment is also responding in new, different ways from earlier post-World War II recessions.”

Levy Institute President Dimitri Papadimitriou writes in Truthout about the uniquely disastrous employment picture that has emerged from this recession.  It is a reminder that, while there is no convincing argument as to why US government debt or deficits are causing any current economic problems, the employment situation represents a clear and present economic danger.  The proportion of political, legislative, and press attention paid the former, compared to the latter, is wildly unjustified by any compelling economic logic.