Economic Dreams - Economic Nightmares

Minsky Wake-up Call

For several years I've been using this blog to bring attention to the work of American economist Hyman Minsky — and watching to see who might be warming up to the work he began and others continue at the Levy Economics Institute at Bard College. In brief, the work is Post Keynesian and tracks money and credit flows with an eye toward instability — stability breeds instability and fragility trumps resilience at times. Bubbles need to be dealt with as they emerge, not by papering over them in the aftermath. Now Financial Times' Martin Wolf, building on a paper from Carmen Reinhart and Kenneth Rogoff deliveris a wake-up call to American bankers: Pay Attention to Minsky!

I will be watching around the blogosphere to see who else, particularly among American economists seems to be warming up to the real causes of great contractions, and who begins to show signs of learning lessons not-yet-learned. I will update this post and add others as I see evidence of economists waking up. Economists have lead the decent to the edge of the Abyss, and are rightfully blamed for their part in the mess. To Wolf:

Asia's revenge, Martin Wolf, October 8, Financial Times: What confronts the world can be seen as the latest in a succession of financial crises that have struck periodically over the last 30 years. The current financial turmoil in the US and Europe affects economies that account for at least half of world output, making this upheaval more significant than all the others. Yet it is also depressingly similar, both in its origins and its results, to earlier shocks. …

Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University identify the similarities in a paper published earlier this year.* They focus on previous crises in high-income countries. But they also note characteristics that are shared with financial crises that have occurred in emerging economies.

This time, most emerging economies have been running huge current account surpluses. So a "large chunk of money has effectively been recycled to a developing economy that exists within the United States' own borders", they point out. "Over a trillion dollars was channelled into the subprime mortgage market, which is comprised of the poorest and least creditworthy borrowers within the US. The final claimaint is different, but in many ways the mechanism is the same." …

[L]inks between the financial fragility in the US and previous emerging market crises mean that the current banking and economic traumas should not be seen as just the product of risky monetary policy, lax regulation and irresponsible finance, important though these were. They have roots in the way the global economy has worked in the era of financial deregulation. Any country that receives a huge and sustained inflow of foreign lending runs the risk of a subsequent financial crisis, because external and domestic financial fragility will grow. Precisely such a crisis is now happening to the US and a number of other high-income countries including the UK.

These latest crises are also related to those that preceded them – particularly the Asian crisis of 1997-98. …

The big global macroeconomic story of this decade was, then, the offsetting emergence of the US and a number of other high-income countries as spenders and borrowers of last resort. Debt-fuelled US households went on an unparalleled spending binge – by dipping into their housing "piggy banks".

In explaining what had happened, Ben Bernanke, when still a governor of the Federal Reserve rather than chairman, referred to the emergence of a "savings glut". The description was accurate. After the turn of the millennium, one of the striking features became the low level of long-term nominal and real interest rates at a time of rapid global economic growth. Cheap money encouraged an orgy of financial innovation, borrowing and spending.

That was also one of the initial causes of the surge in house prices across a large part of the high-income world, particularly in the US, the UK and Spain. …

The savings glut had another dimension, related to a second financial shock – the bursting of the dotcom bubble in 2000. One consequence was the move of the corporate sectors of most high-income countries into financial surplus. In other words, their retained earnings came to exceed their investments. Instead of borrowing from banks and other suppliers of capital, non-financial corporations became providers of finance.

In this world of massive savings surpluses in a range of important countries and weak demand for capital from non-financial corporations, central banks ran easy monetary policies. They did so because they feared the possibility of a shift into deflation. The Fed, in particular, found itself having to offset the contractionary effects of the vast flow of private and, above all, public capital into the US.

A simple way of thinking about what has happened to the global economy in the 2000s is that high-income countries with elastic credit systems and households willing to take on rising debt levels offset the massive surplus savings in the rest of the world. The lax monetary policies facilitated this excess spending, while the housing bubble was the vehicle through which it worked. …

[L]inked dangers between external and internal imbalances, domestic debt accumulations and financial fragility were foretold by a number of analysts. Foremost among them was Wynne Godley of Cambridge university in his prescient work for the Levy Economics Institute of Bard College, which has laid particular stress on the work of the late Hyman Minsky.**

So what might – and should – happen now? The big danger, evidently, is of a financial collapse. The principal offset, in the short run, to the inevitable cuts in spending in the private sector of the crisis-afflicted economies will also be vastly bigger fiscal deficits.

Fortunately, the US and the other afflicted high-income countries have one advantage over the emerging economies: they borrow in their own currencies and have creditworthy governments. Unlike emerging economies, they can therefore slash interest rates and increase fiscal deficits.

Yet the huge fiscal boosts and associated government recapitalisation of shattered financial systems are only a temporary solution. There can be no return to business as usual. It is, above all, neither desirable nor sustainable for global macroeconomic balance to be achieved by recycling huge savings surpluses into the excess consumption of the world’s richest consumers. The former point is self-evident, while the latter has been demonstrated by the recent financial collapse.

So among the most important tasks ahead is to create a system of global finance that allows a more balanced world economy, with excess savings being turned into either high-return investment or consumption by the world’s poor, including in capital- exporting countries such as China. A part of the answer will be the development of local-currency finance in emerging economies, which would make it easier for them to run current account deficits than proved to be the case in the past three decades.

It is essential in any case for countries in a position to do so to expand domestic demand vigorously. Only in this way can the recessionary impulse coming from the corrections in the debt-laden countries be offset.

Yet there is a still bigger challenge ahead. The crisis demonstrates that the world has been unable to combine liberalised capital markets with a reasonable degree of financial stability. A particular problem has been the tendency for large net capital flows and associated current account and domestic financial balances to generate huge crises. This is the biggest of them all.

Lessons must be learnt. But those should not just be about the regulation of the financial sector. Nor should they be only about monetary policy. They must be about how liberalised finance can be made to support the global economy rather than destabilise it.

This is no little local difficulty. It raises the deepest questions about the way forward for our integrated world economy. The learning must start now.

*Is the 2007 US subprime financial crisis so different? An international historical comparison. Working paper 13761, www.nber.org

**The US economy: Is there a way out of the woods? November 2008, www.levy.org [concluding hyperlinks empowered by Iverson]

For more from the Levy Economics Institute see, e.g., Macroeconomics Meets Hyman P. Minsky: The Financial Theory of Investment, L. Randall Wray and Éric Tymoigne, September, 2008:

Expanding on an approach developed by financial economist Hyman Minsky, the authors present an alternative to the standard "efficient markets hypothesis—the relevance of which Minsky vehemently denied. Minsky recognized that, in a modern capitalist economy with complex, expensive, and long-lived assets, the method used to finance asset positions is of critical importance, both for theory and for real-world outcomes—one reason his alternate approach has been embraced by Post Keynesian economists and Wall Street practitioners alike.

[Wray and Tymoigne] argue that the current financial crisis, which began with the collapse of the U.S. subprime mortgage market in 2007, provides a compelling reason to show how Minsky’s approach offers us a solid grounding in the workings of financial capitalism. They examine Minsky’s extension to Keynes’s investment theory of the business cycle, which allowed Minsky to analyze the evolution, over time, of the modern capitalist economy toward fragility—what is well known as his financial instability hypothesis. They then update Minsky's approach to finance with a more detailed examination of asset pricing and the evolution of the banking sector, and conclude with a brief review of the insights that such an approach can provide for analysis of the current global financial crisis

Minsky on 'Flawed Capitalism', 'Flawed Economics'

I am a fan of Hyman Minsky's work, but have not read — until now — any of his books. I am currently reading Stabilizing an Unstable Economy. Here is a timely quote, from Chapter 12, "Introduction to Policy", emphasizing our current plight both as to our political economy and misguided economic ideology/methodology. It could have been written yesterday but was first published in 1986:

… We need to embark on a program os serious change even as we need to be aware that a once-and-for-all resolution of the flaws in capitalism cannot be achieved. Even if a program of reform is successful, the success will be transitory. Innovations, particularly in finance, assure that problems of instability will continue to crop up; the result will be equivalent but not identical bouts of instability to those that are so eviedent in history.

Political leaders and the economists who advise them are to blame for promising more than they or the economy can deliver. The established advisers have failed to make the political leadership and the public aware of the limitations that economics processes and the the ability to administer impose on what policy can achieve. … [O]ur economic leadership does not seem to be aware that the normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciations, unemployment, and poverty in the midst of what could be virtually universal affluence—in short, that financially complex capitalism is inherently flawed.

Economic advisors, whether liberal or conservative, believe in the fundamental "soundness" of the economy. Finding fault with one thing or another, they may advocate policies such as changing Federal Reserve operating techniques, tax reforms, national health insurance, and wars on poverty, but all in all they are satisfied with the basic institutions of modern capitalism. According to today's gospel [extant faults] are due to secondary, not to fundamental, characteristics.

[T]he economists of the policy-advising establishment differ about details: some propose to fine-tune the economy by fiscal tinkering, others want to achieve a natural rate of employment through steady monetary growth. Neither, however, sees anything basically wrong with capitalism as such. The credit crunch of 1966, the liquidity squeeze of 1970, the banking crises of 1974-75, the inflationary spiral of 1979-80 and the distress, national and international, of 1981-82 are, in their view, aberrations, due to either "shocks" or "errors." Since nothing is basically wrong, they also hold that incisive corrective measures are not needed.

The truth of the matter is that something is fundamentally wrong with our economy. As we have shown, a capitalist economy is inherently flawed because its investment and financing processes introduce endogenous destabilizing forces. The markets of a capitalist economy are not well suited to accommodate specialized, long-lived, expensive capital assets. In fact, the underlying economic theory of the policy establishment does not allow for capital assets and financial relations such as exist. The activities of Wall Street and the inputs of bankers to production and investment are not integrated into, but are added onto, the basic allocation-oriented theory.

Economic policy discussions in recent years have centered on how much more (or less) on the one—fiscal policy—and how much less (or more) of the other—monetary policy—is necessary for economic stability and growth. If we are to do better in the future, we must launch a serious debate that looks beyond the level and the techniques of fiscal and monetary policy. Such a debate will acknowledge the instability of our economy and inquire whether this inherent instability is amplified or attenuated by our system of institutions and policy interventions. ….

Today's economic crisis is as profound … as that of the 1930s. … There is no consensus as to what we should do. Conservatives call for freeing up the markets even as their corporate clients lobby for legislation [to] institutionalize and legitimize their market power…. [C]orporate America pays lip service to Adam Smith, while striving to sustain and legitimize the very thing that Smith abhorred—state-mandated market power.

Liberals, instead of articulating and incisive critique of our capitalism as such and pioneering innovative experimentation and change, are wedded to the past. They support minimum-wage increases without questioning whether these laws have served any real purpose since the Great Depression, when reflation was the policy objective. Liberals are unwilling to face up to the shortcomings of policies inherited from the past and are, fundamentally, timid about setting forth in new directions.

As a consequence, instead of analysis and ideas, we get slogans: free markets, economic growth, national planning, supply-side, industrial policy—imprecise phrases that face up to neither the what nor the how of policy objectives. The various programs for change are based on misconceptions of both the strengths and the weaknesses of market processes. One of the reasons for the intellectual poverty of policy proposals is that they continue to be based on ideas drawn from neoclassical theory. Although economic theory is relevant to policy (without an understanding of how our economy works we cannot find cures), for an economic theory to be relevant what happens in the world must be a possible even in the theory. On that score alone, standard economic theory is a failure; the instability so evident in our system cannot happen if the core of standard theory is to be believed.

Today's economic policy is a patchwork. Every change designed to correct some shortcoming has side effects that adversely affect some other aspect of economic and social life. Every ad hoc intervention breeds further intervention. If we wish to improve upon what we now have, we must embark upon an age of institutional and structural reforms that will check the tendencies toward instability and inflation. Standard theory, however, offers us no guidance on that score; for the problems are outside the domain of relevance of the theory. A new era of reform cannot be simply a series of piecemeal changes. Rather, a thorough, integrated approach to our economics problems must be developed; policy must range over the entire economic landscape and fit the pieces together in a consistent, workable way: Piecemeal approaches and patchwork changes will only make a bad situation worse.

Poverty in the midst of plenty and joyless affluence are but symptoms of a profound disorder [Tibor Scitovsky, The Joyless Economy (New York: Oxford University Press, 1976)]. As we have pointed out, persistent financial and economic instability is normal in our capitalist economy. The commitment to growth through private investment—combined with government transfer payments and exploding defense spending—amplifies financial instability and chronic inflation. Indeed, our problems are in part the result of how we have chosen, inadvertently and in ignorance of the consequences, to run the economy. An alternative policy strategy is needed now. We have to go back to square one — 1933 — and build a structure of policy that is based upon a modem [modern?] understanding of how our type of economy generates financial fragility, unemployment, and inflation. [pp. 319-23]

Note: whereas in Minsky's day inflation tended to be more self-grown, today's inflation tends to wander the globe accompanying unfettered capital mobility. Note further that Minsky was careful to introduce his policy 'remedies' with this caution: "Even as I warn against the handwaving that passes for much policy prescription I must warn the reader that I feel much more comfortable with my diagnosis of what ails our economy and analysis of the causes of our discontents than I do with the remedies I propose."

Can Minsky Respond to Krugman's criticism of 'The Hangover Theory'?

Both Mark Thoma and Brad DeLong have recently been playing with Paul Krugman's dissing of the Austrians: The Hangover Theory. I have no such intent here. I have dabbled with Austrian thinking/writing enough to have a healthy respect for complexity, human psychology, market cycles, etc. I have learned economics from various schools of thought and especially, perhaps, from Robert Heilbroner, who was able to probe the minds of the "worldly philosophers". Looking across various schools of thought helped to round out my non-traditional views.

Instead of dissing the "Austrians" or any other school of thought, I just want to attempt to solve a puzzle left by Krugman. Here is a frame:

The Hangover Theory, 12/1998, Paul Krugman: …A recession happens when, for whatever reason, a large part of the private sector tries to increase its cash reserves at the same time. Yet, for all its simplicity, the insight that a slump is about an excess demand for money makes nonsense of the whole hangover theory. For if the problem is that collectively people want to hold more money than there is in circulation, why not simply increase the supply of money?

Questions that Krugman ignores are: How exactly is the supply of money to be increased? How are those who are to lend to be induced to lend? How are those who are to borrow to be induced to dare to borrow? Remember that in the scene Krugman is exploring, 'bankers' (many) have just been burned because they were encouraging ever-more-speculative loans on the way up the credit-bubble mountain, some of which have now failed, leaving the bankers to shoulder some of the loss. What is to make the bankers think they are now encouraging prudent investments? Similarly what is to make businesses think that the environment is now safe to borrow into?

Krugman's puzzle: "The hangover theory, then, turns out to be intellectually incoherent; nobody has managed to explain why bad investments in the past require the unemployment of good workers in the present."

Maybe the Austrians cannot explain it, but Hyman Minsky, following Keynes ideas on market cycles and inherent problems, has managed such an explanation. At least I think so. In Minsky's explanation (expansion) of Keynes financial economics we move from the narrowness of Keynes historical perspective, looking "at a depressed economy, tending to chronic underinvestment and thus to high and long lasting unemployment"; to Minsky's later historical perspective, looking "at a vibrant economy with upward instability, naturally inclined to overinvestment and overindebtedness." (Elisabetti De Antoni, 2005, "The (too?) Optimistic 'financial Keynesianism' of Hyman Minsky" [PDF] p. 25). Dominating both scenes "are expectations and the degree of confidence placed in them" (De Antoni p. 9).

Central to Minsky's theory is "the relationship between debt commitments and profits." (De Antoni p. 5 ). This is where it gets interesting, psychologically and economically, in helping to address the questions, "Who is to lend what to whom?" "Why Would they dare?" What many writers are unwilling to entertain is the lag time necessary to induce either bankers to loan money or credible businesses to borrow money after bubbles burst.

A time lag is needed in order to allow the psychological cloud of pessimism to move far enough into the backdrop to once again begin the cycle of guarded optimism and trust that a better day is possible, then optimism, exuberance, irrational exuberance and boom, then bust, irrational pessimism, pessimism, guarded pessimism, and finally around again to guarded optimism and trust.

This story sounds a bit Austrian. The Minsky twist is that he advocates that central bankers (Minsky uses the term "big government") interrupt the cycle during "irrational" phases on both the upside and the downside in attempts to minimize the run-up and the run-down. Minsky also acknowledges that government action may do more harm than good if timing is not good, or if the form of government action is not appropriate.

This brings us to the "basic criticism made by Minsky against the Neoclassical Synthesis … that it neglected financial relationships, precisely those in which instability lurks" (De Antoni p. 2). The instability derives from time-lags in contracts between borrowers juxtaposed against changes in Fed policy or action, and expectations of such.

De Antoni lays out the story line of the boom/bust cycle:

The relationship between debt commitments and profits is central to Minsky's theory. … Given the limits of collective and individual rationality, in Minsky's world the recent experience is the main guide to the future. The ease with which payment commitments have been met in the recent past determines the confidence in the future fulfillment of debt commitments. This triggers an important deviation amplifying mechanism: "A history of success will tend to diminish the margins of safety that business and bankers require and will thus tend to be associated with increased investment; a history of failure will do the opposite." (Minsky, 1986 [Stabilizing an Unstable Economy] p.187). Expansion thus turns into a euphoric boom. Sooner or later, however, euphoria ends by clashing with reality: "As a previous financial crisis recedes in time, it is quite natural for central bankers, government officials, bankers, and even economists to believe that a new era has arrived. Cassandra-like warnings that nothing basic has changed, that there is a financial breaking point that will lead to deep depression, are naturally ignored in these circumstances" (Minsky, 1986, p. 213). Financing is often based upon the assumption that "the existing state of affairs will continue indefinitely" (Keynes 1936 [The General Theory of Interest, Employment, and Money] p. 152 ). On the contrary, "each state nurtures the forces that lead to its own destruction" (Minsky 1975 [John Maynard Keynes] p. 128). (De Antoni p. 5).

Did Minsky solve the puzzle? I think that he began the solution, and his followers are now continuing the inquiry/discovery, most recently through the work of Eric Tymoigne and others at The Levy Economics Institute, Bard College..". Am I wrong? At minimum I hope more economists will at least explore the work of Minsky and other Post Keynesians.

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See also:
Banking and Financial Crises, Gary A. Dymski, January 2005
Minsky's thesis: Keynesian or Marxian?, Steve Keen, 2001
Krugman and The Liquidity Trap: Why Inflation Won't Bring Recovery in Japan, Jan A. Kregel, March 2000
The Nonlinear Dynamics of Debt Deflation, Steve Keen, 1998

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{Note: I edited this slightly on 1/19, 1/23: Among other things, I put quotes around the word "irrational," i.e. :"'irrational' phases" of market cycles above. As Eric Tymoigne, correctly notes (In an email) " I would be careful to call all those behaviors "irrational" for two reasons. First I think they are rational given the uncertain world we leave in and the institutional framework of capitalism. Acting according to the rational expectation model is irrational. Second, even if large optimism are indeed a reality, they are not necessary, in Minsky's theory, to explain the weakening of the economy."}

A Minsky-like Restatement of Keynes Market Irrationality Warning

Among famous statements attributed to John Maynard Keynes, this one is my favorite: "Markets can stay irrational longer than you can stay solvent." As I learn more about Hyman Minsky, I wonder how he might have restated Keynes' warning. Here is an attempt: "The market is irrational, is not prone toward equilibrium, but instead is subject to cycles of irrational exuberance and irrational pessimism."

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{Update Jan. 5}
A second attempt: "The market is a complex, adaptive social system, is therefore not prone toward equilibrium, but instead subject to phase shifts, cycles, and transfomation. Groups of people who play in the market are prone to cycles of irrational exuberance and irrational pessimsim."

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As to 'equilibrium' Elisabetta De Antoni says, ( "The (too?) optimistic 'financial Keynesianism' of Hyman Minsky," [PDF] p. 6 )

...Minsky totally rejects the 'crutch' represented by the concept of equilibrium. Instad of speaking of equilibrium or disequilibrium, Minsky ... 1986 p. 176— just like Joan Robinson — prefers to refer to states of tranquility hiding within themselves disruptive forces destined to gain strength with the passing of time. In his view: "instability is determined by mechanisms within the system, not outside it; our economy is not unstable because it is shocked by oil, wars or monetary surprises, but because of its nature" (Minsky 1986 [Stabilizing an Unstable Economy] p. 172)...

On 'irrational markets' De Antoni says, (p. 24)

...From a cyclical perspective, rescessions can be traced back to the preceding boom. Quoting Minsky "In some important sense, wha was lost from the insights of the 1920s and 1930s is more significant than what has been retained ... The spectacular panics, debt deflations, and deep depressions that historically followed a speculative boom as well the recovery from depressions are of lesser importance in the analysis of instability than the developments over a period characterized by sustained growth that lead to the mergence of fragile and unstable financial structures." (Minsky, 1986 p. 173).

Minsky advocates for 'big government' to act as a stabilizer to the excessive exuberance of 'free market capitalism,' But Minsky was also aware that 'big government,' if imprudent might destabilize rather than stabilize.

On 'big government stabilization,' De Antoni says (pp.18-19):

Given the tendency of capitalist economies to financial crises, followed by debt deflations and deep depressions, the issue of the efficacy of economic policies acquires a crucial role. From this point of view, Minsky does not place much faith in monetary policy. Given that a great part of the money supply is endogenously created by banks and given the innovative capacity of the financial system, the central bank has only a limited control over the supply of money. In any case money influences the demand for assets, rather than or goods. Thus, the central bank intervention may turn out to be harmful as well as ineffective. Quoting Minsky, (1986), "Monetary policy to constrain undue expansion and inflation operates by way of disruptiong financial markets and asset values. Monetary policy to induce expansion operates by interest rates and the availability of credit, which do not yield increased investment if current and anticipated profits are low" (p. 303-4). Instead of aiming to control the money supply or the behaviour of the economy, the central bank should focus on its function as lender of last resort. By enabling the financing of financial institutions and by sustaining asset prices, the central bank might prevent financial crisis, so removing the threat of debt deflations and deep depressions.

In fact, Minsky assigns to fiscal policy the task of promoting full employment and stabilizing the economy. As he puts it, "fiscal policies are more powerful economic control weapons tha monetary manipulations" (1986 p. 304). ...

No doubt Minsky didn't get everything right, as none of the great economists have. They are human, after all. They lived in times different our own. The complexity and novelty that arise spontaneously from the workings of the complex systems (physical, biological and social) that enfold us guarantee that each of us perceives the world a bit differently, depending on when we live. Still, Minsky got enough right, building particularly from Keynes (who built from foundations laid down earlier) to seriously challenge status-quo financial economics and central bank practices.

For further explorations/extensions of Minsky's financial economics, see particularly the works of Eric Tymoigne and L Randall Wray, The Levy Economics Institute, Bard College.."

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{Update Jan 5, edited Jan. 23}
In Extending Minsky's Classifications of Fragility to Government and the Open Economy, L. Randall Wray argues that "the U.S. is in an increasingly precarious position" ... "[I]t is likely that many individual units have moved from hedge to speculative positions, and even to Ponzi positions…."

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Most Economists Optimistic About 2007

David Altig (macroblog) begins the year with economists' forecasts for 2007. Notably alone in the bears' lair, says Altig, is Nouriel Roubini (whose influence is large on my blogging). Of course we know that Roubini is not alone, although no doubt in a small minority re: 2007.

My blogging this year will likely dig deeper into Hyman Minsky's financial fragility hypothesis, since I believe that Minsky got it pretty much right on financial economics. Among other things I hope to compare Minsky's recommendations to central bankers and other government authorities to what we see them doing, or think we see them doing. More on that as the year unfolds. Right now we will return to Altig:

...[L]atest Economic Forecasting Survey from the Wall Street Journal (page A1 in the print edition):

Economy Poised For '07
Rebound,Forecasters Say
Weakness in Housing, Manufacturing Is
Likely To Take a Lighter Toll

That doesn't mean exactly mean a gangbuster year: The average GDP forecast for the first half of the year is just 2.3 percent -- though the median forecast was higher and not a single one of the 60 respondents was willing to predict negative growth over the first two quarters.

Of course, Calculated Risk had that story last week...

Other than a few economists, the overwhelming consensus view is for a soft landing and GDP growth of 2.5% to 3.0% in 2007. ...

Nearly alone on the other side of the fence, Nouriel Roubini claims, in a post reviewing his not-too-bad 2006 predictions, that he has not given up on expecting the worst. ...

...[T]he consensus among WSJ group is that the dollar will stabilize near 1.3 per euro, about where it is today. ...

Now we'll all wait and see how it is we will be wrong.

Yes we will now wait to see how we will be wrong and how far wrong—for a variety of reasons. Some reasons have to do with the turmoil of the economics profession: so many theories, no dominant paradigm (and those that still dominate seem to be diminishing in their dominance). Some reasons have to do with the vagaries of the field. Although differing in ideology and methodology all the saavy economists seem to recognize that no matter what their theories may tell them, uncertainities, novelty, and outright surprise still seem common.

Dumbed Down in America: Myths we live by

Are we being dumbed down by contemporary mythmakers? Jim Willie says Yes, and includes "economists from many corners, [b]udget advisors, brokerage analysts, government spokesmen, and academic charlatans [as] modern soothsayers, hardly ever correct, always revered, never understood." Willie goes on to say, "whenever things are about to go badly, we face more economic myths in the process of being shattered, and are soon subjected to new ones." Here's more:

The Tragedy of Busted Myths, Jim Willie [9/2/06]: Mythology is powerful. Just a few thousand years ago, men would go to war over strange beliefs about gods and goddesses, or make decisions of state, or act upon the fate of cities and hamlets, or enter into big trade agreements, or embark on grand voyages, or agree to marriage, all after consulting the oracles. They were the gurus of their day, replaced today by economists from many corners. Budget advisors, brokerage analysts, government spokesmen, and academic charlatans are the modern soothsayers, hardly ever correct, always revered, never understood. It seems whenever things are about to go badly, we face more economic myths in the process of being shattered, and are soon subjected to new ones. In their failed wake, we install more controlling (corrupting) mechanisms like the Plunge Protection Team after crises like the 1987 Black Monday and the 2000 Tech Telecom bust.

Once again the motive in promoting silly myths is the same, or at least the nucleus motive is the same. Domestically, that is to deceive the hapless ignorant hopeful public to continue to trust the leadership out of Washington DC and New York City, to continue to remain invested in the Wall Street game, to continue to participate in the consumption game, to avoid a panic and head for exits before the losses mount. On the foreign front, the motive is to encourage other nations to continue to send their hard earned savings into the Great Black Hole that is the USEconomy, to continue to supply and satisfy its desperate credit needs, to continue to pay for the entry fee for selling in its vast marketplace. The unspoken motive is to enable the aristocrats to continue to churn their machinery, to ply their trade of exploiting the great paper game, to further the squeeze on the middle class. In fact, the middle class is the greatest loser from inflation's impact and heavy cost.

INFLATION WRECKAGE
Inflation has its hidden costs. Writers, analysts, and pundits catch the easy victims, like savers who are robbed of the stored value from the drip drip drip of erosion. Like small-time participants who shun the opportunity to grow big. Rising wages, which at first seem like an advantage from a steadily inflating economic system, have turned on the masters of the inflationary machinery. Job outsourcing to Asia has ripped the manufacturing foundation of the USEconomy clean off its mooring and capstone, deprived it of legitimate wealth generation. Consequently, the participants of our mfg-less society have been deceived into believing that consumption within retail chains can stand in its place. It offers the benefit of cleaner air, less sweat, and more fun. What's not to like? Let's go shopping, the great medication for the depressed. Instead of factories belching out smoke, noxious fumes, and rendering its workers musclebound but with damaged bodies from chemical intake, we have clean tidy shopping malls, nifty prevalent consumer retail chains, really cool electronic stores, and nice smelling furniture marts.

Complimenting the networks of consumer havens are our homes, the veritable piggy banks. Who needs to save anymore, so passé? We have mutual funds and trading accounts. So we have suffered a deadly transition from making products in an industrial setting, wherein added value is gained from human labor with the aid of sophisticated machines. We now stand with one foot in the financial credit spin cycle replete with mortgages and car loans and vendor financed sales, not to mention the world of stocks and bonds, and the other foot in the service collage known to keep our devices and grounds in working order and looking spiffy.

Is this progress? No way! It is a tragedy in the making, fully denied. We crossed the Rubicon ten years ago, maybe as long ago as the 1971. The most reckless and irresponsible phase change has been the overdue dependence within the USEconomy on the inflated equity of the entire housing sector. Indeed it sustains the system to a great degree. Americans have not saved actively since the mid-1990 decade, when Greenspan endorsed irrational exuberance by warning about it, but continuing to feed the destructive damaging condition. Several years later, Greenspan actively shocked the world by claiming that gains in home equity suddenly realized should be regarded as legitimate wealth. This is unprecedented in the modern era for a central banker. Worse still, in 2005 Greenspan added insult to injury by stating that "People who took on too much debt were desirous of financial harm." He urged the housing bubble stampede, then stepped out of its path on political fallout. The central question should be "Will the Greenspan legacy be directly linked to the upcoming crisis in housing and the USEconomy, which is of his own making?" Given the utterly imbecilic naïve confounded lack of comprehension of economic matters, blame is likely to go to the current USFed Chairman Bernanke by the present public and current leaders alike.

The entire nation has been dumbed down on all matters economic, at least on the macro level. The crisis will happen on Ben's watch. It is not preventable. Its pathogenesis was designed and laid out carelessly but meticulously by Mr Greenspan. He split town to leave Bernanke with the headache, and likely blame. Without a doubt, Ben was selected to become the bagholder. Poor Ben has less charisma than Alan, perhaps equal ability to explain and confuse, but he tragically has no more available bubbles to engineer like Alan did. Housing is the last bubble. Well, to be more clear, the commodity bull is the final bubble, but it is of a cost nature.

CITATION OF CURRENT MYTHS
The present situation is overflowing with falsehoods, nonsensical beliefs, indefensible notions being actively promoted when required. … It is inconceivable to me how any sane, well educated, competent academic Economics professor of repute could defend a single listed item. Yet the great majority of this corrupted profession do precisely that, defend and promote and carry on the great game. The corruption is of thought process. An economic system dependent upon inflation requires the associated cancerous defensive thought to complement the cancerous policy itself. A certain level of cheerleading is also necessary to keep the public bought in.

Almost all current myths will soon unravel in tragic fashion. Do not expect apologies when they do. Expect instead blame to be put on speculators, blame to be put on the mortgage industry (maybe even Fanny Mae & Freddie Mac), blame to be put on reckless consumers, blame to be put on past administrations, blame to be put on Congress, blame to be put on outsourcing corporations, blame to be put on the Chinese. Do not expect much blame to be put on the high priests Greenspan or Samuelson or Friedman. They are untouchable. Give better than 50-50 odds that sufficient blame will be lodged on Bernanke, to the point that he might be dismissed and shown the door before all monthly calendar pages of 2007 are turned.

Here is a cornucopia of current crazy myths at work, the underpinnings for each to unravel in tragic fashion. Steadfast belief in them would be funny if not so tragic in doling out misery. The list could fill volumes, but in the interest of time and space, only the major prominent myths are cited. The authors and proponents to each myth should feel shame, but they do not, at least not publicly. My guess is that privately, they might offer derision and contempt for the public who accepts their spun claptrap silly beliefs which hold the system together and keeps the caste structure in place. This list is simply mindboggling.

Stephen Roach on Pitfalls of Partial Analysis, Dangers of Confluent Shocks

Stephen Roach's latest, The Pitfallls of Ceteris Paribus echoes Philip Tetlock's criticism of "expert advice' in Expert Political Judgement and Robert Jervis's cautions in Systems Effects: Complexity in Political and Social Life. A bit more on both books here.

Roach's take home message is "As bad luck would have it, a confluence of three potentially powerful shocks — oil, housing, and Fed tightening -- is now in play. All other things the same, the US or global economy may not have been dealt a lethal blow by any one of these shocks. But that may well be beside the point. This is not the time for ceteris paribus." Here's more:

Ceteris paribus may well be the two most dangerous words in the economist's toolkit. Loosely translated from Latin as "all other things being the same," this concept has become a foil for partial-equilibrium analysis — an increasingly fruitless and misleading approach in today's complex and interdependent world. With oil prices rising, the housing cycle turning, and central banks tightening, the pitfalls of ceteris paribus have never been greater.

The US economy is the most obvious and important case in point. There is no lack of rules of thumb to gauge the impacts of shocks. For example, Federal Reserve staff estimates put the impact of a $10 increase in the oil price at -0.2% of forgone GDP growth and +0.2% on the headline CPI — with both impacts spread out over roughly a three-year time period … At the same time, residential construction activity has risen to a post-1960 record of 6.2% of nominal GDP — well above its longer-term mean of 4.5% (over the 1960 to 1995 period). Under the sugar-coated presumption of asymptotic mean reversion, a post-bubble shakeout of homebuilding could knock at least 1.7 percentage points off overall economic growth. A "non-asymptotic" correction would obviously be a different matter altogether. Meanwhile, the Fed has taken the federal funds rate up from 1% to 5.25% over the past two years — a monetary tightening that the Fed's own rules of thumb suggest should already be knocking at least one percentage point off aggregate growth in real GDP.... [W]e have a reasonably clear understanding of how to gauge the impacts of any one of these developments. Unfortunately, it is the interplay that matters in the real world.

… Our penchant for partial analysis is an outgrowth of the event- and sound-bite-driven culture that shapes the day-to-day debate in the media, financial markets, and political circles. I am as guilty as the rest in that respect. War breaks out in the Middle East and the telephone instantly lights up with requests for impact analysis as seen through the lens of the oil price. New home sales disappoint — as they did once again in the just-released June report (a 3% monthly drop to a level that now stands 11% below the year-earlier pace) — and the calls come in for an assessment of the post-housing bubble carnage in the US economy. Same thing happens every time the Fed tightens — or, more aptly these days, changes its mind on monetary policy. We answer these well-intended questions because they fall within the job description of the economist, market strategist, analyst, or pundit. But in doing so, we compartmentalize our answers in a fashion that does great disservice to the ultimate truth.

Yet "context is key" in going from the partial to the broader answer. That's especially the case for the American consumer — quite conceivably the most important call in the global economy these days. Energy prices go up and we typically assess the impact of that development by looking at the energy-related portion of personal consumption expenditures. Currently that share stands at 6.2%, well above the 10-year average of 4.9%. Under alternative geopolitical and oil price scenarios, we then typically model different trajectories of the energy portion of total consumption and render the macro verdict accordingly (see Dick Berner’s 17 July essay, "Tipping Point? "). But here's where the context point is absolutely critical — there is much more going on here than just an increase in oil-related expenditures. The housing market is rolling over, ultimately denying income- and saving-short households the wealth effects they have been aggressively converting into purchasing power and consumption in recent years. Moreover, courtesy of Fed tightening, a resolution of the great bond market conundrum, and "resets" of cut-rate mortgage loans, debt service obligations of overly indebted consumers are also on the rise. In other words, there are a number of other things currently happening to US consumers that render the partial analysis of an oil shock almost meaningless.

And those, of course, are just the first-round implications. If the American consumer finally caves under the weight of this confluence of forces, I suspect business capital spending — the widely presumed next source of recovery — will be quick to follow. I come to that conclusion fully mindful of all the positives that seem to support a much more resilient outlook for this sector — namely, record corporate earnings and cash flows, long-deferred capacity expansion programs, ongoing productivity strategies driven by IT-enabled capital deepening, and the heavy replacement needs of a shorter-lived, increasingly IT-intensive capital stock. Notwithstanding these important considerations, they miss the essence of the capital spending decision: Fixed investment is a "derived demand" highly dependent on expectations of the prospective trajectory of end-market demand. As such, the demand forecast is, itself, an excellent predictor of future pressures on the existing stock of productive capacity — apprising business decision makers of the need to increase the scale of their operations. If demand expectations are marked down in any meaningful fashion —- as could well be the case if the US consumer fades — the investment cycle could quickly shift to the downside. And if capital spending weakens, so, too, will capex-related employment and income generation — putting further pressure on consumers. Yet you won't reach that conclusion by sticking with the rules of ceteris paribus in analyzing the impacts of higher oil prices. …

Empire of Debt: Small Chance of Imploding?

Today's CBS News Sunday Morning aired a segment titled In Debt . The take-home message is:

The United States is a nation of debt. Americans have accrued billions of dollars worth of personal consumer credit, and the number is rising via credit cards, innovative mortgage packages, home equity lines, student loans, etc. At the same time, the U.S. had a negative savings rate last year. Translation: We're spending more than we're earning. Cynthia Bowers says that's like any bubble: The credit bubble can only end one way -- badly.

Addison Wiggin said, if I heard right, that we have a "small chance" of falling into a banking crisis wherein savers as well as debtors need to worry. My question is, "How does Wiggin or anyone else know?"

I thought about flying blind in a snowstorm, worrying about running into a mountain and not knowing whether you were over Alaska or Nebraska. Or worse still not knowing whether your had, say, one chance in a hundred of being over Alaska v. Nebraska or vice versa. It seems to me that we are so far away from anything that has happened historically, that we don't really have a means to know whether or not the chance of crash-landing our economy is small or large.

Addison: How do you know? I want to know. I would sleep much more soundly if I knew that the chance really was "small." My immersion in Complexity Theory denies me the luxury of making statements like "the chances are small" when dealing with geopolitical dealings. My guess is that either I mistook Wiggin's intent else he spoke in haste. But maybe not.

I have taken to Karl Weick's notion that "believing is seeing" (see also) more often than "seeing is believing." And when dealing with matters economic and geopolitical, I find much more of the former than the latter.

Michael Crichton's "Fear, Complexity, & Environmental Management…"

Mickael Crichton delivered a talk recently titled Fear, Complexity, & Environmental Management in the 21st Century (November 6, 2005). Crichton summed up with a quote from Mark Twain, “I’ve seen a heap of trouble in my life, and most of it never came to pass.” Before summing up, though, Crichton works through a litany of forecast disasters that weren't, then says:

It’s no surprise that predictions frequently don’t come true. But such big ones! And so many! All my life I worried about the decay of the environment, the tragic loss of species, the collapse of ecosystems. I feared poisoning by pesticides, alar on apples, falling sperm counts from endocrine disrupters, cancer from power lines, cancer from saccharine, cancer from cell phones, cancer from computer screens, cancer from food coloring, hair spray, electric razors, electric blankets, coffee, chlorinated water…it never seemed to end.

… [F]or the most part, I just went along with what I was being told.

Now, if we are to do better in this new century, what must we do differently? In a word, we must embrace complexity theory. We must understand complex systems.

Grappling with Economic Dilemmas

Today I ran across an interesting blog. It’s called Catallaxis: An Integral Economics Weblog

I found refreshing stuff about organizational learning applied to the framing of markets and market functioning embedded in social and political structures. I learned a bit about Daniel O’Connor’s struggle to better understand both the crisis and possibilities of economics in our emergent world, including insight into economic dilemmas: freedom vs. fairness, efficiency vs. effectiveness, and growth vs. sustainability.

I found much that compliments my own journey of understanding. And I found some interesting application of double- and triple-loop learning in an economics and market framework, particularly in his most recent post, “Asset Price Bubbles: Monetary Inflation and Leveraged Speculation” and in his background paper “Stable Instability”

Below find a few snippets from O’Connor’s site and his book: "A Crisis of Vision" (an introduction to Market Learning: Toward a more Integral Economics)