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July 2011

Robert Waldmann Reads the Washington Post So We Don't Have to


Robert's Stochastic thoughts: Dan Balz writes what I'm sure he considers a very hard hitting column about what's wrong with the debt ceiling negotiations. He concludes the problem is the House Republican Caucus:

But it’s clear that House Republicans are the principal obstacle to any grand bargain that includes substantial new revenue. Their rigid opposition runs contrary to public opinion…

But the impressive thing is that even when assigning blame, Balz feels the need to assert a false equivalence. Actually I'm not sure he felt anything. I think it is likely that he does this without thinking or imagining that there is an alternative. He wrote

Republican opposition to tax increases is an article of faith for the party, but many GOP lawmakers, particularly the freshman who came in with the support of the tea party movement, are more rigidly opposed than ever. Similarly, many Democrats, who have won elections attacking Republicans over Social Security and Medicare, remain strongly opposed to cuts in those programs…

He could also have written

Republican opposition to tax increases is an article of faith for the party, but many GOP lawmakers, particularly the freshman who came in with the support of the tea party movement, are more rigidly opposed than ever. Similarly, many Republicans, who have won elections attacking Democrats over Medicare, remain strongly determined to cut that program and eliminate it if possible…

The last campaign wasn't so long ago. Balz knows perfectly well that Republicans claimed that the PPACA cut Medicare benefits (when they didn't suggest that it established death panels). He also knows that the public disagrees with the Republicans on taxes and he must know that the public strongly agrees with the Democrats on Medicare and Social Security.

What is the justification for the word "similarly." Why did Balz type that word? It is not needed. It is not true. Did he even consider the possibility of not claiming that two things which are fundamentally different are similar?

Notice one asymmetry: Republicans have "faith". Democrats' support for Medicare and Social Security must be based on political calculation. The possibility that people actually sincerely think that cutting those programs is a bad idea is not conceivable even though the vast majority of people in the USA sincerely think that cutting those programs is a bad idea.

Is There Serious Money to Be Made by Shorting Long Treasuries? Probably Not...

Suppose that Treasury short rates stay at 0 for X years, and then "normalize". When they normalize, they take three years to climb back to 5%, and then they stick at 5% until the 10-Yr bond matures. Then:

  • If X=3 then you have lost money unless the current 10-Yr rate < 2.75%
  • If X=2 then you have lost money unless the current 10-Yr rate < 3.25%
  • If X=1 then you have lost money unless the current 10-Yr rate < 3.75%

The upshot? This: Shorting long Treasuries is a bet that (a) short-term rates will exceed 5% on average by a healthy margin once they normalize, or a bet that (b) they will start normalizing very soon now, or a bet that they will overshoots on the way down. And in the meanwhile, until rates "normalize", your trade is showing losses and your investors are seeking better performance elsewhere...

Dean Acheson, FDR's Wishes, and the Origins of World War ii

I am always intrigued by Dean Acheson's account in Present at the Creation of how the U.S. escalated the Pacific crisis in 1941 by embargoing the export of oil from the U.S. (and Indonesia) to Japan. Roosevelt, it appears, had decided against embargoing oil exports as too provocative. Roosevelt, however, was willing to freeze Japanese assets--so that Japanese assets could be used only for purposes of which the U.S. approved.

Dean Acheson as Assistant Secretary of State responsible for implementing this policy decided that Japan should buy its oil not with frozen funds but with either (a) funds from Latin America not covered by the freeze, or (b) funds in the U.S. that had evaded the freeze. The Japanese government refused to admit the existence of any such funds. So no oil.

As Acheson said at the time, it was not that the policy of the United States was to embargo exports of oil. There was no such policy. But there was a state of affairs: oil was embargoed unless Japan wished to pay for oil with non-frozen resources, which it did not. And that state of affairs continued. Did Roosevelt know about this state of affairs? That has never been clear to me.

Acheson always claimed not to know what situation the "state of affairs" caused by his implementation of the asset freezing policy was creating:

Present at the creation my years in   Google Books 11

Contractionary Fiscal Policy Is Contractionary Watch: Great Britain Edition

Remember those claims that Britain was being hammered by winter, and that the British economy would super-snap-back once the snow melted? I do.

David Dayen

British Economy, After Austerity, at Zero Growth in the Past Nine Months: What’s amazing about this debt limit debate, and the headlong rush to austerity, is that we have empirical evidence of what can result, in this kind of economy, when you massively roll back spending. We even know what happens when you do that amid the threat of a debt downgrade rather than the fundamentals of the financial markets. All you have to do is look to Britain, which has never been the same since their austerity package was unveiled by the Tories.

Britain’s economic recovery remains lackluster as official figures Tuesday showed growth of only 0.[8] percent per year in the second quarter of the year from the previous three month period, in part because of the disruption caused by the wedding of Prince William and Kate Middleton. The statistics office also said the economy during the period was heavily influenced by the aftermath of the Japanese earthquake and tsunami, record high temperatures in April and the start of ticket sales for the 2012 Olympic Games in London.

The preliminary growth figure, which is subject to revision, was in line with market. But it may put new pressure on the government and the Bank of England to take steps to quicken up the pace of recovery. The weak second quarter followed six months of essentially no growth, with a drop of [2.0] percent per year in the fourth quarter of last year followed by a gain of [2.0] percent per year in the first quarter.

The excuses in this article are ridiculous: did the economy slow down because a lot of people missed the Tube stop at Notting Hill, too? Anyway, didn’t the William and Kate wedding produce a lot of economic activity?

The point is that Britain rolled back demand during a time when the economy was already weak, and they are suffering through the consequences. Instead of looking at this as a problem to be avoided, US policymakers are on the verge of emulating it. And not even in a good way: the British plan was at least somewhat balanced, with tax increases along with the spending cuts. This shows that the idea of a “balanced approach” is still flawed, because either way, you’re reducing demand during a time with a demand shortfall.

In a couple years, if we’re scratching our heads about zero growth, we can simply look to Britain. They are opening a window into our dim future.

What Is Happening Now That QE II Is Over?

The Treasury is still issuing bonds--it disinvests civil service retirement trust funds when it does so, but it is still issuing bonds. Who is holding them at today's very healthy prices? Who is buying them at today's very healthy prices?

David Greenlaw's guesses:

Morgan Stanley - Global Economic Forum: Who Will Be the Marginal Buyer of Treasuries Post-QE2? June 02, 2 Analysis of the impact of QE1 conducted by Fed staffers concluded that yields (or term premiums) on longer-maturity securities were reduced by around 50bp.  The market adjustment process at the conclusion of QE1 was relatively smooth.  However, the bulk of the Fed's purchases in QE1 involved mortgage-backed securities, and MBS supply was unusually depressed as the buying wound down.  Given that Treasury issuance is expected to continue at an extremely elevated clip for the foreseeable future, how will the market adjust to the loss of most Fed buying?  In other words, who will be the marginal buyer of Treasuries going forward?  Our analysis suggests that heavy buying by the largest foreign holders of Treasuries will be needed to avoid a back-up in yields....

In 2010, net issuance by the Treasury Department amounted to about $1.6 trillion.  Roughly half of these securities were purchased by foreign investors (more on this later).  Other big buyers included households, pension funds and the Fed.... The household sector... is a residual that includes all sectors for which the Fed does not have hard data - for example, domestically based hedge funds, endowments and foundations - as well as any data errors.... Indeed, we suspect that a significant portion of the spike in household purchases of Treasuries seen in the flow of funds accounts during 2009-10 reflects a data error....

There have long been questions surrounding the estimates for the foreign sector.  The Fed relies on the Treasury International Capital System (TICS) data.  But TICS-based estimates often differ substantially from estimates of flows into the US compiled by other nations, such as Japan.  Also, the Treasury Department conducts benchmark surveys of foreign holdings (as opposed to purchases) of US assets at different points in time, and these figures often imply a much different flow of purchases during the relevant interval than seen in the TICS figures.  Indeed, we suspect that a significant portion of the elevation in the household sector holdings of Treasuries seen in recent years actually reflects foreign investor activity that was not picked up by the TICS.... Quite simply, Treasuries are not a favored asset class of the typical household investor....

Looking at other investor categories, a few developments are worth highlighting.  First, commercial banks are not typically big buyers of Treasuries.... The pension category has also shown a significant pick-up in the pace of Treasury buying in recent years.  However, much of this upswing in demand seems to mirror a similar decline in holdings of MBS and thus appears to be part of an asset reallocation within fixed income....

With the Fed pretty much out of the picture after June, it seems clear that foreign demand for Treasuries holds the key going forward.  While market perception is that foreign central banks and sovereign wealth funds play a dominant role in the Treasury market, the TICS data show much heavier buying of Treasuries by private foreign investors in recent years.  During the past year or so, the biggest foreign buyers of Treasuries have been domiciled in the UK, Japan and Canada (in that order)....

At the end of the day, continued heavy buying by the largest foreign holders of Treasuries will probably be necessary to prevent a back-up in yields post QE2.... Finally, we would note that even if foreign investors step up and absorb all of the securities that the Fed has been buying, they won't provide details on the amount and timing of their purchases several weeks in advance - as the Fed currently does. So, at the very least, we should see greater market volatility once the Fed moves to the sidelines.

Haven't seen either the backup or the volatility--so far. It seems as though the foreigners are stepping up...

Liveblogging World War II: July 26, 1941

Dean Acheson on how the United States came to embargo oil exports to Japan in the summer of 1941--thus confronting Imperial Japan with the two choices of (a) abandoning its attempt to conquer China and retreating, or (b) launching yet another war to at a minimum conquer Indonesia:

Present at the creation my years in   Google Books 1

Present at the creation my years in   Google Books 2

Present at the creation my years in   Google Books 3

Present at the creation my years in   Google Books 4

Effect of Anticipated Default

Paul Krugman:

Default In A Liquidity Trap: Nick Rowe asks a good question: if we took our models seriously, what would we expect the effects of threatened default to be on the larger economy? His answer is that expected default should work just like expected inflation, which means that if anything it should be favorable right now. I think this is wrong — but in an interesting way…. [I]nflation doesn’t just erode the value of bonds; it also erodes the value of cash. And that’s why expected inflation can help in a liquidity trap: it makes sitting on cash less attractive. The threat of default doesn’t do that. As far as I know, we’re not talking about a loss of confidence in pieces of paper bearing pictures of dead presidents. And that’s why the threat of default isn’t equivalent — and not expansionary.

I see it slightly differently: a constant nominal interest rate, expected inflation has no effect on the money-bonds margin but makes people want to dump their bonds for goods and services--hence it is expansionary. But at a constant nominal interest rate, expected default makes people want to hold fewer bonds and more money as well. I think both the IS and LM curves should shift equally, and there should be no effect.

Paul goes further:

In fact, I’d argue that it is in fact contractionary, because it raises interest rates even in a liquidity trap…. [I]ntroduce the threat of default. This makes short-term debt worse than cash…. Yet… the Fed is ready to buy bonds to keep the rate at zero. So what happens? In a simple model, investors sell all short-term US debt to the Fed…. [S]uppose the Fed does in fact buy all the short-term debt. Then there is… still a “shadow” rate… that rate can easily go well above zero. This shadow rate, in turn, is — if I’m getting this right — the rate that feeds into the determination of longer-term rates. So we should expect rates to rise all along the term structure…

I think that nominal interest rates do rise, but the increase in nominal interest rates reduces spending on goods and services by exactly as much as the increase in the default probability raises it.

And then, of course, there is:

the question of what happens to the functioning of financial markets. Anil Kashyap tells me that everything will collapse, because repo depends on Treasuries as collateral. But why not just use cash instead? Hey, this is fun! But, you know, I’d rather not test the analysis in practice.

In practice, I think that repo would shift to cash as collateral, I think that the Fed would simply absorb the default risk from those who were worried about it, and that Nick Rowe might be right--as long as the Federal Reserve is willing to keep interest rates near zero by massively expanding its balance sheet.

Of course, the Fed could do the same thing if it were just to massively expand its balance sheet without any overhanging threat of default.

Odd nobody has worked this out fully yet. But I cannot find it anywhere...

FDR Liveblogs World War II: July 25, 1941


Executive Order: Hyde Park, N. Y., July 25, 1941

In view of the unlimited national emergency declared by the President, he has today issued an Executive Order freezing Japanese assets in the United States in the same manner in which assets of various European countries were frozen on June 14, 1941. This measure, in effect, brings all financial and import and export trade transactions in which Japanese interests are involved under the control of the government, and imposes criminal penalties for violation of the order.

This Executive Order, just as the order of June 14, 1941, is designed among other things >to prevent the use of the financial facilities of the United States and trade between Japan and the United States in ways harmful to national defense and American interests, to prevent the liquidation in the United States of assets obtained by duress or conquest and to curb subversive activities in the United States.

At the specific request of Generalissimo Chiang Kai-shek, and for the purpose of helping the Chinese Government, the President has, at the same time, extended the freezing control to Chinese assets in the United States. The administration of the licensing system with respect to Chinese assets will be conducted with a view to strengthening the foreign trade and exchange position of the Chinese Government. The inclusion of China in the Executive Order, in accordance with the wishes of the Chinese Government, is a continuation of this government's policy of assisting China.

Obama and Geithner Have a New Greatest Unforced Error

Felix Salmon explains the situation:

How we got into this fine mess: For 37 years, the debt ceiling has provided an easy way for the party which isn’t in the White House to posture politically against the party which is in the White House. Even Barack Obama voted against raising it, once. Every one of the dozens of times the debt ceiling was reached, there was a small but non-zero probability that something disastrous would happen. And each time, disaster was, predictably, averted. It’s a classic sign of how tail risks are treacherous and breed invidious complacency. We’ve reached the debt ceiling dozens of times; nothing’s ever happened; so there’s nothing to worry about; so there’s no point expending precious political capital doing the right thing and abolishing it.

And now we’re paying the price. It’s increasingly looking like the best-case scenario is that America simply loses its triple-A credit rating….

The lion’s share of the blame here belongs with the Republicans in general, the House Republicans in particular, and the Tea Party caucus within the House Republicans most of all. But it’s not like these people’s existence or intransigence was any great secret. And so the White House tactics over the course of the past few months look dangerously naive….

The budget debate, of course, sets near-term taxation and spending. So seeking to make a virtue out of necessity, Treasury entered negotiations over the debt ceiling to do something longer-term: to put in place a decade-long “fiscal straitjacket” which would constrain future Democratic and Republican administrations alike…. Treasury’s bright idea backfired catastrophically. Far from putting the US on a course of long-term fiscal prudence, it put the country on a log raft with no paddle, careening straight towards a deathly waterfall…. [E]ngag[ing] the House Republicans on long-term fiscal issues was a silly idea — these are people who think you can raise revenues by cutting taxes. A fiscal straitjacket, necessarily, involves some mechanism for raising taxes; since that was always going to be anathema to the Republicans, there was no point even trying to construct one.

The cost of Treasury’s tactical mistake is going to be enormous. I don’t know how much choice Treasury had in the matter, of course: it’s possible that this particular debt-ceiling debate was going to come to tears no matter how the White House decided to approach it. But I can’t help but draw some kind of causal connection between Treasury’s oversized ambitions and the current mess. In any case, it’s a sunk cost at this point. And we’re all going to pay for it, dearly, in the years and decades to come.

What To Do About the Debt Ceiling…

I vote for Calculated Risk's Option #1: The Treasury's lawyers should simply announce at 9 am Monday morning that (a) since the Constitution prohibits questioning the validity of the national debt, and (b) since the continuing resolution that mandates spending through September 30 was passed later in time than the restriction on borrowing, that (c) the debt ceiling is a dead letter. This is so by the oldest of the principles of black-letter law: a law inconsistent with a previous law is deemed to repeal the previous law even if it does not do so explicitly.

An administration that can find lawyers to say that Libya is not "hostilities" and that wanted to reassure markets and reduce economic uncertainty by solving the debt ceiling kabuki theatre debate would have no problem at all with finding lawyers to advance and justify this well-grounded and wise legal interpretation.

The structure of Tim Geithner's testimony to Congress defending his additional borrowing is:

  • The Constitution forbids me from even thinking about default.
  • You ordered me to spend.
  • A previous Congress told me not to borrow, but no Congress can bind its successors, and those of you who are in this Congress here now ordered me to spend.
  • I'm just doing what you told me to do--and what the Constitution directly and explicitly tells me to do.

And then we should move on to the people's business. This episode of kabuki theatre has done nobody any credit. If I had previously had any respect for or confidence in Republicans, this would have shredded it. And each day it continues it further shreds my respect for and confidence in the executive branch.

Calculated Risk:

Calculated Risk: Debt Ceiling Charade: The Smart Options: From a pure economic perspective, here are the best options (#1 is best):

Option #1: Eliminate the debt ceiling. The debt ceiling is a joke. It serves no purpose except political posturing. It is not about the deficit - it is about paying the bills, and the U.S. will pay the bills. I've been making this argument for months. Moody's made the same argument last week: Moody's suggests U.S. eliminate debt ceiling….

Option #2: Pass a "clean" bill raising the debt ceiling enough to get through the next election (so the politicians don't have to embarrass themselves again). Congress could do this at any time….

Option #3: The McConnell Option… give President Obama the authority to increase the debt ceiling, and try to blame Obama for the increases….

This charade has been the worst of American politics. I'll be happy when it is over.

Flying back from a wedding in Salt Lake City, I have this to say:

You Washington politicians and pundits may think that the debt ceiling is just more insider dingbat kabuki, and that nobody outside Washington is paying any attention and it is not doing any damage.

You are wrong.

It is certainly the case that Wall Street has not (yet) panicked, and that the flow-of-funds through capital markets and the confidence in asset values needed to keep investment spending from collapsing (again) and unemployment from spiking (again) has not yet happened.

But Wall Street is not all that matters. A lot of small businessmen and women out here in what you people in Washington sometimes call "flyover country" are and have for some time been (a) desperately anxious about the shortage of demand, (b) somewhat anxious about instability in the tax code, and (c) slightly anxious about what their health-insurance options will be come 2014. Now they are very anxious about (d) the prospect of what they call "a U.S. government bankruptcy" on August 3, 2011. If the people I talk to are in any sense representative, this added risk that they perceive has been a material drag on the U.S. economy this year and will continue to be a material drag until resolved.

Shame on Boehner. Shame on McConnell. Shame on Obama.

The Confidence Fairy Speaks: "It's Demand!"

Jared Bernstein:

Confidence Fairy Speaks: [A] guy who runs his own very small business (a car service).  He told me the biggest problem he faced was “uncertainty.”... In fact, he said: “Yeah, I can’t count on enough customers coming through the door to even plan shifts for my drivers.  I don’t know where this economy is headed.”

In other words, he’s uncertain, but it’s about demand, just like most of the respondents to the WSJ survey (hat tip: KR):

The main reason U.S. companies are reluctant to step up hiring is scant demand, rather than uncertainty over government policies, according to a majority of economists in a new Wall Street Journal survey. “We’re hiring a little here and there—but it’s not what it should be,” said Daniel Cunningham, chief executive of Long-Stanton Manufacturing Co., of Hamilton, Ohio. “And it’s because of the lack of demand.” Long-Stanton, which makes metal parts for the aerospace, medical and other industries, has snapped back from the recession, “but volume is still not up to where it was, or where it should be,” Mr. Cunningham said”...

Getting rid of “Obamacare” wouldn’t help them a whit.  Generating some demand could help them a lot.

Debt Ceiling Soap Opera Continues

Steve Clemons:

Debt Ceiling Soap Opera Continues: The game goes on. This debate is keeping us from thinking through the challenges on jobs, on infrastructure, on bringing the Afghanistan War to a constructive close, on the important developments in Egypt, Syria and Libya; on next generation energy needs; on uncertainties in the health care arena; on just about every subject.

Liveblogging World War II: July 24, 1941

Sumner Wells:

STATEMENT ON JAPANESE-FRENCH COLLABORATION IN INDOCHINA: It will be recalled that in 1940 the Japanese Government gave expression on several occasions to its desire that conditions of disturbance should not spread to the region of the Pacific, with special references to the Netherlands East Indies and French Indochina. This desire was expressly concurred in by many other governments, including the Government of the United States. In statements by this Government, it was made clear that any alteration in the existing status of such areas by other than peaceful processes could not but be prejudicial to the security and peace of the entire Pacific area and that this conclusion was based on a doctrine which has universal application. On September 23, 1940, referring to the events then rapidly happening in the Indochina situation, the Secretary of State stated that it seemed obvious that the existing situation was being upset and that the changes were being achieved under duress. Present developments relating to Indochina provide clear indication that further changes are now being effected under duress.

The present unfortunate situation in which the French Government of Vichy and the French Government of Indochina find themselves is, of course, well known. It is only too clear that they are in no position to resist the pressure exercised upon them. There is no doubt as to the attitude of the Government and people of the United States toward acts of aggression carried out by use or threat of armed force. That attitude has been made abundantly clear. By the course which it has followed and is following in regard to Indochina, the Japanese Government is giving clear indication that it is determined to pursue an objective of expansion by force or threat of force.

There is not apparent to the Government of the United States any valid ground upon which the Japanese Government would be warranted in occupying Indochina or establishing bases in that area as measures of self-defence. There is not the slightest ground for belief on the part of even the most credulous that the Governments of the United States, of Great Britain, or of the Netherlands have any territorial ambitions in Indochina or have been planning any moves which could have been regarded as threats to Japan. This Government can, therefore, only conclude that the action of Japan is undertaken because of the estimated value to Japan of bases in that region primarily for purposes of further and more obvious movements of conquest in adjacent areas.

In the light of previous developments, steps such as are now being taken by the Government of Japan endanger the peaceful use by peaceful nations of the Pacific. They tend to jeopardize the procurement by the United States of essential materials such as tin and rubber which are necessary for the normal economy of this country and the consummation of our defense program. The purchase of tin, rubber, oil, or other raw materials in the Pacific area on equal terms with other nations requiring these materials has never been denied to Japan. The steps which the Japanese Government has taken also endanger the safety of other areas of the Pacific, including the Philippine Islands.

The Government and people of this country fully realize that such developments bear directly upon the vital problem of our national security.

The Obama Administration Thinks That the Republican Members Do the Bidding of Wall Street

One would have thought that the first TARP vote would have given Obama, Geithner, and company pause. But as best as I can tell they sincerely believe that in the final analysis the House Republicans do not want the U.S. defaulting on its debt and S&P downgrading the country, and will reach a deal with the Senate and with Obama.

This seems to me to be a very narrow--and largely unfounded--materialist assessment of what is going on. Steve Benen thinks differently, and raises a possibility I have been fearing since November:

PIf Boehner prioritizes blame over success: House Speaker John Boehner says the short-term measure he plans to announce Sunday to avert a debt limit crisis may not get support from Democratic leaders, but he’ll push forward even without such backing. “The preferable path would be a bipartisan plan that involves all of the leaders, but it’s too early to decide whether that’s possible,” Boehner said on “Fox News Sunday.” “If that’s not possible, I and my Republican colleagues are prepared to move on our own.” Boehner said his plan would be based on the House Republicans’ Cap, Cut and Balance plan that cleared the House but was rejected in the Senate.

This is critically important. What Boehner is describing is a path that makes his caucus happy. What about the 60+ House Republicans who don’t want to raise the debt ceiling under any circumstances? And the need to pick up dozens of House Democratic votes? Boehner is thinking about a plan based on CC&B that would get enough Republican votes to pass, whether Dems like it or not.

There’s a Democratic Senate and a Democratic White House, but there’s a real possibility that House Republicans don’t care. Here’s how this would work: Boehner would reject all efforts to find a practical solution, pass a plan his caucus likes, and then announce that he’s done. “The House passed a bill,” the Speaker will say. “Whether the Senate approves it is up to them, but if they don’t, the crisis will be Democrats’ fault, not Republicans’.”

Boehner’s comments this morning — “I and my Republican colleagues are prepared to move on our own” — sounded a lot like a House leader who’s not even interested in finding a solution at all. His goal is likely to avoid blame, not to resolve the problem.

In other words, Boehner sees the car headed for the cliff, and appears ready to put a brick on the accelerator.

Debt Ceiling Watch: Ezra Klein Makes a Mistake (Nobooy Knows Department)

He doesn't talk to any investors. Instead he talks to… the people at the rating agencies who brought us the subprime mortgage crisis: And so we get:

A small deal won’t cut it: There’s no longer much space to be creative, or incremental, or indecisive, on the debt ceiling. Perhaps there was two or three or four months ago. If we had raised it clean, or attempted the McConnell deal, or invoked the 14th Amendment, or gone for a series of short-term increases, that might have been enough. It isn’t now. Three months ago, all we had to do to keep the markets calm was raise the debt ceiling. Today, if all we do is raise the debt ceiling, there’s a very good chance the markets will turn on us anyway…. It’s about keeping the market confident in our ability to pay our bills, both now and in the future…. And Congress, unfortunately, has made that job a lot harder. A year ago, the market didn’t question our ability to raise the debt ceiling, nor our ability to come to a deficit deal in some reasonable period of time…. But we didn’t take their advice. We yoked the deficit to the debt ceiling….

And so the market reacted. Now the question isn’t simply whether we can raise the debt ceiling and pay our bills; it’s whether we can make the sort of tough choices necessary to pay our bills later. Standard Poor’s, for one, has sharply moved the goalposts. Now they say that if “Congress and the Administration have not achieved a credible solution to the rising U.S. government debt burden and are not likely to achieve one in the foreseeable future,” then they could downgrade us “in the next three months.”…

Simply increasing the debt ceiling might have sufficed a few months ago. It probably won’t now. That goes double for a solution relying on the 14th Amendment, which would add legal uncertainty to an increase in the debt ceiling and show that our broken political system has forced us into completely unprecedented and unpredictable territory. A short-term increase in the debt ceiling, as some Republicans have called for, is also likely to affirm the market’s fears that we can’t make tough compromises.

The market did not tie the debt ceiling to a $4 trillion deal on the deficit. Washington did. But now that it’s not clear that Washington can get the deal, the market may not let it undo the knot.


Ezra Klein: Earlier today, I spoke with David Beers, director of Standard Poor’s sovereign debt department. He explained that it wasn’t economic factors that had put America’s credit rating at risk, nor world events. It was credit-rating agency’s increasing fears that our political system was no longer up to the challenges that face it. “What we’re saying now,” said Beers, “is we question whether despite all the discussions and intense negotiations, if they can’t reach this agreement, will they be able to reach it after the election?”

If we convince Standard Poor’s that our political system has failed, they will downgrade our credit within three months. If they do that, interest rates on our debt will spike, perhaps by 50 basis points, perhaps by more. An easy rule of thumb is that if interest rates rise by 50 basis points, we will lose 600,000 jobs in this country.

At this point, there are three serious options on the table. A $4 trillion deal that includes some revenues, a $1 trillion-$2 trillion deal that’s all spending cuts but leaves much of the job until after the election, and a deal in which Republicans don’t come to a negotiated agreement with President Obama but they grant him the authority -- and let him take the blame -- for raising the debt ceiling. Those are our three options, and Congress needs to pick one. Time is running short.

But there are more very serious options than those three. There is the very serious option of passing a clean increase in the debt ceiling. Or there is the very, very serious option of the Treasury declaring the debt ceiling a dead letter. And then there are the other, more amusing options as well.

The simple fact is that the markets have not linked the short-run debt ceiling debate to America's long-term fiscal imbalances. The markets have not yet judged the U.S. and found it wanting. Ezra shouldn't say that financial markets have done these two things when they have not.

The fact is that nobody knows what will happen to the Ten-Year Treasury yield if S&P downgrades the U.S. credit rating.

  1. The interest rate on the Ten-Year Treasury bond could spike.

  2. The interest rate on the bond could even fall--more chaos means a weaker global economy, and in a weaker global economy in the absence of inflation you should be holding more U.S. Treasury bonds, not fewer.

  3. The interest rate on the bond could stay where it is, as the two types of fear offset each other.

  4. The interest rate on the bond could stay where it is as markets laugh at S&P's chutzpah, at the institution that claimed that MBSs were safe now claims that U.S. Treasuries are risky.

  5. Demand for U.S. Treasuries could fall, but the yield could stay the same as some other large actor--the People's Bank of China or the Federal Reserve--steps in and buys long-term Treasury bonds in order to sataiblize the market.

I have talked over the past two weeks to at least one investor with substantial positions who himself is confident that each of these is the likely possibility.

The future is wide open.

Uncertainty is massive.

Now we should not be doing this. Doing things that have unknowable and quite possibly disastrous consequences is the very definition of stupidity. We should resolve the uncertainty today. And the only way to resolve the uncertainty today is for the Treasury's General Counsel to declare the debt limit a dead letter--implicitly repealed by a combination of Amendment 14 §4 and the Continuing Resolution appropriating spending through September 30, 2011.

But confidently speaking about what will happen in financial markets after talking only to regulators and politicians and not by talking to financiers and watching prices and volumes…

It Is Nice to Have Readers as Careful as Scarecrow…


President Barack Herbert Hoover Obama Explains How to Avoid a Depression: On several occasions after the Great Depression began, President Hoover admonished the public and those demanding the government provide economic relief that the nation had run out of money and that it would be irresponsible to borrow and engage in profligate spending. Over 80 years later, we are hearing virtually the same economic gibberish from President Obama.

From the President’s weekly address:

For years, the government has spent more money than it takes in.  The result is a lot of debt on our nation’s credit card – debt that unless we act will weaken our economy, cause higher interest rates for families, and force us to scale back things like education and Medicare.

Now, folks in Washington like to blame one another for this problem.  But the truth is, neither party is blameless.  And both parties have a responsibility to do something about it.  Every day, families are figuring out how stretch their paychecks – struggling to cut what they can’t afford so they can pay for what’s really important.  It’s time for Washington to do the same thing.  But for that to happen, it means that Democrats and Republicans have to work together.  It means we need to put aside our differences to do what’s right for the country.  Everyone is going to have to be willing to compromise.  Otherwise, we’ll never get anything done.

That’s why we need a balanced approach to cutting the deficit.  We need an approach that goes after waste in the budget and gets rid of pet projects that cost billions of dollars.  We need an approach that makes some serious cuts to worthy programs – cuts I wouldn’t make under normal circumstances.  And we need an approach that asks everybody to do their part.

And via Brad DeLong, here is President Hoover in 1932. In his Budget Message for fiscal year 1933, Hoover wrote:

In framing this Budget, I have proceeded on the basis that the estimates for 1933 should ask for only the minimum amounts which are absolutely essential for the operation of the Government under existing law, after making due allowance for continuing appropriations. The appropriation estimates for 1933 reflect a drastic curtailment of the expenses of Federal activities in all directions where a consideration of the public welfare would permit it…. The welfare of the country demands that the financial integrity of the Federal Government be maintained…. [W]e are now in a period where Federal finances will not permit of the assumption of any obligations which will enlarge the expenditures to be met from the ordinary receipts of the Government…. To those individuals or groups who normally would importune the Congress to enact measures in which they are interested, I wish to say that the most patriotic duty which they can perform at this time is to themselves refrain and to discourage others from seeking any increase in the drain upon public finances…

Gordon's Notes: What killed Intuit's Quicken?


Gordon's Notes: What killed Intuit's Quicken?: Yes, you can still buy something called "Quicken" for Windows…. No matter, Quicken is dead. The failure to produce a reasonable product for OS X is just another nail in the coffin. Intuit itself may well continue. Their share price has done well over the past two years, and the company has moved well beyond their original product line. They may even be earning money (one way or another) from Intuit's, a read-only Cloud product with a few cough privacy and security issues

It's not just Quicken. Back in the 80s and 90s personal financial software was a hot product niche…. So what happened to personal financial software?…. This would be my guess...

The banks stopped cooperating…. The ability to visit web sites and find current investment values was sufficient for a significant fraction of Intuit's customer base. The American middle class fragmented as wealth concentrated in less than 1% of the US population.

The last of these is, of course, the most interesting.

Quicken is not an interesting product for people with millions of dollars to manage…. Quicken is not an interesting product for people with very limited savings and investments, particularly if the investments are largely concentrated in 401K accounts. The natural market for Quicken was individuals and families with significant financial complexity but not wealth.

Over the past fifteen years that market went away…. In the end, I think the collapse of the American middle class killed Quicken.

James Hamilton: Effects of the Fed's large-scale asset purchases


Econbrowser: Effects of the Fed's large-scale asset purchases: Some Federal Reserve officials apparently have a rule of thumb for thinking about the impact of the Fed's large-scale asset purchases.... Brian Sack, Executive Vice President of the Federal Reserve Bank of New York, offered this assessment on Wednesday of what it would mean if the Fed were to decide from here on to let the assets it currently holds mature without rolling them over:

If all asset classes in the SOMA were allowed to run off, the portfolio would decline by about $250 billion per year on average over the first several years…. [T]his path for the balance sheet would, in terms of its effects on the economy, be roughly equivalent to raising the federal funds rate by just over 25 basis point per year over the course of several years.

Sack's proposed rule of thumb seems to be that each $100 billion decrease in the Fed's holdings of long-term securities would roughly correspond to what in normal times we'd measure with a 10 basis point increase in the fed funds rate…. In my research with Cynthia Wu, we… estimate that $400 billion in such purchases would only move the 10-year yield by about 10 basis points, or 2.5 basis points for each $100 billion….

G>ranted, Cynthia's and my estimates of the effects of LSAP are somewhat smaller than those obtained by other researchers, and any of these estimates are subject to considerable uncertainty. But these calculations illustrate that the Fed's rule of thumb could easily be off by a factor of two.

Richard Evans on Chancellor Bruening in 1931

In my email inbox, about Berlin, Summer 1931:

Fatally, however, [conservative German Chancellor] Brüning refused to [expand the currency supply], because he was nervous that printing money that was not tied to the value of gold would cause inflation. Of all the long-term effects of the German inflation, this was probably the most disastrous. But it was not the only reason why Brüning persisted with his deflationary policies long after feasible alternatives had become available. For, crucially, he also hoped to use the continuing high unemployment rate to complete his dismantling of the Weimar welfare state, reduce the influence of labour and thus weaken the opposition…. The bank crisis put into Brüning's hands another card that he was unwilling to use… [but] he did nothing, even though the means of escape were now there and voices were already being raised in public in favour of stimulating demand through government-funded job-creation schemes.

Richard J. Evans, The Coming of the Third Reich, pp. 253-254

Elizabeth Drew Tries to Make Sense of Barack Obama

Paul Krugman summarizes:

President Pushover : The redoubtable Elizabeth Drew has a forthcoming article in the New York Review of Books — not yet online — that confirms all our worst fears. She tells us that past concessions have

established in both Democrats’ and Republicans’ minds the thought that Obama was a weak negotiator—a “pushover.” He was more widely seen among Democrats and other close observers as having a strategy of starting near where he thinks the Republicans are—at the fifty-yard line—and then moving closer to their position. Even more alarming, however, is her window on what the White House is thinking:

It all goes back to the “shellacking” Obama took in the 2010 elections. The President’s political advisers studied the numbers and concluded that the voters wanted the government to spend less. This was an arguable interpretation. Nevertheless, the political advisers believed that elections are decided by middle-of-the-road independent voters, and this group became the target for determining the policies of the next two years.

OK, I’ve never won a tough election. But neither has Obama! The 2008 race was looking close until Sarah Palin and Lehman came along. And as far as I can tell, this assessment both of what 2010 was about and what matters for 2012 is just ludicrous.

As I recall, two things happened last year: voters were angry about the weak economy, and older voters believed that Obama was going to take away their Medicare and send them to the death panels. And so the way to win those voters back is to cut Medicare and weaken the economy?

A further point: even if Obama really does cut spending, will anyone notice? Even people who are supposedly well informed believe that there was a vast expansion of government under Obama, when in fact there wasn’t. So we’re supposed to believe that independent voters will actually be able to cut through the fog — the deliberate fog of Fox, the he-said-she-said of most other media organizations — and give him credit for spending cuts? Remember, whatever he does Republicans will claim that the government is getting bigger — and news organization will report only that “Democrats say” that this isn’t true.

Clarifying Some Misunderstandings about the “Gang of Six” Plan

Bob Greenstein:

Off the Charts Blog: Some of the early reporting on the deficit reduction plan that the Senate’s “Gang of Six” released today appears to have incorrectly or incompletely described two principal elements of the plan:  its reductions in health care programs and its revenue increases.

Some reports today have said that the Gang of Six agreed to expand its health care cuts by $117 billion to convince Senator Coburn to return to the Gang.  Other reports seem to have assumed that the $1 trillion in revenue that the Gang of Six plan would raise over the next 10 years is similar in amount to the $1 trillion in revenue that was purportedly part of the $4 trillion deficit reduction plan that the White House and Congressional leaders were discussing before Speaker Boehner pulled the plug on it 10 days ago.  Neither of these reports or assumptions is correct.

The Gang of Six could not reach agreement on the size of reductions in health care entitlement programs (Medicare, Medicaid, CHIP, and various provisions of the health reform law).  As a result, the Gang’s documents show two different levels of cuts in these programs, with some members of the Gang supporting the lower level and some supporting the higher level....

The Gang of Six plan calls for $1 trillion in higher revenues over ten years... [at] the same revenue baseline concept as the Bowles-Simpson commission (and as President Obama’s 2012 budget and his April budget framework).  This is the so-called “plausible” baseline, which assumes the President and Congress make permanent the Bush tax cuts for people with incomes under $250,000, while letting the tax cuts for people over $250,000 expire on schedule at the end of 2012. One trillion dollars in added revenue over the “plausible baseline” is very different from $1 trillion in added revenue relative to a baseline that assumes all of the Bush tax cuts become permanent — including those for people who make over $250,000 a year.  The $1 trillion in revenues in the $4 trillion deficit-reduction plan that Speaker Boehner walked away from used this lower revenue baseline...

Department of "Huh?!": Libertarians Forecast Inflation Department

Timothy B. Lee:

Why Are Libertarians Inflation Hawks?: Two years ago, my friend Matt Yglesias ... irritated [me]... and [I] made a note to myself to check back in a few years and see how things turned out.... I don’t think we have enough data yet to reach a decisive verdict. It’s possible that that the most recent measurement of 3.6 percent inflation portends a major price rise over the next few months—though the “core” inflation rate of just 1.6 percent suggests otherwise...

Not just the core inflation rate: the wage inflation rate, the level of the unemployment rate, financial market forecasts of inflation, forecasts of inflation by private-industry agents who make their money off of clients who pay for their forecasts rather than politicians who pay for air cover, et cetera, et cetera, et cetera.

Many things are "possible" in this wide green world. But I am having a hard time right now thinking of a bet that has a lower expected payout than the bet that the most recent price-inflation number portends a rise in inflation over the next few months back to, say, Reagan-Bush administration levels...

Drums Along the Firth of Forth: Andrew Gelman Tries to Understand How Economists Think...

Make that "whether economists think"...

Andrew Gelman:

One of the easiest ways to differentiate an economist from almost anyone else in society: Pop economists (or, at least, pop micro-economists) are often making one of two arguments:

  1. People are rational and respond to incentives. Behavior that looks irrational is actually completely rational once you think like an economist.

  2. People are irrational and they need economists, with their open minds, to show them how to be rational and efficient.

Argument 1 is associated with "why do they do that?" sorts of puzzles.... Argument 2 is associated with "we can do better" claims such as why we should fire 80% of public-schools teachers.... The trick is knowing whether you're gonna get 1 or 2 above. They’re complete opposites!... Steven Levitt:

One of the easiest ways to differentiate an economist from almost anyone else in society is to test them with repugnant ideas. Because economists, either by birth or by training, have their mind open, or skewed in just such a way that instead of thinking about whether something is right or wrong, they think about it in terms of whether it's efficient, whether it makes sense. And many of the things that are most repugnant are the things which are indeed quite efficient, but for other reasons -- subtle reasons, sometimes, reasons that are hard for people to understand -- are completely and utterly unacceptable...

Isn;t it interesting, I thought, that Levitt is identifying economists as rational and ordinary people as irrational. That's argument 2.... In other settings... we'd hear him saying how everyone responds to incentives.... The two different arguments get pulled out as necessary.... Which in turn reminds me of this self-negating quote from Levitt protoge Emily Oster:

anthropologists, sociologists, and public-health officials . . . believe that cultural differences -- differences in how entire groups of people think and act -- account for broader social and regional trends. AIDS became a disaster in Africa, the thinking goes, because Africans didn't know how to deal with it. Economists like me [Oster] don't trust that argument. We assume everyone is fundamentally alike...

I love this quote for its twisted logic.... Economists are different from everybody else, because . . . economists "assume everyone is fundamentally alike"! But if everyone is fundamentally alike, how is it that economists are different "from almost anyone else in society"?...

My impression is that these quotes come from a simple division of the world into good and bad things:

  • Good: economists, rationality, efficiency, thinking the unthinkable, believing in “circumstances”

  • Bad: anthropologists, sociologists, public-health officials, irrationality, being deterred by repugnant ideas, believing in “culture”

Good is entrepreneurs, bad is bureaucrats. At some point this breaks down. For example, if Levitt is hired by a city government to help reform its school system, is he a rational, taboo-busting entrepreneur (a good thing) or a culture-loving bureaucrat who thinks he knows better than everybody else (a bad thing)? As a logical structure, the division into Good and Bad has holes. But as emotionally-laden categories (“fuzzy sets,” if you will), I think it works pretty well....

I'm just trying to understand how pop-economics can so rapidly swing back and forth between opposing positions.... It’s ok to distinguish economists from ordinary people (economists are rational and think the unthinkable, ordinary people don’t) and it’s also ok to distinguish economists from other social scientists (economists think ordinary people are rational, other social scientists believe in “culture”). You just have to be careful not to make both arguments in the same paragraph.

P.S. Statisticians are special because, deep in our bones, we know about uncertainty. Economists know about incentives, physicists know about reality, movers can fit big things in the elevator on the first try, evolutionary psychologists know how to get their names in the newspaper, lawyers know you should never never never talk to the cops, and statisticians know about uncertainty. Of that, I’m sure

The Drag on Economic Growth from Nathan Myhrvold, Patent Troll

Needless to say, the patent system really, really needs to be fixed: this is really, really damaging to us.

Alex Blumberg and Laura Sydell:

Intellectual Ventures And The War Over Software Patents : Planet Money : NPR: Myhrvold has more than 100 patents to his name, and he's cast himself as a man determined to give his fellow inventors their due. In 2000, he founded a company called Intellectual Ventures, which he calls "a company that invests in invention." But Myhrvold's company has a different image among many Silicon Valley insiders. The influential blog Techdirt regularly refers to Intellectual Ventures as a patent troll. IPWatchdog, an intellectual property site, called IV "patent troll public enemy #1." These blogs write about how Intellectual Ventures has amassed one of the largest patent portfolios in existence and is going around to technology companies demanding money to license these patents….

[P]eople at companies that have been approached by Intellectual Ventures don't want to talk publicly. "There is a lot of fear about Intellectual Ventures," says Chris Sacca, a venture capitalist who was an early investor in Twitter, among other companies. "You don't want to make yourself a target." Sacca wouldn't say if Intellectual Ventures had been in contact with any of the companies he's invested in. "I tried to put you in touch with other people in this community to talk to you about this and they almost uniformly said they couldn't talk to you," Sacca told us. "They were afraid to." IV has the power to "literally obliterate startups," Sacca says….

IV says it has invented a nuclear technology that's safer and greener than existing technologies. A cooler that can keep vaccines cold for months without electricity. And the world's most high-tech mosquito zapper.

But the lab is a tiny fraction of what IV does. The company has received about 1,000 patents on stuff it's come up with at the lab; it's purchased roughly 30,000 patents from other people. In fact, nothing that's come out of this lab — not the mosquito zapper, not the nuclear technology — has made it into commercial use…. Imagine an inventor out there — someone with a brilliant idea, a breakthrough. This inventor has a patent, but companies are stealing his idea. And this inventor doesn't have the money or legal savvy to stop them. That's where IV comes in. It buys this inventor's patent, and it makes sure that companies who are using the idea pay for it. When we asked for an example of an inventor in this situation, someone with a breakthrough, who wasn't getting paid for it, two separate people at IV pointed us to a guy named Chris Crawford…. So we went to talk to Chris Crawford. But that turned out to be harder than we thought — and it led us on a five month journey, where things did not quite fit the story Intellectual Ventures was telling.

When we followed up with IV to get Chris Crawford's contact info, the company told us it no longer owned Chris Crawford's patent. And Crawford probably wouldn't want to talk right now anyway, the company said, because he was in the middle of litigation. We started digging around and found Chris Crawford in Clearwater, Florida. As predicted, he never responded to our many emails and phone calls. You'll never hear from him in this story. But we were able to locate Chris's patent — number 5771354. He got it in 1998. And the way IV explained the patent to us, Chris Crawford invented something that we do all the time now: He figured out a way to upgrade the software on your home computer over the Internet. In other words, when you turn on your computer and a little box pops up and says, "Click here to upgrade to the newest version of iTunes," that was Chris Crawford's idea.

But when we looked at the patent, it seemed to claim a lot more than that. The name of the actual invention is "an online back-up system." The patent says this invention makes it possible to connect to an online service provider to do a bunch of stuff — software purchases, online rentals, data back ups, information storage. The patent makes it seem like Chris Crawford invented a lot of the most common things we do on the Internet. We weren't sure what to make of all this, so we went to see David Martin, who runs a company called M-Cam. It's hired by governments, banks and business to assess patent quality, which the company does with a fancy piece of software. We asked Martin to assess Chris Crawford's patent. At the same time Crawford's patent was being prosecuted, more than 5,000 other patents were issued for "the same thing," Martin says. Crawford's patent was for "an online backup system." Another patent from the same time was for "efficiently backing up files using multiple computer systems." Yet another was for "mirroring data in a remote data storage system." And then there were three different patents with three different patent numbers but that all had the same title: "System and method for backing up computer files over a wide area computer network."

Martin says about 30 percent of U.S. patents are essentially on things that have already been invented. In 2000, for example, the patent office granted a patent on making toast — patent number 6080436, "Bread Refreshing Method." We also asked Rick McLeod, a patent lawyer and former software engineer, to evaluate Chris Crawford's patent. "None of this was actually new," he told us….

This brings us back to Chris Crawford's patent, the patent Intellectual Ventures cited as an example of how they encourage innovation by ensuring that inventors get paid. As we've said, this patent also seems to cover a big chunk of what happens on the Internet: upgrading software, buying stuff online, and what's called cloud storage. If you have a patent on all that, you could sue a lot of people. And, in fact, that's what's happening with Chris Crawford's patent. Intellectual Venures sold it to a company called Oasis research in June of 2010. Less than a month later, Oasis Research used the patent to sue over a dozen different tech companies, including Rackspace, GoDaddy, and AT&T. We called Oasis several times, but no one ever answered the phone. For a while, the company's voice mail message directed all questions to John Desmarais , a lawyer in New York. He didn't return our phone calls, but we did track him down at an intellectual property conference in San Francisco. He cited attorney-client privilege, and wouldn't tell us anything — not even who owns Oasis Research. (He did say he's a big fan of NPR.)…

The office was in a corridor where all the other doors looked exactly the same —locked, nameplates over the door, no light coming out. It was a corridor of silent, empty offices with names like "Software Rights Archive," and "Bulletproof Technology of Texas." It turns out a lot of those companies in that corridor, maybe every single one of them, is doing exactly what Oasis Research is doing. They appear to have no employees. They are not coming up with new inventions. The companies are in Marshall, Texas because they are filing lawsuits for patent infringement. Patent lawsuits are big business in Marshall, which is part of the eastern district of Texas…. We did find one key detail about Oasis Research. It was in a legal document called a Certification of Interested Parties, which lists all the entities with a financial interest in Oasis. Tom Ewing, an intellectual property lawyer who makes a business of tracking IV, brought it to our attention. The Oasis document lists the usual parties — the plaintiff, the defendants, the attorneys involved. But it also includes one other name: Intellectual Ventures. Peter Detkin, an attorney who co-founded Intellectual Ventures with Nathan Myhrvold, told us that IV likely has a "back-end arrangement" with Oasis…. Intellectual Ventures is taking a cut of whatever money Oasis gets from its lawsuits. Oasis is a company with no operations, no products, and, as far as we can tell, no employees, that is using a very broad patent from 1998 to sue over a dozen companies.

As it happens, Detkin is the man who coined the term "patent troll." He came up with it back in in 1999, when he was working for Intel.

We asked him how it feels to make money from an entity that's behaving much like the patent trolls he once condemned. He said:

These are patents we used to hold, we no longer hold. And we ensure that we have no control over the actions of these third parties. They are independent actors. They are not Intellectual Ventures. They may be monetizing in ways we disagree with, but it's not our call….

We asked if he could point us to a patent that was languishing, but then got licensed and built. "There were two deals that were done," he said. "One was with a toy company. The other was... I can't remember the technology, it was out there last Christmas, but I don't know how it's done."…

For this story, we called people who had licensing arrangements with IV, we called people who were defendants in lawsuits involving IV patents, we called every single company being sued by Oasis Research. No one would talk to us. Part of this is probably fear. Part of it is the fact that agreements with Intellectual Ventures include a non-disclosure agreement that's rumored to be the strictest in Silicon Valley...

So What Happens on August 2?

Here's one possibility:

John Boehner passes his preferred debt ceiling bill through the House...

Harry Reid brings it up in the Senate, and amends it by stripping out all extraneous provisions to leave a clean debt-ceiling increase…

Republicans filibuster…

Harry Reid invokes cloture…

Cloture fails with fewer than 60 votes…

Joe Biden rules that Amendment 14 §4 is inconsistent with the filibuster rule, and declares that debate is closed…

Joe Biden calls the roll of the Senate…

What happens next?

The Heritage Filter: Does America Have a Future in Which There Are Smart Conservatives?

Preview of  Untitled 1

Matthew Yglesias:

Having Plunged Previously, After The Affordable Care Act Passed Private Sector Employment Increased: [P]rivate sector employment has grown after the passage of the Affordable Care Act. But the “math is hard” crowd at the Heritage [Foundation] has discovered that by taking the second derivative of employment you can create a “trend” that makes the ACA look bad. It’s very ingenious. And judged by my Twitter feed, there are actually some conservatives out there who are gullible enough to be taken in by this kind of thing. Clearly, though, no fair-minded person actually interested in the subject is going to be persuaded by this kind of nonsense. I think it’s really too bad that conservative institutions spend a fair amount of time and energy on projects whose only possible effect can be to mislead their own constituency.

John Stuart Mill famously wrote to John Pakington:

I never meant to say that the Conservatives are generally stupid. I meant to say that stupid people are generally Conservative. I believe that is so obviously and universally admitted a principle that I hardly think any gentleman will deny it.

It is quite possible that we are moving into a future in which John Stuart Mill will turn out to be wrong.

If so, I think it will be because of the Heritage Foundation filter. To be a conservative in America today, you see, you have to take the publications of the Heritage Foundation seriously. But as more and more Heritage makes arguments like:

Before the passage of the ACA things were getting worse, but getting worse more slowly as time passed. Since the passage of the ACA things have been getting better. Therefore the ACA made things worse!

it becomes less and less possible for anybody even moderately intelligent and thoughtful to take the Heritage Foundation seriously.

That means that even the moderately intelligent and thoughtful will find themselves being read out of the conservative movement.

As somebody who thinks and has always thought that we need smart conservatives, this is very disturbing to me...

James Fallows on David Leonhardt


David Leonhardt of the NYT: There's only one downside to the news that David Leonhardt will become the new Washington bureau chief for the New York Times: presumably it means that he will do less writing on his own. It is still too rare to find in mainstream journalism people who are (a) comfortable enough with the language, conventions, and math of formal economics to be able to write confidently about the substance of economic issues, rather than just reporting the politics of the issues in a "critics claim..." / "will Obama be vulnerable?" way; but also (b) detached enough from those conventions and shibboleths to be able to report clearly and confidently about what economic specialists get right and wrong.

In recent years Leonhardt's columns and blog posts have demonstrated exactly those two strengths. Regular readers know that -- and so, apparently, did the (sometimes wacky or log-rolling) judges of the Pulitzer committee, who awarded him this year's prize for commentary.  Just a few samples: a column last year on the relationship between the health-care reform bill and the polarization of the American economy; a blog post on tax policy; and a magazine piece about the Chinese economy that was far more discerning and non-gape-jawed than the predictable "I've just gotten here, and these Chinese can do anything!!" visitor's report. Plus two more about China.

Congratulations to Leonhardt (whom I know slightly); congratulations to the Times and its incoming editor, Jill Abramson, for deciding that this was the right outlook to reward in Washington coverage; hey, congrats all around. Let's hope that in exchange for the columns he won't be writing he'll be extending this sensibility to bureau coverage as a whole. 

D-Squared Argues for Industrial Policy--of a Sort


D-squared Digest -- FOR bigger pies and shorter hours and AGAINST more or less everything else: The world's second lowest productivity industry: Unemployment. Furthermore, despite decades of technological advance in the rest of the economy, unemployment remains stubbornly at the bottom of the pile. There have been no major efficiency gains in unemployment in the last hundred years.

Normally I am sceptical of industrial policy, but when the government starts talking about moving resources out of unemployment, I think there is good reason to believe that they might be picking a winner...

Where Is Our Carbon Tax Proposal?

I understand why the Republicans haven't proposed a carbon tax--they, after all, aren't worried about the deficit. They like the deficit because it gives them an excuse to cut spending, and once they have cut spending they can then cut taxes on high income Americans, recreate the deficit, and then cut spending again.

But I don't understand why Obama hasn't proposed a carbon tax.

Ryan Avent:

Climate change: It's hot out there: A "HEAT dome" is descending on Washington. It's hovering over much of America, actually, sending temperatures into triple digits (or the upper 30s, if you prefer). This is just the latest in what has been a remarkable series of extraordinary weather events. America's south is experiencing a record drought. So, too, is the horn of Africa, where a famine may impact millions of people. In late June, an airport in Oman recorded the highest ever low temperature; on the evening of the 27th, the mercury failed to drop below 107 degrees Fahrenheit. Droughts, floods, deadly storms: the news is full of them. While it's not easy to attribute any individual event to climate change, it is clear that a hotter planet translates into a higher frequency of extreme weather events.

When we emit carbon into the atmosphere, we impose a tiny negative cost on society as a whole in the form of more rapid global warm and a greater intensity of the accompanying social ills. Views of the magnitude of this cost differ. Many studies peg it at somewhere between $5 and $150 per tonne of carbon. Other  studies indicate that it could be far higher—perhaps more than $1,000 per tonne. But the cost is positive, and a crucial first step to dealing with climate change, therefore, is to charge people for the carbon they emit. If you put a positive price on carbon, this price will be reflected in the cost of transactions, people will internalise the effect of their behaviour on the climate, and emissions will fall.

This is a pretty straightforward policy solution, and it's one that's been embraced by economists and various other wonks for years....

[I]t's nonetheless noteworthy that in the whole of this major American fiscal debate no one has proposed taxing carbon. Forget the nitpicks; it would be easy to design a tax so that it didn't kick in right away, and so that its impact would be progressive. But people in Washington would literally laugh in your face if you presented a carbon tax as a good policy choice to include in a deficit-reduction package. Whether or not the American government wiggles through this self-created disaster without wrecking the economy, that's a good reason for long-run pessimism.

Dr. Pangloss and Serial Correlation in Asset Values

Almost all of the time economists argue like this:

The value of an asset today depends on what its cash flow is going to be over the next year and on what its value is expected to be in a year, and its value in a year depends on what its cash flow is expected to be between one and two years from now and on what its value will be in two years, and its value in two years depends on what its cash flow is expected to be between two and three years from now and on what its value will be in three years, and so on. So the value of an asset today will be the present discounted value of future cash flows between now and infinity--which means that if the chance of anything unpleasant happening in the future, even the distant future, rises today, that rise shows itself in a fall in the price of the asset right now.

It disturbs Nick Rowe that this doesn't seem to work:

Worthwhile Canadian Initiative: Why does stuff take so long to happen?: For example, the Eurozone crisis. A couple of decades back, I noticed that things often seemed to happen the way economists thought they would happen, but that they always seemed to take about ten times longer to happen than you would have thought they would. We go from one equilibrium to another equilibrium in a few seconds on the chalkboard. It seems to take forever in the real world.

I just read the latest Europe Update on Calculated Risk. And again this morning on Eurointelligence. I then re-read all my old posts on the Eurozone.... Two years, or even one year ago, what I was writing about the Eurozone was an extreme view. Now it's fairly mainstream. There is little in those old posts I would want to change. I have nothing new to add. Things have been slowly getting worse over the last two years. I could feel vindicated. Events have been proving me right (so far). "Look at me! I'm a brilliant economic forecaster, and should be commanding megabucks in speaking fees and throwing wild parties". But maybe I just got lucky....

Some people believe the eurozone crisis is a liquidity crisis. Some people believe it is a solvency crisis. And some, like me, believe you can't really separate the two....

Take liquidity crises first.... [A] sunspot causes people to expect a run... everyone... [tries] to get their cash out... before everyone else gets to the bank.... One minute we are in the good equilibrium, with no run. Then bang!... A "slow motion bank run" is an oxymoron. And yet that seems to be just what has been happening.

Solvency crises don't depend on multiple equilibria, but on changing fundamentals... on expectations of those fundamentals -- whether people expect Greece will be able to pay.... [T]hose expectations should not change slowly and predictably.... Expectations of what will happen at some fixed future time ought to follow a random walk (a martingale, to be precise), where the next move is as likely to be up or down.

Instead, interest rates on Greek and Irish debt have been slowly trending up. Now sure, a martingale can trend up, or down, for a prolonged period, just as you can get 10 heads in a row from a fair coin. But it's unlikely. It's not what I would have expected....

I don't understand why it is taking so long.

But suppose the smart-money traders are risk-averse and credit-constrained. And suppose that there are some dumb-money traders who think the future will be like the past. And suppose there are other traders who believe that they are gambling with the government's money--that if their portfolios crash they will get bailed out, and their view of the chance of rescue-if-crash changes slowly over time. And suppose that there are other traders who used to be the smart nimble money and who think that they are still the smart nimble money--that they will hear the real news first when it arrives, and then trade at old false non-equilibrium prices just at the start of the crash. And suppose that there are other traders who really are the smart nimble money.

Then the law of iterated expectations is unlikely to hold. Instead, you are more likely to get a price pattern that looks more like Paul Krugman's Pangloss value--what is the best that things might possibly be--or a weighted average of iterated rational expectations and Pangloss values. And--if limits to arbitrage bind--is there any reason why the Pangloss value might not evolve over time in the way that puzzles Nick? I think not...

You could say something similar about the U.S. Ten-Year Treasury right now. Indeed, I have been told of two dinners and a lunch, both relatively recently, at which all at the table claimed to still be long Treasuries because they all expected to be the first to hear the news that the U.S. Treasury is going to move and to sell before the price dropped...

The minute the Federal Reserve Bank of New York unexpected raises the Fed Funds target rate by 25 basis points is going to be a very interesting minute indeed, whenever it comes...

My Mommy Always Said There Were No Monsters--No Real Ones--But There Are

Robert Lamb:

Parasitic Wasp Employs Zombie Ladybug to Guard Cocoon: [A] wasp that not only hatches from its egg inside the belly of a ladybug, but upon emerging forces its eviscerated host to guard its cocoon while it transitions from larva to full-grown horror wasp. Dinocampus coccinellae is its name…. [T]he angiosperms introduced… nectar and pollen. So the wasps of old largely abandoned their flesh-eating ways, except for the carnivorous feasts required by their squirming young…. So the fact that that Dinocampus coccinellae hatches inside the belly of a host bug following some makeshift, catastrophic surgery by its parent is nothing out of the ordinary. But when it celebrates its Chest-Burst Mitzvah, that’s when it gets all weird and noteworthy. Normally, the host organism mercifully dies at this point, but DC’s ladybug is not so lucky. Not only does it live, but a little behavior modification forces it to hang around and “guard” its parasite-baby as it grows into adulthood beneath its protective bulk. Scientists believe that secretions left by the larva when it bursts out might play a role in reprograming the host.

But then the ladybug dies right? Surely once the wasp reaches adulthood, our long-suffering host can at last rest in peace. No such luck. This is the insect world, after all. The researchers found that 25 percent of the manipulated ladybugs recovered normal behavior following their ordeal.

I’m really hoping this makes it into the next PIXAR A Bug’s Life movie...

Franklin Roosevelt Liveblogs World War II: July 21, 1941



Last year the Congress of the United States recognizing the gravity of the world situation held that common prudence required that American defence, at that time relatively very weak, be strengthened in its two aspects. The first called for the production of munitions of all kinds. The second called for the training and service of personnel. The Selective Training and Service Act authorized the annual induction into military service of a maximum of 900,000 men for this training and service, of whom 600,000 are now in the army. The Congress also authorized the induction into service of the National Guard, the reserve officers, and other reserve components of the Army of the United States.

In the absence of further action by the Congress, all of those involved must be released from active service on the expiration of twelve months. This means that beginning this Autumn about two-thirds of the Army of the United States will begin a demobilization.

The action taken last year was appropriate to the international situation at that time. It took into consideration the small size and the undeveloped state of our armed forces. The National Guard, which then formed the bulk of these forces, had to be seasoned; its technical training and general efficiency greatly improved. The ranks of the National Guard and the Regular Army had to be brought to full strength; and, in addition, the army required for its tremendous expansion the services of approximately 50,000 reserve officers.

In effect, two steps were taken for the security of the nation. First, the Selective Service Act initiated annual military training as a prime duty of citizenship. Second, the organization and training of field armies was begun-training in team-work-company by company, battalion by battalion, regiment by regiment, and division by division. The objective was to have ready at short notice an organized and integrated personnel of over 1,000,000 men.

I need scarcely emphasize the fact that if and when an organized and integrated company, battalion, regiment or division is compelled to send two-thirds of its members home, those who return to civil life, if called to the colors later on, would have to go through a new period of organization and integration before the new unit to which they were assigned could be depended on for service. The risks and the weaknesses caused by dissolving a trained army in times of national peril were pointed out by George Washington over and over again in his Messages to the Continental Congress.

It is, therefore, obvious that if two-thirds of our present army return to civilian life, it will be almost a year before the effective army strength again reaches one million men.

Today it is imperative that I should officially report to the Congress what the Congress undoubtedly knows: that the international situation is not less grave but is far more grave than it was a year ago. It is so grave, in my opinion, and in the opinion of all who are conversant with the facts, that the army should be maintained in effective strength and without diminution of its effective numbers in a complete state of readiness. Small as it is in comparison with other armies, it should not suffer any form of disorganization or disintegration.

Therefore, we would be taking a grave national risk unless the Congress were to make it possible for us to maintain our present full effective strength and during the coming year give training to as many additional Americans as we can, when immediate readiness for service becomes more and more a vital precautionary measure, the elimination of approximately two-thirds of our trained soldiers, and about three-fourths of the total officer personnel, would be a tragic error.

Occasional individuals, basing their opinions on unsupported evidence or on no evidence at all, may with honest intent assert that the United States need fear no attack on its own territory or on the other nations of this hemisphere by aggressors from without.

Nevertheless, it is the well-nigh unanimous opinion of those who are daily cognizant, as military and naval officers and as government servants in the field of international relations, that schemes and plans of aggressor nations against American security are so evident that the United States and the rest of the Americas are definitely imperiled in their national interests. That is why reluctantly, and only after a careful weighing of all facts and all events, I recently proclaimed that an unlimited national emergency exists.

It is not surprising that millions of patriotic Americans find it difficult in the pursuit of their daily occupations and in the normal lives of their families to give constant thought to the implications of happenings many thousand of miles away. It is hard for most of us to bring such events into focus with our own readily accepted and normal democratic ways of living.

That is why I must refer again to the sequence of conquests-German conquests or attacks-which have continued uninterruptedly throughout several years-all the way from the coup against Austria to the present campaign against Russia....

I realize that personal sacrifices are involved in extending the period of service for selectees, the National Guard and other reserve components of our army. I believe that provision now can and will be made in such an extension to relieve individual cases of undue hardship, and also to relieve older men who should, in justice, be allowed to resume their civilian occupations as quickly as their services can be spared.

Nevertheless, I am confident that the men now in the ranks of the army realize far better than does the general public, the disastrous effect which would result from permitting the present army, only now approaching an acceptable state of efficiency, to melt away and set us back at least six months while new units are being reconstituted from the bottom up and from the top down with new drafts of officers and men.

The legislation of last year provided definitely that if national danger later existed, the one year period of training could be extended by action of the Congress.... I am not asking the Congress for specific language in a specific bill. But I can say frankly that I hope the Congress will acknowledge this national emergency either for a specific period or until revocation by the Congress or the President....

At great cost to the nation, and at increasing dislocation of private buying, we are accepting the material burdens necessary for our security. In such matters we accept the fact of a crisis in our history.

It is true that in modern war men without machines are of little value. It is equally true that machines without men are of no value at all. Let us consolidate the whole of our defense-the whole of our preparation against attack by those enemies of democracy who are the enemies of all that we hold dear.

One final word: time counts. Within two months disintegration, which would follow failure to take Congressional action, will commence in the armies of the United States. Time counts. The responsibility rests solely with the Congress.

Our Economic Problems: Larry Summers Is on Message

Felix Salmon sends us to the Walter Isaacson interview:

The smart and charming Larry Summers: I think the biggest problem the country has right now is not the budget deficit. The biggest problem the country has right now is the jobs deficit. Yes, there’s a risk that we will misplay things and make the mistakes of the 1970′s, and have inflation and have excessive borrowing. But far and away the larger risk is that we will make the mistakes of 1937, and that we will not have a recovery that is sustained, that we will make the mistakes that Japan made, and that we will have a decade or two of stagnation. The right question to be focused on is how to stimulate demand.

Look out there, guys. The Treasury bond rate, Treasury note rate for ten years is 2.85 percent. Nobody is failing to invest because 2.85 percent is too much. They are failing to invest because there are no customers in their store. They are failing to invest because their factories are sitting empty. They are failing to innovate because they’re not sure how large the market for the product will be. That is the problem that we need to address. By the way, an extra percent a year on the growth rate for the next five years will do more for the budget than any amount of the entitlement-cutting that’s under discussion.

So I think the President has been right to be focused, and I think he could even focus more intensely on what is, I think, the central problem, which is how to get enough demand and enough confidence going, so that this economy achieves escape velocity from the recession. We’ve been flying out of the recession, but we’ve been flying out of it dangerously close to stall speed, and doing something about that should be our top priority. I mean it is crazy.

MR. ISAACSON: Does that mean more stimulus?

DR. SUMMERS: Well, you can call it that. That’s one part of it. It is crazy if you think about it, that we have schools across this country where we tell our kids that education is the most important thing in the world, but we ask them to study in classrooms where the paint is chipping off the walls. We can borrow money to invest in fixing that, at 2.8 percent. Twenty percent of the people in the country who are doing construction are unemployed, and we’re not trying to do something about that, when we have a major demand problem? It just doesn’t make any sense. We have infrastructure in this country — I mean you can argue whether we need a new high speed rail system or whether we don’t need a new high speed rail system. But I don’t know what the argument is for letting bridges collapse. I don’t know what the argument is.

I mean every time, and unfortunately it’s fairly often, I fly in and out of Kennedy Airport to any other airport in the world that you might fly to from Kennedy — you can fly to Europe, you can fly to Asia, any of those places, and you compare Kennedy Airport with the airport where you land, and you ask yourself which is the airport of the greatest country, richest, most powerful country in the world? I mean, and you know, you can say airports aren’t that important or whatever. But it is symbolic of an approach to infrastructure that probably never made any sense, and certainly doesn’t make any sense when you can borrow money at 2.8 percent and you’ve got 20 percent of the construction workers unemployed. So I’d rather see us focus on the jobs deficit. I’d rather see us focus on the public investment deficit. I’d rather see us focus on the human capital deficit. Those are deficits that we need to focus on also.

Yes, in the long run right now, thanks mostly to what happened during the Bush administration, the United States of America taxes 14 percent of GDP. Fourteen percent. That’s about four and a half percent below the average of what we’ve done over the post World War II period, and we now have the oldest population that we’re ever going to have, a larger debt than we had before. We have, apart from the aging of the population, a public sector that’s heavily involved in health care, and in every country in the world, health care has grown relative to GDP. The idea that somehow 14 percent is adequate, or that the priorities starting at 14 percent should be to cut taxes, is crazy...

The Jobless Recovery Continues

Economagic Economic Chart Dispenser

The jobless recovery continues.

Shannon Bond at the FT:

US jobless claims rise to 418,000: More Americans filed for unemployment insurance last week as the US labour market continued to struggle amid widespread uncertainty over the stalling economy. Initial claims for jobless benefits rose by 10,000 to 418,000 in the week ending July 16, the labour department said, higher than the 410,000 economists had expected. The tally included 1,750 lay-offs in Minnesota due to the state government shutdown. The four-week moving average of initial claims fell by 2,750 to 421,250.

“We are still waiting for this series to break 400,000 and make meaningful strides downward before we can truly say that the labour market is back on track,” said David Semmens, US economist at Standard Chartered. “The most worrying thing is that it’s showing an uninspiring start to hiring in the third quarter.” While many US companies are reporting strong second-quarter earnings this week, hiring is not likely to pick up until the productivity of existing workers begins to decline, Mr Semmens said.

In addition, “the distortions caused by the annual auto shutdowns at this time of year make it very hard to work out exactly what is happening,” noted Ian Shepherdson, chief US economist at High Frequency Economics. “The auto effect will fade over the next couple of weeks but in the meantime the claims numbers need to be viewed with scepticism.”

Economists' Views of Fiscal Policy: RetCon Department

Scott Sumner--who if he thought about it for long I think would conclude that this isn't wise--lumps Robert Barro together with John Cochrane and Eugene Fama and tries to defend them.

First, Barro does not belong in that basket: I think Barro is mistaken in his belief that right now fiscal policy multipliers are probably less than one, but he has reasons and analytically coherent reasons for thinking so--and they are not the reasons Sumner ascribes to him. By contrast, I cannot find an analytically coherent argument in Fama and Cochrane at all.

Sumner interprets Cochrane (and Barro!) as:

A Slightly Off-Center Perspective on Monetary Problems: basically saying: “if we hold nominal spending constant, fiscal policy can’t fix it.”... [I]t’s really rather sad when people like Krugman and Brad DeLong keep insisting that these guys don’t understand basic macro principles.... I don’t know for sure that Fama was using the same implicit assumption... [but] I think it quite likely that Fama was also cutting corners.... Lots of brilliant people talking past each other.... Welcome to elite macroeconomics, circa 2011.... If I was going to assign blame I’d single out Krugman/DeLong for rudeness and Fama/Cochrane for poor communication skills.

But the argument that Sumner attributes to Cochrane and Fama (and, wrongly, to Barro) is not a coherent argument: if you say "if I assume that fiscal policy does not affect nominal spending then fiscal policy does not affect nominal spending, and so I have proved my case" you haven't made an argument at all.

A coherent argument would argue, somehow, somewhere, that expansionary fiscal policy--the government selling bonds and buying stuff--does not increase nominal GDP. A coherent argument would have to succeed in arguing both of the following:

  • Even though the government is a very large organization that does not need to back each dollar of its spending by the same amount of transactions cash money as private households, when the government ramps up its spending the extra transactions cash balances it needs to hold will lead to a reduction the transactions cash balances in the hands of households, and they have to shrink their spending by the same amount that the government increased it.

  • Even though right now short-term safe nominal interest rates are zero and a great many households and businesses are holding cash as a safe savings vehicle rather than treating it as part of their transactions cash balances, nevertheless bond sales by the Federal Reserve will not lead households and businesses to swap out that cash in their portfolio for Treasury bonds and so raise the transactions money stock.

Cochrane and Fama, of course, do not make either of those arguments convincingly. They do not make either of those arguments at all.

And do recall the initial markers laid down by those who claimed that fiscal expansion would have no effects at all:

John Cochrane: [That spending can spur the economy] is not part of what anybody has taught graduate students since the 1960s. They are fairy tales that have been proved false. It is very comforting in times of stress to go back to the fairy tales we heard as children but it doesn’t make them less false...

John Cochrane: Most fiscal stimulus arguments suffer from three basic fallacies. First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about “crowding out”...

John Cochrane: [S]uppose... people or banks... are pathologically sitting on cash.... Suppose the government could [re]direct that money to people who are willing to keep spending it.... This is not a convincing analysis of the present situation however...

Eugene Fama: Government bailouts and stimulus plans seem attractive when there are idle resources - unemployment. Unfortunately, bailouts and stimulus plans are not a cure. The problem is simple: bailouts and stimulus plans are funded by issuing more government debt. (The money must come from somewhere!) The added debt absorbs savings that would otherwise go to private investment. In the end, despite the existence of idle resources, bailouts and stimulus plans do not add to current resources in use. They just move resources from one use to another…. A common counter to my arguments about why stimulus plans don't work is to claim that the current situation is different. Specifically, the investment equal savings equation doesn't work because savers currently prefer to invest in low risk assets like government bonds rather than in potentially productive but more risky private investment projects. In other words, there is a "flight to quality." Sorry, but this is a fallacy. A flight to quality does raise the prices of less risky assets and lower the prices of more risky assets. But when new savings are used to buy government bonds, the people who sold the bonds must do something with the proceeds. In the end, the new savings have to work their way through to new private investment, and equation (1) always holds.

Robert Lucas: Christina Romer--here's what I think happened. It's her first day on the job and somebody says, you've got to come up with a solution to this--in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.... [I]t's a very naked rationalization for policies that were already, you know, decided on for other reasons…. If we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder--the guys who work on the bridge -- then it's just a wash... there's nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn't going to help, we know that...

In claiming that Cochrane and Fama were really only making the tautological claim that "if we assume nominal GDP is fixed, fiscal policy doesn't affect nominal GDP", Scott is retconing.

"Retcon" is short for "retroactive continuity": the classic example is Damian Cugley's analysis of the coming series Saga of the Swamp Thing, in which a new issue revealed "facts" that up to that point "[were]not part of the narrative and were not intended by earlier writers.... [T]he revelation is that the [Swamp Thing's] memories are false and he is not who he thinks he is..."

The Gang of Six Proposals Are a Bad Idea...

In my email inbox:

they cut the deficit rel to CBO baseline by 0.2% (around $30bn) in fy12, which ain't smart but could be worse. (But they cut a lot more than that in 2013, when unemployment will still be way high.)

Fiscal 2012 runs from October 1, 2011 to September 30, 2012: we really, really do not need for the government to be cutting its spending with unemployment still near 9%. Fiscal 2013 runs from October 1, 2011 2012 to September 30, 2012 2013: we really, really do not need for the government to be cutting its spending with unemployment still north of 8%.

Obama Has Always Been for Premature Fiscal Austerity

Paul Krugman sends us to Mark Thoma who sends us to Jonathan Schwarz, who points out that there is evidence that Obama rejected his economists' judgment that the economy needed a bigger stimulus back at the start of 2009.


A Tiny Revolution: If Only the Czar Knew: This is tough for me, because I was hating on Larry Summers before hating Larry Summers was cool. But I'm going to defend him.... One of the stories... is that some of Obama's economists believed that a stimulus package of over $1.3 trillion was needed—but Larry Summers prevented this news from getting to the president. And here we are in 2011 with a hideous economy that may be getting worse, and it's Larry Summers' fault. This seems to be based mostly on this New Yorker article from October 2009....

But if you go back and look, it's clear Obama was well aware many economists wanted a much larger stimulus bill. Here's a story from January 5, 2009:

President-elect Barack Obama said economists are suggesting a U.S. stimulus may have to be as large as $1.3 trillion, Senate Majority Leader Harry Reid said. Obama “has indicated that there’s at least 20 economists that he’s talked with, and all but one of those believe it should be from $800 billion to $1.2 trillion or $1.3 trillion,” Reid said after meeting with Obama on Capitol Hill.

Then two days later on January 7, Obama held a press conference:

TAPPER: Your team has talked about the stimulus package being $675 to $775 billion. But at the same're going to distribute a memo in which economists say it should be between $800 billion and $1.3 trillion. How do you reconcile that difference...?
OBAMA: Well, we are still in consultation with members of Congress about the final size of the package. We expect that it will be on the high end of our estimates, but [it] will not be as high as some economists have recommended because of the constraints and concerns we have about the existing deficit.

The same day Obama was interviewed on CNBC:

MR. HARWOOD: Tomorrow you're going to give a speech and talk about your economic stimulus package...It looks like it's going to be at the high end of your range, around $775 billion. If it's correct that, as your aides have said, the danger is doing too little rather than too much...why stop at $775 billion? Why not go to the 1.2 trillion (dollars) that some economists have recommended?
PRESIDENT-ELECT OBAMA: ...We've seen ranges from 800 to 1.3 trillion, and our attitude was that, given the legislative process, if we start towards the low end of that, we'll see how it develops.... MR. HARWOOD: So it's going to get bigger.
PRESIDENT-ELECT OBAMA: Well, we don't know yet.

And on January 16, four days before Obama was inaugurated, the Washington Post published an article about a long interview with him:

Obama repeated his assurance that there is "near-unanimity" among economists that government spending will help restore jobs in the short term, adding that some estimates of necessary stimulus now reach $1.3 trillion.

So it's obvious Obama knew what his economists were saying. He had all the information he needed. You can't pin this one on my dear friend Larry Summers.

I am struck by the rhetorical difference with Clinton. Clinton would always say: "This is what the technocrat-economists say is the first-best public policy, and we ought to do that", and then begin the political bargaining. Obama, by contrast, seems to glory in splitting the difference--even when you split the difference between those who know something and those who don't--without ever saying: "we really ought to do the right thing".

Fiscal Policy During the Great Depression

Microsoft Excel

If Congress in 1931 passes a large benefit program for war veterans, and if Hoover vetoes it, and if Congress overrides the veto, and if the money is spent, does Hoover increase spending?

Time, March 9, 1931:

Mar. 9, 1931: Ceremoniously he swung upon the main chamber portal to admit big amiable Maurice Latta, White House clerk. Clerk Latta bowed low from the waist, handed in a paper, bowed low again, vanished. Representatives flocked excitedly into the House, filled its curved rows of black seats. Speaker Longworth drew himself up importantly in his high chair. Everything became quiet. A clerk on the rostrum cleared his throat, began to read the White House document:

To the House of Representatives. I return herewith, without my approval, H.R. 17054, 'an act to increase the loan basis of adjusted service certificates. (To veto a measure all a President has to do is to withhold his signature and return it to the House in which it originated. The Constitution requires him to state his "objections" which compose his vote message.) . . . A potential cash outlay of about $1,700,000,000. . . . The probable number (of veterans) who will avail themselves of the privilege under this bill will require approximately $1,000,000,000. There not being a penny in the Treasury to meet such a demand the Government must borrow... or we must needs impose further taxation.

The sole appeal made for (this bill) is the claim that funds should be provided to veterans in distress.... The number of veterans in need of such relief is a minor percentage of the whole....

We cannot further the restoration of prosperity by borrowing from some of our people to loan to some of our people who are not in need of the money. The theory of stimulation (of business) is based upon the anticipation of wasteful expenditure. If this argument is correct, we should make loans to the whole people.... We must not forget the millions of hardworking families in our country who are striving to pay their debts. They, in the last analysis, must bear the burden of increasing Government aid and taxes. It is not the rich who suffer. When we take employment and taxes form our people, it is the poor who suffer....

I regard the bill as unwise from the standpoint of the veterans themselves and unwise form the standpoint of the welfare of all the people.... But of much graver importance is the whole tendency to open up the Federal Treasury to a thousand purposes.... Each of them breaks the barriers of self-reliance and self-support in our people.

Herbert Hoover.

As the clerk concluded, Floor Leader Tilson led a splattering of Republican applause. Cries of "Vote! Vote!" filled the air. Speaker Longworth repeated the ancient ritual:

The question is, will the House on reconsideration agree to pass the bill, the objections of the President to the contrary notwithstanding?

After 43 minutes "reconsideration," the House flouted the President by repassing the Bonus Loan Bill to the tune of 328-to- 79, a surplus of 56 votes over the required two-thirds majority. Not a single Democrat was among the 79 who supported the President.

Next day it took the Senate three hours' debate to reach a second Bonus vote. The galleries were packed with ex-soldiery. Republican Senator Hastings of Delaware, upholding the President, complained that veterans would "blow in their loans on automobiles and riotous living." He exclaimed: "I do know many ex-soldiers who would steal their certificates from their wives and go out and spend the night with some other woman." Howls and hisses descended upon him from the galleries.

Finally H.R. 17054 automatically became the law of the land when the Senate with 14 votes to spare, overrode (76-to-17) the veto. Only one Democrat -- King of Utah -- joined the forlorn Republican opposition. President Hoover had suffered his most serious Congressional reversal....


The provisions of the new law are simple: 1) veterans borrow 50% of the face value of their certificates instead of 22 1/2%; 2) the interest rate is fixed at 4 1/2%; 3) loans may be negotiated through the 52 branch offices of the Veterans Bureau.

What worried veterans most was President Hoover's statement about "there not being a penny in the Treasury" to make the loans. From a jumble of financial statements these facts emerged: 1) the Veterans Bureau has about $20,000,000 in cash on hand to start making loans; 2) income tax payments up to March 15 will supply enough additional cash to tide the bureau over until the Treasury's March financing; 3) short term loans will raise $200,000,000 in cash which will extinguish an equal amount of securities deposited in the $750,000,000 bonus reserve fund; 4) another $200,000,000 will come in the June financing.

Five minutes after the Senate made H.R. 17054 into law, the Veterans Bureau mailed out its first loan check at the new rate--$431.50 to a needy Baltimore veteran who wanted to have a sick son operated on. Lines quickly formed throughout the land before Veteran Bureau branches. Heading the Washington queue of loan applicants was Charles P. Ruby who got himself into the newspapers and in to breakfast with President Hoover by being first in the White House reception line on New Year's Day.

President Hoover took his defeat with good grace. He announced the Government's loan policy: "Complete priority to applications from veterans who are in need." Commander O'Neil urged legionaries to let those in distress get their money first. Veterans Administrator Hines warned that a full loan on which a veteran paid no interest would virtually eat up the face value of the certificate in the 15 years before it matured. Wall Street recovered from its spasm of fear and began to agree with out-of- town businessmen that a billion dollars deflected into retail trade, into now automobiles, new clothes, new necessities might, after all, give Industry a helpful shove.

Fiscal Policy in the Hoover Administration: The World War Adjusted Compensation Act of 1924 et Sequelae...

From U.S. History

World War Adjusted Compensation Act: Many veterans who returned to the United States at the end of World War I were disappointed to find that their old jobs had been taken by domestic workers at wage levels unknown in prewar times. Bitterness was reduced little by the fact that the federal government had granted a small parting bonus at the time of discharge and some of the states had done likewise. As early as 1919, the American Legion and the Veterans of Foreign Wars began to agitate for what they chose to call “adjusted compensation.” Critics of financial aid to ex-servicemen preferred to use the somewhat derogatory term “bonus.”... The veterans’ advocates argued that their members deserved a cash award to balance out the difference between their modest military pay and the high wages enjoyed by civilian war workers. A compensation measure worked its way through Congress by the fall of 1922, but President Warren Harding vetoed it, an action in keeping with Treasury Secretary Mellon's drive to avoid all unnecessary government expenditures. Undeterred, the veterans’ groups kept up the pressure and succeeded in gaining passage of what was popularly known as the Soldiers' Bonus Act in the spring of 1924. Calvin Coolidge’s veto of the measure was overridden.

Provisions of this law applied to veterans who had held the rank of captain or below and provided:

  • Adjusted compensation... of $1.25 per day for time spent in foreign service and at the rate of $1 per day for domestic service.
  • The sum earned by veterans was not to be paid in cash, but was to be used to create a 20-year endowment; in the short term, participants were entitled to borrow up to 22.5 percent of the value of the fund.

Veterans and their advocates were not satisfied with this measure and pressed immediately for cash settlements. The Republican presidents and legislators of the later 1920s resisted those appeals and the issue would continue into the next decade.


Hoover and the Veterans’ Bonus Proposal: Many ex-servicemen from World War I were in dire economic straits by early 1931. A proposal aimed at improving their situations was advanced by sympathetic veterans’ organizations. Congress responded by approving a measure that would have made available one-half of the adjusted compensation (the so-called “bonus certificates”) provided in the Soldiers' Bonus Act of 1924, which had authorized each veteran to have access to 22.5 per cent of the compensation due to him in the form of a loan against the total amount owing.

In February 1931, President Hoover vetoed this bill, explaining that such largess would deplete meager federal funds. In addition, the measure had been applied to all former servicemen and had not singled out those in dire need — which probably amounted to only about one-quarter of the veterans.

In short order, Congress reconsidered the matter and passed it over Hoover’s veto.

Securitization and Overleverage: A Call for Additional Research

Some Thoughts on Tyler Cowen s Points on the GSEs | Rortybomb

Mike Konczal:

Rortybomb: [T]he GSEs had political pressures to purchase private-label mortgages in 2007 as the credit market was freezing up, in a desperate attempt to unlock it.... This argument, and the graph above, is developed in Roosevelt Institute senior fellows Rob Johnson and Tom Ferguson’s Too Big to Bail: The ‘Paulson Put,’ Presidential Politics, and the Global Financial Meltdown Part II.  One could easily assume that they were buying the worst loans here, aggregating losses on the GSEs.  I’d love to see much more investigations into this...

Really Smart Thoughts on Irrational Exuberance, Housing, and the GSEs from Mike Konczal and David Min

Mike Konczal writes:

Rortybomb: Reviews of Reckless Endangerment, the book on the GSEs (that cover similar ground as the Wallison/Pinto argument) by Gretchen Morgenson and Josh Rosner, are starting to happen.  Jeff Madrick at NYRB’s Blog, Bob Kuttner at The American Prospect and Kevin Drum all have interesting, very critical, things to say about the book.

Meanwhile, Tyler Cowen asks How much did Fannie and Freddie cause the financial crisis?, trying to reground the debate over the GSEs in firmer soil with five points. Many others are answering this question by looking at the collapse moment;  I want to focus on the origination of bad mortgage debt and the bubble itself.  I pinged David Min to see if he wanted to respond, and I throw his arguments in with my own below.

Cowen: “1. It is not denied that the mortgage agencies were guaranteeing about half of all U.S. mortgages right before the crisis…”

David Min: “This conflates outstanding mortgages vs. annual mortgage originations (sort of like a snapshot vs. a video). The GSEs were guaranteeing nearly half of all mortgages in the late 1990s and early 2000s. But from 2002-2005, they saw a fairly precipitous drop in market share, going from about 50% to just under 30% of all mortgage originations. Conversely, private label securitization [PLS] shot up from about 10% to about 40% over the same period. This is, to state the obvious, a very radical shift in mortgage originations that overlapped neatly with the origination of the most toxic home loans. Moreover, this point also papers over the fact that PLS loans have defaulted at over 6x the rate of GSE loans, as well as the fact that private label securitization is responsible for 42% of all delinquencies despite accounting for only 13% of all outstanding loans (as compared to the GSEs being responsible for 22% of all delinquencies despite accounting for 57% of all outstanding loans).”

I think that’s right. So far the debate has been focused on the idea of “other high-risk mortgages,” mortgages with an LTV > 90, for instance. The real split should be between PLS, the brand new private-market way of putting together the mortgage market, and non-PLS.

For #2 Cowen brings up leverage.

Min notes:

“PLS was allowing far more leverage than the GSEs, which seems to contradict this claim. I do agree that absent the GSEs, we would have seen fewer 30 year FRMs…FRM have performed exponentially better than ARMs, and 30 year FRMs have performed far better than any other type of product.”

I’d say if we want to understand how leverage got into the mortgage market specifically, we should look at subprime as well as second-liens and other junior-lien mortgage claims, and what arguments were given for supporting them. My favorite document of what that argument looked liked at the time is something like Charles Calomiris and Joseph R. Mason 1999 AEI paper: High Loan-to-Value Mortgage Lending: Problem or Cure?  That is all about how people should lever up as much as they can as a signaling device, as the junior claims will disrupt bad debt workouts and act as a straightjacket on credit writedowns.  This is explicitly not an affordability mission, but instead a very conservative vision of bankruptcy law and debtor-creditor relationships.  We are living through the consequences of that call.  This extra option to re-lever to consistently re-bid against property appreciation goes hand-in-hand with dynamics of a bubble.

For #3, Arnold Kling has clarified [i.e., abandoned and recanted] his previous thoughts on the GSEs here in a way that I think works better with the data.

Tyler’s #4, “Following the crisis, banks recovered and paid back virtually all of their bridge/bailout.”

Min brings up:  ”The GSEs are essentially single-purpose entities (particularly with the heightened restrictions on their direct investments following the crisis).  They securitize conforming mortgages, and guarantee timely payment of interest and principal on those securities.  They do not engage in derivatives dealing, market making, trading, or any of the other activities that have generated the bulk of bank profits since the 2008 crisis…GSE loss severity on its mortgage exposure (which is its entire business) is exponentially better than that of their private competitors.”

Also another point I don’t see brought up enough is that the GSEs had political pressures to purchase private-label mortgages in 2007 as the credit market was freezing up, in a desperate attempt to unlock it....

Meanwhile, research moves on.  Mian and Sufi’s The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis is likely to be with us for a while as a research standard, and it is telling us to look at the securitization chain.

Chris Bertram Gets a Wish Granted and Is Very Unhappy Indeed

A couple of months ago I noted that Chris Bertram had concluded that it was time for "the left" to abandon social democracy--which Bertram characterized as:

keep[ing] the masses happy by improving their living standards... prone to [t]witter[ing] self-regardingly about “grown-up” politics. Fixated on... with winning elections... have achieved very little... haven’t done much to stem the rise of inequality, to protect working-class communities from the winds of globalisation, to end poverty, or, for that matter, to protect the environment...

and rely instead on a combination of:

populist nationalism[:] culturally conservative, worried by immigration (and willing to indulge popular anxieties), anxious about the effects of markets on working-class community...

and zero-growth greenism.

I said at the time that I disagree with Bertram. I think that unless it is yoked to social democracy greenism tends to turn into nostalgic agrarian conservatism. I think that unless it is yoked to social democracy culturally conservative populist nationalism tends to turn into fascism.

Now Chris Bertram is face-to-face with the culturally conservative populist nationalism he wished for in the face of Maurice Glasman.

He is horrified:

Out of the blue, into the black: I’ve been willing to give Glasman the benefit of the doubt up to now, despite feeling somewhat uncomfortable at some of the things he’s had to say on immigration. After all, Labour lost the last election and we do need some proper discussions about how to connect with a somewhat alienated working-class base. Glasman, with his talk of community and his Polanyi-inspired scepticism about the capacity of the market to ensure genuine well-being seemed a voice worth hearing. Well the mask hasn’t just slipped, it has fallen off, and I think the “blue Labour” project has come to a halt with his latest pronouncements. Intra-left polemics have been marked by too much moralizing denunciation in the past, at the expense of genuine dialogue and understanding. But there is a time for denunciation, and it is now. Today’s Daily Express front page (Headline “Britain Must Ban Migrants”):

Lord Glasman, Ed Miliband’s chief policy guru, wants a temporary halt to immigration to ensure British people are first in the queue for jobs. The Labour peer also urged the Government to renegotiate EU rules allowing the free movement of migrant workers in a decisive break with the open door policy of Tony Blair and Gordon Brown. “The people who live here are the highest priority. We’ve got to listen and be with them. They’re in the right place – it’s us who are not,” he said.

I would note that headlines in the Daily Express are rarely accurate. I would like to see the full interview with Glasman before proclaiming the full anathema.

But perhaps it is time for Bertram to rethink his casual jettisoning of social democracy and the politics of prosperity?

Paul Krugman on the Difference Between Planetary Physics on the One Hand and Economics on the Other

Paul Krugman:

Scribblers and Madmen: Ezra Klein has a good column on the dangers of being wrong about Keynes. As he says, it’s very difficult to respond rationally to an economic crisis when politicians like Eric Cantor completely fail to understand what Keynesianism is all about.... The fact, however, is that these very same crude fallacies are being enunciated, with confidence, by famous and influential economists. Here’s Eugene Fama, arguably our most famous and influential finance economist:

Again, here is my argument in three sentences.

  1. Bailouts and stimulus plans must be financed.
  2. If the financing takes the form of additional government debt, the added debt displaces other uses of the same funds.
  3. Thus, stimulus plans only enhance incomes when they move resources from less productive to more productive uses.

Are any of these statements incorrect?

In his attack on me Krugman implicitly assumes that sentence 3 above is true; that is, the stimulus plan will on balance move resources from less productive to more productive uses. This is indeed the focus of the issue.

That’s exactly what Cantor is saying. It’s completely wrong; the whole point is that stimulus is supposed to put resources that would otherwise be unemployed to work. But at this point, a large part of the economics profession no longer understands that. So why should we expect politicians to get it?

The point is that GOP ignorance on macroeconomics isn’t like GOP ignorance on, say, climate science. In the latter case the bad science comes from a handful of essentially bought and paid for “skeptics”. In the case of macroeconomics, the nonsense is coming from established economists with lots of widely cited papers. Paul Ryan doesn’t have to distill his madness from the scribbling of hacks at Heritage (although he does that too); he can get it over some nice wine from tenured faculty at the University of Chicago.

Klein suggests that what went wrong in the Great Depression was that people hadn’t read Keynes yet; well, what went wrong and continues to go wrong in the Lesser Depression is that eminent economists, or at those so judged by their peers, turned their back on everything Keynes learned.

Left Neoliberalism Versus... What, Exactly? It Is Not at All Clear...

Noah Millman:

Alternatives to Neoliberalism | Politics | The American Scene: Neither of [Matthew Yglesias's] critics are primarily saying that neoliberal policy ideas are bad. [Doug Henwood and Henry Farrell] are saying that neoliberalism is bad politics – not because it can’t win an election, but because it is based on running on good ideas, winning elections, and then implementing those good ideas. And that’s not a self-sustaining politics. From a more traditional left-wing perspective, you don’t start with good ideas – you start with ideas for how to establish enduring power bases.

Broadly speaking, the alternatives to liberalism reject the goal of finding the best policy, meaning the policy that will benefit the most people, in favor of promoting policies that may hurt more people than they help, but that shift the balance of power in favor of the group you’re seeking to represent....

The broad point is: alternatives to neoliberalism won’t be as liberal. They be less-likely to prioritize efficiency. They will also be less-likely to prioritize positive-sum solutions. They will also be less-likely to prioritize basic fairness or democratic principles or whatever else. They will assign a higher priority to increasing the economic and political power of the people they are trying to represent (or their designated representatives)...

DeLong Smackdown Watch: The Tradition of all Dead Generations Weighs Like a Nightmare on the Brains of the Living

Hoisted from Comment: Spang wrote:

Paul Krugman and Mike Konczal on the Political Economy of the Lesser Depression: Doesn't the persistent hyping of the dangers of inflation and the resurgence of "hard money" goldbugs suggest that the relevant intertext here is not the Manifesto, but Eighteenth Brumaire?

Men make their own history, but they do not make it just as they please... the tradition of all dead generations weighs like a nightmare on the brain of the living.

We don't have a rentier class any more, but we have a political/social elite that continues to behave--in its pronouncements, in its policy preferences--as if if were one.

Even pointing out to them that they are not rentiers has little effect because disavowal is so central to the workings of ideology (on which, see pretty much anything by Zizek).

So the structure of the reply [conscious or otherwise] is: "I know that the world we live in is not the 1890s, BUT..." I am curious as to how this sentence should be completed. Is it: "...but still, I wish it were, because in hindsight that seems a pleasant and comfortable world, at least for a tiny fraction of the population with which I identify" or is it "but still, those guys most have known something and the 'laws of economics' do not change [because if they did, how could we say it is a science]"?