I was researching the European Stability Mechanism this morning for a paper on the evolution of the euro, and I ran across this gem of economics art on the ESM webpage.
(The ESM is sort of europe's internal IMF that can lend money to strapped governments with conditions.)
(at Project Syndicate)
The Liz Truss Tragedy
The former British prime minister’s downfall holds important lessons for growth-minded policymakers in the United States, Europe, and elsewhere. While her diagnosis of the country’s economic problem was spot on, she fatally mismanaged both the politics and the messaging of her policy response.
STANFORD – Liz Truss’s stint as British prime minister is over, but she was right that the United Kingdom needs growth. Her downfall is tragic, because growth is the only path out of the country’s economic dilemma.
The UK is surprisingly poor. Its GDP per capita is just $43,000, compared to $60,000 in the United States. The average British home is one-third the size of the average US home. Worse, the country’s economy is not growing. Its GDP per capita is lower than it was in 2007. Productivity – the underlying source of economic growth – has been flat for over a decade.
The UK desperately needs supply-side reforms. Surging inflation tells us that demand-side stimulus is a spent force.
Inflation will be coming down over the coming quarters. This is what the Fed is predicting, that is what the consensus is expecting, and that is what we are predicting. The problem is that this has been the forecast ever since inflation started going up in April 2021, see chart below. Given how systematically wrong inflation forecasts have been over the past 18 months, there are good reasons to be cautious about the current forecast.
It is also how market expectations have evolved. Is inflation inherently unpredictable? Are we collectively in thrall of the same wrong model? Does "expectation" mean the same thing in models and surveys? Are market risk premiums really important?
In previous blog posts here and here, I criticized UK financial regulators for missing simple leverage and margin requirements in UK pension funds. To be clear, I don't criticize the people. The point is, if after 10 years of intense regulation, a group of really smart and dedicated people can't see plain old leverage, the whole project of regulating risks is broken. And it's not just the UK. The Fed bailed out money market funds in 2020. Again.
I insinuated the regulators were not paying attention. I was wrong. It turns out they were paying attention. Which makes the failure all the more stark.
In Friday's Wall Street Journal, Greg Ip writes
In 2018, the Bank of England investigated whether a big rise in interest rates would trigger a cascade of forced selling by bond investors, destabilizing the financial system. The answer was no,
That they did think about it, and they missed it anyway is even more damning for the regulate-risks project.
(At National Review)
What This Year’s Nobel Economists Can Teach Us about Financial Crises
This week, economists are celebrating the Nobel Prize given to Ben Bernanke, Doug Diamond and Phil Dybvig for their work on banking.
Bernanke pointed out that banks matter. In the Great Depression, banks failed, and there was nobody left who knew how to make new loans. The economy contracted, not just for lack of money or for animal spirits of investors, but for lack of credit. Diamond and Dybvig wrote the classic economic model of bank runs, which shows how banks can fail even when they are “illiquid” rather than “insolvent.” The logic works like this: The bank has invested our money in illiquid projects, so if I suspect others are going to run to get their money out, I run to get mine out first before it’s all gone.
But it is no insult to say that these are not eternal verities. The papers were written about 40 years ago. Each was the launching pad for a vast and important investigation. Indeed, Nobel Prizes largely recognize that sort of lasting influence on subsequent work. But that subsequent investigation opens new possibilities. Newton is no less profound for having been followed by Einstein. Each also sought to understand the world as it was, which is how one should start. But there are other possibilities for how the world might be — and how it might be better.
On the same page in today's WSJ:
One third of DC bus riders don't bother to pay the fare. Also in New York.
The State Department is so dysfunctional that processing visa requests takes years.
In New Delhi, an appointment for a nonimmigrant visitor visa takes more than 800 calendar days, or nearly three years; for a student visa, nearly 450 days. The Cato Institute found that more than half of U.S. embassies and consulates world-wide have a waiting time greater than six months for a visitor or business visa appointment, compared with 1% before the pandemic. More than 1 in 4 have a waiting time of a year or more.
In March Congress enacted the EB-5 Reform and Integrity Act of 2022 to streamline the immigrant-visa process for foreign investors who commit significant capital to the U.S. But that reform is swamped by slow administration. U.S. Citizenship and Immigration Services advises applicants that 80% of cases (excluding Chinese nationals, who take even longer to process) are resolved within 52 months, or nearly 4½ years.
A central part of the immigration problem is that asylum claims languish in courts for years. And regular criminal courts also take years. Either spend the money to administer the laws, or change the laws (immigration and visas in particular) to not require administration that we can't provide.
These are just two tips of the iceberg of general incompetence in many parts of our government. Not all: I've had some pleasant interactions with very well run low-level government offices lately. It can be done.
Wanted for the elections: politicians who will campaign simply to administer competently and remedy dysfunction. Efficient government offices, court systems, transit systems and so forth are also crucial infrastructure. Don't lead new grand causes, just mind the store.
Update to my previous post on the UK treasury imbroglio:
Against the backdrop of an unprecedented [really? Literally never?] repricing [translation: fall in prices] in UK assets, the Bank announced a temporary and targeted intervention on Wednesday 28 September to restore market functioning in long-dated government bonds and reduce risks from contagion to credit conditions for UK households and businesses.
It goes on to a hilarious graph to explain how you lose money when you borrow to lever up a portfolio:
The FPC has previously identified underlying vulnerabilities in the system of market- based finance, a number of which were exposed in the ‘dash for cash’ episode in March 20202. The Bank and the FPC strongly support and engage with the important programme of domestic and international work to understand and, where necessary, address those vulnerabilities.
The FPC conducted an assessment of the risks from leverage in the non-bank financial system in 2018, and highlighted the need to monitor risks associated with the use of leverage by LDI funds.
Policy Tensor on the consequences of a Russian nuke (HT Marginal Revolution) was very interesting:
Consider the least escalatory option, that of a “demonstration detonation”: Russian forces air-burst (to avoid the nuclear fallout that results from a ground detonation) a tactical nuclear weapon with sub-kiloton yield (ie, no bigger than a big conventional weapon) over uninhabited territory somewhere in south-eastern Ukraine. This would be consistent with Russia’s “escalate-to-deescalate” doctrine ... What happens then?
Precisely because it is such a dramatic break with precedent, even a demonstration detonation would radically change the character of the Russo-Western conflict over Ukraine. New Yorkers and Berliners etc, are likely to flee the cities. Everywhere, in Europe and America, supermarkets would likely empty within hours. Many local authorities may institute civil defense measures, even as federal governments everywhere urge calm. A widespread breakdown of law and order would be a real possibility; especially in America, where it would be attended by partisan passions and finger-pointing....
Not to bash a hobby horse, but the Fed, SEC, FDIC and so forth are now obsessed with climate risk to the financial system. Chatting with colleagues at the Fed, it is astonishing how much and how detailed the research is in to climate (really weather) scenarios, much of this directed by higher-ups.
Today I will not criticize that effort. Maybe pianos do fall from the sky. What is striking to me, verified in every conversation I have with people in these institutions (please prove me wrong!) is that nobody at these institutions is doing any analysis of any other risk.
This seems like a useful one, for example. Any nuclear explosion is going to make the ATMs go dark. Is anyone at the Fed gaming this out? What if (when) China blockades Taiwan? What about a massive cyberattack on the banking system, a deliberate attempt to cause a run (Russian disinformation that a major bank has had all its account information wiped out, get your cash now)? A new pandemic that looks more like 1350 than the flu?
Nobel Prize season is around the corner. Last year, I blogged in favor of Tom Sowell. I update, with some edits.
Dear Nobel Committee: How can you not give the prize to Tom Sowell this year?
Tom's work evidently merits a Nobel purely as a contribution to economics, covering many issues. But we can't ignore what year it is. Race is a forefront issue of our time. How can you not give the prize to the living economist who has written the most penetrating economic analysis of race?
Yes, he's a free-market economist, and thus characterized as conservative. His deeply fact-based research is uncomfortable to The Narrative. For example, groups that white people cannot tell apart have profoundly different outcomes in the US. Nigerian immigrants are among the highest achieving ethnic groups in the US. West Indians do well. Asians of different waves of immigration and different countries -- Chinese, Laotians, Vietnamese -- show profound differences. Tom has thousands of such facts, impeccably documented.
But you're the Nobel Committee. You care about Science, about facts, about logic, not about cheers from the Davos crowd. You care about issues that are important, as you should, but you do not care about embracing one or the other political narrative's answers to those questions. You care about the reputation of your Prize, for courageously recognizing great research, even if its surprising conclusions upset established orders. And, to your credit, you have given the prize to economists of widely different political enthusiasms through the years.