"If money isn't loosened up, this sucker could go down" - George W. Bush warned in September 2008

Monday, July 26, 2010

Really great links - Misallocating resources - Death of paper money - Austerity - DeLong vs. Rogoff

John Hussman - Misallocating resources - "Since the late 1990's, many employees have earned paychecks for producing capital goods that did not turn out to be worth what companies spent, and consumers have received loans for amounts which they are not actually able to repay. Both of these outcomes have been the economy's way of forcing a large but rather overlooked "correction" in the income distribution back from corporate profits (and by extension shareholders) and toward the average American worker.
        All of this is extraordinarily inefficient, because some people have effectively received windfalls (for example, those who sold their homes at the top of the real estate bubble, and those who have defaulted on large amounts of consumer credit), while other hard-working people have been stiffed. But one way or another, the equilibrium outcome of the economy has been to ensure - whether the transfer of purchasing power was voluntary or not - that American workers were able to purchase the output that was actually produced by the economy.
        What's fascinating about this, however, is that shareholders are still ignoring it. They also ignore the large percentage of reported earnings that are actually quietly distributed to corporate insiders through the issuance of stock and options. They blindly accept that "share repurchases" are somehow a pleasant distribution of earnings, whereas the majority of share repurchases are actually made by companies to do nothing more than offset the dilution from stock shares and options granted to insiders. A good question to ask in the years ahead, immediately after profits are reported, is "how much of this figure is actually delivered to shareholders?" If you've been attentive over the past decade, the answer turns out to be much closer to the dividend yield than to the operating earnings yield that companies have reported.
        For a moment, at least, it is good to be a corporate insider, particularly at major financial companies. First, you get to report productivity gains and "operating profits" - not by making smart investments in productive assets, but instead by writing up debt thanks to Treasury intervention, by misstating your balance sheet thanks to FASB changes last year, and at industrial firms, by cutting the number of workers per unit of capital. Next, you quietly write off large losses on bad investments and unrecoverable loans as "extraordinary expenses," to which investors pay no notice. And to add insult to injury, you deliver a significant portion of the remaining profits to yourself as "incentive compensation," followed by buybacks of stock to offset the dilution, which investors actually cheer because they don't realize they've been taken for suckers."

Ambrose Evans-Pritchard - Velocity of paper money - "The crucial passage comes in Chapter 17 entitled "Velocity". Each big inflation -- whether the early 1920s in Germany, or the Korean and Vietnam wars in the US -- starts with a passive expansion of the quantity money. This sits inert for a surprisingly long time. Asset prices may go up, but latent price inflation is disguised. The effect is much like lighter fuel on a camp fire before the match is struck.
        People’s willingness to hold money can change suddenly for a "psychological and spontaneous reason" , causing a spike in the velocity of money. It can occur at lightning speed, over a few weeks. The shift invariably catches economists by surprise. They wait too long to drain the excess money.
        "Velocity took an almost right-angle turn upward in the summer of 1922," said Mr O Parsson. Reichsbank officials were baffled. They could not fathom why the German people had started to behave differently almost two years after the bank had already boosted the money supply. He contends that public patience snapped abruptly once people lost trust and began to "smell a government rat".
        Some might smile at the Bank of England "surprise" at the recent the jump in Brtiish inflation. Across the Atlantic, Fed critics say the rise in the US monetary base from $871bn to $2,024bn in just two years is an incendiary pyre that will ignite as soon as US money velocity returns to normal."

Brad DeLong - Austerity - "Well, history tells us that there are times and circumstances when countries’ refusal to listen to calls for retrenchment and austerity has led to economic disaster. Times when a country’s supply of savings is inelastic and more government borrowing leads to sharp rises in and high real interest rates are times in which government budget deficits have drained the pool of savings, reduced private investment, and slowed growth--as they did in the U.S. in the second Reagan and the first Bush administration. Times when monetary and fiscal laxity leads to an expectation that government debt will be monetized and to rapid rises in inflation expectations are times in which policy has made a deep recession to restore price stability inevitable--as happened in the U.S. in the Nixon, Ford, and Carter administrations. And times when irrational exuberance on the part of foreign investors leads a country’s public or private sector to borrow heavily in foreign currency, it needs to pre-emptively retrench before foreign investor exuberance wears off, or else--as happened to East Asia in 1997-8, to Mexico in 1994-5, or to Argentina innumerable times since 1890."

Brad DeLong - Rogoff is wrong on debt worries - "Prof Rogoff sees the economy now as suffering from structural maladjustments generated by the expansion of the 2000s in which workers must be trained in new kinds of jobs and shifted over to different sectors in which they have no previous experience, and that that process cannot proceed rapidly without generating inflationary pressures that will destabilise confidence in price stability. I see an economy in which there is enormous slack pretty much everywhere – empty retail storefronts in Berkeley just to my left, anyone? – in which even the US housing stock is no longer above its trend, and in which we are currently building houses at half the trend pace. If output in even our single-family residential-housing sector is significantly depressed below its steady-state growth value – if, economy-wide, 10 per cent of the spending that ought to be there is missing – then we need not policies that carefully create new jobs only in the appropriate sectors but instead policies that create new jobs pretty much anywhere."

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