Without the Bugaboo of the Soviet Union

Marx display, Borders at 14th and H Streets, Washington, D.C., 19 May 2009

Well of course — this is just the media pushing its left-wing agenda. I doubt it. The media has their finger to the wind. During the Bush years they shamelessly kowtowed to Ari Fleischer’s admonition to watch what they write and now that the times are a’ changing, the media is putting up sails for new seas. The mood questioning capitalism is welling up from the ranks with the media wondering how to be relevant. Witness:

“Until 2004, we sold less than 100 copies of Das Kapital per year,” Schuetrumpf [managing director of the Berlin-based publishing house Karl-Diez Verlag, publisher of the German edition of Marx’s collected works] said. “In the 10 months of 2008, we have sold more than 2,500 copies. It is clear that people are interested in learning what Marx has to say about why capitalism does not work.” (Godoy, Julio, “Economy: Turning the Pages Back to Marx and Keynes,” Inter Press Service, 7 November 2008)

And from the picture above, apparently Borders thinks there’s enough interest amidst their customers to turn the Marx collection face-out.

Craziest of all, according to a recent Rasmussen survey, a whopping 20 percent of Americans currently believe that socialism is superior to capitalism (“Just 53% Say Capitalism Better Than Socialism,” 9 April 2009).

During the Cold War, Americans’ strongest association with socialism was the Soviet Union, and after the collapse of communism we were told that left-wing economic ideas had been roundly refuted by events. So the right currently believes itself to be effectively tarnishing the program of President Obama by labeling him a socialist. But it turns out that the existence of the Soviet Union wasn’t just culture jamming socialist ideas, but the negative associations that it generated was lending undue credibility to right-wing ideas as well. The collapse of communism may end up not so much taking left-wing ideas down with it, as depriving those of the right of their cudgel of existent socialism. The association of socialism with Stalinism has lost its effectiveness now that the Soviet Union has become just another historical anecdote. This might explain the even more pronounced positive view of socialism among young respondents in the survey (33 percent of young people favor socialism versus 20 percent among the general population).

Republicans would be advised that in constantly pointing to the popular President Obama as the primary exemplar of socialism, the outcome isn’t so much to tarnish President Obama so much as to burnish socialism in the minds of the young generation. “If Obama is socialism,” they think, “I guess that makes me a socialist.” (Yglesias, Matthew, “The Declining Unpopularity of Socialism,” ThinkProgress, 9 April 2009).

Marx is Back!

April-May 2009, Marx is Back! / 1 de Mayo immigrant's march posters

Out of character for the city, there have been a number of lefty signs around. Some of my recent favorites are the two above. The one on the right is for a Mayday immigrant march. Notice that the flag in the hands of the native American is the United States as a tree with its roots in the shape of the rest of the world. The little plaque on the man’s chest reads both “Sise puede” and “Yes we can.” And the rally is meeting in Malcolm X Park, the unofficial name for Meridian Hill Park (Google Maps | Wikipedia).

I love the socialist conference poster. “Marx is back!” One may wonder where he ever went. I guess some people though that Marxism went into remission after the end of the Cold War. But everyone is on notice that he’s back now.

March 2008-May 2009, Newsweek, Foreign Policy and BusinessWeek, varying degrees of questioning capitalism

With Newsweek going beyond declaring us merely Keynesians now and portraying George Bush, Jr. in the style of Che Guevara, Foreign Policy putting Marx on the cover of their “Big Think” issue (“Why he matters now”), BusinessWeek making Ben Bernanke look like Lenin and including Henry Paulson in Stalinist Soviet style collages and Richard Posner titling his current book A Failure of Capitalism, things are feeling positively European.

But the return of Marx is more than just media camp. With respect to national security, Charles Krauthammer referred to the liberal internationalism of the Clinton years as a “holiday from history” (The Washington Post, 14 February 2003, p. A31). Robert Kagan is now referring to the post-1990s as The Return of History and the End of Dreams. Supposedly September 11, 2001 and the ensuing clash of civilizations has woken us up from our Fukuyam-esque ex-historical state. Similarly, we might refer to the phenomena of “Marx is Back” as the return of history to the economic sphere after 20 years of economic dreams (given that the current crisis has wiped out nearly 15 years of stock market value, it does seem as if it was all a dream). Just as September 11, 2001 broke the exclusive claim of liberal internationalism upon the thinking of the foreign policy establishment and showed that the future would be one of continuing world-historical ideological contention, so the holiday of political-economy that was the Washington Consensus has been knocked askew. The future of the economy will be one of political conflict.

But I kid myself. The legitimacy of capitalism within a given polity has nothing to do with the soundness of ideas and little to do with events. It is primarily a function of the Gini coefficient: the more money there is sloshing around in the upper social strata, the more inassailable the reputation of capitalism. And since that’s hardly going to change in the current crisis, I doubt that the Washington Consensus will emerge with anything more than a few fast forgotten slights.

In this regard the conservatism of the Obama administration should be noted. They are doing whatever they can to handle the current situation with as little enduring systematic change or publicity as possible. And I guess I’m in favor of this. While I may sympathize with dialectical materialism and Marx’s critique of the corruptions of capitalism, he was grossly wrong in his assessment of capitalism as ineluctably hell-bent-for-crisis. I’m essentially an advocate of Keynesian tinkering in a mostly stable system. And besides, alienation is a feature of capitalism, not a bug. The last thing I want is to be railroaded into a syndicate with a bunch of hippies. Those guys are fascists.

The Deus ex Machina of Economic Crisis

In defense of Secretary Geithner’s economic detox plan, Christopher Carroll makes a larger point about the basis of fundamental valuation (“Treasury Rewards Waiting,” The Economist’s Forum, Financial Times, 24 March 2009):

Unlike the critics, the Treasury has absorbed the main lesson from the past 30 years of academic finance research: asset price movements mainly reflect changes in investors’ collective attitude toward risk.

Perhaps the reason this insight has not penetrated, even among academic economists, much beyond the researchers responsible for documenting it, is that it has not been expressed in layman’s terms. Here’s a try: in the Wall Street contest between “fear” and “greed,” fear fluctuates much more than greed (in academic terms, movements in “risk tolerance” explain the bulk of movements in asset prices).

In thinking about economic crises, people have a tendency to contrast fundamentals versus psychology, dismissing so-called psychological factors as “not real” or somehow illegitimately interfering with the proper functioning of the economy. But the economy is not a machine with the humans being somewhat incidental to its operation (at least not yet). Insofar as human desire, priority, ambition, plans and beliefs about what the future holds are more foundational to the enterprise than the material constituents of the economy, psychology is fundamental. At some point, the economy gives way to society as the more fundamental unit of analysis.

This is not to say that the future-oriented plan makers don’t get “spooked” — hence Keynes’s “animal spirits” — and that they are irrational over the medium term to do so; but who can deny that retrenchment is not rational within certain limited considerations. That being said, it is the role of the government to defend the commons.

The Ouroboros Economy II

A few months ago I took the opportunity of the Business Week cover depicting the economy as ouroboros for a few snickers (“Ouroboros to Mise en Abyme,” 28 July 2008). Now the ouroboros economy makes another appearance, this time in the much more serious pages of The New Yorker (Lanchester, John, “Melting into Air,” 10 November 2008, pp. 80-84). Again, I don’t have anything in mind: it’s just an icon shopping around for more meanings. But Mr. Lanchester gives it a novel and grandiose go:

… finance, like other forms of human behavior, underwent a change in the twentieth century, a shift equivalent to the emergence of modernism in the arts — a break with common sense, a turn toward self-referentiality and abstraction and notions that couldn’t be explained in workaday English. In poetry, this moment took place with the publication of “The Waste Land.” In classical music, it was, perhaps, the première of “The Rite of Spring.” Jazz, dance, architecture, painting — all had comparable moments. The moment in finance came in 1973, with the publication of a paper in the Journal of Political Economy titled “The Pricing of Options and Corporate Liabilities,” by Fischer Black and Myron Scholes.

The revolutionary aspect of Black and Scholes’s paper was an equation that enabled people to calculate the price of financial derivatives based on the value of the underlying asset. … The trade in these derivatives was hampered, however, by the fact that — owing to the numerous variables of time and risk — no one knew how to price them. The Black-Scholes formula provided a way to do so. It was a defining moment in the mathematization of the market. The trade in derivatives took off, to the extent that the total market in derivative products around the world is counted in the hundreds of trillions of dollars. Nobody knows the exact figure, but the notional amount certainly exceeds the total value of all the world’s economic output, roughly sixty-six trillion dollars, by a huge factor — perhaps tenfold.

It seems wholly contrary to common sense that the market for products that derive from real things should be unimaginably vaster than the market for things themselves. With derivatives, we seem to enter a modernist world in which risk no longer means what it means in plain English, and in which there is a profound break between the language of finance and that of common sense. …

If the invention of derivatives was the financial world’s modernist dawn, the current crisis is unsettlingly like the birth of postmodernism. For anyone who studied literature in college in the past few decades, there is a weird familiarity about the current crisis: value, in the realm of finance capital, evokes the elusive nature of meaning in deconstructionism. According to Jacques Derrida, the doyen of the school, meaning can never be precisely located; instead, it is always “deferred,” moved elsewhere, located in other meanings, which refer and defer to other meanings — a snake permanently and necessarily eating its own tail. This process is fluid and constant, but at moments the perpetual process of deferral stalls and collapses in on itself. Derrida called this moment an “aporia,” from a Greek term meaning “impasse.” There is something both amusing and appalling about seeing his theories acted out in the world markets to such cataclysmic effect.

The Antiquated Public Paradigm of Economics

Robert Waldmann at Angry Bear goes on a considerable rant about the way that the state of contemporary economics is represented (“What’s Wrong with Economic Theory as Presented to the Public?,” 3 October 2008). It turns out that everything you may have learned in Econ 101 and 102 was representative of the state of the science circa 1950 and that things have become much more complicated since then.

The conclusions of economic theory as presented by many or perhaps most economists do not follow from current economic theory, but rather from the 50 year old efforts at mathematical economic theory.

… the worse problem is that economists who are also libertarian ideologues are lying about the current state of economic theory, not only its very weak scientific standing, but the fact that, even if it were all absolutely true, their policy recommendations do not at all follow from current economic theory.

You mean to tell me that those hoary old supply-demand curves, the very paradigm of economic thought, have been replaced by game-theoretic concepts like Nash equilibrium?

Part of me reads this and thinks “Great! We’re free. We are no longer bound in our policy aspirations by the dictates of the dismal science!,” but then I think that economic policy is way too important for us to just do what we will, without any ability to anticipate probable outcomes or any concern therefor. Surely some portion of what goes on in at least some sectors of economics is on solid ground, right? They sure act like it is at the Federal Reserve or the Congressional Budget Office or the Office of the Chief Actuary of the Social Security Administration.

It would be nice to know Mr. Waldmann’s assessment of the various areas of economics. It would seem that the general equilibrium theory of the microeconomy, any simple notion of market clearing and the possibility of straightforward optimization are all out. Perhaps the macroeconomy is easier? Perhaps social scientific descriptions work better over aggregate social phenomenon? Or perhaps the Federal Reserve Chairman is L. Frank Baum’s proverbial Wizard of Oz, just eyeballing it, but dazzling us munchkins with his light and numbers show?

The Perspective of the World, 2008

The recent, dramatic drops in the Dow Jones Industrial Average command attention, but they are foam. The real currents of the current crisis are mostly hidden from public view. Some journalists are burning a lot of shoe leather to bring that story to light, but I imagine that much of it will remain obscured from history to all but the actors themselves.

And so Fernand Braudel in Civilization and Capitalism, 15th-18th Century, Volume I: The Structures of Everyday Life: The Limits of the Possible (trans. Siân Reynolds, New York: Harper & Row Publishers, 1981):

On the other hand, looking up instead of down from the vast plane of the market economy, one finds that active social hierarchies were constructed on top of it: they could manipulate exchange to their advantage and disturb the established order. In their desire to do so — which was not always consciously expressed — they created anomalies, ‘zones of turbulence’ and conducted their affairs in a very individual way. At this exalted level, a few wealthy merchants in eighteenth-century Amsterdam or sixteenth-century Genoa could throw whole sectors of the European or even world economy into confusion, from a distance. Certain groups of privileged actors were engaged in circuits and calculations that ordinary people knew nothing of. Foreign exchange for example, which was tied to distant trade movements and to the complicated arrangements for credit, was a sophisticated art, open only to a few initiates at most. To me, this second shadowy zone, hovering above the sunlit world of the market economy and constituting its upper limit so to speak, represents the favored domain of capitalism, as we shall see. Without this zone, capitalism is unthinkable: this is where it takes up residence and prospers. (p. 24)

The New York Times last Thursday (Nocera, Joe, et. al., “As Credit Crisis Spiraled, Alarm Led to Action,” 2 October 2008, p. A1):

This is what a credit crisis looks like. It’s not like a stock market crisis, where the scary plunge of stocks is obvious to all. The credit crisis has played out in places most people can’t see. It’s banks refusing to lend to other banks — even though that is one of the most essential functions of the banking system. It’s a loss of confidence in seemingly healthy institutions like Morgan Stanley and Goldman — both of which reported profits even as the pressure was mounting. It is panicked hedge funds pulling out cash. It is frightened investors protecting themselves by buying credit-default swaps — a financial insurance policy against potential bankruptcy — at prices 30 times what they normally would pay.

It was this 36-hour period two weeks ago — from the morning of Wednesday, Sept. 17, to the afternoon of Thursday, Sept. 18 — that spooked policy makers by opening fissures in the worldwide financial system.

Anomalies, zones of turbulence, fissures: call them what you will.

The First Sovereign to Fall?

It would appear that Iceland will be the first sovereign imperiled by this spreading financial crisis (McVeigh, Tracy, “The Party’s Over for Iceland, the Island that Tried to Buy the World, The Observer, 5 October 2008):

Iceland is on the brink of collapse. Inflation and interest rates are raging upwards. The krona, Iceland’s currency, is in freefall and is rated just above those of Zimbabwe and Turkmenistan. One of the country’s three independent banks has been nationalised, another is asking customers for money, and the discredited government and officials from the central bank have been huddled behind closed doors for three days with still no sign of a plan. International banks won’t send any more money and supplies of foreign currency are running out.

People talk about whether a new emergency unity government is needed and if the EU would fast-track the country to membership. On Friday the queues at the banks were huge, as people moved savings into the most secure accounts. Yesterday people were buying up supplies of olive oil and pasta after a supermarket spokesman announced on Friday night that they had no means of paying the foreign currency advances needed to import more foodstuffs.

Iceland is outside the Euro zone so they are facing a currency crisis as well. Take a look at ECB exchange rate data. The Icelandic krona has fallen 181 percent against the euro, from €86.25 one year ago to €156.13 on Friday.

I wonder if there’s any substance to the idea of fast-track E.U. membership. Just like this crisis has precipitated a wave of bank consolidation, maybe it will allow the E.U. to snap up a few holdouts as well. I notice that that hole in the E.U., Switzerland, is also overrepresented as the homecountry to a number of troubled banks.

Update, 6 October 2008: Iceland had to bailout its third largest bank, Glitnir. The problem is that Iceland’s top three banks have assets nine times the GDP of Iceland (Magnusson, Niklas and Helga Kristin Einarsdottir, “Iceland Savers Fear ‘House of Cards’ May Collapse After Glitnir,” Bloomberg, 3 October 2008). One of Portfolio.com’s bloggers points out the obvious (Salmon, Felix, “Iceland: When Too Big To Fail Becomes Too Big To Rescue,” 3 October 2008):

Received opinion has it that if Iceland backstops the Icelandic banks, then the other Nordic countries, or someone, will backstop Iceland.

This was my point in emphasizing the idea of fast-track E.U. membership, E.U. membership being more dignified than IMF intervention.

A Co-President?

Federal Reserve Chairman Ben Bernanke and President George W. Bush

At the constitutional convention in summer of 1789 the founding fathers struggled to find an amenable compromise between those desiring a vigorous executive and those concerned about despotic overreach. One proposal to limit the executive was that instead of concentrating power in a single person, create a miniature division of powers by having a triumvirate of co-presidents.

Events of the past few weeks have been instructive. It would appear that the Federal Reserve Act of 1913 delivered us a co-presidency in a sub-constitutional manner. It would appear that they each have their own portfolio: one is commander and diplomat in chief and the other is the captain of the macro-economy. With his 20 year term, substantial independence, control over interest rates, lending capability, 800 billion in capital and a regulatory mandate over the banking system, the Federal Reserve Chairman has a vast array of powers, while not on par with the official executive, impressive nonetheless.

It’s also worth noting that, like the official President, the Federal Reserve Chairman accrues perhaps the better part of his powers through reputation, as a focal point of attention and the judicious use of his own particular bully pulpit.

This has some potentially troubling implications, depending on where you fall on the democratic spectrum. In this regard, Will Wilkinson has some interesting ruminations on what he calls “the structure of the de facto American constitution” (“What’s an Incrementalist Market Liberal to Think?,” 19 September 2008; the previous post, “The Benign Rule of Ben Bernanke and the Ideal of Democratic Equality, 18 September 2008, along the same lines is also good too).

It’s also worth noting — something that has become apparent throughout the Bush years — that many of the constraints on the presidency are not official, but adhered to only out of tradition. When the situation warrants — or ambition allows — the executive is capable of blowing through its traditional restraint, erupting into a ferocious activism. When this happens in the realm of foreign policy everyone loves it. Nothing gets people excited like a little kicking of foreigner ass. When it happens in the domestic or economic realm, people aren’t so enthusiastic, as Congressional telephone lines, recently clogged with populist anti-high finance carping, will attest.

The Future of Economics: The Arational and the Irrational

Back in 2000 The Economist ran an article titled “The Future of Economics” (4 March 2000, p. 80). It was largely a gloss on a symposium on the same from the Journal of Economic Perspectives (vol. 14, no. 1, Winter 2000). The authors acknowledged that economics was a faltering field. Setting aside the proposition that economics may simply have run it’s course and be into its dotage of diminishing returns, the article considers two possibilities for a way forward:

David Colander of Middlebury College, in an article that looks back on the present from an imagined 2050, blames the current discontent on the orthodox general-equilibrium model that underlies most of today’s economic theory. He favors a shift from the current approach, which has been called “loose-fitting positivism” (propose a model consistent with standard assumptions, then test it), to one based on “loose-fitting pragmatism” (forget about canonical principles, just search for patterns in the data).

Such an approach, he says, would be consistent with “the rise of complexity science within the scientific community generally.” Researchers sitting at their computers, subjecting data to a withering barrage of statistical analysis, would still hope to come up with laws of a sort, or regularities at any rate. But these “laws” would be regarded as provisional and ever-shifting: indeed, the claim is that changeless underlying patterns do not exist. Complex systems expand and evolve; even at the most fundamental level, these patterns are temporary. But whether this approach could still be called “economics” is debatable.

The second approach is much easier to reconcile with traditional methods. Its most celebrated exponent is Richard Thaler of the University of Chicago, who has also written a paper for the symposium. Mr. Thaler agrees that the canonical principles of orthodox theory have led economics astray, but he believes these mistakes can be put right. He seeks, in other words, a tighter-fitting positivism. You improve the fit above all, he would argue, by putting a more realistic account of human cognition at the center of the theory.

Orthodox theory famously assumes that people are rational. In reality, they are not. On the other hand, they are not crazy, or crassly incompetent — in other words, their behavior is not random. If economics could try harder to recognize that people try to be rational, but in certain, often predictable, ways fail to be, the positivist approach would have a better foundation. In essence, what Mr. Thaler calls for is a marriage, or at least much closer cohabitation, between economics and psychology.

I have thought of this article frequently since reading it back in 2000 when it was first published. Given the spate of books along these lines, especially the second, I’d have to say that this was one of the more perspicacious articles that I’ve ever read.

The first approach is an example of Petabyte Age type thinking, eight years before Wired put it on the cover. But of course it is an idea that had to incubate in the rarified world of advanced theoreticians for years before any eruption into the popular conscience. The main offering in this area would be Steven Levitt and Stephen Dubner’s Freakonomics (2005), though their book is not a fully atheoretic inquiry so much as putting of large questions to the test of large data sets. More to the topic would be Ian Ayres’s Super Crunchers: Why Thinking-by-Numbers Is the New Way to Be Smart (2007), though the fact that Mr. Ayres used the very methods he describes in his book to arrive upon a title casts a great deal of doubt on the soundness of said methods.

As for the build a better model of the economic corpuscles approach, it seems to have advanced along far enough that it is now also ready to be packaged up for mass consumption. And of course the psychologists have much more lucrative options in publishing than the mathematicians and computer scientists.

Judging by some of the key phrases in the Economist article (the predictably irrational stuff) I was pretty sure that they had in mind Dan Ariely’s thinking, published as Predictably Irrational (2008), but it turns out that Richard Thaler is, along with Cass Sunstein, the author of Nudge (2008). Rounding out the most omnipresent trio is Tim Harford’s The Logic of Life: The Rational Economics of an Irrational World (2008). Also on the list of offerings along this line would be Ori and Rom Brafman’s Sway: The Irresistible Pull of Irrational Behavior (2008) and Michael Shermer’s The Mind of the Market: Compassionate Apes, Competitive Humans, and Other Tales from Evolutionary Economics (2007).

So that’s the future of economic study. Either a discounting of human rationality in favor of the system effect of irrationality or allowing rationality to drop out in favor of the system effect of economic thing-in-itself.

Federal Reserve Balance Sheet

Amid news that the Federal Reserve is establishing this multi-billion dollar line of credit, extended that many billion in overnight repurchase agreements, contributed $30 billion to the J.P. Morgan buyout of Bear Stearns and spending $83 billion for the purchase of A.I.G., the question lingering in the back of my mind is how is the balance sheet of the Federal Reserve looking right about now. The Federal Reserve doesn’t have unlimited resources at it’s disposal. It has about $800 billion in assets which only buys it a limited amount of credibility. It’s not all that much relative to the scale of modern financial flows.

Anyway, wonder and The Wall Street Journal will deliver (Blackstone, Brian, “U.S. Moves to Bolster Fed Balance Sheet,” 18 September 2008, p. A3 [subscription required]):

Federal Reserve assets, The Wall Street Journal, 18 September 2008

The Treasury, responding to worries that the Federal Reserve could be running out of financial ammunition to deal with the credit crisis, moved to reload the Fed’s gun with $100 billion worth of bullets.

The central bank’s bailouts of Bear Stearns and American International Group Inc., as well as lending programs created in the past year, are putting the Fed’s once-mighty balance sheet at risk. Financial markets have begun to fear that if nothing is done, the Fed might have trouble putting out fires in the future.

The Fed held close to $800 billion in Treasury securities a year ago. By last week, that had dwindled to just under $480 billion. The amount drops to less than $200 billion if the $200 billion pledged to the Term Securities Lending Facility — a Fed lending program created in March for investment banks — and the full $85 billion line to AIG are accounted for, Fed watchers say.

“The tally is so low that it is becoming imperative for the Fed to take actions to enlarge its balance sheet,” said Tony Crescenzi, a strategist at Miller Tabak in New York.

When the Fed lends money to a financial institution, it usually sells an asset such as Treasurys separately in the market and absorbs the cash created by the loan. The goal is to keep a proper level of money flowing through the financial system. If the Fed were to run too low on Treasurys to conduct these operations, it could lose its ability to drain money from the banking system and control inflation.

On Wednesday, the Treasury announced a temporary program to bolster the Fed’s balance sheet and sold $40 billion in 35-day Treasury bills. It announced later in the day that it would hold two additional auctions of Treasury bills on Thursday totaling $60 billion. In effect, Treasury is auctioning off more securities than are needed to fund the federal government, and carrying out the draining function in place of the Fed. The cash from the Treasury’s sales is parked at the Fed.

Of course the government has infinite money, but it comes at a cost. As long as the Fed coffers are topped off, Chairman Bernanke is his own man. But already Federal Reserve assets are approaching levels where he will increasingly be at the behest of Treasury Secretary Paulson and House Financial Services Committee Chairman Barney Frank.