Bubble machine

Occasionally I will take requests on the blog (actually, I'd love to get more), suggestions on something to write about, and I'm happy to put something together if I can think of something to say. A reader/friend asked me to write something about Matt Taibbi's Rolling Stone article titled The Great American Bubble Machine. In it, Taibbi lays the blame for our financial meltdown on investment bank Goldman Sachs:

The first thing you need to know about Goldman Sachs is that it's everywhere. The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.

Any attempt to construct a narrative around all the former Goldmanites in influential positions quickly becomes an absurd and pointless exercise, like trying to make a list of everything. What you need to know is the big picture: If America is circling the drain, Goldman Sachs has found a way to be that drain — an extremely unfortunate loophole in the system of Western democratic capitalism, which never foresaw that in a society governed passively by free markets and free elections, organized greed always defeats disorganized democracy.

Reaction has been severe. Of course, Goldman Sachs has responded with outrage, but many other commentators have leapt to the barricades, accusing Taibbi of overreach and sloppiness. One who has attracted a lot of attention with her "takedown" is The Atlantic's Megan McArdle, and I'll swing back to her in a moment.

But, you ask, what of my take on the original article? Ah, yes, but there's a problem: Rolling Stone has, in their infinite old-media wisdom, not published the whole thing online; the link I provided above is a series of excerpts interspersed with videos of Taibbi. So it's hard for me to provide any cogent analysis of the article without running out to the store and picking up a copy of the mag, and I'm not going to do that. (Kevin Drum fell into the trap, reviewing the article without realizing he was looking at bits and pieces. Once he got on track, he read the whole thing, concluding that, "It's a very good takedown of the modern financial industry and well worth reading." Drum also provides a link to a site that purportedly offers the whole article, but that's not working for me.)

I am left, then, trying to review an article based on excerpts, and that's not fair to the piece. I will not try to claim total objectivity anyway, as I am a fan of Taibbi's writing. His reviews of the Tom Friedman oeuvre are canonical, but I already praised those enough. He is a passionate writer, one who, perhaps, sometimes allows his passions to get in the way of precision.

But that's who he is, and to take the other side, to argue that his vehement eloquence is disqualifying is to refuse to engage with his points. And that is a far greater sin. Witness the quote in a TIME piece from a former journalist, "For the record, I don't think any article that contains the line 'vampire squid sucking the face of humanity' [Taibbi's opening description of Goldman] is real journalism." That quote is vacuous and completely unenlightening. (Taibbi himself responds to TIME's piece here.)

Here's Taibbi's position in an somewhat unfair nutshell: Goldman Sachs has been at the center of every negative investing trend over the last several decades, and their involvement in questionable financial instruments and oil speculation directly led to the current world financial crisis. Furthermore, their connections to people in high places ensures that they will be allowed to profit mightily no matter what happens in the global economy.

And that doesn't really seem too wrong. I sense maybe a little too much conspiracy in Taibbi's article, a bit too much willingness to credit Goldman with prescient malevolence. In my experience, there is rarely a decision arc in even the most powerful companies; rather, there is a culture which approaches problems in consistent ways, thus leading to similar results. Once that culture is seen as successful, it becomes widely adopted and the influence is magnified.

One thinks of, in the business consulting realm, the influence of McKinsey. McKinsey is not responsible for some of the worst management trends of the past 30 years, but they do tell their well-paying clients what they want to hear. Once the concepts (things like dehumanization and offshoring, anything in which customers can reap gains without paying the full costs) get the official McKinsey imprimatur, they become consecrated as holy writ, and McKinsey appears to be at the cutting edge of modern management techniques. I believe something similar happens with Goldman Sachs, that whatever they do quickly pervades the industry, giving the appearance of a conspiracy where none exists.

Which brings me to Megan McArdle. I find this self-styled libertarian to be maddeningly inconsistent, capable of penning some clear-eyed pieces that cut through cant (as in this post about retraining, where she couples her own experience with conventional wisdom and finds reasons to question the "wisdom"), but too often falling into a mush of disorganization. One could pin that on the blog format, but she is a major force in the blogging world and I expect more from her.

At any rate, her criticism of Taibbi has received quite a bit of attention, probably because she begins:

What I think, sadly, is that Matt Taibbi is becoming the Sarah Palin of journalism. He seems to deliberately eschew understanding his subjects, because only corrupt, pointy-headed financial journalists who have been co-opted by the system do that. And Matt Taibbi is here to save you from those pointy headed elites.

(Sarah Palin analogies are always attention grabbers.) Her argument is that Taibbi misemphasizes the importance of the things that Goldman did, that they did do those bad things but they're old news and other people did stuff that was worse, so why pick on Goldman?

She then takes her U of Chicago MBA (a degree she shares with this writer) and rolls right off the tracks:

But in fact, everyone was aware that CDO's were repackaging crap mortgages--that was the point. The idea was pure portfolio theory, broadly agreed upon by everyone involved. Everyone knew a lot of the mortgages might go bad, either by defaulting or prepaying. (This is a risk for bankers, who don't like the idea that if interest rates drop, their 7% mortgage might suddenly turn into a pile of non-interest-bearing cash which can only be invested at 5%.) But if you pool the risk, only some of the bonds will go bad, while others pay off. The result is a less risky, less volatile investment than any individual junk mortgage bond. And it would have worked, too, if it hadn't been for those crazy kids a collapse in the housing market of a scale not seen since the Great Depression.

This betrays a misunderstanding of portfolio theory, in that the risk of the pooled security is less only if there is minimal correlation among the component securities. Diversification works only when the underlying elements are different in nature; when they all stem from the same source, for example, residential mortgages, any downturn in the overall housing market will destroy the value of the pooled security, which is, of course, exactly what happened. There is no magic that allows anyone to take D-level garbage that is all of the same type and turn it into AAA by clever dividing and recombining. That's absolutely basic.

McArdle then hedges her own bets by agreeing with Taibbi's basic point:

Wall Street is an arrogant beast that more than held up its half of the devil's bargain which drove us into our current ugly straits. Bankers who thought they were geniuses were deceived by models that assumed away the possibility of a second great depression. They made a terrifying amount of money doing it. And now that the taxpayers have bailed them out at considerable expense, we don't even get a goddamn fruit basket. Instead they merrily go along paying themselves gigantic bonuses for the singular feat of not driving our economy entirely back to the stone age. I think some populist rage is more than warranted.

She simply disagrees with the way Taibbi chose to illustrate these problems, claiming that he didn't ask the right questions and, therefore, profoundly misunderstands the true nature of the problem. So we should be mad at Goldman, but we should also be mad at others too, and we can't know exactly who we should be mad at for what, and so forth into its own brand of incoherence.

McArdle got some pushback for her piece, especially for her assertion that, "financial meltdowns don't offer villains, for the simple reason that no one person or even one group is powerful enough to take down a whole system." So she wrote another long blog post about that, defending herself with this analogy:

A woman gets into her car, and waves at her husband, who is crossing in front of the car. Pressing the pedal to the ground, she puts it into gear . . . and steams forward at full speed, crushing him against the wall of the garage.

Is she a villain? It rather depends, doesn't it?

Scenario #1: she's angry because she found out he had an affair, and decided to kill him "by accident" for the insurance. Scenario #2: she thought she was stepping on the brake, and stepped on the gas instead. The former is a crime, the latter a tragedy. But you can't divine which simply by knowing that something terrible happened....Villainy involves people who know, or should have known, that what they were doing was likely to lead to the awful results.

I mean, you can quibble and say "You should have known that that was the gas pedal", and indeed you should have, but if, for whatever reason, your senses deluded you, you're not a villain. No, even if you were thinking about the presentation you had due at work--or how angry you were at your husband for having a fling with his secreatary--rather than concentrating on your driving.

When something is common enough, I think it definitionally isn't villanous. It may be a practice that should be fixed--we should all be more careful when starting our cars, I'm sure.

This is a bad analogy, so let's try to fix it. Let's say the woman may or may not know how to drive. Her husband asks her if she knows which is the brake pedal. She confidently answers yes, then steps on the gas and kills him.

Alternatively, she chooses to flip a coin as to which pedal to step on.

Is she a "villain" in either of those scenarios? I don't know, but she is certainly criminally negligent, and we do have societal punishments for that kind of recklessness.

And this is closer to what we've seen from our financial corporations. They took unconscionable risks, actions that could bring down a world financial system, then pled, "No one could have known," when it all went south. Their perverse incentive policies made gambling with OPM (other people's money) acceptable, even necessary. This is not their senses deluding them, this is arrogant heedlessness and, whatever the merits of Taibbi's contention that a great deal of it was due to deliberate manipulation on the part of Goldman Sachs, can't be wished away by McArdle's limp argument.

Then, unsurprisingly, McArdle yet again hedges her bets, telling us that she actually doesn't like Goldman Sachs at all:

I have no reason to love Goldman Sachs, and I don't. I didn't like them when I was interviewing for investment banking internships in business school (worst interviews by far were sponsored by Goldman Sachs and Bear Stearns). I dislike the way their alums, and indeed, their current employees, have permeated our politics and our financial regulatory system like some sort of insidious fungus. I have been repelled by Jon Corzine ever since he spoke at my business school graduation ceremony, where he jovially described how he had cheated his way into a diploma by getting his girlfriend to do his final project for him. He seemed to think this was funny.

She goes on in this vein for a while, but ultimately defends the bankers by claiming that they were stupid, but so was everybody else, and that doesn't equate to villainy, and that no change to history would have allowed us to avert the financial crisis (?!?):

But I think the case needs to be a leetle bit tighter than the fact that bankers make stupid decisions, bankers get paid a lot, and we just had a financial crisis. I'd like to see someone make the case that they did things that were actively, knowingly, illegal and morally turpitudinous, rather than simply totally moronic. Because with the total moron thing, they had an awful lot of company.

Of course, that's actually just the case that Taibbi is making (perhaps it is not as airtight as we would like, but it's a start). When money is entrusted to people who are reckless with it, that's wrong - I suppose we can debate the word "villainy" at some length. But the hands-off, "no one is more wrong than anyone else" attitude is profoundly unhelpful, no matter how much the principal actors in this piece would like it to become the prevailing approach.

[Update: I have come across a site on which the whole Taibbi piece has been posted. I don't believe a complete reading changes anything I've already written, but I'll ponder it some more and come back if I have any additional comments to make.]

Used to put the paycheck in the bank, now we get it there

Kevin Leicht is guest-blogging at Credit Slips this week, and he starts off with an excellent post that discusses the way in which our economy has moved from one in which people consumed based on what they were paid, lowering their risk over time, to one in which consumption is based on debt. He concludes:

More importantly, Henry Ford’s original idea (that workers should be treated well in part because they spend money as a consumer outside the office door) was discarded as a quaint old-fashioned notion. “Let the other guy treat people well, I can’t afford it” seemed to be the individual response of employers around the country and, for a long time anyway, Wall Street loved it. In the business section of the newspaper major downsizing on the front page was accompanied by major jumps in stock prices on the back page.

Over the long term this exposed a classic public goods problem – U.S. consumer purchasing power is something everyone has an interest in but no one has any concrete incentive to contribute to themselves. There are so many alternatives to paying people a decent wage that virtually any alternative is more acceptable than paying people more money or even paying people what they’re worth.

Is this sustainable?? It is difficult to see how. After all, if someone told you that we were going to base the largest developed economy in the world on (a) treating the mass of employees badly, (b) producing many products and services that are consumed offshore and then (c) loaning these same employees money to buy the basic goods and services to keep the entire economy afloat, I would say that someone just walked off a postbellum Southern plantation to sell us on the virtues of sharecropping(!) .

The current economic downturn gives us an opportunity to think hard about this entire I-borrow-because-I-can’t-get-a-decent-wage system. Simply restoring the ability of banks to loan money is not enough. Instead, the actual real earnings-based purchasing power of the American consumer must be restored. This is a much tougher task. Loaning people money is not a perfect substitute for paying them, but it is the easy way out. It produces real differences in political and economic power that can’t be ignored. It also isn’t economically sustainable.

Nothing to add, except to point out that we have structural problems which will prevent the recovery, when it comes, from being a return to what it was before. Robert Reich sees this, in a post from last week:

My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.

The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't "recover" because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin.

There are those of us who have been arguing this for some time, that the rules and the landscape have changed, and we had better start preparing ourselves for reduced opportunity and circumstances. We could do that through intelligent planning, through a recognition that the old rules don't apply any more, but I'm pretty sure we won't do that.

Post-nation nation

Carol A. Burch at Decidedly (a week old; I'm still working on my new blogging schedule):

Success of one's people in those countries [Russia and Asia] is honored, appreciated and focused upon by each individual far more than in the United States, where emphasis is on the individual and individual achievement.

We can see the effect of individual vs. collective consciousness as we look at the shifts in centers of economic and political power in the world today.

Corporations and individuals in the U.S., as is their right in a free society, made decisions that inured to their individual benefit. Production and manufacturing (and the economic and political strengths that are associated with those endeavors) went elsewhere. Certainly, the image of a collective exodus of almost the entire manufacturing base from the nation was probably not part of each individual decision. Yet, cumulatively, over time, this happened. This is the effect of the lack of a collective consciousness. Now, with diminished economic health and clout to influence the world's direction, we, as a country, are less formidable, and are viewed primarily as a voracious consumer society.

Economic strength now centers in the countries that took on the manufacturing. Of note is the fact that these countries operate culturally with a high level of collective consciousness,with a collectively understood and embraced long-term vision of a future in which they will continue to dominate. It is unlikely that the mistakes we made will be repeated there.

Very true. We derided the old Five-Year-Plans of the Soviet Union and China, confusing execution with concept. Then we saw India and China actually plan for the future, focusing resources on growth fields like engineering and computer science. (Keep in mind this didn't constitute a huge risk, these were already well-established as fields of the future by the time these countries got around to supporting them.)

At the same time, the U.S. decided that laissez faire worked so well for economics that it could be applied to anything that even had the slightest economic component. CSI is a hit TV show, of course we'll see students flock to forensics programs despite the reality that budgets will never go up as much as enrollment did. I wonder what all those budding Gil Grissoms are doing now.

One thing that interests me is how this idea was sold to the American people, not that they needed much convincing. There were two large ideas, I think, with which we deluded ourselves that "collective consciousness" was something that could be transcended.

The first was what I call the "lottery mentality," with an added shot of altruism. If we allow everyone to pursue their own aims, each person will maximize their potential, get rich, and then be able to do more for the collective than they ever could just going out and living their lives. What lottery winner fails to say that he'll do more for his church, or for his children, or for his community? We created a virtue out of going out and scrabbling for whatever bucks were there, because, sometime in the future, more will be created for the larger group.

Much of this, of course, was simply mindless claptrap. A lottery is a massive tax and redistribution scheme, but it's hard to see how society profits from it. Much of business works the same way - some aspects of what is done is truly innovative, and betters the lot of humanity, but a great deal more is a way to take money from someone and give it to someone else. [I'm not talking here about the normal business of business, in which customers pay less for something than it's worth to them, but some of the less publicized activities, such as lobbyist-induced tax breaks and offshoring, things for which we never quite figure out the true cost.]

The second "big idea" was one that didn't require us to give up our sense of the collective good, but to expand it. This was what I refer to as the "post-nation" concept, the idea that we uniquely had a responsibility to the world, that even if some of our practices were negative in effect to the U.S., that they benefited the world far more.

We see this in some of the commentary the past few days about Iran, from those thinkers who believe we "must" get involved. That we would undoubtedly pay a price in lives and money to install a president who doesn't have all that much power who might be little better than the one they have is of little consequence; we must interfere because that's what America does.

We also see it in discussions of offshoring in which we blow by the very real negative effects on American workers and move to wondrous tales of how our work is helping the downtrodden of China and India. Whatever we used to call national interest gets subsumed to a utopian ideal of effortless foreign aid.

I guess my point is that the United States has never really lost its sense of the collective unconsciousness, we've just allowed it to be perverted from the straightforward sense of nation that we used to have to some pretty indirect, even strange, concepts. It's not that we've lost sight of the greater good, just that we've allowed it to be twisted into ideas that are so obscure that the true costs and benefits have been lost.

Perhaps these new ideas are, ultimately, better for the world as a whole and we should pursue them, but I don't believe the case is so clear-cut that we shouldn't at least be discussing them. And I'm sure it's just coincidence that they are pushed most ardently by the folks who have the most to gain from their acceptance.

Ups and downs

Sullivan points out that poor Paul Krugman can't seem to make up his mind as to whether the economy is getting better or worse:

Is it just me, or has the economic news started to darken again?

Sullivan then prints a rejoinder from Free Exchange:

The first and most obvious point to make is that news can surprise on the downside while still trending toward improvement if expectations have improved more rapidly than the data.

Which doesn't entirely eliminate the other possibility, that the second and, at least to me, equally obvious point to make is that news can surprise on the upside while still trending toward decline if irrational hope has improved more rapidly than the data.

The free world

This is a favorite topic of mine, the idea that seems prevalent that there is a whole lot of free stuff that isn't being captured in GDP, but has real value, and we should count it to see how great the virtual world is, and so forth. I touched on this last week in a post where I talked about Yglesias's idea that low-selling books should be virtually given away rather than sold for big amounts of money.

The larger issue is expressed well in an older post by Yglesias:

One noteworthy trend we’re experiencing of late is the rising prominence of social production—the creation of valuable information goods on a non-commercial basis. Probably the clearest example is Wikipedia, a hugely useful service that doesn’t produce any economic “value” in GDP terms. Of course valuable activity that doesn’t register in GDP is nothing new—just ask moms spending time taking care of their kids. But the transition to the digital economy is changing things in important ways. In particular, it’s simultaneously making it cheaper than ever to produce and distribute information goods, but harder than ever to capture revenues from information goods.

This is true, but Matt sees this in extremely positive terms, particularly with the idea that retirees will embrace the free economy:

In the future, it might be common for grandpa to spend a couple of hours a day tinkering with open source software. Or maybe he’ll make it his business to attend city council meetings and write on the web about them. People will write whole books and distribute them for free to people’s kindles. A lot of this material may have a “crank” quality to it. But much of it will be genuinely well-informed, and reflect a lifetime of knowledge. Already, I can see in DC’s local blogosphere that there’s a fine line between an annoying busybody and a vital source of information. As the cohort of people with the most time on their hands to just pursue their interests becomes more digitally literate, I think we’ll probably see an explosion of non-commercial activity in a variety of fields. And one important source of success for commercial enterprises will be finding ways to hybridize commercial and non-commercial elements of the production/distribution process.

He kind of limps to the close (endings are tough for me too):

One important implication of this is that we’re almost certainly shifting from a world in which a large and important set of activities aren’t captured in the national economic statistics to a world in which a large, important, and growing set of such activities isn’t captured in the conventional statistics.

I think this is all way too positive. Ultimately, an economy is about doing something or making something that can be exchanged (generally using the medium of money) for something of value that you want. All this free activity is cool and neat, but a whole lot of it comes from a community that is fortunate to have the leisure time to do things that happen to be of interest to others.

Wikipedia is useful (don't tell John McIntyre I said so), but few are lining up to pay for it. There is a hobby quality to it, and to a lot of what passes for so-called "social production." The Internet is great in that a lot of things that people might have done for fun can now be made useful for other people, but we shouldn't confuse that with the workings of a real economy. Some of the most successful projects of the past few years have uncertain realities in a financial sense, and rely on the contributions of people who choose to work on them...and can choose not to work on them.

It's nice to think that a whole army of grandpas are going to go out and donate their time to things that profit a lot of people who are better off than they are, but that's not a sustainable resource that anyone can count on. There's a reason that we have newspapers that assign people to cover city council meetings and write about them and get paid for them - it's called work. I don't think the populace should have to work their civic knowledge around Granddad's annual trip to Florida.

The light at the end of the tunnel...

Time doesn't permit me to develop this theme fully today, but we need to begin to think about what will happen after this recession/depression is over. There is a tacit assumption that the only realistic options are V-shaped, U-shaped, or W-shaped, with only a very few even contemplating the possibility that L-shaped may be far more likely.

We have just lived through a series of booms that wildly inflated our expectations of what we should expect from our economy. And it's possible that there is a "true" level to which we will revert, and it may not be the big-growth model that we assume. It could well be that the lower leg of the "L" is where we should have been all along, that the inexorable nature of the logisitic curve has finally caught up with us, and that we will sink into a prolonged low-growth mode.

What does a computer programmer cost? $50-60K, because that's what we're used to paying? Well, no, they're goods like anything else, so the real answer is, whatever the market demands. Increasingly, we can get perfectly serviceable programmers for $10-15K, so that de facto becomes the cost. To assume that the "American premium" will somehow maintain that big a differential is darned naive. (Substitute "manufacturing worker" or any other movable profession and the argument is the same.)

But, if we pay our computer programmers less (or employ fewer of them), there will be less money floating around for purchases of consumer goods and the like. One could argue (and many have) that displaced programmers will move on to work that is at least as lucrative, but that seems increasingly unlikely given the kinds of jobs that look like growth professions (solar panel installers? wind turbine makers? home health care providers? None of these seem like the stuff of upper middle class aspirations, no matter how necessary they are).

It is possible that Americans are simply overpaid with respect to the rest of the world, that our wages and prices are simply too high in a globalized competitive world. That may be due to historical precedent that is no longer relevant, but it's hard to argue that it's sustainable.

And, in a global sense, there's probably nothing wrong with that. The United States is likely due for a readjustment in light of world market conditions; maintaining the status quo is unwieldy and, quite possibly, unfair and exploitative.

But it does imply a change. Many want to think that we'll just move over and share the top step with billions of others, but that probably can't happen in a world of finite resources. The rise of others will mean some fall for us. It doesn't have to be catastrophic, but it will require some rethinking.

This might seem deflationary, if wages and then prices fall to something closer to world-acceptable levels. Every economist will say that that would be an utter disaster, that it would change our financial landscape in all kinds of unpleasant ways. And that may be right, leaving us only two options. We could inflate our currency; nominal wages and prices would stay roughly where they "should" be, but there would be all sorts of consequences from that, most unpleasant. Or we could see a massive fall in the dollar, as we equalize our wages and prices through foreign exchange. We would see a huge increase in exports, and some industries would find the U.S. labor market more attractive. Since the dollar is the world's reserve currency, there would also be some mighty nasty results from this.

There are a number of mechanisms which might counter this trend somewhat, but I don't see them being sufficient to stem off the larger problems that come from equalization. I hope so, of course, but I can't be too optimistic.

Tim Duy, via Mark Thoma, has an essay that seems slightly more positive, but leaves us, in the end, with at least some version of what I've outlined:

Bottom Line: The economy looks to be turning a corner relative to the downward cyclical force of last year. But this is only a partial victory, as the factors that that started us down this path - namely, a debt-supported consumer spending dynamic - remain in play, and will likely remain in play for years, arguing for a long period of slow growth, punctuated by short-lived bursts of positive data. In such an environment, and considering the importance of government support to sustain financial stability, the odds favor continued policy easing. Those looking for a more positive scenario are pinning their hopes on either an unlikely rapid return to past patterns of consumer behavior, an unlikely rapid evolution in patterns of economic activity that are not consumer dependent, or a decoupling of emerging market economic activity from the US (which could pose a different set of policy challenges).

Brad DeLong believes that we will be sustained by something that has blinded us, so far, to the extent of our problem, the handcuffed dollar-holding foreign governments:

The next generation, therefore, will see a very interesting dance. Call it reverse finance colonialism? Call it something. Foreign governments will be seeking high-return assets for their enormous portfolios without selling dollar-denominated wealth. Consequently, they will have to focus on U.S. corporate securities. With such large-scale investment comes ownership and with ownership comes control. No government will want to play the role of passive investor, with the attendant risk that its partners will tunnel the wealth out from under its grasp, leaving an empty corporate shell.

So what is likely to come to pass is not the socialism feared by the Right—at least not ownership of the means of production by the U.S. government. Instead, it will be ownership of U.S. companies by foreign governments—and on a scale we’ve never before seen.

Can anything stop this progression? Yes. A collapse of world economic growth—which would create a very dangerous and angry world. Or a sudden return to thrift on the part of American consumers—so that we can finance the industrialization of the rest of the world rather than having them finance our consumption. But neither is likely.

That will leave Americans confronting a new and unprecedented phase of globalization. Government agencies in Beijing, Dubai, and Brazilia will have a large financial interest in everything from the health-care policies of American factories to the compensation packages of corporate executives and the apportionment of seats on corporate boards. And their interest will matter: They will, after all, be the people who have the money—just as Americans were the people who had the money in the years after World War II.

So we'll be able to sustain our lifestyle to some extent, but only at the price of becoming financial captives to the countries that can prop up their bad investments only by throwing more money into the pot. I'm not sure DeLong follows his own thinking quite far enough, but it's difficult to see a way in which scenario ends well for anyone.

Oh, details, always with the details

Robert Reich today on the outcome of the Treasury Department "stress tests":

The outcome of the "stress tests" will be that the banks needing extra capital will get it from the Treasury. But where will the money come from, now that the TARP fund is almost exhausted and Congress is dead set against providing more bank bailout money? The Treasury will simply swap debt for equity – turning what the banks owe the government into shares of stock in the banks. Presto. Ailing banks will get more capital, and Tim Geithner won’t have to go back to Congress to ask for it.

But by this sleight-of-hand, the public takes on more risk. Much of the money we originally gave Wall Street took the form of senior debt. We were preferred creditors, meaning that in the event of bankruptcy (or some form of it) we’d get repaid first. But as shareholders, we’d get nothing. As we’ve seen time and again during this economic crisis, shareholders lose big.

Wait a second. Let's go back:

But by this sleight-of-hand, the public takes on more risk.

Professor Reich goes on to discuss the likelihood that, should we become the major bank shareholders, we might well not make the money back (though that doesn't seem to be the common assumption of the administration and most economists), and it's not clear at all how governance is done in a publicly-owned bank (my guess: business as usual, see AIG for details).

It seems to me that pretty much everything that's being done right now pushes risk onto the most vulnerable, and anything that might reduce risk (national health care, for example) is deferred or delayed or otherwise left for later.

Perhaps this is inevitable. After all, the nation as a whole has spent itself and leveraged itself into a remarkably risky position, and none of this can be unwound without involving the "regular people." Clearly, a good portion of what we're experiencing now is actually the realization of the risk we deferred year after year.

But risk rarely spontaneously decreases, it takes positive innovation to do that. Otherwise, most actions just move risk around. For example, the invention of circuit breakers made the use of electricity far less risky than it had been. Traffic lights, the use of automobiles - we could come up with any number of examples.

The financial world, however, has spent its time on innovations that do not in fact reduce risk, but move it around. Sometimes that's been desirable, as it is for commodity futures, in which the risk is removed from the farmer who just wants to focus on growing a healthy crop, and given to a trader who's comfortable with the downside potential (but believes his or her innate smarts will offer upside).

What we've seen over the past few years is the negative side of innovation, a host of complicated-sounding products that have simply moved risk around, and not always to those who are willing to embrace it. We've also had a lot of puffery, much of it expounded by seemingly trustworthy types, to the effect that, for example, the stock market always offers positive returns over the long haul. And we've bought into that puffery, believing that risk has somehow been removed from the system when nothing of the sort has happened.

That hits home only when a family wakes up and realizes that putting Junior's college fund into a can't-drop-in-price house, or worse yet, into a big screen TV, actually pushes their risk (and Junior's) into unacceptable territory.

We can explain a few other things through this spreading of risk (if you want to read some real-life examples of risk-shifting, I direct you once again to Peter Gosselin's excellent book High Wire). Income inequality is a direct consequence of spreading inappropriate risk around the economy.

It's also the case that there is a global risk, and, as we take steps to reduce the risk in other countries, we assume that much more ourselves (creating more certain income streams for Indian computer programmers makes returns for American programmers that much more uncertain - I'll leave it as an exercise as to whether there are other compensations that make up for that).

There is clearly a political opportunity for someone to pick up on and speak to the increasingly risky lives of Americans. It could be done by intelligent re-examination of our national priorities, adjusting spending even as we provide appropriate stimulus; this is unlikely, as chronicled today by EconomistMom. Or we can slip into foolish demagoguery, which appears to be the approach of the Republican Party.

What we could do is reprioritize, accept that our chickens have come home to roost, and intelligently reorder things so as to deal with the reality of a poorer nation than we would like to believe we have. I am not hopeful.

Nationalization

I have held off writing about this, as there are so many people weighing in on what our government should do about the banks.  It is amusing to watch spreading groupthink, as pundits and economists who never would have trusted the Bush administration with massive involvement in the economy leap to ever-widening trust in Geithner and Summers.  One thing you can say for Bush: had he taken over the banking industry and the auto industry and parts of the insurance industry, he would have been absolutely definite about his ability to do so, no matter the actual results.

Here's my view, conditioned by years of considering myself a moderate Republican.  Government involvement is necessary whenever the market cannot achieve a necessary aim, that is, when questions of equity or safety outweigh the magic properties of free-market capitalism.  Almost everyone accepted the federal projects to electrify the nation (for example, the TVA) because electricity was seen as vital to the interests of our citizens, and it was highly unlikely that any private company was going to supply power to certain poor areas.  Other than a few purist zealots, we all think that government should play a role in product safety, because the industries themselves have few incentives to guarantee a certain level of freedom from worry about the dangers of lead paint or infestation (I mention the zealots because there are those who will make a case that the dangers are self-limiting; once consumers realize they're dropping dead from lead-painted toys, they will put the offending companies out of business - most of us reject this "wisdom").

Intervention in the banking industry is touted as necessary because, without it, lack of credit will cripple businesses and consumers and the entire world could be caught in a financial conflagration.  If that's true, then our government has a necessary responsibility to do something other than stand by and hope for the best.

It's a lot harder to make the same case for the auto industry.  There is nothing vital in having a domestic manufacturer of cars, as is obvious when we look at the growing market shares of Toyota, Hyundai, and so forth.  One might still offer an argument if the contention is made that employment cannot take the sudden shock of GM bankruptcy, but, since the remedy currently offered is to drastically reduce employment, that argument doesn't hold up.

So here's what I would suggest.  Let's let the auto industries go.  Maybe Ford will survive, but GM and Chrysler are unlikely to ever become functioning entities again, and it's time to pull off the Band-Aid.

As for banks, let's nationalize them and instantly sell off every piece that isn't commercial or personal banking.  If a bank is doing something that doesn't involve supplying credit to a business or individual, that function has to be excised, because it's not vital to the operation of the republic.  Merger and acquisition advisory services, gone.  Sponsorship of opera nights or marathons, gone.  We simplify the business for two reasons: first, we should only be propping up those parts that are truly necessary, and, second, government may have a better chance to operate a loan operation than it does a CDO shop.  (This would have the pleasant by-product of eliminating those nasty bonuses, as the "hot" banking areas would be on their own.)

---

If you want four more takes on the auto industry question, see the New York Times' Room For Debate, Does the U.S. Need an Auto Industry?

Robert Reich, who has realized that bailout plans rely on the dismissal of workers, is outraged in his post from yesterday, The Auto Bailout Is Going Off the Road.  I respect Professor/Secretary Reich a lot, but he seems a little late to this party:

What? Having General Motors or Chrysler cut tens of thousands of jobs in order to be eligible for a government bailout reminds me of "saving" Vietnam by bombing it to smithereens. Aren't we giving these companies billions of taxpayer dollars to save jobs? If not, we're just transferring money from taxpayers to GM and Chrysler bondholders and shareholders.

Unfortunately, even a man with his intellect doesn't really offer anything useful as an antidote:

The purpose of any auto bailout ought to be to help American auto workers keep their jobs, regardless of whether they work for GM or Toyota or anyone else. Or if they lose their jobs, help them get new ones that pay almost as well. Yet we’re doing exactly the opposite: We're paying GM and Chrysler billions of taxpayer dollars to keep them afloat while they cut tens of thousands of American jobs and slash wages.

True, until we ask the question, what jobs "that pay almost as well," and what does "almost" mean?  This conundrum is the exact reason that our leaders consistently punt on this issue; there are no solutions to this dilemma.  We're seeing the props come out from under this economy, and nobody has the answer for 300 million Americans.

Will employment really get back?

A sobering post from the Federal Reserve Bank of Atlanta studying the growth of employment after recessions. There is little in the way of hard and fast conclusions, given the small number of data points and the changes in the world, but the 2001 recession may be the closest indicator:

The two most recent recessions, which had relatively low rates of job decline, had very drawn-out employment recoveries. In 2001, employment—growing at an average annualized rate of 0.3 percent—took 35 months (nearly three years) to return to prerecessionary levels. The average rate of employment growth was also approximately 0.3 percent after the 1990–91 recession. But because the share of employment lost was less, employment returned to prerecession levels in 19 months.

The post tries to derive some sense of what could happen this time:

If the current recession ended today with a 2.7 percent job decline, and postrecession employment growth resembled the recovery from the 1981–82 recession, then employment would return to prerecessionary levels in approximately 14 months. But if the employment growth path is more similar to the two most recent recessions, then it would take well over eight years for employment to return to prerecession levels.

Since the recession does not appear to be ending today, this has to be seen as optimistic, and one would have to lean toward the eight-year side of things. This is scary.

Steve Benen had something similar in a piece about a Washington Monthly print story by economist James Galbraith. He quotes the editor's note by Paul Glastris:

If Galbraith is right -- and I fear he is -- it means that tens of millions more Americans will be out of work in a year or two or five, even if the stimulus creates all the jobs the president expects. It means that the big banks really are 'zombies' that will neither resume normal lending nor grow their way out of insolvency regardless of how much money the Treasury pours into them. It means that the auto companies will burn through every dime the government lends them and still not turn a profit.

(Galbraith's story is here. Essentially, he believes that the current situation may lie outside the traditional models, leaving us in a state from which proposed methods will be insufficient. Banking may not just come back, and the rest of the economy will be similarly crippled for years to come.)

It's growing increasingly difficult to look at what's happening and believe that, after some rough months, we'll just end up on the upward glide-path to success. It may well be that something is irretrievably broken, and we may just have to steel ourselves to living in a different America.

[Note: I didn't look at the comments to the Fed piece until after I finished this post, but there are some good thoughts there. Sandwichman points out the story is not told wholly by numbers:

Those red, blue and orange lines are not just measuring a change in quantity of an unvarying commodity, they are also concealing the changing characteristics of the jobs being measured. The recovery from this recession is likely to involve a much greater qualitative change in jobs than the previous recoveries. The pace of that recovery thus will reflect how quickly the process of change occurs, not simply a quantitative "return to pre-recession levels."

This part should never be forgotten when people talk about the recovery. The post-recession landscape will be seen as positive only if we end up with an increase in opportunity for all Americans, something that seems increasingly unlikely.]

Prices are down. That's good. No, it's bad...

From the AP:

Consumer prices dipped unexpectedly in March, leaving inflation over the past year falling at the fastest clip in more than a half-century. The recession is expected to keep a lid on inflation as widespread layoffs dampen wage pressures and weak demand keeps companies from raising prices....It was a better performance than the 0.1 percent rise in the Consumer Price Index that economists had expected.

So that's great news, right? "Better" performance?

Maybe not:

Over the past 12 months, core inflation has risen 1.8 percent. While some economists have expressed fears the recession could spawn a destabilizing period of falling prices, other analysts point to the rise in core inflation as evidence that deflation remains only a distant threat.

In fact, some economists worry that all of the moves the Federal Reserve has made to fight the recession and the worst financial crisis in 70 years could be sowing the seeds for inflation troubles down the road.

Well, that actually sounds pretty dire. I'm getting a little confused as to whether we have deflation or inflation, and whether we have good news or bad. If only some learned fellow could put my mind at ease:

In a speech Tuesday, Federal Reserve Chairman Ben Bernanke repeated assurances that the central bank is always mindful of the threats of inflation and is prepared to remove the monetary stimulus it has provided once the economy shows signs of stabilizing.

Oh, OK then. The central bank is on top of it, and will suck all the money out of the economy, the billions and billions of dollars, once there are "signs" of things going better.

Sarcasm aside, we need to be very afraid of this. There are two massive forces colliding, one deflationary as wages and prices are cut, the other inflationary, as the Fed pumps money into the economy. As long as they remain roughly in balance, we'll see only mild price changes.

If we listen to the Chairman, we would believe that the Fed is so thoroughly attuned to the health of the economy that it will know exactly when things are turning around and will remove "monetary stimulus." This is code for money supply and interest rate changes (those are the two monetary tools the Fed has at its disposal).

This is the same Fed that did nothing to curb a tech boom 10 years ago, and did nothing to curb the housing boom of these past several years.

More importantly, monetary policy is not what we're using to put people to work and get the economy moving. We're using fiscal policy, as the government shovels money out the door to soak up all that unused supply of labor.

However, the stimulus money, quite a bit of it, has been marked for long-term projects, infrastructure improvements, just as all the economists and pundits told us it should be. These projects, despite the use of the term "shovel-ready," tend to take a certain amount of time to wind up, and they also are predominately atomic (that is, a single indivisible unit).

For this kind of fine tuning to work, we had better be prepared to see roads to nowhere, bridges half completed, wind farms abandoned...but we know that's not going to happen. Even after the economy starts to turn around, we're going to be committed to finishing these projects, and that will cause distortions in the recovery - even, potentially, more bubbles. We could very easily end up lurching back and forth from boom to bust, never quite getting a handle on doing things that lead to long-term growth and stability. And I don't even need to mention the political swings that will come about.

Too much book-larnin'?

In the category of late to the party, I put a reference to an excellent Vanity Fair article by the reliable Michael Lewis, Wall Street on the Tundra. It chronicles, in painful detail, the way that Iceland messed up its economy. Essentially, the country became obsessed with finance, making scores of young people into untutored investment bankers.

There's too much here to summarize properly, you really have to read it for yourself, but, for me, a telling quote:

Back away from the Icelandic economy and you can’t help but notice something really strange about it: the people have cultivated themselves to the point where they are unsuited for the work available to them. All these exquisitely schooled, sophisticated people, each and every one of whom feels special, are presented with two mainly horrible ways to earn a living: trawler fishing and aluminum smelting. There are, of course, a few jobs in Iceland that any refined, educated person might like to do. Certifying the nonexistence of elves, for instance. (“This will take at least six months—it can be very tricky.”) But not nearly so many as the place needs, given its talent for turning cod into Ph.D.’s. At the dawn of the 21st century, Icelanders were still waiting for some task more suited to their filigreed minds to turn up inside their economy so they might do it.

Enter investment banking.

I do understand that one cannot compare Iceland to the United States (though Lewis certainly finds parallels to our high-flying world of finance), but it seems indicative of something that it is at least possible for a nation to have too much education. It demonstrates that the commonly-held idea that more education is always better is false, that its truth depends on a base that is considerably more complicated.

As I have pointed out before, the labor market is in many ways not a market at all. No one really cares if everyone has an SUV, or a big-screen TV, but we want everyone to be working. The employment market really only works in two cases: either there is so much demand for everyone that the supply mix is immaterial, or the demand has to pretty closely match the supply.

I would contend that, for a very long time, the first condition was true in America (generally, that is; I'm not forgetting the Great Depression). We were so productive and had such resources that we needed everyone, no matter what they did. And as classical economics would tell you, that situation leads to incomes being bid up, and that's just what happened, from CEOs to garbage haulers.

But our growth rate, for a host of reasons, is no longer what it was, even potentially. We're not China that can unleash pent-up demand and grow in the double digits every year. We've moved to a mature phase in which growth can come only from real innovation, and that will never be 10+% again.

So our labor market is in the second situation, that is, the people we're producing have to pretty well match up to the opportunities we have. That matching has to come out of the whole system we have. If we tell our young people (as we have) that agriculture is a dead end for the uneducated, so no one enters the field, but we still need, say, 1,000,000 people to work on farms, we can only get them from two places: from somewhere else, or from those who haven't succeeded in anything else.

That is the crux of the Iceland problem, that they can't paper over the mismatch by importing workers to do the fishing and smelting. There are structural reasons, most social, why that won't work. It also is not clear, if they did import workers, what Icelanders would then do, other than leave the country.

Now I hear the objection. What should happen, if Icelanders are extremely well-educated but have nothing to do, is they should become great innovators and creators. That's the assumption our experts make, that more education will lead our youth to make the future.

That's not wholly untrue. We have a far greater ability to assemble a critical mass of diverse-skilled workers to accomplish things, much more than does Iceland. If we overeducate some number of people, there is some probability that they will find something to do, and it may even be productive and lucrative (like Twitter...but I don't want to start on that).

But some is not 100%, and, in my opinion, it is possible to have too much education, and almost certain in specific fields. Which leads us to the Iceland case, one that I think serves as a cautionary tale for us. Instead of assuming that more education in any field is absolutely required to be a good thing, we need to start looking at the mix, and, perhaps, provide incentives for young people to enter vocations that we're actually going to need. More home health care workers, fewer software engineers.

Otherwise, we're left with the argument that supply inevitably creates its own demand, and we're pretty sure that's not an inviolable law at all.

The good, the bad...TIME edition

The current issue of TIME magazine is a disconcerting mix of good news, bad news, and something in between. The bad news is an article about four countries, Ireland, Spain, Taiwan, and Singapore, and how they're hurting in the current financial crisis. Ireland, for example, is suffering the bounce effect of globalization; many of the jobs that came there from the United States over the last decade are now moving again, to Eastern Europe. It would be good if someone could tell us where all the jobs will eventually land, then we could all move there - Abidjan, anyone?

There is little hope in any of these countries. Ireland hopes to use wind and water to get a toehold in renewable energy, Singapore's diversity is not protecting it against a systemic downturn, Spain is not certain of being able to employ anybody, and Taiwan may have to embrace the mainland to keep their economy going. Even countries that made many of the right choices are facing unpleasantness.

The in-between news is an essay with photos on the plight of Detroit. This once-proud city is now under a million in population, with a third of its land vacant. The items that cite its decline are by now familiar: the loss of jobs as the automakers have fallen, the corruption, the unemployment, and on and on.

The article tries to present hope, but I find it difficult to see how turning an auto body plant into a haven for artists will stem the tide. There are new hotels, and the state is offering massive tax breaks to Hollywood; various Detroiters are quoted as saying that the city is a canvas upon which new and wondrous things can be wrought.

But even in a piece that wants to fill us with optimism, the news is pretty bleak. Here is the end of the story:

As America's 11th largest city tries to mount a comeback, locals battling lean times are far from the only stakeholders. "The problems facing Detroit are definitely going to be cropping up in cities all over the country," says Hollander. "The kind of devastated postindustrial landscape we associate with the Rust Belt is starting to creep into the Sun Belt and may start to become a universal problem." Says Covington: "The rest of the world is just catching up to the hard times we've been experiencing." Which is why the world is now watching Detroit with interest--and waiting to see if it finds a way to rise from the ashes.

Pretty thin evidence for a potential comeback here.

The good news is the cover story, written by novelist Kurt Andersen. The cover features a red RESET button and the text, "The End of Excess: Why this crisis is good for America." The subtitle inside ends, "How a reset can make America a saner, better place."

And I've now told you pretty much everything you need to know about this think piece. It's the standard "we've put ourselves into a big hole, but what will emerge will be brighter and more wonderful than ever." Yes, Andersen cites the ant and the grasshopper. There are also pop-culture swings by Homer Simpson (old bloated America - bad!) and Road Runner cartoons, references to silver linings and exhortations to continue thinking big grand thoughts. Our young peope will move away from the crass, money-making interests of their elders, and dedicate themselves to the public good. We'll be able to do housing right, avoiding our soul-crushing, resource-wasting suburban sprawl. And, as an extra bonus, we'll stop paying attention to Paris Hilton.

Finally, somewhere on the fifth page of five, Andersen gets more serious and confronts some of the hard reality. And you'll be happy to know that even our putative economic competitor doesn't have to be a problem:

Twenty-first century China is the greatest country of the 20th century. Muscular industrialism gets you only so far. Further increases in productivity and prosperity require ingenuity and enterprise applied at the micro scale — digital devices and networked systems, biotechnology, subatomic nanotechnology. As China and other developing countries finally achieve the industrial plenty that we enjoyed 50 years ago, the U.S. can stay ahead once again by pioneering the next-generation technologies that the increasingly industrialized world will require.

That's right, it's more of the idea that a country that can find no jobs for people who want to work in technology will somehow take the lead in developing the next big thing (other than Twitter or Facebook).

The other pillar of Andersen's strategy is that we need to take in more immigrants. He does qualify it by saying we need to, "to encourage as many as possible of the world's smartest and most ambitious people to become Americans." That we have no idea how to identify which of the people who want to come here are smart and ambitious does not deter Andersen in the least.

So what this boils down to is a cleverly-written article right out of the Noonan/Friedman handbook. All inconvenient realities, any recognition of the ways in which the world has dramatically changed, the need to temper balloon-headed thinking about "American ingenuity," these are swept away in a tide of feverish excitement about our "reconstruction and reinvention."

Very little of it is convincing; cheerleading will not get the job done (see Detroit above). Even if this time did present an opportunity to get real about what America can be, we're unlikely to do the hard work necessary. One need only listen to the various leaders, who are pretty well unanimous that we will get through this time, then return to the fervid, profligate ways we "enjoyed" before.

On second thought, TIME doesn't have any good news at all...

A math primer

Not a very light topic for a Sunday, perhaps, but I like math so this post seems like fun to me. I'll try to keep it brief, but I think I need to pull together some of the myths that drive thinking about mathematical topics. I've written about one or more these before, but it's important to keep them in mind.

1) "Exponential" growth

One reads all the time about something that's experiencing exponential growth. Cell phone penetration, chip utilization, and so forth: many things are seen as following an inexorable growth of growth tendency.

Of course, that's not true, not possible, and I wrote about it about a year ago. But it bears repeating. Growth in any real situation more likely follows the logistic curve, the elongated S that features slow growth at the beginning, apparent exponential growth in its maturity, then a flattening as some kind of natural limit presents itself.

There is an upper limit on the number of cell phones we can possibly have; we can differ on that limit (I'd say 30 billion is higher than we will ever see), but it exists. Therefore, any business model or op-ed that depends on "exponential growth" is bound to be wrong. More importantly, at the middle of the S, the rate of growth begins to slow down. Finding this inflection point is vital to understanding the profile of the market in question.

2) Curve fitting

Much of the current discussion about what kind of recession we're having depends on historical precedent. Economists take what happened in the past and extrapolate it to the present, despite a lack of relevant data points (is our current situation like the Great Depression? Who knows, we've only had one?).

This attitude is typified by a recent post from Kevin Drum, where he argues:

If you want to know what's going to happen in the future, you should pay attention to what's happened before...."This time it's different" is probably the most dangerous phrase in the world. It's especially dangerous because every once in a while it's true. But not often.

Drum is arguing for a kind of determinism that is actually more dangerous than what he's saying. I'm not contending that one should accept convoluted arguments to ignore what is patently obvious, just that most real-world models are complex, made up of many components. Ignoring changes to assumptions or conditions has its own perils.

Some simple math. If you tell a student to fit a curve to data points (1, 2) and (2, 4), most will pretty easily come up with y = 2x. But here's what I can do, I can fit a slightly more complicated curve to these points: y = 2x + k(x - 1)(x - 2), where k is any number I want. This is a family of parabolas that pass through the two given points, but I can make one pass through any other point I want, simply by choosing the right k. (And there are literally an infinite number of other curves I could fit, including circles and squares and triangles.)

My point is, the fewer data points we have, the less likely we are to get a model that predicts anything. If I give you those two points, and ask you what y will be when x = 3, you may say 6, but I can make a model that will give any answer I desire. We need to be quite wary about using the past to predict the future.

3) Nonlinearity

[I'm going to be brief and imprecise here, give just enough detail to make my point.]

Nonlinear systems are, roughly, any real system of any complexity. They feature components that depend on one another, that are changed by the changes they themselves generate in other components. Weather is one such system. I suspect the global financial system is the same.

The main result of the study of such systems is that small changes in initial conditions can bring about huge changes down the road. One person decides to go out for a drive in Iowa, and the extra heat generated by burning the gas brings about a monsoon in Bangladesh. (That's an extreme example, and there is evidence that some systems, including weather, feature dampening effects that keep such extremes from happening, but the math is consistent with that.)

Therefore, it's virtually impossible to get a precise forecast of what any real nonlinear system will do. I would wager that we'll never have absolutely exact weather forecasts ("that corner will be 74º with 48% humidity and a NNE wind at 7.6 mph a week from Thursday").

By the same token we can't really predict what, for example, a given stimulus package will do. It is not impossible that an $800 billion package will work perfectly, creating jobs and improving GDP, while $801 billion will force the economy into a chaotic condition that will be worse than what we have now (and, oddly, $802 billion might lead to a perfect result again). But we don't know that ahead of time, and we can't.

So we need to take all the certainties and forget them, and just hope that we will move in the right direction. But we also need to be realistic and understand that...no one really knows.

Happy happy joy joy

There continues to be a prevailing attitude that a lot of our problems are simply the result of pervasive pessimism, that, if we could just perk up and feel good about what's going on, we would see a resurgence of financial strength and national pride. The media comes in for particular criticism here; they insist on talking about layoffs and unemployment and housing prices and dead 401(k)s, and they bring everyone down, and that creates a vicious cycle that makes things even worse.

Rob Horning discussed this in an item that ran about a month ago, where he parses an op-ed by Robert Shiller that replicates the idea of his book (with George Akerlof), Animal Spirits (which has given us one of the more blogged phrases of the past month), that "the Depression narrative could easily end up as a self-fulfilling prophecy." Horning:

If people invest, or spend, not out of strict need or want, but in accordance with how they feel about wanting, then the implication is that the media owes society some happy talk about the economy to keep up the “animal spirits”—Keynes’s term for the irreducible ambition that drives entrepreneurs regardless of their probability of success.

Akerlof has gone so far as to argue that government's role is one of countercyclical confidence: that it cut down people's confidence when times are good, and pump us up when times are bad. Horning quotes Will Wilkinson, who is not very pleased with this reasoning:

I’m extremely suspicious of what strike me as intellectually contentious, ad hoc interventions into the economy aimed at expectation management. Countercyclical economic mood-control initiatives seem to me inconsistent with the maintenance of a general framework of stable rules — that is, they don’t take the importance of expectations seriously enough — while also smacking of illiberal state propaganda.

A skeptical Horning concludes:

Delusional thinking about credit risk got us into this mess, so now the only thing to get us out is more widespread and more doggedly institutionalized delusional thinking? All right then! Not sure how this would help the “trust” and “faith in the system” components of animal spirits, but oh, well. Maybe if we perfect the dissemination of these delusions, we’ll be free at last from those ultimately irrelevant real economic conditions, and the state can just drop in to tell us what condition our animal spirits should be in.

I liken the Shiller-Akerlof attitude to our mental model of how football works. Conditioned by years of "Win one for the Gipper" and "Do you believe in miracles?," Americans have come to believe that any situation can be overcome by the right frame of mind and simply "wanting it more." All the economy needs to come back strong is the right halftime speech, and we will all be inspired to do anything necessary for success.

This seems compelling until we think about it for, say, 15 seconds or so. A football team made up of 160-pounders can be as inspired as we want, but, barring massive injections of PCP, is going to be crushed by the 300-pound linemen of a major college or pro team. No amount of "animal spirits" is going to change the reality that facts are facts. If you've lost your job, confidence doesn't permit you to believe you still have one.

Anyone who's worked in business for a while has seen an example or two of the person who brings very little competence, but a whole mess of confidence. Enthusiasm is confused with ability; that's possibly the result of management's own experience, that projection of a certain image can bring real results, whether in sales or the conference room.

But that should have nothing to do with hiring a programmer or an accountant, jobs where skills actually matter. You can trump up a theory that a positive attitude helps any team, and that may be true in the short run, but, eventually, management's regard for someone who can't actually do anything but be peppy corrodes the team.

The same is true of the economy as a whole. To say that everything's fine, just ignore those pesky media reports or the for sale signs, is to brand yourself as a nincompoop. It's possible to project long-term optimism while being realistic about today; that's something, I think, that Obama has done quite well (though I personally still find his outlook overly rosy). Irrational optimism, optimism that is at odds with actual on-the-ground, is foolish, and the purveyor of such ideas should not be listened to.

Time to get out the map

Citizen Carrie shows us today, among other things, why the Internet is crushing traditional news media. In Stealth White House Meeting with Indian IT Delegation, she reports on a meeting of White House economic officials with a group of business leaders from India. Read it, because it's about all you're going to see from a U.S.-sourced writer about this meeting, and Carrie was able to do that by referencing Indian sources.

But, on to content. The major thrust of the meetings was America's H-1B program, and how desirous the Indian leaders were to have it continue and be expanded. One of the big players in the meetings was Larry Summers, director of Obama's National Economic Council and one of the administration's leading spokespersons for all things economic. Apparently, according to the Indian press, the Indian businessmen came away with confidence that our government, including Obama, was going to continue their support of the program.

India has the natural concern that waning American support for visas that allow Indians to come here and for offshoring will hurt its by-a-thread economy. They see the H-1B program as a cornerstone of free trade; since there are not a lot of goods traveling back and forth between the two countries, it's necessary to keep people and work in the form of services crossing the borders. (Of course, we never hear in any of these articles about the restrictions on Americans taking jobs in India, I guess it would be pretty inconvenient to mention that.)

Carrie cites a Business Week article that fails to mention the White House meeting, but does take up the party line espoused by Infosys co-chairman, Nandan Nilekani, that we need to be concerned that any restrictions on anything will lead to a situation where, "trade between the US and India will be neither free no fair. That’s something people on both sides of the globe need to be concerned about." No mention of possible trade-offs here, but I'll let Carrie have the last word on this point:

Why don't you write a full series of posts along these lines so you can educate Americans on how the loss of good-paying jobs for U.S. citizens is vital for continued good political and economic relations between the U.S. and India? I'm sure if we are fully able to understand the benefits of middle-class workers moving into cardboard boxes, while our "healthy" GDP creates good-paying jobs for Harvard Business School grads, lobbyists, and a select few who are able to latch onto the coattails of the business school grads and the lobbyists, we'd be less likely to call for those uncouth protectionist measures.

One other thing that interested me about the Indian visit was a report of another meeting the delegation had, with "thought leaders" Henry Kissinger and other luminaries (objective sorts like a CEO of a multinational and the former US ambassador to India). What's Kissinger doing here?

It's always possible that Henry has massive contracts with India and so wants to keep the U.S. financial pump flowing, but I had another thought, and, for that, we'll have to refer to the world map (you can look at your atlas if you don't have a map on the wall of your office).

Let's take the 30th parallel north, and start in Saudi Arabia and move east. We start with our "friends" the Saudis, then travel to Iraq, Afghanistan, Pakistan, India, and China. I'm not going to detail our manifold problems in those nations, other than to suggest that an amazing number of our current difficulties have something to do with those six.

And of those six, not one can be counted upon to be a reliable friend to American interests, except, maybe...India? And, if we have to pay a high price for that support, it's very possible that the calculation is that it's worth it. If we have to give a remarkably generous nuclear package to India, we'll do it. If we have to let them have our call-center jobs, we'll do it. If we have to educate their students, then allow them to stay in this country (at least for six years), we'll do it.

But we can't appear to be appeasing India - we're the strongest country in the world - so we wrap the discussion in "free trade," or "jobs Americans can't do," or "helping the downtrodden masses" (the last argument allowing CEOs to think of themselves as Mother Teresas with private jets).

It seems we've completely fallen away from the concept of evaluating policies on the basis of whether they make overall sense. It's not very far from that to the point where we treat any mention of India as being anything other than our good friends (as opposed to a nation with interests of its own) as somehow unpatriotic; we've done that with other countries, and that's not led to positive outcomes, as the U.S. is seen not as an honest broker for good, but as a country that's in the pocket of another. I don't think that makes a lot of sense.

The new economic boom

Andrew Sullivan prints a letter from a reader who has just been laid off. He's not a financial executive or a realtor, he's in the new "boom" industry of infrastructure improvement:

Some construction companies, including the biggest names in the D.C. area, have reduced their workforces by over 90% just to stay afloat. Others have gone bankrupt.

With the collapse in residential construction, and with commercial construction struggling badly, contractors have directed their focus on government projects. For instance, my company bid a small ($600,000) project to demolish an existing government building, haul the material offsite, and restore the work area with new topsoil and grass -- a two, maybe three month-long project. How many contractors bid for this project? THIRTY-SIX! THIRTY-FRIGGING-SIX! Three years ago there probably would have been no more than six or seven bidders, because everybody was so busy. My company cut our bid to the absolute bone, then cut some more. I think we came in 7th or 8th place.

Every bid for government or public authority work we've submitted as a general contractor over the past year has been at cost, meaning break-even. Right now, as my boss told me yesterday morning, we can't even buy jobs (i.e. bidding contracts) at a loss just to keep revenue coming in and the field guys busy.

Competition is a wonderful thing, it really is, and we can see why from this story. With 36 bidders for every project, all these new initiatives that will be generated from the stimulus money will be done at the absolute lowest cost. Our public funds will get the biggest possible bang for the buck.

But there are potential downsides as well, and they may undermine the supposed advantages. The first is quality. I would love to think that all these firms that are winning these bids are doing so while upholding quality, but experience tells me otherwise. Either they're cutting corners somewhere, or they're lowballing the bid to win the contract, and we'll end up paying the overage.

The second is the actions that will be taken to keep costs low, each of which will seem justifiable when we're "spending the taxpayer's money." In this environment, offshoring begins to look downright patriotic, even though it undercuts one of the main reasons we want to embark on this stimulus - that of helping stimulate consumer spending through renewed employment.

We've already seen GM invest a billion dollars, money that was backed up by us, in Brazil. We can bet that the bulk of the modernization of health care systems will be done in other countries.

Thus, we need to temper our expectations for this stimulus. I don't know how it will end up shaking out, but it could well lead, not to a V- or U-shaped output pattern, but to an L, in which we end up stagnant for a long time (while we rebuild the rest of the world). I know that any measures that try to counter this will be labeled as that filthy word "protectionism," but I also know that the last thing we need is an ineffective outlay of public funds.

Choice

I've written before that one of our assumptions, that democracy goes hand in hand with free market capitalism, is flawed. They are two systems which really don't have all that much in common, given that one features "one person, one vote," while the other has as its centerpiece "one person, 40 billion votes" (if that person is Bill Gates). The tensions between the two systems become grossly apparent at various times in our history, and I believe one of those times is happening now.

However, there is one critical common factor of democracy and capitalism, and that factor is choice. Each of them gives a sense of choice that is not present in other systems; we can choose any from a number of candidates, and we can choose any from a number of toothpaste varieties. Of course, these are still constrained choice sets, as we see every presidential campaign when the voters of numerous states are presented with no choice at all, the decision already having been made. Even on the consumer side, choices are certainly not infinite. In general, though, we are usually satisfied that we are being given more rein for our selections than, say, people had in the old Soviet Union.

Naturally, choice requires knowledge, and, while we've made great strides toward making that kind of knowledge more available, it is still not clear that we want a gigantic number of choices for every single thing. Most people prefer Social Security to self-directed investments because there are too many options and the information is not 100% reliable (note that this is an inherent quality of anything that requires a forecast; information can never be complete, and has a cost that can exceed its marginal value).

Choice is also confounded by deliberate attempts to obfuscate and blur. We know this to be true in the political sphere and the economic. Misleading campaign ads, puffy advertising - these techniques have converged in modern marketing, which has become, essentially, the science of attempts to influence people's choices, even if the new selection contradicts their ultimate best interest.

What seems hard for people in these turbulent times is taking a consistent stand on one side or the other of the issue of choice. And it's not easy, especially as we each would like to have our own comfort level of choice (a lawyer who deals with health care issues might feel perfectly comfortable making a decision about a medical plan, and would find a national plan restrictive and unsuitable; the factory worker or software developer who is not immersed daily in these details would welcome the simplicity).

But that doesn't mean that we can't have individual clarity on these matters. If you believe that every home buyer made a free choice, that is, he or she was not defrauded, and you believe that choices have deserved consequences, then it's hard for you to support any kind of restructuring or bailout for homeowners.

And that attitude requires you to be consistent. As we see various companies using their federal money to pay bonuses to their employees (kudos for a job well done??), we hear an argument that is commonly made. Many of these employees are not the high-rolling decision makers who brought the world financial system down, they're clerks and secretaries and mailroom employees who happen to have large amounts of their compensation paid as a year-end bonus. Surely they don't deserve to be penalized for their innocent involvement in the scandals of overleverage.

But that argument ignores choice, the very real choice that each of these employees made when they decided to accept the job. Think of the secretary who is deciding between two jobs, one that pays $30K, the other $20K with a typical $20K bonus. We know that the hiring manager will tout that bonus as money in the bank, as something that has never failed to be paid. Choice, however, requires us to see through that argument to the very real possibility that conditions may not permit that bonus to be paid.

So I don't see how we, in effect, bail out that employee by looking the other way on his bonus simply because he doesn't make as big a base salary as someone who made the other choice. It still comes down to a matter of the choices people have made, and where an individual draws the line on how much we protect people from those choices.

Because then we get into a big argument as to which choices are protectable and which aren't, and I'm not real comfortable that we can reach an equitable conclusion. If there are larger considerations (we have to bail out the banks themselves because they are the blood of our global business system), then, fine, let's get that out on the table. If community stability is an argument for helping overextended homeowners, again, let's be upfront about that.

However, cherry-picking certain groups and their choices as being things we should shore up, and others we should not, runs a risk of being political pandering, and creates a very real possibility of social upheaval on a large scale. With everything else we've got on our plate, we sure don't need that.

If only you were there too, Tom

Yglesias gets it exactly right in a comment on Tom Friedman's latest bit of brilliance. First, Tom:

There is a huge amount of money on the sidelines eager to bet again on America. But right now, there is too much uncertainty; no one knows what will be the new rules governing investments in our biggest financial institutions. If President Obama can produce and sell that plan, private investors, big and small, will give us a stimulus like you’ve never seen.

Which is why I wake up every morning hoping to read this story: “President Obama announced today that he had invited the country’s 20 leading bankers, 20 leading industrialists, 20 top market economists and the Democratic and Republican leaders in the House and Senate to join him and his team at Camp David. ‘We will not come down from the mountain until we have forged a common, transparent strategy for getting us out of this banking crisis,’ the president said, as he boarded his helicopter.”

Yglesias:

Beyond the bipartisanship, in the real world this would be in practice a recipe for rule-by-CEO. A key constraint on the decision-making would need to be that it served the personal financial interests of the 20 “leading bankers” and “leading industrialists” (whatever that might mean) and there’s no reason to think that would serve the public interest. It would be interesting to speculate about what would happen if you held a meeting with all those people and gave them some kind of truth serum that made them speak honestly and bargain in good faith, but that’s not going to happen. Instead, the way the system works is that Obama and has team will need to craft a response and will need to take responsibility for its success or failure.

Of course, this is the usual Friedman recipe for every problem, journalistic or otherwise. Find the nearest rich person, assume that they will act for the common interest instead of their own, and let them run with the ball. If you read Friedman at all closely, you'll see that his interactions are invariably with sheiks and CEOs and princes and international consultants. His few mentions of "regular people" come from other people's reporting.

The rich are hurting, but not that much

Forbes is out with its annual look at the richest people in the world. This is a pointless exercise for many reasons, not the least of which is the unreality of the numbers. Let's say that Bill Gates has a crisis of some sort, and he has to turn all his holdings into cash. There's no way that he's going to be able to sell all his Microsoft stock at the same price; as he starts to sell, the price will drop, and the last share he sells will be at a severely lower price. But that's only a technical objection.

This is more a post about innumeracy. Take a quote from the Reuters story about this exercise:

The net worth of the world's billionaires fell from $4.4 trillion to $2.4 trillion, while the number of billionaires was down to 793 from 1,125.

(The way Forbes itself put it is similar:

The world's richest are also a lot poorer. Their collective net worth is $2.4 trillion, down $2 trillion from a year ago.

The reader is left with the impression that these chieftains have lost 45% of their riches. Perhaps that's supposed to make us feel better about the similar drops we've seen in our 401(k)'s. But, how did Forbes get these numbers?

They took all the billionaires on the list from last year, added up their values, then did the same for this year, and compared. This technique, however, is spurious, because, as is stated in the clause in the Reuters quote above, there are a lot fewer billionaires on the list.

It's as if we compared the wealth of two countries through GDP without correcting for the population - oh, wait, the press does that all the time, too. To be fair, Forbes does mention the average (down 23%), but the first number has no business being reported at all. If I had to guess, I would wager that I would find this impossible to explain to any news editor.

But will the Right scurry away from it?

Sullivan makes a lot of sense in The Center Moves Left?, in which he explains how the Obama administration is responding to actual events, not attempting to recreate France or form a socialist republic:

If your goal is to keep a polity in one piece during an economic crisis, raising some taxes on those who have had a relatively low-tax couple of decades, is again pragmatically defensible. If I thought Obama's goal was to redistribute for the sake of it, I'd be appalled. But that isn't what he's said and it isn't what he believes. Ditto cap-and-trade. I don't think it's the best way to tackle climate change, but I do see it as a legitimate, practical response to climate change - not some expansion of government for its own sake. It's also a real, if flawed, attempt to wean us off oil after a decade in which we learned the hard way what oil-fueled fanaticism can do to us. Again: this is about reacting to changes in the world. It seems to me to be within the conservative mindset to adjust to practical necessity and a changing world.

Once again, we have the curious attempt of Andrew Sullivan to reserve the "conservative" label for the things he believes, despite any evidence that modern American conservatism is anything like that.  I admire the effort, but I think Sullivan's going to have to change his moniker, because the Palin/Jindal Republican Party ain't a gonna.

But his point is spot on: we have massive problems like the economy, climate change, and health care, and the Republicans have been given every opportunity to do something about them, and they haven't made an iota of progress.

Now the Democrats are having their turn, and, while I don't buy into every last piece of it, I sure know what doesn't work.  So let's be cautious, see what happens, and try to respond a lot more quickly than we've seen in this last torpid 28 years.