Category Archive

A couple of quick notes and then some thoughts that I hope I have chance to build on over time.

GDP growth came in of course at around 2.8%. But, what does that tell us? Not much.

For example, personal consumption expenditures were weak at a 2.0% growth rate, but this is largely because Services came in a 0.2% which in turn is because Housing and Utilities Services declined by 13 Billion dollars. And, that is almost certainly due to a warm winter and lower than expected heating bills.

So, what does that tell us about the direction of the economy? Essentially nothing. We can say that Housing and Utilities will likely pop back in the spring meaning that Consumption expenditures could easily grow by 2.5 – 3.0%.

However, information wise that just piles nothingness on top of nothingness. It was strangely warm today, it will likely be less strangely warm tomorrow. That’s what you get from that data.

Autos did well, but we knew that already. Indeed, expenditures on all goods did well.

There is also a bit of handwringing over the fact that inventories contributed so much to GDP growth. But, what does this tell you. Most of this is autos. During the summer there was a major slowdown in parts from Japan. So Hondas and Toyotas started getting lean on lots. Now, they are coming back. That’s inventory adjustment.  But, it tells us little about the underlying economy.

The one real surprise I saw was a decline in non-residential structure investment. I am guessing this means less oil drilling or natural gas fracking, since that’s over a third of all investment in structures and it’s the entire source of growth.

Why that slowdown occurred I don’t know because Census is slow on getting construction data out. However, it will be interesting to see. A change in oil and gas extraction would be a big deal.

Companies continued to buy computers and software. Not really a shocker. Medicare and Medicaid continued to fund money to hospitals and doctors. Not much of a shocker there either.

Government was surprising rough as well and I wonder if their won’t be some revisions there.

In any case I just don’t think there is a whole lot of here, here.

As a quick note, though I can tell by the way business folks talk across twitter there is the sense that the economy is more complicated than it really is.

I mean what do you do. You probably have a house, a car, some clothes and a computer. Chances are you also eat food, sit on chairs, and have a relative who is or was in the hospital. That’s the private sector right there. If you went to school, that’s the public sector.

Done and done. There isn’t much more to it because there is just not that much to people and people are the foundation of the economy.

As per usual I am going to co-sign something that Matt Yglesias wrote.

I don’t exactly want to "defend" the Federal Reserve from the scorn that’s been heaped on it after the release of the 2006 FOMC transcripts, but it is worth paying attention to the timing. . . .

[Residential Construction] enters negative territory in the last quarter of 2005. Then it stays negative all four quarters of 2006, and during all this time the FOMC members are makign statements about how the economy should survive the housing bust. Then it’s negative for four more quarters throughout 2007. And then for the first two quarters of 2008. And all that time from the latter part of 2005 through all of 2006 and 2007 and through the beginning part of 2008, the Federal Reserve is basically doing its job correctly.

Watching at the time it was clear that the US Housing Bubble Burst, the 2008 recession and the Global Financial Crisis three related but definitely distinct things.

Indeed, here is Private Fixed Residential Investment over the boom and bust. Its not my favorite indicator but its denominated similar to what I am going to compare it to. We get a familiar picture.

Now I am going to layer over-top of that the inverse of net exports. Which is in fact net imports, and subtracts from GDP.

And, here is the two summed together for the net contribution to GDP growth.

You can see that by the time the recession hit the Housing-Export complex was actually adding to growth.

Now, why is this an important complex to look at?

Because, as many commenters have noted the boom in residential construction was in large part financed by large external deficit. We borrowed money from the Chinese (and Germans and Japanese) to build a bunch of homes in the United States.

However, the way you borrow money from other countries is by running a trade deficit. As residential construction shrank, so did the trade deficit. This provided the economic offset that kept the economy from going into recession in 2005 as residential construction rolled over.

By the beginning of 2008 though other sectors of the economy – notably non-residential construction and manufacturing, were beginning to weaken. This tipped the economy into recession.

Here is nonresdential fixed investment, a category that includes both nonresidential construction and equipment and software, plotting along with the sum of durable and non-durable goods consumption.

Both turned downward in late 2007 which brought on the recession proper in 2008.

Both the consumption of services and the government sector peaked after the recession began.

The growth in both is so strong its hard to see the change, so this is a zoom in.

You can see the both kinking in the 3rd quarter of 2008. Government goes from slow to an outright fall. Services goes into a much faster fall which it sustains into 2009. That’s the Global Financial Crisis.

We only have real service data going back to 1995 but we can see how different the service and government sector response was this time around as opposed to dot-com.

In the 2001 recession the hit to government and services is barely noticeable where in this recession there has been essentially stagnation since the middle of 2008.

And, the two sectors together are quite large, accounting for about 2/3rds of GDP.

So, we can see the three events, residential construction collapse, recession proper and Global Financial Crisis all as distinct events.

Will Wilkinson has a must-read post on libertarianism, why he’s more of a liberal than a libertarian, and how he’d rather argue more with liberals than libertarians. He also condemns Ron Paul about as well as anyone could in a paragraph of his usual rhetorical genius:

Somebody’s going to ask “Isn’t Ron Paul making a difference?” So I’m going to say, “Yes.” None of this is to say that right-fusionism of the Ron Paul variety isn’t now having an influence, or that none of it is good. I’m glad to see Paul spreading a few profoundly important ideas about foreign policy. But that doesn’t mean Paul’s decades of bilking paranoid bigots with bullshit prophesies of hyperinflationary race war was really a stroke of strategic genius after all. Or maybe it means it was. But that doesn’t make it right. I don’t think Paul would be where he is today without all those years of vile fear-mongering. And I don’t think anyone ought to get away with climbing up that evil ladder, kicking it away, then pretending he was born a thousand feet off the ground in the pure mountain air right there next to heaven. He knew what he was doing, chose to do it, and none of it can be justified by a little TV-time for salutary anti-imperialist and free-market ideas. I’d rather not be affiliated with a “movement” that includes him in even a conflicted way.

I am not quite persuaded by Will’s rejection of the term libertarian to describe himself. Or rather I am not persuaded by his rejection of the term to describe ourselves, since I share a lot of the beliefs he says differentiate him from libertarians. Will appeals to the prevailing public understanding of “libertarianism”, but I think that this is more about the relative importance of a high level of economic freedom to both freedom overall and general welfare than about which rights and liberties are “off the table”.

Maybe I am biased because I don’t want to surrender libertarianism to those I see as the radicals among us. But then again maybe Will is biased because it’s easier to persuade liberals when you call yourself a liberal.

Is this the worst paragraph about economics, at least from a major newspaper, in 2011?

North Dakota currently has the nation’s only state-run bank. Supporters point out that the state is the only one to have had a budget surplus since the economic crisis began, and has an unemployment rate below 4%.

I don’t consider the idea of public sector bank or something like it to be completely absurd, but for this reporter to allow even the hint of a connection between a public sector bank and North Dakota’s economic success is just terrible, irresponsible journalism. Perhaps North Dakota’s recent oil boom that has included a tripling of output over the past few years has something to do with the budget surplus and low unemployment rate? Or maybe it was the state bank that has existed since 1919. I guess it could be either.

One question I want to ask about public sector banks is this: would the financial positions of fiscally troubled states be better or worse if they had public sector banks over the last 15 years? What would the financial position of the State Bank of Illinois be?  I know where my bet is.

The most common sin of economists is to take a point which is true in part and mistake it for one which is true in full. We so enjoy being contrarian and refuting sacrosanct beliefs with the clean and frictionless logic of economics that it doesn’t quite satisfy to point out that these beliefs are simply less true than people think, but must insist that they are fully false. Case in point is this Steven Landsburg post, which Robin Hanson praises, in which he argues that misers are just as admirable as philanthropists:

In this whole world, there is nobody more generous than the miser—the man who could deplete the world’s resources but chooses not to. The only difference between miserliness and philanthropy is that the philanthropist serves a favored few while the miser spreads his largess far and wide.

If you build a house and refuse to buy a house, the rest of the world is one house richer. If you earn a dollar and refuse to spend a dollar, the rest of the world is one dollar richer—because you produced a dollar’s worth of goods and didn’t consume them.

Who exactly gets those goods? That depends on how you save. Put a dollar in the bank and you’ll bid down the interest rate by just enough so someone somewhere can afford an extra dollar’s worth of vacation or home improvement. Put a dollar in your mattress and (by effectively reducing the money supply) you’ll drive down prices by just enough so someone somewhere can have an extra dollar’s worth of coffee with his dinner….

Landsburg’s point would be completely valid and convincing had he simply argued that the miser is more like a philanthropist than is commonly believed, but to fully satisfy the economist itch he must argue that the miser not morally distinct from the philanthropist. What’s missing from Landsburg’s analysis is the common sense fact that the world is full of areas where the social gains from a dollar spent are much larger than a dollar. Whether it is giving the global poor mosquito nets, education, vaccines, other medical care, or just cash, it is clear that it is easy to spend the money in ways that generate huge social gains. Likewise it is not hard to identify areas of basic research with large spillovers that are underinvested in. Of course Landsburg knows there are many ways to spend money and generate much higher social returns than burning money or putting it in the bank, which is why his article in Slate advising people how best to donate to charity didn’t simply advise them to burn it.

In reply to Landburg, Karl argues:

This is because the miser is withholding his assessment of the most utility maximizing uses of his money and that assessment is a valuable thing. Even if the miser knows very little he knows something and as always ignorance is not abdication.

I agree, but I would go a step further than this: the miser is not simply withholding his assessment, but he is signaling that he does not care that the money could generate massive welfare gains, and so he does not care about massive welfare gains. This is because it is simply not credible for a miser to argue that he cannot identify areas where there are large social benefits, or use the money to hire people to identify areas with large social benefits, therefore the only option that remains is sociopathic indifference.

In reply to Karl, Robin argues that he’d “still guess that the miser does more good than the average rich-nation philanthropist”. Surely there are many philanthropists who are terrible at philanthropy. Someone who spends millions creating a public museum filled with Damien Hirst sculptures is generating lower social returns than if he were to miserly put the money in a bank or burn it. But this simply reinforces my original point: Landsburg could’ve made a truer and more persuasive argument had he simply gone with a more modest version of it. That is, he should have said misers are better than some philanthropists. The problem is that most people are already pretty capable of identifying low value philanthropy and begrudging it as a waste of money. If you explained to them that putting the money in the bank or burning it is similar to giving it away to society at large, they would agree that some this is better than some philanthropy. But the contrarian victory there would not be enough to satisfy an economist, and so the argument is oversold.

Europe continues to hang over our heads as does the potential failure of Congress to extend the payroll tax cuts. Nonetheless, the near term trajectory of the economy is meeting or exceeding my expectations.

From CNBC

Sales rose an estimated 6.6 percent to a record $11.4 billion on Black Friday, typically the busiest shopping day of the year for Americans, while the traffic at stores rose 5.1 percent, according to ShopperTrak.

The day’s sales growth was the strongest percentage gain since 2007, when sales rose 8.3 percent on the day after Thanksgiving, said Ed Marcheselli, chief marketing officer at ShopperTrak, which monitors retail traffic.

The fundamentals for a US recovery are in place. Without trip-ups we should be looking at accelerating growth through 2012 and the potential for an enormous boom.

There will also be inflation. Pay no attention to those saying that inflation cannot pick up unless wages pick-up. It can and it will. What they miss is that labor’s share of national income will fall and probably at a slightly faster pace than before the recession. Just my baseline guess.

Nonetheless, the point is that the inflation will be generated by greater corporate profits and much higher returns to natural resource extraction.

Eventually the natural resource extraction returns will fall as capital and technology flood into that sector but I expect that the increase in corporate profits as a fraction of national income will continue for the foreseeable future.

I pick on Tyler because he is probably one the sharpest voices for what I see as a deep misunderstanding of the issue. Though, I think this misunderstanding is incredibly widespread – as holiday gatherings make clear.

Tyler says

Maybe these markets simply will shut down soon.  There is so much talk about what the Germans should do, but I don’t see the viable options.  With Germany’s own credit status now in doubt, eighty percent debt to gdp ratio, massive welfare state, and unfavorable demographics, are they supposed to endorse — going to endorse — ten or fifteen percent price inflation for a few years’ time, all with no guarantee of reforms in the economically weaker countries?  And is that inflation then followed by a subsequent deflation?  Or does it continue forever?  And would Germany have to move to a regime of wage flexibility for the professions too?  How politically feasible is that?  I don’t see how the Germans benefit from going down this road, even if you think, as I do, that the alternatives are quite dire.

Germany doesn’t need to experience any of these things. Germany only needs to agree to letting the ECB stand as Lender of Last Resort.

I haven’t spoken with Tyler personally on this but from my conversations over the holidays I can see that the difficult thing to understand is that what is at issue here is the distribution of private claims over private resources.

On one level you can see this by noting that part of the reforms which Mario Monti is putting in place are to decrease tax evasion. Yet, taxes are simply the forcible extraction of private resources by the government. Its not as if taxes represent the government producing something or even government officials or government pensioners consuming less.

Taxes represent the transfer of resources under the threat of imprisonment. Now, if this could possibly solve your problem then you know that at root the problem has to be about who holds private claims over resources.

You can attack the problem in another way by seeing that Italy is roughly in primary budget balance. This means current borrowing exists only to repay past lenders. Again, this is an issue over the distribution of private claims.

To make the point more clear – this is explicitly not the case for Greece. From a budget standpoint Greece faces a more fundamental issue. It is currently in primary deficit. It would have shift resources from private control to public control in order to balance the budget given the current economic environment.

It is true that Greece’s economic environment is primarily the result of a fundamental mismatch in monetary policy between it and the core countries and so could be solved if Germany were to endure more inflation. However, Greece does face an immediate adding up constraint that Italy does not face.

A third way to see this is to imagine what would happen if Italy repudiated its debt vs. Greece. Italy would then be able to support itself on tax revenue. Greece would not. Greece would have to go back into the bond markets somehow and get more money.

Why is all of this important?

Its important because it means Italy doesn’t actually need anyone to transfer real resources to it. It simply needs someone to manage resource distribution among bondholders. The ECB can do this at virtually no direct cost.

Again that is because nothing actually has to be produced or transferred. Debt just has to be managed.

Perhaps, a fourth way to see this is by noting that you only need new savers to agree to step in where old savers were. This is ultimately a co-ordination issue between groups of savers. Its breaking down because there is a musical chairs issue. No one wants to be the last saver who can’t find someone to whom to transfer his savings.

The ECB can assure this doesn’t happen because the ECB controls the total amount of borrowing from European banks. It can constrict the amount of borrowing to make sure that someone steps up to take the transfer of Italian debt.

All of this is to say that Germany doesn’t have to suffer any near term economic bad effects. What Germany loses in supporting a move like this is the ability to pressure peripheral governments into changing their ways.

In theory one could agree to a new system, along the lines I have proposed, in order to keep the pressure on. The problem, of course, is that if you are even considering offering Lender of Last Resort status then you have signaled that you do not have a complete commitment to irrationality, in which case it immediately becomes in the interest of the peripheral countries to dig in and refuse to change unless Lender of Last Resort status is offered up front.

“We’ve seen six straight months of year over year gains for new vehicle sales, which shows positive momentum for the auto industry, ” said Jesse Toprak, Vice President of Industry Trends and Insights for TrueCar.com.  “There is a strong possibility that we could reach a 14 million SAAR next month.

Link. HT Calculated Risk

Paul Krugman has some words for job creators and other high skilled people: we don’t need you.

…textbook economics says that in a competitive economy, the contribution any individual (or for that matter any factor of production) makes to the economy at the margin is what that individual earns — period. What a worker contributes to GDP with an additional hour of work is that worker’s hourly wage, whether that hourly wage is $6 or $60,000 an hour. This in turn means that the effect on everyone else’s income if a worker chooses to work one hour less is precisely zero. If a hedge fund manager gets $60,000 an hour, and he works one hour less, he reduces GDP by $60,000 — but he also reduces his pay by $60,000, so the net effect on other peoples’ incomes is zip.

First let me just say that the extent to which what people earn is equal to their marginal product is greatly unappreciated, so before I disagree with Krugman I just want to pause and point out that this is truer than most people think. But it’s not true everywhere and always. Note that Krugman does not go so far to say that marginal product *does* in fact equal income, but that “textbook economics says that in a competitive economy…”, and that job creator praise is not “something that comes out of the free-market economic principles these people claim to believe in”, and that “Even if you believe that the top 1% or better yet the top 0.1% are actually earning the money they make…”.

He doesn’t actually say “people earn what they make”, nor does he say how good of an approximation to reality marginal product theory is. But in his economics textbook with Robin Wells, they are a bit more explicit, and do call the marginal product theory a pretty good approximation:

The main conclusion you should raw from this discussion is that marginal productivity theory is not a perfect description of how factor incomes are determined, but that it works pretty well. The deviations are important. But, by and large, in a modern economy with well-functioning labor markets, factors of production are paid the equilibrium value of the marginal product -the value of the marginal product of the last unit employed in the market as a whole.

This is a really important point, and I don’t disagree. But I think that many high skilled, high paid workers, and job creators in the U.S. can be an important deviation from this general rule. Many of these people work at moving the productivity frontier forward, and thus increasing the marginal productivity of other workers. After all, one of the important things that entrepreneurs do is find ways to increase the productivity of other workers so they can underprice their competitors. The process of creative destruction is not manna from heaven. I won’t pretend to know have all the answers about what drives this process, but entrepreneurs, job creators, and high skilled people are an important part of it.

Consider, for instance, that if we suddenly kicked out the top 10% of high IQ people (or 10% most productive people, or 10% most creative people, or whatever) in the U.S.. It strikes me as fairly likely that the total output of the remaining 90% would go down. Krugman seems to argue that this would not be the case. But even if you disagree with me in the short run, in the long-run the productivity increasing innovations these people would have made won’t show up, and the rest of us would have lower productivity as a result.

Now, instead of kicking out the top 10% of workers, just make them work less as a result of high income taxes.  See my concern?

Lowered incentives of job creators and other innovators should be considered as one of the likely downsides to higher taxes.

Note that if you don’t think this is true, then what business do we have subsidizing higher education? If workers capture the entirety of their higher productivity, then I don’t see who gains by giving young people money to go to college rather than just cash.

The group tasked with finding a plan to cut the debt by $1.5 trillion or more has failed to come to an agreement. If you’ll recall, two of the the ratings agencies, Moody’s and Fitch, recently reaffirmed the AAA status of U.S. debt, while S&P downgraded them one notch to AA+. Will the Super Committee’s failure lead to more downgrades? Well nobody is downgrading immediately, but this certainly doesn’t help the odds of preserving AAA status.

S&P has already announced that they will not downgrade as a result of the Super Committee failure, which is not a surprise. In their original downgrade statement S&P cited the debt panel failure part oftheir down-side scenario that they would regard as “consistent with a possible further downgrade to a ‘AA’ long-term rating”. However, that down-side scenario also included other bad things occurring, like higher nominal interest rates for U.S. Treasuries, which have not surfaced.

However, it’s hard not to see the failure of this committee as reaffirming one of S&P’s chief concerns, which is essentially that politicians can’t come to agreement. As they said in their downgrade statement:

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt  burden in a manner consistent with a ‘AAA’ rating and with ‘AAA’ rated  sovereign peers (see Sovereign Government Rating Methodology and Assumptions,”  June 30, 2011, especially Paragraphs 36-41). In our view, the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging…

If you’re concern is that the government is unable to work together and come up with the right solutions to long-term debt problems, it’s my position that the super committee failure should make you more worried. But it’s not necessarily the case that S&P sees it that way. And I see nothing in their August downgrade statement that commits them to further downgrades now that the super committee has failed. If some or all of the automatic cuts end up being nullified, then S&P’s previous statements certainly indicate the risk of a downgrade will go up. How much remains to be seen.

How about Fitch? I’ve read some commenters saying that the failure to come to agreement is actually good news, but Fitch does not see it this way. In their previous statement affirming AAA status they committed themselves more explicitly than S&P:

An upward revision to Fitch’s medium to long-term projections for public debt either as a result of weaker than expected economic recovery or the failure of the Joint Select Committee to reach agreement on at least USD 1.2trn of deficit-reduction measures would likely result in negative rating action….

Agreement and passage into law of a credible set of deficit-reduction measures of at least USD1.2trn by end-2011 would be consistent with Fitch’s own fiscal projections and demonstrate that a sufficiently broad-based political consensus can be forged on how to reduce the budget deficit and provide a platform for the additional measures that will be required over the medium to long term. In the event that the Joint Select Committee is unable to reach an agreement that can secure support from Congress and the Administration, Fitch would be less confident that credible and timely deficit-reduction strategy necessary to underpin the US ‘AAA’ sovereign rating and Stable Outlook will be forthcoming despite the USD1.2trn of automatic cuts that would follow.

So even if the automatic cuts go through as planned, Fitch has previously committed to being “less confident” in the maintenance of the AAA rating. While one can read S&P’s downgrade statement as being concerned about the kind of inability to agree that the Super Committee failure represents, Fitch has come right out and said that they would regard it negatively. Their statement that the failure of the committee would “likely result in negative rating action” is certainly suggests to me that a downgrade will be forthcoming.

All I’m seeing from Moody’s right now is a statement that this news is “informative but not decisive” in it’s decision whether or not to downgrade. This seems to approximately sum up the position of the other two agencies as well, although Fitch’s previous statements look to me to be the most hawkish in terms of how they will view this. I’m in agreement with the ratings agencies, I don’t think this failure is good news.

Via David Wessel, I see that the University of Chicago has a new website with a panel of elite economists answering weekly questions. Tyler is skeptical, but I am already finding it interesting. Here, for instance, is one of the first questions posed:

Federal mandates that government purchases should be “buy American” unless there are exceptional circumstances, such as in the American Recovery and Reinvestment Act of 2009, have a significant positive impact on U.S. manufacturing employment.

The results are overwhelmingly against the statement. Of the 41 respondents, only 4 agree. One of them is Daron Acemoglu who, cites the work of David Autor:

4 years ago I would have disagreed. Recent evidence (Autor Dorn Hanson) suggests yes.Caveat: costs from higher prices & other inefficiencies -see background information here

Yet a few positions down in the experts panel, Autor himself disagrees, and seems to disagree that his study is useful analysis here:

Hard to believe this does much at all. But I’m speaking based on my prior. I’ve not seen any rigorous analysis.

I would like to see more from this website. A great follow-up to this would be a conversation between Autor and Acemoglu about the extent to which Aturos’ work is applicable to the question.

In response to Karl’s post, commenter Th points us to a 1996 article from Krugman where he pens a 100 year retrospective from the point of view of someone 100 years in the future. There are so many interesting things in there, but I just wanted to point out some of the more interesting predictions.

First, Paul predicted the trend towards suburbanization would reverse, which in fact is starting to happen:

During the second half of the 20th century, the densely populated, high-rise city seemed to be in unstoppable decline. Modern telecommunications eliminated much of the need for physical proximity in routine office work, leading more and more companies to shift back-office operations to suburban office parks. It seemed as if cities would vanish and be replaced with a low-rise sprawl punctuated by an occasional cluster of 10-story office towers.

But this proved transitory. For one thing, high gasoline prices and large fees for environmental licenses made a one-person, one-car commuting pattern impractical. Today, the roads belong mostly to hordes of share-a-ride minivans efficiently routed by computers. Moreover, the jobs that had temporarily flourished in the suburbs — mainly office work — were eliminated in vast numbers beginning in the mid-90′s. Some white-collar jobs migrated to low-wage countries; others were taken over by computers. The jobs that could not be shipped abroad or be handled by machines were those that required a human touch — face-to-face interaction between people working directly with physical materials. In short, they were jobs done best in dense urban areas, places served by what is still the most effective mass-transit system yet devised: the elevator.

Here Paul predicts the rise of many small subcultures, and many small celebrities:

Luckily, the same technology that has made it possible to capitalize directly on knowledge has also created many more opportunities for celebrity. The 500-channel world is a place of many subcultures, each with its own heroes. Still, the celebrity economy has been hard on people — especially for those with a scholarly bent. A century ago, it was actually possible to make a living as a more or less pure scholar. Now if you want to devote yourself to scholarship, there are only three choices. Like Charles Darwin, you can be born rich. Like Alfred Wallace, the less-fortunate co-discoverer of evolution, you can make your living doing something else and pursue research as a hobby. Or, like many 19th-century scientists, you can try to cash in on a scholarly reputation by going on the lecture circuit.

The whole thing is really interesting. I wonder the probabilities Krugman would place on these outcomes, and if he has changed his mind at all. He certainly paints a picture of a world where inequality is not such a big problem. Sure there are still the super rich, who made their fortunes off of land and natural resources. But celebrities are both more common and serve a smaller audience, PhDs make as much money as people with a year or less of vocational training, white collar jobs are the ones most commonly replaced by machines. How long does he expect it will be until inequality starts to reverse due to these trends? Or was it just a bit of fun speculation about a possible future world?

Modeled Behavior regular Becky Hargrove asks

Can you make a place in your categories for a quick reference to this discussion related to NGDP

Sure.

I’ll  do this quick and graphically and see if it makes sense

I want to use this chart from EPI for my own evil purposes.

Lots of people want to focus on the right end of this graph. I want to focus on the left.

Look at the entire period of the 70s. Stagflation, awful economy. However, look how few businesses are reporting “poor sales” as a problem. That’s because they weren’t.

Which is why its important to point out that poor sales is not simply a way of saying the economy is doing poorly. It refers to a specific kind of doing poorly and that is on the demand side.

Due to it’s decentralized nature, it’s hard to get a grasp on what the specific goals and complaints of Occupy Wall Street are. But it seems pretty clear at least one complaint of theirs is that “big banks are too big”. But if you think this is true, and you wanted to end it, then why would you occupy Wall Street of all places? What do they expect Wall Street to do about this? Voluntarily shrink? Even if they managed to convince current bank management to do this because… um… the drum circle had a persuasive beat, those managers would be kicked out by shareholders, and rightfully so. And what do they expect Washington to do about this? Break up the big banks? This is probably what they have in mind, but it’s a pipe dream.

Not that there’s anything wrong in protesting in favor of pipe dreams, but if occupying Wall Street and occupying Washington won’t actually help shrink big banks, then what will? Occupy your neighbors, friends, families, and anyone you know who uses the big banks. Tell them to take their deposits out and put them in a local credit union or small bank. Tell them to take loans from these places. Big banks are big for a reason: they have a lot of assets and make a lot of money. They need your deposits, they need to charge you fees. If Americans don’t want Big Banks to be big, then stop using them. There is a very simple way for everyone to vote with their pocketbooks and put their money where their mouths are. So instead of yelling at banks to stop taking deposits and fees, yell at the people around you to stop giving them.

From a new paper:

Do online consumer reviews affect restaurant demand? I investigate this question using a novel dataset combining reviews from the website Yelp.com and restaurant data from the Washington State Department of Revenue. Because Yelp prominently displays a restaurant’s rounded average rating, I can identify the causal impact of Yelp ratings on demand with a regression discontinuity framework that exploits Yelp‟s rounding thresholds. I present three findings about the impact of consumer reviews on the restaurant industry: (1) a one-star increase in Yelp rating leads to a 5-9 percent increase in revenue, (2) this effect is driven by independent restaurants; ratings do not affect restaurants with chain affiliation, and (3) chain restaurants have declined in market share as Yelp penetration has increased. This suggests that online consumer reviews substitute for more traditional forms of reputation…

This is the age of the consumer. One thought this prompts is that when better information allows choices that are more aligned with preferences, it will not show up directly in the consumer price index as an decrease in real prices, even though the standard of living attainable at a given income has gone up.

Say restaurant at restaurant A you can buy a util for $1, but at restaurant B you can buy 1.5 utils for $1. If you were unaware of restaurant B or believed the price of utility to be higher there, then becoming aware of it due to Yelp.com reviews decreases the real price of utils for you, and so is a decrease in your cost of living.

I won’t put forth any guestimates about how much this is worth, but it applies to at least food, arts and entertainment, housing, and automobiles.

Doing the rounds on Mises circuit I am usually identified as a liberal or a person from the left. I don’t really much care so I take that ID.

However, I think its interesting to note that Reihan Salam lays out a conservative vision for what ails America that I agree with.

(1)  . . .a series of federal (subsidies for mortgage debt) and local (zoning restrictions, rent regulations, etc.) interventions have made affordable, high-quality housing scarce in many of the countries most productive and regions regions . . .

(2) Resistance to HOT lanes, private toll roads, etc., exacerbates the accessibility problem by forcing us to rely on slow-moving public bureaucracies that face a number of political imperatives that compel them to, among other things, deploy labor inefficiently, devote resources to projects that aren’t cost-effective, etc.

(3) Allowing for more specialized educational providers and providing parents with flexible K-12 Spending Accounts (KSAs) could help drive down the cost and quality of education.

(4) By transitioning to competitive pricing in Medicare and catastrophic insurance for all but the sickest and poorest under-65s, we would in theory encourage the emergence of low-cost business models for the provision of medical care,

(5) Per the Chen and Chevalier research, we could take a number of steps to attack the supply constraints on the number of licensed medical providers,. . . More aggressively, we could further empower nurse practitioners and physician assistants to undertake work that is currently the province of physicians.

(6) Reform of the FDA could drive down the cost of developing new drug therapies, making them more accessible.

(7) And I imagine that patent reform would have a salutary impact on middle class in all kinds of unpredictable ways.

I think number (4) is more or less a waste of time but I am not really against it. Perhaps ironically, I think people focus way too much on the demand side in health care. The demand side is too dominated by signaling and emotionality to get any traction. The supply side is where all the action is.

Now I am largely in favor of redistribution, but as always I ask – what’s wrong with cash?

Jon Huntsman made the important and underappreciated argument that immigration could help lift housing markets:

“Why is it that Vancouver is the fastest growing real estate market in the world today? They allow immigrants in legally and it lifts all boats. We need to focus as much on legal immigration.”

Suzy Khimm at the Washington Post attempts to throw some cold water on Huntsman’s argument, but I think she gets it wrong. Or more accurately, economist Paul Dales, whom she quotes, gets it wrong. He argues that immigration wouldn’t be significant enough to sop up the excess demand in housing and thus wouldn’t make much of a difference:

…in the short term, the impact may be comparatively negligible. More immigrants overall could have a “marginally positive” effect on the U.S. market by buying vacant homes, but “any impact would be almost unnoticeable” on a national scale given the magnitude of the excess supply, says Paul Dales, a Toronto-based economist for Capital Economics, a research firm. Dales estimates that the overhang is at least one million, and potentially as high as three to four million homes. So even a sudden influx of immigrant homebuyers wouldn’t be enough to make a dent in the market, realistically speaking

There are a couple big missing pieces here. First off, what level of immigration is Dales talking about? If an extra 100,000 a year more isn’t enough, then we can let in an extra 3 million. From his own numbers, this would likely sop up the excess supply, so surely a sudden influx of a large enough amount would make a significant dent in the market.

Second, he’s ignoring the role of expectations. If we commit to some higher level of immigration each year over the next decade, than that changes the expectations for developers about the level of demand they will face, and should help spur development immediately.

I’m glad to see this issue getting discussed, and really glad to see a high profile Republican proposing it, but so far I’ve yet to see an economic argument against it that can’t be solved by increasing the proposed number of immigrants. The argument that such a policy is politically unfeasible is surely in part a function of the fact that journalists and economists aren’t constantly reminding people that, political feasibility aside, more immigration represents one of the best available policies to attack this recession.

In the discussion on teacher employment that Tyler and Karl have been contributing to, Tyler makes a point I want to quickly address:

Note this is a sector where there is a growing realization that quite a few of the workers should, for non-cyclical reasons, be fired anyway.

This is a reason why it would have been possible to fire a significant number and do so consistent with a desirable structural adjustment, thus making the decline not a bad thing per se. Districts could have tried to identify and fire the least productive teachers consistent with Hanushek’s recommendation that we do so.  However, due to LIFO and other restrictive policies I would venture that is by and large not what is happening, and the teachers laid off are simply the most recent hires, or those in areas where you don’t  necessarily want layoffs back but schools have an ability to do so, such as music and art. I don’t have any data on this, but it is what I’ve observed, and I wouldn’t guess this is a controversial point.

Because of this I don’t see any reason why Tyler’s point should be given much of any weight in considering whether we should hire more teachers or not. I’m open to persuasion if someone has actual data on this indicating I am incorrect.

So I started a piece by Gary Becker entitled: The Great Recession and Government Failure. I assumed that it was going to be about how difficult it is to convert blackboard economic policy into real world economic policy and how given that it might be better to take your lumps with the market.

I was thinking it would makes some good points which I could use to talk about “Nihilism All the Way Down” which is the problem that if we accept too many “failures” we end up concluding that the world can only be whatever it is right now.

For example, the market suffers from market failure. Efforts to correct that with the government suffer from government failure. However, efforts to constrain the government could suffer from “liberalization failure”, a term I use to mean the collapse in support for free markets that comes when bad stuff happens. I am sure whatever we do to correct for liberalization failure will suffer from its own failure and away we go down the Nihilistic Escalator until we conclude that its just failure all the way down.

Now, point of fact, that might well be true. But, it certainly no fun and there is no real point to spending a lot of time with. Perhaps that would be Nihilism Failure or even Failure Failure.

So, this would have been an interesting jumping off point. Instead though, I get a diatribe against the current government complete with tropes like

In the U.S., these government actions include an almost $1 trillion in federal spending that was supposed to stimulate the economy. Leading government economists, backed up by essentially no evidence, argued that this spending would stimulate the economy by enough to reduce unemployment rates to under 8%.

Such predictions have been so far off the mark as to be embarrassing. Although definitive studies are not yet available about the stimulus package’s overall effects on the American economy, most everyone agrees that it was badly designed and executed. What the stimulus did produce is a sizable expansion of the federal deficit and debt.

The misdiagnosis of widespread market failure led congressional leaders, after the 2008 election, to propose radical changes in financial institutions and, more generally, much wider regulation and government control of companies and consumer behavior. They proposed higher taxes on upper-income families and businesses, and extensive controls over executive pay, as they bashed “billionaire” businessmen with private planes and expensive lifestyles.

Aside from a somewhat sloppy treatment of the facts this piece is a little more than an exclamation. A simple, “the administration is a bunch of buttheads” would have be told us about as much.

Yet, obviously Gary Becker is capable of much more. Is it simply that the Journal won’t print it?

Here are a two, at least, that turned out to be pretty correct and not widely recognized in 2005:

2. I would think that the U.S. economy is overinvested in non-export durables, most of all residential housing.

3. I would think that we have piled on far too much debt, in both the private and public sectors.

The rest can be found here.

I have some very quick thoughts in reply to Erik Kain’s post at Forbes comparing unions and corporations. His point, in brief, is:

Corporations are legal entities, sanctioned by the state. Why should we be any less sanguine about unions than about corporations? Corporations pool capital and resources, unions pool labor. What’s the difference?

One important difference is that corporations are subject to anti-trust regulation. However, I think libertarians who are otherwise critical of anti-trust activity should be wary of invoking this too strongly. If the market is the best mechanism for ensuring firms do not behave anti-competitively, then why won’t that work for unions?

Another important difference is that, as Coase argued, there are costs to using a price mechanism to coordinate economic activity, and corporations exist as an alternative institution for when such transaction costs are high. One can conceivably frame the voice function of unions in this way as well, however I think that’s better characterized as public goods problem where the group collectively benefits and individuals have insufficient incentives to express worker preferences.

The other “face” of unions, other than the voice face, is the monopoly face. One the one hand economists generally recognize that this is a problem with unions, not a benefit. On the other hand, many non-economists who favor unions use this as an explicit justification unions. If you see anti-competitive behavior as an unintended downside of unions, then one can draw parallels to corporations. If, however, you see anti-competitive behavior as a reason that unions exist, then the comparison falls apart.

The most important difference between the two is that unions suffer from a much more problematic fundamental legal framework. Labor economists are much more likely to argue that the fundamental laws defining unions need reform than IO economists are to complain similarly about corporations.

So what are the complaints? Economists generally agree that worker voice is an important and useful function of unions, and yet unions are vastly diminished in the economy. The problem is that the laws regulating unions, in part due to the way they encourage antagonistic relations with management, have led to what is likely an undersupply of the fundamental purpose of unions: worker voice. As an institution they are failing to provide their primary benefit. On the other hand, the monopoly face of unions is also problematic and some economists argue incompatible with a dynamic economy, but labor laws discourage alternative forms of worker voice that are less prone to these anticompetitive effects.

This isn’t to say corporations are perfect, or that no unions provide net economic benefits. But to put things in overly reductive terms, many economists who are pro-union and many who are anti-union agree that the fundamental laws defining and regulating unions need reform. The same can not be said of corporations.

There is much more to be said about this issue and I don’t consider the above comprehensive overview, but rather a few aspects.

Writing in Bloomberg View, Ed Glaeser argues, among other things, that the GSEs should wait to sell the stock of housing they own slowly:

Exploring options makes sense, because selling homes too quickly means low prices, especially if you are trying to move thousands of foreclosed homes at once. Yet the government needs to be quite careful here as well, because renting homes that were meant to be owned is never easy.

The case for slow sales was made in a classic paper by David Genesove and Chris Mayer, which found that Boston condominium sellers with high loan-to-equity levels sold their units more slowly and got substantially higher prices. Steve Levitt and Chad Syverson found that real estate agents, who presumably know more about housing markets than ordinary sellers, typically take 9.5 days longer to sell their homes and receive 3.7 percent higher prices, holding everything else constant.

By contrast, my colleague John Campbell, along with his co- authors Stefano Giglio and Parag Pathak, estimate a general forced-sale discount of 18 percent and a foreclosure discount of 28 percent.

In a frictionless, efficient market for a commodity good the government could not expect to make money by holding on to the houses and renting them since the net present value of the returns to renting for a year and then selling would be equal to the price they could get for the houses today. Glaeser cites Genesove and Mayer as providing justification for why this might not be the case. However, it is my recollection of this paper that the way that a home seller increases the sale price by waiting is through housing being in a matching market. In this kind of market, the seller gets a higher price by waiting for a better matched buyer. The problem here is that in a matching market you presumably find a better buyer by having the house on the market for longer, not simply by waiting until a later date to sell it. If I recall correctly, this is what Genesove and Mayer argue. In this case, Glaeser’s argument for renting and waiting to sell -at least as justified by the matching market- does not hold.

One could still argue that the optimal sale time of a stock of houses is slow based on the literature on forced sales, which Glaeser also cites. So this is not to say the rental idea is not a good one relative to quickly dumping all the houses onto the market, just that one should caution against interpreting the literature for time-on-the-market as applying to units which are being rented, and thus are not in fact on the market.

David Wessel at the Wall Street Journal reports that President Obama will nominate Alan Krueger to be the new head of the CEA. It’s interesting to note that, among his other areas of research, Krueger done important work on occupational licensing. Here is a paper he co-authored with Morris Kleiner showing that 35% of jobs are licensed or certified by the government. There they report:

Our estimates of the relationship of occupational licensing and wages is consistent with the hypothesized role by members of an occupation to raise wages by using the powers of government to drive up requirements and capture work for the regulated workers for larger geographic areas. These estimates suggest a strong role for the monopoly face of licensing in the labor market. Indeed, the wage premium associated with licensing is strikingly similar to that found in studies of the effect of unions on wages.

And here is an earlier paper, also with Kleiner, on the same. If one is concerned about lowering the long-term unemployment rate, improving the functioning of labor markets, and making it easier for workers to enter into more skilled service jobs, occupational licensing is a good place to look.

Wessel also notes that Carl Shapiro is also being nominated to the CEA. Importantly, Shapiro has done work on patents and antitrust. Here is a summary of a relevant paper:

Economists and policy makers have long recognized that innovators must be able to appropriate a reasonable portion of the social benefits of their innovations if innovation is to be suitably rewarded and encouraged. However, this paper identifies a number of specific fact patterns under which the current U.S. patent system allows patent holders to capture private rewards that exceed their social contributions. Such excessive patentee rewards are socially costly, since they raise the deadweight loss associated with the patent system and discourage innovation by others. Economic efficiency is promoted if rewards to patent holders are aligned with and do not exceed their social contributions. This paper analyzes two major reforms to the patent system designed to spur innovation by better aligning the rewards and contributions of patent holders: establishing an independent invention defense in patent infringement cases, and strengthening the procedures by which patents are re-examined after they are issued. Three additional reforms relating to patent litigation are also studied: limiting the use of injunctions, clarifying the way in which “reasonable royalties” are calculated, and narrowing the definition of “willful infringement.”

The destruction in productive capital can easily mean a hurricane has a net negative economic impact, and not just on wealth but on the flow of economic activity. The positive economic impact of a hurricane comes from households and businesses stocking up on consumption goods and purchasing new capital, perhaps to replace old capital, e.g. buying a new sub-pump because the old one is worn out. This is why a hurricane that is expected to be huge but turns out to be much smaller is the most likely to have a positive economic impact: spending increases but capital is not destroyed.

An important question is how much of the spending will just be short term shifts from the next few weeks into today, as in the case where households stocked up on foods and will eat it over the next few weeks. I think households and business have a lot of what you could call small capital and inventory that just sits around for a long-time, like flashlights and candles, and if this is economic activity shifted forward it is likely to come from farther in the future, making it more likely to have a positive economic impact.

Another thing to consider is prevented economic activity, like restaurant and movie visits pre-empted. Or, say, entire cities being shut down. Here again, the best case scenario is the hurricane is very small.

In a recent post, Karl offered a theory as to why house prices are sticky downward. In short, he argues that house is worth less when it is being sold in a neighborhood with a lot of foreclosures than when it is being sold in a neighborhood with few foreclosures. Foreclosure sellers in an empty neighborhood are in effect playing a game of chicken then, where each wants to be the last to sell so that they can sell into a fuller neighborhood.

This is an interesting theory, and I’d venture it’s going on to some extent. I’m pretty sure you could find a way to test it. However, I think nominal rigidity can be found even in areas where foreclosures are relatively low. The literature on foreclosures suggests they have an impact in the neighborhood of 1% on house values within 1/8 of a mile. Given the costs of holding real estate, including the depreciation, maintenance, and lost value of the flow of services, I doubt it would be profitable for banks to play this game very long in areas with few foreclosures. Second, if the current owners are owner-occupiers, then the houses aren’t vacant, so there is no “empty neighborhood” effect. This means some homes must be owned by non-owner occupiers. It seems unlikely to me that in areas with few foreclosed homes and few non-owner-occupied homes you’d observe a lack of nominal stickiness. Nonetheless, I would not be surprised if this effect explained some nominal stickiness.

To understand how stickiness can happen, it helps to conceptualize the housing market as a matching market. Homes and buyers are highly heterogeneous, and there is no “market price” per se. Rather there is a price for a pair of buyers and sellers. This means that a seller can, ceteris paribus, always hold out longer for a buyer with a higher valuation of the house. The question is, why do sellers wait too long sometimes, and why wait longer for better matches when the market is down?

There is some literature on this that provides evidence for few hypothesis. a 1997 AER paper from Genesove and Mayer argue that the issue stems from a sellers desire to sell at a high enough price to get a 20% downpayment on their next home. Consistent with this, they find that sellers with higher LTVs are on the market for a longer time, set a higher asking price, and in the end get a higher price.

A 2001 QJE paper from Mayer and Genesove chalks up some of the problem to loss aversion. Sellers have a nominal number they paid for their house, and they are willing to wait for a possibly non profit maximizing amount of time until a high valuation buyer comes along. They find evidence that sellers with nominal losses have a longer time on the market,  set higher list prices, and attain a higher selling price. They also find evidence that of the LTV effect from the aforementioned paper, although after controlling for nominal loss aversion the LTV effect is less strong.

So what can be down about this? Countercyclical or subsidized downpayment requirements could also be of use. This provides support for those who have argued that a downpayment subsidy should replace the mortgage interest tax deduction.  Encouraging insurance that protects against nominal losses would encourage homeowners to sell sooner. Of course the best policy to fight nominal loss aversion is simply inflation.

I want to draw attention to this analogy of Eli Dourado’s from a few months ago because it has stuck with me, and I find myself thinking about it often. In it, he says that our restrictions to immigration are attempts to preserve our advantaged positions and are similar to those who sought to preserve aristocracy:

It is perhaps unsurprising that those who think they benefit from the current system wish to keep it. They trot out all kinds of practical-sounding excuses for why we cannot completely open the border. All of these reasons have analogs in the system of class-based privilege. Most of us, I imagine, would like to think that if we were aristocrats of centuries past, we would see through the lameness of the arguments for using the state to keep down the lower classes. Yet the widespread opposition to open borders today shows that we are not that good.

I only disagree with this to the extent that I don’t think it applies to all opponents of open borders. My own opposition, for instance, is I think not grounded in any desire to preserve privilege, and fairly strong on cosmopolitan utilitarian grounds. Nevertheless, for many immigration opponents, I think his charge holds and that more people should consider it.

Bryan Caplan is quoted as having said the following about Robin Hanson:

 ”When the typical economist tells me about his latest research, my standard reaction is ‘Eh, maybe.’ Then I forget about it. When Robin Hanson tells me about his latest research, my standard reaction is ‘No way! Impossible!’ Then I think about it for years.”

I disagree with Eli often -although in the grand scheme of things we are not so far apart- but I think something similar could be said about him, in that his ideas often sound radical at first pass, but they stick with you and provoke much thinking.

The ol’ CAFE standards debate is floating around the blogosphere again thanks to new higher rates on the way. Instead of writing anything substantive about it I want to point to an excellent post from Ed Dolan that says pretty much everything that needs to be said on the issue.

For example, he reports on a newer study that shows price elasticities once proclaimed to have fallen are now on their way back up, and in the range -0.4 to -0.8.

His post also nicely presents some externality based arguments against  CAFE standards:

The tendency of more fuel-efficient vehicles to induce additional driving is known as the “rebound effect.”… [T]he rebound effect causes an absolute increase in those externalities that are proportional to miles driven, including road congestion and traffic accidents. It also increases the cost of road maintenance, because the wear and tear from more miles driven is only partly offset by the lower average weight of high-mileage vehicles.

Note that these externalities are ones that in other contexts are frequently (and rightly) appealed to by the same people who argue for CAFE standards.

In addition, Dolan draws our attention to this graph showing how fuel cost is related to consumption across OECD countries:

As he says, there is a convincingly tight relationship between price and quantity… go figure!

For some good analysis of the new fuel economy standards for big rigs I recommend Megan McArdle’s take.

In the wake of the S&P downgrade, Scott Sumner featured some comments by David Levey, the former Director of Sovereign Ratings for Moody’s, who during his tenure there wrote Moody’s Sovereign Rating Methodology Handbook. Despite his agreement that the United States’ “long-term debt outlook is deteriorating under the pressure of rising entitlement costs and an inefficient, distortionary tax system”, David argued that we have “extra leeway” due to the “the global role of the dollar and the central position of US bond markets”. I had an email discussion with David about the ratings agencies and his position on the downgrade. A lightly edited version follows:

Adam:  Are the judgements you’re making based upon S&P’s recently updated Sovereign Government Rating Methodology and Assumptions, or the guidelines used when you were at S&P? I have only looked at the new guidelines, and I know there was a change made after public comment on proposed rules. So upon which methods are you basing your judgement? And would you say the methodological change is consquential in this regard?

David: Hard to answer the first part of your query, since I was at Moody’s, not S&P. Don’t feel bad about the mix-up. During my working years, even very sophisticated investors would quickly forget which agency had made which rating move and in which order. And any dumb move on either’s part would harm the reputation of both. On methodology, things changed in the mid-2000s. Under pressure from regulators and issuers, the agencies were forced to “open the black box” and become much more explicit about their criteria, scorings, weights attached to various factors, etc. There was a tendency to move to a “scientistic”, quantitative, formulaic approach. I tended to resist that (being a great admirer of Hayek). I saw risk assessment as a multidisciplinary, highly qualitative, judgment process involving a varied weighting of factors. It was not sufficient to assign likelihoods to various risk scenarios in the economic and political areas. The importance of these factors would vary according to each country’s “stage of development” and specific institutional features.

BTW, I never believed that we were somehow smarter than all the other bank/hedge fund analysts doing the same kind of assessment. Our only special claim was that we could be “unbiased” because the company held no financial assets. Of course, that still leaves open all the perverse incentives and “rating shopping” practices that contributed to the agencies’ awful performance in the MBS/CDO markets.

Adam: I also think you’re argument, with a slight modification, is not so different than S&P’s. Here is how I would change your’s to make them consistent:

The bottom line is that the global role of the dollar and the central position of US bond markets make somewhat elevated debt ratios more compatible with a Aaa rating than is the case for other countries, another version of the US’s “exorbitant privilege”. But that extra leeway is finite and serious reforms to entitlement programs, particularly Medicare, must be made in a reasonable time horizon. Given the current deterioration of and divisiveness in fiscal policy, we view the threat that serious reforms are not made in a reasonable time non-negligible.Thus there is a small but significant risk that within the next ten years. global investors will eventually conclude that our political system is incapable of making the needed changes and turn away from US assets, regardless of the institutional strengths of US markets.

How far are you from my edited version of your views? And would this be sufficient for a downgrade?

David: The long-term forecasts for government debt — depending as they do mainly on demographic and medical cost trends — haven’t changed much. We’re just more aware of them and the divisiveness you mention was inevitably going to arise as painful choices got closer and key groups — like the elderly — began to realize what they might be in for. The divisiveness can alternatively be viewed positively as a signal that the intensive social bargaining and political negotiations necessary for a solution are arriving more rapidly than we previously expected.

You say that my argument and S&P’s are not that far apart. No reason they should be. The difference in expected probability of default for a one-notch downgrade near the top of the scale is tiny. The problem is that the symbolic value of a AAA/Aaa makes a downgrade from that level significant far beyond its intrinsic significance. In any case, even with the new wording, I would still total up all the relevant considerations as leaving the US in the AAA category — but maybe not at its very top.

Adam: Felix Salmon characterizes the difference between Moody’s and S&P’s ratings objectives as S&P being only interested in the probability of default, whereas Moody’s is not interested in the the probability of default per se, but rather the expected losses. In addition, he says S&P explicitly does not intend their ratings to be a market signal, whereas Moody’s does. Do you agree with Felix’s characterization of their differences? And if there are differences between agencies in what they intend their ratings to be, is your judgement that S&P shouldn’t have downgraded them based on what they intend their ratings to be, or based on Moody’s intention, or something else?

David: Not an easy question to answer succinctly, but here goes…

I think Felix is wrong. Since S&P has not been as explicit as Moody’s about what their ratings mean, some indirect evidence has to be used. First, S&P “notches” for subordinated debt, meaning that they are taking into account that a default on that debt is likely to have a greater severity than on senior debt. Second, market participants would find ratings almost impossible to use without comparability of meaning. So — in a sense — the markets more or less force equivalence of meaning on the agencies. Third, if the meanings were that different, there would be a lot more “split ratings” (situations where the agencies rate differently) than there are. So, if there is a disagreement between Moody’s (and myself) and S&P on the U.S. rating, it is a substantive one, based on judgments of the likelihood of fundamental reforms to spending and taxation, alongside the financial market characteristics I referred to in my initial statement.

In your comments on Felix’s comments on Nate Silver’s comments on S&P’s decision, you make a point which I think is only half right. You say that sovereign defaults “are always political, rather than economic” and that “A sovereign credit rating is therefore primarily a function of a country’s willingness to pay, rather than its ability to pay.” The truth, however, is more complex. Neither willingness nor ability can be defined independent of the other. “Willingness” depends on political calculations of the degree of sacrifice that would be required to make payment, which in turn depends on the financial resources available or easily raised. “Ability” depends on how much additional resources for debt payment the government can “squeeze out” through reductions in spending or increases in taxation — a political consideration. So the relation between them is -to use an old phrase-”dialectical” and the analysis is based on what Adam Smith called “political economy”. This may sound like “scholastic” nit-picking, but the point is vital for guiding the rating decision process.

“America is a scooter-bound glutton who, when its continuously increasing mass finally overwhelms the doughtiest scooter’s capacities, shakes its fat fists like a mad baby and demands deliverance from the laws of physics.”

Will Wilkinson, The Economist

He has a serious point to make about the unsustainability of our collective fiscal demands, all of which is dwarfed by this quote.

I am channeling Ed Leamer, whom I chided in 2007 for denying the possibility of a recession even though his models were flashing red.

Leamer said

The models say “recession;” the mind says “no way.”
I’m going with the mind. This time the problems in housing will stay in housing. If you are a builder or a broker, it will feel like a deep depression. The rest of us will hardly notice.

Obviously, that was spectacularly wrong.

Well, now here we are a few years later and as ironic as it is I can’t help thinking something similar.

I look at a lot of fundamentals but at the end of the day the money markets drive my forecasts. The money markets are telling me in every possible way that recession is coming. Liquidity demand is rising, inflation expectations are falling, nominal interests rates are collapsing.

However, like Leamer in 2007, I am hard pressed to see what is left to recess? At the time Leamer doubted a recession because he didn’t think there were enough manufacturing jobs left to lose.

This time, I look at construction and local government and think the same thing. The cyclical employment sectors are already so far down. Are we going to start losing jobs in Health Care and Education at this point?

Its possible but its just so hard to wrap your mind around. It’s a macro-economic story that’s never been told.

CNBC had this to say

Standard & Poor’s spoke loudly and clearly when it downgraded US debt, but the Treasury market on Monday didn’t appear to be listening.

While stock markets were selling off around the world bonds rallied. The 30-year bond gained more than a point in price as investors sent their own clear message that in times of turmoil, Treasurys were still the safest house on the block.

The movements seemed to suggest that S&P, for all the bluster and bold headlines its move created, was not calling the shots.

All over the media and my social media network people keep saying things like this. However, this is just the wrong way to think about the world.

Let me explain this way. Lets forget about S&P or downgrades or Europe or any of that.

I was shocked and appalled by the way the debt ceiling debate was handled. I was even more appalled that some people in positions of power seemed to endorse this as the new normal. Playing games with the global economy is no joke and no way for the leaders of the most powerful nation in the world to behave.

In my mind the political mess in Washington was worth a downgrade. And, indeed, I felt less safe than I did a month or two ago about the world and the fate of humanity.

However, what should I do in response to that? I should buy US Treasuries. Yes, buy.

Why?

Because you cannot escape US default risk. Its not like you could go out and buy something else that would guarantee you income in the event the US government defaulted. I am not even sure that investing in farmland or other wild schemes would do it.

Certainly there is no place to stash the trillions of dollars that now sit in Treasuries.

You have to buy Treasuries. There is no alternative.

This is why my reaction to the debacle wasn’t. OMG sell Treasuries. It was OMG we need to create an alternative to Treasuries and fast.

Right now, there is just no way out but through.

The money quote

S&P’s assessment is only remotely serious if you assume that this particular Congress, with its huge contingent of crazy Tea Partiers, is going to serve in perpetuity. But this Congress isn’t going to serve in perpetuity — there are elections next year, and many of the Tea Party freshmen are likely to lose.

They won in 2010 because it was a “wave election” in the middle of a very severe economic slump. But 2012 is a presidential election cycle with an incumbent Democratic president. A lot of these Tea Partiers who won in traditionally Democratic districts (and swing districts) are going to lose. In fact, it’s probably even odds that the Dems take back the House.
The simple fact is that the Tea Partiers are almost certainly at the height of their power in this Congress. And no, the debt ceiling debate doesn’t reflect some sort of secular change in US policymaking — the next time there’s a Republican president, House Republicans will be all about raising the debt ceiling, and Democrats won’t engage in the same kind of political brinksmanship. You’d have to be stunningly naïve not to believe this.

There have also been plenty of political de-escalations over the years — Republicans didn’t shut down the government every year after 1995, for instance. After Tom DeLay won the Medicare Part D vote by holding the vote open for 3 hours, everyone claimed that this would be the new normal on all controversial votes. Didn’t happen. There are plenty of one-off political confrontations. Simply assuming that every political confrontation represents a secular change in US politics and policymaking is ridiculous.

Points all well taken. I’ll have to think this through more but off the cuff I will say the shock factor in seeing what went down with the debt ceiling debate was so intense that it definitely moved the needle on my perception of US creditworthiness.

Seeing that this sort of thing could happen and then hearing Mitch McConnell proclaim that he intends for it to be the new normal is deeply disconcerting.

Perhaps, when heads cool we will look back and see that there never really was a chance at default and that everything was under control despite the theatrics. At this point, however, I don’t see it.

I’ve been wondering how much of last weeks tumbling market was due to rumors that an S&P downgrade was imminent. Here is one claim on this matter that indicates the answer is at least some of it:

At 8 a.m. Friday, S.& P. convened a global conference call of its sovereign rating committee… By 10 a.m., they’d reached a majority decision — the United States no longer was entitled to its top rating…

Rumors of a downgrade were already swirling in the markets — a prime reason the Dow dove more than 200 points at lunchtime, and at 1:15 p.m., the three men called the Treasury to inform them of the decision. “They were not pleased with the news,” Mr. Beers said.

I’ve been trying to pin down where Fitch stands on a downgrade. On the one hand, in the wake of the debt ceiling being raised Fitch and Moody’s were said to reaffirm AAA rating. Media outlets were reporting it like this:

Moody’s Investors Service and Fitch Ratings reaffirmed their triple-A rating for the United States…

On the other hand, Fitch said a full review was under way and would be completed within a month. So might the full review include a downgrade, or is that off the table as the AAA rating has been reaffirmed? A quote from a Fitch spokeperson clears this up:

Analysts from Fitch Ratings were in their offices over the weekend, churning through financial data. The company has said it may take all month to decide. “Our rating is triple A until the day it changes,” said David Riley, the head of global government debt at Fitch Ratings from his office in London. “That being said, we haven’t formally reaffirmed the rating.”

Moody’s reaffirmed the country’s AAA, though it did put the country on negative outlook on Tuesday. The company’s sovereign analyst said Saturday the company is not as concerned about political gridlock.

So despite media reports like those above, Fitch has not “formally reaffirmed” the AAA rating, and a downgrade appears to be on the table for their upcoming review.

One thing to consider is that an S&P downgrade could make a Fitch downgrade more or less likely. If this spurns politicians to action, it will have helped fix the problem it identified, effectively falsifying itself. However, if the downgrade causes rates to increase or hurts the economy through weaker consumer sentiment or some other Animal Spirit / Confidence Fairy effect, then it would make our fiscal situation even worse.

But what would cause Fitch to downgrade? Reports indicate they are less concerned about political gridlock, and appear to be focused on whether either the super committee’s $1.5 trillion in desired cuts or the automatic trigger backup plan will materialize. But how much clearer will that become within the next month? Are there any signals Washington could send that would indicate they’re likely to back out of these cuts?

Karl and China are in agreement about the safety of U.S. financial assets. Karl writes:

“We should begin to talk and think seriously about how to Internationalize the financial system and perhaps secure at least a viable competitor to the US in the issuance of safe assets.”

Echoing this, China’s official Xinhua news agency writes:

“International supervision over the issue of U.S. dollars should be introduced and a new, stable and secured global reserve currency may also be an option to avert a catastrophe caused by any single country…”

There may be no alternative to U.S. financial assets right now, but people are certainly starting to look hard.