The funny thing about The Big Short is that the protagonists expect the mortgages they are shorting to tank when interest rates rise. Of course, interest rates fell more than 99% of people thought possible.
The real problem was the terrible toxic debt taken on by Fannie Mae and Freddie Mac. Although latecomers to the subprime party, they more than made up for it by completely abandoning reason in terms of mortgage lending criteria, and taking on huge bad debts. Leftists will argue they were independent, but they were effectively carrying out an agenda of 'social enterprise' originally started when Andrew Cuomo was head of HUD.
Why do people think nobody went to jail? It was because government's fingerprints were all over the 2008 crash. Bush didn't stop it because he liked the economic stimulus to construction and he didn't want to appear racist, by stopping lending to people who couldn't afford the repayments. Everybody back then thought they were smart enough to avoid debt cycles. They thought they were doing minorities a favour, by giving them access to assets which they couldn't afford, but would nonetheless continue to appreciate in value.
Sure, I get your point of view and largely agree with it. I guess your argument is Hayek and low interest rates, followed by too tight monetary policy in the period immediately leading up to the crisis? I agree.
However, that's no excuse for terrible lending practices. When I worked in retail banking the formula was around 3.5 times the earnings of the primary earner, plus 1 to 1.5 of the income of the secondary earner.
One can stretch those figures somewhat, but anything which hits 5-6 LTI ratios is basically taking on structural risk, and certainly shouldn't be subject to the leveraging common to mortgage lending. More broadly, it's fairly easy to predict the triggering of a new debt cycle crisis. Many people look for when bond yields invert. It's far more reliable and certain to follow LTIs on mortgage lending. It's the problem with housing increasingly being treated as an asset class. Asset inflation is an inherent indicator of future volatility. What goes up must come down.
Once one is aware that LTIs are a great indicator, it's worth then doing a weekly check to see whether there are warning signs in terms mortgage repos, although in the past I have seen signs that Google and other search engines try to hide rises in mortgage repos when the figure rises, unless one uses industry specific language.
There is a question over whether crashes are triggered by consumption trends or financial markets. It's more of a feedback system. The monetary policy element plays a role because it causes financial markets to engage in bad behaviour. Anything beyond a household income LTI of 4.5 is a severe warning sign.
Everybody suddenly became a lot tighter with the LTIs after 2008. They understood that regardless of whether the problem originated with monetary policy, LTIs beyond 4.5 were asking for trouble in the housing sector.
Here's an interesting titbit. Here in the UK, Southern England has been experiencing something of an invisible housing crash. In the South, house price growth has been significantly lower than inflation.
"I guess your argument is Hayek and low interest rates, followed by too tight monetary policy in the period immediately leading up to the crisis?"
No, I reject the Austrian view of macro.
"Here in the UK, Southern England has been experiencing something of an invisible housing crash. In the South, house price growth has been significantly lower than inflation."
A "crash" is not a situation where housing prices rise less than inflation. A crash is a crash. Let's use words in a sensible way.
I'd encourage you to read Kevin Erdmann's stuff on the housing crisis--he has the best take.
Thank you for this, Scott! Of course my little opinion isn't worth much, but I think you know what you're talking about, so keep calling things as you see them! For some of the commenters, people need to recognize that some people on substack actually know what they're talking about. Yes, the USA (United States' Asylum) has become a banana republic and somehow governance has succumbed to domination by illiterates. As for money supply, it seems to me that the goal of private enterprise is to control more of the money supply than the Fed, with the exception that they would always hope it is still in business as the lender of last resort. Imagine how hedge funds and swap markets would behave if there was no such backstop. The other relation to banana-republicism is that too often, banana republics have collapsed due to the rising burden of debt. Brings to mind Alexander Fraser Tytler's quote on the impermanence of democracies and voting what you want from the treasury and ending in dictatorship.
Great comment. Do you follow Steve Keen's work in Ravel? The segment on the monetary model in relation to trade deficits between the US and China really got me thinking about perverse consequences. I started thinking of the way that finance treats imports as beneficial and exports as a drain, when for many sectors of the economy the reverse is actually true.
I went back to look at the British during the period when Sterling was the global reserve currency. The first observation was that although acting as the reserve currency pushed Britain towards deindustrialisation as one would expect, a decline wasn't inevitable or forthcoming. A part of this was fiscal discipline. But another element was invisible income. The British were able to balance the loss in goods production of 5-10% with invisible income from the finance sector.
But here's the crucial problem in the modern era. In a global economy, invisible income in the finance sector is far less subject to tax than other areas of the economy, particular because large elements of the physical economy are more diffuse and far less able to take advantage of tax efficient banking and financial planning, in much the same way that in countries where inheritance taxation prevails, the only thing rich people pay tax on is the family home. This creates a shortfall in government revenue relative to spending, leading inevitably to structural deficits in government spending.
Here's the thing. I don't mean to imply that this is a monocausal phenomenon. There are all sorts of reasons why government can start to allocate a larger share of the resources of a society. But generally, export surplus economies have growth rates which can outpace public spending increases, whilst trade deficit countries (or countries which are more balanced, but have large service sectors exports balancing goods imports) tend to have governments which grow into Leviathan, encompassing a larger and larger share of resource allocation. Some of this is probably Peter Turchin's Overproduction of Elites- there is no modern societal force more destructive than midwits consolidating into a Brahmin Left- but it's also probably a function of elites allocating to the wrong areas of the economy, like government or finance, and having the societal influence to control how resources are allocated. Obviously, VC is an exception in this regard, and incredibly productive in terms of resource allocation. The US has a 20 to 1 VC advantage over the UK for example.
My point would be that economics doesn't operate in isolation. The resource allocation towards specific sectors within an economy can shape aspiration and ambition, as well as culture.
The exception to the tendency for trade deficit countries to have higher debt-to-GDP ratios is obviously China, but it's worth remembering that their taxes as a share of GDP are quite low and their levels of infrastructure spending are quite insane. Another interesting outlier is Australia. It most definitely has 'Dutch Disease', but until they began to fall prey to the net zero insanity, the more comprehensive data on government spending as a share of GDP from Our World in Data showed that their percentage rate was about 3-4% lower than the US, and considerably lower than the Europeans- surprising given the generosity of their social safety nets and their more than adequate military spending.
I would definitely recommend watching the monetary model of the Steve Keen video. It prompted me to ask questions which wouldn't necessarily arise from a standard understanding of the dismal science.
Thank you, Geary, very informative. China (from their perspective) has a trade surplus while also having low domestic demand, which the govt is trying to increase by funding. The main point is that it is the _productivity_ of an economy that can pay for social services; productivity in N. America is in severe decline. Increasing govt debt actually feeds income inequality by shifting govt income into the hands of the rentiers by debt interest payments. That, on top of the opportunity cost of that money which could have funded facilitation of better productivity. Do read https://warwickpowell.substack.com/p/us-government-deficits-and-bonds
The other problem is that the service sector has always been low productivity. Tradables have greater potential for productivity gains. I was watching a podcast the other day. In terms of productivity gains from machinery and labour saving devices, the average Westerner has a lifestyle which previously only would have been sustainable with 40 servants.
Of course, the low productivity nature of the service sector might be about to change, with moves in AI and further automation. It should be noted that high value add service sector isn’t really valid in terms of calculations of productivity.
I agree with you on the rentier economics. It’s worse in the UK. I ran a few calculations about a week ago. Around 25-45% of all profits in the UK for the finance sector are derived from residential housing home ownership. Only 10-15% is mortgages, but then there is the leveraging, and the third layer is on the investment side. By the time one figures in bonds and other government lending, such as money market rates loaned to fund PSBR, then there isn’t a whole lot left for productive economics.
I’ve subscribed to your source. I will take a look tomorrow.
The other thing to consider is high labour supply from the inward migration channel. I was watching an Angus Deaton talk with Paul Krugman. It caught my eye because of the title of the clip. I’ll watch anything where Paul Krugman gets schooled! Anyway, Deaton made the point that productivity growth is higher in tight labour market conditions. Probably entrepreneurs choosing to make trade offs between productivity growth and expansion. When their labour market is less secure, they probably prioritise the former- making for a system-wide qualitative vs. quantitative behavioural push. I checked the economic history out. In America, productivity growth was twice as high prior to the changes which allowed significantly higher amounts of inward migration.
“But I’ve met numerous people that work in the financial industry who have told me that they found my observations to be useful, more useful than the conventional wisdom in the financial press.”
As someone who works in finance, I think your views are persuasive to me because I’ve only taken undergrad-level Econ, and your writings take textbook concepts seriously. I can say from finance where I’m much more of an expert that a lot of issues arise when people don’t take undergrad-level finance seriously, as everything else is an extension of those “basic” models. It seems like Econ discourse suffers from a similar problem (“never reason from a price change,” etc.).
How does the Fed maintain trend NGDP at 4% when the fiscal side needs a 6% deficit to maintain full employment? When and how does the fiscal crisis happen in your model?
I found your blog from a friend's recommendation (as he agrees with your thesis that the Fed caused the 2008 crisis), and I started reading it regularly. However, I quickly noticed I don't have the necessary background to understand macro- so I wanted to know if you have suggestions for books for me to start learning?
I found your blog from a friend's recommendation (as he agrees with your thesis that the Fed caused the 2008 crisis), and I started reading it regularly. However, I quickly noticed I don't have the necessary background to understand macro- so I wanted to know if you have suggestions for books for me to start learning? Thank you
I found your blog from a friend's recommendation (as he agrees with your thesis that the Fed caused the 2008 crisis), and I started reading it regularly. However, I quickly noticed I don't have the necessary background to understand macro- so I wanted to know if you have suggestions for books for me to start learning? Thank you
"...even though the financial crisis occurred here and despite the fact that pundits initially expected the US to suffer much more than Europe...."
this is not correct. There was an even bigger banking crisis (as measured by the size of the balance sheets of failed banks vs. GDP) in Europe. This was followed by a sovereign debt crisis years which everyone remembers and you seem to be referring to. Apart from the fact that Lehman should not be counted as a US bank - its derivatives operations formed a vital node in global bankings ALM practices and had global impact even in far away Austria.
Here is a chronology of failure. you will see large banks failing in Europe and the UK (and in exotic places such as Iceland).
A couple points. I was referring to the period of late 2007, when most of the bank failures were American banks. This was when there was some gloating in Europe. Also the Lehman crisis of Sept. 2008. The European banking problems were primarily an effect of the recession. I don't recall Northern Rock creating a banking crisis--wasn't it taken over?
Iceland is an interesting case. Their banking crisis was far worse than Ireland's banking crisis. But Ireland had a much bigger increase in unemployment, as it was tied down by ECB monetary policy, whereas Iceland adopted monetary stimulus.
Northern Rock first received liquidity support (Sept 2007) then was taken over - as was Bear Stearns. In this period no American bank failed (look at the link)- the failures were related to tiny players, mostly mortgage agents (that had started doing some lending in the form of warehousing), the biggest such player (Countrywide) failed only in the summer of 2008....
A takeover (or the start of liquidity support) of one of the largest banks in a country qualifies as a banking crisis in every textbook for a.) markets start looking for contagion and liquidity costs go up b.) sovereign credit issues may start to surface (they ultimately did in some countries).
I would not rely on European unemployment rates. definitions vary across countries and there are local and EU methodologies in parallel. Looking at 2009 real GDP growth, I see -7.7% for Iceland vs. 5.1% (Ireland). Also Ireland had a much quicker and stronger recovery by that measure.
Technical note aside: the largest part of Icelandic banking assets was booked in their EU subsidiaries which technically (and legally) are subject to local, i.e. not Icelandic deposit insurance.
I view real GDP as far less reliable than unemployment for a small economy like Iceland. In any case, my argument is that better monetary policy would have stabilized NGDP, which seems to have happened in Iceland:
Financial crisis claims are a bit subjective. It reminds me of when Keynesians warned in 2012 that fiscal austerity would produce a recession, and then in 2014 decided that there wasn't any austerity after all. In early 2008, Europeans thought the housing/banking situation was far worse in the US, and only decided otherwise when the recession turned out to be far worse in Europe (which was clearly due to tight ECB monetary policy that reduced NGDP (they weren't even at the zero lower bound until the mid-2010s.)
The problem with Australia as a counter-example is we had neither the GFC nor the Great Recession. If there was a country that was part of one but not the other, that would be a good test case.
When you have folk still writing as if interest rates are the price of money rather than credit, it is hard to get clear thinking on the topic, though perhaps such folk are not in the centre of the debate. I am sceptical about much of the conventional language of economics in this area—such as medium of exchange—as it seems to me to encourages muddy thinking.
I scandalised some folk recently by pointing out that—in a situation where monetisation relied on bullion, particularly silver—trade policy that encouraged bullion inflow was actually good policy, if one lacked local sources of bullion, given the advantages of monetisation. There seem to be certain reflexes (“mercantilism bad!” for instance) that gets thinking stuck in ruts.
There is a literature on wealth effects from asset crashes suppressing spending. Having a well-functioning credit system obviously expands the means of payment and the flexibility in moving resources across time, but surely the worst period of the GFC was relatively short, limited in its reach down the economic system, and would have been shorter still if aggregate spending kept up, which required anchored expectations about the same.
There may be an argument for mercantilism (although I doubt it), but bullion inflows and monetization is not one of them. Monetization does not require trade surpluses.
Obviously, silver tended to flow to where it bought the most (notably China) and away from where it bought the least (the Americas). But this is why I get nervous about “medium of exchange” talk, because folk seem to give ordinary supply and demand a pass, don’t differentiate between money and credit (both being means of payment) clearly enough and don’t give enough credit to the way monetisation expands economies and increases the flexibility of tax-and-spend structures.
I have seen as eminent an economist as Douglass North rabbit on about Chinese “resistance” to foreign goods when the patterns of trade are easily explained by Chinese goods being silver-cheap and European goods being silver-dear. (The Chinese would buy European goods that were not available locally.)
There is also a tendency among scholars to take official Imperial Chinese statements at face value and not ask questions about enforcement and what underlying patterns the official statements are putting a gloss on. (Some of that continues: notably giving Deng far too much credit for what was initial hostility to, followed by pragmatic glossing of, widespread local de-collectivisation and spread of commerce.)
We are talking medieval/early modern economies, where silver is the main monetary metal. If you have no local source of silver (and lots of places didn’t), how do you get the silver inflows without a trade surplus?
(Obviously, once you can issue paper notes, the situation is different.)
There's also the capital account to consider. In any case, even if you need a trade surplus to accumulate silver, that's not an argument for mercantilism, it's an argument for free trade.
Dr. Leland Pritchard predicted the S&L crisis, the rise of the GSEs, and the GFC in May 1980 in an investment letter called IMTRAC published by Dr. Christopher Thomas.
The 2-year rate-of-change, RoC in M*Vt (or AD which the FED can control – i.e., the RoC in N-gDp), peaked in the 2nd qtr. of 2006 @ 12%. Bernanke let it fall to 8% by the 4th qtr. of 2007 (or by 33%). N-gDp fell to 6% in the 3rd qtr. of 2008 (another 25%). N-gDp then plummeted to a -2% in the 2nd qtr. of 2009 (another - 133%). That’s what created the cry, epitomized by Scott Sumner, for targeting N-gDp.
It's a Richard Werner says, banks don't lend deposits. The corollary is that all bank-held savings are lost to both consumption and investment. 2013's taper tantrum was just how I predicted it with my "market zinger" forecast. What happened was that the FDIC removed unlimited transaction deposit insurance activating monetary savings.
One great difficulty is that a lot of people like to always believe that correlation is causation. As Scott has clearly shone, this is not always the case and one needs to dive deeper to see what the underlying factors are/were.
Thomas: We are running an unsustainable fiscal deficit. For example, the Penn-Wharton Budget Model cannot reach closure on the current fiscal trajectory. It has to be forced (read: politically unacceptable tax increases and/or spending cuts) to create a sustainable trajectory. Or look at Lars Christensen's website (The Market Monetarist), where his simplified model also shows an unsustainable trajectory. Or check out Ray Dalio's latest book, How Countries Go Broke.
We've also been running large current account deficits for so long that we now have a deeply negative Net International Investment Position, though with better flow dynamics. The point is that no matter how the stocks and flows are constructed and compared, this can't go on forever.
The narrow issue I'm raising is that acceptable unemployment (4-5%) is inconsistent with unsustainable fiscal deficits (6-7% of GDP, currently about $2T/year, primary deficit already more than 2% of GDP). In a sectoral balance accounting identity, our fiscal deficits and our current account deficits are the other side of the non-government surpluses. And that's where employment comes in. Eventually our creditors (foreign & domestic) will either force us to not run these deficits or, alternatively, exact a very painful price for our excesses. What happens to unemployment when that happens? The short answer is that it will be a combination of inflation, dollar depreciation, money printing, QE, financial repression, large and tax increases, etc.
The Fed has a legislative dual mandate (price stability & maximum employment) but it's really a triple mandate (financial system stability). At some point, maybe this decade, certainly next decade, the trajectory we're on makes this triple mandate impossible. Is NGDP stability even possible at that point? Something has to give and give in a big way. How does Scott see it playing out?
Yep. That's the one big untapped source of government revenue every other advanced economy has, which America doesn't. The irony shouldn't be lost on Americans. Most countries use the revenue from VAT to fund universal healthcare commissioning. America will use it to fund Leviathan government.
The funny thing about The Big Short is that the protagonists expect the mortgages they are shorting to tank when interest rates rise. Of course, interest rates fell more than 99% of people thought possible.
The real problem was the terrible toxic debt taken on by Fannie Mae and Freddie Mac. Although latecomers to the subprime party, they more than made up for it by completely abandoning reason in terms of mortgage lending criteria, and taking on huge bad debts. Leftists will argue they were independent, but they were effectively carrying out an agenda of 'social enterprise' originally started when Andrew Cuomo was head of HUD.
Why do people think nobody went to jail? It was because government's fingerprints were all over the 2008 crash. Bush didn't stop it because he liked the economic stimulus to construction and he didn't want to appear racist, by stopping lending to people who couldn't afford the repayments. Everybody back then thought they were smart enough to avoid debt cycles. They thought they were doing minorities a favour, by giving them access to assets which they couldn't afford, but would nonetheless continue to appreciate in value.
"The real problem was the terrible toxic debt"
No, the real problem was nominal (GDP), i.e., monetary policy.
Sure, I get your point of view and largely agree with it. I guess your argument is Hayek and low interest rates, followed by too tight monetary policy in the period immediately leading up to the crisis? I agree.
However, that's no excuse for terrible lending practices. When I worked in retail banking the formula was around 3.5 times the earnings of the primary earner, plus 1 to 1.5 of the income of the secondary earner.
One can stretch those figures somewhat, but anything which hits 5-6 LTI ratios is basically taking on structural risk, and certainly shouldn't be subject to the leveraging common to mortgage lending. More broadly, it's fairly easy to predict the triggering of a new debt cycle crisis. Many people look for when bond yields invert. It's far more reliable and certain to follow LTIs on mortgage lending. It's the problem with housing increasingly being treated as an asset class. Asset inflation is an inherent indicator of future volatility. What goes up must come down.
Once one is aware that LTIs are a great indicator, it's worth then doing a weekly check to see whether there are warning signs in terms mortgage repos, although in the past I have seen signs that Google and other search engines try to hide rises in mortgage repos when the figure rises, unless one uses industry specific language.
There is a question over whether crashes are triggered by consumption trends or financial markets. It's more of a feedback system. The monetary policy element plays a role because it causes financial markets to engage in bad behaviour. Anything beyond a household income LTI of 4.5 is a severe warning sign.
Everybody suddenly became a lot tighter with the LTIs after 2008. They understood that regardless of whether the problem originated with monetary policy, LTIs beyond 4.5 were asking for trouble in the housing sector.
Here's an interesting titbit. Here in the UK, Southern England has been experiencing something of an invisible housing crash. In the South, house price growth has been significantly lower than inflation.
"I guess your argument is Hayek and low interest rates, followed by too tight monetary policy in the period immediately leading up to the crisis?"
No, I reject the Austrian view of macro.
"Here in the UK, Southern England has been experiencing something of an invisible housing crash. In the South, house price growth has been significantly lower than inflation."
A "crash" is not a situation where housing prices rise less than inflation. A crash is a crash. Let's use words in a sensible way.
I'd encourage you to read Kevin Erdmann's stuff on the housing crisis--he has the best take.
Lol. I was aiming for hyperbole. Sometimes humour doesn’t come across well in writing. I should have used quotation marks. Thanks for the tip.
Thank you for this, Scott! Of course my little opinion isn't worth much, but I think you know what you're talking about, so keep calling things as you see them! For some of the commenters, people need to recognize that some people on substack actually know what they're talking about. Yes, the USA (United States' Asylum) has become a banana republic and somehow governance has succumbed to domination by illiterates. As for money supply, it seems to me that the goal of private enterprise is to control more of the money supply than the Fed, with the exception that they would always hope it is still in business as the lender of last resort. Imagine how hedge funds and swap markets would behave if there was no such backstop. The other relation to banana-republicism is that too often, banana republics have collapsed due to the rising burden of debt. Brings to mind Alexander Fraser Tytler's quote on the impermanence of democracies and voting what you want from the treasury and ending in dictatorship.
Great comment. Do you follow Steve Keen's work in Ravel? The segment on the monetary model in relation to trade deficits between the US and China really got me thinking about perverse consequences. I started thinking of the way that finance treats imports as beneficial and exports as a drain, when for many sectors of the economy the reverse is actually true.
I went back to look at the British during the period when Sterling was the global reserve currency. The first observation was that although acting as the reserve currency pushed Britain towards deindustrialisation as one would expect, a decline wasn't inevitable or forthcoming. A part of this was fiscal discipline. But another element was invisible income. The British were able to balance the loss in goods production of 5-10% with invisible income from the finance sector.
But here's the crucial problem in the modern era. In a global economy, invisible income in the finance sector is far less subject to tax than other areas of the economy, particular because large elements of the physical economy are more diffuse and far less able to take advantage of tax efficient banking and financial planning, in much the same way that in countries where inheritance taxation prevails, the only thing rich people pay tax on is the family home. This creates a shortfall in government revenue relative to spending, leading inevitably to structural deficits in government spending.
Here's the thing. I don't mean to imply that this is a monocausal phenomenon. There are all sorts of reasons why government can start to allocate a larger share of the resources of a society. But generally, export surplus economies have growth rates which can outpace public spending increases, whilst trade deficit countries (or countries which are more balanced, but have large service sectors exports balancing goods imports) tend to have governments which grow into Leviathan, encompassing a larger and larger share of resource allocation. Some of this is probably Peter Turchin's Overproduction of Elites- there is no modern societal force more destructive than midwits consolidating into a Brahmin Left- but it's also probably a function of elites allocating to the wrong areas of the economy, like government or finance, and having the societal influence to control how resources are allocated. Obviously, VC is an exception in this regard, and incredibly productive in terms of resource allocation. The US has a 20 to 1 VC advantage over the UK for example.
My point would be that economics doesn't operate in isolation. The resource allocation towards specific sectors within an economy can shape aspiration and ambition, as well as culture.
The exception to the tendency for trade deficit countries to have higher debt-to-GDP ratios is obviously China, but it's worth remembering that their taxes as a share of GDP are quite low and their levels of infrastructure spending are quite insane. Another interesting outlier is Australia. It most definitely has 'Dutch Disease', but until they began to fall prey to the net zero insanity, the more comprehensive data on government spending as a share of GDP from Our World in Data showed that their percentage rate was about 3-4% lower than the US, and considerably lower than the Europeans- surprising given the generosity of their social safety nets and their more than adequate military spending.
I would definitely recommend watching the monetary model of the Steve Keen video. It prompted me to ask questions which wouldn't necessarily arise from a standard understanding of the dismal science.
https://www.youtube.com/watch?v=po3wtqA3-0A&t=572s
Thank you, Geary, very informative. China (from their perspective) has a trade surplus while also having low domestic demand, which the govt is trying to increase by funding. The main point is that it is the _productivity_ of an economy that can pay for social services; productivity in N. America is in severe decline. Increasing govt debt actually feeds income inequality by shifting govt income into the hands of the rentiers by debt interest payments. That, on top of the opportunity cost of that money which could have funded facilitation of better productivity. Do read https://warwickpowell.substack.com/p/us-government-deficits-and-bonds
The other problem is that the service sector has always been low productivity. Tradables have greater potential for productivity gains. I was watching a podcast the other day. In terms of productivity gains from machinery and labour saving devices, the average Westerner has a lifestyle which previously only would have been sustainable with 40 servants.
Of course, the low productivity nature of the service sector might be about to change, with moves in AI and further automation. It should be noted that high value add service sector isn’t really valid in terms of calculations of productivity.
I agree with you on the rentier economics. It’s worse in the UK. I ran a few calculations about a week ago. Around 25-45% of all profits in the UK for the finance sector are derived from residential housing home ownership. Only 10-15% is mortgages, but then there is the leveraging, and the third layer is on the investment side. By the time one figures in bonds and other government lending, such as money market rates loaned to fund PSBR, then there isn’t a whole lot left for productive economics.
I’ve subscribed to your source. I will take a look tomorrow.
The other thing to consider is high labour supply from the inward migration channel. I was watching an Angus Deaton talk with Paul Krugman. It caught my eye because of the title of the clip. I’ll watch anything where Paul Krugman gets schooled! Anyway, Deaton made the point that productivity growth is higher in tight labour market conditions. Probably entrepreneurs choosing to make trade offs between productivity growth and expansion. When their labour market is less secure, they probably prioritise the former- making for a system-wide qualitative vs. quantitative behavioural push. I checked the economic history out. In America, productivity growth was twice as high prior to the changes which allowed significantly higher amounts of inward migration.
https://www.youtube.com/watch?v=SRBsDcHoWZU&t=13s
“But I’ve met numerous people that work in the financial industry who have told me that they found my observations to be useful, more useful than the conventional wisdom in the financial press.”
As someone who works in finance, I think your views are persuasive to me because I’ve only taken undergrad-level Econ, and your writings take textbook concepts seriously. I can say from finance where I’m much more of an expert that a lot of issues arise when people don’t take undergrad-level finance seriously, as everything else is an extension of those “basic” models. It seems like Econ discourse suffers from a similar problem (“never reason from a price change,” etc.).
Thanks Garrett.
How does the Fed maintain trend NGDP at 4% when the fiscal side needs a 6% deficit to maintain full employment? When and how does the fiscal crisis happen in your model?
It's hard to predict, but the current trajectory is unsustainable.
Why do you think there is relationship between the size of the deficit and unemployment?
Dear Scott Summer,
I found your blog from a friend's recommendation (as he agrees with your thesis that the Fed caused the 2008 crisis), and I started reading it regularly. However, I quickly noticed I don't have the necessary background to understand macro- so I wanted to know if you have suggestions for books for me to start learning?
Thank you
You could start with a principles of economics textbook, and then move on to my book "The Money Illusion".
Is there any principles of economics textbook in particular that you would recommend or are are most already good enough?
Dear Scott Summer,
I found your blog from a friend's recommendation (as he agrees with your thesis that the Fed caused the 2008 crisis), and I started reading it regularly. However, I quickly noticed I don't have the necessary background to understand macro- so I wanted to know if you have suggestions for books for me to start learning? Thank you
Dear Scott Summer,
I found your blog from a friend's recommendation (as he agrees with your thesis that the Fed caused the 2008 crisis), and I started reading it regularly. However, I quickly noticed I don't have the necessary background to understand macro- so I wanted to know if you have suggestions for books for me to start learning? Thank you
Scott,
"...even though the financial crisis occurred here and despite the fact that pundits initially expected the US to suffer much more than Europe...."
this is not correct. There was an even bigger banking crisis (as measured by the size of the balance sheets of failed banks vs. GDP) in Europe. This was followed by a sovereign debt crisis years which everyone remembers and you seem to be referring to. Apart from the fact that Lehman should not be counted as a US bank - its derivatives operations formed a vital node in global bankings ALM practices and had global impact even in far away Austria.
Here is a chronology of failure. you will see large banks failing in Europe and the UK (and in exotic places such as Iceland).
https://en.wikipedia.org/wiki/List_of_banks_acquired_or_bankrupted_during_the_Great_Recession
A couple points. I was referring to the period of late 2007, when most of the bank failures were American banks. This was when there was some gloating in Europe. Also the Lehman crisis of Sept. 2008. The European banking problems were primarily an effect of the recession. I don't recall Northern Rock creating a banking crisis--wasn't it taken over?
Iceland is an interesting case. Their banking crisis was far worse than Ireland's banking crisis. But Ireland had a much bigger increase in unemployment, as it was tied down by ECB monetary policy, whereas Iceland adopted monetary stimulus.
Northern Rock first received liquidity support (Sept 2007) then was taken over - as was Bear Stearns. In this period no American bank failed (look at the link)- the failures were related to tiny players, mostly mortgage agents (that had started doing some lending in the form of warehousing), the biggest such player (Countrywide) failed only in the summer of 2008....
A takeover (or the start of liquidity support) of one of the largest banks in a country qualifies as a banking crisis in every textbook for a.) markets start looking for contagion and liquidity costs go up b.) sovereign credit issues may start to surface (they ultimately did in some countries).
I would not rely on European unemployment rates. definitions vary across countries and there are local and EU methodologies in parallel. Looking at 2009 real GDP growth, I see -7.7% for Iceland vs. 5.1% (Ireland). Also Ireland had a much quicker and stronger recovery by that measure.
Technical note aside: the largest part of Icelandic banking assets was booked in their EU subsidiaries which technically (and legally) are subject to local, i.e. not Icelandic deposit insurance.
I view real GDP as far less reliable than unemployment for a small economy like Iceland. In any case, my argument is that better monetary policy would have stabilized NGDP, which seems to have happened in Iceland:
https://fred.stlouisfed.org/series/CPMNACSAB1GQIS
Ireland had a much worse performance for NGDP, and a much higher unemployment rate increase.
https://fred.stlouisfed.org/series/CPMNACSAB1GQIE
Coincidence? I doubt it.
Financial crisis claims are a bit subjective. It reminds me of when Keynesians warned in 2012 that fiscal austerity would produce a recession, and then in 2014 decided that there wasn't any austerity after all. In early 2008, Europeans thought the housing/banking situation was far worse in the US, and only decided otherwise when the recession turned out to be far worse in Europe (which was clearly due to tight ECB monetary policy that reduced NGDP (they weren't even at the zero lower bound until the mid-2010s.)
The problem with Australia as a counter-example is we had neither the GFC nor the Great Recession. If there was a country that was part of one but not the other, that would be a good test case.
When you have folk still writing as if interest rates are the price of money rather than credit, it is hard to get clear thinking on the topic, though perhaps such folk are not in the centre of the debate. I am sceptical about much of the conventional language of economics in this area—such as medium of exchange—as it seems to me to encourages muddy thinking.
I scandalised some folk recently by pointing out that—in a situation where monetisation relied on bullion, particularly silver—trade policy that encouraged bullion inflow was actually good policy, if one lacked local sources of bullion, given the advantages of monetisation. There seem to be certain reflexes (“mercantilism bad!” for instance) that gets thinking stuck in ruts.
There is a literature on wealth effects from asset crashes suppressing spending. Having a well-functioning credit system obviously expands the means of payment and the flexibility in moving resources across time, but surely the worst period of the GFC was relatively short, limited in its reach down the economic system, and would have been shorter still if aggregate spending kept up, which required anchored expectations about the same.
There may be an argument for mercantilism (although I doubt it), but bullion inflows and monetization is not one of them. Monetization does not require trade surpluses.
Obviously, silver tended to flow to where it bought the most (notably China) and away from where it bought the least (the Americas). But this is why I get nervous about “medium of exchange” talk, because folk seem to give ordinary supply and demand a pass, don’t differentiate between money and credit (both being means of payment) clearly enough and don’t give enough credit to the way monetisation expands economies and increases the flexibility of tax-and-spend structures.
I have seen as eminent an economist as Douglass North rabbit on about Chinese “resistance” to foreign goods when the patterns of trade are easily explained by Chinese goods being silver-cheap and European goods being silver-dear. (The Chinese would buy European goods that were not available locally.)
There is also a tendency among scholars to take official Imperial Chinese statements at face value and not ask questions about enforcement and what underlying patterns the official statements are putting a gloss on. (Some of that continues: notably giving Deng far too much credit for what was initial hostility to, followed by pragmatic glossing of, widespread local de-collectivisation and spread of commerce.)
We are talking medieval/early modern economies, where silver is the main monetary metal. If you have no local source of silver (and lots of places didn’t), how do you get the silver inflows without a trade surplus?
(Obviously, once you can issue paper notes, the situation is different.)
There's also the capital account to consider. In any case, even if you need a trade surplus to accumulate silver, that's not an argument for mercantilism, it's an argument for free trade.
Dr. Leland Pritchard predicted the S&L crisis, the rise of the GSEs, and the GFC in May 1980 in an investment letter called IMTRAC published by Dr. Christopher Thomas.
The 2-year rate-of-change, RoC in M*Vt (or AD which the FED can control – i.e., the RoC in N-gDp), peaked in the 2nd qtr. of 2006 @ 12%. Bernanke let it fall to 8% by the 4th qtr. of 2007 (or by 33%). N-gDp fell to 6% in the 3rd qtr. of 2008 (another 25%). N-gDp then plummeted to a -2% in the 2nd qtr. of 2009 (another - 133%). That’s what created the cry, epitomized by Scott Sumner, for targeting N-gDp.
That's why you measure N-gDp targets with a 2 year roc:
01/1/2019 21111.6 0.039
04/1/2019 21397.938 0.040
07/1/2019 21717.171 0.044
10/1/2019 21933.217 0.049
01/1/2020 21727.657 0.029
04/1/2020 19935.444 -0.068
07/1/2020 21684.551 -0.002
10/1/2020 22068.767 0.006
01/1/2021 22656.793 0.043
04/1/2021 23368.861 0.172
07/1/2021 23921.991 0.103
10/1/2021 24777.038 0.123
01/1/2022 25215.491 0.113
04/1/2022 25805.791 0.104
07/1/2022 26272.011 0.098
10/1/2022 26734.277 0.079
01/1/2023 27164.359 0.077
04/1/2023 27453.815 0.064
07/1/2023 27967.697 0.065
10/1/2023 28296.967 0.058
01/1/2024 28624.069 0.054
04/1/2024 29016.714 0.057
07/1/2024 29374.914 0.050
10/1/2024 29723.864 0.050
01/1/2025 29977.632 0.047
M1 NSA money stock, transaction deposits, means-of-payment money, peaked on 12/27/2004 @ 1467.7. It didn’t exceed that # until 10/27/2008 @ 1514.2
Dec. 2004's money #s wasn't exceeded for 4 years. That is the most contractive money policy since the Great Depression.
It's a Richard Werner says, banks don't lend deposits. The corollary is that all bank-held savings are lost to both consumption and investment. 2013's taper tantrum was just how I predicted it with my "market zinger" forecast. What happened was that the FDIC removed unlimited transaction deposit insurance activating monetary savings.
One great difficulty is that a lot of people like to always believe that correlation is causation. As Scott has clearly shone, this is not always the case and one needs to dive deeper to see what the underlying factors are/were.
Thomas: We are running an unsustainable fiscal deficit. For example, the Penn-Wharton Budget Model cannot reach closure on the current fiscal trajectory. It has to be forced (read: politically unacceptable tax increases and/or spending cuts) to create a sustainable trajectory. Or look at Lars Christensen's website (The Market Monetarist), where his simplified model also shows an unsustainable trajectory. Or check out Ray Dalio's latest book, How Countries Go Broke.
We've also been running large current account deficits for so long that we now have a deeply negative Net International Investment Position, though with better flow dynamics. The point is that no matter how the stocks and flows are constructed and compared, this can't go on forever.
The narrow issue I'm raising is that acceptable unemployment (4-5%) is inconsistent with unsustainable fiscal deficits (6-7% of GDP, currently about $2T/year, primary deficit already more than 2% of GDP). In a sectoral balance accounting identity, our fiscal deficits and our current account deficits are the other side of the non-government surpluses. And that's where employment comes in. Eventually our creditors (foreign & domestic) will either force us to not run these deficits or, alternatively, exact a very painful price for our excesses. What happens to unemployment when that happens? The short answer is that it will be a combination of inflation, dollar depreciation, money printing, QE, financial repression, large and tax increases, etc.
The Fed has a legislative dual mandate (price stability & maximum employment) but it's really a triple mandate (financial system stability). At some point, maybe this decade, certainly next decade, the trajectory we're on makes this triple mandate impossible. Is NGDP stability even possible at that point? Something has to give and give in a big way. How does Scott see it playing out?
"How does Scott see it playing out?"
Probably higher taxes---maybe a VAT.
Yep. That's the one big untapped source of government revenue every other advanced economy has, which America doesn't. The irony shouldn't be lost on Americans. Most countries use the revenue from VAT to fund universal healthcare commissioning. America will use it to fund Leviathan government.
I’d like to see central banks take ownership over _price level_, and by implication the broader nominal aggregates.
And by implication state clearly that sometimes they are, temporarily, aiming for over target inflation, which they will later bring back to target.