This is an interesting item but it misses so much. Extremely unbalanced economies resolve by way of painful adjustments. We have dodged nothing but the new methods and tools have transferred risk to the dollar system and our ability to sustain capital inflows. We are not out of the woods yet by any means and even our denial at this point is part of the pattern.
http://www.voxeu.org/index.php?q=node/3421
What would be surprising is the misplaced confidence and complacency when you consider the US and UK are still in the ICU on full life support but this is just as it was then, hope springs eternal.
Market wrap: Leading stocks made further progress on the rally. Bulls encouraged by optimism from steel industry and Farm Board, by more foreign buying, and by market ability to resist bad news. Major industrials including US Steel, American Can, and GE, staged good gains in first 4 hours. Reactionary tendencies developed in late afternoon on profit taking, but sales were well absorbed on moderate price recessions, with the setback appearing technical. Bond market more active; US govts. and high grade corp. strong; speculative corp. irregular; foreign govts. mixed.
Broad Street Gossip: The head of one prominent Exchange firm has been seeking opinions among his 1,200 customers; finds that experienced traders are now optimistic, having “been through numerous panics” in the past only to see the country recover and become “more prosperous than ever before”. On the other hand, the young trader with less than 10 years experience “can see nothing but black clouds ahead ... and just cannot see how industry can get back on its feet again.”
In past few weeks, fire insurance company funds have been increasingly invested in common stocks of leading companies with safe dividends; viewed as significant since these investments “are directed by shrewd and conservative observers.”
S. Strawn, Montgomery Ward chair., says recovery depends on business men not politicians; warns against “drift toward Bolshevism”; says great problem now is gearing production down so that it will “synchronize with consumption”; implies some wage cuts may be needed.
Market ability to resist bad news is in contrast with a short time ago, when it “ignored any favorable development.” In past week, market has dealt with failure of an Exchange house, wheat irregularity, decline in rail car loadings, bank failures, etc., with little more than a hesitation in the upward trend.
See what I mean? The focus is already on why it was all so easy to fix.
http://newsfrom1930.blogspot.com/2009/11/friday-november-21-1930-dow-18709-048.html
The mild recession we've experienced bears no comparison with the much-mentioned Great Depression. But the difference is more the result of hard lessons learnt than better luck.
This week, Dr David Gruen of Treasury gave a lecture about what economists have learnt from the Depression and how the two events compare.
In Australia, the lead-ups to the two crises were quite different. In the present episode, we'd experienced 17 years of uninterrupted growth, falling unemployment and, in the past five years, booming export prices, leading to hugely improved terms of trade.
By contrast, in the lead-up to the Depression we experienced no real growth for five years, with the unemployment rate rising to 7 per cent. After the Depression began, real GDP fell by almost 10 per cent in 1930-31. The unemployment rate peaked at just under 20 per cent in 1930 (but had fallen to 9 per cent by 1937).
This time, of course, the economy hasn't contracted and is forecast to grow reasonably strongly next year, with the total rise in the unemployment rate expected to be just under 3 percentage points.
And this time we have a standard of living five times what it was then (even for the unemployed) and unemployment benefits which, despite their miserliness, are way better than ''the susso'' of the Depression era.
Gruen says the Depression in Australia had three main causes. First, the extremely unfavourable conditions in the world economy, particularly a large and prolonged deterioration in our terms of trade caused by a fall in the price of wool. This deterioration started in the mid-1920s, well before the Depression began.
By contrast, the deterioration in the terms of trade this time has been much smaller, with the latest level still more than 50 per cent above the average of the 1990s.
The second cause of our Depression was our adherence to the ''gold standard''. (Actually, many Depression scholars have concluded that the decision of most countries to return to the gold standard after World War I was the primary cause of the Depression around the world. So much for Wall Street's crash in October 1929.)
The value of the Australian pound was fixed to a certain amount of gold (the same amount as for the British pound) and anyone could demand that their pound note be exchanged for gold.
Without the gold standard, countries have ''fiat money'', where the value of a $5 note comes simply from the issuing government's command that it be accepted as legal tender in payment of five dollars of debt.
For a long time people disapproved of fiat money, fearing that governments could erode the value of money by permitting inflation or by deciding to ''devalue'' their currency against other countries' currencies.
The hyperinflation in Germany's Weimar Republic in the early 1920s convinced central bankers of the need to return to the gold standard. (In those days, the Commonwealth Bank was a government-owned trading bank and the central bank.)
Trouble is, a country that suffers a major fall in the value of its exports - a deterioration in its terms of trade - needs to respond by devaluing its currency. So sticking with the gold standard ensured the avoidance of inflation, but did so by crunching the economy.
Despite pressure from our deteriorating balance of payments to devalue our currency, we held the line until March 1931, when we left the gold standard and devalued by 25 per cent against the British pound. By then, however, our foreign exchange reserves were run down.
Subsequent research has shown that the sooner a country left the gold standard, the sooner it recovered from the Depression. Big Mistake No.1.
By contrast, in the present crisis our dollar was floating. It acted as a shock absorber for our economy, first by depreciating by 25 per cent in the four months to November last year, then by recovering almost as rapidly.
The third cause of our Depression, according to Gruen, was our inability to borrow abroad from early 1929. Australian governments had borrowed heavily from the London capital market during the 1920s to fund a string of large infrastructure investments, rapidly increasing our foreign debt.
London banks pressed Australian governments for repayments. Our banks restricted their loans to businesses, which put pressure on the economy.
By contrast, although the latest crisis would have shut our banks out of world capital markets, our Government used the strength of its own balance sheet to guarantee the banks' overseas borrowings, for a fee.
Turning to monetary (interest-rate) policy, it was ''tragically tight'' in the run up to the Depression because of the defence of the gold standard, and even after the devaluation the banks delayed cutting interest rates for two years. Big Mistake No.2.
By contrast, this time the official interest rate was slashed late last year and early this year, even while our exchange rate was depreciating rapidly. That we got away with this without adverse reaction from the market or fears of high inflation is a testament to the credibility of the inflation-targeting framework we installed in the early 1990s.
Turning to fiscal (budgetary) policy, the low level of foreign exchange reserves caused by the delay in devaluing the pound prevented fiscal policy from being used to stimulate activity and actually forced governments to curtail their spending.
Then, under the Premiers' Plan of 1931, government spending was cut by 20 per cent and federal and state taxes were increased to finance repayments to the British banks. So fiscal policy was managed in a way that made the economy worse rather than better. Big Mistake No.3.
By contrast, this time the Federal Government's financial position was strong and the Rudd Government quickly lashed out with big stimulus spending.
Now, you can conclude that this time we were lucky to have the economy in good shape when the crisis struck. But we weren't in better shape by accident. Economists have been studying the mistakes of the Depression for decades and have been taking steps for just as long to ensure they aren't repeated.
One lesson was to steer clear of the gold standard and (later) to move to floating exchange rates. Another was that fiscal and monetary policies should be used to stimulate private demand during downturns, but also (and more recently) that they should be ''reloaded'' during the good times to be ready for the next recession.
And don't forget that the better shape of our external environment this time is thanks largely to other countries - including China - having learnt the same lessons.
Ross Gittins is the Herald's economics editor.
http://www.smh.com.au/business/learning-from-the-great-depression-20091113-iens.html
Showing posts with label gittins. Show all posts
Showing posts with label gittins. Show all posts
22 November 2009
19 September 2009
Self-righting markets and other shibboleths
The global financial crisis has revealed major weaknesses in conventional economics. Economists will need to face up to these if their discipline is to recover its reputation and relevance.
Many of these shortcomings arise from the belief that markets and economies are inherently stable. That is, the market system is self-righting. It's usually in ''equilibrium'' (balance) and, should some external event push it into disequilibrium, this sets off a process that returns the system to equilibrium quickly and easily.
Economists hold to this belief for various reasons. One is that it makes economics nice and neat, providing simple explanations and predictions (the predictions may not be very accurate, but who's counting?). It makes it easier to conduct economic analysis using maths rather than words, which makes academic economists feel scientific and intellectually high-powered.
But the belief in self-righting markets also fits nicely with the political philosophy of libertarianism - the supremacy of freedom of the individual, the minimal need for governments and taxes.
And it suits business interests, who want maximum freedom to make a buck in any way they see fit.
One of the many implications of the belief that markets are inherently stable is that there's no such thing as a business cycle. The economy is almost always at full employment because supply creates its own demand.
But surely, you may object, the whole discipline of macroeconomics is the study of how to stabilise the economy as it moves through the business cycle. Well, it used to be. Increasingly, however, it's been about trying to prove that governments are incapable of influencing the course of the macro economy and that what seems to be a cycle of deficient or excessive demand isn't really.
One notion is that the ups and downs are caused by people taking a bit of time to adjust to new advances in technology. Another is that unemployment is voluntary. Workers are so well off that when they consider the wage rates they're being offered are insufficient they take an unpaid holiday.
To the extent that some academic economists still believe in the existence of the business cycle, they study the concrete factors that cause it - the ups and downs in business inventories, for instance - not the more ephemeral, psychological factors such as optimism and pessimism, greed and fear.
But if the business cycle doesn't exist then it surely must also be the case that sharemarket crashes and financial crises don't happen.
Once again, you may think that the evidence of crashes and crises is readily apparent from the historical record. It is, but the dominant stream in academic economics has become adept at ignoring it.
Although on the one hand the study of economic history has fallen out of fashion in university economics courses, on the other some academics have sought to prove that the Dutch Tulip Bubble of 1624 and the South Sea Bubble of 1720 were really examples of wrong-headed government intervention in markets, not market failure.
Do you see what all this means? It means academic economists tend to focus their attention on what happens when everything is going right - when markets are in equilibrium - and give little thought to the circumstances in which things could go wrong.
Now do you see why so few economists could see the global financial crisis coming? They didn't see it because they weren't looking for it.
(Even those who now contrive to believe that the problems we've seen in the past year and more were caused by faulty government intervention in markets, rather than any fault on the part of markets themselves, weren't warning that these interventions could lead to disaster. No, markets were getting their way and the anti-government brigade was content that all would be well.)
This is the charge made by David Colander, of Middlebury College in Vermont, and six other American and European academics in a much-quoted paper, The Financial Crisis and the Systemic Failure of Academic Economics, that's come to be known as the Dahlem report.
One implication of this is that, despite its pretensions to the contrary, economics isn't very scientific. Like the rest of us, economists suffer from what psychologists call ''confirmation bias'' - they look for evidence that confirms their prior beliefs.
They tend to interpret evidence in ways that favour their beliefs. They remember evidence that goes their way and forget evidence that doesn't. We all do this, it's part of our lack of rationality - and economists are just as irrational as the rest of us.
In contrast, the scientific method involves trying to falsify your hypothesis, not confirm it.
Milton Friedman argued in a famous paper that it didn't matter if a model was built on unrealistic assumptions (such as human rationality). What mattered was whether the model led to accurate predictions.
You wouldn't believe it, but there are still economists who draw comfort from this pragmatic doctrine. You say economics produces inaccurate predictions? Not that I've ever noticed, it doesn't.
Another consequence of the assumption that markets always work well is that economists put a lot of effort into arguing for the removal of small inefficiencies caused by government intervention - restrictive shopping hours, for instance - while academics do little to study or help prevent the gross inefficiencies caused by having thousands of workers lying idle as a result of financial crises and recessions.
Now, economists are terribly defensive people and they'll be able to think of exceptions to every charge I've made. It's true that not all academic economists doubt the existence of the business cycle or asset-price bubbles. There are even some who study our lack of rationality. And economic practitioners, including econocrats, don't all share the extreme views of the academics.
But what I've described is the dominant view prevailing among academic economists. Behavioural economists, for instance, are a fringe minority. And it's surprising how much influence the doctrines of the high priests have on the beliefs and behaviour of practitioners.
The trouble with economics is that the conventional theory has come adrift from the real world and taken on a life of its own. The answer is for academic economics to become less theory-driven and more empirical.
There needs to be a lot more emphasis on testing theories against empirical evidence - and looking for falsification - and on simply seeking to identify empirical relationships and regularities.
With enough of these, economists could search for new theories to explain those relationships. But we also need more study of how markets and economies come unstuck.
Ross Gittins is the Herald's Economics Editor.
Ads by Google
http://www.smh.com.au/business/selfrighting-markets-and-other-shibboleths-20090918-fvb3.html
Many of these shortcomings arise from the belief that markets and economies are inherently stable. That is, the market system is self-righting. It's usually in ''equilibrium'' (balance) and, should some external event push it into disequilibrium, this sets off a process that returns the system to equilibrium quickly and easily.
Economists hold to this belief for various reasons. One is that it makes economics nice and neat, providing simple explanations and predictions (the predictions may not be very accurate, but who's counting?). It makes it easier to conduct economic analysis using maths rather than words, which makes academic economists feel scientific and intellectually high-powered.
But the belief in self-righting markets also fits nicely with the political philosophy of libertarianism - the supremacy of freedom of the individual, the minimal need for governments and taxes.
And it suits business interests, who want maximum freedom to make a buck in any way they see fit.
One of the many implications of the belief that markets are inherently stable is that there's no such thing as a business cycle. The economy is almost always at full employment because supply creates its own demand.
But surely, you may object, the whole discipline of macroeconomics is the study of how to stabilise the economy as it moves through the business cycle. Well, it used to be. Increasingly, however, it's been about trying to prove that governments are incapable of influencing the course of the macro economy and that what seems to be a cycle of deficient or excessive demand isn't really.
One notion is that the ups and downs are caused by people taking a bit of time to adjust to new advances in technology. Another is that unemployment is voluntary. Workers are so well off that when they consider the wage rates they're being offered are insufficient they take an unpaid holiday.
To the extent that some academic economists still believe in the existence of the business cycle, they study the concrete factors that cause it - the ups and downs in business inventories, for instance - not the more ephemeral, psychological factors such as optimism and pessimism, greed and fear.
But if the business cycle doesn't exist then it surely must also be the case that sharemarket crashes and financial crises don't happen.
Once again, you may think that the evidence of crashes and crises is readily apparent from the historical record. It is, but the dominant stream in academic economics has become adept at ignoring it.
Although on the one hand the study of economic history has fallen out of fashion in university economics courses, on the other some academics have sought to prove that the Dutch Tulip Bubble of 1624 and the South Sea Bubble of 1720 were really examples of wrong-headed government intervention in markets, not market failure.
Do you see what all this means? It means academic economists tend to focus their attention on what happens when everything is going right - when markets are in equilibrium - and give little thought to the circumstances in which things could go wrong.
Now do you see why so few economists could see the global financial crisis coming? They didn't see it because they weren't looking for it.
(Even those who now contrive to believe that the problems we've seen in the past year and more were caused by faulty government intervention in markets, rather than any fault on the part of markets themselves, weren't warning that these interventions could lead to disaster. No, markets were getting their way and the anti-government brigade was content that all would be well.)
This is the charge made by David Colander, of Middlebury College in Vermont, and six other American and European academics in a much-quoted paper, The Financial Crisis and the Systemic Failure of Academic Economics, that's come to be known as the Dahlem report.
One implication of this is that, despite its pretensions to the contrary, economics isn't very scientific. Like the rest of us, economists suffer from what psychologists call ''confirmation bias'' - they look for evidence that confirms their prior beliefs.
They tend to interpret evidence in ways that favour their beliefs. They remember evidence that goes their way and forget evidence that doesn't. We all do this, it's part of our lack of rationality - and economists are just as irrational as the rest of us.
In contrast, the scientific method involves trying to falsify your hypothesis, not confirm it.
Milton Friedman argued in a famous paper that it didn't matter if a model was built on unrealistic assumptions (such as human rationality). What mattered was whether the model led to accurate predictions.
You wouldn't believe it, but there are still economists who draw comfort from this pragmatic doctrine. You say economics produces inaccurate predictions? Not that I've ever noticed, it doesn't.
Another consequence of the assumption that markets always work well is that economists put a lot of effort into arguing for the removal of small inefficiencies caused by government intervention - restrictive shopping hours, for instance - while academics do little to study or help prevent the gross inefficiencies caused by having thousands of workers lying idle as a result of financial crises and recessions.
Now, economists are terribly defensive people and they'll be able to think of exceptions to every charge I've made. It's true that not all academic economists doubt the existence of the business cycle or asset-price bubbles. There are even some who study our lack of rationality. And economic practitioners, including econocrats, don't all share the extreme views of the academics.
But what I've described is the dominant view prevailing among academic economists. Behavioural economists, for instance, are a fringe minority. And it's surprising how much influence the doctrines of the high priests have on the beliefs and behaviour of practitioners.
The trouble with economics is that the conventional theory has come adrift from the real world and taken on a life of its own. The answer is for academic economics to become less theory-driven and more empirical.
There needs to be a lot more emphasis on testing theories against empirical evidence - and looking for falsification - and on simply seeking to identify empirical relationships and regularities.
With enough of these, economists could search for new theories to explain those relationships. But we also need more study of how markets and economies come unstuck.
Ross Gittins is the Herald's Economics Editor.
Ads by Google
http://www.smh.com.au/business/selfrighting-markets-and-other-shibboleths-20090918-fvb3.html
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