Sunday, June 29, 2014

The French Revolution as Chinese dynastic crisis

This is an essay on the interaction between states and social orders, using China as a prism to examine European patterns, rather than the other way around. According to Japanese historian Naito "Konan" Torajiro, the history of modern China began in the Song dynasty (960-1279), making China the first modern society; an analysis known as the Naito HypothesisGiven that Song dynasty China had paper money, meritocratic bureaucratised autocracy, tax-paid soldiers, public rituals but private religion, scholar-gentry replacing vanishing landed aristocracy--even the offering of prizes for better crossbow designs--I find Naito's proposition to be very plausible.

I see no reason to presume that modernity began in Europe. Especially given the way various Enlightenment folk thought Chinese government more advanced in its forms of management than European states. Britain, for example, did not introduce civil service examinations until the mid C19th, over twelve hundred years after China had pioneered them and about nine centuries after they had become the only path to officialdom.
I am, however, uncomfortable with calling the previous period in Chinese history "medieval", as Naito often did. I prefer the term he also used of middle antiquity (chuko in Japanese), though I would call it China's late antiquity. And yes, that means I hold that China did not have a medieval period as such; it went straight from its late antiquity to the early modern. (The essay continues after the fold.)

Saturday, June 28, 2014

Revolutionary divides

It is in the nature of successful revolutions (successful in the sense of imposing a new political order which persists) to divide their society. They represent a political bargain implemented by force. Those against whom such force was applied are not participants in the revolutionary bargain, they have it imposed on them.

The Glorious Revolution, the American Revolution and the French Revolution all had this effect. The alienated from the Glorious Revolution were the Jacobites, from the American Revolution were the Tories and from the French Revolution throne-and-altar France.

Absent, faded or enduring
Of the three Revolutionary regimes, the American revolutionary republic was by far the most ruthlessly successful in dealing with the said divide. The American Tories were expelled and their property confiscated. (The American Revolution generated more refugees than did the French Revolution.) Thereafter, there may have been arguments about the implications of the Revolution (in a sense, Americans have argued about little else since) but being in favour of the Revolution itself (even if not quite the same Revolution was being conceived) has been the overwhelming social consensus. Hence the US Constitution--the embodiment of said consensus Revolution--being the icon it is. Given that migrants went to the US precisely because it was the polity that the Revolution created, they have not disturbed that social consensus or the Constitution's iconic status. (If anything, they have reinforced it.)

The political order established by Glorious Revolution was not in a position to simply expel all supporters of the deposed King James and had to endure various Celtic fringe revolts for decades after. Indeed, the last, 1745, was the biggest and most threatening. One could say that Catholic Ireland was never fully reconciled to the new order, but as it had never been fully reconciled to any English dominated order, that is not really a case of a revolutionary divide. (Of course, one could also argue the failure to incorporate Catholic Ireland as a participant in the new political order entrenched Irish alienation.)

In the end, the passage of time won, more or less. The Revolutionary political bargain was broad enough, and flexible enough, to expand to encompass the previously disenfranchised. Though the harrowing of the Highlands after the disaster at Culloden (1746) was the iron fist which blocked off alternatives. To claim that the contemporary push for Scottish independence represents a continuing divide over the Glorious Revolution seems an excessively long bow, since even the pro-independence Scots want to continue along the broad constitutional path the Revolution established. They are about reversing the Act of Union (1707), not the Revolutionary settlement.

The French Revolution is a complex case. There was fairly clearly a resurgence of the Revolution-alienated in the radical right politics of the 1930s, for example, and in the Vichy regime. A resurgence one could reasonable argue has re-manifested in the electoral prominence of the Front National today. The politics of the guillotine made the French Revolution far more elite fratricidal than either the American or Glorious Revolutions, while the brutality of the suppression of the Vendee also has no real counterpart in either the Glorious or American Revolutions. So France remains a country where the divide over its Revolution remains a much more live issue than in the UK or the US. That the French Revolution was not able to create a stable political order (again, unlike the American or Glorious Revolutions)--France currently being on its Fifth Republic, having also had two Empires and three Monarchies since the Revolution--also points to a more divided society. 

Sui generis framing
That the US Revolutionary order became functionally consensual so early may distort American perspectives. Certainly, they had their own Civil War, but that can be put in the slavery box. Either way, it was not a revolt against the Revolutionary Order as such, but a fight over its implications. The Confederate Constitution was, after all, just a tweaking of the US Constitution, with the tweakings being very much about slavery.

But Americans can look at their country, one that was always ethnically mixed, see a common political (and to some extent social) enterprise agreed upon and a stable political order being created. The expulsion of the Tories gets written out of the story, the British legal and political heritage also gets somewhat written out (or taken for granted: that they were fortunate heirs of the Glorious Revolution is not much dwelled upon) and the Civil War becomes a heroic fight over a noble cause and a peculiar institution, enabling it to be put in a special historical box. So they can look at a country like Iraq and not consider how much they are treating a backwash of European imperialism as an inviolable entity. Not every political inheritance is a suitable basis for that workable social bargaining that makes for stable political orders.

Yes, the US Founding Fathers created (on the second try) an enduring political order, but they were dealing with populations who had already been through the selective process of migrating there in the first place as well as the experience of representative politics within the British colonies. Electoral social bargaining was already part of their operative experience in relatively egalitarian social settings (given Amerindians and slaves were not part of the political nation). As was the notion of some broad common enterprise.  American historical experience is fairly sui generis. It is a poor basis for thinking about societies with very different histories and structures. But moving outside American framings is both conceptually difficult and politically fraught. Yet, without such moving beyond American framings, American policy is going to continue to have a ham-fisted quality when dealing with very different societies and histories.

[Cross-posted at Skepticlawyer.]

Sunday, June 22, 2014

Memories of Ray Evans (1935-2014)

I was greatly saddened to learn, via email, of the death of Ray Evans.  I first met Ray sometime in the 1980s, when he was an indefatigable fighter for labour market reform. The attempt by the new Hawke Government, via the Hancock Report, to expand even further the legal privileges of the union movement inspired him to co-found the H R Nicholls Society

It was typical Ray--to get politicians, business folk, academics, people with relevant experience to come together, to analyse, to inform and, above all, to not have the sense of being alone. Ray was a great opponent of the perennial modern tendency to try and declare debate closed and the holders of dissident opinions to be wicked. 

As the Society's website announces, the Society is in favour of minimal regulation of the labour market. More specifically, it seeks freedom of contract and association. Not to have special arrangements and special privileges entrenched in law. The Society itself was subject to ferocious denunciations from within the "Industrial Relations Club" (the IR Club), not least from those employer organisations who relied on selling their services as navigators of regulatory complexity. Said organisations were nowhere near as publicly and virulently vocal as the union and wider labour movement, but their hostile backgrounding of journalists against the Society helped to entrench the "extremist" tag. 

Yet, looking back, the current regulatory structure of Australian labour markets have moved much more in the direction the Society advocated than its critics wanted. Labour market regulation still protect job incumbents against labour market outsiders, but a great deal less than used to be the case. Union privilege has been pared back somewhat. As the Australian and the Victorian Opposition Leaders both contemplate the embarrassments that the corrupt thuggery that so intensely tribal a culture as the union and labour movement is, alas, prone to, the case against said legal privileges looks even better.

Australia enjoys comparatively low unemployment (though not down to pre-1973 levels); the previous pattern of each round of the business cycle leaving unemployment higher than it was before has been broken. The biggest single factor in that was getting monetary policy mostly right, but the opening up of the labour market also played a role. The more regulations privilege insiders, the more folk are left on the outside (which is what unemployment is): a principle the entrenched high unemployment (particularly youth unemployment) of many European labour markets display

Through it all, Ray Evans just kept going. He once described himself as a "defender of sound doctrine" and it was this combination of being certain in his own mind, coupled with a great appetite for knowledge, which he could deploy with great facility, that made him such a powerful advocate of ideas. He was also a much-travelled man, with great anecdotes about his travels. Such as being in Iceland when they were celebrating their great diplomatic success in blocking Australia's election to the UN Security Council (they took umbrage at our anti-whaling policies) or Texans being completely puzzled by the notion of Government "releasing land" for housing.

But an advocate always on the lookout for the like-minded. You did not have to agree on everything, just be able and willing to contribute to the particular cause in hand. So, for example, he got Gough Whitlam to speak at a memorial for Bert Kelly, the "Modest Member". Ray's differences with Whitlam were manifold, but they agreed on free trade, and that was enough. (Trade protection is, of course, another form of legal privileging.)

Ray Evans was a defender of traditions and traditional belief who also treasured the dynamism of Western civilisation. His outlook tended towards the Burkian: Burke's comment that:
When bad men combine, the good must associate; else they will fall one by one, an unpitied sacrifice in a contemptible struggle.
spoke powerfully to Ray, hence his founding of a series of advocacy societies and discussion forums, as Patrick Morgan sets out in his online obituary. Not a noted admirer of Keynes, Ray continually acted upon Keynes's assertion that:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.
One suspects that he would also have agreed with Keynes that:
I can be influenced by what seems to me to be justice and good sense; but the class war will find me on the side of the educated bourgeoisie.
Except that he would not have bought into the notion of a class war. Something his critics typically never understood is that he thought the IR Club was against the long term (and sometimes short term) interests of the workers as much as, in some ways more than, the interests of anyone else. Corralling workers into compulsory union coverage bred corrupt and complacent unions hostile to innovation. (Which is one point where I demur from Patrick Morgan's obituary: Ray would never have agreed that workers should not be able to sue for breach of contract--that would just be a new form of legal privileging.)

It was always an error to too glibly pigeonhole Ray. This was brought home to me when he expressed admiration for Oliver Cromwell, describing him as a "great man". Ray took a broad view of the heritage of the past and the possibilities of the future. He was very much against "blood-and-soil" notions, believing that liberty and salvation were possibilities open to all who embraced what they required.
The dynamism of Western civilisation is its most distinctive and enduring feature, creating constant conundrums for Western conservatives, hence a prudential liberal such as Edmund Burke becoming an icon of Anglosphere conservatism. Another way in which Ray followed Burke was his religion was a great anchor for him amidst the storm of debate and events. Contemporary trends within the Anglican communion distressed him. I am not surprised that, according to Patrick Morgan's obituary, he contemplated moving to the new Anglican rite of the Catholic Church ("crossing the Rubicon"--going to Rome--as it is known), but also not surprised he never took the step. He was ultimately grounded in Anglosphere Protestant traditionalism and, however much he sought to encourage like-minded folk to discuss and debate and then, so fortified, contribute to the wider public debate, the Protestant notion of being naked before God spoke to him. He was very much a man looking forward to what future could be created, however grounded in the past he was.

We were never friends, simply associates. We disagreed on some obvious matters. But I always treasured the spaces he opened up for civilised discussion, debate, learning and sharing of experience. He had been physically frail for sometime, though his mind was as definite and active as ever. 

He was a man who was very definitely there, you noticed Ray. He had strong sense of humour, with a hearty laugh. If you offered him a thought or significant fact he had not come across, a quizzical expression would cross his face as he considered what was offered. If he thought it was simply wrong, he would disagree vigorously, forcefully and knowledgeably

Part of what made him so effective, is that he never felt any great need to take credit. The goal was the thing. Some years ago, a think tank he had not been involved in presented him with an award for his services to public debate. At the dinner, he gave a speech centring on how important St Augustine's ideas were for the development of Western political traditions, connecting the deep past to the present and prospects for the future. Including how important working class patriotism had been to the survival of the West. He finished, and simply left the podium. He had had his say, he left his audience to consider the ideas presented to them.

His death leads me with a sense of being bereft. But the sense of what is lost and gone is itself a tribute to the worthiness of the man who is no longer with us. 

[Cross-posted at Skepticlawyer.]

Sunday, June 15, 2014

Why monetarist victory is necessary: so central banks cannot hide

A guest post at Marcus Nunes's blog Historinhas (sans graphs).

In the debate about how to think about the Great Inflation of the 1970s, Milton Friedman's policy advice--constant growth in a targeted monetary aggregate--turned out to be misplaced. Indeed, the failure of the Thatcher Government's monetary aggregate targeting led to the popularisation of Goodhart's Law:
Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.
Ironically, the point Milton Friedman had originally made (pdf) in his critique of the use of the Phillips Curve for policy purposes--that such a use will change people's expectations, and thus their behaviour, rendering the relationship between inflation and unemployment no longer useful for policy purposes--turned out to also apply to his own policy advice to target monetary aggregates being based, as it was, on the notion that monetary turnover (velocity) was relatively stable (or could be made so by quantitative targeting).

Victory (to a point)
Nevertheless, the wider macroeconomic victory of Milton Friedman--the acceptance that inflation is always and everywhere a monetary phenomenon--was a necessary step in the taming of inflation. Why? Because once the monetary nature of inflation was accepted, the responsibility of central banks for inflation became clear, incorporated in what is sometimes called the new neoclassical synthesis.  So the problem simply became a matter of finding a way to operationalise the responsibility of central banks. Such a way was found with inflation targeting. (Pioneered by, of all places, New Zealand under Reserve Bank of New Zealand Governor Don Brash.)

In other words, accepting that inflation was a monetary phenomenon gave the central banks no place to hide.

There were two problems which flowed from this. First, what became most widely accepted was narrow inflation targeting, where maintenance of price stability (typically defined as 2% inflation a year) became the only, or dominant, policy target of the central bank.

The second is that, in the wider economics profession, the dominant macroeconomics became New Keynesian economics, where the incorporation of monetarist notions is often glossed over: they do not play much part in David Romer's 1993 paper (pdf), for example. The frequent use of Dynamic Stochastic General Equilibrium (DSGE) Models, which have some problems incorporating money and monetary effects, rather exacerbated this. Brad DeLong, conversely, makes explicit (pdf) the importance of what he calls Classic Monetarism in New Keynesianism.

Burdensome responsibility
Given the way central banks now pride themselves on--indeed, sometimes seem to define their role as--"taming" inflation, it is easy to forget how resistant many central banks were to the notion that inflation was their responsibility. And a major appeal of narrow inflation targeting is precisely that it minimises the responsibilities of central banks.

Which is why a new (market) monetarist victory is necessary. For the crucial step in flattening the business cycle is to gain acceptance that the intensity of the business cycle is also a monetary phenomenon: that central banks control the level of aggregate demand. Once that is accepted, the responsibility of central banks for stabilising the path of total spending on goods and services is clear, and it is just a matter of finding ways to operationalize that responsibility.

Given Scott Sumner's very reasonable hypothesis that central banks (particularly the US Federal Reservetend to follow the macroeconomic consensus of the mainstream economics profession, this means the debate within said profession is very important; though still as part of the wider policy debate.

While central banks are not held accountable for the effects of what they do, and do not do, achieving a stable (macro)economic framework for people to go about the business of their lives is going to be a happy accident when it should be what policy makers—and specifically central bankers—are held accountable for.

ADDENDA: Noah Smith is very enthusiastic about Japanese PM Shinzo Abe because, among other reasons:
In other words, unlike everyone else in the world, Abe listened to Milton Friedman, and the results are looking good.

[Cross-posted at Skepticlawyer.]

Friday, June 13, 2014

Hard money is not the same as sound money

A post by Jonathan Finegold on sound money pointed me towards how to express an important distinction--that hard money is not the same as sound money. JF defines sound money thusly:
a monetary system that best promotes coordination between market agents.
Unsurprisingly, a somewhat "Austrian" definition, but clear enough. I would go with the money that maximises its transaction utility, but it would come to much the same thing. Which is to say, money being sound is not merely about the exchange value of money (either for other monies or for goods and services), nor even its exchange value across time (i.e. its role as an asset), but also about the exchanges (transactions) it is used in. If money maintains or increases its exchange value against goods and services (measured by, say, the GDP deflator) but at the cost of depressing the level (measured by goods and services) of exchanges it is used in, then that is not sound money.

It is, however, hard money. 

Which is the difference: hard money is money that maintains or increases its exchange value for goods and services (or other monies or both). The more it increases its said exchange value, the "harder" it is. But that does not tell us that how sound it is: indeed, often hardness and soundness are contra-indicated (more of one is less of the other). To increase money's value as an asset is to reduce its moneyness and that way disaster (or, at least, much economic unpleasantness) lies, remembering that being an asset is the least distinctive thing about money.

Deflation distinction
The distinction between good, bad and ugly deflation is useful (pdf) here. Good deflation comes from falling prices due to increasing productivity. The IT industry is a classic example of good deflation--Moore's law and all that. There is a sense in which the entire increase in living standards from whenever is all good deflation--if, for example, we use labour-time at average wages as our measure.

Bad and ugly deflation--what we might call monetary deflation--is all about money increasing in value relative to output, thereby depressing aggregate demand (i.e. total spending on goods and services), pushing downwards on income, raising the value of debt. Bad and ugly deflation is from hard money, from money increasing in exchange value. It is not sound money, as the actual use of money in productive transaction is trending downwards as money's exchange value is trending up. Money-as-asset is overwhelming money-as-facilitator-of-transactions--the real point of money; what makes money, money.

Central banks should be sound, not hard
We do not want central banks to obsess over providing hard money, we want them to provide sound money. To focus on money as tool, not money as asset; to focus on its utility, its role in the economy as a whole, not on its (exchange) value. Narrow inflation targeting central banks--such as the Bank of Japan (BoJ) during the "lost decades", the European Central Bank (ECB) since the Eurozone crisis--produce hard money. They do not produce sound money. The Reserve Bank of Australia (RBA) does that.

The most disastrous example of producing hard money which was desperately unsound was the policies of the Bank of France (BoF) in creating the Great Depression, the classic example of ugly deflation at its ugliest. Money was extremely hard (and getting harder and harder) but also catastrophically unsound. Money was "better and better" as an asset, worse and worse as a facilitator of transactions.

One problem is that hard money is actually relatively easy to produce and has a whole lot of ready-made chest-thumping rhetoric to go with it. It does not help that Austrian school theory has such a presumption towards central banks being inflationary, that the problem of hard money is simply not natural to their analytical framework. (Not a sin of all Austrian economists--several above links are to works by economists associated with the Austrian school--but one very common in the wider Austrian community.)

Disorder dangers
Another problem is the conservative penchant for producing fetishes of order--such as "preserving" the "value" (rather than the utility) of money. Hence so many conservatives riding the gold standard down to destruction in the Great Depression and so many obsessing over utterly imaginary inflationary dangers today. They focus on money as asset, losing sight of money as tool. On the thing itself and not its wider role, thereby actually failing to defend the wider system. They defend the fetish (the gold standard, narrow inflation targeting) as a bulwark of order, regardless of how much actual disorder it is creating.

Thereby, of course, undermining and discrediting the very social order they are so keen to defend.

Including the international order. Not only does the social disorder created by hard money make extremist regimes more likely, the economic contraction and stagnation hard money creates undermines the confidence and capacities of Western states. Folk have pointed to how much like a late 1930s Hitler Russian President Vladimir Putin is, except on behalf of Russians outside Rodina rather than Germans outside the Reich. That both were confronting Western Powers weakened in both strength and confidence by central bankers disastrously pursuing hard, rather than sound, money policies is another similarity less remarked upon.

Money qua money is a tool for transactions. Sacrificing its use (in transactions) for its (exchange) value is to undermine its real utility to an economy--which is to facilitate transactions, to have maximum transaction utility; to have a monetary system that best promotes coordination between market agents. 

Hard money is really, really not the same as sound money.  It would be a massive step forward in public policy if more people understood that.

[Cross-posted at Skepticlawyer.]

Monday, June 9, 2014

Too big not to fail: the rise and fall of Fannie Mae

The debate over the role (if any) of the Community Reinvestment Act (CRA) in the sub-prime crisis, and thus the Global Financial Crisis (GFC), often seems to be a stand-in for other issues. In particular, to what extent was either financial meltdown the consequences of government regulation (or the lack thereof).

The answer to the former question is: almost entirely, if by government regulation one includes the full gamut of government interventions and political game-playing. In a market economy, failures of regulation and government intervention always manifest as market outcomes. By the simple expedient of declaring such government interventions and regulations irrelevant or insignificant, said market outcomes can then be pointed to as "proof" of market failure.

But that is ideology blocking analysis. Corporations are pavlovian profit monsters--they will go where profits lead them. They act according to the incentives offered them, within the range of managerial competence. (Hence markets as economic selection processes.)

In the case of the US finance industry, particularly the US housing finance industry, various government interventions profoundly shaped the incentives facing participants in the market, with part of the problem being those being regulated having rather too much influence over how they were regulated.

With no entity playing the political game more relentlessly, narrowly effectively or ultimately self-destructedly than the Federal National Mortgage Association (FNMA) or Fannie Mae. As long-time Wall Street Journal journalist James R. Hagerty sets out in his highly readable history of Fannie Mae, The Fateful History of Fannie Mae: New Deal Birth to Mortgage Crisis Fall.

Supporting housing finance
Fannie Mae started operating in 1938, a late New Deal initiative. While fairly small in its early days, it grew until it became one of the biggest financial institutions in the world. For its first 30 years, it had a monopoly over the US secondary mortgage market. As an Australian reading the book, the idea that housing finance needed government support seems a little bizarre. We have a home-ownership rate slightly above the US's (ex-communist countries generally top the rankings), but did not need to create anything like Fannie Mae or Freddie Mac, or the other US government founded/supported finance entities, to do it.

But such efforts suited some very politically effective interests, such as realtors. The implicit or explicit taxpayer guarantee allowed more funds to be pushed into housing at lower cost. At one point, Hagerty quotes Adam Smith's scepticism about government-sponsored companies:
These companies, though they may, perhaps, have been useful for the first introduction of some branches of commerce, by making at their own expense an experiment which the state might not think it prudent to make, have in the long run proved, universally, either burdensome or useless. 
Fannie Mae provides a dramatic example of Adam having a point. The US$187bn the taxpayer's invested in bailing out Fannie Mae and Freddie Mac may have been more than returned, but their role in fuelling destructive, massively over-leveraged, housing price booms imposed a much greater social cost than that.

Having previously read Fragile by Design, Hagerty's book also put the CRA into a much more useful context, even though it plays a small role in his book. There was a long history of US federal government action to support housing finance. The CRA was a way of extending that pattern of action to urban minorities. The problem with the CRA was not the Act itself, but the way it then came to feed back into, and amplified, already existing patterns, which were also amplifying for other reasons. It was a building block in the edifice that created the sub-prime crisis, no more than that (but also no less).

Hagerty takes us through the history of Fannie Mae, with an enduring feature being attempts to either regulate it more closely, or to fully privatise it, being fought off by Fannie Mae. Fannie Mae wanted to keep its government guarantee (an implicit guarantee, once it became a company with shareholders), because that lowered the cost of its capital, but without tighter prudential regulation, because that would have reduced its ability to leverage off its government guarantee. Fannie Mae's leadership played the political game increasingly effectively, including using such tactics as hiring as many lobbying firms as practicable, so they could not be hired to lobby against it.

To a large degree, Fannie Mae got the regulatory framework it wanted, though part of the trade-off became to expand its support for housing finance. As a result, the prudential rules covering it became increasingly vulnerable to catastrophic failure, if there was a large enough rise in interest rates or fall in house prices. Which, of course, there duly was.

Government guarantees to financial entities require matching prudential regulation if catastrophe is not to be avoided. But Fannie Mae was too politically useful; which it leveraged ruthlessly, to avoid inconvenient prudential regulation to match its government guarantee. Fannie Mae became too good at selling itself as the perfect (off-budget) housing finance problem solver.

As the various housing bubbles across the US started to deflate, a desperate housing industry lobbied hard for Congress to "do something". And there was Fannie Mae and Freddie Mac, available to "do something" off-budget. So, as the housing bubbles deflated, Fannie Mae and Freddie Mac increased their exposure. But this was the end run of a long process of ever-lower standards of lending without compensating increases in prudential requirements.  The necessary corollary to government guarantees if said guarantees were not to make the financial system more vulnerable rather than less.

Pay and ...
And then it all collapsed, wiping out Fannie Mae and Freddie Mac's share values and requiring a $US187bn bailout of the two government-sponsored-enterprises (GSEs). It was as if nothing had been learnt from the Savings & Loans crisis. Which, in effect, it had not.

What Calomiris & Haber call the game of bank bargains has been perennially played in the US to suit narrow interests and not broad ones. As in this case, with the taxpayers left holding the bag (again) as helping the housing industry by "off-budget" measures suddenly went dramatically on-budget.

It is useless to complain that the politics was "corrupted", as if that is the only problem: we have to deal with politics as it is, not as it might be. There is certainly a role for seeking to have better functioning institutions, for informed debate, for exposure. But to change nothing about the political institutions and framings of debate, and then expect the players to reliably and continually act differently, is naive at best.

It was not as if the housing booms themselves were not also significantly responses to regulation. Land rationing was a major driver of where the US housing booms did (or did not) occur. For any asset, if quantity responses are dampened, then price responses become more intense. That is, if supply is constrained (such as by land rationing), then the price of a class of assets (such as land-approved-for-housing) will become more susceptible to demand shocks (both upwards and downwards). Or, in this case, upwards then downwards. Especially if a government guarantee is leveraged into pumping more and cheaper finance into purchasing said asset.

So, local governments were rationing land (driving up house values and property tax revenue), Congress wanted off-budget help to the housing industry and home-owners (both middle class and those aspiring to be so), driving up the funds being pumped into supply-constrained markets, banks wanted to benefit from the too-big-to-fail subsidy, and prudential regulators either did not want to pick unfortunate fights or were overwhelmed by the superior lobbying power of those that they were attempting to regulate. With no-one playing the political game more effectively, or more ultimately disastrously, than Fannie Mae. Which became too politically big not to fail. 

... then repeat
But Fannie Mae and Freddie Mac have been bailed out, not killed off. The too-big-to-fail subsidy is now absolutely established, as are the GSE's government guarantees. Blaming "Wall St" or "easy money", or whatever, means that the game of helping a powerful industry off-budget--in part by not forcing sufficient prudential requirements to match the government guarantees--continues to be played. After all, the imbalance is very much based on providing (positive) externalities to those who usefully notice and passing the costs on to those who do not.

The Savings & Loans Crisis was Mark 1. The Sub-Prime Crisis was Mark 2. The pieces are being set in place to have Mark 3. With "corporate greed" the perennial theatrical villain, so that the real players can continue to play their political games, and taxpayers and home-owners can be set to take the fall, yet again.

But Hagerty's book--clearly based on talking to everyone who matters and reading every report--provides a well-written, clear and informative history of past, present and (sadly) likely future.

[Cross-posted at Skepticlawyer.]

Friday, June 6, 2014

The ECB's failure

These two graphs, taken from here, express vividly how much worse the performance of the European Central Bank (ECB) has been compared to the US Federal Reserve (the Fed). Between the two of them, they caused the Great Recession, but the Fed has done much better since.
The ECB's dismal performance also helps explain the recent European election results (see previous post).

Monday, June 2, 2014

Andrew Sullivan being extremely sensible

Andrew Sullivan's commentary on the EU election results is by far the most sensible thing on the results I have read, since he gets both sides and realises the underlying conflict has to be managed, not "won". I particularly liked:
And, more to the point, Europeans increasingly feel they are not given a choice in any of this. So they vented.
Making folk feel ignored and powerless is not the path to social harmony. Also:
But when the money ran out, and the recession hit, and the EU only bailed out members on the basis of brutal austerity … the deal began to fray. Now that growth is returning, if only anemically, it appears, moreover, to be benefiting Blue Europe – the elites, the property-owners, the transnationals – while leaving ordinary, working- and middle-class Europeans in the dust. That fuels another layer of mistrust and despair.
The consequences of the ECB's "hard money" policy continue to resonate, badly.

ADDENDA: Sociologist Frank Furedi also has very sensible things to say about the Eurosceptic vote and how not to think about it (via).

Sunday, June 1, 2014

Small-yet-broad is beautiful (or why it is good to have been British)

The central purpose of Calomiris & Haber's Fragile by Design: the Political Origins of Banking Crises is to explain to Americans why their banking system does not perform as well as other countries--particularly compared to that of their neighbour, Canada. In chapter 14, the authors put the matter quite starkly:
... if a highly stable banking system is defined as one that has been crisis-free since 1970, then only six out of 117 countries--Australia, Canada, Hong Kong, Malta, New Zealand, and Singapore--meet the threshold for being both credit abundant and crisis free.
As the authors note, all six were part of the British Empire. Three (Hong Kong, Malta and Singapore) are city-states. The other three (Australia, Canada and New Zealand) are among the world's most stable and long-lived democracies. The authors argue that these latter three countries also have something else in common:
... the structures and political histories of these three countries tended to mitigate the ability of populists and bankers to form coalitions that disadvantage everyone else.
Something that is very clear, is that "de-regulation" is a term empty of explanatory power. All successful six have liberalised financial markets--Australia and New Zealand, for example, were leaders in financial "de-regulation". If someone starts trying to blame the Global Financial Crisis (GFC) on "de-regulation", you can stop reading, they have nothing useful to say.

It is very much the point of Calomiris & Haber's Fragile by Design to look at these issues comparatively and historically, which gets in the way of all sorts of congenial ideological narratives. Their final chapter (Chapter 15) is entitled "Reality is a Plague on Many Houses" just to make that point--particularly that Americans need to look outside their own history for answers.

Playing the game
In Chapter 2, The Game of Bank Bargains, they make it quite explicit that the question is always the actual structure of financial regulation:
... the normal functioning of banks depends on three sets of property rights that only government can provide. Banks need powerful governments. But power may not be wielded in the interests of bankers unless bankers can convince the group in control of the government to partner with them.
Hence the game of bank bargains. Hence also the political origins of banking crises. Or, as they say:
... our goal is to explore why banking is all about politics--and always has been.
It is inherent in the nature of banking given that:
Any enterprise whose inputs and outputs consist primarily of promises to repay debts is inherently unstable and risky.
Banks have to deal with credit risk and liquidity risk. Hence banks are pioneers of limited liability laws:
... in the vast majority of countries, the first enterprises to seek charters granting their shareholders a limit on liability were banks: the special limited-liability acts for banks typically antedated general incorporation laws by decades.
Which brings the government into the heart of banking.
A bank cannot simply declare that its shareholders have limited liability or other legal protections. Only the government can offer these. It does so by granting privileges--through bank charters--and enforcing them in courts. A charter is not just a license; it is a contract between the bank and the government.
To have an effective bank bargain, (1) bank assets have to be protected from government expropriation, (2) minority shareholders and depositors have to be able to stop bank insiders expropriating their assets or else be compensated for accepting the risk of expropriation by bank insiders, and (3) there has to be mechanisms to protect bank insiders, minority shareholders and depositors from expropriation by borrowers or else be compensated for accepting the risk of expropriation by borrowers.

Since 1970, six jurisdictions have managed to do all that. Why so few jurisdictions? Because governments face conflicts of interest in managing the game of bank bargains. They regulate banks, but borrow from them. They discipline debtors, but often rely on them for political support. They allocates losses among creditors in cases of bank failures, but may simultaneously look to them for political support. The constant temptation is to shift the game of bank bargains to benefit those who usefully notice at the cost of those who do not; the arsonists in charge of the fire brigade problem, with government having, as Calomiris & Haber put it "multiple opportunities to behave opportunistically".

Most governments fail this test. Hence only 6 out of 117 jurisdictions managing the game of bank bargains so as to provide abundant credit but avoiding bank crises.

If the standard is set so as to include countries that have avoided a crisis since 1970, but are only required to have a level of credit to GDP equal to the mean across all countries, we get all the way to 13 jurisdictions out of 117: the "successful six" are joined by the Bahamas, Bahrain, Barbados, Belize, Macao, Mauritius and South Africa. All are former parts of the British Empire, except Macao, and all achieved independence peacefully.

Out of the 13, all but 3 are small islands or city-states. While, like Australia and New Zealand, South Africa (since the 1997 constitution was a brokered deal with the white minority) has institutions which:
... make it hard to populist movements to form coalitions with banks to enact regulatory policies that benefit them at the expense of everyone else.
The US, by contrast, not so much.

Small islands and city-states dominate the list of the successful players of the game of bank bargains because they are simply much more likely to have broadly-based bargains. (Though Iceland is a salutary reminder that success is not guaranteed from being small.)

As for the worst performers, setting the criteria as having at least two bank crises since 1970 and credit to GDP ratio at or below average gives us: Chad, the Democratic Republic of Congo, Argentina, Bolivia, Brazil, Cameroon, the Central African Republic, Colombia, Costa Rica, Ecuador, Kenya, Mexico, Nigeria, the Philippines, Turkey and Uruguay. (Kenya is clearly letting the British-is-better side down, though its path to independence was marred by violence.[Nigeria is also letting the British-is-better side down, but it is basically a mistake as a single country.]) Basically, as the authors point out, autocracies, new democracies or democracies whose institutions provide few barriers to rent-seeking.

Broadening the question
When we look at lists of per capita GDP on a purchasing price parity (PPP) basis, we can see that the US is the only large country in the top 10 persistently included: the others being small (less than 10 million in population) as well as oil-rich, monarchical or democratic (or some combination thereof--looking at you Norway). So, clearly the US continues to do something right.

Of course, since the US is seriously a federation, it could be argued it is really a bunch of small countries operating in close formation. That what is by far the largest state by population (California) is also something of a public-policy mess adds plausibility to the claim. As does the only two countries with populations of over 10 million to get into any of the lists being Canada and Australia (also federations).

Clearly, the trick is to have responsive states. With smaller being generally better, as information flows more easily and more inclusively. It is generally just harder to stick it to folks (either by what you do or what you don't do) in a way that doesn't get noticed in smaller jurisdictions. (Unless jurisdictions are so small they fly under the media radar but are big enough to be semi-anonymous--urban local government in Oz has a bit of a problem there.)

There is an important caveat though, which Calomiris & Haber identify in discussing why Canada's "bank bargain" has consistently worked so much better than the US's--forcing policy bargaining to be at a broad level is less likely to generate nasty externalities. The Canadian "game of bank bargains" was played at a national level in a parliamentary-and-imperial system, so created a stable, interests-encompassing bargain more sensitive to long-term consequences.

The US "game of bank bargains" was played at State and Federal levels in coalitions built by adding individual constituencies together in congressional systems, creating unstable, interests-excluding bargains less sensitive to long-term consequences. (Since banking is all about risks across time, long term consequences are a particular problem for bank bargains.) But that is not actually an argument for bigger-being-better (Canada was always a much less populous jurisdiction than the US). It is an argument for more broadly-based being better. And broader is easier if smaller.

Still, that politicians are going to be looking to craft useful (to them) externalities means we can only expect politicians to deal with awkwardly visible negative externalities, not be a general solution to the problem of externalities. And we should also be sceptical of public policy mechanisms well set up to generate politically useful externalities. My nominations:
Public ownership.
Bureaucratic approval systems. (Unconstitutional in Germany, and good on them--they get their reward in much more rational housing markets.)
Complex tax rules.
Low visibility regulations. (Which would be most of them.)

[Cross-posted at Skepticlawyer.]