Opinion

Felix Salmon

A vision of gloom and chaos

Felix Salmon
Sep 9, 2010 14:29 UTC

Just in time for the new year, Ian Bremmer and Nouriel Roubini have delivered a 4,000-word thumbsucker on the global political economy. Essentially, they take Mohamed El-Erian’s idea of a “new normal” and start getting very specific about where and how it’s going to fall apart. And it’s hard to disagree with things like this:

G-20 heads of state will gather in Seoul in November, and there will be plenty more such summits in years to come. Yet policy responses to transnational problems will continue to be improvised and incomplete. U.S. negotiators will resist any institutional framework that allows foreign leaders to impose binding rules on Washington. China will stoke growth to create new jobs, managing development to try to prevent crises that could provoke the kind of social unrest the state can’t contain. Russian leaders will continue to try to attract foreign investment while extending state control across strategic sectors of the domestic economy and using the country’s energy resources as geopolitical leverage. India will pursue trade liberalization at its own pace. Brazil will try to use its newly discovered offshore oil to enable state-run oil company Petróleo Brasileiro to become an ever-more useful tool of economic policy. Saudi Arabia will use its still-considerable reserves to help manage oil prices and will act as producer and lender of last resort when it finds good value for its money. Efforts to move these governments toward harmonious and effective policy responses to problems that extend beyond the financial crisis — collective security, counterterrorism, climate change and global public health emergencies — will fall short.

The result is that the historical guardians of prosperity and growth will shrink in importance, to be replaced by mechanisms which are much more likely to fail.

State capitalism will produce a reversal in the trade and capital account liberalization of the past several years as protectionism breeds more protectionism…

The emergence, virtually overnight, of the formerly obscure G-20 as the world’s preeminent economic policymaking body provides a glimpse into a more chaotic future. It also suggests that the old levers of hegemonic stability and influence exercised so expertly by the British in the first golden age of globalization (roughly 1880 to 1914) and by the U.S. in the second (1989 to 2008) will have far less purchase in the new, postcrisis age.

By the time that Bremmer and Roubini work out what this all means for markets, the line of hypothetical causality is long and therefore no prediction can carry any great degree of certainty. But there’s no good reason why this shouldn’t be true:

The reopening of the fire hoses of credit and capital that occurred during the bubble years will happen again and intensify the boom-and-bust cycles. Driven by ever-more- desperate policymakers in the U.S., Europe and Japan, these cycles will both shorten and magnify. Political, policy and regulatory uncertainty will increase, and as a result, financial crises will become more frequent and costly, while risk aversion, volatility and uncertainty will rise. The illusions of the Great Moderation — a phrase coined by Harvard University economist James Stock to describe the two-decade period that started in the late ’80s, with its quasireligious embrace of market efficiency and infinite American power — will have created the era of the Great Financial Instability. And nothing could hasten the decline of American influence more than another self-inflicted catastrophe of global market capitalism.

Investors don’t even need to believe this; they just need to protect against it in order for it to start becoming self-fulfilling. The dot-com crash came from people taking too much risk, and was relatively harmless. The recent financial crisis was a consequence of too much risk-aversion — everybody piling into paper carrying the magical “AAA” branding. That kind of crisis is much more damaging. And risk-aversion is at least as prevalent now as it was during the Great Moderation: just look at the disconnect between fluffy bond prices and modest stock prices.

In order for capitalistic animal spirits, especially in fast-growing economies, to rescue us all from a series of horrible financial earthquakes, everybody’s going to have to become a lot less risk-averse. And I don’t see that happening any time soon.

COMMENT

I have to chime in and say that I agree with Michael above. The idea that the problems of the last few years were brought about by risk aversion is one that you’ve expressed several times in the past, but that just doesn’t quite sit right with me.

Just because people piled into securities that were (misleadingly) rated AAA doesn’t mean that they were risk averse. It means that they were sold a product that was too good to be true. High returns with little perceived downside. Why would you buy stocks when you can buy mortgages? It’s not risk aversion, it’s risk ignorance.

How about the person that uses a credit card with a 0% interest rate but then doesn’t read the fine print (6 month teaser rate then 27% thereafter)? Is that person risk averse? If they were, then wouldn’t they have opted for the credit card at 4% interest? In my opinion, there’s a difference between aversion to cost and not actually knowing the cost.

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Counterparties

Felix Salmon
Sep 9, 2010 05:15 UTC

Scarborough and Kinsley to write for Politico — NYT

Find out what is “the greatest diva moment of all time” — Awl

Mandelman’s a fan of American Homeowner Preservation — ML-implode

WSJ vs NYT, Taiwan-style — YouTube

Some vegetable oils have a bigger footprint than animal fats, and vegan farming means the large-scale killing of animals — Guardian

Tad Friend’s quintessentially New York walk from the Empire State Building to Central Park — TNY

COMMENT

Felix, the Diva post was a fine listen and read. What a hoot! or was it the graphs and the circular graph that had you mesmerized?

The Guardian piece was ok, but the comments were outstanding! Such as…

“And if stupidity is an excuse for eating things, I’ve met some eminently edible people – isn’t the argument about sentience rather than intellect?”

Thanks for the links!

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Basel III: The compromise

Felix Salmon
Sep 9, 2010 05:00 UTC

Maybe 9% was too good to be true after all. According to David Walker, of Australia’s Banking Day, a compromise with “nations including Germany, France, Italy and Japan” has knocked 0.5% off the proposed Tier 1 capital requirements, and another 0.5% off the proposed conservation buffer. As a result, banks wanting to pay dividends are now going to have to have a minimum of 8% Tier 1 capital, rather than 9%.

If* the new ratios are strictly enforced once they become fully phased in, this is still a big improvement over what we had before, and a win for the community of global bank regulators. Still, we’re not there yet: final agreement won’t come until the G20 meets in Seoul in November. Fingers crossed nothing else will get diluted between now and then.

*This of course is a big if, and Kindred Winecoff, for one, thinks that it’s hopeless to even dream that it might become reality:

Politicians won’t give up their domestic authority or ability to address changing local circumstances, so agreements made in Basel are subject to interpretation, implementation, and enforcement by domestic regulators. The U.S. still hasn’t come into full compliance with Basel II, for example, and there is essentially no recourse for other nations or the BIS to force it to do so.

There’s certainly a coordination problem here: countries have every incentive to drag their feet and watch the rest of the world tighten up, leaving their own banks at a global competitive advantage. But having clear rules and a coordination problem is a vast improvement over having no clear rules at all. And if the G20 can agree to do this in November, I have some hope that they can also commit to hold each others’ feet to the fire going forwards, if one of them starts backsliding.

COMMENT

I find the meetings in Davos very important, as they close some of the gaps of the G20 decisions.

Example: In November 2010, the Financial Stability Board (FSB) and the G20 endorsed the Basel III Accord. The Basel Committee has developed the framework.

And what they have discussed in Davos?

I read in the summary prepared by William Dowell:

“While the Basel III Accord dealt with efforts to create international norms for financial regulation, the fact is that each country adds its own regulatory framework to the mix.

The result is an overly complex financial environment that works against efforts to stimulate the economy and promote future growth.

The trend to overemphasize regulation to prevent future crises also overlooks the fact that the crisis in 2007-2008 was an exceptional event.

An analogy can be made to aircraft seat belts. It makes sense to have the best safety belts possible just as it makes sense to make rational rules for banking but, in the case of passenger airplanes, it makes even more sense to invest in an effective air traffic control system that prevents a crash from happening in the first place.

In the case of the financial system, establishing a consistent international structure is likely to be even more crucial than focusing on individual banks.

The difficulty in harmonizing the international system is that each country needs to deal with its own domestic political reality, and that inevitably takes precedence over international agreements.”

George Lekatis
http://www.basel-iii-association.com

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Can you launder money through black hotels?

Felix Salmon
Sep 9, 2010 03:00 UTC

John Le Carré has a new book out, Our Kind of Traitor, which stars a big-deal Russian money launderer called Dima. There’s not actually all that much on the mechanics of money laundering, but this would be rather clever, I think, if it actually worked:

‘Would somebody mind telling me what a black hotel is?’ Matlock demanded of the air in front of him. ‘I happen to take my holidays in Madeira. There never seemed anything very black about my hotel.’

Fired by a need to protect the subdued Hector, Luke appointed himself the somebody who would tell Matlock what a black hotel was:

‘You buy a bit of prime land, usually on the sea, Billy. You pay cash for it, you build a five-star luxury-hotel resort. Maybe several. For cash. And throw in fifty or so holiday bungalows if you’ve got the space. You bring in the best furniture, cutlery, china, linen. From then on your hotels and bungalows are full up. Except that nobody ever stays in them, you see. If a travel agent calls: sorry, we’re fully booked. Every month a security van rolls up at the bank and unloads all the cash that’s been taken in room rentals, bungalow rentals, the restaurants, the casinos, the nightclubs and bars. After a couple of years, your resorts are in perfect shape to be sold with a brilliant trading record.’

No response beyond a raising of Matlock’s avuncular smile to maximum strength.

‘It’s not only resorts either, actually. It can be one of those strangely white holiday villages — you must have seen them, trickling down Turkish valleys to the sea — it can be, well, scores of villas, obviously, it can be pretty well anything that’s lettable. Car hire too, provided you can fudge the paperwork.’

The book as a whole is very cleverly constructed, and full of wildly implausible ever-so-English characters who sound as though they’ve just walked out of a Noel Coward play. It’s a rollicking read, and I got through it in no time; I’m now wondering how common this black hotel ruse really is. Do people really buy hotels which have never actually been stayed in? One would think that before shelling out vast amounts of money for a seafront resort you might at least take a look at Tripadvisor. Still, I suppose that absent a legitimate buyer, Money Launderer Number One could always just sell to Money Launderer Number Two.

Update: Otto, in the real world, explains how black gold mines work in Peru — and even provides an example.

COMMENT

Two choices:

1. John Le Carré should attend a money laundering class :)

2. John Le Carré knows that the readers of his books will never understand how money laundering works, so he decided to make it simple (and add some “secrets” of the rich that sell).

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The power and serendipity of Google Instant

Felix Salmon
Sep 8, 2010 22:36 UTC

Tyler Cowen has yet to make up his mind about Google Instant: it’s fun, he says, “but I find it distracting and it will lose me time in serendipitous diversions”.

My initial reaction to that is one of incredulity: Tyler’s a blogger, which means that he more than most people gets real, immediate benefit from serendipitous diversions. More generally, while I’ve never been particularly persuaded by the complaint that searching on Google involves less serendipity than browsing in a physical library, it’s pretty obviously no bad thing if Google starts throwing up serendipitous-yet-germane results in real time. Think of it like the random mutations which power evolution.

Google’s Matt Cutts explains how this kind of thing can be extremely powerful:

I was recently researching a congressperson. With Google Instant, it was more visible to me that this congressperson had proposed an energy plan, so I refined my search to learn more, and quickly found myself reading a post on the congressperson’s blog that had been on page 2 of the search results.

Ben Gomes mentioned this during the Q&A, but with Google Instant I find myself digging into a query more. Take a query like [roth ira v]. That brings up Autocomplete suggestions like [roth ira vs traditional ira], [roth ira vanguard], and [roth ira vs 401k]. Suddenly I’m able to explore those queries more just by pressing the up/down arrow key. I can get a preview of what the results will be, add or subtract words to modify my query, and hit enter at any time… When I was in grad school, I had a professor who mentioned that peoples’ information need often change over the course of a search session. Google Instant makes that process even easier: people can dig into a topic and find out new areas to explore with very little work.

So I think that Alexis Madrigal is worried about nothing here:

I worry that Google is driving more traffic to the most statistically probable searches. The most-trafficked ways of searching for something will get more trafficked. I wouldn’t be surprised to see the number of unique searches drop because people see something in the list that makes sense, even if it’s not exactly how they’d have put it.

This may only be a slight narrowing of our collective imagination, but it’s worth noting because it’s another way in which algorithmic suggestions or restrictions shape our behavior, even (or especially) when they are soft and/or useful.

It would be interesting to see Google quantify this effect: I’m sure they have the ability to do that. But my gut feeling is that, contra Madrigal, the most-trafficked ways of searching for something will actually get less trafficked. Lots of people are currently searching for that congressperson, or doing a general search on Roth IRA. Those searches are now going to get much more granular and useful. The tail might get a little bit thinner, although I doubt it. But the head is going to get much thinner. Which will have an overall positive effect when it comes to shaping our behavior: we’re going to be much less likely to just end up going to the sites at the top of the search results for the most popular terms. And that’s got to be a good thing.

COMMENT

Bad results, faster. I’d say we’ve got a winner!

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Is it possible for the government to reduce unemployment?

Felix Salmon
Sep 8, 2010 22:02 UTC

There was a reasonably interesting call today between various bloggers and Jason Furman, an economic policy wonk at the White House. The main message was that the Obama administration’s new economic-stimulus proposals were essentially ways of front-loading attempts to create long-term economic growth, and that unemployment would come down as and when that growth arrived.

I wasn’t particularly convinced. There’s a colorable case — made today by Brad DeLong — that all of these proposals, coming as they do halfway into Obama’s four-year term in office, are too little too late, compared to the messages that Larry Summers and others were sending at the beginning of 2009.

On the call, Furman valiantly tried to paint policies like cash-for-clunkers and the extension of unemployment insurance as being all about creating jobs, but the fact is that it’s hard for any government to create jobs, beyond simply hiring more people, and the effect of those policies on the unemployment rate was surely minimal at best.

Mike Konczal honed in, with his question, on one of the key vicious cycles in the economy: the high unemployment rate is making the housing market worse, and then in turn the weak housing market is exacerbating the unemployment rate, by making it much harder for people to move to where the jobs are.

Furman waffled a bit, saying that while a couple of years ago it was the housing market which was instrumental in causing the broader economic crisis, now the “direction of causation” is in many cases the other way around, with the weak economy hurting the housing market. Well, yes. But that doesn’t really say much about jobs.

So I asked him again, about jobs in particular, and Furman started talking about the drivers of economic recovery, and how this time around it’s not going to be housing. He did eventually manage to bring jobs in, saying that the infrastructure bill and the R&D credit and the small business bill “taken together would have a meaningful impact on unemployment today”.

But they wouldn’t, would they. Of the three, only the small business bill looks like it’s really targeted at creating jobs, as opposed to stimulating the economy more broadly and hoping that somehow higher GDP is going to feed through into lower unemployment. But the unemployment problem is tough, and sticky, and I’d much rather see proposals really aimed at tackling it head-on, rather than just trying to get there through big-picture macroeconomic effects. Make it easy for people to move out of their underwater houses, for instance.

On the other hand, maybe what we’re seeing here is a White House economic team which is fully cognizant of what government economic policy can and can’t achieve. And while keeping the economy from slipping back into recession is something doable, bringing unemployment back down, even to where it was when Obama first took office, isn’t. They’re not going to admit that in public, but neither are they going to expend too much effort tilting at windmills.

COMMENT

Fiscal austerity and money printing. Really, it works.

It is what is happening in Britain right now and they are faring much better than we are. Their bubble actually exceeded ours by quite a bit.

American substitution works too. Not for shoes but there are many things, such as cars and airplanes and Subzero fridges that can go either way.

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Why Greece won’t turn itself around

Felix Salmon
Sep 8, 2010 18:53 UTC

If you haven’t yet read Michael Lewis’s fantastic piece on Greece, you should really carve out some time to do so. It’s almost impossible to summarize, but suffice to say that it serves as an utterly convincing and highly entertaining 11,500-word rejoinder to the IMF’s bullish case that Greece can somehow avoid default.

Essentially, the only way that Greece can survive its current debt crisis without default and/or devaluation is by a concerted and nationwide pulling-together for the sake of the country as a whole, including an unprecedented willingness on the part of Greece’s citizens to pay their taxes. But that’s not going to happen.

Where waste ends and theft begins almost doesn’t matter; the one masks and thus enables the other. It’s simply assumed, for instance, that anyone who is working for the government is meant to be bribed…

The only Greeks who paid their taxes were the ones who could not avoid doing so—the salaried employees of corporations, who had their taxes withheld from their paychecks. The vast economy of self-employed workers—everyone from doctors to the guys who ran the kiosks that sold the International Herald Tribune—cheated (one big reason why Greece has the highest percentage of self-employed workers of any European country). “It’s become a cultural trait,” he said. “The Greek people never learned to pay their taxes. And they never did because no one is punished. No one has ever been punished. It’s a cavalier offense—like a gentleman not opening a door for a lady.”

The scale of Greek tax cheating was at least as incredible as its scope: an estimated two-thirds of Greek doctors reported incomes under 12,000 euros a year—which meant, because incomes below that amount weren’t taxable, that even plastic surgeons making millions a year paid no tax at all. The problem wasn’t the law—there was a law on the books that made it a jailable offense to cheat the government out of more than 150,000 euros—but its enforcement. “If the law was enforced,” the tax collector said, “every doctor in Greece would be in jail.” I laughed, and he gave me a stare. “I am completely serious.” …

In Athens, I several times had a feeling new to me as a journalist: a complete lack of interest in what was obviously shocking material. I’d sit down with someone who knew the inner workings of the Greek government: a big-time banker, a tax collector, a deputy finance minister, a former M.P. I’d take out my notepad and start writing down the stories that spilled out of them. Scandal after scandal poured forth. Twenty minutes into it I’d lose interest. There were simply too many: they could fill libraries, never mind a magazine article.

The Greek state was not just corrupt but also corrupting… No success of any kind is regarded without suspicion. Everyone is pretty sure everyone is cheating on his taxes, or bribing politicians, or taking bribes, or lying about the value of his real estate. And this total absence of faith in one another is self-reinforcing. The epidemic of lying and cheating and stealing makes any sort of civic life impossible; the collapse of civic life only encourages more lying, cheating, and stealing.

I’m sure the squeals of outrage are already beginning to emanate from Greece and from Greeks around the world: Lewis loves exaggerating national stereotypes, as he showed in his Iceland piece, and he does that even more here. After reading his article, I’d say it’s almost Greek, the impunity with which he throws around generalizations that most other journalists would naturally hedge and tone down. Who’s going to prosecute or punish him?

On the other hand, it really is useful to look at national characteristics when it comes to things like sovereign debt: it’s a simple historical fact that countries like Greece and Ecuador are much more likely to default than countries like, say, Canada or the Netherlands. And Lewis, with his article, does a very good job of showing how much of a gulf still separates Greece from most of the rest of the EU. It’s a timely reminder.

COMMENT

What everyone forgets when trying to understand these problems in Greece is this:

1. Once the social securities taxes are included, Greeks are the *second highest taxed* people in Europe and one of the highest taxed in the world, yet government services and infrastructure absolutely suck. No wonder they don’t like paying these exorbitant taxes!

2. There is no concept here of streamlining and cutting red tape. Efficiency in government processes is an unheard of concept. Government bureaucracy exists to: (a) provide cushy jobs with a pension (b) terrorize the masses, hence extract bribes, with trivial paperwork and endless, meaningless hurdles to getting anything done. Government bureaucracy and red tape stifle initiative. Business is strangled at birth. It is so awful, so inefficient and backward, that it is impossible to get anything done without either having relatives/contacts in the system or paying someone off. Yet if you have the right relatives anything is possible. The only laws that get enforced, really, are those that give paper bureaucrats power. Just try and set up a business in Greece as a foreigner – you’ll find out all about it!

3. There are few modern management practices. Business and public sector are top-down, extremely hierarchical with no devolution of decision making. Jobs are therefore unrewarding and promotion is based on who your family is, not on ability. Salaries are very low and are not independent living wages so people depend on their families for support and bribes become attractive. But families are shrinking and divorce rates high. Prospects are bleak for many so there is little motivation to work hard. Consequently, the idea that your job or career partly defines you and you should enjoy it is not one held by many Greeks.

While we’re bashing Greece – it should be noted that Italy is reputed to be just as bad in all respects. We are talking a Mediterranean thing here.

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No reason to be optimistic about house prices

Felix Salmon
Sep 8, 2010 14:48 UTC

David Leonhardt has delivered yet another excellent housing column, full of sharp insights and careful thinking. The key concept in the piece is the distinction between the idea that houses rise with incomes, on the one hand, and the idea that they rise with inflation, on the other. If house prices generally rise with inflation, as Bob Schiller thinks, then they have quite a ways further to fall. On the other hand, if they rise with incomes, then they’ve already mean-reverted.

I think that Leonhardt is right in thinking that houses are more likely to rise with incomes than with inflation. Houses sell for whatever buyers can afford; the key numbers here are the total monthly outlays, on the one hand, and income, on the other. If mortgage rates remain steady, then house prices, once they start clearing, are likely to rise in line with incomes.

But on the strength of that premise, I’m not nearly as bullish as Leonhardt, for three big reasons.

Firstly, mortgage rates are not going to remain steady: they’re going to rise. A $2,000-a-month mortgage payment at 4.5% will buy you $530,000 of house. At 6.5%, it will buy you $368,000 of house. That’s a 30% decline.

Secondly, as the home sales figures showed, houses are not clearing right now. And insofar as they are, they’re only doing so because of trillions of dollars of implicit federal subsidies being pumped into the mortgage market via Fannie, Freddie, the FHA, and other state-owned agencies. The government has prevented home prices from dropping to their natural level. Which might be sensible policy, but also means that you can’t take today’s prices as market-clearing.

And finally, incomes are the final shoe to drop in this recession. We’ve had a nasty fall in GDP, and in the stock market. We’ve had a large rise in unemployment. But we haven’t had any kind of decline in real wages — quite the opposite, in fact. Leonhardt says that “housing does not rank with unemployment, the trade deficit, the budget deficit or consumer debt as one of the economy’s biggest problems.” But what effect does he think that those big problems are going to have on incomes, over the long term, in a world which is globalizing inexorably and where Americans in general get paid far more than their peers doing similar jobs in foreign countries?

On top of the big reasons, there are smaller concerns which should worry anybody thinking about buying a house right now, including the massive shadow inventory of homes which would be on the market if the market were only a bit more normal. And then there’s this, from Leonhardt’s conclusion:

The ratio of median house price to income is about 3.4, compared with a prebubble average of about 3.2…

If you can imagine staying much longer than a few years, you should take some comfort in the fact that the bubble seems mostly deflated. Sometime soon, prices should begin rising again. They may not quite keep up with incomes, but they will probably outpace the price of food and clothing.

Keep those ratios in mind: if you’re spending something in the neighborhood of 3X your annual income on a house, you’ll probably be OK. But that’s certainly not the kind of ratio that I see here in New York.

And yes, housing is undoubtedly a better investment than food and clothing, but that’s not saying very much. Remember that food and clothing have been falling in price, steadily, over the course of decades. Even if houses just kept pace with inflation, they would probably outperform food and clothing.

As David Merkel says today:

We all become worse capital allocators when there is no safe place to put excess funds. It tempts people to stupid decisions.

Buying a house constitutes a monster allocation of capital to real estate, at a time when the outlook for house prices has never been foggier. I’m far from convinced that it makes sense right now.

COMMENT

Real estate in ‘specific areas’ goes into high demand and short supply. We are not in short supply today, and there IS no high demand. ‘Quality’ real estate changes with the years, and high quality ten years ago is a boarded up abandoned home today. In Adam Smith’s day, we had tons of immigrants coming in, and so yes, there was always a demand for more homes. In this day and age, we are overbought and overbuilt, and keeping out the new blood that would drive the market.
And real estate is taxed as a fairly equitable way to pay taxes (although no farmer will agree with it, hehe), not to suppress prices.
==Bob D.

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Counterparties

Felix Salmon
Sep 8, 2010 04:51 UTC

Michael Lewis on Greece — VF

The politics of Basel III — IPE@UNC

“The only drivers likely to look first are those who have doored a cyclist some time in the recent past” — Riding to Win

A Visual Guide to Deflation — Mint

COMMENT

Michael Lewis’s article on Greece is a must-read.

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