Stimulating spending and manufacturing optimism (9 Feb 2008)

Congress recently passed a stimulus package -- which has become one of those weird set phrases in the recent news cycle, like "rogue trader" Jerome Kerviel, or the subprime meltdown or the "credit crunch." The demands of internet search engines seem to encourage the formation of such news nuggets. These set phrases become concrete abstractions, holding together and stabilizing a collection of related ideas that are actually in tension. Thereby simplified, they circulate like currency and can be deployed in lieu of a richer understanding or a more comprehensive explanation of the forces at work. The main thing I know about the stimulus package is that it means the government will send me $600 simply for being a taxpayer.

You would that would be delightful, but it seems more frightening, like something a banana republic would do. It seems akin to giving hobos booze on election day as a reward for their vote. Also, the economic problems seem to be derived from too much irresponsible borrowing and spending, so it seems peculiar that the solution would be to give consumers more money and tell them to spend it freely. It's like giving kids pudding when they haven't eaten their meat.

Built into the phrase stimulus package are assumptions about what fiscal policy (aka money spent by the government) can accomplish. The main assumption is that the economy is moving into a recession because of a failure of aggregate demand, which is a consequence of credit suddenly becoming unavailable for risky and non-risky borrowers alike. Therefore the government borrows from the future (by increasing the deficit) and hands out checks to regular folks and encourages them to spend it. You don't have to revile Keynes to be skeptical of this. Tyler Cowen makes a good case against it here:

Most fundamentally, more aggregate demand is not the answer because insufficient aggregate demand was not the problem in the first place. Just as a social framing effect (and lots of fraud) led subprime loans to be perceived as "not very risky," right now social framing effects -- call them collective fear -- are causing lower asset prices, some degree of credit constipation, and higher risk premia. The economy is undergoing a sectoral shift toward less risky assets and that can bring an economic downturn. The shift itself is costly, it brings thorny coordination problems (e.g., sudden insolvencies, overturning of credit expectations), and lower-yielding assets also mean less wealth. Lack of liquidity simply is not the fundamental problem.

But then logic of the stimulus package may be less economical than political, as is usually the case when it comes to fiscal policy -- who should get the fruits of government spending is always a political question. This package is not likely to have much direct effect on the economy, but it will certainly affect voters' attitudes. The stimulus seems a matter of preventing a hiatus in standards of living -- of habitual shopping, that is -- and forestalling the unrest this would cause. So instead of helping adapt consumers to more "realistic" limitations on their consumption, we will do what we can to encourage them that no limits exist. This is called bolstering consumer confidence, and seems likely enough to work. America is an optimistic place, after all.

Chinese arithmetic (26 May 2007)

I have a naive faith in the transparency of numbers, trusting that they have no significance in themselves but allow us to see directly through to the importance of the amount they have measured. Numbers are truly floating signifiers, with no meaning until they are given a context, something to count. I naively believe that everyone else fundamentally feels the same way, in the abstract. This seems a cornerstone principle of what it means to be rational, and it draws the boundaries that mark off the territory of superstition. The incantations of economic data or earnings reports, with their endless litany of percentage gains and year-over-year comparisons and moving averages, seem in part an elaborate ritual to testify to the neutrality and clarity of numbers, so solemnly are they invoked to give meaning not to themselves but to large intractable phenomena in the economy. Few reading these stories about economic indicators or market performance reports care about the specific numbers, only the justification and the argument that the numbers allows to be built around them. They anchor the ongoing narrative of capitalist practice without usurping it. The efficient transparency of numbers facilitates the smooth series of exchanges and calibrations capitalism requires -- the price system works because no one presumably fetishizes the price itself but rather allows it to shift freely according to conditions.

That's why a story like this one from the Wall Street Journal a few days ago is so disturbing: it relates how numerology contributes to driving the Chinese stock markets.

Part superstition and part self-fulfilling prophecy, numerology is a basic trading strategy in China. The philosophy reflects the widespread belief in Chinese society that numbers contain clues to good fortune.
It is a little noticed force adding fuel to a roaring market in the world's fourth-biggest economy. The benchmark Shanghai Composite Index is up 56% this year and quadruple its level at mid-2005, a spike that is raising concerns about an investment bubble.
Investors' zeal to base decisions in numerology also helps explain why Beijing has been unable to temper enthusiasm in the stock market through conventional measures, like credit tightening last week.
To professional observers, the Chinese investing public's trust in the predictive power of numbers -- rather than fundamentals like business prospects or profit -- is one of many reminders of how buying on the Shanghai and Shenzhen stock exchanges looks like gambling.
Brokerages are set up like casinos. Investors drink tea, smoke and chat as they make trades on computers lined up like slot machines. Instead of dropping in coins, they swipe bank cards to pay for shares.

What makes this so flabbergasting, I think, is the enormous effort made in business discourse to make stock markets not seem like gambling. a great deal of emphasis is placed on providing information that justifies stock prices, connecting them to earnings in elaborate ways. But if the stock prices have more to do with the numbers themselves, then it's just roulette. Then it's predictable only in the sense of self-fulfilling prophecy mentioned above, which scuttles the idea that economic growth and the stock market are connected, that stock market bubbles are producing real progress or change in the society at large.

And then an article like this one, from last week's Economist seems scarier.

For the government the situation poses quite a challenge, particularly as anecdotal reports indicate that the stock buying craze is rampant both among the urban middle class and less well off sections of society like taxi drivers, pensioners and students. Should the market suffer a downturn these people could vent their fury, as investors did in the late 1990s when stock price crashes occurred, threatening political stability. The government will want to avoid such scenes in 2007 and 2008, as the Chinese Communist Party holds its five-yearly congress and the Olympics kick off in Beijing.

Inducing novice investors with possibly numerologically based investing strategies into an overheated market seems like a recipe for catastrophe.

Hence, from this week's Economist:

The Chinese consider four to be a very unlucky number (because in Mandarin it sounds like the word death). The number 4444 is thus presumably as bad as it gets. So suppose the Shanghai A-share index closes during the next week at 4,444 (it stood at 4,375 on May 23rd), which is quite possible given its 258% gain since the beginning of 2006; might that frighten investors enough to cause the share-price bubble to burst?

It just seems terrifying to me that stock markets can aggregate people's superstition and give it agency in the nonbelieving world at large.

Incentives to work and spend (19 Aopril 2007)

As someone who has groused about the negative savings rate in America (it seems indicative of competitive consumption for its own sake that yields little in well-being, and signals a muted lack of faith in the future), I feel obliged to present a contrary view. Writing at Slate, Henry Blodget makes the case that a rational response to the American tax system is to spend as much as possible.

The problem is how we tax investment gains. Over the past 80 years, the average annual return on Treasury bills (a proxy for savings accounts) has been 3.7 percent per year. Inflation, meanwhile, has averaged 3.1 percent per year. This combination has produced a "real return" of a paltry 0.6 percent per year. If you got to keep that 0.6 percent, you might still have an incentive to save: A $616 real gain on $10,000 in 10 years wouldn't be much, but it would at least be $616 more than you have now. Unless you're so poor that you're exempt from taxes, however, or so flush that you can afford to lock up cash for decades in a tax-deferred annuity or retirement account, you won't be keeping that 0.6 percent. You'll be giving all of it—and probably more—to the government.

Blodget proposes making savings taxfree, which makes some sense if you think about middle class folk building up little nest eggs. But you have to consider who would really benefit from tax free savings -- those with massive estates or inherited wealth. If we stop taxing interest and dividends, more tax dollars would have to come from levies on income -- what John Edwards is talking about when he complains that we tax work instead of wealth. Such a tax scheme would create incentives to elude work as much as possible, or at least disguise work as some other form of income (say, stock options).

The other alternative is to tax consumption instead of income -- through a sales tax or VAT. But then you run into the problem that such taxes are typically regressive (the burden of them is proportionally heavier on those with less income). Perhaps that complaint becomes less ignificant when we consider that our current system is getting more regressive as we speak.

Nonetheless, if one believes that consumption has negative externalities, as Robert Frank argues here, and one accepts the economists' prescription of taxes to rectify externalities, then the policy course is plain. Writes Frank:

In Luxury Fever, I suggested that we scrap our current progressive tax on income in favor of a far more steeply progressive tax on consumption. Because total consumption for each family can be measured as the simple difference between the amount it earns each year (as currently reported to the IRS) and the amount it saves, such a tax would be relatively easy to administer. And if the tax were coupled with a large standard deduction (say $7,500 per person) and had low marginal tax rates on low levels of consumption, it would be even less burdensome for the poor than our current income tax.

More important, it would provide top earners with strong incentives to save more and limit the rate at which they increase the size of their mansions. Their doing so would reinforce the incentives on those just below the top to do likewise, and so on all the way down. Phased in gradually, this tax would slowly reduce the share of national income devoted to consumption and increase the corresponding share devoted to investment. Total spending would continue at levels sufficient to maintain full employment, and greater investment would lead to more rapid growth in productivity.

Of course, taxing consumption (which people associate with rewards, pleasure, etc.) is never going to be as politically feasible as taxing work (which people all too often associate with drudgery, humiliation, subservience, and boredom). And it seems doubtful that changes in our attitude would follow from changes in the incentives generated by tax policy. The same problem seems to beset any potential tax on carbon consumption -- our attitudes toward gasoline consumption won't change as fast as our attitudes toward the politicians who levied the tax -- they have everything to lose and nothing to gain. (but the respect of future generations grateful to still have an inhabitable coastline. But then, what's that worth now?)

Realistic optimism: oxymoron (5 April 2007)

Americans seem to regard optimism as a sign of strength of character, an quasi-spiritual eagerness to take what life throws at you, to make lemonade from lemons, to take the kind of risks that yield great discoveries, etc. There is also a tendency to conflate optimism with cheerfulness, even though optimism in a business context often has more to do with rapacious greed and hubris than fellow feeling. Optimism is usually what's necessary to fuel utopian schemes, speculative bubbles and risky, destabilizing gambles. Optimism often supplies the gullibility that allows people to overlook such codicils as "Past performance is no guarantee of future success" and "Actual results may differ" and "Caveat emptor". Since it is sanctioned as a laudable value, optimism is consumable as an experiential good, it's an end in itself that's facilitated by assuming risk.

It seems to me that optimism, at a personal level, tends to be a luxury that most people can't afford. From the BPS Research Digest, here's some substantiation for that view: Researchers have found that people tend to ignore the complications involved with taking on debt because they sunnily assume they will pay it back before any of those problems kick in.

Given their high interest rates, why do so many people continue to borrow money on credit cards? According to Sha Yang and colleagues, part of the answer has to do with people being unrealistically optimistic about paying off their balance each month.... “We show that unrealistic optimism may be one of the psychological explanations underlying why some consumers prefer credit cards with features that are not in their best interest, which has long been a puzzle for both researchers and credit card marketers”, the researchers said, adding that public policy may be needed to protect such people.

I don't know that we need the state to mandate pessimism (I'd lose my competitive advantage). This would be the same kind of paternalism that would intervene to prevent people from wasting money on lottery tickets and depriving them of the pleasurable fantasy that they might win -- this may make the cost of tickets money well spent, as far as they are concerned, regardless of whether they ever win or understand their real chances. But it seems a contradiction in terms to talk of realistic optimism; isn't optimism by definition unrealistic? To point out that those in debt are "optimistic" is almost tautological. Optimism can perhaps be defined as chronic shortsightedness, though the same could be said of extreme pessimism, I suppose. But pessimism seems less like shortsightedness and more a matter of taking in and processing too much of reality, as when pot-induced hypersensitivity becomes raging paranoia. And isn't the "reality principle" a matter of tempering expectations and acknowledging inevitable shortcomings and failures? Reality is defined in terms of the way it thwarts optimism; if we dispense with that yardstick, then we perhaps are in Baudrillard's hyperreal, where skepticism is impossible because there is nothing in which it can be grounded.

Pent-up pessimism (28 Feb 2007)

A break from Billy Squier video deconstruction for something more trivial: Yesterday, stock markets around the world fell precipitously: In America the Dow dropped 3.3%, the S&P 500 was down 3.5%. What prompted the sell off seems to have been the Chinese market falling by 9% on Monday (which may or may not have had something to do with Greenspan talking about recessions in Hong Kong) and the report that durable goods orders fell 7.8%.

But the truth is, as Felix Salmon reminds us here, that no one knows exactly why this happened.

any halfways-decent financial journalist gets it, and, if honest, would simply write a story saying "the market went down and we don't know why". But instead we're inundated with "explanations", from an assassination attempt on Dick Cheney (Daily Intelligencer: "Are investors balking because Cheney was attacked? Or because he wasn't hurt?") to a drop in one of the most boring economic series in the US. (Go on – quick – tell me what a durable goods order even is.)

CNN quoted Hugh Johnson, chief strategist at ThomasLloyd Global Asset Management, who shares this scary perspective: "Markets can decline in one seemingly isolated part of the world and that decline can be transmitted to other parts of the world through the psychology," he said. This is by no means an isolated or unusually insightful comment about investor psychology. The Capital Speculator blog echoes the sentiment:

we don't have a clue about what's coming. But we do have a firm grasp of history, which is conveniently available for all to see in full clarity.
The fact that China and subprime mortgage markets have slipped may be dismissed as marginal events of no real relevance to the capital markets. But we think such stumbles are early warning signs of things to come. Granted, this is a highly speculative notion and so readers should proceed accordingly. Nonetheless, we think our view has merit if only because bull markets have flourished across the spectrum of asset classes for some time and, well, nothing lasts forever.
As such, we're keeping a diary of market corrections large and small. If and when they accumulate, the broader investment community may become jittery. It's virtually impossible to predict market peaks and troughs, but at this late stage in the bull market cycle we're increasingly anxious and so we're keeping an eye out for additional warning signs. Having built up a tidy nest egg, we're in no rush to watch it evaporate. Been there, done that. Wealth preservation, in short, is at the top of our financial priorities at the moment.
It's never clear what might trigger a broader sell off, but we're mindful that it could be seemingly low-risk events when the supply of optimism reigns supreme around the world. History suggests no less. No, the financial gods don't wave flags or ring bells at market tops or bottoms, although sometimes they whisper in your ear and suggest things.

In other words, bull markets last until they don't anymore.

It's disturbing to think that shareholders are like Wile E. Coyote having just run off the cliff, and they can stay aloft only as long as they don't notice there's no longer any ground beneath them. Suddenly business seems much more like astrology, and the copious amounts of carefully scrutinized market data (which usually reassure me) become no better than the careful tracking of the stars' movements and configurations. The data can be verified, but the interpretations seem more and more speculative.

Also, if confidence alone is what props up markets, the business press becomes implicated in either sustaining or undermining it; virtually everything one reads in it must be considered in that light and the optimism expressed must always be discounted: that means this sort of story about stocks bouncing back today must be held in some suspicion (unless, that is, you don't really care why markets move as long as they move upward) -- the headlines are almost always out of step with the information buried in the article. The widely disseminated bias against pessimism has roots in this; it's a crime against the economy (just as it lets the terrorists win if we don't go shopping).

For a real dose of unfettered skepticism, you need to dig a little deeper into to the econoblogosphere: Here's arch-pessimist Nouriel Roubini, by way of macroblog with some unpleasant medicine:

The US is likely to enter into a recession in 2007; and even a likely and early easing of monetary policy by the Fed will not prevent such a recession as there are too many weaknesses in the US economy: a housing recession, an auto recession, a manufacturing recession, a real investment recession (as corporations are reducing real capital investment and inventories are falling), a US consumer that is on the ropes and at its tipping point; a meltdown in sub-prime mortgages that is leading to a generalized credit crunch in the economy. It is already ugly and it will get uglier in the real economy and in the financial markets. We are likely to observe a vicious cycle where a credit crunch and a persistent sell-off in equities leads to a worsening of the real economy with a hard landing (recession) that then weakens further the financial system. One cannot rule out a broader banking crisis if a deep recession occurs.

Dean Baker, after ridiculing the business press's tendency to get only the opinions of the same prognosticators who failed to see the drop coming ("After all, once we accept that the earth revolves around the sun, we don't want to get all our information on astronomy from believers in an earth centered universe"), also looks at the fundamentals and doesn't like what he sees:

The fundamentals I see are the unraveling of a housing bubble, leading to further declines in the housing sector, and a big hit on consumption, as the fuel of bubble created housing equity disappears. The hope that declining construction and weak consumption would be offset by soaring investment disappeared with yesterday's data showing a sharp drop in durable goods orders. It looks like investment is going the wrong way. Throw in the fact that rising interest rates in Japan may slow the inflow of foreign capital that has kept long-term interest rates so low and productivity growth appears to have slowed sharply (benchmark revisions next week will push reported productivity growth over the last two years downward) and it's pretty hard to find much positive in this picture.

This WSJ editorial, hoping to forestall rate cuts by the Fed, blames the mortgage-related securities industry and the repackaged subprime loans that have been unwinding lately. You would think they would welcome rate cuts as stimulus, but that would run the risk of boosting inflation (which is bad for those who don't live off wages) and also could spur currency movements and jeopardize the mysterious carry trade -- borrowing money at low rates in Japan to invest elsewhere, where rates are higher. According to the NYTimes article:

The possibility of rate cuts by the Federal Reserve also kindled concerns that American interest rates might eventually fall far enough to significantly close the gap with Japan’s rock-bottom rates. That gap is wide now. Japanese overnight lending rates are 0.5 percent compared to 5.25 percent in the United States. But if the gap shrinks, it could slow or halt the so-called yen carry trade, in which investors borrow hundreds of billions of dollars worth of Japanese money to invest in stock markets across Asia and around the world in search of higher returns. If this flow of money stops, or reverses, it could prompt larger sell-offs on Wall Street and drive the yen even higher, hurting Japanese exporters even more, analysts said. “Bernanke holds the trigger,” said Kiichi Fujita, a strategist in Tokyo for Nomura Securities. “If he cuts interest rates in America, the worry is that the yen carry trade will unwind.”

I'm sure it's my financial naivete, but the carry trade (like many forms of currency arbitrage) always seems immoral to me, like cheating -- it seems weird to make money not for producing anything but for shifting nominal figures around -- but I suppose they are taking on a fair amount of risk. When the value is nominal, it can go against you in a hurry.