Saturday, October 31, 2009

Economics Bashing Wrong, Lucas

Does the financial crisis represent a failure of economics, both of macroeconomics and of financial economics? This criticism is widespread and fashionable nowadays, but wrong. Nobel laureate and Chicago economist Robert Lucas explains very convincingly why in an article published by The Economist here . The efficient market hypothesis is not disproved, on the one hand, and mainstream macroeconomic modelling has been mostly useful and not off the mark, on the other hand, contrary to what critics and journalists have claimed. A must read.

Friday, October 30, 2009

The Dollar Carry Trade and the Next Bubble

Nouriel Roubini, the New York University professor that correctly predicted the recent banking crisis, notes that investors worldwide are borrowing dollars to buy assets including equities and commodities, and he fears that they are again at it, fueling “huge” bubbles that may spark another financial crisis, reports Bloomerg’s Michael Patterson here.

Thursday, October 29, 2009

Goodhart vs. Kay

“Narrow banking is not the answer to systemic fragility” writes Charles Goodhart who develops some good arguments against the narrow banking proposal in his October 28 Financial Times column here .

He is wrong however on one point at least: being in favor of smaller, more specialized banks, as an objective for the future, after a reform of the system, is not the same thing as claiming that financial authorities should not have helped large diversified banks avoid bankruptcy in the recent past. The impact on the economy would have been devastating given their sheer size, and it is precisely for that reason that banks should be compelled to downsize and re-specialize in the future. The failure of one or a few smaller investment banks would then not jeopardize the whole economy, which is the main point of the "too big to fail" reform proposal.

He then argues that in a narrow banking system, depositors would shift their funds towards risky financial institutions during relatively safe periods, only to return to safer institutions when risks increase, and thus would exacerbate the cyclical instability of the economy. But that would not be the case if investment banks were not allowed to manage current payments for depositors, just as corporations in general are not allowed to manage the payments needs of their shareholders.

Soros vs Markets

George Soros launches a $50 million onslaught on free market economics. Read the Newsweek story here .

Wednesday, October 28, 2009

Imperfect Financial Information

Most people, and commentators, do not understand what the efficient market hypothesis means. As I claimed in past posts on this blog, the big crash (especially in stock markets around the world) and the financial crisis (essentially a banking crisis) do not refute the hypothesis. As Jeremy J. Siegel (author of Stocks for the Long Run, McGraw Hill, now in its fourth edition) writes in the Wall Street Journal here , “neither the ratings agencies’ mistakes nor the overleveraging by financial firms was the fault of an academic hypothesis".

Market prices can reflect all the available information, and nevertheless change drastically from one period to another. We should not forget that information about the environment is constantly changing too.

So, after all, the market for information is imperfect indeed since most people who write in the field do not get the basics right.

Hat tip to Greg Mankiw.

Tuesday, October 27, 2009

British Schadenfreude

Follow my advice, not my policy. The Financial Times rejoices about the strength of the euro here, relative to the dollar and to the pound which have been plunging lately.

According to the City’s newspaper: “A strong common currency is better than none at all. Before, dollar strength would set off currency chaos by creating incentives for beggar-thy-neighbour attempts at weakening national currencies. Not only was this self-defeating: it also softened exporter’s market discipline, since relying on policy action became easier than raising productivity.”

Now indeed the pleasures of currency depreciation are reserved for the happy few: the US and the UK. And of course, currency depreciations are all the more effective when the partners in exchange do not retaliate. That’s exactly what has strengthened the German economy competitive position within Europe since the 1990s. Could it be that the Financial Times advice is slightly biased towards British self interest?

Sunday, October 25, 2009

Health Insurance Transatlantic Differences

Tyler Cowen (Marginal Revolution) has some good arguments against universal mandatory health insurance here .

I do favor such a system for European countries where universal health insurance already exists, but is tax financed. The US case is different since health insurance is optional there. The debate thus is mostly about the desirability (or not) of universal coverage.

Wednesday, October 21, 2009

Volcker, Stiglitz, King, and Classical Banking

According to The New York Times here , the former Fed chief said the giant banks must be broken apart and separated from risky trading on Wall Street, a view shared by Joe Stiglitz, but not by Alan Greenspan, nor apparently by the White House, including Larry Summers.

At the same time the British get serious about it, and especially Mervyn King, governor of the Bank of England, who called on Tuesday night for banks to be split into separate utility companies and risky ventures, saying it was “a delusion” to think tougher regulation would prevent future financial crises (The Financial Times, October 20).

In this most important debate we side with Volcker, Stiglitz and King, because, among other reasons such as a limited belief in the independence and efficiency of regulations (as the late George Stigler clearly explained), the overall abundance of information in the early 21st century calls for smaller, less diversified corporations, not bigger unfocused and difficult to control ones. “Too big to fail” is the major risk in finance for the near future, and banks are all too willing to go that way again. A modern version of the Glass-Steagall Act is a must in international bank reform.

Tuesday, October 20, 2009

Common Sense from a European Economist (at last)

It comes from Willem Buiter, a professor at the London School of Economics, who writes in the Financial Times here that “the euro has become a currency on steroids. (…) The strength of the currency is hurting the exporting and import-competing sectors of the Euro Area. Unemployment and excess capacity continue to rise.”

And he then adds: “any disinterested observer would be hard-pushed to avoid the conclusion that the Eurozone is paying the price for the ECB’s excessively tight monetary policy.” Moreover “The ECB is violating its price stability mandate by tolerating, aiding and abetting deflation in the Euro Area.”

The conclusion: “If the ECB persists in acting in a willfully asymmetric manner, its cherished independence will be taken from it. The letter of the Treaty will provide no protection against popular anger and political opportunism.”

Fair enough. But two observations are in order: first, this analysis points in the right direction but covers only half of the problem. As explained in my previous post, most of the foreign trade of the Eurozone countries is intra-zone. It follows that adjusting – at last – the euro exchange rate vis-à-vis the other major currencies (dollar, yen or yuan) will not solve the basic intra-zone imbalance of implicit (or shadow) exchange rates, for instance between Germany and Italy. This is a source of permanent real disequilibrium, mostly in Italy since Germans have a very low tolerance for inflation and much higher acceptance of deflation and wage moderation, or even of wage cuts. It is a good recipe for Germany but not so for France, Spain or Italy.

And second, where were you professor Buiter when the battle for and against the creation of the euro was raging, and when the euroskeptics were precisely warning in advance against the dangers that have become so real, alas, today? It would have been much better for Europeans if this dramatic mistake had been avoided from the start.

So let’s repeat the basic warning: a euro depreciation (did someone say “competitive devaluation”?)is necessary. But it will NOT solve the long term problem of inadequate and disequilibrium intra zone implicit exchange rates.

Monday, October 19, 2009

Euro vs Growth (again …)

There is, according to today’s Wall Street Journal , a growing political concern that the strength of the European single currency may jeopardize the region’s economic recovery.

A cheaper Euro, however, would not really suffice to strengthen growth here since there is also considerable intra-eurozone misalignment of “implicit” – or “shadow” --national exchange rates, while the intra-zone trade represents the largest part of member countries foreign trade.

Eventually, a few governments will have to face the harsh reality: the creation of the Euro was a mistake, their mistake, which only benefitted local bankers and cartelized industries ... and, yes, Germany.

Saturday, October 17, 2009

Alan Greenspan Joins the Classical Banking Club

Bloomberg reports (October 15) that the former Chairman of the Federal Reserve told the Council on Foreign Relations in New York, about the banks:
“If they’re too big to fail, they’re too big, (…). In 1911 we broke up standard Oil – so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”

Let us add that in 1911 very large firms usually had a big competitive advantage over smaller ones, while the reverse is true today. All other sectors’ largest firms have been downsizing, on average, and the conglomerates of the 60s disappeared a long time ago. Indeed, the banking sector has been able to avoid such an adaptation because of state support.

Read the article here .

Thursday, October 15, 2009

Why Financial Regulatory Reform is Not the Answer

A very good paper by Vincent R. Reinhart in The American here .

L’euro cher favorise-t-il la croissance ?

Dans la série « dix ans pour que la moindre vérité économique arrive à se frayer un chemin dans les média et dans le monde politique » voici un article du Monde qui mérite d’être lu. Il ne fait certes qu’exposer quelques truismes économiques. Mais dans notre pays le simple énoncé de truismes constitue une véritable révolution intellectuelle tant la langue de bois est dominante et la technocratie incontestée. Par conséquent, si même le Monde y vient, c’est qu’il n’y a plus aucun moyen de nier l’évidence. Se souvient-on encore (ne serait-ce que pour sourire) du thème de la propagande officielle, favori de MM. Trichet et Thibaut de Silguy, lors de la mise en place de l’euro : « l’euro fort favorisera la croissance » ?

Aujourd’hui le constat macroéconomique élémentaire du contraire est parvenu enfin jusqu’aux colonnes du Monde : le dollar faible, c’est-à-dire l’euro fort, coûte cher en croissance perdue aux pays membres de la zone. Autre expression de la même absurdité, un peu moins triomphante, qu’il devient plus difficile d’asséner, l’expérience ayant été abondamment faite et la preuve, hélas, infligée à notre économie: « la valeur du taux de change n’affecte pas la croissance économique », ou encore, « les dévaluations ne renforcent pas la compétitivité des entreprises exportatrices ni de l’économie en général ». Sauf que les Etats-Unis, où les économistes sont plus courageux et les technocrates moins dominants, savent bien, eux, utiliser la faiblesse de leur monnaie quand nécessaire et avec effet.

Faut-il répéter encore que dans une économie ouverte le taux de change est LE prix le plus important ? Faut-il encore répéter qu’en ce qui concerne l’Euro toutes les affirmations officielles et toutes les promesses étaient purement et simplement mensongères ? (voir mon article « Les promesses de l’euro : Tout était faux », Il Sole-24 Ore, décembre 2001 et Renaissance des Hommes et des idées, juin 2002, disponibles et téléchargeables sur mon site

Faut-il encore répéter que seule la sortie de l’euro (alliée à la réduction de l’impôt sur le travail) donnera une bouffée d’oxygène à la croissance, en France et dans les autres pays de la zone euro qui ne font pas « naturellement » partie (de par leurs caractéristiques structurelles) de la petite zone mark (Allemagne, Autriche, Belgique, Luxembourg, Pays-Bas)?

Oui sans doute. Puis-je alors conseiller la relecture de mon livre de 1998 : L’erreur européenne ? Oui certainement car il montre, avec le recul de l’expérience, à tous ceux qui se veulent « pragmatiques » et récusent par ignorance les vertus d’une analyse économique fondamentale, ce que peuvent coûter, très concrètement, dix années d’expérimentation hasardeuse aux conséquences très prévisibles – et prévues – coût supporté par l’économie en général et – très pragmatiquement - par les Français en particulier.

Alors répétons : il n’y a que deux réformes - et deux réformes seulement (oublions les taxis et autres distractions pascaliennes) - qui soient susceptibles de sortir l’économie de l’enlisement qu’elle subit depuis les années 80: la sortie de l’euro (et donc la possibilité d’adopter une politique monétaire et de change enfin conforme aux nécessités de l’environnement français) d’une part, et l’allègement radical des cotisations sociales (avec maintien intégral des transferts en faveur des plus faibles salaires pour la couverture d’assurance maladie) telle que décrite dans mon récent article « Comment gagner plus » publié dans la revue Commentaire (numéro du Printemps 2009) et disponible sur mon site, de l’autre.

Sortie de l’euro, car un simple assouplissement de la gestion monétaire de la BCE et un endiguement de sa hausse par rapport au dollar, ne changera rien à la fixité des parités de change entre pays européens, gelée « définitivement » par l’euro, alors que ces parités implicites se situent à des niveaux de déséquilibre, et tandis que l’essentiel de nos échanges extérieurs se fait à l’intérieur même de l’Europe. Il faut donc sortir de l’euro, quitte à le laisser subsister aux bons soins de l’Allemagne (voir également mon article "D'abord sortir de l'euro ... condition de la reprise, de l'emploi, et des réformes de structures", décembre 2005).

Après avoir payé très cher l’absurdité ubuesque, mais étroitement intéressée, de nos technocrates pendant vingt ans et plus, peut-être y a-t-il, aujourd’hui au moins, quelque espoir d’une prise de conscience de la réalité des choses ?

Merci à un lecteur fidèle, Thierry, pour m’avoir signalé cet article.

Tuesday, October 13, 2009

The Right to Health and Limited Generosity

William Easterly posts a realistic evaluation of the consequences of the "rigth to health" advocacy, both on his blog Aid Watch, and in the Financial Times (October 12). He claims that a constant volume of funds is reoriented towards politically supported health care programs, such as those concerning the treatment for AIDS, and helps mostly that part of the population that is politically influential, and away from the other big killers of the poor -- such as pneumonia, measles and diarrhoeal diseases, which together accounted for 5 million deaths in 2008.

Altruistic intentions, given a limited amount of generosity, thus result in more inequality, not less.

In Praise of Practical Economics ( … at last)

Here is another view of the Nobel laureates, by David Henderson .

Monday, October 12, 2009

The Nobel Goes to the Economics of Organizations

Both laureates, Elinor Ostrom and Oliver Williamson, have contributed to the field of organizational economics, or economics of institutions. The latter term is broader but less apt as “institutions” mean different things to different people. “Organizations” here mean non-market arrangements, mostly hierarchical structures, either in the field of politics or in the economics of production, structures in which decisions are more or less concentrated, in contrast to markets where they are decentralized.

A good description of the laureates’ contributions is presented by Michael Spence here .

Hat tip to Greg Mankiw for the reference.

Thursday, October 8, 2009

Feldstein Joins the Health Voucher Club

Martin Feldstein has just reinvented the health care reform that I have been promoting for many years, in French unfortunately. Read his paper in today’s Washington Post here , and my recent paper published in revue Commentaire, “Comment gagner plus”, on my homepage (, or a translation of it (easy to obtain now with an automatic translator).

Edmund Phelps is also in favor of reducing the payroll tax in order to increase workers compensation, but since he does not explain how to reduce public spending without penalizing lower income families, it is not really a viable option. For a solution to this problem a health voucher is necessary, and coupled with a mandatory purchase, it is economically much more efficient than a publicly supplied, payroll-tax-financed, universal health insurance.

The time for reform apparently is coming.

Posner (and Becker) on Health Insurance Systems

Richard Posner provides a quite interesting description of the Swiss Health Care System on the Becker-Posner blog (October 4), a system in which “almost all health insurance is bought by the insured. Everyone is required to buy a health insurance policy that provides a specified minimum of benefits (they can buy more expensive policies of they want), but there are subsidies for people for whom the expense would be a hardship; about 30 percent of the population receives a subsidy. (…)
There are many insurance companies, and people can switch freely among them. Copayments or deductibles are larger, and as a result the average out-of-pocket cost of health care is higher in Switzerland then in the United States. But the aggregate cost of health care is much lower in Switzerland – 11 percent of GDP versus our 16 percent – though higher than in any other country besides the United States.” (Posner). But note that the insurance premium is also “out-of-pocket” there.

What both authors fail to mention, however, is that such a system, not relying on the payroll tax for financing, is characterized by a much reduced welfare cost of taxes, and thus does not discourage work in the way a payroll-tax-financed system does. As Larry Summers showed, a mandatory consumption does not generate a welfare cost the same way a tax does.

The Swiss system is the best example of what I suggest a French reformed (and US to be created) systems should look like (my paper "Comment gagner plus").

As noted by Posner “there is general satisfaction among the Swiss with their system, although there is some grumbling over the high cost of medical care”. But, I would add, this is because the Swiss pay their health-care insurance out of their own pocket and can switch for another insurer anytime. They thus pay -- quite logically -- more attention to its cost, while households that don’t even know that they are paying for insurance through the payroll tax don’t bother about the cost of insurance. This is an additional benefit of the Swiss system.

Tuesday, October 6, 2009

France Is 100% Bentham

David Brooks has posted an interesting op-ed in the New York Times (October 5) here , contrasting the Bentham's approach to Hume’s one on economic policy reform and innovation.

Certainly France is a Benthamite country, and the whole of the French bureaucratico-political class, as well as “intellectuals”, agree on one point: leave the experimental evolutionary approach to ignorant foreigners (especially “anglo-saxons” ones).

Hat tip to Greg Mankiw.

Sunday, October 4, 2009

What the Bears Think

Stocks are not cheap by historical standards as shown above. Bears are mostly unreconstructed. The Economist summarizes their argument here .

Friday, October 2, 2009

John Kay and Martin Wolf join the Classical Banking Club

After providing some easy excuses for bank managers (see my July 8, “Narrow Banking and John Kay” post) John Kay has joined the Classical Banking Club that I created on this blog (“Classical or Narrow Banking?”, April 24) by publishing a pamphlet for the London-based Centre for the Study of Financial Innovation, titled "Narrow Banking: The reform of banking regulation".

Martin Wolf now does the same in the Financial Times (“Why narrow banking is not the finance solution”, September 29), although he criticizes Kay for not considering the risk that would remain in the “quasi-banks” that would still be allowed to invest in long-term and risky assets on “wafer thin equity” and short term borrowing.

He prefers the more complete proposal of Laurence Kotlikoff (Boston University) that was favorably commented upon on this blog (“The Classical Banking Club: Further suggestions”, May 14). For Kotlikoff and co-authors, all financial firms should be organized according to the principle of “limited purpose banking”, in which no leverage would be authorized and assets should be both specialized and matched by a same amount of equity -- and not by short term deposits. That equity would be borne by investors in these funds, who would thus be supposed to know the risks they would accept, as all shareholders are supposed to do. The possible failure of such funds would not endanger depositors in the much less risky “classical banks”, and would thus not choke the payment and credit system, nor coerce in that way the financial authorities into salvaging them.

The conclusion of Kotlikoff and co-author Goodman (The New Republic, May 14) is still valid however: “Bankers will likely fight this reform tooth and nail” and, I would add, would divert attention by suggesting new regulation instead.

Martin Wolf concludes on a somewhat more optimistic note: “The authorities will not entertain such radical ideas right now. But the financial system is so inherently fragile that radical reform cannot be pronounced dead. It is only dormant”.