Tag: financial crisis

Greece: a Shakespearean Tragedy


In the Greek bailout episode the Greek government has been behaving much like the self-pitying Antonio from “The Merchant of Venice,” while the EU has been posing as a rather heavy-handed Shylock. Despite being aware of the damaging consequences of a Greek default and potential exit from the Eurozone, the EU seems intent of having its pound of flesh. By subjecting Greece to additional austerity provisions, it may be risking the revival of the Euro financial crisis—this time with serious geostrategic implications.

For five years the Greek people have been dealing with a series of austerity measures that have crippled their economic prospects. The Greek economy has contracted a jaw-dropping 25% during this period, forcing Greece into a deep recession that now borders on depression, with a 26% unemployment rate and a debt level of 180% of GDP. The resulting loss of jobs and livelihoods has been staggering; tens of thousands of Greeks are barely getting by.

But on the eve of its default this week the Greek government capitulated and at the 11th hour informed the EU it would accept additional austerity after all, only to be told by the EU that its offer had expired. Adding insult to injury, a senior EU official stated “The previous program has expired. So now we need to start new negotiations as regards a new program.” Tragically, Greece may no longer be in the Eurozone by then. Continue reading


The Problems With China

Yesterday’s IMF report on China “praised China’s leaders” for responding quickly to its recent economic slowdown and concluded that “China’s economy seems to be undergoing a soft landing, though global headwinds are increasing.” It also repeated increasingly frequent warnings about the fragility of the banking sector and suggested that there are “significant downsize risks” ahead in China. 

China may have a soft landing amid the current slowdown, but it is worth reminding ourselves that it is a country with enormous contradictions — many of which look to be far more complicated than the challenges faced by the United States. (I’ll leave it to better-trained comparativists to produce more rigorous empirical evaluation of this proposition). Market reforms fueled much of China’s growth in the past two decades, but its state capitalism model still favors state owned enterprises and market reforms in the banking system have lagged. Almost all of the 4 trillion RMB stimulus in 2009 (the equivalent of roughly $650bn or somewhere between 4 and 6 times the amount of the US stimulus) and the most recent stimulus was spent on capital spending in infrastructure. And, while this stimulus approach enabled China to weather the recent slowdown this spring and the 2009 storm and maintain an 8% growth rate (the bullet trains are really cool), those policies have also exacerbated a number of challenges.

First, the stimulus was not done through traditional mechanisms of fiscal policy, but through a dramatic credit expansion — much of which happened off of bank balance sheets making it almost impossible to assess the extent of debt (and exposure to potential asset bubbles). As Kai-yuan Tsui from Chinese University in Hong Kong warned in a paper last fall, the credit-based stimulus created powerful incentives for both banks and local government officials to assume extensive levels of debt and to push forward on risky infrastruture projects. I think its fair to say that we have no idea what kind of debt levels have been incurred here or how vulnerable the Chinese financial system is at this point, but I’ve heard both Bank and IMF officials express serious concerns about how totally in the dark they feel about the current situation.

Second, as the IMF report warned, China is increasingly finding itself in an infrastructure trap and has far greater infrastructural capacity than demand — a situation that is simply unsustainable and “uneconomic.” (Sure it has lots of high speed rail capacity, but only a fraction of rail riders can afford the tickets; it has airports that no one can use — and it has a beautiful Olympic stadium, but it’s simply too big for most athletic events even in China). But, even more problematic is that the political leadership has not yet demonstrated an ability to shift to alternative stimulus options such as subsidies for consumption or new fiscal policies on social safety nets and such.

Furthermore, a friend who teaches at Fudan University told me that in the rush to keep growth and employment high, local building codes, environmental regulations, labor laws, and a host of other emerging regulatory policies were summarily discarded. This has resulted not only in shoddy construction, but also further empowered some of the most corrupt local officials around the country and has increasingly frustrated local populations who resent the corruption and dramatic rise in income inequality. All of this poses a major challenge to the leadership’s social harmony policies.

It seems to me that IR scholarship needs to consider the implications of this messier economic, political, and social situation within “China’s rise” and the implications this will have for global politics. To be sure, China is a country that will continue to command a major global economic presence and consume a ton of global resources. It will continue to expand its international economic and diplomatic presence. But its economic growth will slow (and may even face a sharp decline if a banking/local debt crisis spikes) all the while its demographic (aging), environmental, and political challenges increase. Ruchir Sharma’s conclusion is that China will face a “natural slowdown” and that the global balance of power will shift from one of “finance to politics.”

I tend to agree. This hegemonic transition looks to be one in which both the hegemon and the most-likely hegemonic rival stumble at some point before the finish line.


State of the Field, Redux: What’s Wrong with IPE?

There are a few things that make me really hot under the collar. The first is the unending 100+ degree summer heat in central Texas. The second is the unending debate on the “state of the field”, in particular the state of the International Political Economy (IPE) discipline. It is a topic near and dear to my heart (IPE, not Texas heat). A few years ago, I was so provoked by Benjamin Cohen’s trenchant intellectual history of IPE and the reactions that followed that I put together a special issue on the so-called “American School of IPE” in Review of International Political Economy. This was soon followed by a special issue on the British School of IPE, edited by Nicola Phillips in New Political Economy. Finally, in hopes of achieving some closure on all the kvetching and navel-gazing, Nicola and I combined the two special issues and solicited a new round of essays, which came out last year as a book on the Past, Present and Future of IPE. At that point, I decided to stop worrying about the state of the field and return to more rewarding, substantive research.

But Dan’s blog from a week ago on the state of IPE today brought all the angst back. Dan raised a simple, yet powerful question: why have our top journals (specifically International Organization) had so few articles on the global financial crisis? For that matter, why do the top journals have so few IPE articles on anything of real importance to the world economy today?

Rather than stew in my juices and provide a snarky reply, I turned to some of my uber-talented IPE friends with these questions. Here are two great responses I received from Mark Blyth and Thomas Oatley, which I reproduce here, with my thanks.

From Thomas Oatley, Associate Professor at UNC Chapel Hill, author most recently of a great IPE piece in IO, “The Reductionist Gamble: Open Economy Politics in the Global Economy“:

Perhaps no research directly relevant to the American financial crisis has appeared in IO because mainstream American IPE values general knowledge over case-specific knowledge. It believes further that general knowledge is produced through the statistical analysis of large samples. David Singer, in a recent APSA Political Economy section newsletter, nicely summarizes the kind of research this orientation implies. “From a research design perspective, a reasonable way forward is to test hypotheses about the conditional impact of capital inflows on the probability of financial crises in the developed world. The scope and quality of regulation are likely contenders for inclusion in such a model. The cases of Australia and Spain suggest that large capital inflows might be less destabilizing if the banking system faces strict capital requirements and prohibitions against non-traditional banking activities. Other possible conditioning variables include, inter alia, resource endowments, partisanship, and corporate governance.”

So why hasn’t IO published research along the lines Singer proposes? I suspect that such research has yet to appear because standard statistical techniques are not well suited to the complex causality that characterizes banking crises. This causal complexity has two dimensions. The first is equifinality: multiple causal paths produce banking crises. Post liberalization “capital inflow bonanzas” that drove the Scandinavian crises is a different mechanism than the “post-Louvre over-valued yen with abundant domestic savings” mechanism that generated Japan’s banking crisis in the late 1980s, which is a different mechanism than the over-exposure to Greek sovereign debt that underlies current weakness of German banks. All three mechanisms might be different than the “zero private savings, large government deficit and global savings glut of historic proportions” mechanism that caused the US crisis.

Second, causality may be conjunctural. That is, rather than having a consistent effect across cases, the impact of a variable might depend on how it combines with other factors. An over-valued currency on its own may not increase the probability of a banking crisis, but an over-valued currency in combination with surplus domestic savings and a particular regulatory structure may have caused Japan’s banking crisis. Multiple conjunctural causality is challenging for standard statistical techniques, although techniques for managing these challenges do exist (see Bear Braumoeller. 2003. “Political Complexity and the Study of Politics,” Political Analysis 11: 209-233).

Why haven’t quantitatively oriented IPE scholars applied techniques such as Braumoeller’s to the study of banking crises? I think the problem may rest in the rarity of major banking crises. According to Reinhart and Reinhart, only 5 major systemic banking crises occurred in developed countries between 1973 and 2007. If three or four distinct causal mechanisms are at work in these five crises, it will be difficult to find statistically significant configurations among sub-sets of crises.

In short, I would argue that no articles directly relevant to the financial crisis have appeared in IO because the field attaches little value to studying the US crisis in isolation, and the banking crises with which it might share common properties are so infrequent that statistical techniques are unlikely to identify general relationships. As a result, an event of supreme global importance gains very little attention from American IPE scholars.

From Mark Blyth, Professor at Brown University, hard at work on a book about the financial crisis that is bound to be a classic in the field:

There are more than a few IPE scholars who have written about the financial crisis and its aftermath. Its just that they have done so in venues that are not as cumbersome as traditional peer reviewed journals. There are two problems with looking to such journals as venues.

The first is the ‘hit the moving target’ problem. I wrote a piece in 2008 called ‘this time it really is different’ on the 2008 crisis and the EU, and by the time I got editor comments, it had morphed into the Euro crisis. Add publication time-tabling into this and almost anything you can say about this is redundant. By the time you revise it to catch up its redundant again. Economists (as usual) have an advantage over us with sites like the NBER and VOXEU designed to get it out quickly, so they get the press.

The second is the ‘discipline of discipline’ problem. Frankly, younger IPE scholars are taught to work with quant data and not say anything beyond it. That’s the skill set. They are taught to do ‘tractable’ questions. What’s tractable about the GFC? That’s a problem when past data is absolutely no use in discerning future trends beyond broad Reinhardt and Rogoff ‘lets dump medieval Spain and modern France in the same data set and talk about defaults’ approach.

Others can talk about intellectual hegemony and the like, but as someone who has sat on a board for many years, I can say its the submissions or lack thereof the is the real killer. Why aren’t IPE journals publishing crisis work? Possibly because no one is submitting it? Or because its much more bang for the buck and much faster to publish in Foreign Affairs or on line?

One last thought. All journal submissions need to be tied into disciplinary debates in order to pass the sniff test at a journal. So what is the debate that the crisis ties into that IPE has a track record on? US decline (got that wrong several times)? Institutional change (most popular models are all about incremental change while the world gets smacked by a Black Swan every week)? Diffusion? (of what, panic)? Human Rights and Trade? (relevance?)

The fundamental problem is that IPE imagines a world quite unlike the one we actually inhabit much of the time. As a consequence when we are asked to comment on the world we actually inhabit, we have little to say.

Finally, I should note that there are in fact some great works out there by IPE scholars that directly hit on the current global financial crisis. I won’t try to be comprehensive, in fear of overlooking several obvious examples, but I’ve read (or re-read) three in the past month that are simply terrific: Herman Schwartz’s Subprime Nation; Randy Germain’s Global Politics and Financial Governance, and Eric Helleiner, Stefano Pagliari and Hubert Zimmermann’s (eds) Global Finance in Crisis.

If anyone out there can point to other great sources – in journals and books – please send in your suggested readings list.


Partisanship vs. Policy: the Housing Bubble Debate

Morgensen’s and Rosner’s new book appears to have breathed new life into claims that responsibility for the housing bubble can be laid at the feet of Democrats, ACORN, and Fannie and Freddie. Given that buyers of the book at Amazon are also snatching up works by Ann Coulter, Glenn Beck, and Andrew Breitbart, I’m pretty sure that it is on its way to becoming the housing-bubble bible for all those who also are learning how Constantine’s conversion to Christianity and the Battle of Poitiers were key “tipping points” in the history of human freedom.

It strikes me as unlikely that a closer chronicle of the shady political dealings surrounding housing policy in the 1990s tells us very much new about the causes of the bubble. But I find it interesting that conservatives are so gleeful about their account because it implicates a lot of Democrats. As a partisan matter, that’s obviously of interest. But as a policy matter? It seems odd that conservatives would be so eager to swallow a story ultimately more consonant with progressive goals than their own.

The underlying problems here center around deregulation (including the loosening of lending standards), a federal reserve that refused to exercise oversight or take steps to deal with a growing bubble, and the influence of moneyed interests on policy. The drive to extend homeownership to poor minorities who had, because of discriminatory practices, been excluded from access to housing equity, certainly played a role here, e.g., it led to some well-intentioned policies that soon became co-opted by housing lenders.

But without those other mechanisms we can’t really get from the “progressive” policy (more homeownership for poor minorities) to the current economic crisis, and those mechanisms are overwhelmingly ones that progressives, rather than conservatives, want to address. Indeed, can overwhelming proportion of the failures attributed to the Clinton administration stem from its tack rightward on financial and regulatory policy. The bad behavior of Democrats largely centers around their pursuit of corporate cash.

However desperately folks like Mead may try to link this to a general criticism of third way politics, the core “problems” have little to do with the progressive elements of that fusion.* Conservative policies aren’t designed to rectify these failures, but to entrench them in American politics and policy.

*The giveaway? One of Mead’s examples of a “third way scheme” discredited by Morgensen’s and Rosner’s account of the housing bubble is the “cap-and-trade” approach to reducing carbon emissions. But the cap-and-trade approach was embraced by progressives in an attempt to find common ground with conservatives, who generally supported the approach until Obama proposed it.**

**While I’m on the subject of Mead, I remember how every “economic collapse” scenario from when I debated in high school (c. 1991) culminated with a quotation from him about how a major economic slump would lead to outbreaks of interstate conflict around the globe. As it obviously did. Just look at all those interstate wars in, er, well, uh….


Riverdance your way through through the Irish Bailout in two minutes: Taiwan animation style!

From NMA – those who brought you the Tiger Woods Video, and the USA-China Currency Crisis Rap Battle video comes the Ireland Bailout video (which I can’t make fit in the frame! Edit: Fixed!)

As an IR blogger with an interest in econ, you might be interested in this animated take on Ireland’s current state of financial distress. I can’t vouch that a leprechaun really charged into Biffo’s office as he was taking in a Guiness, but we tried our hardest to condense the situation in less than two minutes.

Please watch it if only for the signs the protesters are holding at the end.

Despite the email, I don’t pride myself on a knowledge of economic issues. (My bank account can attest to this. Pension-shmention, I want shoes!) However, as this is the internet, I will add my uninformed £0.02.

While I can’t resist the Riverdancing corporate investors, I think the video may end up too pessimistically. Ireland is in a lot of trouble to be sure, but one has the sense now that at least all of the dirt is on the table. This is unlike Greece, for example, where nobody seems to actually know what’s going on or where the problems actually end. (Michael Lewis’ take on this in Vanity Fair is amazing.) One can believe (or hope) that there won’t be many more nasty surprises.

So while I’m not trying to downplay the setback that this bailout represents, I remain slightly optimistic in that I believe that there is now at least a foundation from where Ireland can make a comeback (albeit at a tough price.) It has a well educated and entrepreneurial population. It seems willing to do whatever it takes. And it has certainly seen worse than this.

As for me, I’m just going to keep compiling these videos until I have enough to use them to replace my first year lectures.


Social Construction and Deceit

I’m fascinated by the narratives of the financial crisis that basically cast it as a mass deception. Clearly we need to develop a scale of deceptive practices and think about how this all relates to the social construction(s) of reality(ies). At the simple end there are the flat-out lies, for example those told by the peddlers of certain types of mortgages, but things quickly get more complicated. There are the accounting tricks used by big banks to understate their risk exposure (for example, a Wall Street Journal headline on April 9, “Big Banks Mask Risk Levels”, tells much of that story). There are the practices being revealed by the investigation of Lehman’s Repo 105 and related practices, as illustrated in the New York Times April 12 story, “Lehman Channeled Risks Through ‘Alter Ego’ Firm”. And of course there is the unfolding SEC case against Goldman Sachs allegedly “misleading” investors about the quality of securities linked to subprime mortgages, as detailed in yesterday’s Wall Street Joural. But these are surely only the tip of the iceberg.

Beyond and beneath the overt fraud and lying are more insidious forms of deceit, insidious because they are more difficult to pin down and identify as deceptive. There is the deceit lurking in the very complexity of our postmodern financial practices — this is nicely illustrated in an interview by Christopher Lydon of Michael Lewis, who has seamlessly morphed from sports writer to chronicler of the dark side of financial capitalism. On the web-page that hosts the interview (from Brown’s Watson Institute, no less!), there is a great quote from Lewis where he says “complexity becomes opacity.” I would go further and say that deceit comes to lurk in complexity. And at still another level down, there is the Simon Johnson and James Kwak argument in 13 Bankers (a book that has its own website — yikes!) that not only was there regulatory capture of the US government by financial firms, but also ideological capture — the dissemination of a world view. To quote from Johnson and Kwak’s introduction: “No conspiracy was necessary. Even Summers, a brilliant and notoriously skeptical academic economist…was won over by the siren song of financial innovation and deregulation. By 1998, it was part of the worldview of the Washington elite that what was good for Wall Street was good for America” (p. 10).

Shouldn’t social constructivists be all over this stuff? Well, there is the one little problem that if you posit that reality is socially constructed, then how do you distinguish socially constructed and accepted lies from socially constructed truths? Especially if the “lies” are accepted as truths? The way I’ve been dealing with this in my work on hypocrisy (a piece of this work is coming out in Blyth, Abdelal, and Parsons, eds. forthcoming Cornell book, Constructing the International Economy) is to treat alternative “versions” of truth as contending constructions. But I think this sort of washes out the moral judgment that some sort of deception has been practiced, and that deception is wrong. If you cannot evaluate deception against a “hard truth”, then what sort of criteria are available? I’m thinking the Duck might be a good place to fire off that question, though I don’t want the answer to hinge purely on methodological issues. If the financial meltdown was at least partly a consequence of mass deception, then does the issue in practical terms boil down to a question of whether a mass deception is sustainable over time? You could look at money that way, maybe, as a sustainable (usually, though maybe not in Greece right now) mass delusion. So what makes a mass delusion sustainable, as opposed to unsustainable? Actually I’ve now typed myself to the edge of a philosophical abyss but instead of deleting this post I’m just going to post it.


Replace the Dollar?

A friend writes,* “What the end of hegemony looks like…”

In another indication that China is growing increasingly concerned about holding huge dollar reserves, the head of its central bank has called for the eventual creation of a new international currency reserve to replace the dollar.

In a paper released Monday, Zhou Xiaochuan, governor of the People’s Bank of China, said a new currency reserve system controlled by the International Monetary Fund could prove more stable and economically viable.

A new system is necessary, he said, because the global economic crisis has revealed the “inherent vulnerabilities and systemic risks in the existing international monetary system.”

On the one hand, true. China’s over $1 trillion in dollar-denominated reserves aren’t as safe as they once were, and a devaluation of that asset through inflation would not be good for China. But, where else are they going to go?

While few analysts believe that the dollar will be replaced as the world’s dominant foreign exchange reserve anytime soon, the proposal suggests that China is preparing to assume a more influential role in the world. Russia recently made a similar proposal.

Lets look at this more closely. The Dollar has its privileged position in the world economy because a) many economists believe that the world economy needs some sort of stable reserve currency, b) the US is willing and can afford to maintain such a strong currency, and c) the rest of the world has left this arrangement unchallenged and benefits from it. Much of this is classic Kindleberger–the world economy needs a stabilizer, one stabilizer, to stabilize the global economy as market, currency, and lender of last resort. The US is that stabilizer.

The third of those reasons–acceptance by other world powers–is now under some degree of threat as China starts to fret about its dollar position. However, absent another actor willing and able to play the role of stabilizer, everyone–China included–risks putting themselves in a significantly worse position should the dollar lose its pride of place in the international economic system.

China suggests that the IMF’s SDR form a new reserve currency. This indicates they really aren’t all that serious about actually doing anything to dislodge the dollar. For one, to have a currency able to act as a reserve currency requires backing of a stable, authoritative, empowered entity that can manipulate fiscal and monetary policy as needed to protect the value of its currency. We call this a sovereign state. To give the IMF such rights would make the IMF a de-facto global economic sovereign. China has no demonstrated desire to create supra-national authority, not at the UN, nor the IMF. Moreover, there is a significant and real cost to maintaining a strong reserve currency. The strength of the dollar makes the US a great destination for products–we can afford to buy others’ cheap stuff. A significantly de-valued dollar (coupled with an increased value of other currencies like the Yuan or Yen or Won) would be a disaster to economies that rely on exports. China would need to show that it is willing and able to take on a stabilizing role in the global economy, which just doesn’t seem in the cards as of yet.

Perhaps, though, this might be read as an attempt to gain leverage:

The timing of the Chinese announcement, analysts said, could also be aimed at giving Beijing more leverage to negotiate with the United States and other nations in London on trade and on proposals about how to stabilize the global economy.

All that said, it would be foolish for US policy planners to simply ignore China’s (and others) growing dissatisfaction with the Bretton Woods legacy system that now constitutes the global economy. The fundamental bargains that made such a hegemonic system possible (cf Ikenberry) have become frayed, and while neither China nor the EU (nor India, for that matter) are poised to overthrow US hegemony in the short term, they can clearly erode US hegemony by driving up the cost of acting as a stabilizer. In the medium term, this imposes a cost on everyone, as the global economy (and security order) falters without a clear stabilizer, but from a realist perspective, the relative gains (or in this case declines) could benefit the challengers to US hegemony–at least that’s what they are betting on.

*as in, a friend of mine forwarded me a link to that article with the caption. I have never met David Barboza, the author of the NYT article.


Hegemony, the Economy, and Baseball’s Winter Meetings

Baseball’s winter meetings start today in Vegas, which means loads of hot-stove league excitement for baseball fans like myself. However, I don’t expect my team to make one of the marquee deals, those big money contracts are usually the province of the big market, big money teams like the Yankees, Mets, Sawks, and Angles.

The art of rooting for a small market team is to understand how to do more with less, and, most importantly, how to minimize risk in the land of free-agent mega-contracts. If you’re the Yankees, you can sign a Carl Pavano, say, to a 4-year, $40 million contract, and when misses 2 full seasons and large portions of two more, you grouse about it and then go sign another pitcher to replace him and continue about your merry way. If you’re a small market GM, however, such contracts aren’t even an option. You can’t afford to put so much of your scarce revenue into a non-performing player. So, small market teams must look for diamonds in the rough, offering low risk, in terms of guaranteed money, contracts to a number of players, hoping one works out because they can’t afford to be wrong on a guaranteed, multi-year, mega-million dollar deal that would cripple the franchise.

In short, the key difference between the big money teams and small market teams is their capacity to absorb a mistake.

Which brings us to tonight’s word: weathering the global recession.

In grading a series of papers for my Hegemony class, an interesting theme emerged. While many contemporary commentators are lamenting the fact that the current global economic meltdown has put a damper on US global leadership, I think that there is an under-appreciated aspect to the economic crisis. Namely, the US is in a position to weather the storm, absorb the hit, and recover. Yes, there is certainly more economic pain to come and, for certain, it will hurt. But, if you haven’t noticed, this economic crisis is global, and its going to hurt the rest of the world a lot more than it will hurt the USA.

With the price of oil now down to $43/barrel, oil producing nations are in dire straits. The promises they made at $140 are ludicrous, and much of their basic economic models are simply unsustainable at prices this low. Russia, Venezuela, Saudi Arabia–they are all in serious trouble.

Even China, the supposed great rival to US hegemony, is in dire economic straits. They have proposed a $500 billion stimulus package, but depend on the health of global export markets to keep factories humming and producing the 9-11% annual economic growth they need to maintain domestic political stability. This puts the CCP in a real political bind.

All of which is to say, the US standing in the world might not be as drastically reduced as a result of the global economic crisis as one might initially think. Everyone will take a hit, but the Yankees / Yanquis are in a much stronger position to be able to absorb the hit and remain competitive. We are strong enough to recover from our own mistakes. Others are not so bit or so fortunate.


Krugman goes constructionist

Many years ago, I attended a talk by Michael Shapiro. He was doing something on memory and place, and showed a clip from some Steve Martin movie–Father of the Bride, maybe II–and a colleague of mine, ever the concerned young scholar, said Yes, but Professor Shapiro, over in Bosnia (which was going on at the time), people are dying, and here you are showing movies. What does this tell us that we should do to stop that?
And he replied: Who is this “we”?

In his current column, Paul Krugman channels his inner pomo and opens with a similar story:

A few months ago I found myself at a meeting of economists and finance officials, discussing — what else? — the crisis. There was a lot of soul-searching going on. One senior policy maker asked, “Why didn’t we see this coming?”

There was, of course, only one thing to say in reply, so I said it: “What do you mean ‘we,’ white man?”

His point–the “establishment” didn’t allow itself to see this coming, despite the fact that a number of critics and contrarians warned otherwise. Thus, this, “unprecedented” crisis “no one” saw coming.

Krugman makes a key point: that this economic event is constructed as a “crisis” rather than a natural correction that could have been (was) foreseen and for which we might have (should have) planned in advance (and a few did). An accepted wisdom of success is built around particular policy choices to make them seem “rational” and “logical” and when something doesn’t fit those, it portends a “crisis.”

This point is not all that new to the constructivist IR literature– Weldes pointed out, with respect to the Cuban Missile Crisis, that a series of events must be discursively constructed to be a crisis.

So to is an economic crisis. There are plenty who saw this coming, and some who saw this as a natural and needed corrective to an out-of-control market. They just don’t count as part of that “we.”


From Liar’s Poker to A House of Cards

Michael Lewis’s account of the collapse of Wall Street is a must read for insight and understand of what was going on that led to the current mess.

I know it won’t, but it should, end this foolish notion that markets are self-organizing, self-regulating, rational entities where rational actors maximize value and where self-interested firms don’t lie, cheat, and steal. Markets are social entities, perhaps best studied as networks governed by certain rules and norms–and those rules and norms read more like and MBA textbook than an Econ textbook. The implications of that are, I think, quite profound. Invisible hand my !#$%.


Asking the Wrong Questions

One thing that has been bothering me of late in the Presidential debate is how the press and the public are asking the wrong questions of the candidates about the economy. While part of it may be symptomatic of a general lack of understanding as to what is going on, it also betrays an intellectual laziness in those covering and discussing the campaign. Wedded to tired lines of debate, these questions rehash what we think is important and distract from the development of an understanding of the current state of affairs which has very little relationship to the ancien regime.

Two general areas of inquiry really stand out.

The first is the “How are you going to pay for this?” bit. Lehrer asked a version of this in the first debate. The set-up goes something like this: We’ve spent $300B on Fannie and Freddie, authorized $700B for the TARP bailout/rescue, have 2 wars, and you want to cut taxes. So, clearly something you are promising will have to go. What promise are you going to break?

Here’s the problem with that answer: It assumes that the government is going to have the luxury of choosing among its spending programs as this economic crisis deepens. The old-school view is that government debt is part of the problem and steps must be taken toward a balanced budget. But, in a matter of weeks, several decades of economic orthodoxy has fallen by the wayside as the Administration reaches deeper and deeper into the government’s interventionist toolbox trying to find something that works. In one day, Paulson spent as much money as the Wars cost in a year on a government take-over of AIG. Former Bush-Administration officials are calling for faster government action, picking winners and losers from among US financial institutions. As Brad DeLong points out, the pendulum has swung back toward (if not past) Keynes.

What Keynesian economics calls for is counter-cyclical government spending to mitigate the effects of an economic downturn on a society. We’re well into the crisis, but have yet to see a real move toward counter-cyclical spending. We’ve seen all kinds of other ad-hoc government intervention in the economy in the financial sector, but little for “main street.”

What this question overlooks is the fact that the government probably ought to be spending on all of the candidate’s priorities, and maybe then some. Does it drive up the deficit? Sure. But that’s the Keynesian point–increased government debt now to avoid a deeper recession later. Given the potential severity of the economic downturn, all this spending and more might be necessary. Yet, asking the question as posed–what will you cut–frames the discussion in the old and now discredited economic context. It makes it harder for the next President to spend what he’ll need to in order to help the nation as a whole.

The second question that bothers me is “What’s your plan” to solve the crisis. This question has both a flawed premise and produces a counter-productive discussion.

The flawed premise is to realistically expect these two campaigns to come up with a silver bullet before they have the full resources of the US government at their disposal. Obama and McCain have a team of very smart economic advisers working for them from their current jobs. The Treasury and Fed have full time staff who have spent a career working on issues just such as this. They have legal authority, resources, and expertise to gather information, devise plans, and map out potential consequences. They also have the ability and responsibility to consult and coordinate with allies in the G-7 and international institutions like the IMF. And, despite all these advantages, they still have not come up with anything that seems to work.

This question also produces a counter-productive discussion. This crisis is moving with such velocity that any plan seems outdated days later. The $700 Billion TARP that just had to pass? Already obsolete, as Paulson has moved on to directly injecting capital into banks–something that wasn’t even in his original plan. Does anyone think that either a McCain or Obama plan would still be relevant by Election Day, let alone Inauguration Day? Neither candidate can do anything now–what we want is what they will do once they get into office–but no one has any idea what the financial markets will look like in mid-January.

Asking the wrong questions generates tremendous amounts of heat with little light to illuminate any useful understanding of the issue.


Barak Obama and the Renewal of American Hegemony

By way of introduction… I’ve been pondering a post along these lines for a short while now, but this isn’t going to exactly be the post I had originally envisioned. Rather, inspired by the ongoing financial crisis and some things I read this evening, a slightly different version has emerged. Now, onto the show:

A significant challenge for the next President will be dealing with the percipitous decline in American Hegemony since 2001. All three pillars of American power have severely eroded, leaving an open to mount a challenge to America’s international leadership. Following Iraq and Afghanistan, the US military is stretched thin. More significantly, the success of insurgency warfare coupled with the failure of non-proliferation policies in North Korea and Iran have shown the door to resist US military pressure–build a nuke or threaten to draw the US into a protracted guerrilla conflict that mitigates its conventional military advantage. Economically, the current credit crisis is now spreading globally, calling the US economic leadership into significant question. And, socially, the past 7 years have eroded the US moral authority and respect around the world.

The real question, though, is what will the next president do? These declines, while significant, are not necessarily the end of the American Era. My core argument is that Obama, unlike McCain, has the unique potential to restore American leadership in at least 2 of these critical foundations of US power.

Most importantly, Obama has the potential to restore America’s moral authority, its international standing and respect, and its legitimacy as a world leader. This is not to say that he’s the candidate that the Europeans like. Rather, this is to say that the idea of Obama represents such a shift for America’s image in the rest of the world that he offers the chance to restore America’s lost luster. Obama gains the moral authority as a world leader capable of speaking directly to the people of the world, inspiring them to follow a path with the US leading the way.

As the current economic crisis unfolds, I think this has incredibly significant economic implications. The post-War international economic order that persists to this day is one of Embedded Liberalism. As Ruggie has argued, this order reflected a social purpose emblematic of US national identity, shaping the world order in its own image. As that image has fallen internationally in recent years, so too has the legitimacy of the current international order.

Obama would find himself in a unique position to ask the world to update that order. Now, I happen to think that come February 2009, whoever is the next President will be asking the rest of the world for many of the same things. Take, for instance, Europe. Both McCain and Obama will probably be asking the Europeans for help in Afghanistan, as well with help in responding to the fall-out of this economic crisis. The Europeans can much more easily ignore McCain. Ignoring Obama is much more difficult.

More significantly, Obama has an ability that few US presidents have had–the ability to “go public,” going over the heads of the European leaders and speaking directly to the European public, mobilizing them on behalf of his agenda, putting pressure on potentially reluctant governments.

The proximate inspiration for my slight shift in thinking is an NYT article about the current financial crisis stoking fears of a global recession. As this crisis grows in scope and complexity, the existing institutions of the US established international economic order are increasingly on the sidelines, leaving fewer and fewer pathways to coordinated global action to address a growing global economic meltdown.

The trouble is, these institutions no longer have the resources or authority to lead such an effort. The I.M.F., which played a central role in the Asian crisis, has been relegated to the sidelines this time — its credibility tarnished by that episode and its skills ill-suited to a crisis in advanced economies. These days, it mainly issues lonely warnings about the impact on developing countries.

The Group of 7, which once functioned as a sort of command center for the global economy, is similarly depleted, according to critics. It no longer represents the world’s economic drivers, they said, and badly needs to be expanded to include rising powers like China and India.

“The globalization of the crisis means we need a globalization of responses,” said C. Fred Bergsten, the director of the Peterson Institute for International Economics. “But most of the responses will be national. For all the institutions we have, we don’t have the right institutions to do this.”

That is particularly true in Europe, which has an effective central bank but lacks a unified legislature or treasury to coordinate or finance a rescue of the banking system. So far, economists say, Europe’s response to the crisis in its banks has been mostly marked by denial and dissension.

Having the financial resources to respond to the crisis is a matter of material power. Having the authority to act is an element of social power, producing the legitimacy for an institution or material capability to command the respect of others.

This is vitally important when the heart of the current crisis is a crisis of confidence in financial markets. Additional funds can restore liquidity. Restoring confidence requires the social power to restore the legitimacy of the financial institutions in the economy. The Government (any government of any nation) does not have the money to back the entire economy of a nation. But, that government can restore confidence in national institutions with guarantees that bestow credibility and legitimacy. Similarly, credible and functional international institutions could potentially do the same for the global economy. As
Robert Reich
points out:

Leadership isn’t just about passing a big piece of legislation. It’s about explaining and thereby gaining trust and confidence from a public — including a global public — that’s otherwise afraid and confused. A credible and powerful explanation is necessary right now — about where we’ve been, how we got into this mess, and how a particular plan (in this case, the bailout), will get us out of it.

The next president will need to exercise global leadership on two fronts. First, he will need to inspire the basic confidence in the global economy that it needs to function. Second, he will need to ask the countries of the world to reform the existing institutions in order to create something capable of dealing with such crises in the future.

A president able to legitimate such a project has the potential to renew America’s global leadership and American hegemony.

In my view, Obama has that potential. McCain does not.


A better job at telling the story…

David Leonhardt does a better job than most explaining the significance of the ongoing economic crisis and its parallel to the great depression. He finally understands the need to connect the dots, from bank failure, to credit crisis to impact on your household economy.

The crucial point is that a modern economy can’t function when people can’t easily get credit. It takes a while for this to become obvious, since most companies and households don’t take out big new loans every day. But it will eventually become obvious, and painfully so. Already, a lack of car loans has caused vehicle sales to fall further.

He leads off with an interesting parable, I’ll give you the open and the punchline from his conclusion, the rest is worth a read.

In 1929, Meyer Mishkin owned a shop in New York that sold silk shirts to workingmen. When the stock market crashed that October, he turned to his son, then a student at City College, and offered a version of this sentiment: It serves those rich scoundrels right.

A year later, as Wall Street’s problems were starting to spill into the broader economy, Mr. Mishkin’s store went out of business. He no longer had enough customers. His son had to go to work to support the family, and Mr. Mishkin never held a steady job again….

But in the end, this really isn’t about Wall Street. It’s about reducing the risk that something really bad happens. It’s about limiting the damage from the past decade’s financial excesses. Unfortunately, there is no way to accomplish that without also extending a helping hand to Wall Street. That is where our credit markets are, and we need them to start working again.

Update: Krugman has a solid analysis of the two flawed narratives of the crisis. I don’t know if this Krugman comment is something to inspire confidence or deeper concern: “The real financial rescue still lies in the future, probably under the Obama administration.”


Bailing out the bailout

Rachel Maddow just asked perhaps the most insightful question of this bailout to date: Is this economic crisis global warming or the Iraq War? Is it a real crisis that builds slowly that people fail to acknowledge, or is it a bunch of hype and hysteria over what is, in the end, nothing.

Laura D’Andrea Tyson says that this credit crunch is real and real bad, and your job is at risk. Its not a bail-out, but a rescue of a broken market.

Therein lies the rub. I think there are two fundamental issues that have doomed the bailout bill earlier today.

First, this is a really complicated mess, and no one understands what is actually going on. Who among you actually understands credit-default swaps, or the leveraging of commercial paper for mortgage-backed securities? Not me. Probably not you. One of the major difficulties here is that there is no story to explain what is happening, leaving no reason to justify the extraordinary actions necessary to save the economic markets. There’s a lot of assigning of blame, but there’s little explanation of what actually is the problem. I’m not saying that there needs to be a blue-ribbon commission producing a report. Rather, what is needed is a narrative that makes sense of what is going on in such a way that people can actually understand what is happening and that justifies a response. All we have now is a series of bank failures, the biggest drop in the Dow ever, and a back and forth of Presidential politics.

So what has actually happened? Two items have broken through: 1) people can’t pay mortgages and 2) wall street bankers made some poor bets. Neither of these really sounds all that drastic, and neither of these really calls out for action. People are annoyed with others who borrowed over their heads when they were responsible, but its hard to blame families for tough economic times. No one really has any sympathy for Wall Street.

The massive problems that remain–the credit crunch, the insolvency of key financial instruments, the potential lack of cash for business operations, this is much more significant but much less of the story. If a rescue operation is going to have any chance of success, its proponents need to develop a narrative on the crisis before they can sell the solution.

Second, this is a “bailout.” Of Wall Street, no less. No one likes to bail-out fat cats who make poor decisions. Except that at this point its far beyond a bailout, its rescue of a broken financial system by extensive nationalization, regulation, and government intervention. This intervention needs another frame. FDR, who has re-emerged as everyone’s favorite President these days, was an expert at this. The New Deal socialized large parts of the economy. Lend-Lease paved the way for entry into World War II. But Roosevelt was expert in telling the American People that, when your neighbor’s house is on fire, you give them the hose now and worry about payment later.

This is more than a bailout, its a rescue of a broken system on the verge of collapse. Except that you wouldn’t know that from the event itself. If Congress and the Administration are going to rescue the economy, they need a plausible narrative of what is going on to explain the seriousness of the problem and to form the basis of a political coalition. Then they need to start talking about a government rescue to save the economy, and drop all this Wall Street bailout jargon.


Scribbles in My Notebook on AIG

One of my favorite Cleveland sports columnists often does a column of brief observations and insights after a game or big event. I don’t scribble, and I lack a notebook, but watching the AIG bailout has me thinking about a few things:

Wow, that’s a lot of money. To put this in perspective, recall the 2004 Presidential Election, when Kerry was rolled for being for the $87 billion before he was against it. That was a yearly supplemental appropriation to fund the war in Iraq and Afghanistan. Paulson spent about the same to bail out AIG in one day.

This may have avoided an imminent financial crisis, but (and I’m not the first to say this, but its so important as to bear repeating) this 1) did nothing to address the roots of this crisis that got us to this point in the first place and 2) did nothing to address the fact that another shoe dropping seems imminent. Shouldn’t there be hearings on emergency financial sector reform or something?

I think Sebastian Mallaby made a good point in the Post yesterday:

If Paulson’s gamble pays off, it could affect the character of globalization. For the past two decades or so, international finance has developed largely on U.S. terms and in the U.S. image. The Federal Reserve has stood behind the dollar, which is the world’s dominant reserve currency, and the world’s faith in the dollar has allowed the Fed to cut interest rates in response to global shocks such as Russia’s default in 1998 without risking a run on the currency. Meanwhile, U.S. banks have dreamed up funky new financial instruments that have been marketed all over the world. To a considerable extent, the globalization of finance has meant its Americanization.

The first 12 months of this crisis scrambled that equation. The Fed cut interest rates, as it often does in response to trouble. But this time the world lost confidence in the dollar, which failed to play its traditional role as a safe store of value in tough times and instead seesawed wildly. The innovative U.S. banks lost billions of dollars and were forced to turn for help to the new masters of finance — foreign sovereign wealth funds. And U.S.-style financial innovation suffered a massive reputational blow. No less a commentator than Paul Volcker, the former Fed chairman, has emerged to denounce it.

The longer the financial turbulence goes on, the greater the likely backlash against U.S.-style financial globalization. But Paulson’s gamble — if it succeeds — could limit the damage. By refusing to use the Fed’s balance sheet to bail out Lehman, he may have saved the Fed from becoming further bogged down in its crisis-management role, freeing it to focus more on preserving the value of the dollar. And by repealing the too-entangled doctrine, Paulson may have strengthened market penalties for banks that mismanage modern financial instruments — thereby increasing the chances that sophisticated, market-based finance can flourish safely.

I don’ think folks yet understand how profound this crisis might become. The Dollar as Global Reserve currency allows the US to do all kinds of things that no other country can get away with. The US budget looks more like Argentina in a bad year than the IMF recommended Washington Consensus, but the US can get away with it and Argentina can’t because the US can always sell debt, and there remains a market for dollar-denominated debt. If the dollar loses this preeminent position, the US is in for major major economic turbulence.

In less than a week, the Dow lost nearly 1000 points reacting to the AIG bailout. But, this is a highly skewed indicator, because AID is one of the 30 stocks that make up the Dow. AIG’s loss in value has a direct impact on the Dow–the decline is not a great indicator of the degree of investor mood. Better would be the Dow without AIG or some other indicator. But, the Dow, S&P 500, and NASDAQ are all down about 4-5% today (AIG is part of the S&P also).

Lots of people are making a comparison to the bailout of Chrysler back in the early 80’s. I wonder if the bailout of Mexico in 1994 might be more appropriate–the Treasury and Fed acting on their own to bail out a bad and highly interconnected position in the global economy.

One really hopes that Krugman is right about this: Bernanke is a leading expert on the Great Depression, so he might be able to keep it from happening again.


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