Blown Bubbles
- Posted by ryan on May 4th, 2009 filed in Economics, Policy/Politics
Ezra quotes the great Jim Surowiecki:
There have been three big banking booms in modern U.S. history. The first began in the late nineteenth century, during the Second Industrial Revolution, when bankers like J. P. Morgan funded the creation of industrial giants like U.S. Steel and International Harvester. The second wave came in the twenties, as electrification transformed manufacturing, and the modern consumer economy took hold. The third wave accompanied the information-technology revolution. Each wave, Philippon shows, was propelled by the need to fund new businesses, and each left finance significantly bigger than before. In all these cases, it wasn’t so much that the bankers had changed; the world had.
The same can’t be said, though, of the boom of the past decade. The housing bubble was unique, and uniquely awful. Each of the previous waves had come in response to a profound shift in the real economy. With the housing bubble, by contrast, there was no meaningful development in the real economy that could explain why homes were suddenly so much more attractive or valuable. The only thing that had changed, really, was that banks were flinging cheap money at would-be homeowners, essentially conjuring up profits out of nowhere. And while previous booms (at least, those of the twenties and the nineties) did end in tears, along the way they made the economy more productive and more innovative in a lasting way. That’s not true of the past decade. Banking grew bigger and more profitable. But all we got in exchange was acres of empty houses in Phoenix.
And he adds:
My understanding of the going theory here — and it is, admittedly, a bit choppy — is that the housing bubble emerged somewhat differently than most bubbles. It’s not that we found a new sector to lavish with money and just got overexcited. It’s that we had too much money — that “global glut” you sometimes hear about, or the “giant pool of money” that This American Life famously tracked — and had to find a way to spend it. The housing bubble was a bad solution to a problem of excess money, in other words. But if we hadn’t bubbled up the housing sector, we would have inflated something else.
But I’d like to phrase the question differently. Given the glut of money that ended up in American banks (more on that here), what would have been the best-case scenario for our economy? Obviously the housing bubble wouldn’t have been it. But was there a best-case scenario? Or were we simply letting so much currency dock on our shores that some sort of bubble-ish outcome was effectively inevitable?
There were two primary sources for the global savings glut: growing reserves in oil exporting nations, and growing reserves in trade surplus nations, notably China. China’s surplus accumulated largely based on its management of the value of the yuan against the dollar, which left China with huge holdings of American debt, including Treasuries and agencies (which helped hold mortgage rates down). China’s growth also boosted oil exporter reserves by driving up oil prices.
So we had this enormous pool of money, much of which was going directly back to America. Production of tradable goods in America was disadvantaged by the undervalued yuan, however, which meant that investment increasingly flowed to non-tradable sectors, primarily housing. Add in the great wave of migration to Sunbelt cities that took place in the 1990s and 2000s and innovation in mortgage financing, and you have the ingredients for a bubble.
Things didn’t have to turn out like that. We could have pushed for appreciation in the yuan, though I doubt much would have come of it. Greenspan could have acted more aggressively to raise interest rates as the bubble grew, but that also would have had a limited impact on the inflation of the bubble. What needed to happen to limit the growth of the housing bubble was a substantial regulatory push focused on underwriting standards, ratings of structured financial products, and bank leverage. But of course, there was absolutely no appetite for such changes during the boom.
On the other side of things, it obviously would have been nice to have thought a bit more deeply about how to take advantage of the savings glut. The glut meant that the American government could borrow extremely cheaply (”deficits don’t matter,” said Cheney), which opened the door for a lot of deficit spending. One might have looked at the dynamics of the economy — a manufacturing economy struggling as China enjoyed catch-up growth — and determined to use deficit spending to shore-up the safety net (to help struggling workers) and invest heavily in education, health care, and infrastructure to secure long-term economic growth. Alternatively, one might have decided to spend several trillion dollars on wars abroad. But again, there was not much public demand for a large program of public investment, deficit funded or otherwise.
Now, the Bush presidency was particularly ill-timed. What we needed least over the last decade, it seems clear, was wasteful deficit spending and a hands-off approach to financial markets. It’s hard to know how different a Gore presidency would have been. I like to think he would have avoided Iraq, achieved gains on health care and energy investments, and been quicker to recognize trouble in financial markets, but the world in the early 2000s was a different place. The myth of the finance-based economy had to be well and truly shattered before an appetite for something new could be cultivated.
May 4th, 2009 at 3:00 pm
The “prevailing theory” of course requires the premise that an international surplus exists somehow prior or independent of matching international deficit somewhere else.
Calling the savings a “glut” is an effort to create the impression through choice of adjective that external balances are similar to some real commodity that can pile up in a warehouse somewhere as the owner searches furiously for some buyer.
The “glut” of current account surpluses by surplus countries is, of course, identically the “glut” of current account deficits by deficit countries, but in the “savings glut” theory, the “glut” of current account surpluses is granted causal force while the “glut” of deficits is merely a helpless bystandard.
When thinking by false analogy is replaced with looking at the actual transactions, an entirely different picture emerges. The ongoing neo-mercentalist monetary policy of China (and others) required creating domestic currency in order to use to purchase foreign exchange to maintain the exchange rate discount of the yuan/renminbi. That directly finances the current account deficit of the United States … since China maintaining a discount to the US$ under its pure float exchange rate is identically China maintaining the US$ at a premium over the US$ pure float exchange rate.
There is the creation of the pool of liquidity that the argument by analogy does not notice until it shows up as a current account surplus in the surplus countries.
May 4th, 2009 at 3:01 pm
It’s hard to know how different a Gore presidency would have been. I like to think he would have avoided Iraq, achieved gains on health care and energy investments, and been quicker to recognize trouble in financial markets, but the world in the early 2000s was a different place.
He would have certainly avoided Iraq, because ultimately the only reason we went into Iraq was that Bush and Cheney wanted us to, and were able to get the rest of us to go along. No Bush and Cheney, no Iraq invasion.
(The real question is, what would have happened when Gore got the “Bin Ladin Determined to Strike in U.S.” PDB on August 6, 2001? I think there’s a good case that, for all we knew, 9/11 would have just been another glorious early fall day.)
It’s hard to say whether Gore would have managed any gains in health care and energy investments, because the GOP would have (initially, at least) controlled the House.
I like to think Gore would have responded to some of the early indicators of predatory lending, where old ladies who owned their houses free and clear were talked into complex mortgages that they had no business having anything to do with.
Other than that, I think he would have likely given the banksters 80% of the additional deregulation they got during the Bush years, rather than all of it. After all, caving to the financial ‘industry’ was a bipartisan failing.
May 4th, 2009 at 4:28 pm
We could have pushed for appreciation in the yuan, though I doubt much would have come of it. Greenspan could have acted more aggressively to raise interest rates as the bubble grew, but that also would have had a limited impact on the inflation of the bubble.
We could also have imposed quotas on imports of manufactured goods. That remedy, whatever else you think of it, cannot be dismissed as ineffective. Establishment economists certainly can disagree with fair trade policies, but it is intellectually dishonest to write such policies out of the realm of possibility so that one need not evaluate them on their merits.
May 4th, 2009 at 4:38 pm
Ben, we could also have gone to war with China. That, too, was a possibility. I didn’t address it because it seemed like such an obviously terrible idea.
China was following a well-established strategy for economic development, and in doing so it raised hundreds of millions of people out of dire poverty. Why we’d risk a devastating trade war in order to prevent China from following the same path to wealth we did is completely beyond me.
May 4th, 2009 at 5:56 pm
What Surowiecki missed in his analysis is while the last bubble may have done nothing good for the U.S., it did underwrite a transformation in China (and in many other export-driven nations). And this change absolutely came “in response to a profound shift in the real economy,” i.e. the new economic geography of free trade, globalization and globe-spanning, just-in-time supply chains. Everything Americans bought with their home equity and cheap credit reinforced the global manufacturing system put in place over the last decade. Whether your sympathies lie with Thomas Friedman or Barry Lynn (author of End of the Line, an excellent critique) it’s difficult to argue this wasn’t a profound shift in the economic order of things.
May 26th, 2009 at 12:05 pm
From a layman’s perspective, it’s easy to get lost among the trees and lose complete sight of the larger forest when discussing something as complex, with as many technical vectors and social implications, as the US China trade relationship.
Maybe it’s naive of me, but I am still amazed that people can go on about this situation without stopping to take note, at least here and there, of China’s political realities. No, it’s not a totalitarian slave state as when Mao starved 50 million people to death; but no, on the other hand, it is not a modern liberal democracy, or anything remotely like one, either. The Communist Party still wields arbitrary power and, in the absence of an independent justice system, ordinary people still have much to fear from the authorities.
Then there’s this now-cliché notion that capitalism has “lifted” so many tens of millions out of poverty. Where do people do the research to come up with the facts that might support this sweeping assertion? Where do you get reliable numbers on living standards and income and benefits for average Chinese? A certain proportion of the population (but how many exactly?) has improved its condition through business activity — but how much of that is based in corruption and cronyism? Some people have “escaped” the cruel drudgery of life on collective farms, but only to give the best years of their lives to a different kind of cruelty, that of the sweatshop factory which is often run like an industrialized collective farm. Meanwhile, tens of millions of rural folk have seen their impoverishment grow even nastier, dispossessed of whatever meager land rights they might have had. Can anyone prove that the number of Chinese “lifted” into a comfortable middle class existence outweighs the tens of millions reduced to inhuman indigence, without even the traditional iron rice bowl for life support? I suspect the opposite is true. The scattered and inexact reports of widespread desperate protests, often put down with bloody violence, would seem to indicate that large numbers of Chinese are feeling oppressed by their country’s economic course.
So we come to China’s currency policy. Does a cheap remnimbi really help the average Chinese worker any more than an excessively strong dollar helps American workers? By basing the global economic system on this (dis)balance in currency valuations workers in both countries are reduced to a marginal existence. The American worker is put out of a job, and the Chinese worker is deprived of the purchasing power he or she could expect to gain by participating in their country’s increased productivity and the increased profitability of its enterprises. China’s demand deficit is surely a result of its overwhelming democracy deficit.
The only people who really benefit from the current situation are the business and financial elites of both countries. A stronger yuan as the basis for the expansion of China’s domestic markets would give more Chinese the opportunity to live a civilized existence, but their leaders don’t want that because they have already tied their personal fortunes to the value of their vast dollar holdings. A weaker dollar would give the US manufacturing sector a chance to compete globally and employ more blue collar people here at home. But that would also reduce the purchasing power of the educated classes who control the political process and determine the conventional wisdom on fiscal matters.
So our elites, our leaders, the “smart” people in both societies have made a conscious decision to tie their fate, and ours, to a system run by a sclerotic authoritarian, tinpot dictatorship — all because the only way they can see to holding on to their shaky financial situation is to consent to a system that treats tens of millions of human beings as bereft of any real economic rights, ie, nothing better than cheap labor. The life of a person whose existence is treated as a disposable commodity by the smart people is not really an up-”lifting” notion, is it?
Those who wield economic power in our country and have deliberately chosen to financially ally themselves with China’s feudal managers should be ashamed of their capitulation to relentless expediency. And the worst thing is that this global system’s manifest corruption will doom it to repeat the cycle of phony boom and increasingly destructive collapse.