Krugman Is Still Wrong About MMT – and with it still wrong on deficit

On Friday Paul Krugman posted the first of what has become 2-3 posts on his blog wherein he claims that MMT is “just wrong”.  As I noted Friday here, I commented on his blog to point out how his post was deceptive and misrepresented MMT.  I was not alone.  Well over 100 people have taken him task in his comments section for not having done his homework on MMT.

For those that want a more detailed refutation of the nonsense Krugman published, here’s a few links that have come up the last few days:

Bill Mitchell at Billyblog My favorite quote here:

Poor scholarship also involves not learning from your errors. You have often rightly accused the main body of our profession of having their heads in the sand (see How Did Economists Get It So Wrong?) and being inflexible in responding to the crisis.

Yet, you seem to keep wheeling the same errors of reasoning out yourself.

Scott Fulwiller writing at NakedCapitalism

The Daily Kos made three posts:

Paul Takes Another Swipe at MMT

Krugman Misleads His Readers – AGAIN!

The lesson, kids, is that even Nobel prize winners need to keep doing their homework.  If you are going to criticize some ideas, it is very important to actually read the stuff first.

 

General Electric Is A Welfare Queen

Ronald Reagan introduced the nation in 1976 to the concept and existence of welfare queens, private citizens that pay no taxes but manipulate the system to obtain large amounts of government money.  Sometimes welfare queens have very profitable but socially destructive businesses on the side and make even more profits.  If that’s true, then General Electric is a welfare queen. Most of their businesses depend on government funding such as military expenditures, medicare expenditures, or nuclear powerplants.  But they pay nothing, zip, zilch, nada in taxes.  But they get to keep large profits.  Do they use those profits to create U.S. jobs? Nope. When you’ve got pipeline to the inside of the government, it’s very profitable.  As I’ve said before, it’s good to advise the king.

From Political Irony:


© Jeff Danziger

General Electric had profits of over $14 billion in 2010 and yet paid no taxes. In fact, they received a tax benefit of $3.2 billion. Now that’s corporate welfare! How does GE do it? By hiring former treasury officials to work in their tax department, and by aggressive lobbying to get tax laws changed to their favor.

Fifty or so years ago, 30% of all federal revenue came from corporations. Now it is only 6.6% — far less than individuals pay. In fact, a majority of large corporations don’t pay any taxes at all. And yet Republicans still want to cut corporate taxes even more.

 

Shock Doctrine and Wisconsin and Michigan

Author Naomi Klein wrote a book a few years ago called Shock Doctrine.  It is a powerful antidote to the pro-free markets, pro-globalization stories of authors such as Daniel Yergin and Stanislaw who wrote Commanding Heights.  I wish Shock Doctrine were a full-length video to juxtaposition against Commanding Heights. In the book, Klein documents how repeatedly over a 40 year period various crises have been exploited by right-wing, free-market fundamentalists to implement policies that could not be implemented via ordinary democratic means.  Further, Klein documents how the exploitation of these crises was not accidental. It was intentional. Amy Goodman notes of the book:

In it, she reveals how those in power use times of crisis to push through undemocratic, radical, free market economic policies.

The book, published in early 2008, mostly deals with crises in other countries. Some were political, some economic, some war-related, and some natural disasters. It is a disturbing and yet riveting tale.  The “reforms” forced through in country after country inevitably work to the benefit of the global elite corporations and banks. Yet in the book most of the crises and forced “reforms” are in either poor or developing countries. It’s possible to read the book and think that we in the developed, industrialized countries are immune to such anti-democratic exploitation of either real or contrived crises.  Yes, Klein offers the example of Katrina striking New Orleans to illustrate that it “can happen here”, yet it’s possible to think not. Now it’s time to think again.

Now it’s 2011 and the crises have come to the U.S. and other developed countries. In the U.K., a new conservative government has chosen to whip up a fear of a sovereign debt crisis. “We don’t want to be like Greece”, despite the reality that the U.K., having it’s own currency, can never be in the circumstances Greece is.  They are exploiting the fear of crisis to mount a massive dismantling of public benefits that would not otherwise be possible. A dismantling they didn’t explain prior to the election.

But what I want to observe is that Shock Doctrine tactics have come to the U.S.  In Congress, Republicans are claiming the government is “broke” despite the evidence that the government can borrow unlimited amounts at near-zero interest rates and despite the fact that the U.S. cannot go “broke”. But they are using this supposed “crisis” to try to reduce or dismantle a fundamentally sound, socially beneficial program like Social Security. Heck, even if there were a budget crisis for the government, Social Security isn’t the cause and cutting isn’t the solution.  Yet the tactic here is pure shock doctrine.

I’ve mentioned before how we’re seeing Shock Doctrine in Wisconsin, Ohio, and other states that are attempting to repeal collective bargaining rights for public workers and to bust unions is pure Shock Doctrine. There is now an extensive interview with Naomi Klein where she talks about these events:

we are seeing right-wing ideologues across the country using economic crisis as a pretext to really wage a kind of a final battle in a 50-year war against trade unions, where we’ve seen membership in trade unions drop precipitously. And public sector unions are the last labor stronghold, and they’re going after it. And these governors did not run elections promising to do these radical actions, but they are using the pretext of crisis to do things that they couldn’t get elected promising to do.

And, you know, that’s the core argument of and the thesis of the book, is not that there’s something wrong with responding to a crisis decisively. Crises demand decisive responses. The issue is this backhanded attempt to use a crisis to centralize power, to subvert democracy, to avoid public debate, to say, “We have no time for democracy. It’s just too messy. It doesn’t matter what you want. We have no choice. We just have to ram it through.” And we’re seeing this in 16 states. I mean, it’s impossible to keep track of it. It’s happening on such a huge scale.

Teachers’ unions are getting the worst of it. March 8th was International Women’s Day. This is—you know, as you pointed out on your show, it’s overwhelmingly women who are providing the services that are under attack. It’s not just labor that’s under attack; it’s the services that the labor is providing that’s under attack: it’s healthcare, it’s education, it’s those fundamental care-giving services across the country, which could be profitable if they were privatized.

Later in the interview, Klein touches on what’s happening here in Michigan. In Michigan we have Governor Rick Snyder, a man who won a landslide by specifically not telling anyone what he planned to do other than “re-invent” Michigan.  Yet within days of taking office he announces plans to raise taxes on senior citizens and poor people. He further cuts state funding of local governments and school districts. Then he and the Republican legislature pass a new law to allow the governor to appoint an “emergency financial manager” with dictatorial powers to take over any local government or school district in financial trouble. All of this it is claimed is necessary because of a budget “crisis”.  Yet the budget “crisis” is itself largely the result of Snyder’s own proposal to repeal existing business taxes and replace them with business taxes that collect much less money.  It’s a crisis that Snyder largely creates and then proposes to “solve” by repealing voters rights’ to run their own local governments.

AMY GOODMAN: Well, let me ask you about Michigan. About a thousand people rallied in Michigan—

NAOMI KLEIN: Yeah.

AMY GOODMAN:—reminiscent of Wisconsin. Talk about the proposal there.

NAOMI KLEIN: … there’s so much going on that these extraordinary measures are just getting lost in the shuffle. But in Michigan, there is a bill that’s already passed the House. It’s on the verge of passing the Senate. And I’ll just read you some excerpts from it. It says that in the case of an economic crisis, that the governor has the authority to authorize the emergency manager—this is somebody who would be appointed—to reject, modify or terminate the terms of an existing contract or collective bargaining agreement, authorize the emergency manager for a municipal government—OK, so we’re not—we’re talking about towns, municipalities across the state—to disincorporate. So, an appointed official with the ability to dissolve an elected body, when they want to.

AMY GOODMAN: A municipal government.

NAOMI KLEIN: A municipal government. And it says specifically, “or dissolve the municipal government.” So we’ve seen this happening with school boards, saying, “OK, this is a failing school board. We’re taking over. We’re dissolving it. We’re canceling the contracts.” You know, what this reminds me of is New Orleans after Hurricane Katrina, when the teachers were fired en masse and then it became a laboratory for charter schools. You know, people in New Orleans—and you know this, Amy—warned us. They said, “What’s happening to us is going to happen to you.”

Think of the power now concentrated in the Governor.  If any local government or school district doesn’t do what Governor Snyder wants, if the local voters don’t want their schools run the way Snyder does, then Snyder cuts the funding to the school district/city.  They fall into “financial trouble”.  Snyder appoints a crony as financial manager.  The financial manager can go so far as to privatize the entire city and dissolve the entire existence of the city.  So much for popular will and voters speaking in a democracy.  Meanwhile, Snyder, the Governor becomes a very, very powerful man. And power can always be converted into great wealth.  Welcome to the banana republic and crony capitalism. Outcomes no voter would support if given a choice. Courtesy of the Shock Doctrine.

Corporate Influence – GE and Radioactive Fallout

This morning the news came that more than 2 weeks after the tsunami in Japan, 4 of the 6 nuclear reactors at Fukashima are still not stable.  Indeed, 1 or 2 of the reactors are suspected of having leaks from, at best, the pipes into and out of the core reactor containment housing, and, at worst, the reactor containment housing itself.  Numerous stories have already been run about how Tokyo Electric Power (TEPCO), the owner and operator of the Fukashima plant has had a checkered past with regard to safety and inspection compliance.  That’s to be expected when large corporations have unwarranted political influence and when an established industry “captures” the regulators. See here for more about regulatory capture.

But let’s ask who made the containment vessels and the reactor itself which has failed.  Why it’s none other than the U.S.’s own General Electric.  The very same firm that holds itself as “bringing good things to life” in this case is “bringing half-lives to things and people”.  Economic Policy Institute explains:

There can hardly be a more frightening person to be President Obama’s pet CEO than GE Chairman and CEO Jeffrey Immelt. Yet, that is exactly who has the President’s ear at the White House.

It is becoming apparent that GE, rather than “bringing good things to life”, has a unique ability to cozy up to government, massage regulations and bring dangerous toxins into our lives—and I mean seriously dangerous.

NYT now tells us about the containment vessels at the damaged nuclear power plants in Japan are manufactured by GE:
…the type of containment vessel and pressure suppression system used in the failing reactors at Japan’s Fukushima Daiichi plant — and in 23 American reactors at 16 plants — is physically less robust, and it has long been thought to be more susceptible to failure in an emergency than competing designs.

G.E. began making the Mark 1 boiling water reactors in the 1960s, marketing them as cheaper and easier to build — in part because they used a comparatively smaller and less expensive containment structure.

Feeling better about the value system and judgements of the people advising the President?  I’m not.

Structural vs. Cyclical Unemployment Revisited: Doing Nothing Is Not a Smart Option

An update on the question of structural vs. cyclical unemployment, this time with respect to policy options for each. For background, see these previous posts:  on how economists define or distinguish between structural and cyclical and a look at the situation in 2011.  Time is short and specialization is efficient, so I’ll quote Mark Thoma on this (and he’ll quote Peter Diamond and Christie Romer):

I wish I’d remembered point three when I wrote recently about the difficulty of separating cyclical and structural unemployment. I was saying, essentially, the same thing that Peter Diamnond says here (via):

Second, for the current moment, the argument about the aggregate demand side is academic, in the negative sense of the word. Current estimates I have seen of how much of the increase in unemployment from a few years ago is “structural,” rather than due to inadequate aggregate demand, still leaves enough need for aggregate demand stimulation that it is clear what direction is needed for further policies.

Third, I am skeptical of the value of attempting to separate cyclical from structural unemployment over a business cycle…. The tighter the labor market and the more valuable the filling of a vacancy, the more a firm is willing to hire a worker who is a less good match, who may need more training…. [A] worker who might be viewed as structurally unemployed, as facing serious mismatch in the current state of the economy, may be readily employable in a tight labor market. The common practice of thinking about the extent of unemployment as a sum of frictional, structural and cyclical parts misses the point…. [D]irect measures of frictional or structural unemployment… dependent on the tightness of the labor market… have limited relevance for the role of demand stimulation policies. The idea that the US economy is not adaptable and capable of dealing with the need for skills and jobs to adapt to each other is peculiar, given the long history of unemployment going up and down. When the labor market is tight and firms have trouble finding workers, they reach out to places they have not looked before and extend training in order to find workers who can fill their needs. Supporting current stimulus policies as very good for the economy is entirely compatible with taking care to avoid future inflation.

Thus, no matter how you slice it or how you define it — and even with a very generous interpretation of the structural estimates — there is still plenty of cyclical unemployment (or, perhaps more precisely, employment that will respond to an increase in demand) to worry about, and plenty for policy to do.

But suppose that, contrary to what the estimates are telling us, there is a large, dominant, structural component. Does that mean we sit on our hands and do nothing? Nope, Christy Romer makes a point I’ve made many times. Even if the problem is structural, there are still things we can do to help:

There’s this debate going on over what the source of the unemployment is: Do we not have enough aggregate demand, or is it structural? What frustrates me is the advocates of the structural theory go from saying it’s hard to turn construction workers into nurses to saying we should do nothing. If you think our problem is structural, there are things we should be doing: money for training, or helping people get out of their mortgages, or massive investment in Detroit. I don’t believe that skills are the problem here, but if that’s your point of view, there’s still a lot we can do. Saying it’s structural is not the same as saying it’s not our problem.

No matter the cause, we’ve dropped the ball on the unemployment problem (and have yet to pick it up). As I said last week, “We have enough money to pay for military action in Libya, but not for job creation?” But Bob Herbert’s last column at the NY Times says it better:

Losing Our Way, by Bob Herbert, Commentary, NY Times: So here we are pouring shiploads of cash into yet another war, this time in Libya, while simultaneously demolishing school budgets, closing libraries, laying off teachers and police officers, and generally letting the bottom fall out of the quality of life here at home.

Welcome to America in the second decade of the 21st century. An army of long-term unemployed workers is spread across the land, the human fallout from the Great Recession and long years of misguided economic policies. Optimism is in short supply. The few jobs now being created too often pay a pittance, not nearly enough to pry open the doors to a middle-class standard of living. …

The U.S. has not just misplaced its priorities. When the most powerful country ever to inhabit the earth finds it so easy to plunge into the horror of warfare but almost impossible to find adequate work for its people or to properly educate its young, it has lost its way entirely. …

Millions and millions of people still unemployed, the prospects of a slow, slow recovery of employment ahead of us (along with the permanent damage that long-term unemployment brings about), and few people in Washington seem to care.

What’s A Derivative?

A colleague (non-econ) asks: What’s a “derivative” in plain terms?  The plainest answer, yet not very helpful, is that derivatives are a Wall Street cross between the Frankenstein  monster and the blob: they’re a banker-made monster that’s out of control and swallowing the global economy.

But let’s look at derivatives in a less inflammatory way.  Derivatives are a very broad class of financial contracts (also called securities) that depend on some other financial contract for their value.  That “other financial contract” is called the underlying security. Before we get to derivatives, though, let’s look at the most basic “underlying securities”, or what we consider “fundamental” financial contracts or securities.  These include stocks in companies (also called equities), debt contracts (mortgages or bonds), commodities contracts (purchase of actual physical things such as wheat, oil, gold, etc), and foreign exchange (purchase some other currency with a different currency).  These are the contracts that most people think of when they think of Wall Street. These are transactions where something of value in the real world is being bought/sold. When fundamental transactions happen, ownership of something real changes hands for a price.  Example: you buy 100 shares of Acme Rockets stock at $20 per share. You pay $2,000 to the seller now and you get 100 shares of ownership of Acme Rockets.  What determines the price of an underlying fundamental security? Well it’s supply-and-demand, who wants to buy it and who wants to sell it and for how much.  But there’s an underlying real-world economic logic to the valuation over the long-haul.  Over the long-haul, today’s price of a stock should be related to the future profitability and growth of the company. The price of bond today depends on the interest rate the debtor pays, how long to maturity, etc. Same for a mortgage. Today’s supply-and-demand for real-world physical oil or wheat determines today’s “cash” price for delivery of those commodities now. When a fundamental contract transaction (equity, bond, commodity, or foreign exchange) happens, the price is set, the deal is done right now, and it’s over.  It’s just like buying milk at the store today. Go through the check-out line, pay the money, get the milk, done deal.

In contrast, derivatives involve promises about future transactions. A derivative contract involves a promise by one party, the contract seller, to deliver or sell some other financial contract in the future at a price that is fixed now.  The promised contract is called the “underlying security”.  The original class of derivative contracts were called futures contracts and options contracts. Both have some valuable uses in the real world, but both can be prone to abuse.  The idea is generally to manage the risk of some future price movements in the underlying security. Let’s look at a couple examples.

Example 1: Suppose a farmer, we’ll call him Curly, has corn planted on his farm. It’s May.  Based on his experience he expects to harvest and sell x bushels of corn next September. Right now, in May, the price of corn is relatively attractive.  Let’s say the cash delivery price for corn in May is $100. Curly’s afraid that when September comes, the price will drop. He wants to lock in the current price and make his life predictable and less uncertain. Curly sells a futures contract for September delivery.  In other words, Curly sells his promise to sell in the future.  The futures contract itself sells for maybe $1.  In other words, Curly gets $1 to get him to promise to sell at the fixed price of $100 in Septemeber no matter what cash prices are in September. Who would buy such a promise? Well maybe it’s Kellogg’s who wants to nail down the future price of raw materials. Or maybe it’s a speculator like Larry. He sells the contract to Larry. The contract establishes that Larry, the buyer/owner of the futures contract, promises to pay $100 for x bushels of wheat in September and that Curly promises to deliver x bushels at pre-determined spot for $100 in September.  The contract makes sense to Larry since he expects corn to be selling for $104 in September and he plans on taking the delivery at $100 and immediately selling it for $104.  If Larry is right, then he spends $1 now in May and makes $4 in September.  He triples his money with very little actual cash involved up front. Of course, if Larry is wrong and the September price is $98, then he’s out the original $1 for the contract and he’ll lose $2 on the corn in September. In effect, Larry is making a bet on the future price of the fundamental commodity price in the future.  A futures contract is a derivative. Larry could sell his futures contract to yet a third party, say Moe, in July if wants. Then Curly must deliver to Moe. The present price of a futures contract is (in theory) determined by the price movements of the underlying security.

Example 2:  Stock Options. Suppose Groucho, a stock market speculator, thinks that Acme stock is going to rise from $100 per share to $120 a share in the next year. Groucho only has $10,000 in cash right now. He could buy 100 shares at $10, wait, then sell for $12. He makes a $2.000 profit, or 20%, in one year.  But Groucho doesn’t care about actually owning the company, he’s only interested in stock price movements. So instead of buying the stock itself (the underlying security) he buys an option contract.  The option contract says Groucho has the right, at his choice, to purchase Acme stock for $100 per share at any time for the next 12 months from a particular seller. Who would sell a contract like this? Well suppose a pension fund already owns lots of Acme stock. The pension fund doesn’t think it will rise that high, or if it rises that high then they want to cash out and take their profits. The pension fund sells the options contract to Groucho at a price of $0.50 per share.  So Groucho puts his whole $10,000 into the options contract.  He buys the right to buy 20,000 shares at $100 in the future from the pension fund.  Suppose the price only rises to $110 instead of what Groucho thought it would do.  Nonetheless, he “exercises” the option. That is, he forces the pension fund to sell 20,000 to him at $100.  He simultaneously tells his broker to sell the 20,000 shares in the open market at $100.  Groucho makes 20,000 times $10 difference in price = $200,000 profit. But of course the original options contract cost him $10,000.  He turned his $10,000 into $200,000.  Nice return. Stock options are like highly leveraged betting on future stock prices.

So derivatives are financial contracts based upon some other financial contracts.  The current price or value of a derivative contract should be rationally derived from the prices of the underlying securities, hence the name derivatives.  In practice, though, derivative contracts allow large numbers of people with large sums to make “bets” on the future price movements of underlying securities.

When this old man was in the brokerage business 35 years ago, futures contracts and options contracts were pretty much the extent of derivatives.  The biggest players were usually firms with legitimate needs to nail down future prices and limit real-world risk. Economics Blog explains as:

How and why do firms use derivatives to hedge risk?

Financial derivatives are a mechanism for managing risk. They involve options to buy or sell at a certain price in the future. This means that a firm can guarantee being able to buy or sell a contract at a certain price.

But that’s all changed today.  Wall Street has expanded the scope and nature of derivative contracts beyond any real-economic needs.  Huge sums are now involved with huge leverage. Wall Street is now a huge global casino.  There are now derivatives contracts such as:

  • CDS: Credit Default Swaps – bets on whether some bonds/companies go bankrupt. Buy a CDS along with the bonds you buy and you insure yourself against the debtor going bankrupt. Or skip the bonds completely and simply bet on whether the company will go bankrupt.  The large number of CDS’s on GM bonds in 2009 was one reason why it was impossible to work-out a rescue or restructuring of GM and bankruptcy was the only option.  Major banks and funds who owned GM bonds also owned CDS’s and profited from the bankruptcy, as I predicted before the fact. See also here.
  • MBS: Mortgage Backed Securites – The infamous bonds sold who derive their value from the payments received from a pool of home mortgages.
  • Collateralized Debt Securities – bonds based on the value and cash flow of a pool of other debt contracts such as consumer credit card accounts or car loans.  It’s not the loans themselves, but it’s based on the cash flow of the loans.
  • Interest Rate Swaps – bets on the future movements of interest rates
  • Exchange rate swaps – promises to deliver foreign currency at fixed rates at some future data – a bet on exchange rate movements.

The sums are beyond astronomical now.  The world’s total GDP, the total value of everything of real economic value that the entire planet produces each year is in the neighborhood of $65-75 trillion each year.  But 2-3 years ago when the global financial meltdown started, the total value of all existing derivative contracts world-wide was estimated at over $600 trillion.  In oil alone, the total value of all oil futures contracts, if they were actually exercised and resulted in delivery of oil, would require more than 6 times the amount of actual oil we produce.

The derivatives markets are now pure gambling. A casino on a global scale. And like a casino, it’s rigged. It’s possible some individuals to win big. But it’s also possible to lose really, really big.  The house, however, never loses. The global banks that create and operate these derivative contracts and markets, the Goldman Sachs, JPMorgan Chases, Citis, BoA’s, etc. can’t lose.  Heads, they get management and broker fees plus profits.  Tails, they get management and broker fees and the taxpayer or central bank picks up the tab for the loss.