News & Events

By Dimitri B. Papadimitriou

January 5, 2012. Copyright © 2012, Los Angeles Times

International experience shows that direct job creation by governments is one of the very few options that has succeeded at raising employment levels more than just marginally during a crisis.

Is high unemployment as certain as death and taxes? Of course not. But if we depend on the private sector to bring rates down, joblessness could join those two certainties.

International experience shows that direct job creation by governments is one of the very few options that has succeeded at raising employment levels more than just marginally during a crisis. Nonetheless, unfounded optimism about the power of privately fueled growth underlies the latest round of interventions in Europe. The assumption that the business sector has the ability to absorb enough labor to end the unemployment crisis remains almost unquestioned.

And it is a crisis, despite the recent employment upsurge in much of the world. In Portugal, Ireland, Greece and Spain, high unemployment has continued, with anemic confidence indicators and planned-purchases data in Greece, for example, showing clear evidence that businesses and consumers are bracing for a protracted recession. In economies that are improving, outrageously high unemployment rates among important groups, particularly youths, signal the start of both a threat and a tragedy. Grave labor issues are scattered around the globe.

It's unreasonable to expect private enterprises to solve these problems. Full employment isn't an objective of businesses. Companies usually strive to keep staffing at a minimum—we've all heard the virtues of "lean and mean." There simply isn't any known automatic mechanism, in the markets or elsewhere, that creates jobs in numbers that match the pool of people willing and able to work.

In contrast, direct public-service job creation programs by governments have a history of long-term positive results. Throughout the last century, the United States, Sweden, India, South Africa, Argentina, Ethiopia, South Korea, Peru, Bangladesh, Ghana, Cambodia and Chile, among others, have intermittently adopted policies that made them "employers of last resort"—a term coined by economist Hyman Minsky in the 1960s—when private sector demand wasn't sufficient.

South Korea, for example, during the meltdown of 1997-'98, implemented a Master Plan for Tackling Unemployment that accounted for 10% of government expenditure. It employed workers on public projects that included cultivating forests, building small public facilities, repairing public utilities, environmental cleanup work, staffing community and welfare centers, and information/technology-related projects targeted at the young and computer-literate. The overall economy expanded and thrived in the aftermath.

In 2005, France outlined a program in which the government paid laid-off workers their former salaries. It showed that this model could ultimately cost the nation a lower percentage of GDP than unemployment compensation or other traditional remedies.

Of course, these ideas came long after America's Depression-era initiatives had already proved that government could successfully fulfill the role of employer without competing with the private sector. Programs such as the Public Works Administration and the Civilian Conservation Corps were followed by a "golden" era in American capitalism, and now, decades later, those policies are still providing rewards. The vogue to dismiss the 1940s recovery as entirely the result of World War II reflects political positioning, not economic data.

At the theoretical heart of job-creation programs is this fact: Only government, because it is not seeking profitability when it is hiring, can create a demand for labor that is elastic enough to keep a nation near full employment. During a downturn, when a government offers a demand for unemployed workers, it takes on a role analogous to the one that the Federal Reserve plays when it provides liquidity to banks. As in banking, setting an appropriate rate—in this case, a wage—is one key component for success, with the goal of employing those willing and able to work at or marginally below prevailing informal wages.

And, as in any good public policy, another key is rigorous, scientific monitoring and evaluation. South Africa, in response to a projected unemployment rate of 33% by 2014, has launched a $2.5-billion initiative to create 1 million "cumulative work opportunities" over five years. Analysis by Rania Antonopoulos of the Levy Institute found that care-provisioning jobs—such as home-based workers who care for the ill, the elderly or young children—had a significantly stronger impact as an employment multiplier than infrastructure-oriented or "green" opportunities. Not all jobs are created equal.

The benefits of direct job creation aren't just transitory. It's well documented that persistent unemployment results in a permanent loss of output and labor productivity. During a crisis, jobs combat these potential future effects. When the good times are rolling, they support those excluded from the prosperity while stimulating demand through feedback loops that increase the economy's vibrancy.

This is the moment to expand the range of policy responses to unemployment.

There's no evidence that work creation policies either hurt private business or break national treasuries. Incurring national debt to restore an economy through direct job creation isn't frivolous. It is logical, practical, effective and humane.

Background Briefing: Ian Masters Interviews Dimitri B. Papadimitriou

Copyright © 2011 KPFK. All Rights Reserved.

Masters and Papadimitriou discuss the looming financial crisis in the eurozone, the possibility of contagion, and the OECD's warning of an impending recession in Europe and the UK unless the European Central Bank takes action. Full audio of the interview is available here.

By Dan Monaco

The Straddler, Fall 2011. All content © The Straddler

I
The events leading up to and following the financial crisis in 2008 led to widespread deployment of the term “Minsky Moment,” used to describe the painful termination of what Hyman Minsky called “runaway expansion.” In boom times, according to Minsky, stable profit growth resulting from speculative (debt-fueled) risk-taking leads to ever greater speculative risk-taking until the bubble finally bursts and a debt-deflation crisis ensues as investors liquidate their assets to cover their debt liabilities. The longer the “runaway expansion” lasts, the more dramatic the “Minsky Moment” is liable to be.

In June I traveled to the Minsky Summer Seminar at the Levy Institute at Bard College. The train stop closest to Bard is Amtrak’s Rhinecliff station, and the journey to it from New York City takes you up the eastern bank of the Hudson River for about ninety minutes. It’s hard not to be struck by the beauty of the Hudson, broad and grand between its beveled cliffs, a steady, workmanlike current, simultaneously fierce and serene, operating like a paradoxically silent operatic ostinato. Pleasure cruises run between New York City and Albany, and it is not unusual to see a barge heading in this direction or that, evoking the Hudson Valley’s manufacturing history.

Of course, the Hudson River is also infamous for its having been contaminated by toxic polychlorinated biphenyls (PCBs) from General Electric’s manufacturing plants in Hudson Falls and Fort Edward. The result of years of mostly legal dumping of PCBs between 1947 and 1977 led to a large stretch of the river being declared a Superfund Site in 1984. Turmoil, controversy, and legal battles ensued; cleanup dredging began in earnest in 2009.

Knowing this as one looks out a railcar window at the river leads to an odd and occasionally eerie appreciation of the scenery. It might also inspire a thought or two on the occupation of the economist. For there is a sense in which all economists are implicitly charged with advancing recommendations on the appropriate use of an apparatus—call it the labor and money arrangements of man—which one might with only slight exaggeration describe as a sort of savage machinery. This apparatus is capable, when adequately structured, of advancing human well-being; it is capable, too, of setting well-being back, of passing over certain sections of humanity—including populations within nations, nations themselves, continents, and generations.

But there is also a sense in which, at least to the eyes of an outsider, the codes of the profession, and the dominant modes of thought within the field, seem to put the economist who fully acknowledges the potency of the poorly secured munitions ship whose course he is seeking to influence in a bit of an odd position. If he thinks it is best to grapple with the navigation plan, he must still contend with the tendencies of the moiety of his brethren who, in spite of the field’s outsized political and cultural influence, either deny that their conclusions have anything to do with something as complex as the actual practice of seafaring, or who—hewing closely to the field’s first principles—regard an absence of captaincy as the best captaincy, the rarely manned bridge the best manned bridge.

“Economists have lost their credibility because they do not actually deal with the real world,” Dimitri Papadimitriou, President of the Levy Institute, told me in my conversation with him. “But there were and are certainly some economists, including Hyman Minsky, who looked at the real world not as an exception case.”

“Minsky was in some ways a pioneer. He saw that economic theory assumed that everything is known and that there is some tendency of the system to reach for equilibrium and, at times, to reach periods of ‘tranquility,’ as he preferred to call them. Of course, he never believed that stability was possible. He didn’t believe in the invisible hand. There’s a reason why it’s invisible—because it’s not there.”

II
It is characteristic of capitalism, according to Minsky’s John Maynard Keynes, that it fails to maintain full employment,(1) and that its most essential traits are instability and uncertainty.

JMK appeared in 1975, just as the postwar “Golden Age” of global capitalism was coming to an end in a decade marked by oil shocks, unsustainable levels of inflation, the dismantling of the Bretton Woods international monetary system, rising rates of unemployment, and growing popular familiarity with the concepts of “stagflation” (stagnation and inflation) and the “misery index” (unemployment plus inflation).

The 1970s were a crucial period for both economic policy and economic study; the decade’s disruptions were exhibited to impugn the effectiveness of, and ultimately abandon mainstream adherence to, Keynesian economics. As Peter Temin, an economic historian at MIT, told The Straddler in February, there were two reactions within economics to the problems of the 1970s: “One was to patch up [Keynesian] theory and extend it. The other came from people who said that Keynesian theory is terrible—it got us into this mess, we have to do something different. And that fed into this desire to use mathematics to set up elaborate models and to have everything be efficient."(2)

It led, in other words, to the recrudescence of precisely the sort of clean neoclassical models of efficiency, equilibrium, and omniscience from which Keynes, in 1937, had broken by publishing The General Theory of Employment, Interest, and Money.

The return back to neoclassical economics, however, was made easier by its never having really left. The Keynesianism prevailing for a time before, and for the thirty years after, the second World War was in fact a neoclassical synthesis of old ideas and new theory.

In Minsky’s recap of the standard telling, the process of synthesis began with J.R. Hicks’ influential 1937 article “Mr. Keynes and the ‘Classics’,” which introduced an interpretation and a simplified model (IS-LM) by which to understand Keynes. Hicks’ interpretation was the foundation of the influential economist Alvin Hansen’s work “in hammering out the American version of standard Keynesianism."(3) As a result, American (and a great deal of international) economic policy was guided by a neoclassical synthesis called Keynesianism into the 1970s.

Without getting into the neoclassical synthesis’ IS-LM model (which examines the relationships between interests rates and GDP), or the intricacies, such as they are, of neoclassical Quantity Theory (which essentially argues that prices are exclusively related to the amount of money in circulation), the fundamental difference between Keynesianism (whatever the version) and neoclassical theory is that the former argues that some form of government intervention into the economy is necessary to achieve full-employment stability, while the latter holds, to use Minsky’s words, that “a decentralized economy is fundamentally stable."(4)

Johan Van Overtveldt’s history of the Chicago School provides a succinct summary of the worldview underlying neoclassical theory:

The basic assumption of neoclassical economic theory is the proposition that in a competitive market environment, individuals and corporations pursuing their own self-interests necessarily promote the best interests of society as a whole.(5)

Thus, neoclassical economics, whatever its modifications or adjustments, is always in essence a cry for “pure” capitalism, while Keynesianism, whatever its color, is always at heart a proffered solution (more or less “radical,” depending upon one’s interpretation) to the problems of capitalism from within capitalism.

In JMK, Minsky writes that in the 1930s, neoclassical economics had held that events like the onset of depressions were anomalies; once they began there was nothing to do but ride them out. Coming from a different direction, orthodox Marxists “interpreted the Great Depression as confirming the validity of the view that capitalism is inherently unstable. Thus, during the depression’s worst days, the mainstream of orthodox economists and the Marxists came to the same policy conclusions: …nothing useful could be done to counteract depressions."(6)

The General Theory was thus simultaneously a response to worldwide depression, a dramatic (if not a clean) break with neoclassical economics, and an argument that while capitalism is “inherently unstable,” policy solutions from within do exist to ensure that “business cycles, while not avoidable, [can] be controlled."(7)

What made Keynes’ theory possible, in Minsky’s view, was a radical paradigm shift in perception that placed the “fragile” workings of the financial sector at the center of a complex modern capitalist economy:

Whereas classical economics and the neoclassical synthesis are based upon a barter paradigm—the image is of a yeoman or a craftsman trading in a village market—Keynesian theory rests upon a speculative-financial paradigm—the image is of a banker making his deals on a [sic] Wall Street.(8)

In this capitalist economy, full-employment equilibrium—indeed, equilibrium in general—is not possible because each stage of the business cycle contains the loose strands of its own unraveling. Actors operating in a sophisticated financial sector are engaged in “decision-making under conditions of intractable uncertainty” and as a result there are always “processes at work which will ‘disequilibriate’ the system."(9)

Financial collapses are the most pronounced examples of these disequilibriations:

[T]he financial system necessary for capitalist vitality and vigor…contains the potential for runaway expansion, powered by an investment boom. This runaway expansion is brought to a halt because accumulated financial changes render the financial system fragile, so that not unusual changes can trigger serious financial difficulties.… [S]tability…is destabilizing.(10)

III
What of Minsky’s claim that Keynes was basically misinterpreted by mainstream economics? And what of this claim in the context of capitalism’s “Golden Age?” Whether or not the neoclassical synthesis was an accurate interpretation of Keynes, the thirty years following World War II were notable in the history of capitalism for their relatively stable growth and their approximation to full employment. I put these questions to Papadimitriou.

Papadimitriou: Minsky realized that there were some important features that prevented a full-blown crisis from occurring. There were a number of near crises, but Minsky would agree that during the “Golden Age” there was a crucial role that both big government played as well as the big bank [i.e., the Federal Reserve].

Minsky was always interested in what is apt policy versus what particular item one should look for in a policy. Minsky’s own policy was that if you believe stability is destabilizing—that is, there is a tendency for the system to destabilize—you need to be prepared for that and do something about it to prevent it.

Yes, you can assume that private markets can be self-regulating as a result of profit seeking—you don’t want anything bad to happen. But on the other hand, we know that avarice and greed become a lot more important than self-restraint and self-regulation. So my suspicion is that Minsky would have said that you have to be able to rely on something other than policies emanating from traditional economic theory, like the neoclassical synthesis. As, for example, in the same way as Schumpeter had said that there will always be technological innovation, and therefore you will have creative destruction, Minsky was cognizant of financial innovation. And, there is a need, then, for sophisticated instruments of regulation that are required to keep up with financial innovation, especially if you believe that a sophisticated economy as ours is more or less a finance-guided economy. Look what has happened especially now, where the free-market mantra took hold beginning with the Reagan Presidency. Look at the results.

Had Minsky been alive today, he would have said that government doesn’t only have to play a role in expenditures [to generate adequate aggregate demand], but also, a role in industrial policy. And that has been absent. The American economy is superior to other economies in terms of high technology, aerospace, and probably agriculture. But you cannot sustain growth to provide for 300 million people [on these industries alone].

In addition to emphasizing that “there is no final solution to the problems of organizing economic life,"(11) Minsky argued that policies based on a correct interpretation of Keynes would direct government expenditures towards more socially and individually productive ends, and would also promote a more equitable distribution of income. Writing as the neoclassical synthesis was on the verge of giving way, he lamented the military spending and empty consumption of capital-intensive goods that had marked its heyday.

As Keynes summarized The General Theory, he avowed that there were two lessons to be learned from the argument. The first was the obvious lesson that policy can establish a closer approximation to full employment than had, on average, been achieved. The second, more subtle, lesson was that policy can establish a closer approximation to a more logical and equitable distribution of income than had been achieved.

To date [i.e., 1975] the first lesson has been learned, albeit in a manner that makes an approximation to full employment heavily dependent upon government spending in the form of defense production and private investment that sacrifices present plenty for questionable benefits in the future. … [T]he second lesson has been forgotten; the need for policy aimed to achieve justice and equity in income distribution has not only been ignored but it has been so to speak turned on its head.(12)

Raising questions of income distribution and inequality in America tends to lead, in both elite and barroom discourse, to cries of “class warfare” or worse, so I asked Papadimitriou to elaborate a bit on Minsky’s idea of equality in the context of the reality of default American economic ideology.

Papadimitriou: Minsky was very concerned about poverty. He thought the government should approach the poor from the perspective of, “why are they poor?” and seek to restructure the view about what government should do. He was against the idea of government transfers to alleviate poverty. He would have been intolerant of the government’s failure to do now what was done during the Great Depression through employment programs such as the Works Progress Administration and other programs of the New Deal, because he thought that by giving the poor these transfers the government changed their behavior as opposed to providing them with a job—giving them a goal and, to some extent, the capacity to enjoy a standard of living and social inclusion.

Minsky was realistic that the sort of equality connotated by the word “equality” is not achievable—it wasn’t achieved under socialism; it wasn’t achieved under communism. But, nevertheless, the question is, is it appropriate for one-tenth of the population to control that gigantic percentage of wealth, and to command that kind of income, relative to the bottom half, which basically does not have a chance to realize the prosperity that can be achieved in this country.

You can put it in a different way. The government plays the role of a redistributive vehicle. As an example, Minsky and others would be appalled at the Bush tax cuts being continued. They don’t do anything for aggregate demand, they don’t do anything in terms of increasing employment, and they don’t do anything in setting the economy on a path for growth. Therefore, Minsky would have insisted that these tax cuts cause the wrong kind of debt for the government to incur. He would have suggested other policies—for example, promulgating a tax structure that is progressive and not, like the payroll tax, regressive—that could bring about better outcomes. That would not lead to the same maldistribution of wealth we are experiencing currently.

But what about the perception of this maldistribution of wealth? There seems to be an odd phenomenon, arguably not limited to American society, by which the reality of discontent with income and wealth maldistribution is held in check by ambivalent feelings about to what degree it is actually malevolent. Back in April, former U.S. Senator Phil Gramm authored an op-ed in the Wall Street Journal in which he argued that Barack Obama’s presidency had brought about “higher taxes on the most productive members of American society."(13) This is a familiar stance on the right that is not wholly rejected by the population at large: the wealthy may create abundant riches for themselves, but they are the job creators who provide us with employment, and so anything we do to hurt their bottom line just ends up hurting our own. Or, even if that’s a bit hard to take, in any case, any remedy the government would come up with to address maldistribution would be worse than the malady itself.

And this ambivalence has an additional, aspirational contour. There is a famous quote, attributed to John Steinbeck, that runs, “Socialism never took root in America because the poor see themselves not as an exploited proletariat but as temporarily embarrassed millionaires.” I asked Papadimitriou if, putting the question of socialism aside, he thought the attitude towards the rich by the poor was in some ways informed by their seeing themselves not as the poor, “but as temporarily embarrassed millionaires.”

Papadimitriou: The majority of the population has that perspective, and that comes out clearly in the surveys that are run on individuals who are surviving on welfare checks and yet are against taxation because they believe there could be a time that they will be hurt. There is this longing, to go back to Steinbeck’s words, to become a millionaire.

On the other hand, there is another group of the population that is totally disenfranchised, and I doubt that these people have any notion that they will ever actually find a ticket out of their misery. You can see that in the inner cities, and in the increase of homelessness. IV
With respect to creating a culture that is receptive to the idea that there is a role for the government in promoting a more equitable society, the challenge faced by people like the Minskians is fourfold. First, a significant portion of the population at large must agree that the so-called “American Dream” is not alive and well. As Papadimitriou told me, “the ‘American Dream’ is fulfilled only for a segment of the population. Maybe the one percent in the income distribution ladder.”

Second, this same portion of the population must accept that the receding of the “American Dream” is not a result of government malfeasance but has its roots in the present structure of the system in which private actors operate.

Third, there must be widespread willingness to accept that government has a place in bringing about better economic outcomes and more equitable distributions of income.

Fourth, people must be willing to act on these beliefs to press the government to take action. (For all its myriad failings and inefficiencies, the government possesses a quality unique among powerful entities in that it is subject to some form of democratic accountability.)

Just how challenging the current ideological climate makes all of this was well encapsulated in an exchange that took place in July between Paul Krugman and George Will. Just after word emerged of a pending agreement between the House, Senate, and President to raise the ceiling on federal debt in exchange for spending cuts and budgetary reductions, both Will and Krugman appeared on the “roundtable” segment of ABC’s This Week:

Krugman: We used to talk about the Japanese and their lost decade. We’re going to look to them as a role model. They did better than we’re doing. This is going to go on—I have nobody I know who thinks the unemployment rate is going to be below eight percent at the end of next year. With these spending cuts it might well be above nine percent at the end of next year. There is no light at the end of this tunnel. We’re having a debate in Washington which is all about, “Gee, we’re going to make this economy worse, but are we going to make it worse on ninety percent of the Republicans’ terms or a hundred percent of the Republicans’ terms?” And the answer is a hundred percent.

Will: Paul’s right, we are a third of the way to a lost decade. But we’re a third of the way after TARP, the stimulus, Cash for Clunkers, dollars for dishwashers, cash for caulkers, the entire range of stimulus—the Keynesian approach which, by its own evidence, simply hasn’t worked. Now, Paul would double down—

Krugman: In advance—one important point to make is that people like me said, in advance, this wasn’t remotely big enough. It’s not an after the fact—

Will: That’s true.

Krugman: —it’s not coming back afterwards. Right from the beginning, I looked at the numbers—people like me looked at the numbers and said, we’re going to have cutbacks at the state and local level, you’ve got a federal increase which is going to be barely enough to limit those cutbacks. There’s going to be no net fiscal stimulus if you look at government as a whole, which is what happened. So here we are.

Will: It would be good to go to the electorate and have a Krugman election this time, saying, “Resolved, the government is too frugal. Let’s vote."(14)

And so, even in the face and fallout of a disastrous economic collapse brought about by a financial crisis that occurred in the maw of an era of pronounced deregulation and government rollback, the burden of proof remains on anyone who would argue that properly calibrated government intervention into the economy is not only necessary, but is also capable of producing more positive outcomes. (It is, of course, worth noting that many forms of government expenditure—defense and less visible subsidies and tax incentives for large businesses and wealthy individuals being obvious examples—are somehow exempted from categorization as government intervention into the economy.)

Thus, Will, who is somewhat rare among contemporary conservative commentators in broadcast media in that his is the professorial posture of a man who likes to take his arguments on the plane of ideas, was quite comfortable responding to Krugman’s points with nothing more than an arched rhetorical eyebrow, confident (not without cause) that such a response was all that was necessary to refute the most modest and elementary recommendations derived from Keynesianism.

In responding to a crisis which they agree calls for a basic Keynesian response, then, left-of-(rather conservative)-center political actors and analysts (Larry Summers, for example—a hedge-fund liberal and the most prominent embodiment of the “New Keynesian” heirs to the neoclassical synthesis, who was instrumental in developing the partially effective stimulus bill of 2009, and who was also an ardent supporter of financial deregulation in the 1990s—called for additional stimulus in 2011) find themselves in a circular process by which they are:

constrained by politics and ideology which → limits the force of the response which → leads to outcomes that partially attenuate but do not end the crisis which → allows opponents who have helped build constraints on a potential Keynesian response to claim to demonstrate that Keynesianism does not work which → builds even more confining constraints on its application.

And, if, returning to Minsky, he is correct that Keynes has been misinterpreted, the process above is, in some ways, the same process that Keynesianism itself underwent during, and immediately following, the reign of the neoclassical synthesis.

V
Why should Keynes’ theory have “triggered an aborted, or incomplete, revolution in economic thought?” Minsky offers a number of reasons. He suggests, for example, that The General Theory is a “clumsy statement” (“a great deal of the new [theory] is imprecisely stated and poorly explained”); that Keynes’ didn’t have a chance to participate in the interpretative debate following its publication (he was sidelined by a heart attack and then went to work in the war effort); and that it is not possible to perform controlled experiments in the social sciences (a familiar lament).(15) But two of Minsky’s explanations in particular stand out.

1) According to Minsky, “the older standard theory, after assimilating a few Keynesian phrases and relations, made what was taken to be real scientific advances.”

Even though economists had often argued as if the laissez-faire proposition, about the common good being served as if by an invisible hand by a regime of free competitive markets, were firmly established, it is only since World War II that mathematical economists have been able to achieve elegant formal proofs of the validity of this proposition for a market economy—albeit under such highly restrictive assumptions that the practical relevance of the theory is suspect.(16)

Keynes was therefore “made to ride piggy-back on mathematical general-equilibrium theory.”

As an outsider, it is hard not to see in this assimilation a manifestation of a broader tendency in mainstream economics to reach for an equilibrium of another kind. The au fond assumption away from which the field, generally speaking, seems to resist being pulled, and towards which it inevitably claws its way back, is precisely the neoclassical proposition Van Overtreldt describes in the citation above.

Of all of the social sciences, famously incomplete in their ability to comprehend human affairs, economics seems to be the least capable of acknowledging its limitations—or perhaps it is simply the most skilled at cagily hedging those limitations. After all, it seems reasonable to assume that the economic affairs of man are a complex affair, full of inconsistencies, contradictions, and odd behavior. Messy, in other words. And yet, it appears that theories within mainstream economics seeking to account for this mess—or seeking to counter the deleterious consequences of this mess—are at best partially assimilated, and at worst, wholly rejected in favor of models and modes of thought that don’t just envision and promote the benefits of the competitive workings of free and unfettered markets, but that also create an ideal out of them.(17) Further, any deviation is met with a redoubled effort to reinforce and/or retrofit the ideal. As Peter Temin told The Straddler, “The kind of models that many people use—general equilibrium models—start from assumptions of perfect competition, omniscient consumers, and various like things which give rise to an efficient economy. As far as I know, there has never been an economy that actually looked like that—it’s an intellectual construct."(18)

James Kenneth Galbraith’s words to The Straddler back in March of 2010 are of a similar flavor—and go further towards hinting at an explanation of why this might be:

[W]hen we encounter a doctrine of harmonization, of the smoothly functioning realization of the interests of all, the great and the small, which is textbook market economics, people should recognize that this is sand being thrown in their faces—that this cannot possibly be a realistic representation of the world in which we actually live. Take it as an analytic principle that one has to look at the behavior of the great with a cold eye.(19)

There is a famous and oft-cited quote of Keynes from The General Theory which runs:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.

Minsky agrees and disagrees, proposing that this quote “needs to be amended to allow the political process to select for influence those ideas which are attuned to the interests of the rich and powerful.” That is, ideas are important, but those ideas best suited to the advance and further entrenchment of the “vested interests” are often selected as the most important.

Perhaps it is this process, beyond the limitations of the field qua investigative social science, that accounts for mainstream economics’ radical idealism with respect to the functioning of capitalism.

2) But there is a further point to be made, using the final potential reason Minsky lists for the failure of full-throated Keynesianism to take hold as a point of departure:

[T]he Keynesian Revolution may have been aborted because the standard neoclassical interpretation led to a policy posture that was adequate for the time. Given the close memory of the Great Depression in the immediate post-World War II era, all that economic policy really had to promise was that the Great Depression would not recur. … Questions as to whether the success of standard policy could be sustained and questions of “for whom” and “what kind” and about the nature of full employment were not raised. The Keynesian Revolution may have been aborted because the lessons drawn from the standard interpretation not only did not require any radical reformulation of the society but also were sufficient for the rather undemanding performance criteria that were ruling.(20)

One wonders—in an age of florid and ever-increasing income inequality, stagnating wages for the majority of Americans, the recent development of high and persistent unemployment, and the pronounced deterioration in the quality of experience for the citizen as laborer (not only has job security disappeared, but the erosion of benefits for members of the workforce has increased as a structural adjustment of the meaning of employment continues apace) and for the citizen as consumer (interactions with providers of goods and services leave the consumer not infrequently in a netherworld between simultaneously complex, shoddy, and quickly obsolete products and poor, generally unresponsive support service)—if the implementation of an effective method to remedy the recent trajectory of economic citizenry would now require a radical reformulation of society. Or, what is more likely, if a change in society’s structure that, while not particularly radical, would be perceived as radical by those who have benefitted most from its current arrangements. Perhaps this is why Barack Obama’s speech on September 19th, in which he issued recommendations for tax increases on high-end incomes, and which contained a knowing and preemptive rhetorical strike against those who would call it class warfare, was greeted with cries of class warfare. (Class warfare, incidentally, is a concept with notable and defining instances in the actions of mankind. Examples in modern history include the French Revolution, the Russian Revolution, the Chinese Revolution, and America’s nineteenth-century labor battles. None of these events or movements seem to have had at its vanguard a battering ram in the shape of a modest tax increase.)

While a small sector of the society has been well served by the workings of America’s economic system, the vast majority of the population has reason for discontent. One suspects that this might become even more the case as the future unfolds. Under these circumstances, if you’re interested in defending the status quo, better to fight on the plane upon which you are strongest by wrapping yourself in the rhetorical trappings of American economic ideology and the reassuring tropes of American self-identity than to join the battle on the plane of real-world outcomes and conditions.

And better, too, if you are an economist with a stake in the game—a little too cozy, perhaps, with those who foot the bills, but by no means operating outside of the ethics of the field in which you ply your trade—to retreat to models demonstrating the fundamental correctness of your position, even if these models, in the end, have a dubious relationship to the actual world.

VI
It should be noted that in some ways, Minsky’s pessimism about the possibilities for stability within capitalism, may prove—subsequent to the 2008 “Minsky Moment”—too optimistic for present circumstances.

Speaking extemporaneously on a panel at the Levy Institute in June, the Washington University economist Steven Fazzari pointed up the potential for a cycle to get stuck at a particular stage:

What’s the converse of “stability is destabilizing?” Instability is stabilizing. I don’t know that Hy[man Minksy] would have ever said that, but the theory does imply this to some extent because it is a theory of indefinite cycles. So you get the boom, you hit the peak, you get the crisis, the crisis is cleansing—it may be extremely painful, but you wipe out the weaker units and you reestablish the conditions for growth again when the balance sheets are in some sense repaired. I think that’s the basic theory, the basic story.

So in that context, if you want to tie my question—what will be the aggregate demand generating process going forward—to a Minsky perspective, you have to ask how long will it take for balance sheets to be repaired? How long will it be until more robust conditions in the financial system are established?

A necessary condition for a more robust recovery is the improvement of the household balance sheet—leading to a restoration of better consumption, given that consumption is such a big part of demand. But I’m actually not fully convinced that this is sufficient. It’s necessary, but I’m not sure it’s sufficient.

Income distribution is a fundamental structural problem that goes beyond finance. The growth model in the US over the past three decades was one of relatively stagnant income growth across much of the income distribution, plugging the hole in demand with more consumer borrowing. So balance sheet improvement can help but it doesn’t seem to me that it deals with the additional issue of the income distribution. And there’s nothing on the table from a policy perspective or a structural perspective that would change this.

In other words, absent some significant event or dramatic change in policy, the fuse may have blown on the washing machine, leaving us stuck on soak.

Paul Davidson, editor of the Journal of Post Keynesian Economics, made a similar argument in his remarks at the Institute:

From the end of World War I to the beginning of World War II, the unemployment rate in the UK was double digits, except for one year when it was 9.7. That doesn’t sound like a cyclical problem to me, and it didn’t sound like it to Keynes, who basically argued that the economy had settled down at a long-run, stable unemployment rate which was very high. Just look at Japan in the 1990s and 2000s—and, I’m afraid to say, maybe a decade or two in the United States, beginning in 2007. So it’s not the ups and downs of a roller coaster—the capitalist system can be stable at less than full employment.

No one can know what will happen as the avenues to affluence and the economic expectations (be they grand or modest) that people have for their lives are more and more ostentatiously occluded for more and more members of the population. It’s not likely to be pleasant, as grievances tend to manifest themselves in all sorts of odd and often irrational ways (the Tea Party being Exhibit A in our own times). But it’s also always possible, of course, that the worm will turn and those who benefit least will fix their attention on those who benefit most. Perhaps this is American capitalism’s fundamental anxiety—indeed, perhaps it always has been. But in the aftermath—and in the midst—of its greatest crisis in eighty years, a heightened unease may help account for its pronounced defensiveness,(21) and the rigidity of its scholarly underpinnings.

VII
There remain broader questions. Though we are in a tough spot today partially because consumers are less able to play their accustomed role in demand generation, Minsky’s speculation that “[t]he joylessness of American affluence may be due to the lack of a goal, the acceptance of a standard in which ‘more’ is really not worth the effort"(22) rings no less true in these circumstances.

As of 1975, according to Minsky, “[t]he combination of investment that leads to no, or minimal net increment to useful capital, perennial war preparation, and consumption fads [had] succeeded in maintaining employment.” But though the period of the “Golden Age” had been remarkable in purely quantitative economic terms, in America it had “put all—the affluent, the poor, and those in between—on a fruitless inflationary treadmill, accompanied by…deterioration in the biological and social environment."(23)

And so, even if we accept that an economy should be geared towards full-employment with stable growth, a reasonably equitable distribution of income, and the potential to enjoy prosperity and affluence as goals, what form will this growth take? What do we mean by prosperity and affluence? And what are qualitative contours by which to gauge the well-being of members of our society?

At a time where a move back to some contemporary approximation of the moderate principles underlying the neoclassical synthesis would be regarded as radical, perhaps it is worth putting these larger, qualitative questions on the table as well.

Perhaps, too, it is time to urge the field of economics to wrestle with the complexity of a system whose limitations it is best not to elide in simplified models that have a Panglossian sanguinity at their core. And perhaps too it would be well to investigate the complexities that are actually produced by the limits of the capabilities of field.

For, as Minsky writes as he closes JMK, if, like Keynes, we think it best to live under an economic system “that sustains the basic properties of capitalism,” it should not be “because of the virtues of unfettered capitalism but in spite of its defects, which, though great, can in principle be controlled. ...[I]f capitalism is to be controlled so that the basic triad of efficiency, justice, and liberty is achieved, then the design of the controls will have to be enlightened by an awareness of what was obvious to Keynes—that with regard to both the stability of employment and the distribution of income, capitalism is flawed."(24)

Notes

1. “Full employment” is generally understood to mean a situation in which every person of working age who wants to work has a job, which is of course different than saying every person of working age has a job. In practical terms, unemployment rates below three, four, or even five percent—like those seen in the 50s and 60s, and again in the 90s—have typically been considered reasonably close approximations to full employment, not least because of the perceived relationship between low unemployment rates and the danger of an “overheating” economy leading to high rates of inflation. Indeed, there is a not uncontroversial concept in economics, the NAIRU (Non Accelerating Inflation Rate of Unemployment), which argues that there is a rate of unemployment (sometimes infelicitously termed the “natural” rate of unemployment) below which an economy ought not go lest it risk unsustainable rates of inflation. It is a subject of some debate precisely what this rate is, or if it is the same rate at all times, or if it is even a useful concept, but it’s typically claimed to be in the neighborhood of five percent.

It is also worth noting, of course, that the official rate of unemployment is always lower than the actual rate of unemployment because official measurements fail to include significant portions of the nonworking population. For example, in September of 2011, the unemployment rate in the United States stood at 9.1 percent, or 14 million, according to the Department of Labor. But there were an additional 2.5 million, or 1.6 percent, who were officially not counted (how many were unofficially not counted is another matter):

“In September, about 2.5 million persons were marginally attached to the labor force, about the same as a year earlier.… These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.…

“Among the marginally attached, there were 1.0 million discouraged workers in September…. Discouraged workers are persons not currently looking for work because they believe no jobs are available for them.”* (*United States Department of Labor. Employment Situation—September 2001. Washington D.C.: Bureau of Labor Statistics, 2011. http://www.bls.gov/news.release/pdf/empsit.pdf [bold type in original].)

The so-called “underemployed,” people who would like to work full time but are working in part-time jobs, are also not included in official measures of unemployment.

2. “What’s Natural? Peter Temin in Conversation with The Straddler.” The Straddler, springsummer2011. http://www.thestraddler.com/20117/piece5.php

3. Minsky, Hyman P. John Maynard Keynes. New York: McGraw Hill, 2008. 32.

4. Ibid. 2.

5. Overtveldt, Johan van. The Chicago School. Evanston, IL: Agate B2, 2007. 52.

6. Minsky. Op. cit. 6

7. Ibid. 7.

8. Ibid. 55.

9. Ibid. 11, 59.

10. Ibid. 11.

11. Ibid. 166.

12. Ibid. 158.

13. Gramm, Phil. “The Obama Growth Discount.” Wall Street Journal. 15 Apr 2011.
http://online.wsj.com/article/SB10001424052748703983104576262763594126624.html [my emphasis].

14. “Roundtable.” This Week with Christiane Amanpour. ABC: 31 Jul 2011.
http://abcnews.go.com/ThisWeek/video/roundtable-part-budget-endgame-14198610.

15. Minsky. Op. cit. 11-15.

16. Ibid. 15. Minsky continues:

“It turns out that the accomplishments of pure theory during the 1950s and 1960s are more apparent than real, when the problems of a financially sophisticated capitalist economy are under consideration.… Thus the purely intellectual pursuit of consistency between what was taken to be an elegant and scientifically valid microeconomics and a presumably crude macroeconomics has turned [o]ut to have been a false pursuit; microeconomics is at least as crude as macroeconomics.”

17. As one of The Straddler’s contributing editors, Gary Peatling, observes:

“I’m wondering if this unreality of neoclassical economics is itself a defense mechanism. Since a really unregulated economy is impossible (and is not even desired by the richest and most powerful vested corporate interests), any failure can be blamed on residual regulation. Hence the tenets are always irrefutable, in the manner of what Karl Popper termed a ‘bad science’ (although Popper might not have identified this). Also I’m reminded of John Ruskin’s comment that political economy was like science of gymnastics devised on the assumption that humans have no skeletons.” (Peatling, Gary. Personal communication. October 25, 2011)

18. Temin. Op. cit.

19. “The Predators’ Boneyard: A Conversation with James Kenneth Galbraith.” The Straddler, springsummer2010. http://www.thestraddler.com/20105/piece2.php

20. Minsky. Op. Cit. 16.

21. A comparatively mild articulation of this defensiveness was on display in a sympathetic 2010 New York Times Magazine profile of “lifelong Democrat” Jamie Dimon, CEO of Chase Bank:

“The executive I encountered was on a mission to reclaim a respected place for his industry, even as he admits that it committed serious mistakes. He was adamant that government officials—he seemed to include President Obama—have been unfairly tarring all bankers indiscriminately. ‘It’s harmful, it’s unfair and it leads to bad policy,’ he told me again and again. It’s a subject that makes him boil, because Dimon’s career has been all about being discriminating—about weighing this or that particular risk, sifting through the merits of this or that loan.” (Lowenstein, Roger. “Jamie Dimon: America’s Least-Hated Banker.” New York Times Dec. 1, 2010. www.nytimes.com/2010/12/05/magazine/05Dimon-t.html)

22. Minsky. Op Cit. 164.

23. Ibid. 163.

24. Ibid. 165.

Background Briefing: Ian Masters Interviews Dimitri B. Papadimitriou

October 23, 2011. Copyright © 2011 KPFK. All Rights Reserved.

Pacific Radio host Ian Masters interviews President Dimitri B. Papadimitriou about the looming crisis in the eurozone, the inadequacy of current proposals to resolve it, and the real possibility of contagion on this side of the pond. Full audio of the interview is available here.

By Thomas Masterson

Multiplier Effect, October 21, 2011

I study the distribution of wealth and income here at the Levy Institute, so I read the first five hundred words of Robert Samuelson’s Washington Post column on inequality (“The Backlash against the Rich,” October 9th) with interest and approval. But I knew it couldn’t last. Once Samuelson gets beyond description and attempts explanation and analysis, he is clearly out of his depth.

Samuelson turns his gaze to the proposal to raise income taxes on those with incomes above a million dollars, whom he refers to as “job creators”—a Republican Party talking point that Samuelson repeats uncritically. He makes two mistakes in citing a paper [Working Paper No. 589], written by my colleague Ed Wolff, in which the distribution of assets for the top 1% of households by wealth (total assets minus total debt) is compared to the distribution for the bottom 80%. First, Samuelson seems to assume that those people who own privately held businesses are small business owners. Second, not all of the people in the top 1% of household wealth are households making more than $1 million a year in income.

In Ed Wolff’s paper we see that the wealthiest 1% of U.S. households in 2007 held more than half of their net worth in “unincorporated business equity and other real estate,” and only 26% in financial assets such as stocks, mutual funds, bonds, etc. It is clear that Samuelson is translating the former category as “small and medium-sized companies.” This could be an honest mistake. But it is a mistake. There is no evidence in Ed Wolff’s paper that the top 1% contains all (or no) “small business owners.” Just that they hold twice as much wealth in privately held businesses as in publicly traded businesses. And as Kevin Drum of Mother Jones put it, “[w]e’re talking about people who earn upwards of a million dollars a year, after all. You don’t get that from taking a minority stake in your brother-in-law’s auto shop.”

If we actually look at those U.S. households receiving $1 million or more in income (using the 2007 Survey of Consumer Finances, as Ed Wolff does), we are talking about 0.37% of households. In terms of the composition of their assets, the picture is pretty much the same for them as for the wealthiest 1% of U.S. households. But only 24% of the top 1% of household wealth are in the million-dollar income club. If you look at the bottom 99.6% or the bottom 80%, the picture is very different. While the average net worth for the millionaires is $23.5 million, the rest of us have just under $445,000, and the bottom 80% have less than half that.

Even if you assume that all those people making a million or more in income are small business owners (stop laughing now, I’m trying to make a point), where is the evidence that raising income taxes on the wealthy will prevent them from creating jobs? There is no evidence. Here are the facts: Clinton raised the top rate to 39.6% and employment expanded by more than 20% during his presidency, while Bush the Younger lowered top rates and saw only a 2.3% increase in employment during his eight years. This is correlation, not causation, of course, but certainly no evidence for the claim that raising top rates is a job-killer.

Samuelson might appeal to logic, perhaps. But logic must deny the appeal. There is no valid logical argument, merely this: (1) raise taxes; (2) ???; (3) fewer jobs. There is, however, a case to be made in support of raising taxes on those with high incomes. Raising income taxes will increase the incentive to use profits to invest in the business (thereby increasing business-owners’ wealth) rather than as income. Which one of those options creates more jobs?

More importantly, Samuelson misses the elephant in the room in his discussion of the possible reasons for the increase in inequality over the last 30 years: public policy. Beginning with Ronald Reagan and continuing through Bush the Elder, Clinton, Bush the Younger, and right through to Obama, public policy has shifted more and more toward the benefit of the wealthy. In just about every sphere of public policy that impacts the economy, there has been an almost unilateral shift from policies that help workers to policies that help employers. From agricultural subsidies and embargoes that favor agribusinesses, to free trade policies that help manufacturers to move their plants to the location of the lowest bidder, and labor policies that have enabled the rollback of union power almost everywhere except the public sector itself, the policy landscape has looked ever more appealing to the wealthy and ever more bleak to the worker.

The Gold Report

Business Insider, October 19, 2011. Copyright © 2011 Business Insider, Inc. All rights reserved.

The Gold Report: Many of the resource companies in Pinetree Capital’s investment portfolio are gold companies. Gold went from above $1,900/ounce (oz.) in early September to around $1,600/oz. currently. Now, European central banks have sold 1.1 million metric tons of gold into the market to drive the price lower. Pinetree’s share price has followed gold lower and your exposure to gold remains high. What’s Pinetree’s pitch to investors right now?

Marshall Auerback: We had a very significant run up in the gold price, so some correction is understandable. But the conditions that created the run-up to $1,900/oz. have not dissipated. If anything, they’ve become more pronounced, notably in the Eurozone, where investors must begin to seriously consider the possibility of a break-up of the European monetary union and the implications that has for gold. And if you look at the monetary overhangs in places like China and Japan, it’s hard to find stores of value there either. So we have had some significant spec liquidation, some central bank sales—a plus, as central bankers are usually a great contrary indicator—and yet the price appears to have stabilized around $1,600/oz. Gold stocks, in contrast, still reflect valuations that are substantially lower than the current gold price. It is also important to note that the capital markets, in contrast to late 2008, have not shut down. Good quality mining projects can still obtain funding, especially for projects with robust economics, which a number of our holdings possess.

Pinetree has a unique structure. We raise money from the markets, which means that our longer-term funding requirements are, to some degree, shaped by market perceptions and market enthusiasm for resource stocks. But it also means we are not subject to monthly, daily or quarterly redemption pressures, so we can hold on to some smaller names that now offer the most compelling value they have offered in years.

TGR: A few years ago, Pinetree went from being focused on technology and biotechnology stocks to resource-based equities.

MA: Yes, the fundamental thesis has not changed. The developing world is likely to remain the dominant social, political and economic theme for at least the next few generations. Commodity prices have soared because the depletion of readily available resources is now finally outstripping the ingenuity of mankind to extract these resources. That is not just our view. Jeremy Grantham of GMO believes that this has changed the fundamental trend in real commodity prices, though the explosive nature of these prices in recent years has no doubt been amplified by speculation and historically unprecedented and ultimately unsustainable fixed investment in China. So you will get periodic corrections, especially during periods of global economic slowdown, but we don’t think this changes the long-term thesis. The portfolio composition has changed somewhat to reflect a changed economic environment of less base metals, more precious metals, but that is a tactical, as opposed to strategic, decision.

TGR: Did that one-month, $300-dollar drop in the gold price ruin gold’s reputation as a safe-haven investment?

MA: Not really. The price rise was, like other commodities, undoubtedly amplified by the actions of trend-following speculators. These are generally weak holders, and they tend to get shaken out when there are market gyrations of the sort that we have experienced over the past few months. But the fundamental reasons for holding gold have, if anything, grown stronger over the past few months.

TGR: Is the fear-trade gone? Is gold now trading strictly on supply and demand fundamentals?

MA: Given the way that markets have traded toward the end of the quarter, where you get maximum incentive to “paint the tape” in an upward direction, we think it is way too premature to suggest that the fear trade is over. Ultimately, though, gold is a supply/demand story. The market has been in fundamental deficit for decades and only the sales and leasing of gold by the central banks have prevented an even more acute price explosion.

TGR: The market is always about timing, but timing is even more important now given the rampant volatility in the markets. Fearing an economic collapse, many investors exited the junior sector once the volatility started in August. Many of those same investors remain on the sidelines today and some probably want to get back in. Is there something they should wait for—like a bottoming of the gold price—or is now the time to return?

MA: We think the time when you get maximum valuation is during these periods of turbulence and fear, when the baby gets thrown out with the bathwater. The good stuff is thrown out along with the bad as redemption pressures mount. Since we are in a comfortable position vis-à-vis our cash positions, we are in a good position to capitalize. Especially as Pinetree, for reasons explained before, doesn’t face comparable redemption pressures.

TGR: Our readers are primarily retail investors who like the high-risk, high-reward nature of the precious metals juniors. Pinetree is essentially a retail investor with lots of cash and a crack research team. How is Pinetree playing the current market? Have you been adding to your positions on the market dips? Have you sold off? Have you held tight? Give us the scoop.

MA: We try to “feed the ducks while they’re quacking,” in the sense that we recognize that many of these holdings are small and illiquid, and we tend to take large, strategic stakes. When our assessments are largely validated by market action, then we find that it is a good time to reduce, particularly because with these smaller, less liquid names, we are almost always going to be a bit early because we have to trim when there is good demand. This is especially the case when the company’s development has largely tracked what our analysts forecasted and with that comes the growing popularity of the shares with the broader market. Selling in those kinds of situations gives us the flexibility to take on new deals or, as is the case today, to buy from distressed sellers.

TGR: What are your favorite five gold plays in the Pinetree Capital portfolio?

MA: Gold Canyon Resources Inc. (GCU:TSX.V) is one. We are big believers in this deposit. The initial resource should be out by the end of this year and is promising to be several million ounces with grades exceeding most other bulk tonnage deposits in Canada. Looking at the dimensions of the deposit, specifically the new extension to the southeast, the potential here continues to grow far beyond what the company’s initial resource will give it credit for.

Queenston Mining Inc. (QMI:TSX) is the consolidation of key past producing mines in the prolific Kirkland Lake mining camp. There is an Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) take-out potential. Extensive drilling on the Upper Beaver and the South Mine complex joint venture with Kirkland Lake Gold Inc. (KGI:TSX) continues to add ounces.

RoxGold Inc. (ROG: TSX.V) is operating in Burkina Faso and has just raised the money needed to acquire 100% of its flagship asset. High-grade deposits are very hard to come by and the results it has consistently seen show potential for just that. With mid-major companies operating in the region, as RoxGold continues to add size, it becomes more and more likely to be an attractive candidate for a take-out.

Continental Gold Ltd. (CNL:TSX) recently reported a very large high-grade resource on its Buritica gold/silver/base metals deposit in Colombia. If you look around right now there aren’t too many deposits that hold size and grade like this one and, with 250 kilometers of assays to come since the resource was calculated, there is still a lot of upside from here.

Mawson Resources Ltd. (MAW:TSX; MWSNF:OTCPK; MRY:Fkft) is exploring at Rompas in Finland, a new discovery with bonanza gold where samples up to 22,723 grams per ton (g/t) gold and 43.6% uranium have been identified. The weighted average of all channel samples from the 2010 program is 0.59m at 203.66 g/t of gold and 0.73% uranium within a sampling footprint of 6.0 km. strike and 200–250m width. More than 300 discovery sites have now been identified within the mineralized footprint. At this very early stage of exploration, Rompas has to be considered as one of the most exciting global gold discoveries (with a uranium credit) to emerge into the marketplace, in terms of its high grades and hundreds of surface showing over a large area.

TGR: What are three gold plays Pinetree has positions in that few have ever heard of?

MA: Redstar Gold Corp. (RGC:TSX.V) is exploring in Alaska where properties have limited historical drilling. However, the company has seen very high grades. Currently, it is drilling up there and with the recent addition of the International Tower Hill Mines Ltd. CEO to their board, there is reason for interest. The company also has a joint venture with Confederation Minerals Ltd. (CFM:TSX.V) up in Red Lake. Thus far, Redstar has seen very high grades over 200 g/t over narrow widths stretching over a potentially several kilometer-long strike length. This kind of project requires lots of drilling; however, thus far, there has been some good continuity of success and with any sort of thicker intervals, this would be a project well worth the interest.

Prosperity Goldfields Corp.’s (PPG:TSX.V) exploration is headed up by Quinton Hennigh, who is also on the board of Gold Canyon and is heading up its exploration program. Stock had a large run-up prior to results, which the market clearly saw as disappointing. Despite this, we think these results show great promise given that Prosperity was the first in the area and the potential size of this deposit is very large. This project is in Nunavut; however, a winter camp has been set up and, relative to the region, the infrastructure is better than most.

Terreno Resources Corp. (TNO:TSX.V) is focused on a few different resources in South America. The company just raised $2.8 million and so it is cashed up to move forward on the initial exploration of both precious/base metal projects in Argentina as well as their phosphate/potash exploration in Brazil. It has had some solid trench results thus far down in Argentina, which is promising. The phosphate/potash market seems to be one of the few places where most analysts agree there will be a lift in pricing in the future so we are excited to see the exploration results.

TGR: Let’s switch gears to silver. Does Pinetree believe silver is a better near-term investment than gold?

MA: No, we think gold is likely to be the better performer if a global recession becomes the predominant concern, as opposed to systemic issues. That said, there have been some fairly violent moves to the downside over the last few weeks. The bear talk on China has really been overdone. Remember, China has over $2 trillion in foreign exchange reserves, so it has ample firepower to combat the forces of recession. In the very short term, we could get these massively oversold conditions worked off if it looked like the world was not coming to an end and silver could have a nice pop. Look at the U.S. data recently:

• Since late August, the U.S. economic data has surprised somewhat to the upside.
• Initial unemployment claims rose less than expected; September chain store sales look stronger than expected; Ford Motor Company’s sales for September were up 9%.
• It looks as though GDP growth may come in better than 2% annually in both the third and fourth quarters, surpassing recent pessimistic expectations.

As far as China itself goes, suddenly all the analysts, economists and portfolio managers that were all bulled up on China two years ago, a year ago and even six months ago have become all beared up on China. We are hearing about an imminent hard landing in China from everyone. So why the sudden bearishness about China?

It is claimed that China’s informal credit market is out of control. Property developers and businesses are starved for credit; business investment and real estate will fall. A hard landing is at hand. Let’s put this informal credit market into perspective.

This informal credit market is estimated at 3–4 trillion yuan RMB. The Chinese economy is now estimated at something north of 40 trillion yuan. According to Fitch, the formal credit market plus the shadow banking system totals about 70 trillion yuan.

When one looks at these numbers one can see that the growth of informal lending and the extremely high interest rates on informal lending represent a problem in China. But it does not impact a significant share of aggregate expenditures.

The real problem lies with the banking system and the shadow banking system.

TGR: Is this important credit market now poised to take Chinese aggregate demand down?

MA: We doubt it. Interest rates in the banking system are negative in real terms. The banking system is still expanding at a double-digit annual rate. Interest rates in the shadow banking system are much higher; they are no doubt positive in real terms, but it appears they are not usurious. In any case, this credit is still being allowed to expand at a very rapid rate. Will the authorities be able to deal with problems in the banking system or shadow banking systems, which are the credit markets that matter?

The answer is probably yes. The biggest credit excesses and the biggest white elephant fixed investments in this cycle lie with the local authorities. The Chinese government in one fell swoop removed half a trillion dollars of such loans off the backs of these local authorities. A half a trillion dollars! That is as large as the entire alleged informal credit market that everyone is getting so beared up about.

Longer term, the Chinese economy is an out-of-control Ponzi economy. Labor force growth will go negative. Surplus labor in agriculture is depleting. Fixed investment is impossibly high relative to a falling warranted rate of growth. Very bad things will eventually happen. However, the Chinese economy is also an extreme command economy. Extraordinary measures will be taken to avert these very negative outcomes.

The Chinese economy is highly indebted. The Chinese central government is not. Before the proverbial you-know-what hits the fan, the Chinese government will use its balance sheet to keep the white-elephant over-investment juggernaut going. Do not underestimate the fiscal capacity of the Chinese government and its willingness to use it. We do not think the excesses today in the Chinese informal credit market are a reason to get very beared up on China all of a sudden. The Chinese bear story will unfold progressively over a long time.

The real threat in China is inflation. China’s fixed investment has become increasingly credit dependent. To keep the fixed-investment juggernaut going and avert a hard landing, there must be sustained rapid money and credit expansion. There is already a large monetary overhang. The combination of these flow and stock dynamics threaten a very high inflation down the road. Which again makes the long-term case for gold very bullish.

TGR: Where is Pinetree getting its exposure to silver?

MA: Apogee Silver Ltd. (APE:TSX.V). The company’s primary focus is the Pulacayo-Paca Property located in southwestern Bolivia. The property includes the historic Pulacayo mine, which was the second largest silver mine in Bolivia’s history with historical production exceeding 600 million ounces of silver. Although there is obviously some risk with dealing in Bolivia, there are still many operating mines and we feel the deposit warrants the risk.

Southern Silver Exploration Corp. (SSV:TSX.V; SEG:Fkft) recently acquired the Cerro Las Minitas property in Durango, Mexico. There is a history of production right in the middle of the property and thus far, the company’s initial holes have been promising. This is a very early stage project and there is a lot more definition needed before a resource can be laid out; however, Southern Silver is in a good region and we feel the property certainly has potential.

TGR: What are some investment themes that you expect to play out in the coming months?

MA: We think that the markets could surprise again to the upside as we have apparently discounted a double dip recession, whereas a slowdown might be more accurate. This period might end up being closer to 1998 than 2008.

The trouble with the view that we are heading for another 2008 is that all crises are different. But they do share one common element: the inability of markets to perceive that when a market discontinuity is fresh in the minds of investors (e.g., 2008); it seldom repeats until that institutional memory is dissipated. Now, I believe that European banks are insolvent conditional upon the PIIGS collectively being insolvent. Clearly, this is the case for Greece (although the European Central Bank (ECB) could easily forestall this if it keeps buying Greek debt), but for the others, this is unclear—and, particularly in the case of Spain and Italy, a function of the rates at which they can borrow. So while the ECB provides a liquidity backstop, they have the room to adjust. Of course, the missing ingredient is growth. Europe already looks as though it has slid into recession. I would argue that recession, as opposed to systemic risk and bank runs, is already priced into European stock markets. But nothing is certain.

While the current crisis in Europe is worse than the 1998 crisis with LTCM and Russia, in 1998 it was thought that the entire system would collapse. Remember in 1998 Fed funds were 5%, not zero; 10-year notes, above 4%, not 2%+; 2-year notes were 5%; SPX was 30x earnings, not 15x. We had not gone through a 1974-style liquidation in reverse parabola terms except for the one day 1987 sell-off, as we did in 2008–2009. Real estate (houses) was not selling for prices yielding 10%–15% on lower-end real estate, but that is where the focus of foreclosures is felt. The story will be told in the next eight trading days.

TGR: Thank you for your insights.

As Pinetree Capital’s corporate spokesperson, Marshall Auerback is a member of Pinetree’s board of directors and has some 28 years of global experience in financial markets worldwide. He plays a key role in the formulation and articulation of Pinetree’s investment strategy. Auerback is a research associate for the Levy Institute and a fellow for the Economists for Peace and Security.

By Catherine Hollander

National Journal, October 11, 2011. Copyright © 2011 by National Journal Group Inc.

The U.S. job market has shown lackluster growth recently, to put it mildly.

The September employment report, released on Friday, revealed that nonfarm payrolls added just 103,000 jobs last month—not horrific, but still under the threshold economists say they need to cross in order to dent unemployment. The Senate is likely to vote on the job-creation proposals in President Obama’s $447 billion American Jobs Act this week, but the bill’s passage is a long shot.

As they consider the legislation, lawmakers may want to reflect on their counterparts across the Atlantic.

While each economy faces unique obstacles to growth, fellow developed countries like Germany, Denmark, and France have implemented programs analogous to some found in Obama’s jobs bill with success. These include job-search programs accompanying unemployment benefits and stepped-up apprenticeship programs.

Other countries have developed programs not found in the president’s legislation, such as mechanisms to certify workers who have gained skills on the job rather than in the classroom.

Unemployment insurance programs vary widely from country to country. As of 2007, the most recent year for which data was available, the U.S. paid employees 13.6 percent of their previous earnings on average, compared with 24.7 percent in the Organisation for Economic Co-operation and Development as a whole, which counts the U.S. and 33 other wealthy countries as members.

The U.S. also has short-lasting unemployment benefits compared with most of the other OECD members. By itself, this provides a “powerful incentive” for the unemployed to look for their next job, according to Gary Burtless, an economist at the Brookings Institution.

But other OECD countries have deployed different incentives to get recipients of unemployment benefits back to work. Many low-paying jobs in the U.S. pay around the same as the benefits. Other countries have ensured work earnings are higher than unemployment benefits, incentivizing recipients to look for a job, according to Stefano Scarpetta, the OECD’s Deputy Director for Employment, Labour, and Social Affairs. 

Some OECD countries have bolstered their programs to help the recipients of unemployment insurance re-enter the workforce. France and others have made unemployment benefits conditional on searching for a job and participating in re-employment programs. The U.S. has paid less attention to investing in such labor market institutions, Scarpetta said.

He recommended focusing on “training, apprenticeship, and skills” to boost unemployment among the most vulnerable sectors of the population -- the young and long-term unemployed. Countries such as Germany and Denmark stepped up their traditional apprenticeship programs in response to the economic downturn. The pumped-up programs have a strong track record of landing apprentices with jobs, Scarpetta said.

The American Jobs Act proposes to do this through new training for the recipients of unemployment insurance -- so-called “bridge to work” programs modeled after efforts in Georgia and North Carolina. These programs allow long-term unemployed workers to continue receiving unemployment benefits while they pursue work-based training.

Such training could have secondary benefits, eliminating unwanted social trends such as crime and depression that are associated with high unemployment levels, according to Dimitri Papadimitriou, president of Bard College’s Levy Economics Institute. He called the training programs a “very good idea.”

But Papadimitriou cautioned that without a more general economic recovery, simply training unemployed workers doesn’t guarantee jobs. Others fear it will be difficult to find employers willing to bring in unpaid trainees. They like to maintain control over the hiring process, Brookings’s Burtless said.

It would be more fruitful in the long run to reform the way the U.S. thinks about employment training, he said.

Several OECD countries, including Portugal, have created mechanisms by which workers who drop out of school but gain skills on the job can have those skills certified, making them more attractive to potential employers.

The U.S. places too much emphasis on formal educational credentials and not enough on skills acquisition, Burtless said. A European-style certification program could make on-the-job training more valuable by providing workers with proof that they have a transferable skill.

Such a program runs the risk of locking workers into too-rigid skill certifications, which could harm their ability to appear flexible in a changing workforce, according to Randall Eberts, president of the Upjohn Institute for Employment Research. It would not provide immediate unemployment relief, and it would take time for employers and workers to recognize the value of the certificate, but it could provide a huge help in the long run to a large portion of workers who complete their training on the job, Burtless said.

Some economists were hesitant to make comparisons between the U.S. and the smaller European countries, whose economies operate in a different political environment. And it will ultimately take strong overall economic growth to turn around the labor market. Supply-side changes will have a limited impact without an accompanying improvement in demand, Papadimitriou argued.

But in the end, the point is not that other developed countries have it all figured out—it’s that no one does, and looking at programs that have been implemented abroad can be a useful jumping-off point for discussions of job-creation measures in the U.S.

By Dimitri B. Papadimitriou

Truthout, September 9, 2011. Copyright © 2011 Truthout. All Rights Reserved.

“By 1970, the governments of the wealthy countries began to take it for granted that they had truly discovered the secret of cornucopia. Politicians of left and right alike believed that modern economic policy was able to keep economies expanding very fast—and endlessly. That left only the congenial question of dividing up the new wealth that was being steadily generated.”

Those words, from a Washington Post editorial more than twenty-five years ago, echoed the beliefs not only of politicians and the press, but of mainstream economics professionals resistant to the idea that growth in a market economy would ever stagnate over a protracted period.

And some of the data did fit nicely. Through several recessions and recoveries, inflation-adjusted GDP rose almost in tandem with a line of predicted growth expectations. But in November 2007, something changed. Real GDP dropped down from what was expected by more than 11 percent, and, as this summer’s data has shown, it hasn’t returned to its pre-recession trend.

The unusual slump has provoked a stream of commentary that attempts to define the problem, but it hardly matters whether the downturn is identified as the second dip of a “double-dip” recession, a continuation of the “Great Recession,” a fast-moving slowdown, a slow nosedive, a long-term stall-out, or a confirmation that the economy has entered a Japanese-style “lost decade.” Growth during the 21st century is following a different trend line than it did in the 20th, and employment is also responding in new, different ways from earlier post–World War II recessions.

A range of additional data also indicates that what we’re hearing is not the regular breathing of an economy as it contracts and expands. Annual growth rates and quarterly moving averages—when examined starting in the mid 1970s, as Greg Hannsgen and I did at the Levy Economics Institute [see One-Pager No. 12]—show a steady decline beginning in 2000.

And the employment numbers make the case yet again. Look at the graph below, with separate lines for the past six recessions. It traces employment-to-population ratios, beginning with the first month of each recession. These ratios are used to measure, among other things, how well a nation utilizes its workforce—a kind of labor drop-out rate.

You can see at a glance that the pink line indicating the current recession—yes, that one down near the bottom of the chart—is an outlier in the group. It shows that by the 43rd month of the downturn, the ratio stood at just over 58 percent, meaning that 58 percent of the population was employed. That figure is 4.6 percent less than at the recession’s start, when more than 62 percent were working. And it means that this employment decline is steeper, deeper, and longer than in any of the previous five recessions by a long shot.

Even in the two worst recoveries during the past forty years, this ratio never before declined by more than three percent. By the time the five recessions were this far along, employment had returned either to pre-recession levels, or to a distance from the recession’s start that was, at worst, two percent, compared to the current more than four percent.

Together, this data makes the case that we’re in a prolonged slump that’s highly unusual, and requires action that’s far more aggressive than the usual responses. Job creation should be the government’s urgent, first priority. The nation needs to recognize just how perilous the employment disaster is—and what a marked departure this recession is from any we’ve seen in the modern era.

Dimitri B. Papadimitriou is President of the Levy Economics Institute of Bard College and Executive Vice President and Jerome Levy Professor of Economics at Bard College.

Interview with Pavlina R. Tcherneva

September 8, 2011. © 2011 by Wisconsin Public Radio

As Obama tours the East promoting his jobs bill, and jobs forums spring up across Wisconsin, Research Associate Tcherneva and host Ben Merens talk about what should be done now to address unemployment. Full audio of the interview is available here.

By Peter S. Goodman

Huffington Post, September 1, 2011. Copyright © 2011 TheHuffingtonPost.com, Inc. | “The Huffington Post” is a registered trademark of TheHuffingtonPost.com, Inc. All rights reserved.

As President Obama puts the finish on a much-touted program aimed at promoting job creation, public expectations appear low, owing to national dismay over a deep unemployment crisis and the partisan division ruling Washington.

But put aside the limitations of political possibility—granted, a bit like ignoring gravity—and many economists assert there is much the government could do to put large numbers of Americans back to work.

At the top of many to-do lists is government spending into the tens of billions of dollars to finance large-scale public works projects, a strategy that could address a gaping mismatch: Nearly 14 million Americans are officially out of work, yet a great deal of work needs to be done, from repairing dilapidated roads and bridges, to retrofitting government office buildings with energy-efficient infrastructure.

“If the government spends the money directly on government-funded projects, that puts people on payrolls,” said Gary Burtless, a former Labor Department economist and now a senior fellow at the Brookings Institution in Washington. He added that the bulk of hiring and spending is likely to be confined to the domestic economy. “You can’t get Brazilian workers to pave a road here in the United States, and lots of capital goods that go into infrastructure would also be produced in the United States,” he said.

Critics of infrastructure spending as a proposed fix for unemployment have argued that it can be inefficient: A surge of money let loose through federal and state bureaucracies invites waste and abuse. To which proponents ask, compared to what?

“The other waste that we should keep front and center in our minds is having nine percent of the workforce unemployed,” Burtless said. “If some of the money is wasted because it is spent too quickly, you’ve got to put that in context of the complete waste of the talents and abilities of the 11 million Americans who would be working if we were at full employment today.”

Infrastructure spending is particularly promising, say proponents, because it is likely to generate jobs in the very areas of the economy that have been hardest hit as the housing boom has gone bust—construction and manufacturing.

“We still have mass layoffs in those sectors,” said Pavlina R. Tcherneva, an economist at Franklin & Marshall College. “It seems very obvious that we can absorb large numbers of workers in those sectors for the public good.”

One proposal that has gained favor among some economists in recent months—among them, Jared Bernstein, previously chief economic adviser to Vice President Biden and now a senior fellow at the Center on Budget and Policy Priorities—would direct $50 billion toward repairing aging schools, with a particular focus on making buildings more energy efficient. Proponents say this spending would be financed over a decade by closing $46 billion worth of tax loopholes that now favor the traditional oil and gas industry.

According to an outline of the Fix America’s Schools Today proposal, the nation’s roughly 100,000 public schools confront a backlog of deferred maintenance projects that reaches $270 billion, meaning this money could quickly be absorbed and put to use.

“This is labor-intensive work,” Bernstein told the Huffington Post. “And that’s a good thing. That means more jobs.”

Bernstein helped craft the nearly $800 billion in stimulus spending measures delivered by the Obama administration in early 2009—a package that has since become a symbol of disappointment across the ideological spectrum. Those favoring more aggressive government intervention, led by the economists and Nobel laureates Paul Krugman and Joseph Stiglitz, derided it as too small and poorly targeted to reinvigorate economic growth. Conservatives such as John Taylor, a member of the Council of Economic Advisers in the George H.W. Bush administration, and now a senior fellow at Stanford University’s Hoover Institution, pronounced it a wholesale waste of money that did not create jobs.

But Bernstein and many other economists maintain that the package prevented the unemployment rate from climbing even higher, and he would favor unleashing a new dose of one of its key components: aid for distressed state and local governments, whose budget troubles have prompted deep and sustained layoffs. This is now the dominant force exacerbating joblessness.

“It’s as simple as two plus two,” Bernstein said. “You have states that have to balance their budgets and they are still cutting deeply and they either raise taxes or reduce service, and they have been doing more of the latter, leading to layoffs. State and local fiscal relief would be a great way to get much needed, fast-acting medicine into the system.”

But as Bernstein acknowledges, such proposals are not on the agenda among the decision-makers in Washington, who have instead been consumed with debate over how to reduce the federal budget deficit.

“I don’t see it on anyone’s to do list,” Bernstein said. “It’s very much a should. I’m not sure if it’s a could.”

Among job creation initiatives that experts say could emerge from Washington—albeit, not without considerable congressional wrangling—are the continuation of a temporary reduction on payroll taxes, and the extension of emergency unemployment benefits for people who have been out of work for six months or longer. Both of these temporary programs are set to expire at the end of the year, absent congressional action.

Collectively, they are pumping between $150 billion and $170 billion annually into the economy, Bernstein said.

Beyond the Beltway considerations constraining the scope of policy, some economists advocate more sweeping efforts to generate new jobs by the million.

Tcherneva, the Franklin & Marshall economist, says we need a modern version of the Works Progress Administration, one of the most ambitious undertakings of the New Deal, the federal government’s response to the alarming joblessness of the Great Depression. Then, the government directly employed millions of people, aiming them at building out public works projects of enduring value—dams, highways, parks and firehouses. This time, the federal government could channel funds to state and local government that could then employ private sector firms to build and revamp the needed infrastructure of today, adding light rail to reduce traffic congestion in major cities, upgrading parks and improving access to public education.

“There is such a wide need out there,” Tcherneva said. “The private sector is not creating enough jobs. We need an explicit government commitment to put the jobless to work.”

Some economists argue that infrastructure spending, while a potentially useful way to generate jobs, is not the most potent channel. A paper published last year by the Levy Economics Institute of Bard College concludes that so-called social care—meaning early childhood education and home health care for the elderly—could generate even more jobs per federal dollar spent than infrastructure projects.

“It gives you about twice as many jobs per buck as infrastructure,” said Thomas Masterson, an economist at the Levy Institute and one of the paper’s authors. “And it’s more targeted for women who tend to be disadvantaged.”

The paper calls for $50 billion in annual government spending to hire early childhood educators who would provide child care for young children whose parents cannot afford it. The money would also provide home health care aides for the elderly.

Both of these areas of the economy provide large numbers of jobs to people lacking college degrees—a group now struggling with particularly severe unemployment. Among high school graduates 25 years and older who did not complete college, less than 55 percent are now employed, according to the Department of Labor. That is down from 60 percent four years ago.

Beyond the direct employment benefits, such a program would enable parents now unable to pay for child care to earn income outside their homes, while boosting the skills of children receiving care, Masterson said. Many states are now slashing support for subsidized childcare programs, while also cutting cash assistance programs for poor single mothers.

Other economists assert that the key to job creation is a focus on the people who should be cutting the paychecks, generating fresh incentives for employers to hire.

Two years ago, when the economy was still shedding hundreds of thousands of jobs each month, Aaron Edlin, an economist at the University of California at Berkeley and Edmund Phelps, an economist and Nobel laureate at Columbia University, delivered a paper calling for targeted tax credits for employers who hire low-wage workers.

“The credits would quickly boost the number of low-wage people that businesses employ,” the scholars asserted in their paper. “As the market for low-wage people tightened, the competition for them would pull up low-end pay rates.”

Edlin told HuffPost that this approach is now more urgently needed than ever.

“We have a serious risk of a double-dip recession,” he said. “If one is willing to ignore the political constraints, the best way to get large numbers of people back to work is to give tax credits or subsidies to employers for employing people, and particularly the people who have suffered the most, and that’s low wage people.”

Debate centers on whether such programs would produce sufficient benefits in an economy now painfully short of demand for goods and services, as consumers battered by years of diminishing fortunes pull back on spending.

Masterson, the Levy Institute economist, said that most employers are too worried about weak sales prospects to respond to an incentive to hire.

“If they can’t sell the stuff that they can make now, then why are they going to hire more people?” he said.

But in an economy the size of the United States’, some companies are always expanding. The tax incentives might coax those employers to hire more people than they would have otherwise. And once those workers have extra wages, they would distribute them at other businesses, thus creating more jobs—a virtuous cycle. This is the theory, at least.

“If workers are temporaily on sale,” said Brookings’ Burtless, “that will give employers a reason to add to their payrolls sooner rather than later.”

By Agostino Fontevecchia

Forbes, August 30, 2011. © 2011 Forbes.com LLC™. All Rights Reserved.

“[This] recession has turned into a prolonged and very unusual slump in growth, preventing a labor-market recovery,” explained Dimitri Papadimitriou, head of the Levy Economics Institute, in a recent paper called Not Your Father’s Recession. The economist makes the argument that post-crisis GDP growth rates are about 11.9% off of historical standards, which, along with the employment-to-population ratio, suggest the current macroeconomic environment is a lot more challenging than in other recessions and will need the intervention of government to recover.

“Considering the already severe slump in job creation, it hardly matters whether such a downturn would constitute the second dip of a ‘double-dip’ recession, a continuation of the ‘Great Recession,’ or a confirmation that the economy has entered a Japanese-style ‘lost decade,’” wrote Papadimitriou, adding that a labor-market recovery appears unlikely without help from the government, and the data proves it.

Economics hasn’t come to terms with the possibility of a market economy stagnating over a protracted period because its models are based on constant growth. The reality is that market economies have grown relentlessly during the XX century.

Papadimitriou illustrates it with a chart overlaying an exponential growth line to an inflation adjusted-GDP series from 1967 to today. The match is almost exact all the way to 2007; today, real GDP is “11.9 per cent less than one would have expected based on earlier data.”

It’s no surprise that a depressed U.S. economy has kept output at multi-year lows. Recent revisions show Q2 GDP growing at a meager 1%, suggesting post-recession growth came from now-exhausted stimulus packages. Papadimitriou takes it one step further, arguing that average GDP, as illustrated by 12-quater, 20-quarter, and 28-quarter moving averages, has been declining since 2000.

One of the most worrying signs of the U.S.’ generalized economic weakness is the state of labor markets, particularly when compared with other post-recession recoveries.

Employment-to-population ratios bottom out 18 to 37 months after the onset of the recession in each of the previous six cases of output contraction. This time around, 43 months after the beginning of the recession, the trend continues to be negative, with the ratio down 4.6% to 58.1% in what has been almost four years of negligible recovery in labor markets.

With Chairman Ben Bernanke choosing to stay on the sidelines and the private sector immersed in a cycle of deleveraging, Papadimitriou points the finger at government, noting “the [federal] government has barely begun the task of creating the new jobs needed to deal with this disaster.”

Further stimulus will face staunch opposition in Congress, with Tea Party candidates taking the reins of the Republican Party on a cut spending-platform. The White House has leaked, though, an announcement that President Obama will unveil a new jobs plan, which is expected to be some sort of stimulus, in September.

It remains to be seen whether the situation in Europe will worsen, or if a moderate improvement in economic conditions in the second half of the year, coupled with Obama’s coming plan, will help push the economy out of the gutter.

By Alexander Eichler

Huffington Post, August 22, 2011. Copyright © 2011 TheHuffingtonPost.com, Inc. | “The Huffington Post” is a registered trademark of TheHuffingtonPost.com, Inc. All rights reserved.

During the 2008 financial crisis, when the nation’s banking system seemed on the verge of collapse, President George W. Bush authorized a $700 billion bailout of the financial industry. The U.S. Treasury implemented that program, known as TARP, in an effort to stave off economic catastrophe.

At the same time, and in the years that followed, the Federal Reserve was undertaking its own rescue operation, in the form of private, previously undisclosed loans to banks and other institutions—lending as much as $1.2 trillion, nearly twice the amount of the Treasury bailout, according to a data analysis performed by Bloomberg News and published on Monday.

The scope of the Fed’s private lending had previously only been guessed at, but figures obtained under the Freedom of Information Act by Bloomberg News show that the nation’s central banker issued loans to more than 300 institutions between August 2007 and April 2010, including over 100 loans of $1 billion or more.

While the Fed’s loans likely helped to prevent a complete implosion of the global banking system, analysts say they fear the loans may have contributed to an atmosphere of complacency on Wall Street. Banks that received emergency cash infusions during the crisis may now believe the Fed will always be there to bail them out of trouble, the thinking goes.

“It is a classic case of moral hazard,” Dimitri Papadimitriou, president of the Levy Economics Institute of Bard College, told The Huffington Post.

The Federal Reserve itself had argued that the details of its emergency loans should be kept out of the public eye, claiming that the reputations of the firms involved could suffer if they were seen to be taking money from the government in order to stay afloat. Many of the banks that borrowed from the Fed had previously appealed to the Supreme Court to keep those records secret.

However, an invocation of the Freedom of Information Act forced the Fed to release more than 29,000 pages of documents, revealing the extent to which the financial sector relied on Federal Reserve dollars during the worst days of the crisis.

Given the extraordinary size of the loans, the public has a right to know what happened, said David Jones, an executive professor at the Lutgert College of Business at Florida Gulf Coast University.

“It’s completely valid at some point to say, ‘Who did the borrowing?’“ Jones told The Huffington Post. “It was appropriate, under this special set of circumstances, to divulge the information.”

Among the largest borrowers were Bank of America, which borrowed $91.4 billion; Goldman Sachs, which was in debt for $69 billion; JPMorgan Chase, which borrowed $68.6 billion; Citigroup, which borrowed $99.5 billion and Morgan Stanley, the biggest borrower of all, to which the Fed loaned $107 billion.

In addition, the Fed issued sizable loans to a number of foreign banks, including the Royal Bank of Scotland, which borrowed $84.5 billion; Credit Suisse Group, which borrowed $60.8 billion and Germany’s Deutsche Bank, to which the Fed lent $66 billion. Nearly half of the 30 largest borrowers were European firms, according to Bloomberg News.

While the amount of lending that took place is remarkable, some argue that the Fed’s error was not in issuing the loans, but rather in doing so without setting stronger policy reform conditions for the money.

Dean Baker, co-director of the Center for Economic and Policy Research, told The Huffington Post that Federal Reserve Chairman Ben Bernanke could have attached a “quid pro quo” to the emergency loans—stipulating, for example, that the money would only come through if the banks agreed to do business in a less risky way going forward.

“This is the moment all the banks were on their backs,” Baker said. “The Fed ran to the rescue and got nothing in return.”

A previous disclosure in December found that the Fed issued $9 trillion in low-interest overnight loans to banks and other Wall Street companies during the crisis. The $1.2 trillion figure represents the peak amount of outstanding loans, which occurred on December 5, 2008, according to Bloomberg News.

Some critics contend that while the Fed was right to support the financial sector, the government didn’t do enough to help ordinary citizens who were also seeing their wealth evaporate during the crisis.

Papadimitriou told The Huffington Post that the Fed issued many of its biggest loans during the Bush administration, and that “they didn’t appear to have any difficulty supporting the financial sector, but very much difficulty supporting the real sector, households.”

Consumer spending suffered and unemployment spiked in the wake of the financial crisis, and the economy remains weak today. Output is low, consumer confidence is down and millions are still out of work—factors that have some economists worried about the possibility of a double-dip recession.

The TARP bailout, led by the Treasury, was the subject of much popular ire when it occurred, since it was seen as a case of the government throwing money at the financial sector at the expense of everyday Americans. Similarly, the Fed’s $1.2 trillion in emergency loans were primarily aimed at keeping major financial institutions on their feet.

“One would assume banks are too interconnected, you have to help all of them,” Papadimitriou said. “But if you take households in total, they are also all interconnected. They are also too big to fail.”

New Economic Perspectives, August 13, 2011. Copyright © 2010 KPFK. All Rights Reserved.

Senior Scholar Wray joins Masters for a macroeconomic analysis of adverse economic trends at home and abroad amid dire predictions of a double-dip recession in the United States and defaults in Europe, connecting the dots to see if we are indeed at a Smoot-Hawley moment where the Congress, instead of reversing economic decline, has accelerated it. Full audio of the interview is available here.

By Dimitri B. Papadimitriou

May 26, 2011. Copyright © 2011 New Geography

It's been more than three years since the Great Recession began, and it's no longer debatable that the federal spending in its wake did not provoke inflation. Years of forecasts by fiscal conservatives about the result of government expenditures have proved to be wrong. After three fiscal stimulus packages, core inflation—which excludes the volatile prices of oil and commodities—remains very much in check. The core rate is the most reliable guide to future inflation, and it has not trended upward.

Headline inflation, however, the rate that does include these two, has increased. Is the recent uptick in gas and food prices a game-changer on inflation? Does it mean that predictions of an inflation tsunami were well-founded? And what's the best course to follow now?

Many commodity prices have made double and triple digit gains over the past year. The changes are more than a blip—cotton futures, for example, have risen 162 percent—even if the cost of oil continues to decline. These prices are notoriously subject to rapid change for reasons that don't reflect the structure of the U.S. economy. Factors can include Middle East politics, weather, activity in the developing world, and, most significantly today, speculative profiteering.

Gold and other commodities have become a hot destination for players—money managers—as these markets have become the rare opportunity for high returns. In the absence of federal regulation and supervision, the low interest rates that are so crucial to business growth and to the vast majority of Americans have been allowed to feed into the permissive speculative superstructure.

The run-up has clearly impacted the poor and the hungry in the undeveloped world. In academic and policy circles, there's a high level confidence that commodities account for only a small share of GDP in wealthy countries, and so aren't of concern as long as core inflation is under control. At the Levy Institute, in contrast, our research shows that even in the developed world expensive food, energy, and materials can crowd out other household purchases. Consumer budgets can be hurt even before serious headline inflation appears.

If commodity prices were to continue to climb broadly and sharply, the Federal Reserve could face the prospect of a serious episode of cost-push inflation, similar to what we saw in the 1970s and '80s. Fed Chairman Ben Bernanke might find himself occupying the chair of Paul Volcker in more ways than one.

This kind of inflation is caused neither by the effects of low interest rates on the broader economy, nor by government spending. And, as with any symptom of ill health, the cause dictates the appropriate treatment. So if Bernanke's response was to raise interest rates dramatically in the hope of abating inflation to some arbitrarily low target, it would be a risky mistake. An interest rate rise would be a serious danger to growth and job creation. Business and labor are far too fragile to deal with a double whammy from rising gas and food prices coupled with monetary policy tightening.

A better response would be "watchful waiting," a phrase seen in the December 1996 minutes of the FOMC (Federal Open Market Committee) meeting. A commodity price inflation could remain at least somewhat isolated.

Higher commodity prices will be used as an excuse to charge that the Fed's supposedly lax policy has unleashed an inflationary flood of cash throughout the economy. But the Fed's so-called "easy money" is parked at the Fed itself, as bank reserves, since banks are not lending. This can't cause inflation either. Logic hasn't stopped newly re-branded Republican presidential candidate Newt Gingrich, who recently admonished that "The Bernanke policy of printing money is setting the stage for mass inflation."

Those who purchase securities for long-term investment evidently disagree. Bond traders aren't anticipating an inflationary surge. Just look at the yield spread between inflation-indexed and non-indexed Treasury securities of the same maturity. It has remained almost constant over the past year. In other words, buyers who want their returns insulated from inflation are paying only slightly more for protection than they were last year. That flatness—the unwillingness to pay a premium for inflation insurance—indicates that long-term bond buyers haven't revised their inflation forecasts.

Also unlikely to revise their predictions: inflation doom-drummers, even as energy prices level, and wages, another inflation indicator, are by no means jumping. Like eons of "the-end-is-nigh" prognosticators, they don't exactly have a great track record. Back in spring 2008, a frenzied Glenn Beck urged Fox viewers to "Buy that coat and shoes for next year now." Some of his Washington cohorts are coy about inflation's estimated time of arrival. Republican House Majority Leader Eric Cantor, for example, tells us that "fears" of "future" inflation are "hanging over the marketplace." Others, like former Pennsylvania Senator Rick Santorum, say it's already arrived (Obama brought it). The accusations continue despite a lengthy stretch of the lowest inflation rates in modern US history, even with the current commodities rise.

Paul Ryan (R-WI) has been hailed as both a truth sayer and a soothsayer on the economy. He recommends that the Federal Reserve raise interest rates now to head off inflation "before the cow is out of the barn," ignoring the pain this would cause families and businesses. Here's my recommendation: Don't trust predictions about the future from those who've misread the present, and been very wrong in the past.

Dimitri Papadimitriou is President of the Levy Economics Institute of Bard College, and Executive Vice President and Jerome Levy Professor of Economics at Bard College.

By Dimitri B. Papadimitriou

May 13, 2011. Copyright © 2011, Los Angeles Times

For 20 years, U.S. exports have trailed imports. Addressing the imbalance could hugely boost the job market.

One school of thought about the so-called jobless recovery of the American economy blames high unemployment on the federal deficit. But that’s blaming the wrong deficit.

To achieve an authentic recovery that includes new jobs, the deficit we need to cut is in trade.

For 20 years, America’s exports have been surpassed by its imports, with a big bite of that trade deficit composed of oil imports. Addressing the imbalance could have a huge effect on the job market, but only if it goes beyond reducing imports. We need to actively strengthen exports as well.

Even if the economic recovery continues, as is likely, joblessness will remain a colossal disaster. The unemployment rate is hovering at about 9%, and for some groups it is far higher. Nearly 16% of African Americans are unemployed, with young people and Latinos not far behind. The United States is about 19 million jobs behind the curve if employment is to return to its pre-recession levels. Among the world’s most developed nations, the G-7, we have the highest unemployment. Here at the Levy Economics Institute, even in our best-case growth scenario, we see unemployment dropping only to about 7%—way above healthy levels—by 2015. We’re not alone in that pessimism: The figures vary, but the prevailing outlook, including from the Federal Reserve is that job-seekers face years of pain.

Exports are key to meeting the urgent need for new jobs. The White House estimates that every $1 billion in exports creates 5,000 jobs. This makes it crucial for companies to find more customers in the rest of the world.

In addition to aircraft and other transport vehicles, U.S. industrial equipment, pharmaceuticals, chemicals, semiconductors and agricultural products—raw and processed—have a track record of success in the global marketplace, along with millions of goods from medium-size and small companies.

There are things that could be done to help American exporters. A devaluation of the dollar beyond the current downward creep would be a start. A weaker dollar would reduce the cost of our exports in foreign markets, in turn generating demand from buyers abroad. It would also encourage American consumers to buy domestic products because our goods would have a price advantage over imported ones. And the resulting rise in exports would have a side benefit: reducing the national budget deficit, because GDP growth and lower unemployment would mean larger government revenues and less spending on safety-net programs.

Devaluation does have some downsides, of course. Over the long haul, it can cause inflation, but that is not an immediate danger because core inflation is currently at or near record lows. Still, consumers would probably be paying more in the short term for oil and other imports.

In the long term, international monetary reforms would certainly be a preferable route to devaluing the dollar. Global imbalances are on the G-20 radar screen, but a serious policy response has yet to be floated. One helpful monetary reform would be to expand Special Drawing Rights—artificial, blended currency units governed by the International Monetary Fund—as supplemental currency reserves. This could only be done by an accord among the G-20 countries. International agreements take time—the World Trade Organization’s Doha talks will soon celebrate their 10th anniversary—so moving the dollar’s exchange rate is a better short-term solution.

Even then, ramping up American exports will be difficult. The White House has set a goal of doubling exports over five years, but the current mania for spending cuts may work against that ambition. In the House of Representatives, the Small Business Committee has advocated rescinding $30 million in Small Business Administration grants to states for promoting exports and sharply cutting the SBA’s Office of International Trade. These savings would be counterproductive and would work against the nation’s best interests.

It’s true that our trade account balance has recently improved. The better figures, though, aren’t a sign of healthy growth or an upcoming job surge. They reflect more a drop in imports rather than a growth in exports, and the drop has come because of less demand for goods in the recession’s shadow and amid ongoing financial fears.

Exports are starting to rise. But making sure that the upward curve continues will be crucial to addressing our still-worrisome unemployment rate.

Dimitri B. Papadimitriou is president of the Levy Economics Institute of Bard College and a professor of economics there. He is a former vice chairman of Congress’ Trade Deficit Review Commission

Pema Levy Interviews James K. Galbraith

The American Prospect, May 5, 2011. © 2011 by The American Prospect, Inc.

A deal is taking shape between Congress and the administration on the debt-ceiling vote, and it will likely include some spending cuts in exchange for increasing the amount the government can borrow.

As these negotiations play out, we’re constantly warned that the debt-ceiling fight has high stakes. Refusing to raise the ceiling will prevent us from paying debts and will destroy the faith our bondholders—that is, China—have in us. Or will it? The Prospect talked with James K. Galbraith, the Lloyd M. Bentsen Jr. Chair in Government/Business Relations at the University of Texas at Austin, about just how accurate the doomsday predictions really are.

Everyone says that if we don’t raise the debt ceiling soon, we’ll have a financial disaster on our hands. How accurate are these catastrophic predictions?

Failure to raise the debt limit would be, for sure, a bad idea. Whether it would produce a fiscal and bond market Armageddon, I think, is really doubtful.

This is a group of politicians saying, give me cuts or I will shoot the economy. So that’s the political problem that we face. And one way I think to handle that problem is to point out that what the hostage-takers have in their hands may well not be a nuclear grenade; it might be something much less cataclysmic.

A few weeks ago, the ratings agency Standard & Poor’s warned that the United States could lose its AAA rating on U.S. debt (securities, bonds, etc.), which could have serious repercussions for the economy. How do you gauge the chances of a downgrade?

One can’t judge what Standard & Poor’s or Moody’s will do, because they’ve gotten most everything else wrong in the last decade. These are firms that graded vast mounds of worthless mortgage-backed paper as AAA because of the crafty ways it was securitized. These are firms that never to my knowledge downgraded a major corporate fraud—Enron and so forth—more than a few days in advance of its collapse. And they routinely give cities lower ratings than they should based upon the default rates on those instruments. They have no particular competence in Europe, either. So, it’s a little bit unpredictable what a corporation with that track record is going to do.

Is there a danger we’ll default?

If you read the 14th Amendment, Section 4, it says that the [validity of the] debt of the United States authorized by law—including pensions, by the way, so including Social Security—shall not be questioned. So long as we are run by the Constitution, we’re going to pay the debt.

One fear is that not raising the ceiling will cause a global panic or at least a ripple effect if the U.S. fails to pay its foreign creditors. What will foreign creditors do if we default on our bonds?

Let’s suppose that the Treasury actually says to the People’s Bank of China, sorry, we can’t write a check to you right now. Well, in the case of the People’s Bank of China, the bond that they hold would become a defaulted bond, but it would still be there. And the Treasury would still recognize its obligation on that bond and would presumably be willing to pay accrued interest on it. The Treasury would probably say, it’s going to be a few days while we resolve this, and the People’s Bank of China would, in my view, probably do nothing.

If I were sitting in the position of a foreign holder of U.S. Treasury securities in that situation, the last thing I would want would be a panic. I would want this problem to go away.

And if there is a panic?

I think the right analogy to that would be the failure of Congress to pass the [Troubled Asset Relief Program] on the first round. The stock market went down by 800 points. That sent a very powerful political wake-up call, and suddenly people changed their positions. The most likely thing if we actually go to this stage where there is real turmoil would be that Congress—the hostage-takers—would drop their guns.

So the question I would have then is: Does it make sense to give the hostage-takers what they want? Which are massive cuts. And I think it does not make sense by any stretch of the imagination to agree that the debt ceiling shall be the point of leverage for coming to a decision, which is what the Republicans want and unfortunately what some Democrats like Kent Conrad want.

This would be an act of just gross negotiating folly to set the precedent that the debt-ceiling negotiations become the way in which the extremists get what they want.

This Q&A has been edited for length and clarity.

The Big Picture with Thom Hartmann, May 2, 2011

In a two-part interview, Senior Scholar Galbraith discusses the “vast raid” on the home equity of the middle class by financial predators, “green” investment as a basis for economic growth, the importance of government regulation in establishing and maintaining markets, and how the substance of domestic policy has moved away from fostering “the common good.”

Copyright 2010 The Economist; Letters, June 10, 2010

Sir,

Your obituary of Wynne Godley (May 29th) did an injustice to his considerable intellectual achievements in macroeconomics and his courage in going against the orthodoxy that has ruled the economics profession for the past three decades. That very orthodoxy is now under attack all across the world, its otiose theoretical constructions having been exposed to the harsh light of actual economic events. Godley’s contributions to macroeconomics include his 1978 work on pricing with Kenneth Coutts and William Nordhaus, the textbook written in 1983 with Francis Cripps that inspired the “New Cambridge” group, and his 2006 book on monetary economics, written with Marc Lavoie.

His often-cited success as a macroeconomic forecaster came about precisely because he developed a systematic framework for analysing the impact of potential developments, applied first to the British economy at Cambridge and subsequently to America’s economy at the Levy Economics Institute.

Instead of taking the trouble to address these contributions, your piece settled for personal gossip, ending with a snide comment that “against a background like this, a little waywardness in the world of macroeconomics seems entirely forgivable.”

Anwar Shaikh
Professor of Economics
New School for Social Research
New York

Gennaro Zezza
Associate Professor of Economics
University of Cassino
Cassino, Italy

Dimitri Papadimitriou
President
Levy Economics Institute
Bard College
Annandale-on-Hudson, New York

Friday, February 19, 2010 02:00. Copyright The Financial Times Limited 2010.

From Mr Dimitri B. Papadimitriou

Sir, Martin Feldstein (February 17) argues in favour of Greece taking a holiday from the eurozone. While his very thoughtful comment makes sense on the face of it, if implemented I believe it will bankrupt Greece absolutely.

Under his plan, once the new drachma is devalued there would be a very strong demand for wages and prices to rise in tandem with the devaluation, so that parity is maintained with the euro. The result would be high inflation rates and even bigger budget deficits. The country’s holiday from the eurozone would likely become permanent, and prime minister George Papandreou’s valiant efforts to change the culture of a country’s expanding and wasteful public sector, rife with tax avoidance and evasion, will be forever lost.

The plethora of articles in your pages and others, some arguing in favour and others against a bail-out, contribute to market confusion and drive the country’s financing costs to record levels. It is not yet clear that a bail-out is even needed, but this market confusion is rendering the government’s ability to achieve its deficit goals ever more difficult.

Since the architects of economic and monetary union are neither about to change the system, nor to provide a sympathetic ear and a helping hand, what Greece really needs now is a holiday from further market confusion being created by contradictory, alarmist public commentary.

Dimitri B. Papadimitriou
President
Levy Economics Institute
Annandale, NY, US

By James K. Galbraith

By James K. Galbraith, Thought and Action, The NEA Higher Education Journal, Fall 2009.

This article is partly a response to Paul Krugman’s piece in the Sunday New York Times of September 6, 2009, on the failures of the economists in the face of the crisis. Here, Senior Scholar James K. Galbraith takes up the challenge of identifying some of those economists—the “nobodies” of the profession—who did see it coming, and who have not gotten the credit they deserve. He also points out the urgent need to expand the academic space and the public visibility of ongoing work that is of actual value when faced with the many deep problems of economic life in our time—an imperative for university administrators, for funding agencies, for foundations, and for students.

By Stephen Mihm

Since the global financial system started unraveling in dramatic fashion two years ago, distinguished economists have suffered a crisis of their own. Ivy League professors who had trumpeted the dawn of a new era of stability have scrambled to explain how, exactly, the worst financial crisis since the Great Depression had ambushed their entire profession.

Amid the hand-wringing and the self-flagellation, a few more cerebral commentators started to speak about the arrival of a “Minsky moment,” and a growing number of insiders began to warn of a coming “Minsky meltdown.”

“Minsky” was shorthand for Hyman Minsky, a hitherto obscure macroeconomist who died over a decade ago. Many economists had never heard of him when the crisis struck, and he remains a shadowy figure in the profession. But lately he has begun emerging as perhaps the most prescient big-picture thinker about what, exactly, we are going through. A contrarian amid the conformity of postwar America, an expert in the then-unfashionable subfields of finance and crisis, Minsky was one economist who saw what was coming. He predicted, decades ago, almost exactly the kind of meltdown that recently hammered the global economy.

In recent months Minsky’s star has only risen. Nobel Prize–winning economists talk about incorporating his insights, and copies of his books are back in print and selling well. He’s gone from being a nearly forgotten figure to a key player in the debate over how to fix the financial system.

But if Minsky was as right as he seems to have been, the news is not exactly encouraging. He believed in capitalism, but also believed it had almost a genetic weakness. Modern finance, he argued, was far from the stabilizing force that mainstream economics portrayed; rather, it was a system that created the illusion of stability while simultaneously creating the conditions for an inevitable and dramatic collapse.

In other words, the one person who foresaw the crisis also believed that our whole financial system contains the seeds of its own destruction. “Instability,” he wrote, “is an inherent and inescapable flaw of capitalism.”

Minsky’s vision might have been dark, but he was not a fatalist; he believed it was possible to craft policies that could blunt the collateral damage caused by financial crises. But with a growing number of economists eager to declare the recession over, and the crisis itself apparently behind us, these policies may prove as discomforting as the theories that prompted them in the first place. Indeed, as economists re-embrace Minsky’s prophetic insights, it is far from clear that they’re ready to reckon with the full implications of what he saw.

In an ideal world, a profession dedicated to the study of capitalism would be as freewheeling and innovative as its ostensible subject. But economics has often been subject to powerful orthodoxies, and never more so than when Minsky arrived on the scene.

That orthodoxy, born in the years after World War II, was known as the neoclassical synthesis. The older belief in a self-regulating, self-stabilizing free market had selectively absorbed a few insights from John Maynard Keynes, the great economist of the 1930s who wrote extensively of the ways that capitalism might fail to maintain full employment. Most economists still believed that free-market capitalism was a fundamentally stable basis for an economy, though thanks to Keynes, some now acknowledged that government might under certain circumstances play a role in keeping the economy—and employment—on an even keel.

Economists like Paul Samuelson became the public face of the new establishment; he and others at a handful of top universities became deeply influential in Washington. In theory, Minsky could have been an academic star in this new establishment: like Samuelson, he earned his doctorate in economics at Harvard University, where he studied with legendary Austrian economist Joseph Schumpeter, as well as future Nobel laureate Wassily Leontief.

But Minsky was cut from different cloth than many of the other big names. The descendent of immigrants from Minsk, in modern-day Belarus, Minsky was a red-diaper baby, the son of Menshevik socialists. While most economists spent the 1950s and 1960s toiling over mathematical models, Minsky pursued research on poverty, hardly the hottest subfield of economics. With long, wild, white hair, Minsky was closer to the counterculture than to mainstream economics. He was, recalls the economist L. Randall Wray, a former student, a “character.”

So while his colleagues from graduate school went on to win Nobel prizes and rise to the top of academia, Minsky languished. He drifted from Brown to Berkeley and eventually to Washington University. Indeed, many economists weren’t even aware of his work. One assessment of Minsky published in 1997 simply noted that his “work has not had a major influence in the macroeconomic discussions of the last thirty years.”

Yet he was busy. In addition to poverty, Minsky began to delve into the field of finance, which despite its seeming importance had no place in the theories formulated by Samuelson and others. He also began to ask a simple, if disturbing question: “Can �it’ happen again?”—where “it” was, like Harry Potter's nemesis Voldemort, the thing that could not be named: the Great Depression.

In his writings, Minsky looked to his intellectual hero, Keynes, arguably the greatest economist of the 20th century. But where most economists drew a single, simplistic lesson from Keynes—that government could step in and micromanage the economy, smooth out the business cycle, and keep things on an even keel—Minsky had no interest in what he and a handful of other dissident economists came to call “bastard Keynesianism.”

Instead, Minsky drew his own, far darker, lessons from Keynes’s landmark writings, which dealt not only with the problem of unemployment, but with money and banking. Although Keynes had never stated this explicitly, Minsky argued that Keynes’s collective work amounted to a powerful argument that capitalism was by its very nature unstable and prone to collapse. Far from trending toward some magical state of equilibrium, capitalism would inevitably do the opposite. It would lurch over a cliff.

This insight bore the stamp of his advisor Joseph Schumpeter, the noted Austrian economist now famous for documenting capitalism's ceaseless process of “creative destruction.” But Minsky spent more time thinking about destruction than creation. In doing so, he formulated an intriguing theory: not only was capitalism prone to collapse, he argued, it was precisely its periods of economic stability that would set the stage for monumental crises.

Minsky called his idea the “Financial Instability Hypothesis.” In the wake of a depression, he noted, financial institutions are extraordinarily conservative, as are businesses. With the borrowers and the lenders who fuel the economy all steering clear of high-risk deals, things go smoothly: loans are almost always paid on time, businesses generally succeed, and everyone does well. That success, however, inevitably encourages borrowers and lenders to take on more risk in the reasonable hope of making more money. As Minsky observed, “Success breeds a disregard of the possibility of failure.”

As people forget that failure is a possibility, a “euphoric economy” eventually develops, fueled by the rise of far riskier borrowers—what he called speculative borrowers, those whose income would cover interest payments but not the principal; and those he called “Ponzi borrowers,” those whose income could cover neither, and could only pay their bills by borrowing still further. As these latter categories grew, the overall economy would shift from a conservative but profitable environment to a much more freewheeling system dominated by players whose survival depended not on sound business plans, but on borrowed money and freely available credit.

Once that kind of economy had developed, any panic could wreck the market. The failure of a single firm, for example, or the revelation of a staggering fraud could trigger fear and a sudden, economy-wide attempt to shed debt. This watershed moment—what was later dubbed the “Minsky moment”—would create an environment deeply inhospitable to all borrowers. The speculators and Ponzi borrowers would collapse first, as they lost access to the credit they needed to survive. Even the more stable players might find themselves unable to pay their debt without selling off assets; their forced sales would send asset prices spiraling downward, and inevitably, the entire rickety financial edifice would start to collapse. Businesses would falter, and the crisis would spill over to the “real” economy that depended on the now-collapsing financial system.

From the 1960s onward, Minsky elaborated on this hypothesis. At the time he believed that this shift was already underway: postwar stability, financial innovation, and the receding memory of the Great Depression were gradually setting the stage for a crisis of epic proportions. Most of what he had to say fell on deaf ears. The 1960s were an era of solid growth, and although the economic stagnation of the 1970s was a blow to mainstream neo-Keynesian economics, it did not send policymakers scurrying to Minsky. Instead, a new free market fundamentalism took root: government was the problem, not the solution.

Moreover, the new dogma coincided with a remarkable era of stability. The period from the late 1980s onward has been dubbed the “Great Moderation,” a time of shallow recessions and great resilience among most major industrial economies. Things had never been more stable. The likelihood that “it” could happen again now seemed laughable.

Yet throughout this period, the financial system—not the economy, but finance as an industry—was growing by leaps and bounds. Minsky spent the last years of his life, in the early 1990s, warning of the dangers of securitization and other forms of financial innovation, but few economists listened. Nor did they pay attention to consumers’ and companies’ growing dependence on debt, and the growing use of leverage within the financial system.

By the end of the 20th century, the financial system that Minsky had warned about had materialized, complete with speculative borrowers, Ponzi borrowers, and precious few of the conservative borrowers who were the bedrock of a truly stable economy. Over decades, we really had forgotten the meaning of risk. When storied financial firms started to fall, sending shockwaves through the ”real” economy, his predictions started to look a lot like a road map.

“This wasn’t a Minsky moment,'' explains Randall Wray. “It was a Minsky half-century.”

Minsky is now all the rage. A year ago, an influential Financial Times columnist confided to readers that rereading Minsky's 1986 “masterpiece”—“Stabilizing an Unstable Economy”—“helped clear my mind on this crisis.” Others joined the chorus. Earlier this year, two economic heavyweights—Paul Krugman and Brad DeLong—both tipped their hats to him in public forums. Indeed, the Nobel Prize–winning Krugman titled one of the Robbins lectures at the London School of Economics “The Night They Re-read Minsky.”

Today most economists, it’s safe to say, are probably reading Minsky for the first time, trying to fit his unconventional insights into the theoretical scaffolding of their profession. If Minsky were alive today, he would no doubt applaud this belated acknowledgment, even if it has come at a terrible cost. As he once wryly observed, “There is nothing wrong with macroeconomics that another depression [won't] cure.”

But does Minsky’s work offer us any practical help? If capitalism is inherently self-destructive and unstable—never mind that it produces inequality and unemployment, as Keynes had observed—now what?

After spending his life warning of the perils of the complacency that comes with stability—and having it fall on deaf ears—Minsky was understandably pessimistic about the ability to short-circuit the tragic cycle of boom and bust. But he did believe that much could be done to ameliorate the damage.

To prevent the Minsky moment from becoming a national calamity, part of his solution (which was shared with other economists) was to have the Federal Reserve—what he liked to call the “Big Bank”—step into the breach and act as a lender of last resort to firms under siege. By throwing lines of liquidity to foundering firms, the Federal Reserve could break the cycle and stabilize the financial system. It failed to do so during the Great Depression, when it stood by and let a banking crisis spiral out of control. This time, under the leadership of Ben Bernanke—like Minsky, a scholar of the Depression—it took a very different approach, becoming a lender of last resort to everything from hedge funds to investment banks to money market funds.

Minsky’s other solution, however, was considerably more radical and less palatable politically. The preferred mainstream tactic for pulling the economy out of a crisis was—and is—based on the Keynesian notion of “priming the pump” by sending money that will employ lots of high-skilled, unionized labor—by building a new high-speed train line, for example.

Minsky, however, argued for a “bubble-up” approach, sending money to the poor and unskilled first. The government—or what he liked to call “Big Government”—should become the “employer of last resort,” he said, offering a job to anyone who wanted one at a set minimum wage. It would be paid to workers who would supply child care, clean streets, and provide services that would give taxpayers a visible return on their dollars. In being available to everyone, it would be even more ambitious than the New Deal, sharply reducing the welfare rolls by guaranteeing a job for anyone who was able to work. Such a program would not only help the poor and unskilled, he believed, but would put a floor beneath everyone else's wages too, preventing salaries of more skilled workers from falling too precipitously, and sending benefits up the socioeconomic ladder.

While economists may be acknowledging some of Minsky’s points on financial instability, it's safe to say that even liberal policymakers are still a long way from thinking about such an expanded role for the American government. If nothing else, an expensive full-employment program would veer far too close to socialism for the comfort of politicians. For his part, Wray thinks that the critics are apt to misunderstand Minsky. “He saw these ideas as perfectly consistent with capitalism,” says Wray. “They would make capitalism better.”

But not perfect. Indeed, if there's anything to be drawn from Minsky’s collected work, it's that perfection, like stability and equilibrium, are mirages. Minsky did not share his profession's quaint belief that everything could be reduced to a tidy model, or a pat theory. His was a kind of existential economics: capitalism, like life itself, is difficult, even tragic. “There is no simple answer to the problems of our capitalism,” wrote Minsky. “There is no solution that can be transformed into a catchy phrase and carried on banners.”

It's a sentiment that may limit the extent to which Minsky becomes part of any new orthodoxy. But that’s probably how he would have preferred it, believes liberal economist James Galbraith. “I think he would resist being domesticated,” says Galbraith. “He spent his career in professional isolation.”

Stephen Mihm is a history professor at the University of Georgia and author of “A Nation of Counterfeiters” (Harvard, 2007).

By Dirk Bezemer

September 7, 2009. Copyright 2009 The Financial Times Limited.

From the beginning of the credit crisis and ensuing recession, it has become conventional wisdom that “no one saw this coming.” Anatole Kaletsky wrote in The Times of “those who failed to foresee the gravity of this crisis”—a group that included “almost every leading economist and financier in the world.” Glenn Stevens, governor of the Reserve Bank of Australia, said: “I do not know anyone who predicted this course of events. But it has occurred, it has implications, and so we must reflect on it.” We must indeed.

Because, in fact, many had seen it coming for years. They were ignored by an establishment that, as the former Federal Reserve chairman Alan Greenspan professed in his October 2008 testimony to Congress, watched with “shocked disbelief” as its “whole intellectual edifice collapsed in the summer [of 2007].” Official models missed the crisis not because the conditions were so unusual, as we are often told. They missed it by design. It is impossible to warn against a debt deflation recession in a model world where debt does not exist. This is the world our policymakers have been living in. They urgently need to change habitat.

I undertook a study of the models used by those who did see it coming.* They include Kurt Richebächer, an investment newsletter writer, who wrote in 2001 that “the new housing bubble—together with the bond and stock bubbles—will [inevitably] implode in the foreseeable future, plunging the US economy into a protracted, deep recession”; and in 2006, when the housing market turned, that “all remaining questions pertain solely to [the] speed, depth and duration of the economy’s downturn.” Wynne Godley of the Levy Economics Institute wrote in 2006 that “the small slowdown in the rate at which US household debt levels are rising resulting from the house price decline, will immediately lead to a sustained growth recession before 2010.” Michael Hudson of the University of Missouri wrote in 2006 that “debt deflation will shrink the ‘real’ economy, drive down real wages, and push our debt-ridden economy into Japan-style stagnation or worse.” Importantly, these and other analysts not only foresaw and timed the end of the credit boom, but also perceived this would inevitably produce recession in the US. How did they do it?

Central to the contrarians’ thinking is an accounting of financial flows (of credit, interest, profit and wages) and stocks (debt and wealth) in the economy, as well as a sharp distinction between the real economy and the financial sector (including property). In these “flow-of-funds” models, liquidity generated in the financial sector flows to companies, households and the government as they borrow. This may facilitate fixed-capital investment, production and consumption, but also asset-price inflation and debt growth. Liquidity returns to the financial sector as investment or in debt service and fees.

It follows that there is a trade-off in the use of credit, so that financial investment may crowd out the financing of production. A second key insight is that, since the economy’s assets and liabilities must balance, growing financial asset markets find their counterpart in a growing debt burden. They also swell payment flows of debt service and financial fees. Flow-of-funds models quantify the sustainability of the debt burden and the financial sector’s drain on the real economy. This allows their users to foresee when finance’s relation to the real economy turns from supportive to extractive, and when a breaking point will be reached.

Such calculations are conspicuous by their absence in official forecasters’ models in the US, the UK and the Organisation for Economic Co-operation and Development. In line with mainstream economic theory, balance sheet variables are assumed to adapt automatically to changes in the real economy, and can thus be safely omitted. This practice ignores the fact that in most advanced economies, financial sector turnover is many times larger than total gross domestic product; or that growth in the US and UK has been finance-driven since the turn of the millennium.

Perhaps because of this omission, the OECD commented in August 2007 that “the current economic situation is in many ways better than what we have experienced in years. . . . Our central forecast remains indeed quite benign: a soft landing in the United States [and] a strong and sustained recovery in Europe.” Official US forecasters could tell Reuters as late as September 2007 that the recession in the US was “not a dominant risk.” This was well after the Levy Economics Institute, for example, predicted in April of that year that output growth would slow “almost to zero sometime between now and 2008.”

Policymakers have resisted inclusion of balance sheets and the flow of funds in their models by arguing that bubbles cannot be easily identified, nor their effects reliably anticipated. The above analysts have shown that this is, in fact, feasible, and indeed essential if we are to “see it coming” next time. The financial sector is just as real as the real economy. Our policymakers, and the analysts they rely on, ignore balance sheets and the flow of funds at their peril—and ours.

*“No One Saw This Coming”: Understanding Financial Crisis Through Accounting Models, MPRA

The writer is a fellow at the economics and business department of the University of Groningen in the Netherlands.

By Martin Wolf

October 8, 2008. Copyright 2008 The Financial Times Limited. “FT” and “Financial Times” are trademarks of the Financial Times.

“Things that can’t go on forever, don’t.” —Herbert Stein, former chairman of the US presidential Council of Economic Advisers

What confronts the world can be seen as the latest in a succession of financial crises that have struck periodically over the last 30 years. The current financial turmoil in the US and Europe affects economies that account for at least half of world output, making this upheaval more significant than all the others. Yet it is also depressingly similar, both in its origins and its results, to earlier shocks.

To trace the parallels—and help in understanding how the present pressing problems can be addressed—one needs to look back to the late 1970s. Petrodollars, the foreign exchange earned by oil exporting countries amid sharp jumps in the crude price, were recycled via western banks to less wealthy emerging economies, principally in Latin America.

This resulted in the first of the big crises of modern times, when Mexico’s 1982 announcement of its inability to service its debt brought the money-centre banks of New York and London to their knees.

Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University identify the similarities in a paper published earlier this year.* They focus on previous crises in high-income countries. But they also note characteristics that are shared with financial crises that have occurred in emerging economies.

This time, most emerging economies have been running huge current account surpluses. So a “large chunk of money has effectively been recycled to a developing economy that exists within the United States’ own borders,” they point out. “Over a trillion dollars was channelled into the subprime mortgage market, which is comprised of the poorest and least creditworthy borrowers within the US. The final claimaint is different, but in many ways the mechanism is the same.”

The links between the financial fragility in the US and previous emerging market crises mean that the current banking and economic traumas should not be seen as just the product of risky monetary policy, lax regulation and irresponsible finance, important though these were. They have roots in the way the global economy has worked in the era of financial deregulation. Any country that receives a huge and sustained inflow of foreign lending runs the risk of a subsequent financial crisis, because external and domestic financial fragility will grow. Precisely such a crisis is now happening to the US and a number of other high-income countries including the UK.

These latest crises are also related to those that preceded them—particularly the Asian crisis of 1997–98. Only after this shock did emerging economies become massive capital exporters. This pattern was reinforced by China’s choice of an export-oriented development path, partly influenced by fear of what had happened to its neighbours during the Asian crisis. It was further entrenched by the recent jumps in the oil price and the consequent explosion in the current account surpluses of oil exporting countries.

The big global macroeconomic story of this decade was, then, the offsetting emergence of the US and a number of other high-income countries as spenders and borrowers of last resort. Debt-fuelled US households went on an unparalleled spending binge by dipping into their housing “piggy banks.”

In explaining what had happened, Ben Bernanke, when still a governor of the Federal Reserve rather than chairman, referred to the emergence of a “savings glut.” The description was accurate. After the turn of the millennium, one of the striking features became the low level of long-term nominal and real interest rates at a time of rapid global economic growth. Cheap money encouraged an orgy of financial innovation, borrowing and spending.

That was also one of the initial causes of the surge in house prices across a large part of the high-income world, particularly in the US, the UK and Spain.

What lay behind the savings glut? The first development was the shift of emerging economies into a large surplus of savings over investment. Within the emerging economies, the big shifts were in Asia and in the oil exporting countries (see chart). By 2007, according to the International Monetary Fund, the aggregate savings surpluses of these two groups of countries had reached around 2 per cent of world output.

Despite being a huge oil importer, China emerged as the world’s biggest surplus country: its current account surplus was $372bn (£215bn, €272bn) in 2007, which was not only more than 11 per cent of its gross domestic product, but almost as big as the combined surpluses of Japan ($213bn) and Germany ($185bn), the two largest high-income capital exporters.

Last year, the aggregate surpluses of the world’s surplus countries reached $1,680bn, according to the IMF. The top 10 (China, Japan, Germany, Saudi Arabia, Russia, Switzerland, Norway, Kuwait, the Netherlands and the United Arab Emirates) generated more than 70 per cent of this total. The surpluses of the top 10 countries represented at least 8 per cent of their aggregate GDP and about one-quarter of their aggregate gross savings.

Meanwhile, the huge US deficit absorbed 44 per cent of this total. The US, UK, Spain and Australia—four countries with housing bubbles—absorbed 63 per cent of the world’s current account surpluses.

That represented a vast shift of capital—but unlike in the 1970s and early 1980s, it went to some of the world’s richest countries. Moreover, the emergence of the surpluses was the result of deliberate policies—shown in the accumulation of official foreign currency reserves and the expansion of the sovereign wealth funds over this period.

Quite reasonably, the energy exporters were transforming one asset—oil—into another—claims on foreigners. Others were recycling current account surpluses and private capital inflows into official capital outflows, keeping exchange rates down and competitiveness up. Some described this new system, of which China was the most important proponent, as “Bretton Woods II,” after the pegged adjustable exchange rates set-up that collapsed in the early 1970s. Others called it “export-led growth” or depicted it as a system of self-insurance.

Yet the justification is less important than the consequences. Between January 2000 and April 2007, the stock of global foreign currency reserves rose by $5,200bn. Thus three-quarters of all the foreign currency reserves accumulated since the beginning of time have been piled up in this decade. Inevitably, a high proportion—probably close to two-thirds—of these sums were placed in dollars, thereby supporting the US currency and financing US external deficits.

The savings glut had another dimension, related to a second financial shock—the bursting of the dot-com bubble in 2000. One consequence was the move of the corporate sectors of most high-income countries into financial surplus. In other words, their retained earnings came to exceed their investments. Instead of borrowing from banks and other suppliers of capital, non-financial corporations became providers of finance.

In this world of massive savings surpluses in a range of important countries and weak demand for capital from non-financial corporations, central banks ran easy monetary policies. They did so because they feared the possibility of a shift into deflation. The Fed, in particular, found itself having to offset the contractionary effects of the vast flow of private and, above all, public capital into the US.

A simple way of thinking about what has happened to the global economy in the 2000s is that high-income countries with elastic credit systems and households willing to take on rising debt levels offset the massive surplus savings in the rest of the world. The lax monetary policies facilitated this excess spending, while the housing bubble was the vehicle through which it worked.

The charts show what happened, as a result, to “financial balances”—the difference between expenditure and income inside the US economy. If one looks at three sectors—foreign, government and private—it is evident that the first has had a huge surplus this decade—offset, as it has to be, by deficits in the other two.

In the early 2000s, the US fiscal deficit was the main offset. In the middle years of the decade, the private sector ran a large deficit while the government’s shrank. Now that the recession-hit private sector is moving back into balance at enormous speed, the government deficit is exploding once again.

Looking at what happened inside the private sector, a striking contrast can be seen between the corporate and household realms. Households moved into a huge financial deficit, which peaked at just under 4 per cent of GDP in the second quarter of 2005. Then, as the housing bubble burst, housebuilding collapsed and households started saving more. With remarkable speed, the household financial deficit disappeared. Today’s explosion in the fiscal deficit is the offset.

Inevitably, huge household financial deficits also mean huge accumulations of household debt. This was strikingly true in the US and UK. In the process, the financial sector accumulated an ever greater stock of claims not just on other sectors but on itself. This frightening complexity, which lies at the root of many of the current difficulties, was facilitated by the environment of easy borrowing and search for high returns in an environment of low real rates of interest. These linked dangers between external and internal imbalances, domestic debt accumulations and financial fragility were foretold by a number of analysts. Foremost among them was Wynne Godley of Cambridge University in his prescient work for the Levy Economics Institute of Bard College, which has laid particular stress on the work of the late Hyman Minsky.**

So what might—and should—happen now? The big danger, evidently, is of a financial collapse. The principal offset, in the short run, to the inevitable cuts in spending in the private sector of the crisis-afflicted economies will also be vastly bigger fiscal deficits.

Fortunately, the US and the other afflicted high-income countries have one advantage over the emerging economies: they borrow in their own currencies and have creditworthy governments. Unlike emerging economies, they can therefore slash interest rates and increase fiscal deficits.

Yet the huge fiscal boosts and associated government recapitalisation of shattered financial systems are only a temporary solution. There can be no return to business as usual. It is, above all, neither desirable nor sustainable for global macroeconomic balance to be achieved by recycling huge savings surpluses into the excess consumption of the world’s richest consumers. The former point is self-evident, while the latter has been demonstrated by the recent financial collapse.

So among the most important tasks ahead is to create a system of global finance that allows a more balanced world economy, with excess savings being turned into either high-return investment or consumption by the world’s poor, including in capital-exporting countries such as China. A part of the answer will be the development of local-currency finance in emerging economies, which would make it easier for them to run current account deficits than proved to be the case in the past three decades.

It is essential in any case for countries in a position to do so to expand domestic demand vigorously. Only in this way can the recessionary impulse coming from the corrections in the debt-laden countries be offset.

Yet there is a still bigger challenge ahead. The crisis demonstrates that the world has been unable to combine liberalised capital markets with a reasonable degree of financial stability. A particular problem has been the tendency for large net capital flows and associated current account and domestic financial balances to generate huge crises. This is the biggest of them all.

Lessons must be learnt. But those should not just be about the regulation of the financial sector. Nor should they be only about monetary policy. They must be about how liberalised finance can be made to support the global economy rather than destabilise it.

This is no little local difficulty. It raises the deepest questions about the way forward for our integrated world economy. The learning must start now.

*“Is the 2007 US subprime financial crisis so different? An international historical comparison.” Working paper 13761, www.nber.org

**The US economy: Is there a way out of the woods? November 2007, www.levyinstitute.org

The writer is the FT’s chief economics commentator and author of Fixing Global Finance, published in the US this month by Johns Hopkins University Press and forthcoming in the UK through Yale University Press.

By Wolfgang Münchau

FT.com, September 3, 2007. Copyright 2007 The Financial Times Limited. “FT” and “Financial Times” are trademarks of the Financial Times

“Financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design. . . . The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.” —John Kenneth Galbraith, A Short History of Financial Euphoria

The late John Kenneth Galbraith would have enjoyed this summer. He was no expert on modern credit markets but his analysis of historic bubbles fits our most recent boom and bust episode with uncanny precision.

All historic bubbles were accompanied by a sharp rise in leverage. A salient feature of modern bubbles is the emergence of innovative financial products. No matter whether we are talking about junk bonds or modern collateralised debt obligations (CDOs), as Galbraith has pointed out, such products boil down to variants of debt secured on a real asset.

By historic standards, our credit bubble is probably one of the largest ever, given the sheer size of the market itself and the degree of euphoria that was characteristic in the final stages of the boom. While the fallout was initially concentrated in the financial sector itself, it would be surprising if the ongoing problems did not trickle down into the real economy. The availability of credit affects house prices and numerous studies have demonstrated the interlinkages between US house prices and US economic growth.

So what should central banks do? I suspect that central banks are not going to be the main actors in any rescue operation, but rather governments. Central banks' room for manoeuvre to cut interest rates is more constrained this time than during the most recent recession. But more important, this is not the kind of crisis that can easily be stopped by a few hasty rate cuts or bank bail-outs. If your subprime mortgage exceeds the value of your house by 10 per cent, and if the monthly payments exceed your income, no positive interest rate could bail you out. Your only hope is some serious debt relief.

The economists Dimitri Papadimitriou, Greg Hannsgen and Gennaro Zezza last week published a study* in which they demonstrated the danger to US economic growth posed by the present real estate crisis. Their policy recommendations go significantly beyond the usual bail-out calls. They argue that it is almost impossible for policymakers to stop the decline in real estate prices, but “if the Fed and Congress can work to stop any incipient recession, they will prevent job losses, which are one of the main contributors to foreclosures. An effective job-creation method could be some form of employer-of-last-resort programme that offers government jobs to all workers who ask for them”.

We should remember that the subprime market is not the only unstable subsection of the credit market. Once US consumption slows, we should prepare for a crisis in credit card and car finance CDOs. And once corporate bankruptcies start to rise again as the cycle turns down, both in the US and in Europe, we will probably hear about problems with collateralised loan obligations. The credit market is very deep and offers significant potential for contagion.

In this sense, the debate about whether this is a liquidity or a solvency crisis is beside the point. Banks may look at their CDO investments as a source of temporary illiquidity, but may sooner or later realise that they are sitting on a pile of junk. The fiscal and monetary authorities should therefore assume that they are confronted with a solvency crisis. Bailing out the odd bank, as the Germans did last month, is not going to be sufficient and perhaps not even necessary.

Instead, the monetary and fiscal authorities should stand ready to support the economy if and when needed. Lower interest rates will probably be part of any such deal, but a large part of the help will invariably come from fiscal policy. The US Federal Reserve will probably cut interest rates soon and the European Central Bank will almost certainly postpone the rate rise it unwisely preannounced only a few weeks ago. I am convinced the next interest rate movement both in the US and the eurozone will be downwards.

One of the problems the monetary authorities have to deal with is moral hazard. This is not a theoretical issue, as some suggest, but a far more immediate concern. Moral hazard is the result of asymmetric expectations, as markets expect the central bank to bail out the financial sector during a time of crisis. The problem of moral hazard is to some extent related to the monetary policy strategy of central banks, with their mechanistic focus on a single consumer price index. Such strategies often have no space for asset prices, but markets know fully well that central banks must invariably take account of asset prices during sharp downturns. One way out of this asymmetry is for central banks to include asset prices into their policy frameworks in some form or other.

This said, a bail-out of the financial system will probably become unavoidable, but it should be accompanied with structural policy changes. Tighter financial regulation is probable. The role of the ratings agencies is bound to change too. And central banks should reconsider their monetary policy frameworks. They are part of the problem.

*Cracks in the Foundations of Growth, Levy Institute, www.levyinstitute.org/pubs/ppb_90.pdf

Mr. Minsky long argued markets were crisis prone; his “moment” has arrived

By Justin Lahart. The Wall Street Journal, August 18, 2007, Page A1
Copyright 2007 Dow Jones & Company, Inc.

The recent market turmoil is rocking investors around the globe. But it is raising the stock of one person: a little-known economist whose views have suddenly become very popular.

Hyman Minsky, who died more than a decade ago, spent much of his career advancing the idea that financial systems are inherently susceptible to bouts of speculation that, if they last long enough, end in crises. At a time when many economists were coming to believe in the efficiency of markets, Mr. Minsky was considered somewhat of a radical for his stress on their tendency toward excess and upheaval.

Today, his views are reverberating from New York to Hong Kong as economists and traders try to understand what’s happening in the markets. The Levy Economics Institute of Bard College, where Mr. Minsky worked for the last six years of his life, is planning to reprint two books by the economist—one on John Maynard Keynes, the other on unstable economies. The latter book was being offered on the Internet for thousands of dollars.

Christopher Wood, a widely read Hong Kong-based analyst for CLSA Group, told his clients that recent cash injections by central banks designed “to prevent, or at least delay, a ’Minsky moment,’ is evidence of market failure.”

Indeed, the Minsky moment has become a fashionable catch phrase on Wall Street. It refers to the time when over-indebted investors are forced to sell even their solid investments to make good on their loans, sparking sharp declines in financial markets and demand for cash that can force central bankers to lend a hand.

Mr. Minsky, who died in 1996 at the age of 77, was a tall man with unruly hair who wore unpressed suits. He approached the world as “one big research tank,” says Diana Minsky, his daughter, an art history professor at Bard. “Economics was an integrated part of his life. It wasn’t isolated. There wasn’t a sense that work was something he did at the office.”

She recalls how, on a trip to a village in Italy to meet friends, Mr. Minsky ended up interviewing workers at a glove maker to understand how small-scale capitalism worked in the local economy.

Although he was born in Chicago, Mr. Minsky didn’t have many fans in the “Chicago School” of economists, who believed that markets were efficient. A follower of the economist John Maynard Keynes, he died just before a decade of financial crises in Asia, Russia, tech stocks, corporate credit and now mortgage debt, began to lend credence to his ideas.

Following those periods of tumult, more investors turned to the investment classic “Manias, Panics, and Crashes: A History of Financial Crises,” by Charles Kindleberger, a professor at the Massachusetts Institute of Technology who leaned heavily on Mr. Minsky’s work.

Mr. Kindleberger showed that financial crises unfolded the way that Mr. Minsky said they would. Though a loyal follower, Mr. Kindleberger described Mr. Minsky as “a man with a reputation among monetary theorists for being particularly pessimistic, even lugubrious, in his emphasis on the fragility of the monetary system and its propensity to disaster.”

At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they’ve taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. “This is likely to lead to a collapse of asset values,” Mr. Minsky wrote.

When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.

“We are in the midst of a Minsky moment, bordering on a Minsky meltdown,” says Paul McCulley, an economist and fund manager at Pacific Investment Management Co., the world’s largest bond-fund manager, in an email exchange.

The housing market is a case in point, says Investment Technology Group Inc. economist Robert Barbera, who first met Mr. Minsky in the late 1980s. When home buyers were expected to have a down payment of 10% or 20% to qualify for a mortgage, and to provide income documentation that showed they’d be able to make payments, there was minimal risk. But as home prices rose, and speculators entered the market, lenders relaxed their guard and began offering loans with no money down and little or no documentation.

Once home prices stalled and, in many of the more-speculative markets, fell, there was a big problem.

“If you’re lending to home buyers with 20% down and house prices fall by 2%, so what?” Mr. Barbera says. If most of a lender’s portfolio is tied up in loans to buyers who “don’t put anything down and house prices fall by 2%, you’re bankrupt,” he says.

Several money managers are laying claim to spotting the Minsky moment first. “I featured him about 18 months ago,” says Jeremy Grantham, chairman of GMO LLC, which manages $150 billion in assets. He pointed to a note in early 2006 when he wrote that investors had become too comfortable that financial markets were safe, and consequently were taking on too much risk, just as Mr. Minsky predicted. “Guinea pigs of the world unite. We have nothing to lose but our shirts,” he concluded.

It was Mr. McCulley at Pacific Investment, though, who coined the phrase “Minsky moment” during the Russian debt crisis in 1998.

Laurence Meyer, who served on the faculty with Mr. Minsky at Washington University in St. Louis, was a Federal Reserve Governor during those turbulent times. Mr. Meyer says that when he was an academic, Mr. Minsky’s work didn’t interest him very much, but that changed when he went into the real world. He says he grew to appreciate it even more when he was at the Fed watching financial crises unfold.

“Had Minsky been there, he probably would have been calling me and alerting me along the ride. And that would have been a good thing,” Mr. Meyer says. “Every year that goes by, I appreciate him more. I hear myself sometimes and I think, oh my gosh, I sound like Hy Minsky.“

Steven Fazzari, an economics professor at Washington University, says that Mr. Minsky would have supported the Federal Reserve’s recent move to provide cash and cut the rate it charges banks on loans from its discount window to try to avert a financial crisis that could spill over to the economy. But he would probably be worried, too, that the moves might be bailing out investors who would all too soon be speculating again.

Having seen recent events unfold in the way his friend and former colleague predicted, Mr. Fazzari says, “I hope he’s someplace saying, ‘Aha, I told you so!’”

—Jon E. Hilsenrath contributed to this article.

Copyright 2007 The Financial Times Limited Financial Times (London, England) June 22, 2007 Friday; Asia Edition 1; Letters to the Editor

Sir, Kerin Hope is right to report on the seriousness of the bond deal in Greece, which “sparks calls for early Greek poll” (report, June 19). It is paramount, though, for the Greek government, before it concludes on a possible early poll, to investigate who the actual bearer of these structured bonds is.

If a large proportion were to be held by international investors, then there may be an argument that structured bonds may save the taxpayer some of the cost of servicing that debt. But, if a large proportion of these structured bonds ends up in the portfolios of the Greek pension funds, as it seems to be the case, the government may be accused of taking advantage of the unsophisticated boards of the pension funds to minimise its tax liabilities. The Greek Treasury is gaining at the expense of the pension funds. This is not just an ethical issue; it is a clear responsibility of the government itself, as it is the one that sets up the legal structure of the pension funds. This suggests that the whole structure requires overhauling and the government should proceed with extreme care and responsibility.

Some general guidelines on the overhauling process may be useful. The management of the portfolios of the pension funds should be placed with the private sector that has the requisite skills and expertise. The asset management companies that would run the portfolios would be directly accountable to the boards of the pension funds. The boards, on the other hand, should not be appointed by the government, but they should be elected by their members, to whom they should be accountable. The responsibility of the boards should be to set up the decision-making process of the portfolio management and not be responsible for the investment decisions, as it happens now. The government should avoid the finance of the budget deficit through private placements as this undermines transparency. The normal practice of issuing ordinary fixed income government bonds through auctions that involve primary dealers is the only way to ensure that the burden to the tax-payer is kept to a minimum. In such an auction the government would fetch the market price on the issue of its bonds, which incorporates the risk that the market attaches to such bonds.

Philip Arestis,
University Director of Research,
Cambridge Centre for Economic and Public Policy,
University of Cambridge, UK

Elias Karakitsos,
Chairman, Global Economic Research,
Associate Member, Cambridge Centre for Economic and Public Policy,
University of Cambridge, UK

Copyright 2006 The Financial Times Limited (London, England)Wednesday, May 30, 2006; Financial Times; USA Edition; Letters to the Editor

Sir, Martin Feldstein (“The falling dollar sets a test for Asia and Europe”, May 26) provides a good account of the problems caused by global imbalances [which closely resembles, in its structure, the analysis contained in many reports published by the Levy Institute during the last seven years]. However, his statement that following devaluation in the mid 1980s there was a 40 per cent fall in the trade deficit is very misleading because, when expressed as a proportion of gross domestic product, the fall was only 1.5 per cent.

The US trade deficit peaked at about 3 per cent of GDP in 1986 and fell (by 50 per cent!) to 1.5 per cent at the end of 1989. There was a small further fall after the end of 1989, but this was surely caused by the sharp economic slowdown, and ultimately recession, which occurred in 1990.

A 1.5 per cent improvement in the deficit, which has reached 67 per cent of GDP, would hardly sustain the US economy if there were now the large rise in saving Prof. Feldstein expects. I conclude the strategic predicament, with its disinflationary possibilities for the US and the rest of the world, is more intractable than he suggests. Published by:
The Financial Times

Copyright 2005 The Financial Times Limited (London, England)Wednesday, February 15, 2006; Financial Times; USA Edition; Letters to the Editor

Sir, Balance of payments deficits often cause concern because they may result in financing difficulties and, possibly, a disorderly depreciation of the currency.

The U.K. payments deficit would seem to be too small, at present, to worry about. But it is the balance of trade, not payments, that measures the direct effect of a deficit on the demand for domestically produced goods and services.

The trade deficit of the US is now about 6.5 per cent of gross domestic product while that of the U.K. is about 4.5 per cent. In both countries domestic demand in total has so far been held up by budget deficits as well as by personal expenditure (on consumption and investment combined) far in excess of disposable income, and this has perforce been financed by unusually high borrowing leading to rapidly rising personal indebtedness.

In other words, the growing subtractions from demand caused by trade deficits, which now seem to be structural, have so far been made good by injections of demand which are essentially temporary.

The unusual size of the deficits, both in the US and in the U.K., has introduced a novel element into economic prospects viewed strategically because if (or when) personal borrowing and expenditure slows down, neither government has any obvious politically feasible policy instrument to avert a prolonged deficiency in total demand.

Cuts in interest rates might conceivably reignite the housing booms for a time but could not provide permanent motors for growth.

Published by:
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Copyright 2005 The Financial Times Limited (London, England)Wednesday, September 21, 2005; Financial Times; USA Edition; Letters to the Editor

Sir, In his article, “Only leadership can defuse America's fiscal time-bomb” (September 15), Jagadeesh Gokhale claims that US fiscal deficits will force the Fed to face a “surfeit of Treasuries,” leading it to put too many dollars in circulation as it buys excess bonds; and that the fiscal deficits will lead to slow productivity growth and high unemployment by “eroding the capital stock.”

With respect to the first claim, Mr. Gokhale misunderstands reserve accounting. Budget deficits lead ceteris paribus to net credits to banking system reserves that are drained through bond sales—either open market sales by the central bank or new issues by the Treasury.

The central bank would only buy Treasuries if banks were short of reserves—an unlikely event in the current situation with annual budget deficits of at least $330bn.

In any case, central bank interventions are automatic, triggered by excess or deficient reserve positions of banks that cause the overnight interest rate to move away from target.

There is no plausible circumstance in which the Fed would not be able to provide or withdraw reserves to keep rates on target.

Mr. Gokhale's second claim appears to be based on the “crowding-out” argument—that a budget deficit absorbs private sector saving, leaving less to finance private investment. He is ignoring the fact that the current account deficit, now 6.3 per cent of gross domestic product, makes the large budget deficit necessary if aggregate demand is to be sustained. If the government were now to cut its deficit without increasing net export demand, it would only succeed in reducing output, thereby reducing saving and investment as well.

Whether or not the current fiscal stance is the correct one, it is not creating any operational difficulties for the central bank, nor is it reducing the private capital stock by absorbing saving.

Published by:
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Copyright 1992 The Financial Times Limited (London, England)Tuesday, March 2, 2004; Financial Times USA Edition 2; Letters to the Editor; Pg. 12

Sir, Nicholas Garganas may be right to suggest that European Central Bank monetary policy is appropriate (“ECB official gives blunt rebuff to rate cut call,” February 27). Your editorial in the same issue (“Currencies cause Schroder pain”) may also be right to suggest that although one may sympathise with the German chancellor’s plea for an interest rate cut, “the ECB in Frankfurt has to take account of conditions in the euro area as a whole.” The argument, however, is more complex.

The buoyancy of the US economy since the end of the Iraq war and the spectacular recovery of exports in the US, and that of the euro area and Japan to a lesser extent, have raised hopes of a US-led world recovery. However, the euro area has suffered significant losses in competitiveness because of the strong appreciation of the euro in the past three years and its slow adjustment of competitiveness to changes in the nominal exchange rate. These developments in (G-3) competitiveness augur well for a rise in US and Japan exports from a world recovery, but they cast doubts on whether the euro area can benefit from it.

Despite these concerns we would suggest that if the US economy were to grow as fast as potential output in the next two years, then the world economy would recover. Such growth would be sufficient to offset previous. losses in competitiveness and allow the euro area to enjoy an export-led recovery. But, a rate cut by the ECB would not have the desired effect of restraining the euro rise, as its business cycle is synchronised with that of the US Since the burst of the bubble in 2000 both players are struggling to recover and a weak currency is desirable by both.

In the absence of intervention the only stable outcome is the one that favours dollar weakness and this is the one that markets impose. Investors, in trying to protect the value of their portfolios, usually enforce a stable outcome, because it would lead to a US-led world recovery. Whereas a dollar rise (and consequently a euro fall) would not help the rest of the world and, perhaps, not even the euro area itself.

In this respect, the experience of France in the early 1980s is pertinent. Similarly, in the period between the end of the Asian-Russian crisis (1998) and the burst of the equity bubble (2000) the ECB, and before it the Bundesbank, was again unable to stem the euro plight, in spite of tight monetary policy because its business cycle was again synchronised with that of the US

By contrast, whenever the US business cycle is not synchronised with that of the euro area, the resulting equilibrium is stable, simply because there is no conflict—one player’s interest dictates a strong currency, while the other’s dictates a weak currency. This was the case between 1994 and 1998, when the US was overheated but the euro area was operating with spare capacity.

George Garganas and your editorial may be right in their conclusions but the justification of the argument is far deeper and more complex.

Published by:
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Copyright 2003 The Financial Times Limited (London, England)Thursday, September 11, 2003; Financial Times; USA Edition; Letters to the Editor

Sir, Jagadeesh Gokhale and Kent Smetters (“Americar’s budget bookkeeping scandal,“ September 9) present a highly misleading analogy to highlight US budget accounting.

In their analogy, they present US with an 18-year old who earns $2,000 a month, spends $1,800 on necessities, and has $200 left over. But this 18-year-old is also building up $500 a month in credit card debt for a net deficit of $300 a month. And they have him/her planning to do this every month into the future.

What their analogy does not do is reflect reality. In the future, our 18-year-old average worker can expect to earn more money per month and will very likely marry someone who also earns a pay cheque.

Eventually, the 18-year-old and his/her family will earn enough to pay for necessities, cover their credit card debt (even if it grows somewhat) and perhaps save a little.

While Mr. Gokhale and Mr. Smetters are correct that the US budget accounting does not reflect future pension and healthcare liabilities accumulating in the current pay-as-you-go system (their so-called government "credit card" debt), they ignore the fact that the US economy (total earnings in the analogy) also will be larger in the future.

By focsing on the non-existent crisis of faulty US bookkeeping (with entitlement reform as the solution), they draw attention away from a true crisis: the US health care system (public but especially private), which is in dire need of reform.

Published by:
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Copyright 2003 The Financial Times Limited (London, England)Monday, September 8, 2003; Financial Times; USA Edition; Letters to the Editor

Sir, Ed Crooks and Tony Major (Comment & Analysis, September 1) are right to question the ability of the eurozone economy to catch up with the US economy. Indeed, they are right to argue that the eurozone economy “will struggle to improve potential growth,” and thereby “will leave the world on course for an unbalanced and potentially unstable recovery.”

It is, however, regrettable that they have not taken the argument further. For it is important to ask why this may be the case.

We suggest that the answer to this question is not difficult to gauge. It is the implementation of the wrong set of policies introduced since the inauguration of the euro in January 1999, after general deflationary policies in the preceding years.

The stability and growth pact constrains national governments in the application of their fiscal policies, while monetary policy has not been expansionary, despite recent reductions in the “repo” rate, the official European Central Bank rate of interest. Furthermore, both policies have produced serious “divergence” among the member states of the economic and monetary union in view of the “one-size-fits-all” nature of both policies.

It is, thus, the case that the institutional arrangements that govern economic policy within the eurozone economy cannot deliver higher growth (it is expected to be negative in the second quarter of 2003) and lower unemployment (at 8.9 per cent currently, as compared to a 6.2 per cent US rate, not to mention the lower 5 per cent in the U.K.).

What is more disturbing is the highly unequal growth rates in the eurozone: the periphery enjoying rather “healthy” growth rates while the “core” economies, Germany, Italy, and the Netherlands, are now in recession, having experienced two consecutive quarters of negative growth rates, and France’s second quarter of 2003 having contracted.

An interesting, and related issue, is that productivity in some eurozone countries is about the same level as in the US, once it is measured on a “per hour” basis: the evidence corroborates the view that Americans work longer hours than many Europeans.

Inflexible labour markets cannot be the reason for the poor eurozone economic performance. Germany in the past, for example during the 1950s and 1960s, despite labour markets even more “inflexible” than currently, managed to deliver healthier growth rates than the US “The US” had “much more flexible markets” then and could “lay off workers” just as easily then as now. Germany did deliver a great deal more than the US, then! More recently, and as the authors also readily acknowledge, eurozone business investment in the second half of the 1990s rose more steeply than in the US Surely the eurozone was not more flexible then.

The eurozone can catch up with America, but sensible economic policies are desperately needed to enable it to do so. The authors recognise this in the case of the US. Why not for the eurozone economy as well? Such a combination will produce more long-lasting growth and high employment, not merely for the two countries but also for the world as a whole.

Published by:
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Copyright 2003 The Financial Times Limited (London, England)Friday, August 29, 2003; Financial Times; USA Edition; Letters to the Editor

Sir, Martin Feldstein (“Fiscal activism would speed a recovery,” August 26) is clearly correct to argue that fiscal activism should be used under current economic circumstances. He is, though, incorrect to suggest that monetary policy will be more effective as an economic stabiliser in the near future.

Fiscal policy, used prudently to manipulate aggregate demand to achieve high levels of employment, is very much in order. Monetary policy, on the other hand, is impotent when interest rates are rapidly approaching their floor of zero and inflation is practically non-existent.

The Americans, the Japanese and the eurozone economies are the primary examples of the ineffectiveness of central bank actions. Only fiscal policy can rescue economies that are either in recession, or growth recession, as the case may be.

The eurozone countries are experiencing unacceptable unemployment rates of 8.9 per cent, growth recession and inflation generally above the 2 per cent target of the European Central Bank. The European Commission now warns of further stagnation in the third quarter of 2003. This unenviable performance is the result of the stability and growth pact and its nature—along with that of monetary policy—of “one-size-fits-all,” an argument that has been well rehearsed in the Financial Times.

Fiscal policy has been severely constrained by the pact and it has not been allowed to support monetary policy, itself having become destabilising and contributing to the current eurozone recession.

France and Germany must be right when they justify their violation of the fiscal rules by saying the pact has brought “too much stability and not enough growth.”

Japan is emerging with some growth because of government commitment to fiscal deficit (currently at 7.5 per cent of gross domestic product—much higher than the pact’s 3 per cent). The US’s budget deficit will increase in the order of 6–7 per cent of GDP well into the future; it will not stabilise at the 2 per cent level as Mr. Feldstein argues. Indeed, the world is looking to the US with its changed fiscal stance, and not to the actions of the Federal Reserve, to become the motor of the global economy

Published by:
The Financial Times

The slowdown in economic growth and rising unemployment in the euro area, with major economies slipping into recession, have revealed serious faultlines in the stability and growth pact governing the euro area's macroeconomic policies. The pact dictates that budget deficits must not exceed 3% of GDP, with a requirement budgets are in balance or surplus on average. Countries that do not adhere to these limits are threatened with fines. It should come as no surprise that slowdown pushes up deficits and has taken some countries over the 3% limit, notably in Germany and France.

For now, penalties for countries exceeding the limit have not been imposed and countries are given up to four years to meet the budget deficit requirements. Although there has been some bending of them, the rules remain in place. Indeed, the European Central Bank and members of the commission are demanding strict adherence to the rules of the pact in future. They are supported by the small countries of the eurozone, which complain that it is unfair for them to have to adhere to the pact while its main architects, Germany and France, do not.

The ECB and some governments view the zone's slowdown as the result of structural factors—labour market rigidities above all—and the failure to tackle burgeoning budget deficits. The rigidities, though, have been around for a long time: during the 50s and 60s, when many European economies were booming, especially Germany's "economic miracle" of the 70s. It is adherence to the pact's rules to limit budget deficits, which thereby can require tax rises and expenditure cuts in the face of recession, that has promoted the present slowdown.

This has not been helped by the ECB's inability to take action to stimulate the zone's economies. The recession has raised severe questions about the appropriateness of the institutional and policy arrangements governing the single currency and their ability to deal with unemployment, recession and inflation.

The limit on budget deficits and the overall balanced budget requirement are severe, running counter to the experience of the past six decades, not allowing public capital investment to be funded by borrowing and more severe than necessary to maintain the 60% public debt to GDP ratio.

Seeking to enforce the requirements of the pact imposes a substantial deflationary thrust and calls for flexibility in the pact's terms do not deal with the underlying problem. It is often argued the budget position of each country has to be restrained because of externalities, or spillover effects. These sometimes take the form of a government's spending putting upward pressure on interest rates and raising the cost of borrowing for others. This may then spill over into other countries and may cause the ECB to raise rates to dampen inflation.

Without accepting that expenditure would necessarily have these effects, we would say the expansion of private sector spending could be expected to have similar effects to those resulting from public spending. Fluctuations in the overall level of expenditure come into play mostly because of fluctuations in private expenditure. The logic of imposing limits on public expenditure would also apply to the private sector. Perhaps there should be limits on private sector deficit or on the trade account.

The pact threatens to become an "instability and no growth pact", with the thrust of fiscal and monetary policies pushing the eurozone economies in a deflationary direction, with Germany, Italy, and the Netherlands now in recession.

No wonder the EC president, Romano Prodi, complains that current pact arrangements are "rigid" and "stupid", and it would not be an exaggeration to suggest they have also become a standing joke.

France and Germany's justification for violating the fiscal rules is that the pact has delivered too much stability and not enough growth. Changes at this juncture in global economic development are very pressing. The falling dollar provides an opportunity for expansion. For, without strong growth outside the US, the economic imbalances may undermine the rest of the world's prospects.

The euro countries should take a lead. What is needed is a fundamental change so a truly effective pact emerges. Coordination of monetary and fiscal policies is paramount but requires monetary authorities to enter into agreements with fiscal authorities and a removal of limits on national deficits. And those deficits should be used to ensure high levels of activity within the euro area.