Tuesday, May 31, 2011

In Defense of Meritocracy (Part 2)

My Second article in a series of two, where I explain how meritocracy is behind the success of the most developed Latin societies, is now available at OrdemLivre.org (in Portuguese). I translate a passage:
Particularly worrying is the case of Brazil. After importing the worst from the antimeritocratic movement in Europe, without having ever implemented or understood the ideal of republican or confederate meritocracy, it now imports, apparently with pleasure, the worst from the antimeritocratic movement in America. It is essential to recognize that, in the case of Brazil, a country of predominantly Latin culture, if there is a chance to emulate successful countries that are culturally close, this emulation must pass through the strengthening of Brazilian meritocratic institutions. This is exactly the opposite of what governments have been doing in Brazil.

Monday, May 23, 2011

Federal Reserve, the Mondustrial Authority of the United States

Since the beginning of the financial crisis, it became pretty obvious to me that the Fed had decided to abandon its duties to sound monetary policy so it could use its money printing powers to directly solve the problems of a certain number of large and insolvent banks. John Taylor defines and analyzes these exotic and newly acquired functions of the Fed. He says:
Although some have pointed to an increase in the demand for money or reserves due to flight to quality during the financial crisis, this examination of the dynamics of the Federal Reserve’s balance sheet and other factors shows that it was due to the increase in loans and securities purchased by the Federal Reserve in order to assist specific firms and sectors. ...

But rather than go further in this direction it would be more appropriate for the Federal Reserve to begin to move back to monetary policy rather than what I have called here mondustrial policy. ...

[Nonetheless,] it may be difficult for the Federal Reserve to move in this direction or to exit from its current policy. It is already going down a path to purchase $700 billion more in securities backed by mortgages, credit card debt, student loans, and auto loans. It has stated that these actions are necessary because of the financial crisis. But are there no limits to increasing the size of such purchases in the future? And once the Federal Reserve owns these securities, they will be politically difficult to sell. ...

What justification is there for an independent government agency to engage in such industrial policy?
Taylor also offers evidence that the humongous issuing of bank reserves was the cause of the inordinate fall in monetary multipliers and velocities of circulation seen in the US after the crisis, and not the contrary. As he explains:
But the very severity of the panic in 2008 makes it difficult to convince people that there was not a panic-driven increase in the demand for the monetary base at that time, and I frequently hear economists and economic students sticking to [this] interpretation. ... [However,] the months since the start of QE2 are not even close to the panic observed in the fall of 2008. So it is ... difficult to argue that the Fed was responding to a panic-driven or otherwise autonomous increase in the demand for the monetary base. Much more likely is that — as in the fall of 2008 — banks simply absorbed the increased supply of the monetary base which the Fed used to finance QE2. In fact, if you look at the chart (which goes through April 2011), you can see the same inverse relationship between the money multiplier and the monetary base during QE2 as during 2008--2009

Sunday, May 22, 2011

Local Hatred as a Long-Term Phenomenon

Voigtländer and Voth apply spatial econometrics to the question of historical anti-Semitism in Europe and find evidence that hatred is a long-term local phenomenon, as they explain in this VoxEU.org post:
Our findings thus reinforce recent research in economics that documents just how persistent culture is. Raquel Fernandez and Alessandra Fogli (2009) show that the fertility of the children of immigrants to America is still influenced by what is happening in their parents’ home countries; Nathan Nunn and Leonard Wantchekon (2009) argue that areas in Africa affected by the slave trade in the 19th century still show lower levels of trust; and Saumitra Jha (2008) found that Indian cities with a history of peaceful coexistence between Muslims and Hindus have had lower levels of inter-ethnic violence in the recent past. In this context, our findings are striking because they concern anti-Semitism, a trait without any direct economic benefit (and probably some harmful economic consequences over the long run), and because we document persistence over a much longer time horizon than other studies.

Thursday, May 19, 2011

The Euro: a Documentary

One of my students at Euromed Management, Guillaume Allier, produced and directed a nice documentary (in French) about the euro. It's titled "L'Euro: petite histoire... d'une grande monnaie?"

It's divided in five parts, which can be watched below. Enjoy!

Partie 1 : La longue marche vers l’euro

Partie 2 : Le fonctionnement de l’euro

Partie 3 : L’euro sur l’économie européenne

Partie 4 : Quelles perspectives pour l’euro ?

Partie 5 : Sauver l’euro ?

Wednesday, May 11, 2011

Facts Versus Complacency in Currency Markets: Reaching a Dangerous Crossroad

Dollar against trade-weighted currency basket - or how to debase a currency (click on the graph to magnify)

Axel Merk writes a very interesting article in the Financial Times about the state of currency markets. His analysis matches most of my own insights on what has been going on. First, he explains the dollar weakness despite the fact that there's a debt crisis going on in parts of Europe:
Imagine a country that spends and prints trillions to patch up any problem.

Now imagine another country where there is no central Treasury, meaning that bail-outs are less easy, and which has a central bank that’s mopped up liquidity over the past year, rather than engage in quantitative easing.

Why does it surprise anyone that the latter, the eurozone, has a stronger currency than the former, the US? Because of peripheral countries’ debt refinancing issues? And the potential for contagion? These are real and serious issues, but in our assessment, they should be primarily priced into the spreads of eurozone bonds, not the euro itself.
Then he explains, among other reasons, why so many believe that Ben Bernanke lacks intellectual credibility as monetary authority:
Think of it this way: in the US, Federal Reserve chairman Ben Bernanke has testified that going off the gold standard during the Great Depression helped the US recover faster than other countries. Fast forward to today: we believe Bernanke embraces a weaker currency as a monetary policy tool to help address the current state of the US economy. What many overlook is that someone must be on the other side of that trade: today it is the eurozone, which is experiencing a strong currency, despite the many challenges faced within the 17-nation bloc.
He concludes by stating that, due to the monetary and fiscal policy mistakes that have yet been made, it's going to be very hard for the US to avoid high inflation in the medium to long term:
In the US, the day investors come to the reality that inflation, rather than fiscal discipline, is the path of least political resistance may be the day the bond market won’t be as forgiving. Unlike the eurozone, where consumers stopped spending and started saving a decade ago, the highly indebted US consumer may not be able to stomach higher interest rates. The large US current account deficit also makes the dollar more vulnerable to a misbehaving bond market than the eurozone.

In the medium term, we are far more concerned about risks to the US dollar than those posed by the Greek drama to the euro.
No matter what happens, one thing is clear: a financial crossroad has been created where many investors will heavily gain while many others will heavily lose.

Friday, May 6, 2011

No Matter How You Cut It, QE Remains Wrong

The Federal Reserve is fully committed to a "fire at will" monetary experiment called Quantitative Easing (QE). It basically means that the central bank allows affiliated banks to exchange all kinds of "colorful" pieces of paper for another "colorful" piece of paper called dollar. Note that only banks are allowed to participate: you're not allowed to bring any of your own colorful pieces of paper (such as your house title or your high school diploma) to the Fed and exchange it for dollars.

The interesting thing about QE is that, no matter how you try to explain its effects on the economy, you get to the conclusion that it's wrong. If you're one of those economists that think that printing high-powered money as if there's no future has avoided an American output collapse without creating inflationary pressures, then you need to explain the fast rate of depreciation of the dollar and the increasing price of commodities while unemployment remains high, investment low and growth anemic. If you say that it's not the dollar that is weakening, that it is the price of commodities and other currencies that are frothing, then it doesn't really matter: the monetary policy is wrong anyway for creating such frothing (no need to get into the merit of what a bubble really is as long as it is QE that is causing it).

I'm for a much simpler explanation for the monetary policy problems that we're experiencing. It's a combination of two typical problems in central banking: (a) central banks historically overestimate negative output gaps (remember the 70s!) and (b) the inflationary effects of monetary expansions can take a very long time to happen, particularly after a long period of stability and falling but yet high central bank credibility. In other words, we should never underestimate the power of denial when it comes to potential output and NAIRU calculations. On the other hand, central bank credibility has only gone down since the beginning of this crisis.

On the subject, The Economist's Buttonwood asks the gazillion dollar question on frothing asset and commodity prices:
The equity market sell-off could be ascribed to the same weak growth numbers that sparked the commodity decline. Nevertheless, it does draw attention to the contradictions inherent in this long bull-run. Central banks are holding interest rates low (and using QE) because the economy is weak. But if the economy is weak, why have equity and commodity prices done so well?

Wednesday, May 4, 2011

In Defense of Meritocracy (Part 1)

My first article in a series of two where I defend meritocracy as an alternative or complement to democracy is now available at OrdemLivre.org (in Portuguese). I translate a passage:
Meritocracy is present in several aspects of successful political and economic systems. The free market, for example, is one of the most important decentralized meritocratic institutions, a fact ignored even by economists. In it, those that offer goods or services are compensated according to the market value, and those who demand are able to acquire them if willing to pay the necessary compensation. The arrangement is meritocratic, because the decision-making power stems from the economic capacity of those who supply and demand.

Tuesday, May 3, 2011

Attention Fed: Headline Inflation Matters

This is the conclusion of Hellen Mees at VoxEU.org:
Even if the current spike in headline inflation proves to be transitory, past experience suggests that it may well lead to a permanent increase in real hourly wages. Unless monetary policymakers in the US favour feverish boom-and-bust cycles with prolonged periods of high unemployment, they had better start paying close attention to headline inflation, like their counterparts at the ECB do.

Sunday, May 1, 2011

7th Art: Inception (2010)

There's no question that "Inception" is an entertaining movie, but I see a troublesome trend here: just like in science, could it be the case that overspecialization is taking a toll on the movie industry? I couldn't shake off a sense of disconnectedness throughout the enterprise, and enterprise is what it felt like to me, not storytelling. Good enterprising naturally, technically well done, but it didn't sink in. A lot like science as it's done these days.

Examples of that: no matter how good is the virtual reality rendering in those recent movies, acting remains detached from the environment. It's the chroma key syndrome. Besides, the overuse of video game-like action sequences in contemporaneous movie making is becoming really boring, and this is from someone that is young enough to have played first-person shooter games somewhat avidly. All the tech wizardry in these movies feels a lot like those jazz fusion songs of the 80s that were probably fun to play but were not so fun to listen to.

In other words, stick to the originals: Tarkovsky's "Solaris" for narrative and emotional depth, and the Wachowskis' "The Matrix" for surreal daredevilry.