Econo-limericks

A few economics-themed limericks spotted over at the WSJ economic blog this afternoon beginning with Fed chief Ben Bernanke:

“I’m afraid,” said Bernanke to Geithner,
“The debt crisis still has lots of bite in ‘er.
Though it may cause some ranklin’
I’ll print lots more Franklins:
We’ll loosen our money, not tighten ‘er!”
...
Said Bernanke, stroking his beard,
“This ‘-flation’ is worse than I feared;
All the research I see
Is pointing to ‘de-’;
It’s the ‘in-’ crowd that strikes me as weird.”

One called “Overheard at Goldman Sachs”:
“We assume that you know what you’re doing,
In this ill-advised trade you’re pursuing,
But the opposite bet
That we place on your debt
May eventually hasten your ruin.”

That last one is an instant classic. There are lots more at Limericks Economiques.

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Dr. Doom and Deputy Doom at CNBC.com

CNBC has two stories out this morning that should scare the bejeebers out of investors, but, the ongoing rally seems indefatigable as of late. Dr. Doom notes in this report that the odds of a double-dip recession were 20 percent before the recent spate of negative economic data.

Poor economic data in the US coupled with Europe's debt crisis are contributing to an increase of the risk of the US economy going through a double-dip recession, Nouriel Roubini, who predicted the 2007 financial crisis, wrote in a research paper.
...
The Roubini Global Economics benchmark scenario puts the risk of a double dip at 20 percent, while a slow, protracted, U-shaped recovery is given the highest probability of 60 percent.

But since the end of February new macroeconomic data from the US have come out and "they have been almost uniformly poor, if not outright awful," Roubini wrote.

Consumer confidence has "tanked", new home sales are "collapsing," existing home sales are also falling sharply, as is construction activity, while initial jobless claims remain "stubbornly high" above the 400,000 mark, he said.

Roubini was unimpressed by the 5.9 percent growth rate for the economy in the fourth quarter as it was largely an inventory rebuilding surge and it came at a time when the maximum impact of the government stimulus was being felt.

A Roubini "protege" (now there's a word that you don't hear too much anymore...) apparently known as "Deputy Doom" also showed up on CNBC.com this morning in this story about another topic that you don't hear too much about anymore - inflation.

'It's Going to Be Inflation Everywhere:' Deputy Doom
The global economy is entering a next "supercycle" phase that will generate inflation necessary for recovery, a strategist and protege of noted economist Nouriel Roubini told CNBC.

Arun Motianey, director of fixed income strategy at Roubini's RBG Capital, said the supercycles feature periods of commodity booms followed by busts, and the US economy is on the verge of an inflationary period that will generate a sharp rise in prices.

"We're heading into a world of inflation because we are highly indebted and we are indebted here in the US economy in the household sector and in the financial sector," said Motianey, author of the book "SuperCycles."
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"It's going to be inflation everywhere and it's going to happen really through the weakness of the US dollar," he said. "Then inflation in those other parts of the world that are expecting appreciating currencies, they're going to inflate as well because that's the way you ultimately correct this."

You also don't hear too much about "supercycles" these days...

The idea that we were in the middle of a "commodities supercycle" a few years back and that it has been on pause - not over - will likely gain traction as we move further and further away from the cataclysmic events of 2008-2009.

Of course, economists seem to be doing their part to help in that regard and a subject that you do hear a lot of talk about these days is their sudden "embrace" of higher inflation (for the sake of recovery, that is), as seen in this piece at voxeu - A 4% inflation target?

At some point in the years ahead, economists will probably wish inflation was only 4 percent.

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The dismal set hasn't learned much

More evidence that the dismal science as currently practiced may be entering another leg down in what is now a decade long death spiral comes in two reports this morning, the first being this Wall Street Journal item where cutting edge economic thinking has it that higher inflation a few years back might have saved us all from the financial market crash and global economic meltdown eighteen months ago.

For the past quarter century, inflation has been a bogeyman that eats wealth and causes instability. But lately some smart people—including the chief economist at the International Monetary Fund and a senior Federal Reserve researcher—have been wondering aloud if a little more of it might actually be a good thing.
...
The new argument for inflation goes like this: Low inflation and the low interest rates that accompany it leave central banks little room to maneuver when shocks hit. After Lehman Brothers collapsed in 2008, for example, the U.S. Federal Reserve quickly cut interest rates to near zero, but couldn't go any lower even though the economy needed a lot more stimulus.

Economists call this the "zero bound" problem. If inflation were a little higher to begin with, and thus interest rates were a little higher, the argument goes, the Fed would have had more room to cut interest rates and provided more juice to the economy.

Yes, the problem was that inflation wasn't high enough...

Sadly, if economists had not been so dimwitted in making the disastrous mistake of thinking that real estate was more of an investment than a consumer good and then pulling home prices out of the official measure of inflation back in the 1980s, even they would have seen that there were serious problems beginning seven or eight years ago when something could have been done about a nascent housing bubble before it nearly destroyed the world.

In the world of dismal scientists, if something doesn't show up in the data, it doesn't exist, so, the housing bubble never existed - that is, until it burst.

Economists across the pond don't seem to be making any better progress in getting back in touch with the real world, though, the use of the word 'back' is, perhaps, being generous.

In the Telegraph today, Edmund Conway writes of being mystified by the ongoing debate about whether deficits should be cut sooner rather than later as it misses some very fundamental points about the current condition.

In short, I am dismayed by it. In fact, I would go further and say it illustrates why the economists’ profession simply hasn’t learnt from the atrocious intellectual and policy mess it made ahead of the crisis.
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One of the things we learnt from the crisis is that there was a dearth of people propounding truly counterintuitive, counterfactual economic theories. And that those who did were simply ignored. The mainstream failed to see the woods from the trees. It became obsessed with far smaller debates (productivity, protectionism etc) but failed to step back and ask whether the entire edifice of financial economics was about to collapse, which, of course it did. But despite this neglect, the economists always seemed busy.

My feeling is that we’re in a similar position now. These letters represent a similar mirage of intellectual activity which disguises the fact that the economic mainstream is again neglecting deeper questions about where we’re heading. But then perhaps that’s what always happens when politics and economics collides.

It looks like it's going to be another bad year for the economics profession, though they remain an optimistic bunch, predicting just this morning that the U.S. recovery will grow steadily this year and next with jobs returning aplenty.

Lynn Reaser, president of the National Association for Business Economics, commented on the late-January survey of 48 economist noting, "We see a healthy expansion under way, although it will take time to reduce economic slack and repair damaged balance sheets."

We'll find out just how healthy the economic expansion is soon enough.

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Robert Shiller in Davos

Some of the world's smartest and dumbest economists have gathered in Davos, Switzerland to talk about the global banking system and how they're all hoping that 2010 doesn't turn out like 2008. CNBC's Becky Quick grabbed Yale economist Robert Shiller for a quick chat.

Obviously, Shiller is one of the sharper tools in the economic shed, starting this interview by noting of his duller brethren: "The problem with a lot of economic theory is that they have not recognized what drives the economy." Sad, but true.

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Economists, weathermen, and Paul Volcker

From David Rosenberg's daily missive at Gluskin Sheff today:

Question: Why did God create economists?
Answer: To make the weatherman feel good about themselves.

Also, on the Obama Administration's underutilization of former Fed Chairman Paul Volcker:

The fact that Paul Volcker, whose integrity is fully intact, supported this ticket and the luring effect this had on a lot of folks, should not be forgotten. If Paul Volcker is on your side, then you must be on a path that is going to do some good from an economics perspective at the very least; and you must be a moderate too. Instead what we have is the loss of an additional five million jobs since the 2008 election and a record level of intrusion by the government into almost all aspects of the financial markets and the economy and confidence levels among consumers and small businesses languishing at recession levels.

Now we see that all Paul Volcker really was to the Obama team was a vote-getter during the election — it is really disturbing to see this article on page C1 of the WSJ (Volcker’s Influence is Diminishing). One would think that the person who took the tough action to rid the economy of inflation, and it took two severe recessions but for the greater long-term good, would be the guy you would want to have implementing debt-reduction and austerity programs that will help take the economy into a completely fresh up-cycle, even if it takes five years to get there, as opposed to policies that are merely going to prolong the malaise, just as the New Deal did back in the 1930s with respect to resource misallocation on a grand scale.

To save the banks to only then apply a special tax to the banks to pay for the ongoing stimulus aimed at perpetually stimulating a 71% consumption/GDP ratio and a 67.4% homeownership rate is just one display of policy confusion that we are sure will be discussed in detail in future economic history textbooks.

Well put. Independents who were swayed by the inclusion of the only former Fed chairman with any credibility left are rightly disappointed at this juncture.

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U.K. economy continues to contract

The other country with what will, eventually, be called a "basket case" economy - due to its huge, unsustainable twin deficits and dearth of domestic savings that finally resulted in finance and consumption led growth to permanently stall - released new data today indicating that economic growth continued to contract in the third quarter, disappointing analysts who were expecting the first gain in a year-and-a-half.

This report in the Telegraph has all the details:

The economy unexpectedly shrank by 0.4pc in the third quarter, defying expectations that the UK had emerged from recession with 0.2pc growth. Shadow Chancellor George Osborne said the figures were “deeply disappointing”.
The Chancellor however insisted the figures were in line with his forecasts. “I’ve always been clear that growth will return at the turn of year,” he said.

Manufacturing and construction made negative contributions to economic growth and the overall contraction from the start of the recession has now reached 6 percent, the largest since the Great Depression, also known as the Great Slump (at least according to Wikipedia).

John Philpott, chief economist at the Chartered Institute of Personnel and Development, noted that the recession "looks more like a depression" a view that was echoed by Edmund Conway in this piece that also appeared in the Telegraph.

This recession just became a depression
It is difficult to know what to be most shocked by in the gross domestic product figures published by the Office for National Statistics this morning: the fact that we are in the longest-lasting deepest continuous recession in recorded history or that no-one in the City foresaw it*.

Leaving aside the City’s failings, with which we are intimately familiar, the scale of the economic collapse is disturbing. The National Institute for Economic and Social Research has been calling this a “depression” rather than a recession for some time – these figures surely now underline such a description.

Mr. Conway then goes on to break the numbers down a bit with the expected results.

Things don't look very good across the pond and, naturally, at a time like this, many look to assign blame for what has happened and, naturally, economists once again are the prime suspects as detailed in this story at The Guardian.

Economists perform dismally again
City fails to predict longest recession since records began

So, there we have it, the recession is the longest since quarterly records began in 1955 and, guess what, the City again failed to predict it.

The average forecast from economists in the Square Mile was that the economy had expanded by 0.2% in the July to September period. But in fact, according to the ONS's preliminary figures, it contracted by 0.4% - the sixth drop in a row. That's a big forecasting error, really big.

Sure, we had had dismal industrial output figures recently and poor retail sales figures yesterday, but, undeterred, the guys in the City decided those warning signs did not change the view that all the stimulus of 0.5% interest rates and all that quantitative easing, combined with cuts in VAT and a falling pound, were bound to push the economy back to growth in the third quarter.

Of course, these are the same people who failed to see the recession coming so really we shouldn't have even paid any attention to their forecasts in the first place.

Ouch! Economists are really having a bad year.

Bloomberg reports that the crew at the Bank of England (mostly economists, you'd think) may have to print up a bunch more money to help the cause.

Come to think of it, economists are having a bad decade.

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The Fed economists

A link to this Ryan Grim story at the Huffington Post was provided in the comments section yesterday by Idaho Spud and, since it's been popping up all over the place since then, it seemed like a good idea to send a bit more traffic their way since it really is a masterpiece - a fine example of how the "alternative" media is sometimes way ahead of the mainstream media.

Priceless: How The Federal Reserve Bought The Economics Profession

The Federal Reserve, through its extensive network of consultants, visiting scholars, alumni and staff economists, so thoroughly dominates the field of economics that real criticism of the central bank has become a career liability for members of the profession, an investigation by the Huffington Post has found.

This dominance helps explain how, even after the Fed failed to foresee the greatest economic collapse since the Great Depression, the central bank has largely escaped criticism from academic economists. In the Fed's thrall, the economists missed it, too.

"The Fed has a lock on the economics world," says Joshua Rosner, a Wall Street analyst who correctly called the meltdown. "There is no room for other views, which I guess is why economists got it so wrong."

This is a long and detailed look at a profession that has been criticized often here in these pages over the years and it goes a long way in explaining why we're currently in such a mess.

Well worth the time to read in its entirety, below are a few excerpts that struck me as being particularly damning.

One critical way the Fed exerts control on academic economists is through its relationships with the field's gatekeepers. For instance, at the Journal of Monetary Economics, a must-publish venue for rising economists, more than half of the editorial board members are currently on the Fed payroll -- and the rest have been in the past.
...
The Federal Reserve's Board of Governors employs 220 PhD economists and a host of researchers and support staff, according to a Fed spokeswoman. The 12 regional banks employ scores more. (HuffPost placed calls to them but was unable to get exact numbers.) The Fed also doles out millions of dollars in contracts to economists for consulting assignments, papers, presentations, workshops, and that plum gig known as a "visiting scholarship." A Fed spokeswoman says that exact figures for the number of economists contracted with weren't available. But, she says, the Federal Reserve spent $389.2 million in 2008 on "monetary and economic policy," money spent on analysis, research, data gathering, and studies on market structure; $433 million is budgeted for 2009.

That's a lot of money for a relatively small number of economists.
...
The Fed keeps many of the influential editors of prominent academic journals on its payroll. It is common for a journal editor to review submissions dealing with Fed policy while also taking the bank's money. A HuffPost review of seven top journals found that 84 of the 190 editorial board members were affiliated with the Federal Reserve in one way or another.

"Try to publish an article critical of the Fed with an editor who works for the Fed," says Galbraith. And the journals, in turn, determine which economists get tenure and what ideas are considered respectable.

The pharmaceutical industry has similarly worked to control key medical journals, but that involves several companies. In the field of economics, it's just the Fed.
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Publishing in top journals is, like in any discipline, the key to getting tenure. Indeed, pursuing tenure ironically requires a kind of fealty to the dominant economic ideology that is the precise opposite of the purpose of tenure, which is to protect academics who present oppositional perspectives.

And while most academic disciplines and top-tier journals are controlled by some defining paradigm, in an academic field like poetry, that situation can do no harm other than to, perhaps, a forest of trees. Economics, unfortunately, collides with reality -- as it did with the Fed's incorrect reading of the housing bubble and failure to regulate financial institutions. Neither was a matter of incompetence, but both resulted from the Fed's unchallenged assumptions about the way the market worked.
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The Huffington Post reviewed the mastheads of the American Journal of Economics, the Journal of Economic Perspectives, Journal of Economic Literature, the American Economic Journal: Applied Economics, American Economic Journal: Economic Policy, the Journal of Political Economy and the Journal of Monetary Economics.

HuffPost interns Googled around looking for resumes and otherwise searched for Fed connections for the 190 people on those mastheads. Of the 84 that were affiliated with the Federal Reserve at one point in their careers, 21 were on the Fed payroll even as they served as gatekeepers at prominent journals.
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At the Journal of Monetary Economics, every single member of the editorial board is or has been affiliated with the Fed and 14 of the 26 board members are presently on the Fed payroll.

The stories about Alan Blinder and Paul Krugman are particularly telling and, never having worked in academia, it's difficult to appreciate how pervasive the Fed's influence might be for those looking to advance their careers.

It does go a long way, however, in explaining why you hear such little criticism of the central bank from most mainstream economists.

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Just dismal...

In a guest article at the The Economist, in response to at least three less-than-flattering assessments of the profession in recent weeks, Chicago University Economic Professor Robert Lucas defends economic models and their contributions to Mankind.

One thing we are not going to have, now or ever, is a set of models that forecasts sudden falls in the value of financial assets, like the declines that followed the failure of Lehman Brothers in September. This is nothing new. It has been known for more than 40 years and is one of the main implications of Eugene Fama’s “efficient-market hypothesis” (EMH), which states that the price of a financial asset reflects all relevant, generally available information. If an economist had a formula that could reliably forecast crises a week in advance, say, then that formula would become part of generally available information and prices would fall a week earlier.

How about throwing out all of the failed models along with efficient market theory and setting a modest goal of looking at how asset prices and people interact in an effort to spot the next giant speculative bubble before it destroys the world?

It didn't take any models or elaborate theories to conclude that when Fannie and Freddie couldn't file financial statements back in 2003 due to their use of derivatives, there was something seriously wrong and the correct remedy was not to outsource their operations to Wall Street, away from the prying eyes of regulators.

When in 2005 and 2006, mortgage lenders joked that "anyone who could fog a mirror could get a loan", it was already too late, but the damage done in 2008 might have been mitigted if these activities were not broadly characterized as "financial innovation" amongst economists.

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A fertile moment for economists

The Telegraph's Edmund Conway writes about the failure of contemporary economic thought and of "excitement" amongst the ranks of the dismal set that a new era is dawning.

Following its failure to fix the current mess, economics has tumbled into a full-blown existential crisis. The fall has been something to behold. Not so long ago, the discipline seemed omnipotent: if you wanted to fix anything from environmental ruin to welfare policy, there was only one solution: call in an economist.

But late last year, Alan Greenspan, the former Federal Reserve chief and high priest of capitalism, was forced to admit in a Congressional hearing that he had "found a flaw" in the foundations of his economic understanding. Nice euphemism.
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But in a strange way, the by-product of this financial collapse has been to free economics of this burden. In the corridors of the Bank of England and Treasury, there is a distinct whiff of excitement. For the first time in decades, economists have been able to throw away their textbooks and go back to first principles; to exhume once-sacrilegious figures such as John Maynard Keynes or Friedrich Hayek. It is unsettling, no doubt, but this is a fertile moment, an opportunity from which may be born a better model of how to run an economy.

We are already seeing the consequences. In the future, markets will be less free; there will be more regulation; the state will be more interventionist. Taxes may become more redistributive. But from the ashes of the crisis may come a new understanding of how to run an economy that is both more successful, and more stable, than the failed models of the past.

Then again, maybe if the world's money were made sound again and there were some reasonable limits on credit creation, economists could go back to doing what they were doing for the better part of the last few centuries and meet with much more success.

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The Economist on the failure of economics

The venerable Economist magazine must be feeling at least a little bit tarnished after the heavy (and well-deserved) criticism that has been directed toward the profession that they have represented since 1843 though, admittedly, they cover much more than economics.

In this report, they offer up a heavy dose of introspection:

What went wrong with economics

OF ALL the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself. A few years ago, the dismal science was being acclaimed as a way of explaining ever more forms of human behaviour, from drug-dealing to sumo-wrestling. Wall Street ransacked the best universities for game theorists and options modellers. And on the public stage, economists were seen as far more trustworthy than politicians. John McCain joked that Alan Greenspan, then chairman of the Federal Reserve, was so indispensable that if he died, the president should “prop him up and put a pair of dark glasses on him.”

Yes, the profession clearly peaked (along with the housing bubble) when Freakonomics was published in 2006, but, more importantly, it's been some time since I've thought about that quip from a very different John McCain in late-1999.

It's aging well...

From Wikiquote comes the complete text and a reference at CNN. McCain said, "I would not only reappoint Mr. Greenspan -- if Mr. Greenspan should happen to die, God forbid -- I would do like was did in the movie, 'Weekend at Bernie's.' I'd prop him up and put a pair of dark glasses on him and keep him as long as we could".

That may have produced a better outcome that what actually occurred between 2000 and 2006 when the former Fed Chairman retired.

Hmmm... back to The Economist:

In the wake of the biggest economic calamity in 80 years that reputation has taken a beating. In the public mind an arrogant profession has been humbled. Though economists are still at the centre of the policy debate—think of Ben Bernanke or Larry Summers in America or Mervyn King in Britain—their pronouncements are viewed with more scepticism than before. The profession itself is suffering from guilt and rancour. In a recent lecture, Paul Krugman, winner of the Nobel prize in economics in 2008, argued that much of the past 30 years of macroeconomics was “spectacularly useless at best, and positively harmful at worst.” Barry Eichengreen, a prominent American economic historian, says the crisis has “cast into doubt much of what we thought we knew about economics.”
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There are three main critiques: that macro and financial economists helped cause the crisis, that they failed to spot it, and that they have no idea how to fix it.

The first charge is half right. Macroeconomists, especially within central banks, were too fixated on taming inflation and too cavalier about asset bubbles. Financial economists, meanwhile, formalised theories of the efficiency of markets, fuelling the notion that markets would regulate themselves and financial innovation was always beneficial. Wall Street’s most esoteric instruments were built on these ideas.
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The charge that most economists failed to see the crisis coming also has merit. To be sure, some warned of trouble. The likes of Robert Shiller of Yale, Nouriel Roubini of New York University and the team at the Bank for International Settlements are now famous for their prescience. But most were blindsided. And even worrywarts who felt something was amiss had no idea of how bad the consequences would be.

That was partly to do with professional silos, which limited both the tools available and the imaginations of the practitioners. Few financial economists thought much about illiquidity or counterparty risk, for instance, because their standard models ignore it; and few worried about the effect on the overall economy of the markets for all asset classes seizing up simultaneously, since few believed that was possible.
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What about trying to fix it? Here the financial crisis has blown apart the fragile consensus between purists and Keynesians that monetary policy was the best way to smooth the business cycle. In many countries short-term interest rates are near zero and in a banking crisis monetary policy works less well. With their compromise tool useless, both sides have retreated to their roots, ignoring the other camp’s ideas. Keynesians, such as Mr Krugman, have become uncritical supporters of fiscal stimulus. Purists are vocal opponents. To outsiders, the cacophony underlines the profession’s uselessness.

They would have been well served to make the point that many Wall Street economists (and whatever the equivalent street is in London) are bound to serve their masters who much prefer rosy predictions than the alternative.

It is no coincidence that most bearish economists in recent years have few ties to the banking industry, financial media outlets like CNBC, or investment banking where optimism seems to be a prerequisite for the job.

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Now they listen to William White

This story and associated slide show in Spiegel Online (hat tip Tailwind) about William White, former chief economist at the BIS (Bank for International Settlements), offers new hope that maybe, just maybe, the global economy will someday be put on a steadier course.

William White predicted the approaching financial crisis years before 2007's subprime meltdown. But central bankers preferred to listen to his great rival Alan Greenspan instead, with devastating consequences for the global economy.

Mr. White has been something of hero at this blog, his summer musings in the BIS annual report anxiously awaited year after year, then endlessly fawned over as should be clear from the list of previous posts below:

• May 18, 2006 - A Monetary Policy Double Standard
• Jun 29, 2006 - Catch the Swamp Fever!
• Jun 26, 2007 - Austrian economics in the WSJ
• Jul 01, 2008 - BIS Chief Economist William White channels his inner-Austrian
• Dec 11, 2008 - William White: "The facts are so obvious"
• Apr 01, 2009 - White vs. Greenspan - No Contest

It's nice to see that others are now listening...

This is a quite lengthy article, well worth reading in its entirety. Here's the best part:

White recognized the brewing disaster. The analysis department at the BIS has a collection of data from every bank around the globe, considered the most impressive in the world. It enabled the economists working in this nerve center of high finance to look on, practically in real time, as a poisonous concoction began to brew in the international financial system.

White and his team of experts observed the real estate bubble developing in the United States. They criticized the increasingly impenetrable securitization business, vehemently pointed out the perils of risky loans and provided evidence of the lack of credibility of the rating agencies. In their view, the reason for the lack of restraint in the financial markets was that there was simply too much cheap money available on the market. To give all this money somewhere to go, investment bankers invented new financial products that were increasingly sophisticated, imaginative -- and hazardous.

As far back as 2003, White implored central bankers to rethink their strategies, noting that instability in the financial markets had triggered inflation, the "villain" in the global economy. "One hopes that it will not require a disorderly unwinding of current excesses to prove convincingly that we have indeed been on a dangerous path," White wrote in 2006.

In the restrained world of central bankers, it would have been difficult for White to express himself more clearly.

Now White has been proved right -- to an almost apocalyptical degree. And yet gloating is the last thing on his mind. He, the chief economist at the central bank for central banks, predicted the disaster, and yet not even his own clientele was willing to believe him. It was probably the biggest failure of the world's central bankers since the founding of the BIS in 1930. They knew everything and did nothing. Their gigantic machinery of analysis kept spitting out new scenarios of doom, but they might as well have been transmitted directly into space.

For years, the regulators of the global money supply ignored the advice of their top experts, probably because it would require them to do something unheard of, namely embark on a fundamental change in direction.

The prevailing model was banal: no inflation, no problem. But White wanted central bankers to take things a step further by preventing the development of bubbles and taking corrective action. He believed that interest rates ought to be raised in good times, even when there is no risk of inflation. This, he argued, counteracts bubbles and makes it possible to lower interest rates in bad times. He also advised the banks to beef up their reserves during a recovery so that they would be in a position to lend money in a downturn.

If White's model had been applied, it might have been possible to avoid the collapse of the financial system -- or at least soften the fall. But there was simply no support for his ideas in the singular, and highly secretive, world of central bankers.

They were all too busy patting each other on the back, apparently, after wholeheartedly endorsing all of the mid-decade "financial innovation" that had produced the closest thing Mankind has ever seen to an economic and financial market utopia.

That utopia didn't last very long...

ooo

This week's cartoon from The Economist:

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The systemic failure of academic economics

A few barbs have been cast in the direction of Steve Keen from this little outpost in the financial blogosphere before (something having to do with an irreversible deflation death spiral or somesuch), but many thanks are in order today for bringing to our attention some amazing introspection by a few enlightened individuals who practice the dismal science.

In And you think I'm ornery?, Steve points us to The Dahlem Report(.pfd):

The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.

And that's just the executive summary.

The introspection becomes even more brutal another page or two in:

It is obvious, even to the casual observer that these models fail to account for the actual evolution of the real-world economy. Moreover, the current academic agenda has largely crowded out research on the inherent causes of financial crises. There has also been little exploration of early indicators of system crisis and potential ways to prevent this malady from developing. In fact, if one browses through the academic macroeconomics and finance literature, “systemic crisis” appears like an otherworldly event that is absent from economic models. Most models, by design, offer no immediate handle on how to think about or deal with this recurring phenomenon. In our hour of greatest need, societies around the world are left to grope in the dark without a theory. That, to us, is a systemic failure of the economics profession.

The entire paper is worth reading in its entirely - very nicely done.

It's possible that Floyd Norris at the New York Times may have had a look at this before penning yesterday's Failing Upward at the Fed in what is yet another scathing attack on central banks and their policies.

Books will be written on the failure of the Fed in the last cycle. It decided that it did not need to worry itself over rising asset prices. So it stood by, first in the technology stock bubble, then in the housing bubble. It saw credit getting excessively loose, and leverage piling up, but comforted us with assurances that if there was a bubble, the Fed knew how to clean up after it burst, principally by cutting interest rates.

It championed letting the shadow financial system grow without oversight, and shied away from doing anything about highly risky mortgages.

Perhaps most important, the Fed and other regulators had no idea how much risk they had allowed into the system. They knew that various financial innovations were designed to let banks make more money without being required to put up more capital, but they did not figure out that that meant the capital there might be inadequate. They threw up their hands at the complexity of it all, and said banks could use their own models to assess risk.

In sum, the Fed thought it had learned the lessons of the 1930s, but it had not learned the lesson of the 1920s, that allowing asset prices to soar to absurdly leveraged heights could lead to a financial collapse as the need to repay loans forced sales that drove prices lower, resulting in the need to repay more loans, and so on and so on.
...
Mr. Bernanke’s predecessor, Alan Greenspan, has been trying to restore his reputation without admitting any error beyond assuming that banks would act rationally in making loans, and therefore not requiring large enough capital buffers.

“The real lesson here appears to be that bank regulators cannot fully or accurately forecast whether, for example, subprime mortgages will turn toxic or whether a particular tranche of a collateralized debt obligation will default, or even if the financial system will seize up,” he said in a speech last week to the Economic Club of New York. It sounded to me a little like a failing student protesting, “Dad, nobody could have passed that test.”

Is the current Fed leadership so modest about its abilities? No doubt it cannot “fully or accurately” forecast what will happen, but does it think that it can do a much better job now than it did in the years leading up to the current crisis? If so, how?

These are all good questions. It's nice to see them being asked.

ooo

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A dismal outlook for dismal scientists

Justin Lahart reports in today's Wall Street Journal that employment for economists is falling below trend. That is, there appears to be a widening output gap - the difference between the actual hiring of economists and the hiring that could be achieved if people still believed that economists knew what they were doing.

Job Market for Economists Turns ... Dismal
The dismal economy has claimed yet another victim: jobs for the economists who study it.

Columbia University's economics department, for example, isn't making any new hires this year. That's in stark contrast to last year, when Columbia poached eight economics professors from other schools, and hired one economist out of graduate school. The University of North Carolina at Chapel Hill, Amherst College and the University of Minnesota all have suspended their searches for economics professors. And Harvard University has gotten permission to hire just one person -- only after "many rounds of negotiation," according to Harvard economist Lawrence Katz, who is handling recruiting this year. Typically, Harvard hires two or three economics professors out of graduate school.

The hesitancy to add staff is completely understandable.

It's akin to what medical schools might do if they woke up one day and realized that people are now dying because of what they've taught doctors over the years.

Much sought after, high paying positions at investment banks and hedge funds are, understandably, drying up now that the entire global economy is in the tank.

That's probably a good thing - idle time often results in introspection.

The rollback comes at a historic time, as economists struggle to explain the worst financial crisis since the Great Depression. The crisis, which few economists saw coming, revealed deep gaps in many of the standard ways that economics approaches the economy, driving home the need for fresh thinking and talent.

I'll go ahead and say what Justin was too polite to utter, speaking directly to new-grads:

Much of what they taught you in school is apparently wrong - otherwise, we wouldn't be rapidly approaching what looks to be another Great Depression.

The inability of economists to pull their noses out of academic papers and statistics and to look at the real world has been a major cause of the ongoing crisis, yet, by and large, you still don't have a clue.

Here's just one example.

Wake the f#@k up!

What was perhaps most distressing about this entire article (which is in the public area of the Journal and is well worth reading in its entirety) is that, apparently, economics professors are among the highest paid staff at many universities with average annual salaries of $86K for new hires.

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Another central banker finds a flaw

Last October, Alan Greenspan, the former head of the central bank in the U.S., sheepishly told Congress that he "found a flaw" in his theoretical framework of how the world works, going on to note that he never thought large portions of the financial industry would look past long-term solvency to achieve short-term gains.

Or something like that...

It's all here in Greenspan finds a flaw.

Well, apparently, flawed views of the world aren't unique to the western side of the Atlantic Ocean as word comes from the Telegraph this morning that Bank of England Governor Mervyn King (aka "Unswerving Mervyn") is thought to have been using flawed models of the British Economy, leading to the dramatic reversal of monetary policy over the last year that has seen short-term lending rates rise and then fall faster than London home prices.

It's all here in Flawed model 'blinded' King to credit crisis.

That's a lot of flaws and blind spots for two of the most important economies in the world.

Some excerpts:

Former members of the monetary policy committee will this week call on Mervyn King to tear up the Bank of England's complex mathematical model of the economy, as the Bank is accused of having exacerbated the recession by failing to cut interest rates fast enough when the credit crunch hit.

As King prepares to issue the Bank's latest economic forecasts this week, three former MPC members, Sushil Wadhwani, Willem Buiter and DeAnne Julius, have agreed to join an extraordinary experiment by number-crunchers at consultancy Fathom to build a rival to the Bank of England Quarterly Model (BEQM), its main forecasting model.

Interest rates have now been slashed to an unprecedented low of 1% to cushion the economy against the worsening downturn; but they were left on hold for much of last year, as MPC members fretted about the risk that rising oil prices would affect the public's "inflation expectations", which would in turn lead to surging wages. Critics say using BEQM to guide its decisions had blinded King and his colleagues to warning signs in the outside world.

Using information gleaned from publicly available documents and Bank insiders, Fathom's number-crunchers have constructed a replica of BEQM. It shows that the model actually stops working when interest rates hit zero - an increasingly pressing possibility - and fails to allow for the impact of a credit shortage on the economy.

Fathom's director, Danny Gabay, himself a former Bank economist, argues that interest rates would have been cut earlier and faster, and the recession might have been less severe, if Mervyn King and his colleagues had relied less rigidly on mathematical models, and taken more notice of what independent MPC member David Blanchflower has called "the economics of walking about".

It's funny that you don't hear too many economists criticizing other economists for not doing enough "walking about" earlier in the decade when wild-eyed lenders, borrowers, insurance companies, and hedge funds were setting the stage for the financial collapse that has occurred over the last year or so.

More and more, the current era is starting to sound like the Great Depression in that history starts after a financial bubble is fully inflated - as if how things got to that point are unimportant.

Read any history of the Great Depression (except for those written by Austrian economists) and you'll find that the accounting begins in 1929 with the stock market crash.

Never mind about the Florida housing bubble in 1925 and the credit excesses that led to the stock market bubble a few years later, for most practicing economists and virtually all central bank economists, the problems begin in 1929.

They didn't. They began much earlier in the decade then and now.

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Dumb and dumber

[The following conversation between two top U.S. economists was recently overheard at the World Economic Forum in Davos, Switzerland. For obvious reasons, their names have been withheld - they will be referred to here as Lloyd and Harry.]

Two economists hatch a plan to save the global economy...

Lloyd: Harry, what are we going to do about deflation? We missed it by a whisker last month in the U.S., but you know next month's Consumer Price Index is going to show deflation and then people are going to stop spending money because they know they'll get lower prices if they just wait a little longer and that's going to just kill the economy...as if things aren't already bad enough.

That's what happened during the Great Depression and you know it will happen again if we allow deflation to take hold.

Harry: I know Lloyd, that's been keeping me up at night too. A lot of us our scratching our heads right about now. Macroeconomics used to be easy. Over the last twenty years, all you had to do was raise interest rates when the CPI went up and lower rates when the CPI went down, though that deflation scare in 2002-2003 was pretty frightening.

Lloyd: It's a good thing that we had Greenspan around at the time because he snuffed out that deflation like it was nobody's business. He had it down on the mat with those low interest rates and he wasn't going to let it up no matter what. That was really something!

Harry: Yes it was. You know all this criticism he's taken lately is really unfair. If he hadn't done what he did, we'd be six years into a deflationary spiral and people would be saying, "It's all Greenspan's fault for not doing enough to fight deflation".

Lloyd: Yeah, it really is unfair, but, what are we going to do about deflation this time Harry? Short-term rates are already at zero and the Federal Reserve and Treasury have already bought or guaranteed trillions of dollars worth of bank assets and, so far, quantitative easing just isn't working.

Harry: I don't know Lloyd, maybe if we can put our heads together we can come up with something, anything, to stop that deflation train that's barreling down the tracks.
Lloyd: You know, Merrill Lynch is predicting year-over-year inflation of minus 3.2 percent by summertime - I guess we'll all have to stop talking about in-flation and start saying de-flation when these new inflation numbers come out...or should I say, "when the de-flation numbers come out".

Harry: And I hear Goldman Sachs just polled some money managers and found that 83 percent of them think de-flation, not in-flation, is now the biggest threat to the global economy. I just hate the sound of that...de-flation.

Lloyd: Hmmm... what to do...

Harry: Hmmm... is right.

Lloyd: Hey, I've got an idea. You know how some people still think that the price of gold is some sort of an indication of future inflation?

Harry: Uh-oh. Don't start any of your "crazy gold talk" again Lloyd. You've studied all the same textbooks as I have and you've got a PhD in economics just like I do yet, about once a year, you seem to get this wild hair up your derriere where you somehow think that the price of gold is relevant in what we do.

Lloyd: Just hear me out, Harry. I think I may be on to something that could really save our bacon here - you know, economists aren't all that popular these days because, except for Roubini, Shiller, and a couple of others, none of us saw this financial crisis coming.

Harry: Yeah, I really thought we were going to be OK with a zero savings rate in the U.S. back in 2005 because we were all so house-rich. I hear Bernanke's upside down on that place he bought in Washington back at the peak of the bubble when he was appointed Fed chair.

Lloyd: Don't distract me Harry.

Harry: Sorry.
Lloyd: Anyway, you and I both know that gold is irrelevant - why banks still keep the stuff is beyond me and, please, don't get me started on the Germans and their weird fascination with the stuff today, almost a hundred years after that Weimar episode.

But, a lot of the people in the world still think gold does matter, so if the gold price went higher, that might get enough people to start questioning the CPI numbers which, as we both know, are going to tell the real story this year - deflation.

Harry: You know, that's an interesting idea. It's inflation expectations that are important, so if enough people expect inflation because the price of gold is rising, maybe they'll be more likely to spend their money even if prices are falling.

Lloyd: Exactly. Back in the Great Depression, long before we had computers and our advanced economic models, they had the currency fixed to gold - $20 an ounce as I recall. When they revalued gold in 1933 to $35 an ounce, that's when things started to improve. To revalue gold, they had to print up lots and lots of new money and that's what really cured the deflation of the 1930s.

Harry: I've read about that...

Lloyd: You know, President Obama already thinks of himself as the new FDR, we could probably talk to Bernanke and Geithner and get him on board. If we could somehow push the price up to $1,500 or $2,000, then people would stop obsessing about deflation and go out and spend some money. You know adjusted for inflation, gold could go to about $2,500 and still not exceed its 1980 high, so it wouldn't really be extraordinary - we could still say that gold hasn't made any gains in 30 years.

Harry: Adjusting the price of gold for inflation? Lloyd, remember that you have a PhD in economics - don't embarrass yourself. Uh-oh! You've got that crazy look in your eye again Lloyd - I get the feeling that the next thing you're going to tell me is that the Federal Reserve, today, should print up money and buy gold.

Lloyd: Exactly!
Harry: Hmmm...

Lloyd: Look, people are scared to death with all these job losses and falling home prices so they're not borrowing and spending as they should. When deflation hits this spring, things will get even worse. If we could somehow convince them that we have in-flation instead of de-flation, despite what the government's data says, maybe that will help.

Harry: You know, that wouldn't cost much either. Let's see...100 tonnes of gold costs somewhere around $3 billion. If we went out and bought, say, 1,000 tonnes, that would be a good start and no one would notice an extra $30 billion on the Fed's balance sheet.

Lloyd: Yeah, that's just a drop in the bucket compared to all the other money that's being borrowed and printed to try to get us out of this mess.

Harry: Plus, the Fed would have the gold in their possession - they'd probably make money on the deal, unlike all the other stuff they've been buying lately.

Lloyd: It's just crazy enough that it might work. Huh?

Harry: Yes, it just might work, Lloyd.

Lloyd: I'm glad we had this talk - I think we really came up with something that might help.

Harry: You know, sometimes you really surprise me Lloyd - I don't know why everyone says you're so dumb.

Lloyd: Who says I'm dumb?

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Disease and cure - one and the same?

In this morning's commentary at Bloomberg, Caroline Baum wonders how the cure and the disease can be one and the same for what ails the nation's economy.

Someone returning to Earth from a yearlong sojourn in outer space could be excused for feeling disoriented.

After all, when said space traveler departed our fair planet, the U.S. economy was buckling under the weight of the burst housing bubble. The blame game was in full swing, with the villains ranging from Alan Greenspan and his easy money policies to consumers borrowing and spending beyond their means to financial institutions enabling profligate spending to a misallocation of capital to housing.

Fast forward one year, the crisis is still going strong, the villains are still under attack, yet something curious has happened: The policies and actions responsible for the economy’s illness are now being prescribed as cures.

After recounting just what brings us to the current point - technology boom, technology bust, housing boom, housing bust - and pondering the current freakishly low interest rates and freakishly large balance sheet of the Federal Reserve, attention is focused on the economists who are now in charge.

President Barack Obama’s crack economics team, including Larry Summers and Christina Romer, and Fed officials from Ben Bernanke on down have to understand that the problem of too much leverage can’t be fixed with more borrowing; that a misallocation of capital to housing can’t be cured with incentives to buy more homes; that consumers (and the nation) can’t spend their way to prosperity.

At least I hope they do.

Hope is a good thing. It's not always effective, but it's a good thing.

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Why Keynes was wrong

Fed Chairman Ben Bernanke's speech earlier today, in which he details the many reasons why only the government (and its central bank) can save us now, is a bit longish - have a look at this from the Center for Freedom and Prosperity Foundation in the meantime.

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Nouriel Roubini - playboy economist

This story is rather old, but it's the first I've heard it, something that wouldn't have happened if not for this mostly flattering piece in the Financial Times in which Nouriel Roubini is referred to as a "playboy economist", the picture below from Gawker confirming such.
The big smile on Dr. Doom's face notwithstanding, it seems that a dust up began two months ago when Nick Denton at Gawker penned The Secret Pleasures of Dr. Doom, in which, the social life of the renowned New York economist was chronicled.

As short excerpt:

The image of Dr. Doom may satisfy the needs of the media and partygoers this Halloween—but Roubini is anything but dour. The 50-year-old Iranian-Jewish economist is a promiscuous Facebook friend who draws a cosmopolitan crowd to the frequent parties at his Tribeca loft—an apartment with walls indented with plaster vulvas, incidentally.

Yikes!

Things degraded rapidly from there as this search at Gawker reveals. A few of the highlights are shown below:

10/15 - Credit Crunch's Dr. Doom Is A Facebook Stalker
10/16 - 'Nick Denton Is An Anti-Semite With A Nazi Mind'
10/16 - Let's Go Over the Rules of Internet Microfeuds Again
10/17 - Journalists Are 'Bunch of Wimps' Blackmailed By Gawker, Says Dr. Meltdown

Lots of interesting reading there with many more photos...

As for the Financial Times piece, it now all seems rather odd. What is apparently the first in a series of articles dubbed "Faces of the Crisis", the retelling of Nouriel Roubini's involvement in the 2008 financial crisis begins with his personal life:

In the buzzy, scruffy warren of offices in New York from which Nouriel Roubini runs his economics aggregration and commentary website, one of the young cyber-serfs has taped a New York Post story about the boss to the chalky wall. “NYU Playboy Warns: Econ Party’s Over”, the sub-heading declares, next to a photograph of a smiling, open-shirted Mr Roubini, sandwiched between two attractive young women.

Not so long ago, the phrase “playboy economist” would have been a joky oxymoron, likely to feature in satirical lists alongside “selfless hedge fund manager” and (at least before the US surge in Iraq) “military intelligence”. But, in a sign that practitioners of the dismal science are among the few beneficiaries of the global economic meltdown, this crisis has transformed the 50-year-old New York University professor from a respected academic economist into a minor celebrity.

Mr Roubini, who offered one of the first and most nuanced predictions of the financial and economic crash, is ambivalent about the personal scrutiny his fame has attracted. After Nick Denton, founder of the Gawker website, first pointed to the contrast between the economist’s “Dr Doom” public persona and his party-going private life, Mr Roubini sent Mr Denton a Facebook message in which he declared: “I work very, very hard and I also enjoy life . . . To paraphrase Seinfeld: anything wrong with that?”

The rest of the commentary is about what you might expect including comments by billionaire philanthropist George Soros and Mohamed El-Erian, chief executive at Pimco, who, for all I know may be two of Nouriel's "wingmen" along with Barney Stinson.

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Keynesian Economics Is Wrong

This video was sent to me by the folks at the Center for Freedom and Prosperity Foundation - it's not a bad summary of the current system but offers no alternatives or suggestions for improvement.

Now that we are probably nearing the end of the Keynesian era, it's natural to wonder what comes next and how we get from here to there.

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Ron Paul's choice for Person of the Year

In the current issue of Time, Representative Ron Paul (R-Texas) voices his opinion on who the magazine should choose as their Person of the Year.
Ludwig probably doesn't stand much of a chance, what with the competition offered in this same issue - conservative commentator and author Ann Coulter favors Vice-Presidential nominee Sarah Palin, Olympian Dara Torres goes for Oprah Winfrey, and Nobel Peace Prize winner Muhammad Yunus likes President-elect Barack Obama.

ooo

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