Tag: economics

The first problem with Paul Krugman’s hypothesis is that 2010 is not 1938, it is 1931. This should be obvious because at no point in the last two years has anyone except me, Robert Prechter, Mike Shedlock, Karl Denninger and a few other economic heretics admitted that we have been in a depression for months now.

Here’s the situation: The U.S. economy has been crippled by a financial crisis. The president’s policies have limited the damage, but they were too cautious, and unemployment remains disastrously high. More action is clearly needed. Yet the public has soured on government activism, and seems poised to deal Democrats a severe defeat in the midterm elections.

The president in question is Franklin Delano Roosevelt; the year is 1938….

From an economic point of view World War II was, above all, a burst of deficit-financed government spending, on a scale that would never have been approved otherwise. Over the course of the war the federal government borrowed an amount equal to roughly twice the value of G.D.P. in 1940 — the equivalent of roughly $30 trillion today.

Had anyone proposed spending even a fraction that much before the war, people would have said the same things they’re saying today. They would have warned about crushing debt and runaway inflation. They would also have said, rightly, that the Depression was in large part caused by excess debt — and then have declared that it was impossible to fix this problem by issuing even more debt.

But guess what? Deficit spending created an economic boom — and the boom laid the foundation for long-run prosperity. Overall debt in the economy — public plus private — actually fell as a percentage of G.D.P., thanks to economic growth and, yes, some inflation, which reduced the real value of outstanding debts. And after the war, thanks to the improved financial position of the private sector, the economy was able to thrive without continuing deficits.

The second problem here is that Krugman is making a standard post hoc ergo propter hoc mistake. While the US did engage in a massive burst of unrestrained federal spending, it was not the spending that produced the postwar prosperity except in that it paid for the munitions and manpower that was used to destroy every industrialized economy that was not already destroyed by the Germans or the Japanese.

And the third problem, of course, is that the Keynesian notion that government spending is economic growth, let alone is capable of creating growth that is a multiple of the spending, is both logically and empirically false. Remember, no one even began to recognize that the Great Depression was a great depression until the end of 1931.

A number of people have asked me what “the education bubble” means. While it’s not actually a true investment bubble since purchasing a college education is not a bona fide investment, the ever-rising cost of a college degree does have frothy and bubblicious aspects that can be seen very clearly in this chart from TaxProfBlog that compares CPI inflation vs the increase in US home prices vs the increase in college tuition.

In combination with the huge increase in students attending college, the value of a college degree is presently around one-third of what it was in 1990. I had previously estimated it was 28% of the value… but in either case, this assumes you are one of the 50% of college attendess who manages to successfully complete a college program and receive a degree within five years.

Karl Denninger is alerted to potential fraud in the housing price statistics:

I have a very disturbing email that came in this evening. It alleges out-and-out fraudulent reporting of home sales in one of the regional MLS systems. That is, prices paid that are in fact much lower than the “sold” prices reported in the MLS.

The person in question claims to have seen over 100 of these in his area. I have copies of two, and it appears, from the evidence that I have, that at least for those two the claim is accurate.

One in particular I was able to pull the auction data on. It “sold” under reserve, is listed as sold in the MLS at ~25% higher than the “sold” bid, and the premium is disclosed as 5%. This property also has a 90-day “anti-flip” provision on it, implying that the paper may be held by one of the GSEs. (It’s a nice-looking place, incidentally.)

Here’s the problem, obviously – Case-Schiller and other “home statistics” numbers related to price paid are all computed off these numbers provided by the local Realty boards (via NAR.) If the data in the MLS is bogus then so is the so-called “median sales price” and so are Case-Schiller’s numbers! These are not small discrepancies either – in both cases the “over-reporting” is by approximately 25%!

This would explain why housing prices have been mysteriously moving up while the number of home sales continues to plummet. It’s as if it’s not enough to cook the GDP, CPI-U, and U3 numbers, things are getting so bad that they have to create fictional statistics for practically everything in order to “hide the decline”.

Hey, it worked for the climate scientists. For a while.

I’m so good, I can not only tell you that a mainstream economist is going to be wrong, I can even tell you what his excuse for being wrong is going to be. Here’s Paul Krugman’s ex post facto explanation for why the stimulus failed:

What’s going on here? It’s basically the Fifty Herbert Hoovers problem. Because state and local governments can’t run persistent deficits, and because aid to those government was shortchanged, cutbacks at lower levels of government have undermined expansion at the federal level. Overall government purchases have actually grown more slowly than the economy’s potential output.

This is, of course, his alternate explanation. His primary explanation, which everyone anticipated, was that the stimlus was too small. Even though it was $187 billion larger than he said it had to be. It should be noted that Krugman is attempting to kill two errors with one rationalization here, as he’s also attempting to explain why he was wrong to predict that Germany’s economic performance would be worse than the USA’s due to their rejection of further stimulus.

The revision was, of course, UNEXPECTED!

The nation’s gross domestic product — the broadest measure of the economy’s output — grew at a 1.6 percent annual rate in the April-to-June period, the Commerce Department said Friday. That’s down from an initial estimate of 2.4 percent last month and much slower than the first quarter’s 3.7 percent pace.

Anyone still think my prediction of at least one negative quarter for GDP in 2010 is going to be incorrect? Heck, if you consider that they lowered the Q2 number by one-third from only one month ago, Q2 might be reported negative before the end of the year. And remember, that’s the map. The territory has been negative no matter what the map says now.

Except, you know, for those who expected home sales to fall off a cliff as a result of the homebuyer’s credit pulling demand forward, exactly as Austrian theory has been explaining for decades:

New U.S. single-family home sales unexpectedly fell in July to set their slowest pace on record while prices were the lowest in more than 6-1/2 years. The Commerce Department said sales dropped 12.4 percent to a 276,000 unit annual rate, the lowest since the series started in 1963, from a downwardly revised 315,000 units in June. Analysts polled by Reuters had forecast new home sales unchanged at a 330,000 unit pace last month.

Emphasis added, with a good deal of derision. Now note how they’re still talking about the possibility of a “double-dip” recession.

“”The odds of the dreaded double-dip are increasing. I’ve been one of the only people in the double-dip camp explicitly, but more and more of the people who have been playing in the game of what is the probability — 20 percent, 30 percent — are going to start saying maybe it is 50 percent.”

What a load of complete CYA nonsense. There will be no double-dip because there has been absolutely no recovery from which to dip again. The so-called recovery is a simple statistical trick utilizing government spending to paper over the continuing economic contraction. As the second stimulus runs out, the extent of the contraction will become more readily apparent to everyone. Extend, pretend, and hope for change has failed.

My contempt for anklebiters notwithstanding, I very much appreciate substantive criticism. This is why. When you refuse to pay attention to your critics, all you manage to do is increase the likelihood that you will look even more ridiculous in the future, as Paul Krugman demonstrates by continuing to cling to his ignorant idea of a nonexistent “hangover theory”:

[A]t least some members of the FOMC have bought into the hangover theory — the modern version of liquidationism in which mass unemployment is somehow necessary in the aftermath of a burst bubble:

Narayana Kocherlakota, president of the Minneapolis Fed, argued that a large part of today’s unemployment problem is caused by issues the Fed can’t solve, such as the mismatch between the skills of jobless workers and the skills that employers wanted.

Here’s what Kocherlakota said in a speech after the meeting:

Whatever the source, though, it is hard to see how the Fed can do much to cure this problem. Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.

I tried, in that old piece on hangover theorists, to explain what’s wrong with this view in general.

Tried and completely failed, Mr. Nobel Prize winner. Krugman clearly has no idea how badly he was bitchslapped on that piece by me and numerous others. He knows nothing of Austrian economics, he has learned nothing in 12 years of its core concepts playing out right in front of his eyes, and he has absolutely no idea what is going on with the economy right now.

What’s worse is that Krugman clearly knows that his critics exist, as evidenced by his comments on his blog and the fact that he reads the comments that are posted there. Krugman isn’t just an ignorant economist, he has willfully and stubbornly chosen to remain that way.

The personable personalities behind the Neo-Keynesian lunacy aside, it’s pretty much as bad as I expected:

On HAMP, officials were surprisingly candid. The program has gotten a lot of bad press in terms of its Kafka-esque qualification process and its limited success in generating mortgage modifications under which families become able and willing to pay their debt. Officials pointed out that what may have been an agonizing process for individuals was a useful palliative for the system as a whole. Even if most HAMP applicants ultimately default, the program prevented an outbreak of foreclosures exactly when the system could have handled it least. There were murmurs among the bloggers of “extend and pretend”, but I don’t think that’s quite right. This was extend-and-don’t-even-bother-to-pretend. The program was successful in the sense that it kept the patient alive until it had begun to heal. And the patient of this metaphor was not a struggling homeowner, but the financial system, a.k.a. the banks. Policymakers openly judged HAMP to be a qualified success because it helped banks muddle through what might have been a fatal shock. I believe these policymakers conflate, in full sincerity, incumbent financial institutions with “the system”, “the economy”, and “ordinary Americans”. Treasury officials are not cruel people. I’m sure they would have preferred if the program had worked out better for homeowners as well. But they have larger concerns, and from their perspective, HAMP has helped to address those.

Needless to say, I’m shocked. These programs are NEVER designed to help the people they are advertised as helping in order to justify their passage through Congress. It was just another form of bank bailout. The mistake, of course, is the assumption that the banks are going to be in any better shape to handle the flood of foreclosures that have been delayed since the “expected” economic recovery has proved illusory. The fact that the past situation was dangerous is no indication that the future one will be any less so.

Finally, our conversation turned to the current macroeconomic doldrums. Thankfully, there was none of the “let’s look on the bright side” chipperness of Timothy Geithner’s recent New York Times op-ed. Treasury officials didn’t downplay how bad things are. They did point out that considering the headwinds the economy faces, things are a bit better than they might be. The account went roughly like this: Last year, after the doldrums of March, the economy grew faster and performed better than most would have forecast. But recently it encountered two obstacles, one expected, the other an unexpected near cataclysm. The spurt of GDP growth due to post-panic inventory restocking was always going to end. But a sovereign debt crisis in Europe strong enough to shake confidence and financial markets in the US was not expected. Taking all that into account, things are a bit better than they might have been. One Treasury official pointed out that if we could return to the path of consensus growth forecasts from just before the troubles in Europe, we would have two or three difficult years ahead of us yet, but would be on a decent path. I took this as a kind of optimistic but plausible thought experiment on where we might be going…. I was impressed that Treasury officials had a pretty good understanding of the impediments to growth going forward. They understood that the core problem preventing business expansion isn’t access to capital but absence of demand.

I find this self-serving and ex post facto explanation to be entirely dubious. The Treasury gang might have as reasonably broken into song and blamed Canada. I was one of many economics observers to expect numerous sovereign debt crises, which is why I was writing about them in RGD before they happened. I expected them to begin in Ireland and Spain, not Dubai and Greece, but sovereign debt overload is an extraordinarily target-rich environment these days. The only country that comes up for discussion in this regard that isn’t a likely candidate for the next debt crisis is Italy because its debt/GDP issues don’t take into account its sizable black economy.

The grimly amusing thing is that we are presently on the precipice of another 2008-style meltdown and precisely none of these bloggers or Treasury officials appear to be aware of it. This is probably because they’re clearly all still subject to the conceptual limitations of their Neo-Keynesian models. The core problem isn’t either access to capital or an absence of demand, but rather a widespread inability to service debt or add more debt combined with the natural shifting back of the demand curve to its normal non-debt-inflated limits. And this isn’t a problem they can do much about; in fact, trying to keep the insolvent zombie banks afloat throughout the debt-deleveraging process is only going to waste incredible sums of money and extend the depression for years.

As Instapundit likes to say, the country is in the very best of hands.

This is an extreme example of the cash-out game, but it shouldn’t be hard to understand why the US economy is so completely hopeless as a result:

It’s obvious from looking through the property records that many borrowers supplemented their lifestyles with regular trips to the home ATM machine. The regularity and the size of these withdrawals is astonishing. It also explains much about why houses are so popular in California. If owning real estate gives you the opportunity to obtain hundreds of thousands of dollars for doing absolutely nothing, ownership will be highly desired; in fact, it becomes the primary reason people buy homes. Californian’s live in their own personal ATM machines.

The owners of today’s featured property paid $441,000 on 4/25/1991. I don’t have their original mortgage information, but it is likely that they put 20% down ($88,200) and borrowed $352,800.

* On 5/27/1997 they obtained a stand-alone second for $50,000.
* On 12/7/1998 they refinanced their first mortgage for $387,500.
* On 3/26/1999 they got a $47,500 stand-alone second.
* On 12/28/2000 they refinanced with a $441,000 first mortgage and crossed the threshold of borrowing more than they paid.
* On 3/31/2004 they refinanced with a $536,250 first mortgage.
* On 10/5/2004 they obtained a $628,000 first mortgage.
* On 11/30/2005 they refinanced with a $686,250 Option ARM with a 1.5% teaser rate.
* On 5/3/2007 they obtained a second mortgage for $15,764.
* On 7/3/2007, after witnessing the above patter of serial refinancing, World Savings Bank brilliantly loaned them $788,000 in an Option ARM.

Total property debt is $788,000 plus negative amortization and missed payments. Total mortgage equity withdrawal is $435,200 including their down payment. Total squatting time was minimal as the bank moved quickly to evict these squatters.

The important thing to understand from this is that there is no such thing as “home ownership” with a mortgage. It’s just renting from a bank. The problem is that debt is intrinsically inflationary, (inflationistas take note regarding the implications of this in a debt-deleveraging environment), so the willingness of others to take on debt severely harms the ability of more prudent individuals to make purchases without debt.

On a related note, watch for panic over the UNEXPECTED collapse in home sales next week. Now that the federal credits have expired, Texas monthly home sales have fallen 25% to the lowest July level since 1997.