Reading

• Krugman made a post recently about how many jobs we need and a promotes a plan to do so:
  
  

  The most specific, persuasive case I’ve seen for more Fed action comes from Joseph Gagnon, a former Fed staffer now at the Peterson Institute for International Economics. Basing his analysis on the prior work of none other than Mr. Bernanke himself, in his previous incarnation as an economic researcher, Mr. Gagnon urges the Fed to expand credit by buying a further $2 trillion in assets. Such a program could do a lot to promote faster growth, while having hardly any downside.
  

  When I read this piece, I was a little struck by how casually he used the $2 trillion number. That's a lot of money, and a lot of debt. Thankfully, The Mess That Greenspan Made agrees:
  
  

  Hardly any downside, that is, unless we're in the middle of a long deferred, fundamental change for the U.S. economy in which the credit expansion seen at all levels over the last few decades - government, corporate, and personal - can no longer produce growth.
  
  

• Mish Shedlock points out that the bond market (usually worth keeping an eye on) is starting to worry about our deficit:
  
  

  The so-called yield curve touched 372 basis points, the most in at least 29 years, as the bonds drew a yield of 4.52 percent. The so-called yield curve has widened from 191 basis points at the end of 2008, with the Fed anchoring its target rate at a record-low range of zero to 0.25 percent and the Treasury extending the average maturity of U.S. debt.
  ...
  “The market is continuing to worry about the massive amount of Treasury issuance that’s going to hit the market well into next year,” said Ian Lyngen, senior government bond strategist at CRT Capital Group LLC in Stamford, Connecticut.
  

• JP Morgan is apparently not concerned about anything actually being done with regards to the "too big to fail" issue. No surprise.
  
  

  Overall, we are left with a big bank that is getting bigger.  It has been (relatively) well run by Mr. Dimon, but there are no assurances for the future.  Given that the “Resolution Authority” is at this point a mythical beast – with no potential effect on the problem of “Too Big To Fail” – we should worry a great deal.
  We could set a hard size cap on banks like JPMorgan Chase (e.g., on assets relative to GDP), which could force them to find ways to spin-off businesses – and return to the much smaller and more manageable size of the early 1990s.  There is no evidence this would be disruptive or cause any economic difficulties.  But, for political reasons, this won’t happen any time soon – the size and power of banks like JPMorgan is put to good use on Capitol Hill.
  

• However, Goldman makes a change to its bonus structure. I wonder if this will be beneficial. It's not in line with Dr. Mintzberg's idea of getting rid of bonuses altogether (as the Goldman strategy still presumes stock price is a good measure of corporate performance), but it does feel like a small step in the right direction:
  
  

  With a resurgent Goldman set to award billions of dollars in bonuses — a trove that could rival the record payouts of the bubble years — the bank said that its 30 most-senior executives would be paid in the form of a special stock, rather than in cash.
  

Ratings Agencies Getting Away Clean

The NYT published a pretty scathing article on how Congress is doing just about nothing to the ratings agencies despite their contributions (some of which have been documented on this blog) to the recent financial crisis:

Without question, the credit rating system is one of the capitalism’s strangest hybrids: profit-making companies that perform what is essentially a regulatory role. The companies serve the public, which expect them to stamp their imprimatur on safe securities and safe securities alone. But they also serve their shareholders, who profit whenever that imprimatur shows up on a security, safe or not.
To make matters more complicated, rating agencies are deeply entrenched in millions of transactions. Statutes and rules require that mutual fund and money managers of almost every stripe buy only those bonds that have been given high grades by a Nationally Recognized Statistical Rating Organization, as the agencies are officially known.
But even if there is no foolproof way to reform the rating agencies, the measures that Congress is now backing are strikingly weak, a number of critics say. There is no talk, for instance, about creating a fee-financed, independent credit rating agency, one modeled along the lines of the Public Company Accounting Oversight Board, which was established to oversee auditors after the Enron debacle — an idea floated by Christopher J. Dodd, the Senate Banking Committee chairman as recently as August.
That approach would attack the conflict of interest problem head on.

Double Dip threat is back?

A long while back, I wrote that I believed we would face a double-dip recession, though I certainly got the time-frame wrong.
Krugman just put up a post on the same issue, and it made me think about why we might still be facing this "W" shape recovery. It relates strongly to Brenner's paper below: we're running out of ways to stimulate business activity. There does not seem to be a bubble left to inflate. When government stimulus runs out (and I don't think we'll see another stimulus package - doesn't seem politically feasible right now) next year, who will spend? From Krugman:

Two stories this morning highlight the risks. The WSJ has a report on highway construction titled Job Cuts Loom as Stimulus Fades:

Highway-construction companies around the country, having completed the mostly small projects paid for by the federal economic-stimulus package, are starting to see their business run aground, an ominous sign for the nation’s weak employment picture.

Meanwhile, the ISM for manufacturing suggests that industrial growth is already slowing down.
I’d be more sanguine about all of this if there were any indications that private, final demand is taking off — consumers, business investment, whatever. But I haven’t seen anything suggesting that sort of thing.

Also, deflation is still looming. Japan is already there. America faces the prospect as well, though if the Treasury keeps pumping out dollars, we also face a risk of inflation down the road. Take a look at this, which has more on double-dip risk (emphasis mine):

The Fed has to do one of two things: They either have to pull $1.5 trillion out of the system by June, which would collapse the economy, or face hyperinflation. This is why the Fed has instructed banks to inform them when and how much of the TARP funds they can return. At best they can expect $300 to $400 billion plus the $200 billion the Fed already has in hand.
We believe the Fed will opt for letting the system run into hyperinflation. All signs tell us they cannot risk allowing the undertow of deflation to take over the economy. The system cannot stand such a withdrawal of funds. They also must depend on assistance from Congress in supplying a second stimulus plan. That would probably be $400 to $800 billion. A lack of such funding would send the economy and the stock market into a tailspin. Even with such funding the economy cannot expect any growth to speak of and at best a sideways movement for perhaps a year.

Their belief goes directly counter to my belief that we will not see a second stimulus plan. If we do not, as I believe, we face the deflationary threat and a true double-dip. If, however, another stimulus plan is passed (which seems more and more necessary, though I still think is too politically unacceptable in the short-term), we may be okay for a while yet.

I know this is a highly doom-and-gloom scenario. Hopefully, I'm wrong, and the world economy recovers more smoothly than I expect.

Also, I wanted to post a short follow-up to the Brenner post below. One thing his analysis does is completely destroy the China-decoupling theory. Note that it was a far more popular theory before the recession than it is now, but it does still get some mention. I think the Brenner write-up finishes it off in my mind, but here's some more on it anyway: The China Decoupling Myth.

Robert Brenner Insight

Robert Brenner is a historian at UCLA. My dad recently pointed me to a paper he wrote that has some fascinating analysis of the root causes of where we are today, economically. The title of the paper, in my mind, is somewhat misleading - so for those of you who are sensitive to any perceived attack on modern banking, please keep reading it. Since it's a 74 page paper, however, I would point you also to this article, which does a great job of summarizing Brenner's paper.
My (preliminary and probably poorly thought-out) understanding of his analysis is that we're locked into a strange loop in which East Asian countries have been, since the 1960's, purposefully forcing over-capacity in manufacturing, which causes downward prices, profit margins, and wage pressure internationally. However, this downward pressure affects the very consumers they intend to sell to, so they simultaneously prop up those consumers (mostly, the United States, and I imagine Europe to a lesser degree) by buying up debt (emphasis mine):

Japan had, from the mid 1950s on, deliberately staked its prosperity on the construction of excess global capacity in a series of key industries beginning with textiles and marching up the value-added chain from ship building and steel through machine tools, a wide range of consumer durables, and capital equipment, as well as a host of important upstream components. Japan did not launch industries. Rather, it targeted markets that were already served by existing capacity in other countries. Japanese companies built their own capacity to capture these markets and then, backed by patient financing and enjoying the advantage of an undervalued currency with predictable labor costs and meticulous attention to quality control, flooded global markets with “torrential rain-type exports” to quote a Japanese government term. The result was to destroy profitability in these industries, forcing foreign competitors either to abandon the industry in question or to cut costs drastically – most commonly, by shifting production to low wage, developing countries.

Subsequently, in its momentous shift away from the Stalinist economic model of autarkic industrialization, China would follow the road blazed by Japan: the deliberate creation of overcapacity in targeted industries aimed at the global market and with the necessary cheap financing overseen and/or organized by the state. Deng Xiaoping's visit to Japan in 1978 – the first ever by a de facto head of the Chinese government – may well be the most important foreign trip ever made by a Chinese leader.

These two countries – and the smaller economies of East and Southeast Asia that followed in their wake ¬– could not, however, escape the consequences of their systematic creation of overcapacity and the resultant decline in manufacturing profitability. To save the global system on which they themselves had come to depend, they were forced to turn around and provide the waves of credit that permitted the financial lynchpin of the global capitalist system – the United States ¬– to continue to act as the world's primary engine of demand.

As Brenner notes in discussing how the explosion in deficits by the George W. Bush administration was financed, “... Japanese economic authorities saved the day by unleashing an unprecedented wave of purchases of dollar-denominated assets. Between the start of 2003 and the first quarter of 2004 ... Japan's monetary authorities created 35 trillion yen, equivalent to roughly one percent of world GDP, and used it to buy approximately $320 billion of US government bonds and (the debt of government-sponsored institutions such as Freddie Mac), enough to cover 77 per cent of the US budget deficit during fiscal year 2004. Nor were the Japanese alone. Above all China, but also Korea, Taiwan, and other East Asian governments taken together increased their dollar reserves by $465 billion and $507 billion....”

I want to make it clear that Brenner is not really playing a "blame game", in which he tries to point to East Asia as the bad guy. He spends just as much time criticizing American policy for blatantly encouraging this situation (emphasis mine):

The fundamental source of today’s crisis is the steadily declining vitality of the advanced capitalist economies over three decades, business-cycle by business-cycle, right into the present. The long term weakening of capital accumulation and of aggregate demand has been rooted in a profound system-wide decline and failure to recover of the rate of return on capital, resulting largely—though not only--from a persistent tendency to over-capacity, i.e. oversupply, in global manufacturing industries. From the start of the long downturn in 1973, economic authorities staved off the kind of crises that had historically plagued the capitalist system by resort to ever greater borrowing, public and private, subsidizing demand. But they secured a modicum of stability only at the cost of deepening stagnation, as the ever greater buildup of debt and the failure to disperse over-capacity left the economy ever less responsive to stimulus. ...
To stop the bleeding and insure growth, the Federal Reserve Board turned, from
just after mid-decade, to the desperate remedy pioneered by Japanese economic authorities a decade previously, under similar circumstances. Corporations and households, rather than the government, would henceforth propel the economy forward through titanic bouts of borrowing and deficit spending, made possible by historic increases in their on-paper wealth, themselves enabled by record run-ups in asset prices, the latter animated by low costs of borrowing. Private deficits, corporate and household, would thus replace public ones. The key to the whole process would be an unceasing supply of cheap credit to fuel the asset markets, ultimately insured by the Federal Reserve.
As it turned out, easy money was made available throughout the entire subsequent period. The weakness of business investment made for a sharp reduction in the demand by business for credit. East Asian governments’ unending purchases of dollar-denominated assets with the goal of keeping the value of their currencies down, the competitiveness of their manufacturing up, and the borrowing and the purchasing power of US consumers increasing made for a rising supply of subsidized loans. So the real cost of long term borrowing steadily declined. Meanwhile, the US Central Bank made sure that short term interest rates never rose to such an extent as to jeopardize profit-making in the financial markets by reducing the Federal Funds Rate at every sign of trouble. One has therefore witnessed for the last dozen years or so the extraordinary spectacle of a world economy in which the continuation of capital accumulation has come literally to depend upon historic waves of speculation, carefully nurtured and publicly rationalized by state policy makers and regulators—first in equities between 1995 and 2000, then in housing and leveraged lending between 2000 and 2007. What is good for Goldman Sachs--no longer GM--is what is good for America.

What is missing is a solution. He's a historian, so all he's trying to do is give us the history. Fine. I have to admit, I personally don't see much of a realistic solution. What would probably help is an American acceptance that we've lived well beyond our means and are due for a serious reduction in living standards (completely unacceptable politically, of course). What might simultaneously help is China trying to focus more on domestic consumption as a path to future growth rather than continued exports, but I have no clue what their policies on that are. What will likely happen is we will limp on in this manner for some time yet - Asian exporters will keep flooding us with both cheap goods and plenty of money. I imagine that this can't last indefinitely, but I've no idea what the future really holds.

"The problem isn’t that they are poorly designed. The problem is that they exist."

The title refers to executive bonuses. CD emailed me a great piece from MIT Sloan Management Review. The main purpose of the review is to show that executive compensation is poorly structured. What I really like is that it's one of the first "legitimate" publications (read: not a random angry blogger/talking head) to suggest entirely scrapping executive bonuses. That this school is one of the prominent producers of the very executives they are criticizing only furthers the articles' relevance. It is important to note that the article itself was written by Dr. Mintzberg of McGill University in Montreal, but it isn't being considered an op-ed.

One of the most compelling points is that even bonuses based on "performance measures" are a flawed idea:

How do you assess the long-term performance of a chief executive? Some proposals look at three years, others as many as 10 years. But can we even be sure of 10 years? Is a decade long enough in the life of a large company, with all its natural momentum? How many years of questionable management did it take to bring General Motors to its knees?

Conversely, if a company’s stock price goes up and stays up for several years, does that signify the definitive success of the current chief executive? What if the previous CEO made some good decisions that later kicked in? Don’t we all talk about the long-term influence of executive decisions? Have we forgotten about that?

He concludes with a pretty funny (though thoughtful) bit:

Actually, bonuses can serve one purpose. It has been claimed that if you don’t pay them, you don’t get the right person in the CEO chair. I believe that if you do pay bonuses, you get the wrong person in that chair. At the worst, you get a self-centered narcissist. At the best, you get someone who is willing to be singled out from everyone else by virtue of the compensation plan. Is this any way to build community within an enterprise, even to foster the very sense of enterprise that is so fundamental to economic strength?

Accordingly, executive bonuses provide the perfect tool to screen candidates for the CEO job. Anyone who insists on them should be dismissed out of hand, because he or she has demonstrated an absence of the leadership attitude required for a sustainable enterprise.

Of course, this might thin the roster of candidates. Good. Most need to be thinned, in order to be refilled with people who don’t allow their own needs to take precedence over those of the community they wish to lead.