Dubai is not systemically significant. If its troubles open our eyes to the likely imminence of the start of the final leg of the journey from household default through bank default to sovereign default, it may do some systemic good, by alerting fiscal policy makers to the vulnerability of their nations’ fiscal-financial positions, and by educating citizens and voters to the urgency of deep fiscal burden sharing.
The markets today were in a bit of a tizzy because the Dubai World Group, a holding company owned 100 percent by Dubai’s government, and Nakheel, a wholly owned subsidiary of Dubai World, imposed a debt restructuring and debt service standstill - failed to perform on their debt or, in ordinary if not legal language, defaulted on their debt. The combination of the Islamic holiday of Eid and the Thanksgiving holiday in the US boosted the magnitude of the financial market kerfuffle.
I don’t see what the big deal is. Dubai has experienced for most of this decade the craziest construction boom seen in the Middle East since the construction of the Great Pyramids. That boom turned to bust – as booms invariably do. Property developers tend to be highly geared and very procyclical in their revenue flows and access to the capital markets. During construction slumps they drop like flies. Because the property sector is risky (ask Donald Trump), its creditors tend to get better interest rates than the sovereign rate. Dubai is no exception to this rule. If you earn a risk premium during good times, you should not moan when the borrower defaults from time to time when the going gets tough.
Science with very few (if any) data
Doing statistical analysis on a sample of size 1 is either a very frustrating or a very liberating exercise. The academic discipline known as history falls into that category. Most applied social science, including applied economics, does too. Applied economists use means fair and foul to try to escape from the reality that economics is not a discipline where controlled experiments are possible. The situation that an economically relevant problem can be studied by means of a control group and a treatment group that are identical as regards all but one external or exogenous driver, whose influence can as a result be isolated, identified and measured, does not arise in practice.
Saturday, August 1, my family will wing its way, DV, to Boston, MA. From there we will trek on to Martha’s Vineyard to spend the month of August doing nothing in particular. The combination of bad airport novels, adequate supplies of white wine (including, tell it not in Gath, vino verde) and the nearness of lots of family I don’t see enough of should enable me to recharge the nigh-depleted batteries. Safe and sheltered in the company of other effete liberals and pointy-headed intellectuals, I hope to have the time to finally write the bad book (tentatively titled ‘Oi Oikonomiks!’) I have promised my agent. This blog will fall silent (not before time, I can hear you mutter) until September.
The only blight on the landscape of this holiday is that, once again, a US presidential family has decided to vacation on Martha’s Vineyard during the month of August. From earlier visitations by the Clintons, I know that the arrival of the presidential hordes on the Vineyard represent a massive negative externality for all those who go there in pursuit of the same thing the president and his family seek: peace and quiet. Whether the local economy gets a temporary or lasting boost, I leave as a project for Econ 101.
The presidential party (or presidential court) that tags along on any presidential journey, let alone a temporary relocation involving the entire presidential nuclear family, looks and behaves like an occupying army. There are hundreds, if not thousands of persons charged with security, ranging from the secret service to the specially beefed-up state and local police forces. Communications experts, specialist medical personnel, myriad advisers and countless other presidential hangers-on cause the Vineyard to sink at least a foot deeper into the sea. The carbon footprint is bigger than that of the yeti. The press corps and assorted other media camp out all over the island, competing with the presidential staff for first place in the hot air emission stakes. Roads are blocked. Traditional rights-of-way are suspended. Beaches become inaccessible.
In the current worldwide debate about greenhouse gas emissions, the political leaders of the new big polluters (NBPs, especially China and India) attempt to shift the burden of reducing the global flow of new carbon-dioxide-equivalent (CO2E) emissions to the old big polluters (OBPs, mainly Europe, North America and Japan) by claiming the moral high ground, based on two arguments: (1) we are poor, you are rich, and (2) it’s our turn now to pollute.
I will, in what follows, take as given the proposition that (1) global warming is a reality; (2) global warming is a bad thing and (3) that human-made CO2E emissions are a significant contributor to global warming. The science underlying these propositions is inevitably shaky – as has to be the case for any non-experimental science. Still I believe that, even if I don’t really know whether my grandchildren are more likely to swim down Oxford Street or to ice-skate down Oxford street, the cost of not doing something about man-made CO2E emissions if they are indeed as harmful as the Greenhouse Lobby argues is vastly greater than the cost of unnecessarily restricting CO2E emissions – an application of the precautionary principle, if you want.
Further expansionary monetary policy has become rather ineffective in the overdeveloped world because banks are capital-constrained rather than liquidity-constrained and because liquidity spreads in financial markets that bypass the banks have shrunk remarkably. Remaining spreads between sovereign debt instruments and assorted private securities of similar maturities can now be rationalised quite easily as reflecting just differential default risk. Until the banks get significantly more capital on their balance sheets, quantitative easing, credit easing and enhanced credit support are examples of pushing on a string.
The banks will take the liquidity offered and redeposit the bulk of it with the central bank again rather than lending it to the private sector or purchasing more risk financial instruments. Low official policy rates (and the expectation of the official policy rate being kept at a low level for a further significant period of time) will help recapitalise the banks. So will the quasi-fiscal subsidies most central banks have been channelling into the banking system through the favourable terms offered by the central banks to the private banks in their transactions, facilities etc., but such gradual recapitalisation through wide margins on low volumes of lending is slow and could lead to a re-run of Japan’s lost decade for much of the G7.
Further expansionary fiscal policy is likely to be ineffective in most of the G7 countries (possibly excepting Germany and Canada). This is, first, because households are short of capital and overly indebted and, second, because any further increase in short-term fiscal deficits is likely to undermine confidence in the sustainability of the fiscal-financial-monetary programme of the state.
Today’s guest blogger is Elena Panaritis, an expert in property rights, creating markets in illiquid real estate assets, and public sector management. She is also the author of Prosperity Unbound; Building Property Markets with Trust, which is definitely not one of those odious get-rich-quick-in-real-estate-without-capital-brains-or-effort books. Instead it is a get real book for social entrepreneurs about how to turn real estate possessions into socially productive, and indeed also privately profitable, capital.
This Crisis Demands Non-Traditional Solutions to Get to a Path of Quick Recovery
By Elena Panaritis
Two years after it began, there is now a coalescing of opinion about the causes of the U.S. financial crisis and what should be done to resolve it, yet there is a serious element missing both in the causation analysis as well as in the prescriptive solution. This crisis, which has infected the global economy so severely, is very much a non-traditional one that calls for a non-traditional solution. The impact in the United States so far has been worse than anything since the Great Depression: unemployment reached 9.5 percent in June, up from 7.8 percent in January, home prices were down 27% at the end of the first quarter from their 2006 peak, and 1.5 million homes were in foreclosure. After jumping by 30 percent in February, home foreclosure rates tapered off but are again on the rise. According to the New York Times, the loss in property value could total $500 billion.
The Fed is in trouble. Obama administration proposals for enhancing the Fed’s supervisory and regulatory role and for assigning it new macro-prudential responsibilities and powers – effectively turning it into the nation’s systemic risk regulator - are meeting with strong and vocal opposition. The criticism is not just coming from the other agencies in the US financial sector regulatory and supervisory spaghetti bowl – agencies that would stand to lose power and influence or could be put out of business completely. The desire for stronger Congressional oversight of the Fed is no longer confined to a few libertarian fruitcakes, conspiracy theorists and old lefties. It is a mainstream view that the Fed has failed to foresee and prevent the crisis, that it has managed it ineffectively since it started, and that it has allowed itself to be used as a quasi-fiscal instrument of the US Treasury, by-passing Congressional control. Are any or all of these criticisms justified? Let’s ponder a few of them.
California’s public finances are in many ways a microcosm of those of the US as a whole. Admittedly, the state government’s deficit is tiny compared to that of the federal government. The state of California has a budget deficit this year of $26.3bn (about 1.5% of state GDP, which was just over $1.8 trillion in 2007), on revenues of just $113bn. Its total outstanding stock of state debt is also small, with just $59bn in general debt, $8bn in bonds linked to securitised revenues and about $2bn in commercial paper. In contrast, the US federal government is about to run a budget deficit in the 13 to 14 percent of GDP range (that is, the federal deficit is about the size of the state of California’s GDP!).
California, like every US state, will be hit by federal deficit and by the manner in which this is eventually brought under control again, be it through tax increases, public spending cuts, inflation or sovereign default. The state deficit, and the manner of its eventual resolution, represents pain for Californians on top of the shared misery they will endure as a result of California’s contribution to the resolution of the unsustainability in the federal public finances.
Private insurance only works if there is risk. If the risk is eliminated, profitable insurance is impossible. This holds for health insurance as it holds for credit default swaps. When risk vanishes, insurance turns into redistribution. That’s a task for the state, whether through the tax payer or by mandated pooling in quasi-private insurance schemes of individuals with known heterogeneous health profiles.
The rise of genomics - the branch of genetics that studies organisms in terms of their full DNA sequences or genomes – will in the not too distant future kill off most private health insurance. That’s probably a good thing, for two reasons. First, because of asymmetric information, when there is risk and uncertainty about a person’s future health, health insurance markets are badly affected by adverse selection and moral hazard. Second, because the private health insurance industry is a monument to inefficiency everywhere and, especially in the US, a rent-seeking Leviathan whose ruthless lobbying efforts corrupt all it touches.