Monthly Archive for December, 2008


Americans: Be afraid.

With forecasts for annualised U.S. real GDP growth in 2008:Q4 as low as -6% (!) and seriously smart people worrying about next year, both from the left and the right, you really do have to wonder how ugly it’s going to get.  Looking at the world as a whole is a recipe for staying under the covers tomorrow morning, too.


The three best things I’ve read on the US car (auto) bailout …

… are this opinion piece in the FT by Joseph Stiglitz, this brief blog entry by Matthew Yglesis and this blog entry by Robert Cringley.

Stiglitz’s piece makes, to me, a compelling argument for letting the firms go into Chapter 11 bankruptcy, albeit (given the state of the market) with government guarantees for any further financing they may need for restructuring. The following four paragraphs are among the most succinct and clearly written on the US car industry:

 Wall Street’s focus on quarterly returns encouraged the short-sighted behaviour that contributed to their own demise and that of America’s manufacturing, including the automotive industry. Today, they are asking to escape accountability. We should not allow it.
[…]
The US car industry will not be shut down, but it does need to be restructured. That is what Chapter 11 of America’s bankruptcy code is supposed to do. A variant of pre-packaged bankruptcy – where all the terms are set before going before the bankruptcy court – can allow them to produce better and more environmentally sound cars. It can also address legacy retiree obligations. The companies may need additional finance. Given the state of financial markets, the US government may have to provide that at terms that give the taxpayers a full return to compensate them for the risk. Government guarantees can provide assurances, as they did two decades ago when Chrysler faced its crisis.

With financial restructuring, the real assets do not disappear. Equity investors (who failed to fulfil their responsibility of oversight) lose everything; bondholders get converted into equity owners and may lose substantial amounts. Freed of the obligation to pay interest, the carmakers will be in a better position. Taxpayer dollars will go far further. Moral hazard – the undermining of incentives – will be averted: a strong message will be sent.

Some will talk of the pension funds and others that will suffer. Yes, but that is true of every investment that has diminished. The government may need to help some pension funds but it is better to do so directly, than via massive bail-outs hoping that a little of the money trickles down to the “widows and orphans”.

I would perhaps suppliment Professor Stiglitz’s words by proposing that government support to workers laid-off as part of the restructuring could be improved dramatically over the provisions currently available. They should not only include lengthening the duration of unemployment payments and paying for retraining programmes, but also payments to help with relocation if anybody is willing to (voluntarily!) move to find work. An Obama administration might also be reasonably expected to look to Michigan for skilled manual labour in it’s push for infrastructure renewal/expansion.

Yglesis’ brief note observes a vital co-ordination problem when it comes to restructuring what is genuinely a global industry:

One thing here is that as best I can tell none of the five countries — US, Japan, Germany, France, Korea — with substantial auto industries are willing to let their national favorites fail. And yet there seems to be substantial global overcapacity in car manufacturing. If a few of the existing firms are allowed to fail, then the survivors will be in good shape. But if nobody fails, then all the firms worldwide will be left suffering because of overcapacity problems, all potentially drawing bailouts and subsidies indefinitely.

Finally, Cringely’s piece investigates how a successful US car firm ought to be run by imagining that Steve Jobs (of Apple) was running it.  The idea is not his.  Thomas Friedman briefly mentioned in early November that …

… somebody ought to call Steve Jobs, who doesn’t need to be bribed to do innovation, and ask him if he’d like to do national service and run a car company for a year. I’d bet it wouldn’t take him much longer than that to come up with the G.M. iCar.

It was something of a trite comment, and it was picked up by many people in the IT industry who got a little over-excited when imagining the details of what functionality the iCar should have (for example).  In contrast, Cringely looked at the most important thing that somebody trying to emulate Apple might bring to the car industry:  it’s design and manufacturing process:

… embracing these [new technologies] requires the companies do something else that Jobs came to embrace with Apple’s products – stop building most of their own cars.

There are two aspects to this possible outsourcing issue. First is the whole concept of car companies as manufacturing their own products. There is plenty of outsourcing of car components. Most companies don’t make their own brakes, for example. Yamaha makes whole engines for Ford. Entire model lines are bought and rebadged from one maker to another. But nobody does it for everything, yet that’s what Steve Jobs would do.

All the U.S. car companies are closing plants, for example, and all are doing so because of overcapacity. But what would happen if just one of those companies — say Chrysler — decided that two years from now it would no longer actually assemble ANY of its own vehicles? Instead they’d put out an RFQ to every company in the world for 300,000 Chrysler Town & Country minivans as an example. Now THAT would be a dramatic move.

And a good one, frankly, because with a single pen stroke most of the overcapacity would be removed from the U.S. car market. Chrysler would have to shut down all those plants and lay off all those people, true, but doing it all the way all at once would change the nature of the company’s labor agreements such that there wouldn’t be a whimper. When you are eliminating 8 percent of capacity the tussle is over WHICH 8 percent. When you are eliminating ALL capacity, there is no tussle.

So Chrysler reaches out to contract manufacturers in this scenario and you know those manufacturers would fight for the work and probably give Chrysler a heck of a deal. For current models, for example, Chrysler could probably sell the tooling and maybe even the entire assembly plant for a lot more than they’d get from the real estate alone. But that particular advantage, I’d say, would be unique to the first big player to throw in the production towel.

In this scenario, Chrysler becomes a design, marketing, sales, and service organization. What’s wrong with that? They can change products more often and more completely because of their dramatically lower investment in production capital. They can pit their various suppliers against each other more effectively than could a surviving car manufacturer. It’s what Steve would do.

This is brilliant stuff.


Negative interest rates on US government debt and Brad DeLong (Updated)

The interest rates on US government debt has turned negative (again) as a result of the enormous flight to perceived safety.  I guess they’ll be able to fund their gargantuan bailouts more easily, at least.

Brad DeLong has written a short and much celebrated essay (available on Cato and his own site) on the financial crisis and (consequently) why investors currently love government debt and hate everything else.  I’ll add my voice to those suggesting that you read the whole thing.  Here is the crux of it:

[T]he wealth of global capital fluctuates … for five reasons:

  1. Savings and Investment: Savings that are transformed into investment add to the productive physical — and organizational, and technological, and intellectual — capital stock of the world. This is the first and in the long run the most important source of fluctuations — in this case, growth — in global capital wealth.
  2. News: Good and bad news about resource constraints, technological opportunities, and political arrangements raise or lower expectations of the cash that is going to flow to those with property and contract rights to the fruits of capital in the future. Such news drives changes in expectations that are a second source of fluctuations in global capital wealth.
  3. Default Discount: Not all the deeds and contracts will turn out to be worth what they promise or indeed even the paper that they are written on. Fluctuations in the degree to which future payments will fall short of present commitments are a third source of fluctuations in global capital wealth.
  4. Liquidity Discount: The cash flowing to capital arrives in the present rather than the future, and people prefer — to varying degrees at different times — the bird in the hand to the one in the bush that will arrive in hand next year. Fluctuations in this liquidity discount are yet a fourth source of fluctuations in global capital wealth.
  5. Risk Discount: Even holding constant the expected value and the date at which the cash will arrive, people prefer certainty to uncertainty. A risky cash flow with both upside and downside is worth less than a certain cash flow by an amount that depends on global risk tolerance. Fluctuations in global risk tolerance are the fifth and final source of fluctuations in global capital wealth.

In the past two years the wealth that is the global capital stock has fallen in value from $80 trillion to $60 trillion. Savings has not fallen through the floor. We have had little or no bad news about resource constraints, technological opportunities, or political arrangements. Thus (1) and (2) have not been operating. The action has all been in (3), (4), and (5).

As far as (3) is concerned, the recognition that a lot of people are not going to pay their mortgages and thus that a lot of holders of CDOs, MBSs, and counterparties, creditors, and shareholders of financial institutions with mortgage-related assets has increased the default discount by $2 trillion. And the fact that the financial crisis has brought on a recession has further increased the default discount — bond coupons that won’t be paid and stock dividends that won’t live up to firm promises — by a further $4 trillion. So we have a $6 trillion increase in the magnitude of (3) the default discount. The problem is that we have a $20 trillion decline in market values.

Some people have criticised Brad for his characterisation of the liquidity discount, suggesting that he has confused it with the (pure) rate of time preference.  I don’t think he is confused.  Firstly because he’s a genuine expert in the field and if he’s confused,  we’re in big trouble; and secondly because the two concepts are interlinked.

The liquidity discount is that an inability to readily buy or sell an asset – typically evidenced by low trading volumes and a large bid/ask spread – reduces it’s value.

The pure rate of time preference is a measure of impatience.  $1 today is preferred over $1 tomorrow even if there is no inflation. [Update: see below]

The two are linked because if you want to sell assets in an illiquid market, you can either sell them at a huge discount immediately or sell them gradually over time.  The liquidity discount is (presumably) therefore a monotonically increasing function of the pure rate of time preference for a given level of liquidity.

Minor update:

A more correct illustration of the pure rate of time preference would be to say:

Suppose that you could get a guaranteed (i.e. risk-free) annual rate of return of 4% and there is no inflation.  A positive pure rate of time preference says that $1 today is preferred over $1.04 in a year’s time.


Perspective

Everybody’s wringing their hands over the fact that the US economy suffered a net loss of 533,000 jobs in November.  That’s an awful lot and it’s gotta hurt.  Most media outlets are also observing that it’s the worst month for employment since 1974.  Here is the Wall Street Journal:

The U.S. lost half a million jobs in November, the largest one-month drop since 1974, as employers brace for a recession that’s expected to stretch through much of 2009.

The New York Times:

The nation’s employers cut 533,000 jobs in November, the Bureau of Labor Statistics reported Friday.

Not since December 1974, toward the end of a severe recession, have so many jobs disappeared in a single month — and the current recession, far from ending, appears to be just gathering steam.

These facts are true, but they’re also misleading.  There are two important things that nobody that I can see is mentioning:

Firstly, the population of the USA has grown by over 43% in the last 34 years.  In 1974 the resident population was 213 million.  Today it is 306 million [source].  Losing half a million jobs in 1974 was a much bigger event than it is today.

Secondly, a much greater share of households only had one source of income in 1974 compared to today.  Back then, if the sole worker lost their job, the family was in serious trouble.  Today, if one of the (more often than not) two workers in a household loses their job, the family still suffers but far less than they would have back then.

Both of those will be cold comfort to anyone losing their job, but when watching events at a macroscopic level – looking at the country as a whole – it’s important to keep some perspective.

As a side note:  The entry of women into the workforce will have served to reduce at least the scale, if not the likelihood, of a catostrophic loss of income to a household in the sense of Carroll (QJE 1997) (the paper is downloadable here).  What work has been done investigating the links between female participation rates (or, more generally, the number of workers per household) and the extent of buffer-stock saving?

Update:

Paul Krugman looks at the ratio of employed people to total population:

Calculated Risk looks at the Year-over-Year percentage change in employment.

You’ll note, though, that they are both bloggers and not mainstream media.


The sky is blue …

… news at eleven.

The National Bureau of Economic Research (NBER), the official business-cycle dating body for the U.S., has declared that the United States is in a recession and that it started in December 2007.

The data were a little confusing in calling the timing.  Gross Domestic Product (GDP) and Gross Domestic Income (GDI) are two sides of the same coin.  Figures regarding their levels and growth rates ought to be the same and differ only because of statistical (i.e. counting) errors.  From the formal release:

The committee believes that the two most reliable comprehensive estimates of aggregate domestic production are normally the quarterly estimate of real Gross Domestic Product and the quarterly estimate of real Gross Domestic Income, both produced by the Bureau of Economic Analysis. In concept, the two should be the same, because sales of products generate income for producers and workers equal to the value of the sales. However, because the measurement on the product and income sides proceeds somewhat independently, the two actual measures differ by a statistical discrepancy. The product-side estimates fell slightly in 2007Q4, rose slightly in 2008Q1, rose again in 2008Q2, and fell slightly in 2008Q3. The income-side estimates reached their peak in 2007Q3, fell slightly in 2007Q4 and 2008Q1, rose slightly in 2008Q2 to a level below its peak in 2007Q3, and fell again in 2008Q3. Thus, the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity.

The brief respite in the middle of 2008 appears to be the result of the first fiscal stimulus package.  Nevertheless, it seems quite clear that the overall trend has been downward.

The committee declared December 2007 as the peak after looking at payroll (i.e. employment) data:

Payroll employment, the number of filled jobs in the economy based on the Bureau of Labor Statistics’ large survey of employers, reached a peak in December 2007 and has declined in every month since then. An alternative measure of employment, measured by the BLS’s household survey, reached a peak in November 2007, declined early in 2008, expanded temporarily in April to a level below its November 2007 peak, and has declined in every month since April 2008.

… and personal income (less transfer payments):

Our measure of real personal income less transfers peaked in December 2007, displayed a zig-zag pattern from then until June 2008 at levels slightly below the December 2007 peak, and has generally declined since June.

… and real manufacturing and wholesale-retail trade sales:

Real manufacturing and wholesale-retail trade sales reached a well-defined peak in June 2008.

… and the Federal Reserve Board’s index of industrial production:

This measure has quite restricted coverage—it includes manufacturing, mining, and utilities but excludes all services and government. Industrial production peaked in January 2008, fell through May 2008, rose slightly in June and July, and then fell substantially from July to September. It rose somewhat in October with the resumption of oil production disturbed by hurricanes in the previous month. The October value of the industrial production index remained a substantial 4.7 percent below its value in January 2008.

The only really interesting thing in all of this to me is to observe that the first fiscal stimulus and the corresponding positive growth in 2008:Q2 saved some embarrassment for the Republican Party.  The negative 2008:Q3 figures were only released on the 25th of November, three weeks after the U.S. election.  Had the 2008:Q2 figures been even faintly negative, there may have been considerable (and, I think, reasonable) pressure for the recession to have been formally recognised in the middle of the campaign.