What do Google and Dunder Mifflin have in common?

Paper Mills. No, Google isn't making a foray into the forest products and packaging industry. The company will obviously use the defunct paper mill to house a massive data center.

This is an unremarkable story unto itself, but to me, it represents a symbolic transition of old industry to new. There's also a tinge of irony here. A company that categorizes and delivers knowledge to people electronically replaces one that profited from the delivery of information through an anachronistic channel: the printed page. (If you don't think that paper is outdated, may I remind you that your are reading a blog on a computer and that Amazon just launched the Kindle 2 this week.)

More importantly, this story illustrates the merits of creative destruction. One could draw the conclusion from Stora Enso's press release that Google itself may be partly responsible for the mill's "persistent losses in recent years and poor long-term profitability prospects". Even so, Google offers society exponentially more value in return. As our economy falters and businesses fail, I hope that our leaders (and opinionators) carefully consider actions (and words) that may impede transformative process of creative destruction.

We may never know the next great American car company if we artificially extend the life of the incumbents. So when you see an empty paper mill or idle auto manufacturing plant, think not of jobs lost, but imagine the next great product or service from a company that will take over that space.

Is it an onus?

Pundits like to act outraged when they hear Wall Streeters complain that $500,000 isn't that much money. They're right that it's a lot of money...if you don't live an upper crust lifestyle in New York. 

When a basic apartment goes for more than a million, 500k can go pretty quick. Obama and his economic team are quite right that all firms should be cutting back in this " winter of hardship" (seriously?). But capping executive pay is a pretty blunt and inefficient method of forcing companies to do this. Companies receiving federal bailout funds should certainly be subject to strict scrutiny, but if an executive can successfully employ this "bridge" money to shore up balance sheets and lead a return to profitability, shouldn't they be rewarded accordingly? 

Wall Street's "bonus" culture has been entrenched for so long that we seem to forgot exactly what one normally earns a bonus for. We shouldn't embrace it in it's current form, nor should we pay regulators the exorbitant amounts previously earned by execs. As always in times of hardship, we swing from one extreme to the other and suggest heavy handed ways to counter problems we didn't see coming and are all occasionally guilty of hyperbole.

Let's let government service remain just that and reinstitute the true meaning of bonus.

(Photo via c-weiss)

Be afraid, be very afraid

This is the single most frightening passage I've read since Lehman Brothers fell. If it's true, then it sure gives credence to the doomsday prophets.

On C-Span, Rep. Paul Kanjorski (D-PA) explained how the Federal Reserve
told members of Congress about an electronic run on the banks "to the tune of
$550 billion dollars" within "an hour or two" last fall. According to Kanjorski,
on September 18, 2008 the Fed tried to "stem the tide" by pumping money into the
financial system but it didn't work and decided instead to announce an immediate
increase in deposit insurance to $250,000 per account to stop the panic.
Said Kanjorski: "If they had not done that, their estimation is that by 2 p.m. that
afternoon, $5.5 trillion would have been drawn out of the money market system of
the U.S., would have collapsed the entire economy of the U.S., and within 24
hours the world economy would have collapsed. It would have been the end of our
economic system and our political system as we know it."

Devaluing the rouble

Last month, the Bank of Russia announced a floor under the rouble. So much for that. The floor was already tested this week and the central bank is burning through reserves faster than Putin does ABBA cover bands. On the surface, we would expect Russia to have little difficulty in defending the rouble, given the substantial accumulation of foreign exchange reserves in recent years (high commodity prices + booming exports + the long shadow of the 1998 rouble crisis = big time reserves). But look a little deeper, and that cushion isn't quite a comfortable as it appears.

In fact, Russia is in big, big trouble.

The Russian government didn't anticipate the sudden, rapid decline in commodity prices (to be fair, few did), and it is now struggling to balance its obligations amidst declining revenues and FX earnings. Its 2009 budget relies on $95/barrel oil, and billions of dollars have been committed in support of the banking sector (not to mention the money provided major companies crippled with debt). Defending the rouble and supporting the banking sector/companies alone consumed approximately 40% of Russia's FX reserves since summer 2008, and were a major factor in the Fitch downgrade on Wednesday. If the government's recent actions are any indication, Russia's foreign exchange reserves will come under increasing pressure in 2009. It delayed discussions on amending the budget, and publicly stated that it won't make any cuts to this year’s spending. With social instability spreading, it is unlikely the government will make any significant cut to the budget over 2009-2010. Furthermore, its new crisis strategy directly targets the banking sector, which should be applauded, but will require a significant amount of capital.

Which brings us back to the rouble. The central bank's ability to defend the rouble will be seriously constrained by the budget and banking sector support. Its decision to gradually devalue the rouble, as opposed to allowing it to freely fall to its market equilibrium, has proven ill advised and sacrificed a greater share of foreign exchange reserves than was otherwise necessary. Little official debt, falling imports, and the complacency of the Russian elite would have made a single devaluation possible. But now the central bank is in a bind; let the rouble fall and you risk a loss of confidence in the central bank, keep defending it in the hope that the oil price recovers and you play a dangerous game of Russian roulette (no pun intended).

Russia's spending and banking sector support are necessary under the current economic and financial conditions. The market already expects a further devaluation of the rouble; artificially supporting it is a losing battle that only increases the risk of a serious run on the currency and drains its foreign exchange reserves. Russia should set the rouble free.

(photo from melted snowball's photostream)

Give the Big Three a bailout!

Ford, General Motors, and Chrysler need a bailout. But they're asking the wrong guys for money. Instead of driving their hybrids to Washington DC, they ought to fly into Riyadh and Dubai.

First off, no one makes fun of you for flying on your private jet. Saudi Prince Al Waleed Bin Talal just placed a personal order for a private Airbus A380! If you don't show up on a private jet, you're nobody. Secondly, Saudi Arabia and the UAE have money to spare: at least one trillion dollars in their sovereign wealth funds. The Big Three need about $34 billion to stay afloat, (which they have promised to pay back!), and it is important that they don't shut down. There is a dangerous domino effect if just one of the Big Three falls: they use many of the same suppliers, so if one goes down it might drag the others with it and lose some 2.5 million jobs in the process. This is probably an overestimate, and with so much of their production outsourced abroad, the pain would be spread around quite a bit. Still, it wouldn't be good.

The oil exporting countries have a vested interest in keeping SUV producing companies running. All car companies are hurting these days, but the Big Three are not sitting on enough cash to get through these tough times. Part of this is due to their brand-killing habit of making lots of bad cars, but they are working hard to fix that. The UAW has made some serious concessions, the Big Three are investing tons in R&D, and many of their cars are on par with Japanese and German imports these days (Disclaimer: I drive a Honda Civic, which was made in Ohio, interestingly enough).

Hell, all of OPEC should chip in and give a bailout to the Big Three. And if OPEC fails to bailout the Big Three, maybe Beijing would be interested? If they did I would take back all the mean things I said here. For selfish reasons, I am rooting for a bailout because someday I want to buy that new Camaro.

Bailout blues: Big Three edition

As someone who argued strongly in favor of a bailout for the financial sector earlier this fall, I am absolutely flabbergasted that a bailout for America’s car makers is under serious consideration. In short, this is a terrible idea, and there are no legitimate parallels to bailing out (recapitalizing?) the financial sector. The financial sector is essentially like the economy’s plumbing: if the pipes aren’t working, nothing works. By contrast, the auto industry is a bit like an old, poorly-functioning toilet: if it doesn’t work, it’s best to just get rid of it rather than paying exorbitant sums to refurbish it.

Spurious analogy? Perhaps. But this is truly bad policy. You can go to any number of sources for an explanation why: I particularly liked Megan McArdle’s posts and Dave’s at IPE-J. In short, Congress is proposing to devote a good chunk of finite resources* to struggling, out-dated firms with high fixed costs, no track record of innovation, no proven capability of making a product people actually want to buy, and no systemic connection to the greater economy. The halcyon days of “As GM goes, so goes America” are long gone, if they ever even existed. In fact, the only halfway decent argument that I can find to justify such a handout is to avoid a possible crisis of confidence: if the auto industry were to fail, would it cause consumer confidence (and spending) to collapse? It’s a novel interpretation, but one that I don’t find entirely convincing.

Nonetheless, it is looking increasingly likely that a bailout for the auto industry will happen possibly as early as this coming week during the lame duck session of Congress. I am particularly interested in what this says about our President-elect, who has come out forcefully on the side of intervention. Frankly, I can’t help but feel slightly nervous about the implications. This isn’t change. This is old-school, interventionist Democratic policy, which didn’t work very well on the first go-round. In my view, this bailout is in no small part about the demands of the United Auto Workers, who campaigned strongly for Mr. Obama’s election. I sympathize with their desire to preserve a high standard of living for union members, but unfortunately that way of life no longer seems sustainable. (Please read this post in its entirety before you feed me to the lions over that last statement.)

My point is this: in order to deliver on the massive change that Mr. Obama has promised in policy areas such as education and health care, he will need to do battle with powerful entrenched interest groups. It will be a long fight, but this is a poor showing in the first round.

* I don’t care if we've been spending like money grows on trees: it all has to come from somewhere, and if we borrow it, then sooner or later we have to pay the bill. I for one don’t want tax rates in the 40 – 50% range when I’m in my 40s because of terrible fiscal policy now.

The G20 and SWFs

The G20 is scheduled to meet this Saturday to outline a set of guidelines for the world's 20 largest economies to coordinate action in light of the worsening global economic milieu. An illustrious crew of economists at VoxEU have written the book (literally) on what government officials need to say and do to deliver the world from catastrophe. The prescriptions are as banally predictable as all the doomsday yarns and the fact that government officials will inevitably do the wrong thing. Beyond the obvious calls for increased cooperation and coordination, one piece of advice struck me as quite odd. Guillermo Calvo, via Dani Rodrik:

The new Bretton Woods institutions should be more tolerant of controls on capital mobility, especially as those controls centre on limiting the actions of the banking sector.

True, these new capital controls may certainly help developing countries stall capital flight; but there are a number of complications. The dollar is still seen as the safest asset in the world. For that reason, SWFs (from China to Dubai) have been sinking ever more money into dollar denominated assets - at least one piece of anecdotal evidence to explain the recent rise of the dollar. This has, at least in part, kept the US out of the worst of the crisis. There is no way the US will allow new restrictions on capital outflows to be the bulwark of any new "Bretton Woods". Not only are such controls notoriously hard to enforce, they would probably bring the dollar back down, and I have a feeling that's something we would be loathe to support.

To be sure, global capital flows were somehow involved in the current financial troubles. But to reiterate, our current situation is far too complicated and opaque to be blamed on any single silver bullet: whether they are swaps, the housing bubble, or capital outflows. The underlying root was a mispricing and misunderstanding of risk throughout the financial model.

Capital outflows allow investors to put their money where they see fit. SWFs represent, by far, the largest outflows of capital. They are intended to mitigate risk and exist to safely invest currency reserves in the way that will most diversify national wealth. For their sake, and ours, let's keep letting them.

(Image: New Yorker)

Ideas and influence

Dan Drezner raised an interesting question that has crossed my mind several times during the most recent spat of financial turmoil: are governments responding to the opinions of academic economists? 

A small piece of anecdotal evidence for our readers. Last Thursday, Charles Calomiris posted on VoxEU that governments needed to directly buy up bank shares; Krugman (PROPS) had made the same argument. In case you hadn't heard, the Treasury announced today that they will do exactly that. Was Paulson responding to academic opinion?

Certainly the UK's (and other Europeans') decisions to buy direct stock in banks influenced the US decision but when the "innovators" of Wall Street land us in a sea of trouble, government officials have incentive to take the advice of more tempered minds from the halls of academia, even when the man implementing the plans is a Goldman alum. But whether this represents a permanent shift toward a more intellectually founded economic policy is a much different question. I'm leaning towards this being the case based on my opinion that the explosion of economics blog and popular writing on the dismal science has fundamentally shifted the way economics is viewed by laymen and policy wonks alike. Readers, what do you think?

Someone old and something new

We all know the debate wasn't earth shattering; far from it. One original notion was voiced throughout the sea of talking points and it came up in the first response. From CNN's transcript, Sen. McCain:

As president of the United States, Alan, I would order the secretary of the treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes - at the diminished value of those homes and let people be able to make those payments and stay in their homes.

Now this certainly seems to me like a substantive proposal and, please correct me if I'm wrong, I haven't heard or read any pundit discussion on this shift. I've made my feelings known, and though I'm not a rabid fan, I don't understand why Sen. Obama is the "socialist" when Sen. McCain wants the government to buy every bad loan. Would you rather the government own your home loan or equity in a institution that holds your debt? Personally I wouldn't mind that extra buffer between Mr. Paulson and my home. I'm sure some of our readers disagree with me...let me know in the comments.

More thoughts: bailout fallout

The Senate is set to vote on the bailout presently, so I thought I’d add some more thoughts before that. Quick civics lesson: the gravitas of the upper chamber in the American legislature, combined with the relatively greater insulation from public opinion that a six year term affords, have traditionally resulted in greater bipartisanship. I imagine the bill will pass. Of course, I thought it would pass in the House as well.

First, in the comments section of yesterday’s post, Bradley has weighed in with an excellent, substantive overview of the issues at stake from a financial perspective. I strongly encourage you to read it.

Second, I forgot to add yesterday that perhaps another reason to support the bailout is that there is less choice about government intervention than it seems. Both the Fed and the Treasury have made it clear that, absent any new authorization, they will continue to intervene in the markets as necessary (provided they have the legal and monetary capacity to do so).

Turning to political ramifications, our friend Rory over at IPE-J noted today that the US presidential race is starting to break for Mr. Obama. Indeed, all the major poll-aggregators (which are more accurate than individual polls: I like Pollster and FiveThirtyEight) have noted significant swings following the first debate, both at the national level and in the major swing states. This bodes well for the prediction I made back in July. No matter how much you claim to be a maverick, people need someone to blame when the economy is doing poorly. Right or wrong, the incumbent party invariably takes the brunt of voters’ anger. Also, the fact that Sarah Palin is one of the most unqualified candidates to run for high office in the history of the United States doesn’t help. Her favorability ratings have plummeted from 47% favorable/23% unfavorable on Sept 11th, to 36% favorable/ 39% unfavorable today. She's done an admirable job of shoring up Mr. McCain's right flank, but she's making him less appealing to indpendent voters in the center of the political spectrum. Perhaps things will change if Putin rears his head in the near future.

As Rory presciently notes, Mr. McCain really needs Mr. Obama to forget to wear clothes to the next debate.

I was elected to lead, not to read!

Well we are at crisis levels. The bailout, which plenty of people say won't work anyway, has stalled in an incredible fashion today. I won't try to give a run down of the issues at hand, but let's be clear that neither I, the President, nor both candidates fully understood the subtleties of our current pickle, despite the stellar briefings I'm sure they have all received. Apparently neither do any of our elected representatives because despite all of the calls for immediate action we are being greeted with limp and tepid responses carrying no weight. For clear explanation read these concise and lucid treatments of what's happening and why.

As Brad Setser points out, the balance sheet of the Fed reveals the huge nature of the deal. It's sad, and in this situation downright scary, that an election season filled with promises of bipartisan compromise has devolved into another typical session of Washington malaise. To be perfectly frank I'm ready for some good 'ole unilateral, unchecked decision making rather than this current handwringing and indecision. And besides, Paulson isn't nearly as bad as Russ Cargill.