Friday, July 27, 2012

Status of Threat of Great Depression II

About a month ago, definitive op-eds in the Financial Times and
elsewhere were warning us that
the possibility a new Thirties style Great Depression starting within
about one year is far too serious
and realistic to ignore.

It is still so.

Before the details and possible response, some background....

Budget sequestration doesn't get many headlines this month, but it is
very much in process.
As I understand it, January is when it all hits the fan for actual
government net spending. I have seen estimates that
unemployment will quickly go over 9%. And, yes, I wonder what the
specific impacts will be;
it's hard to know, and the House has even passed a bill demanding more
details. All of us wonder what
the impact will be on us. In addition, I pray that it doesn't kill the
unique new DARPA
plan for hypersonics research, which has the chance of saving the US
future capabilities in space just in time before it is too late.
(It's not a billion dollar item, but at a time of cutbacks, it is
common for bureaucracies to circle the wagons and save
old stuff first.)

Likewise, the Financial Times said this morning that many are expecting
the shoe to finally fall off for Greece
before too long, and -- despite what was achieved this past month --
for the dominoes to keep falling.
A lot was achieved this past month or two, but not enough. It reminds me of the story about
the guy who finally got usable tires for his car, but
never got around to the engine.

I don't know how it cuts in China, but I don't expect deus ex machina
from them. They have their own problems.

One humorous aside: in China, I ran across quite a few Moslem people
this time. Honest to God, some were truly excited
about the prospect of the US electing a President who would be a
devout member of the Mormon brotherhood, and
finally put alcohol and caffeine in their proper places, and show a
little more respect for polygamy. The Saudis who own so much of Fox
would undoubtedly agree. More seriously, I can imagine a scenario in
which Romney takes office in January, and unemployment immediately
ticks up a point or two,
and half the lights go out due to unprotected EMP, and then things
become really messy. It could really happen.


Of course,everything above and below is just personal rumination, not
representing anyone, and not
proposing A Position.

I have tried to back off a little, and map out what COULD be done, in
principle, in a broad way, to prevent a new global depression.

It seems to me that there are two essential global constraints we need
to think about.

1. First, there are constraints due to the need for each major
decision center (US, EU, China) to maximize its goal independently.
I strongly conjecture that we are caught in a kind of "prisoner's
dilemma," which I have talked about before. This leads to the first
major domain
for possible action to make things better: could we somehow come up
with workable agreements of US, EU and China to get out of the
prisoner's dilemma situation
somehow, and move to more of a Pareto optimum? Note that I haven't
given details, but in general, in principle, this is a very
fundamental tool
for saving ourselves, if we can use it effectively. Let me call this
"lever one."

2. In the US, dollar bills and coins only get into circulation by the
action of Federal Reserve Banks LOANING them to other banks, who in
turn loan
them to others. This puts a pretty firm constraint on TOTAL debt in
the US. (Of course, folks like Milton Friedman undoubtedly have texts
giving much more
detail on exactly how this works.) Federal debt is not the only debt
which matters; consider China's problem with provincial debt, and our
problems in earlier years with consumer debt!.
Yet it is not so realistic to talk about lowering TOTAL debt, under
this system. In a way, the goal may be to MOVE debt to places like
where it may be offset by real tangible value of productive assets.

In theory, we do not have to stay with this general system. The Roman
Empire survived reasonably well for awhile just using the new
currency for
direct spending. I do not know what China really does here. In theory,
there could be a second lever of changing the system, to make
total net debt more avoidable. I would call this the second possible
lever for action... but it has obvious problems, and I have far less
specifics I can see here right now.
I mention it for completeness, not because I have anything to propose
right now. But for the long term, I do wonder just how necessary such
debt really is?
How much could it be biasing the future of humanity?


And then, we get back to the usual "two practical levers" that
everyone knows about, the "fiscal" and "monetary policy" levers.

For fiscal policy... it still comes back to something I have discussed
before: the importance of estimating the total job creation value
PER DOLLAR of government debt, either spending or tax incentives. So
far as I know, a few Japanese eoconomists in the office of their
president are
the only ones who have taken this very simple common-sense approach to
minimizing debt without raising unemployment, or maximizing employment
living within some debt constraint. Unemployment does not HAVE to rise
above 9% for the level of debt reduction implied by the sequestration
if we take such an approach, but can we? Not if sacred cows rule the Congress.

But there is another aspect of ordinary government policy which also
can help. For example, we have discussed the Shield Act, which would
add to the deficit to any significant degree. But by mandating
hardening of the power grid, it would mandate electric utility systems
to invest (hopefully VERY QUICKLY)
in off-the-shelf equipment to harden their systems. This would cause a
small increase in electricity rates, spreading out the cost over many
years, accompanied by
a much larger immediate private sector investment ( financed by the
"good" kind of corporate debt) creating jobs in the construction and
heavy industry sectors,
which are especially depressed even now. The Open Fuel Standard bill
would have similar benefits, on balance, though not quite so graphic.
Changing Renewable Fuel Standards to an appropriate equally strong
Low Carbon Fuel Standards law (as we have discussed before) likewise.
Much larger and more important, in my view, would be measures in
Europe mandating utility purchase at 15 cents per kwh for all solar
from solar farms operating within the EU, as much as people can
generate up to about half of daytime peak demand. (Of course, the US
and China could do the same,
and we could even possibly AGREE to some form of this by treaty.)

Regarding monetary policy, second-guessing someone as smart and as
focused as Ben Bernanke is very hazardous. He says he is doing all he
can do,
but that monetary policy is not enough. That suggests that the minimum
risk to the world economy would come from maximizing what we do on the
fiscal/regulatory side (REMEMBERING to maintain shock absorbers for
the eventual time when unemployment gets all the way back down to 5%),
and MAKING that enough to get us back to 5% smoothly, and making deals
between US and EU and China such that all three know they can get away
with zero real interest rates in paying off
resulting government debt.

But... maybe there is also something else which could be done on the
monetary side, at least in the long term.

One may ask:

Is the present system for channeling loans really the most efficient
in the long-term, for dealing with the uncertainties and reflexive
and vicious cycles of pessimism (positive bubbles and negative
bubbles)? Just as electricity markets now work better
since the era of Enron, now that new computerized markets based on
more modern algorithms get rid of some of the
erroneous arbitrage noise, could they do the same for financial
markets somehow, and not just in the realm of millisecond twitch
Could a different structure of "plays" better factorize the gigantic
"matrix" of uncertainties and actors?

Stuff like Glass-Steagel might help a little, but maybe a more truly
optimizing alternative might be possible, if the very best new
systems methods are applied. Worth thinking about.

This final "lever" reminds me a bit of Martha's question about
batteries. To PROPERLY value and operate a battery within the power
grid really requires
an advanced form of adaptive dynamic programming (ADP), because of the
difficult uncertainties, context complexities, and need for correct
I suspect that NONE of the technical traders in the world financial
market know the relevant mathematics; a lot of what they do is based
on applying metaphors from domains like
superstring theory or Soviet aircraft design (recycled from a guy at
Bell Labs) or local, myopic chaos. Large scale financial flows are not
really easier than batteries.

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