Capitalist Realism & economics

rumble

Well-known member
"Plenty of firms in America's protected markets were earning healthy rents from a system that was gradually destroyed by a long trajectory of deregulation and liberalisation (a process that ultimately went to far, alas). But this loss for entrenched interests at the expense of newcomers is, as I've suggested, a complicated thing, more complicated at least than bad guys making out at the expense of the good guys. "

You're getting towards the key part of this.

Under Fordism, those large rents were being spit up between owners of capital, managers and workers (the entrenched interests) fairly equally via union bargaining, fiscal transfers etc. When Volcker made credit very scarce, and increased the returns to capital holders, he shifted the balance of power to capital. What was really remarkable about it was that for the first time the Fed was willing to cause a serious recession, just to get rid of inflation. That was unprecedented. Workers are expendable, managers are expendable, but you need credit to survive. When interest rates went up to 20% that basically meant that the rents that had been split by workers and managers all went to the owners of capital, forcing the other two into a subservient position. It also weakened the equity market relative to the bond market, meaning that companies who failed to extract enough profits out of their companies to compete with the high rates of return in the bond market would be taken over through a bond-financed LBO. Managers were forced to either put the cuts on workers, or face a takeover and getting fired themselves. Obviously they chose to sack the workers.

The reason it gets pointed to so often is because it marked the end of the worker-friendly post-war compromise between labour, government and capital (Fordism) with capital coming out on top. When the rates were lowered again, capital retained its enlarged share of the profits and extracted it through the equity market, rather than the credit markets, while managers became adept at paying themselves out via large salaries and equity options. Workers just lost out.
 

rumble

Well-known member
"As for right now, I think that the situation is quite different. There is almost no expected inflation (see forecasts in Joseph Gagnon's recent paper), so no reason to hold back when unemployment is so high. I am 180 degrees from them, but I'm not at all convinced that what Volcker did was wrong. Unemployment was already rising along with inflation. Post Volker, both of those things were brought down and the US entered a long period of stable growth."

I'll grant that back then there was at least some plausible explanation for inflation hawks, even though it turned out to be wrong. This time it just exposes their craven self-interest in the face of mountains of empirical evidence to the contrary.

re: inflation & the 70s

I'm no fan of Arthur Burns. He messed up by lowering rates in response to cost-push inflation, but two wrongs don't make a right. I think that both Burns and Volcker should have realized that a supply shock was beyond their realm of responsibility, and should have left it to be dealt with via fiscal measures if anything.
 

vimothy

yurp
Okay, I think that's a pretty compelling narrative. But let me come back to the reason I dismissed it when I read Woebot's review: it pins a lot on Volcker. As a metaphor, it works. You could use the October '79 FOMC meeting to mark the transition between two economic regimes. But in reality, this transition was happening well before Volcker was given chair of the Fed.

For instance, you could think of it like this: If we go back to the start of the Fordist golden era, there was low population growth off the back of the Great Depression (and the effects of WWII), and so upward pressure on wages. Big Industry and Big Labour were assured of their seats at the table and fed a healthy diet of rents. The American economy became stagnant and inefficient and firms in Europe and Japan became relatively better in core industries. Technological innovation was happening elsewhere. This lays the ground work for the later failure of these industries. Because American firms were protected and mollycoddled, other countries like Germany and Japan got much better at making stuff.

Add to this the baby boom--there were nearly four million more young people entering the workforce in 1970 than in 1960--and you have structural problems well before the floating of the dollar, the oil shocks, or the Volcker Fed. By 1970, growth was at 0%, inflation was at 6%.

Along comes Nixon. He doesn't want to raise interest rates to defend the dollar's parity with gold (which underpins the global economy). Instead, he rescinds the commitment to gold and floats the dollar--which then declines in value by 25%--imposes price and wage controls, and has Burns goose the economy with liquidity.

That 25% drop in the dollar does good things for the US economy in the short term, but comes straight out of the dollar holdings of America's trading partners. When OPEC tripled the price of oil, the dollar had lost roughly a third of its value. When OPEC tripled prices for the final time, it was roughly back to where it was in real terms prior to the floating of the dollar. The oil shocks were a direct consequence of Nixon and Burns' policy decisions. They were not exogenous.

And then there's price controls. Their removal causes more inflation. And even though monetary policy is expansive, unemployment is trending up, and hyperinflation is not unimaginable. Enter Volcker, who basically underscores his commitment to combating inflation by throwing the economy into recession.

I don't know who's story is right. Maybe they're not mutually exclusive. I don't tend to think of things in terms of the interests of capital and labour, and I'm not sure I believe that this concept can really explain all these different things. Industrial dysfunctionality and demographic pressures can account for a lot. America was also descending from its post-war highs (when it accounted for half of global GDP). The were some unfortunate policy mistakes (as ever). But it's interesting to think that this liberal era might have been dying from the moment it was born, in the same way that the resultant swing to the right is now being undone by the very factors that brought it into being.
 
Last edited:

rumble

Well-known member
yeah the Volcker recession isn't the entire story, but it is a useful turning point.

I think you touch on one of the actual structural problems at the time, but get the diagnosis wrong:

"The American economy became stagnant and inefficient and firms in Europe and Japan became relatively better in core industries. Technological innovation was happening elsewhere. This lays the ground work for the later failure of these industries. Because American firms were protected and mollycoddled, other countries like Germany and Japan got much better at making stuff."

Japan's companies were way more protected and mollycoddled than America's. What was actually going on here was a leftover from the Marshall Plan, with Japan and Germany being allowed to run undervalued currencies. That's what was destroying the competitiveness of American companies. The structural problem was misaligned exchange rates and it was the Plaza Accord partially solved it in 1985, despite continued protectionism in Japan. I'd contend that it was that, rather than Volcker's actions that led to the eventual rise in employment.

The same situation is playing out right now with the undervalued Asian currencies.

"That 25% drop in the dollar does good things for the US economy in the short term, but comes straight out of the dollar holdings of America's trading partners. When OPEC tripled the price of oil, the dollar had lost roughly a third of its value. When OPEC tripled prices for the final time, it was roughly back to where it was in real terms prior to the floating of the dollar. The oil shocks were a direct consequence of Nixon and Burns' policy decisions. They were not exogenous."

How was the politically motivated OPEC action a consequence of Nixon and Burns? Isn't it generally considered exogenous?

Price controls were also another bad response at the time.

In general, I think that the problems with the post-war system were emerging in the late 60s, increased throughout the 1970s and were poorly dealt with, then finally came to came to a head with Volcker. Basically, my view of the 70s is that the unemployment was due to undervalued currencies of trading partners, while cost-push inflation was caused by the oil shocks and devaluation of the dollar.
 
Last edited:

rumble

Well-known member
the Randy Waldman article is good.. I agree with most of his stuff.

I think that the narrative he charts out there is basically consistent with my view.
 

vimothy

yurp
Hmmm, you're right to point out that Japanese firms were also mollycoddled. (And as with the US, many of the factors that seemed to give Japan the edge in the early post-war period later came back to bite them on the ass big time when they entered their protracted downturn). But it also seems to be the case that American firms became more and more inefficient over that period, that they fell behind in the technological innovation stakes, and that American output was restricted. Paul Krugman described the post-war US economy as “socialism without the justice”. But since Japanese firms were also heavily protected, could an overvalued dollar (relative to its trading partners) explain why America fell behind? I don’t know. I can’t see how that would make Japanese manufacturers so much better at making cars, for example, although it obviously has balance of trade implications. But I would like to see some evidence, if you could post links to papers or data.

The issue of the RMB is interesting. I’m not totally convinced that it is all bad, however. I find Scott Sumner’s argument that the global economy also gets a lift off the back of expansive Chinese monetary policy, just like it would get a lift off the back of expansive US monetary policy (here’s hoping), quite persuasive. Clearly, raising rates now would be an unpopular measure domestically for the CCP.

“How was the politically motivated OPEC action a consequence of Nixon and Burns?”

I just mean that OPEC was responding to the devaluation of the dollar—the rises were not unpredictable shocks but measured responses to the falling dollar. Compare the dollar price of oil with the dollar price of gold (apologies for the slightly weird range of dates—I can’t be arsed fiddling around with these any more):

fredgraph.png


monthly_dollar.gif


You can see that they both increase by a similar factor—which makes sense: the price of oil went up by roughly the amount that the dollar went down, because oil is priced in dollars. Otherwise, oil producers would be losing a lot of money. Monetary policy was ultimately the cause of the oil shocks.
 

rumble

Well-known member
That's a pretty novel reading of the oil crises that blows the monetary aspect way out of proportion. The largest movements were not in response to the devaluation of the dollar.

If an embargo in response to the Yom Kippur war in 1973, and the second oil crisis caused by the Iranian revolution in 1979 (the two large jumps on your graph) are not examples of an exogenous supply shock, then I don't know what is.

http://en.wikipedia.org/wiki/1973_oil_crisis
http://en.wikipedia.org/wiki/1979_energy_crisis

The decline of oil prices in the 80s was also due to supply exceeding demand, rather than monetary issues:

http://en.wikipedia.org/wiki/1980s_oil_glut

I don't really see the correlation between the price of oil and price of gold as strong evidence of monetary policy being the causal link. The increase in oil prices was inflationary and destabilizing, while inflation and instability increase the price of gold. It seems pretty straightforward to me.
 

rumble

Well-known member
real prices didn't end up unchanged (from the DOE):

800px-Nominalrealoilprices1968-2006.png


surely you are not using the price of gold as the measure of real prices?

They are correlated, but the price of goods (oil) in terms of gold is NOT the real price.
 

vimothy

yurp
Look, if you think I'm a gold-bug, we're on different planets. I'm certainly not going to get into an argument about whether Bretton Woods was a good idea. But measuring the price of oil in gold is a function of the gold standard. It is the gold standard.

BTW, your wiki link doesn't even work. Now I'll never know the difference between real and nominal prices!
 

rumble

Well-known member
" measuring the price of oil in gold is a function of the gold standard. It is the gold standard."

but the gold standard ended in the 30's (or 70s if you want to count BW as a gold standard, even though it differed from a true gold standard in important respects)

Why would you use it after that point? TBH the only people I do hear using it are nostalgic gold-bugs.
 

vimothy

yurp
Not because it's the troof, but merely because it's the relevant discontinuity: yesterday my barrel of oil was worth $P, which means--is exactly the same thing as--a fixed price in gold, say G; today it's worth 0.05 * G, even though the price is unchanged at $P. I'm not saying that the gold value of the dollar (at whatever point) is its true value. That is indeed bollocks on stilts. But consider this: if it isn't an actual, real devaluation, there wouldn't be any gains associated with leaving the gold standard in the Great Depression. Somebody must have lost out when the dollar was floated and dropped.
 
Last edited:

rumble

Well-known member
"Somebody must have lost out when the dollar was floated and dropped."

The owners of capital, obviously, just like in any devaluation.

The point is that, post-gold standard, gold by itself is useless for measuring the devaluation, since it becomes just another asset. If you use it as the measure of real prices it leads to errors like concluding that real oil prices in the 70s were unchanged, when in fact the opposite is true.

anyways, to get back to an earlier point that I never addressed:

"The issue of the RMB is interesting. I’m not totally convinced that it is all bad, however. I find Scott Sumner’s argument that the global economy also gets a lift off the back of expansive Chinese monetary policy, just like it would get a lift off the back of expansive US monetary policy (here’s hoping), quite persuasive. Clearly, raising rates now would be an unpopular measure domestically for the CCP."

"raising rates"? Based on your last sentence there it is quite clear that you don't know how the Chinese economic system works. Scott Sumner's views on China are so amazingly ludicrous that I find it difficult to believe that he is an actual person and not some sort of elaborate hoax made up by the Yes Men. That's not even taking into account his half-baked NGDP futures targeting theory... All you need to know about Scott Sumner is this: Scott Sumner is a mentalist.
 
Last edited:

rumble

Well-known member
a good place to start in thinking about Chinese trade politics with the standard Mundell-Flemming trilemma and Dani Rodrik's trilemma. These are models that have explicitly been used by economists in the Chinese government itself while crafting policy.

If you can figure out where in each trilemma China or the US, or the global trade system in general is located, it goes a long way towards explaining the current frictions:

looneyOct2.gif
 
Top