Excess Liquidity Is To Blame, Guillermo Calvo

Here, one of the world’s leading macroeconomists argues that the explosion of commodity prices is the result of a very real global financial storm associated with excess liquidity in several non-G7 countries and nourished by the low interest rates set by G7 central banks. The commodity price explosion is a harbinger of future inflation.

Oil, metals, and now food prices are heading to the sky with a virulence that is hard to rationalise on the basis of world output growth – not even on the basis of China’s and India’s fast growth, let alone the expected global slowdown. This phenomenon has been accompanied by much higher transaction volumes in forward markets. Thus, analysts and policymakers have been quick in pointing an accusing finger at the proverbial speculator, who has even been declared persona non grata in some countries, like India, where commodity futures have been banned.

Absence of a substantial increase in physical commodity inventories has been mentioned as evidence of absence of speculative activity (by Martin Wolf and, more guardedly, Paul Krugman).

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I Don't Buy Calvo's Argument, Paul Krugman

Guillermo Calvo is one of my favorite economists. But — you know there had to be a but — I just don’t buy his latest missive. Still, it’s important that we have this debate: something awesome is happening to oil and other commodities, and figuring out what it means is crucial.

So, a couple of points.

First, Calvo dismisses the argument that the absence of physical hoarding is evidence against a speculation/liquidity source of high commodity prices. “Suppose, for the sake of the argument, that the demand for commodities for current consumption or production is completely inelastic …” Well, that’s assuming your conclusion.

When I think about speculation, I always start from Paul Samuelson’s classic analysis in terms of intertemporal price equilibrium (a 1957 paper — and not available, as far as I can tell, online. Why isn’t Weltwirtschaftliches Archiv on JSTOR?). Speculation can affect spot prices because it takes physical stuff off the market. Argue, if you like, that the inventory data are unreliable, or that stuff is being held in the ground; but don’t tell me that physical quantities are irrelevant.

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More from Paul Krugman and Mark Thoma

MBIA Debt Is Setting Up a Quandary , New York Times

The risks associated with the vast, unregulated market for credit default swaps played a crucial role in the bailout of Bear Stearns. Now these financial instruments are taking center stage in another Wall Street drama: whether regulators will let MBIA, the big bond insurance company, renege on a promise to shore up a crucial unit with $900 million in capital.

MBIA has written $137 billion in swaps, which are privately traded insurance contracts that let people bet on companies’ financial health. Most of these contracts stipulate that if MBIA’s bond insurance unit becomes insolvent or is taken over by state regulators, buyers can demand payment immediately.

But if that were to happen, MBIA would have far less money to pay policyholders and owners of municipal bonds backed by the company. So the swaps give MBIA significant leverage over Eric R. Dinallo, the commissioner of the New York State insurance department, who wanted the company to bolster its insurance unit with the $900 million in cash.

In the case of Bear Stearns, the Federal Reserve feared that credit default swaps might unleash a chain reaction of losses if the bank were allowed to collapse. Given the threat that similar swaps may pose to MBIA, Mr. Dinallo is unlikely to push for a regulatory takeover of the subsidiary even if Joseph W. Brown, MBIA’s chief executive, refuses to recapitalize the unit.

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NY Times Story Is Inaccurate and Misleading, MBIA

Armonk, NY – A story in the New York Times on June 18, entitled “MBIA Debt is Setting Up a Quandary.” contains inaccuracies and is misleading. Following are the specifics:

#1: The story leads with the speculative question of “whether regulators will let MBIA…renege on a promise to shore up a crucial unit with $900 million in capital.” That phrasing is erroneous, primarily because no such “promise” has ever been made. The $900 million referenced is part of the net proceeds from the Company's $1.1 billion equity offering that closed in February, which was issued as part of MBIA’s overall capital strengthening plan. The prospectus for the offering stated in the Use of Proceeds section: “We estimate that the net proceeds from this offering and the backstop commitment will be approximately $959 million, after deducting estimated expenses relating to this offering and the backstop commitment. The net proceeds of this offering and the backstop commitment shall be used to support our business plan and operations.” No promise was made to put the capital in MBIA Insurance Corporation.

In a January 9 press release, MBIA said “Upon successful completion of its capital management plan, the Company expects to meet or exceed the rating agencies' current capital requirements for MBIA to retain its Triple-A ratings. Based on discussions with the rating agencies and the commentary they have released to the market, the Company believes that the successful implementation of this capital plan will result in a robust capital position that will lead to stable ratings.”

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Debunking the "Wealth Effect", Christopher Flavelle

Last Thursday, the Federal Reserve reported that Americans' net wealth fell for a second consecutive quarter, a nerve-rattling drop after five years of growth. The fall in wealth stems largely from declining house prices and comes as the economy overall continues to struggle. These coinciding events reinforce the idea of a reverse "wealth effect": As the value of people's assets declines, their spending will fall significantly, wreaking havoc on the economy. But no matter how popular that theory is in the business press, it's unsupported by economic facts.

The premise behind the wealth effect seems sensible enough: When the value of your assets—like stocks or a house—rises, you feel wealthier and are more likely to splurge. When it falls, you're likely to curb your spending, either because you can't take as much equity out of your home or because you simply feel poorer and so change your behavior. Aggregated across the economy as a whole, the wealth effect suggests that current falling home prices should lead to a recession.

That premise underpins much economic writing. On Saturday, the New York Times' Peter S. Goodman wrote that since last fall, "economic troubles that began with falling home prices have rippled out to other areas of the economy—to shopping malls, grocery stores and home improvement outlets."

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In Praise of the Wealth Effect, Jubin Zelveh


Mark Thoma pointed last week to a typically catchy headline from Slate: "Debunking the 'Wealth Effect'"

For the uninitiated, the wealth effect refers to an increase in spending as a result of a rise in wealth (in this case through things like stock or home price appreciation). In his story, writer Christopher Flavelle says:

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(Flavelle lets Backus do the talking here, and Backus is an excellent economist, but not the best verbal communicator. The other time I heard him speak was at a debate in which he, along with a couple of others, were tasked with defending the position that Markets Are Moral. Unfortunately, Backus took a couple of moments at the beginning of his alloted time to talk about how economists like to get together, drink beer, and talk shop. This left him with much less time to actually argue his case for the morality of markets. It wasn't all his fault, but before the debate, 68 percent of the people in the audience favored the competing view that markets are not moral. After the debate, that contingency grew to 76 percent. This should serve as a note to economists: no more cute anecdotes about how much your profession likes beer, we get it.)

But back to Slate.

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Taxing the 'Not-So-Rich' Rich, Jane Sasseen

By any measure, Dr. Howard Hammer and his wife, Hope, have a comfortable life. Hammer, 40, has built a thriving practice as an ear, nose, and throat specialist, while Hope, 39, has switched to part-time work as a real estate lawyer after years at a big firm in order to spend more time with Arielle, 7, and Matthew, 9. Home is a four-bedroom house in the Philadelphia suburbs, and between them, they bring in over $300,000 a year. "We can't complain," he says. "We're certainly not struggling."

But are they wealthy? That's far more debatable. Hammer, who feels the same pressures squeezing Americans up and down the income ladder, says he's anything but. Ever-rising prices for gas, health insurance, and other expenses are hitting hard, as are the $3,000-a-month mortgage and the $2,000 he still pays monthly to whittle down his $160,000 medical school debt. A six-year residency gave Hammer a delayed start saving for retirement, so he worries if he's stashing enough in his 401(k). By the time the couple contributes to the children's college fund, there's little extra at the end of the month.

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Is That A Small Violin I Hear Playing?, Tom Bozzo

In BusinessWeek, Jane Sasseen's "Taxing the 'Not-So-Rich' Rich" tries to make me feel, uh, well, here's the lede:

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Granted, income is a flow and wealth is a stock. There's nothing much beyond self-control that would prevent a family with a 97th-percentile income a la the Hammers from spending drunken sailors under the table (if perhaps in ways the drunken sailors would find dull), seeing as the modern economy's undeniable talent is providing an array of goods and services capable of relieving anyone of their money for arbitrary values of "their money."

Still, a regularity of the income-and-wealth data is that households with $300,000/year incomes also tend to be in high percentiles of the wealth distribution. In the Fed's 2004 Survey of Consumer Finances, for example, households in the 75th-90th percentile range for the wealth distribution had a median income of $77,000 (in 2004 dollars) and a mean income of $87,800. So there's some skew to the income distribution for people in that wealth fractile, but you can conclude that there aren't too many people making $300,000/year who aren't also in the top 10% of the wealth distribution. At least, they're for the most part rapidly on the way there.

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