Freshwater versus saltwater circa 1988

As a follow-up to my post on debt and it’s exclusion as a subject of merit amongst several schools of economic thought, I wanted to bring a New York Times article from 1988 to your attention. This article by Peter Kilborn, a Washington, D.C. based former correspondent for the New York Times, is timeless.

It reads like an article right out of 2008 or 2009 and highlights how little has been decided in the debate about the economic effect, size and role of government. Many of the key players – Paul Krugman, Larry Summers, and Robert Lucas to name a few – are the same. At issue is the divide between freshwater and saltwater economists that has been raging for at least a generation now. Kilborn says:

To tinker or not to tinker? For decades most politicians and professors of economics have taken it for granted that the Government must adjust the engines of the economy to avoid recessions and create jobs. But lately, a long-belittled school of skeptics who think the Government usually just gums things up is gaining attention and influence.

The skeptics are known as ”fresh water” economists, less for the purity of their thought than for their origins at universities along the shores of the Great Lakes.

The school’s views are filtering into such lofty citadels of mainstream ‘’salt water” economics as Harvard, the Massachusetts Institute of Technology, Princeton and Stanford. Its theories also appeal to economists who are advising the Presidential election campaign of George Bush, and, to a lesser extent, those working for Michael S. Dukakis.

The fresh-water people build their case for minimal intervention on the view that workers, consumers, business executives and investors anticipate changes in the economy faster than the Government and can adjust to them better on their own.

On some level, one could say this divide is manifest in how the political fault lines in the U.S. are forming. Larry Summers, President Obama’s chief economic advisor, is a saltwater type with definite freshwater sympathies. 

On the other side of the political spectrum are those who want small government, a view championed by Ronald Reagan in the 1980s. Republicans are drawn to this positioning because it invokes the Reagan presidency, which was a high point for the post-Nixonian Republican Party. 

You will have noticed my post earlier today on Sarah Palin walking in the small government, Libertarian mantle as she crafts a strategy to take control of the party.

In the article, Krugman sums up the crux of the divide nicely, with Robert Lucas taking the other side:

”The basic distinction,” he said, ”is do you think recessions present a problem? And do you think the Government can do something to avert them? The fresh-water people say that recessions either are nothing to worry about or that in any case, the Government can’t do anything about them.”

Robert E. Lucas, the undisputed dean of the fresh-water school and chairman of the economics department at the University of Chicago, said, ”What we’re turning against is the idea that you can fine-tune the economy with any policy at all.” The university has long been the home of monetarist economics, which maintains that steady, noninflationary growth results from steady growth of the money supply and of which the newer theory is an offshoot.

So, if you are wondering where all of the back and forth is coming from on economic theory and why it has failed us, take a step back in time to the late 1980s. The debate is pretty much the same today.


‘Fresh Water’ Economists Gain – NY Times

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News from around the web: 2009-09-01

  • Beijing’s derivative default stance rattles banks | Reuters

    Hat tip aitrader. A report that Chinese state-owned companies will be allowed to walk away from loss-making commodity derivative trades provoked anger and dismay among investment bankers on Monday as they feared it may set a damaging precedent.

  • John McAfee’s New Mexico Land Auctioned for $1.15 Million –

    The software entrepreneur John McAfee, whose fortune has dwindled to about $4 million, from more than $100 million, sold the last of his major real estate holdings on Saturday: a 157-acre spread in Rodeo, N.M., where he and his friends flew lightweight airplanes.

  • Are the Bulls Heading Toward a Cliff? at

    Investors’ hearty appetite for any good economic news is filling the stock market with the equivalent of empty calories. Our pundits say that the economy is indeed improving on a slow and incremental basis, but they also warn that the path to stability and the path to growth are getting conflated in a classic bear market rally.

  • Facebook Quitters: Find Out When Someone De-Friends You

    The act of de-friending someone on Facebook may have just become a bit more socially awkward. There’s now a Greasemonkey add-on (available here) that will check your network at scheduled intervals to see if anyone has removed you and alert you when it happens.

  • – Time to Wind Down Fannie and Freddie –

    Fannie Mae and Freddie Mac shouldn’t be allowed to languish in Uncle Sam’s arms. But as the anniversary of their seizure by the government approaches, the mortgage financing giants remain the biggest black holes in the financial firmament.

  • Hit by Recession, Cocaine Dealers Resort to Cold-calling — New York Magazine

    Hat tip Judith: Sammy, another coke dealer, was equally aloof. "On weekends, I was making twenty house calls per night," he says, "And there were always 20 to 25 that got shafted."…For Tim C., a longtime street dealer whose headquarters are in Washington Square Park, the problem has trickled down… "It sucks. You’re gonna find me at the post office if this goes on for much longer." Then the stock market crashed, and people started losing Sammy’s number. But he didn’t lose theirs. "It was a 646 number," says Nate, 26, who works at an investment bank; he got three calls from Sammy in one week.

  • Why this rally might head into fall – Bill Fleckenstein

    Throughout the recent stock market rally, I have proclaimed my agnosticism about what might happen next, although I’ve been leaning toward the viewpoint that the government’s money printing may make stocks go higher. Thus, I have not wanted to short stocks…the market might be ripe for a correction. However, being "ripe for" and actually undergoing a correction are two different things. I wouldn’t be the least bit surprised to see some sort of serious pullback. But to repeat, for now I have no interest in trying to capitalize on that from the short side, except perhaps by using a couple of ideas for a bit of insurance.

  • House prices drop 1.1pc in July, extending two-year slump –

    House prices dropped again in July, extending a slump that has dragged prices to the lowest in more than five years. Prices fell 1.1pc from the previous month and were down 12.5pc from a year earlier, Irish Life & Permanent (IL&P) said in a monthly report today. The annual drop is the biggest since the index began in 1996. House prices have fallen in every month since May 2007 and are now 24pc below their peak in the early part of that year.

  • Canada Economy Shrank at 3.4% Pace in Second Quarter –

    Canada’s economy shrank faster than expected in the second quarter and the country’s first recession since 1991 is proving deeper than thought, even as growth in June indicates the contraction is nearing an end.

  • Goldman Sachs Hedge Funds Report

    Goldman Sachs has released a new report on the hedge funds industry, Hedge Fund Monitor… Among the key findings: Net long exposure has increased significantly to the highest since June 08 amidst improving economic data, stabilizing capital markets, and rising equity prices. Hedge funds net long is now 31%, a return to "pre-Lehman" levels.

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    Government banking Irish edition

    The Irish government today announced that, if necessary, it is prepared to take majority shareholding in ailing Irish banks. However, it has ruled out full-scale nationalisation. But, what is a majority share by government except nationalisation?

    This is a duplicitous parsing of words that hides a more sinister interpretation of what is happening in Ireland.

    Here’s what Ireland’s Finance Minister Brian Lenihan has to say, according to the Guardian newspaper:

    "Some institutions may need capital after they have transferred loans to Nama," Lenihan told a joint Irish parliamentary finance committee this afternoon. But the minister ruled out full-scale nationalisation of the country’s banks. "This will increase the state’s ownership in these banks and in some cases that may result in a majority shareholding," he said.

    So, if I could paraphrase Lenihan, he is saying: we are having a temporary problem in Ireland whereby some of the weaker but systemically important institutions need more capital.  We in government are going to give them that capital to maintain the functioning of the financial system.  Technically, this makes us the majority owner, with all the rights, privileges and responsibilities ownership entails.  However, we don’t want to be bank owners and will look to reduce our stake when these firms return to a better capital position or raise more funds from private investors.

    I translate this as Lenihan implying the government intends to socialize the losses of the Irish banking system despite the looming fiscal problems in the country.  In my view, this is the worst outcome of potential policy remedies and the least free-market approach.  However, there may be a silver lining in terms of a healthier banking system.

    Back in March when everyone was actually talking about solutions, James Kwak categorized three dominant potential banking system solutions. I have bolded the parts I intend to stress:

    I think there are three main positions in this debate:

    • A1: The banking system is broken. Banks need to get rid of their toxic assets and they need more capital. The solution is for the government to buy their toxic assets at a high price (or insure those assets) and to give them lots of cheap capital.
    • A2: The banking system is broken. Banks need to get rid of their toxic assets and they need more capital. The solution is for the government to take them over, transfer off their toxic assets, recapitalize them, and (when possible) sell them back into the private sector.
    • B: The banking system is basically sound and will recover if we give it some time. In the meantime, the government should give the banks just enough money and intervene as little as possible to keep them afloat until asset prices recover.

    Do you recognize these solutions? A1 is America’s dead-on-arrival PPIP program which was killed by A2, used successfully by the FDIC every Friday night, and A3, otherwise know as the bailout of too-big-to-fail institutions like Citigroup and Bank of America, neither of which has yet to return TARP money.

    It sure sounds like Ireland is trying to implement solution B a.k.a. socialization of too big to fail bank losses.  The problem of course is the Iceland scenario i.e. a situation in which the government, now majority owner of several large financial institutions, cannot credibly act as guarantor for those institutions, but has implicitly or explicitly promised to do so. I don’t like the drip-drip-drip approach because it creates the zombie bank problem I just spoke of in my last post on Scandinavia.  This is the same approach taken with RBS and Lloyd’s-HBOS and in the U.S. with Citi and BofA. But, in Ireland, there is even more downside risk as there was in Iceland.

    However, at a minimum, the Irish are talking about hiving off bad assets from good and trying to re-insert the cleansed financial entity into the banking system.  This is the approach Sweden took in its early 1990s bank crisis. If one is going to have government banking – and this is what is happening in Ireland no matter how you parse the words – one needs to know that the resulting private financial institutions will be healthy.  Ireland’s National Asset Management Agency gives the country a good chance of getting those healthy banks.

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    News from around the web: 2009-08-03

  • Unconscionable Math – Taunter Media

    The math of denying health insurance retroactively

  • The scope — and dangers — of GE’s control of NBC and MSNBC – Glenn Greenwald –

    This is what happens when corporations control media

  • Turning on a Paradigm – Brad Setser: Follow the Money

    The role ideology in economics and animal spirits in markets

  • The SEC Settlement: One Small BofA Fine, One Big Problem for Ken Lewis – Deal Journal – WSJ

    Looking for Lewis to leave BofA

  • GM cuts hourly workforce by 6,000 – BBC News

    65% took early retirement. 30% took buyouts.

  • More debate about the validity of economic data – Michael Pettis

    More in-depth China analysis from Pettis, now also on validity of China’s stats.

  • Krawcheck Joins BofA Amid Talk of Succession – DealBook Blog –

    The famed former Bernstein analyst finds a new gig.

  • The China stock bubble is back – Tim Iacono

    This bubble doesn’t necessarily mean economic disaster in China.

  • Australia’s property bubble – Felix Salmon

    Bigger than the one in America. But it hasn’t burst. Canada’s was not as big but is another conspicuous bubble yet to fully burst.

  • Google CEO Eric Schmidt Resigns From Apple Board. Surprised?

    In response to Apple’s anti-competitive behavior.

  • Whitney Tilson And High Frequency Trading v3 | zero hedge

    Good balance of views on this topic.

  • Private Equity Said to Carry $400 Billion in Debt – DealBook Blog –

    Must be repaid over next five years

  • Retail sales fall back in Germany – BBC News

    Consumption in Germany is weak

  • HSBC profit halves to $5 billion as bad debts jump | Reuters

    More than half of bad debt came from America

  • Home owners ‘face five years of negative equity’ – Telegraph

    Those who bought at the peak face 5 more years, one reason nationwide brought back the 125% mortgage.

  • Pound hits 10-month dollar high – BBC News

    1.6850 is a huge upside move. Sterling is moving up against the Euro as well.

  • Jobless graduate sues her college

    Only in America. Litigious society at work.

  • China’s Manufacturing Expands Amid Signs of Global Recovery –

    Order growth driven by domestic demand.

  • How Children View And Treat Their Peers With Undesirable Characteristics

    if a child feels that an undesirable characteristic is under some sort of personal control, they are less likely to respond favorably to someone who displays that characteristic

  • Rewarding Bad Actors – Paul Krugman

    Provocative. I don’t agree 100%, but definitely worth a read.

  • Foreclosures and the continuing crisis – James Suriowiecki

    Focus on banks has left homeowners out to dry.

  • A Canadian doctor diagnoses U.S. healthcare – Los Angeles Times

    Since I am in Canada right now, I find this interesting. Hat tip Mark Thoma.

  • Dr. Doom Sees Double-Dip Recession Risk, in Remarks Down Under – Real Time Economics – WSJ

    Underlying demand is weak.

  • Japanese wages in record plunge

    Doesn’t make recovery easy.


    Distraction of the Day: First Black supermodel dies at 61

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    ISM shows manufacturing sector close to recovery

    Today the July 2009 Manufacturing ISM Report On Business was released and the widely followed PMI Index came in ahead of expectations at 48.9.  Any number below 50 represents contraction, so this figure shows that the manufacturing sector in the US contracted for an 18th consecutive month.  Nevertheless, the improvement since the beginning of the year is marked and given the trend, the sector will likely be above 50 next month or soon thereafter.

    ISM 2009-07

    Last month I mentioned that new orders were no longer increasing as the reading had slipped below 50.  That was very worrying to me and it makes new orders a number to watch going forward.  There was a brisk uptick in new orders in July that, if sustained, will mean that increased production is not just a result of restocking of inventory but of actual order flow for product.

    Now, if you read Calculated Risk’s take on this report, you would get the impression that things are still looking pretty bad in the manufacturing sector.  I have immense respect for the work done at CR , but that type of post reflects a clear bearish bias.  I have a bearish bias as toward the US economy as well, otherwise my blog wouldn’t be named Credit Writedowns.  However, I see the facts as they are presented – and this report was very bullish.

    Not only did new orders tick up, but a number of other data points show expansion: production, supplier deliveries and order backlogs, in particular.  You should also note that the ISM data suggests the overall economy is growing for a third month in a row.

    Given this data and other recent bullish economic reports, don’t be surprised if Q3 GDP change prints a positive number.  If it does, it is very likely that the recession is all but over right now.  Mind you, I still am talking about a weak Q4 or Q1 2010 recovery and possible double dip.  But, I am aware that it is mostly upside economic risk that is apparent in the US. The data cannot be ignored.  And right now, it is very bullish.

    Manufacturing ISM Report On Business – ISM website

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