Rogoff, Reinhart, and minding your "D'oh"s and "Duh"s

"D'oh!" according to the Oxford English Dictionary (really!) is self--and-past-referential (think "eureka" with a self-deprecating slant) while "duh" refers, insultingly, to others without any sense of time.  In the words of Matt Groening, "so, you might say 'D'oh!' when you've been stupid, and 'Duh!' when you think someone else is being stupid, but then duh!, everyone knows that, right?"

Timing, as the saying goes, is everything.  In Carmen Reinhart's and Kenneth Rogoff's experience timing is the difference between enjoying bestselling author status and wearing a (metaphoric) dunce cap.  Examining centuries of history and most major trading nations of earth, This Time Is Different, their impressively researched, financial perspective on financial crises won them great fame, credibility and, I assume, money.    Based on the same data and premise- too much debt is bad- their paper,  "Growth in a Time of Debt", merely narrowed its focus to the public sector.   Their timing, and tone, with the benefit of hindsight, couldn't have been worse. 

Why?    

It's as simple as the difference between "D'oh" and "duh" and an interesting mental habit known as confirmation bias.

As evidenced by the wild who, how and why speculations following the Boston Marathon bombing, people's search for meaning in the face of disaster often leads inside rather than out.  Upset when the unthinkable becomes real, the threatened mind redoubles its efforts confirming other assumed aspects of "reality."  Those fearful of radical Islam before the bombing weren't surprised when first a Saudi National, and then Chechen immigrants were labelled suspects.  Their bias confirmed, no further questions needed to be asked.

This mental habit has its virtues. Imagine feeling the need to thoroughly examine a table's stability before putting a coffee mug down?  or a road's stability before driving?  A quick biased glance usually suffices for most.  Expertise in a field depends, in part, on informed bias.  An experienced auto mechanic (at least back when human diagnostics were the norm) usually narrowed down problems after a few questions, glances and a listen (whether they used this information to save you money is another matter entirely).

Sometimes, however, even well-informed bias misses warning signs hindsight, informed by consequence, can't ignore.  Homer Simpson's famous "D'oh!" got laughs because we've all been there.

For Reinhart and Rogoff, however, the crisis of 2008 wasn't a "D'oh" but a "duh" event.  Their bias wasn't a revelation occasioned by the crisis, its roots, as I'll soon explain, are much older than that.  The revelation was that others, influential others, didn't share their bias and maybe they could change that.

Years before This Time is Different was conceived Mr. Rogoff revealed his bias in a letter to Joseph Stiglitz just dripping with "duh": You seem to believe that if a distressed government issues more currency, its citizens will suddenly think it more valuable. You seem to believe that when investors are no longer willing to hold a government's debt, all that needs to be done is to increase the supply and it will sell like hot cakes. We at the IMF—no, make that we on the Planet Earth—have considerable experience suggesting otherwise. We earthlings have found that when a country in fiscal distress tries to escape by printing more money, inflation rises, often uncontrollably. Uncontrolled inflation strangles growth, hurting the entire populace but, especially the indigent. The laws of economics may be different in your part of the gamma quadrant, but around here we find that when an almost bankrupt government fails to credibly constrain the time profile of its fiscal deficits, things generally get worse instead of better.
 
Ouch!

In book form, their bias won them fame and fortune by eliciting "Doh"s.  Unlike the letter excerpt above with its reference to different laws in your part of the gamma quadrant, their book modestly hoped to give future policy makers and investors a bit more pause. 

That same bias, in the follow-up paper more closely resembled the letter in tone than the book.  In Congressional testimony, Carmen Reinhart wasn't sharing their bias to give pause, but to form policy.  Stripped of some nuance, and thus more actionable (politicians dream of such one-handed economists) correlation became dissent quashing causation. 

A unilateral causal pattern from growth to debt, however, does not accord with the evidence. Public debt surges are associated with a higher incidence of debt crises. In the current context, even a cursory reading of the recent turmoil in Greece and other European countries can be importantly traced to the adverse impacts of high levels of government debt (or potentially guaranteed debt) on county risk and economic outcomes.

There is scant evidence to suggest that high debt has little impact on growth.

Duh (ok, she didn't say that)

Another thing she didn't say was: In most instances, with enough pain and suffering, a determined debtor country can usually repay foreign creditors. The question most leaders face is where to draw the line. The decision is not always a completely rational one. Romanian dictator Nikolai Ceauşescu single-mindedly insisted on repaying, in the span of a few years, the debt of $ 9 billion owed by his poor nation to foreign banks during the 1980s debt crisis. Romanians were forced to live through cold winters with little or no heat, and factories were forced to cut back because of limited electricity.  
Reinhart, Carmen M.; Rogoff, Kenneth (2009-09-11). This Time Is Different


I copied the above from their book and am not surprised Reinhart didn't share it with Congress.  The story didn't fit what she was trying to sell.  In the event, Ceausecu's policy of austerity led not only to revolution, but his own execution.  That tale would have made for bad "optics" as they say in Washington.

 
Switching tone from "D'oh" to "duh" has its perils as explained here:  Duh is more derisive than doh. Perhaps because the word is associated with Homer Simpson, doh has a humorous quality about it. Duh is sometimes deployed with humorous intent, but more often for the purpose of mocking oneself or another. Put another way, saying duh in the wrong place at the wrong time could ignite a bar brawl. To my knowledge, no physical violence has ever been sparked by the word doh.

Dissenting economists, who'd previously been civil, dropped the gloves. Preferring to brawl in words and numbers rather than fists, the growing number of dissenters increased their scrutiny of the data.  Hell, it seems, hath no fury like an economist duh-ed.  Like Joe Wilson  fighting "stove-piped" data and the 16 words the dissenters' charges of cherry picked data, un-reproducible results, and excel coding errors started flying.  The damage, however, had been done.  Austerity in policy circles became a "duh".  I hope the bias doesn't lead to self-fulfillment.

In the event the US might have muddled through but for this, don't assume I'm laying the blame entirely on their, no doubt, well meaning shoulders.  To me, their bias was a catalyst which ignited another more commonly held bias.

Money not only matters, it matters a lot.

Hoping to give pause to austerity cheerleaders I'll offer a dissenting opinion (most likely to a chorus of "duhs" from the dissenting economists noted above).  It's not so much the size of the debt, it's what you do with it that matters.  Duration, source and relation of debt to current growth shouldn't be ignored but, in my view, the use of debt generated funds and the context of time and place are at least as important considerations.  While nothing is guaranteed in such matters, debt incurred to build hoped to be productive capital shouldn't incite as much worry as debt incurred to buy sports cars and vacation homes (or debt incurred to pay banks to hide the true level of debt).

What we in the US have been doing with debt sourced funds is a study for another time.  What we will do with it in the future is still unwritten.

The Kins(l)ey Report (on Inflation)

One could, in a debate of US inflation prospects, discuss the virtues of issuing the currency in which your debt is denominated, and the ability of US political leadership to enact tough change counter-balanced, I think, by the magnitude of the debt in question relative to world GDP, and the actual history of US political leadership to enact tough change. But my aim is not (in this essay) a reasoned debate but a notice of the lack thereof.


If, like me, you're an official member of the pajama wearing blogger corps, you might be familiar with the recent debate over US inflation prospects between Michael Kinsley and Paul Krugman, et. al. If not, here's Kinsley's initial article, Krugman's rebuttal, Kinsley's retort, and Krugman's rebuttal of the retort.

Krugman's second rebuttal dripped with condescension, or so it seemed to me, recalling memories of school yard bullies. Those memories tempted me to begin this article with a quip about Krugman needing to pick on someone his own size......, but I'll use a different metaphor.

"Ouch!," you might be thinking, "that's a bit cruel."

True.

So's this line from Krugman to Kinsley: "I’m tempted to get into an argument about whether it’s “bullying” to suggest that if you’re going to write about an economic issue, you might want to study it first. But what I really want to do is..."

Don't you love the artful use of the non-statement statement?

Aside from my belief that future events are more likely to follow some variation of Kinsley's nightmare scenario than Krugman's Japan model (about which, more here), the element of the exchange that inspired this post was Krugman's nasty dismissal of an apparently serious inquiry from one who apparently admires his views.

Kinsley's initial article contains statements like: "am I crazy?", "Every economist I admire, from Paul Krugman and Larry Summers on down, is convinced that inflation will remain low for as long as we can predict", "I can’t help feeling that the gold bugs are right", and "My fear is not the result of economic analysis. It’s more from the realm of psychology."

These are the words of a humble student searching for wisdom to quell his fears.

The wise Professor Krugman begins his rebuttal with: "Mike Kinsley has an odd piece in the Atlantic in which he confesses himself terrified about future inflation, even though there’s no hint of that problem in the real world."

You can almost see the sneering Professor holding up the student's paper in front of the class as you read the words (at least I could).

Using the tried and true nasty Professor trick of tossing about a bit of relevant jargon and a counter-example, Krugman expects Kinsley to slink back into his seat.

To his credit, Kinsley doesn't flinch.... much. He almost falls for the Professorial misdirection (debating whether a sudden 100% inflation shock is better than a Weimar hyper-inflation is like debating whether losing both legs is better than getting killed- I see your point, but I'll take none of the above) but then gets back on point, telling the Prof (in effect), "you didn't answer my question."

Why not inflation?

As Kinsley argued, the 70s demonstrated the US is not immune to inflation and Gold has risen from $275 to over $1000 during the past decade. Perhaps Kinsley's main confusion lies in his focus on the future tense, instead of seeing it as an ongoing issue.

Kinsley's search for the truth on inflation reminds me of Alfred Kinsey's search for truth on human sexual habits, which led to the publication of two books on human sexuality known collectively as the Kinsey Reports. Like Kinsley (or so it seems to me) Kinsey's search for truth battled with popular conceptions of what should (in some views) be, but wasn't.

In a sense Kinsey reported on what everyone (collectively) knew, but was afraid to say. The fear (perhaps, with the benefit of hindsight, somewhat justified) among then current opinion shapers was, in part, that open discussion would release the genie from the bottle. Hugh Hefner, of Playboy fame, credits Kinsey with opening his eyes to human sexual experience.

Krugman, in my view, is too smart an economist to dismiss outright the possibility of another significant inflation episode in the US, which may or may not be followed by hyper-inflation.

To use his phrasing, for those dismissing prediction of substantial US inflation, what is it about the US now that looks different to you from Thailand, Korea and Indonesia in say, 1997 (or Russia in 1998, or Iceland just recently)? Substantial public and private sector debt? Check. Huge expansion in the monetary base? Check. Large external debts and ongoing external deficits? Check. Increasing difficulties rolling over ever shorter term debt? Check. And yet each of those countries suffered, not multi-year hyperinflation, admittedly, but a sudden substantial (50-100% or more) inflation shock.

There are, admittedly, differences. As I wrote, I was using his phrasing and argument form. One could debate the virtues of issuing the currency in which your debt is denominated, and the ability of US political leadership to enact tough change counter-balanced, I think, by the magnitude of the debt in question relative to world GDP, and the actual history of US political leadership to enact tough change. But my aim is not a reasoned debate but a notice of the lack thereof.

Mr. Krugman might snidely respond to my snidely put question that the issue was hyper-inflation. I lived in Asia during their crisis and such shocks are worth worrying about even if hyper-inflation is avoided (besides, his use of Japan- a nation which self-finances, which seems to me a critical distinction- as counter-point suggests even moderate inflation is unlikely). Moreover, as Kinsley notes, who knows what policy makers will opt to do when the next crisis erupts. The history of the Bernanke Fed is not one of monetary restraint in a time of crisis.

I suspect that Krugman, not the economist, but the opinion shaper is, like those Kinsey battled, trying to keep the genie in the bottle- thus the Professorial dismissal instead of reasoned discussion of the issue. Inflation has both psychological and real world causes- when the two unite, the fireworks begin.

Perhaps, in a limited fashion, the Kinsley Report on Inflation will have a similar effect as Kinsey's, (then again maybe both should be seen as catalyst instead of cause) by bringing the debate into the open.

I wonder who the Hugh Hefner of Inflation will prove to be- perhaps Bill Murphy of GATA?

My advice to Kinsley is to have the courage of his convictions and buy some Gold, the price of which may have been as suppressed as reasoned open debate on US inflation prospects appears to be- both actions aim at the same effect.  I did (at $275 for Krugman's information) and I'm still holding.

Roubini Forgets the Riskiest Asset of All (the US$)

Since March there has been a massive rally in all sorts of risky assets – equities, oil, energy and commodity prices – a narrowing of high-yield and high-grade credit spreads, and an even bigger rally in emerging market asset classes (their stocks, bonds and currencies). At the same time, the dollar has weakened sharply , while government bond yields have gently increased but stayed low and stable.  Nouriel Roubini

Mr. Roubini, whose views I usually find most enlightening, was one of the few prominent economists who forecast the financial crisis of 2008.  Recently, however, perhaps due to a 2005 forecast of an unraveling of Bretton Woods II and sharp decline in the US$ that didn't pan out (at least so far), Mr. Roubini, judging by the above argument, assumes that the US$ is "here to stay" at least in the medium term. 

I disagree (and think he and Mr. Setser should have stuck to their earlier views- sometimes such things take time).

In A Brief History of Time, Stephen Hawking relates the story below which is quite germane to a discussion of Mr. Roubini's view.
A well-known scientist (some say it was Bertrand Russell) once gave a public lecture on astronomy. He described how the earth orbits around the sun and how the sun, in turn, orbits around the center of a vast collection of stars called our galaxy. At the end of the lecture, a little old lady at the back of the room got up and said: "What you have told us is rubbish. The world is really a flat plate supported on the back of a giant tortoise." The scientist gave a superior smile before replying, "What is the tortoise standing on?" "You're very clever, young man, very clever", said the old lady. "But it's turtles all the way down!"

The question, on what belief(s) does your argument rest, gained increased importance ever since David Hume pulled the rug out from under those who assumed any "real-world" arguments were validly based on pure reason. Hume's argument, never refuted, at least to my knowledge, is that "always being followed by" is not the same as caused by. We might infer such, and certainly act on the view that what has happened in the past will happen again, but as we didn't make the rules of the universe, we don't really know. At best we can believe.

On what turtle does Mr. Roubini's view rest? It rests on the view that the US$ has intrinsic value. As he argues: First, the dollar cannot fall to zero and at some point it will stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their shorts.

I ask, why can't the value of the US$ fall to zero? From the long view of History, the odds of a currency of virtually no intrinsic value declining to that value is high, which might explain Voltaire's quote on paper money.

Perhaps, however, Mr. Roubini was speaking of the medium term, and using the value of the Japanese Yen as a "turtle" to support his argument. Alas, the US is not Japan. Despite their fiscal woes, Japan runs a current account surplus- last month's surplus came in at $13B. The world is not awash in Yen, on the contrary, Japan is awash in US$s, as are quite a few other nations- China comes to mind.

When the Yen was the carry trade vehicle of choice, the risk, which manifested from time to time, was of a sharp rally due to the lack of Yen in international markets. If Japan ran a current account deficit this risk would be much diminished. I suspect if Japan was running a C/A deficit when it opted for a zero-interest-rate-policy (ZIRP) the Yen would have quickly lost a good deal of its value.

The US has both a C/A deficit and a ZIRP. While I agree with Mr. Roubini that the US ZIRP is inspiring the mother of all carry trades, which can inspire sharp corrections, that risk is, in my view, more than offset by the mother of all long positions in the riskiest "asset" of all, the US$. The ZIRP makes holding US$s a losing proposition, as Mr. Roubini notes.

The turtle on which Mr. Roubini's view stands is the notion that the US$ is an asset, when, in my view, it is a liability. By statute there is no fixed exchange rate between the US$ and anything other than US$ debts.  Each time an adjustment arises such that there is a shortage of US$s, the Fed rides in to "add liquidity" because they are more interested in keeping the big banks afloat than the currency. Until that changes, the mother of all carry trades will, despite the odd setback, continue to grow.