Calling it Right: Excerpts from Niall Ferguson’s Pre-Crisis Journalism

“According to calculations published by Barron's in February, over the next two years the monthly payments on about $600 billion of mortgages taken out by borrowers in the so-called subprime market (those with checkered or nonexistent credit histories) will increase by as much as 50 percent. This is because many A.R.M.'s have two-year teaser periods to entice borrowers. After that, the meaning of ‘adjustable’ suddenly becomes (in this case, painfully) apparent. The dinosaurs, we conjecture, succumbed to global climate change. The American beast — call it debtlodocus — faces a comparable economic challenge. The global economic climate seems to be changing. We hear no more talk of deflation; we hear a lot about rising rates. For America's giant, dinosaurlike economy — with its small, wealthy head; its big, fat middle; and its long low-income tail — there is a tried-and-tested response to a change in the weather. Dollar depreciation and inflation have saved the debtlodocus before. The assumption seems to be that they will do the trick again. Yet this time may be different. For sinking like a velociraptor's fangs into the tail of the debtlodocus are interest-rate hikes that may outpace and check any increase in inflation. And no one knows when and how violently the leviathan may react to this slowly discernible pain.”
June 11, 2006

“Growing U.S. household debt has been the single biggest driver of global growth in the past five years. When Americans do finally stop borrowing and start saving, the effects could be bigger than the bankies anticipate. (Fact: 29 per cent of borrowers who took out mortgages in the U.S. last year have no equity in their homes or owe more than their house is worth.) My guess is that belts are already being tightened. Certainly, consumer confidence has fallen to levels we’ve seen only twice in the past ten years.
“‘Magnitude in affairs is a valid defence for certain irregularities’: I often think of Melmotte’s motto when I walk through the West End, where the hedgies hang out. The way we live now is, of course, different in many ways from the way Trollope’s contemporaries lived. (They didn’t have Big Brother or the World Cup.) But certain things remain the same. ‘All the world knew that just at the present moment money was very “tight” in the City,’ is Melmotte’s reply when his creditors press him for payment. Thanks to the bankies and their inflation targets, money is tight again today, and getting tighter. How long before the first big hedgie is pushed over the edge? Or will the bankies blink first?”
June 16, 2006

Is this global moral hazard?
•Fed stands ready to pump liquidity if any asset prices fall too fast
•Asian CBs stand ready to absorb vast quantities of dollars as reserves
–Reigniting inflation
–Encouraging speculative behavior: everyone is too big to fail
Rest of developed world likely to follow Japan into deflationary, low growth pattern.
November 10, 2006

“… monetary expansion in our time does not translate into significantly higher prices in shopping malls. We don't expect it to. Rather, it translates into significantly higher prices for capital assets, particularly real estate and equities. The people who find it easiest to borrow money these days are hedge funds and private equity firms. Through leveraged buy outs, the latter can easily acquire companies and, by improving their cashflow, boost their valuations. These guys then buy houses in Chelsea with the millions they make.”
November 19, 2006

“… It is perfectly possible to imagine a liquidity crisis too big for the monetary authorities to handle alone. As in 1914, governments would need to step in. … Federal bail-outs for the likes of Goldman Sachs may seem unimaginable to us now.  But financial history reminds us that ten-sigma events do happen. And, when they do, liquidity can ebb much more quickly than it previously flowed.”
January 2007

“The best explanation for the good times is liquidity. Thanks to global integration and financial innovation, higher short-term interest rates have not translated into monetary tightening. On the contrary, the world economy has been swimming in credit of every conceivable kind. Money-supply figures for the U.S. understate the phenomenon because billions of dollars flow abroad every month to finance the American trade deficit. The world's central banks control about $5 trillion of reserves. This in turn has raised monetary growth rates. The total value of commercial-bank assets worldwide is close to $56 trillion, and bank loans are only one of the many forms credit now takes.
“The key question is whether something could happen in 2007 to drain away this liquidity. For most investors and policymakers, the nightmare scenario remains that of the post-1929 Depression, when a stock-market crash was followed by a spectacular wave of bank failures and a massive monetary meltdown. However, by blaming the Hungry Thirties on blunders by the Federal Reserve, we reassure ourselves that history couldn't repeat itself. Today's central bankers are smarter. But history provides an example of another liquidity crisis that went far beyond what central banks could cope with. …
“A stock-market shutdown in 2007? History warns us not to rule it out.”
January 5, 2007,9171,1574140,00.html

“East Chimericans generate massive trade surpluses which they immediately lend back to West Chimerica. By channeling all these surpluses through government hands into government paper, East Chimerica depresses the key long-term interest rate in West Chimerica. And thanks to artificially low interest rates, financial and real assets in West Chimerica and its satellites are booming.”
February 5, 2007

“Maybe, just maybe, not everyone is cut out to be a property owner. Maybe, just maybe, we should not be bribing and cajoling people at the margin into taking out mortgages and buying houses. And maybe, just maybe, a day of reckoning is approaching, when the costs of this policy will have to be borne not just by a minority of over-burdened households, but by everyone. … the problems in the subprime mortgage market are not confined to the borrowers alone. On the contrary, the current explosion of defaults and foreclosures threatens to set off a chain reaction extending right through the global financial system. It's not just that big banks have allowed their subsidiaries to make bad loans, though you can see some big names (among them Deutsche Bank) in the Memphis foreclosure notices. Much more serious is the way that subprime mortgage defaults can now have an impact on seemingly unconnected financial markets. The key is the way that subprime mortgage-backed bonds have been used as the underlying collateral for fancy instruments called Collateralised Debt Obligations (CDOs), which are divided into various slices or "tranches", with different credit qualities.  This is financial alchemy: using subprime mortgages to produce a top tranche of triple-A-rated securities is the equivalent of turning lead into gold.
July 15, 2007

“… the really big crises in history unfolded over months and years, not mere days. In these protracted sequences of events, there were many gloomy nights, but also many false dawns. Because hope springs eternal, people tended to attach more importance to the latter than the former, mistaking them for real dawns and blinding themselves to the underlying downward drift. I think we are in one of these protracted crises now. … The combination of tighter borrowing conditions, job losses in finance and housing, and a growing mood of pessimism among consumers could prove to be a more toxic cocktail than many investors still want to believe. … Volatility is back with a vengeance, with the market up one day and down the next. But the swing downwards will be bigger still if people start to believe that a US recession is around the corner. Nor will the pain be confined to North America. Despite all hopeful talk about the economic ‘decoupling’ of Asia from the United States, the coming year and a half may yet expose the Orient's continued reliance on exports to the Occidental consumer. If Uncle Sam has to tighten his belt, the whole world will have to breathe in.”
September 2, 2007

“The central banks are no more to be blamed for this crisis than the fire brigade is to be blamed for a blazing house. In each case, they are struggling to perform their proper role as lenders of last resort – as defined over a century ago by Walter Bagehot in his classic Lombard Street. But they are doubly constrained: first by the increasingly complicated legislation that governs their actions and, secondly, by the vast scale and complexity of global capital markets.”
September 23, 2007

“The big question for our time is: are we on the brink of a ‘great dying’ - one of those mass extinctions of species that have occurred periodically in the history of life on earth, such as the Cretaceous-Tertiary crisis that killed off the dinosaurs? It is a scenario that many biologists have reason to fear, as man-made climate change wreaks havoc with natural habitats around the globe. A great dying is also a scenario that financial analysts should worry about, as another man-made disaster - the subprime mortgage crisis - works its way through the global financial system.”
December 14, 2007

“… What began as a US crisis is fast becoming a world crisis. Small wonder only a handful of global equity markets are in positive territory relative to August 2007, while more than half have declined by between 10 and 40 per cent. The US slowdown will also affect many emerging markets more reliant on exports than China. At the same time, the global slowdown is about to kick away the last prop keeping the US recession at bay. No, this is not the Great Depression 2.0; the Fed and the Treasury are seeing to that. But, as in the 1930s, the critical phase is not the US phase. It is when the crisis goes global that the term ‘credit crunch’ will no longer suffice.”
August 7, 2008

“Cheap money and deficit finance were the techniques recommended by Keynes and others in the 1930s as solutions to the problem of the Depression. They were used and abused in the 1960s and 1970s when there was no depression, with ultimately disastrous inflationary results. But can these techniques work now? So far, what they have achieved is what might be called a Great Repression. They have in effect repressed, but not cured, a depression. The question is whether, as some psychological theories would suggest, repression is a sustainable strategy or whether, at some point, the patient will come out of denial, break down and admit the terrible truth.”
September 22, 2008

Quantitative Teasing

Back on November 15, 2010, I was one of the signatories of the following letter, addressed to the Chairman of the Federal Reserve, Ben Bernanke, which was published in the Wall Street Journal:

We believe the Federal Reserve's large-scale asset purchase plan (so-called "quantitative easing") should be reconsidered and discontinued. We do not believe such a plan is necessary or advisable under current circumstances. The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed's objective of promoting employment.

We subscribe to your statement in The Washington Post on November 4 that "the Federal Reserve cannot solve all the economy's problems on its own." In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.

We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.

The Fed's purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems.

A number of people have written snide comments about this letter, including the author of these words:

… if you write about current affairs and you're never wrong, you just aren't sticking your neck out enough. Stuff happens, and sometimes it's not the stuff you thought would happen.

… I've been wrong many times over the years, usually on minor things but sometimes on big ones.

This of course is the man who used to boast that he had only ever made two mistakes - unlike us members of the "Always Wrong Club". But now it turns out he's been "wrong many times over the years". Amazing how memory plays tricks. Or perhaps someonejogged his memory.

Now, when someone of that caliber calls you out for having been wrong about the future path of inflation, you have a right to remind him that one of his "many mistakes' included … being wrong about the future path of inflation. Guess what? Predicting the future path of inflation is actually quite difficult, whether or not you have a Nobel Prize.

In any case, our 2010 letter did not make a prediction about inflation. What we said was:

The planned asset purchases risk currency debasement and inflation, and we do not think they will achieve the Fed's objective of promoting employment.

Note that word "risk". And note the absence of a date. There is in fact still a risk of currency debasement and inflation. The monetary base of the United States Federal Reserve has increased by a factor of 1.9 since we published our letter (and by a factor of more than 4 since the financial crisis began). The gross federal debt, meanwhile, has increased by 25%, from $13.8 trillion in November 2010 to $17.2 trillion. A rising share of that debt now sits on the Fed's balance sheet. It is true (as I wrote elsewhere in 2010) that "deflation is a bigger threat than inflation" in the short run. But can anyone with the slightest knowledge of financial history claim that there is no risk of inflation in policies that have so hugely increased the monetary base and the public debt in time of peace? Clearly, these things by themselves do not make higher inflation inevitable. That would take some combination of faster growth of broader monetary aggregates, higher velocity of circulation, changes in expectations, and so on. But to dismiss the risk of inflation after just three years is a bit like dismissing the case for global warming after three cool summers.

What about the doubt we expressed about the efficacy of quantitative easing (QE) in promoting employment? Since then, the unemployment rate has come down from 9.8% to 7.3%, to be sure. But few economists would claim this as a triumph. And none that I know would attribute all of the decline in unemployment to QE.

Larry Summers recently reignited the debate on the U.S. economy's poor performance by raising the specter of "secular stagnation". I think he is right about that, but wrong to attribute it to insufficient policy stimulus. As our 2010 letter said:

We think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.

That remains my view. It is an argument set out at length in my book The Great Degeneration.

Finally, we wrote as follows:

We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.

This worry seems as valid today as it was then - indeed more so.

Our letter was prompted by the announcement of QE2. We are now in the second year of QE3. How exactly the policy was supposed to work remains a matter for debate. The original idea was that large-scale asset purchases would stimulate the economy through the so-called "portfolio balance channel". More recently, Fed Governor Jeremy Stein has proposed an alternative "recruitment channel".

Whatever the mechanism, the most striking consequence of the policy has indeed been very rapid inflation - of asset prices. The S&P 500 has risen by 50% since the publication of our letter. Though generally regarded by a cause for celebration (even by those commentators who otherwise lament increasing inequality), this bull market has been accompanied by significant financial market distortions, just as we foresaw.

Even more prescient was our warning that more QE would make it difficult to normalize monetary policy. As recently as last October's International Monetary Fund meeting in Tokyo, Chairman Bernanke was still insisting that this was not the case and that ending QE would be straightforward. Raghuram Rajan and I begged to differ. In essence, our point was that, as a volatility-depressing policy, QE would be impossible to end without increasing volatility. What happened in the summer of this year bore out our critique. The very mention of a future reduction of Fed asset purchases caused a spike in ten-year yields, the ramifications of which were so alarming to Chairman Bernanke and his colleagues that the planned "taper" was postponed.

The Fed itself now acknowledges the potential costs and risks of QE. The March minutes of the FOMC set these out in some detail. More recently, in an important paper, three economists at the Fed have acknowledged the "uncertainty regarding the efficacy and costs associated with additional [large-scale asset] purchases". As they very correctly observe: "Since asset purchases are such a new policy tool, the historical record for judging such effects is limited." Quite so.

Contrary to what has been claimed here and elsewhere, there is therefore no need whatever for the signatories of that 2010 letter to retract a word of what we wrote. It is those who have willfully misrepresented our letter who should do the retracting.

Inflated Claims

Josh Barro is the son of a famous economist. Maybe that’s why the website Business Insider allows him to write about economics. Maybe it’s also why he feels the need to stick up for another famous economist by attacking that individual’s principal detractor. The famous economist himself solemnly promised us that he would not reply – “never” – to my charges that he was wrong about the financial crisis and “derped” about the euro. But blogging is addictive, so this week he was back at it, though – discretion being the better part of valor, or a polite word for cowardice – he thought it better not to name me and, predictably, ducked the questions I raised about his integrity last week. Sadly, the master and his claque have got their messages badly mixed. The master was sticking up for claque members conspicuously unqualified to write about economic questions. Barro, meanwhile, had suddenly discovered that having a graduate degree in economics is important (though not important enough for him to get one).

A PhD won’t give you everything, I freely admit, but it should teach you how to engage in serious debate. Example: If someone goes around telling the world something to the effect of, “I am always right, except maybe twice,” and I point out that he was in fact wrong – and wrong repeatedly – about the two most important economic events of the past decade, then it is not an effective retort to say: “Yeah, but you were once wrong about inflation.” This is not about me. I don’t go around claiming that I am always right.

The second thing a good graduate program should teach you is to avoid the language of the gutter. Phrases like “full of crap” are like boomerangs. They come right back at the person who throws them.

The third thing Barro would learn from further study is simply to do research. If you want to accuse me of being consistently wrong about inflation, you really do need to come up with more than one paragraph in one Newsweek column published more than two years ago. (Memo to Adam Ozimek: this applies to you too.) As it happens, a couple of readers at the time questioned my reference to Shadowstats in that column, and with good reason. A journalist from Harper’s magazine also wrote to me, passing on a highly persuasive rebuttal to John Williams’s allegations from an official at the Bureau of Labor Statistics. After looking into the issue, I wrote that “it might be prudent to hold off reprinting those numbers” (from Shadowstats) and, when it became clear that the journalist intended nevertheless to do so, I advised that Harper’s at least run the Shadowstats and BLS figures side by side. Thereafter, as even a cursory bit of research would have shown Barro, I made no further reference to Shadowstats and significantly altered my view on inflation. For example, in a Financial Times article published in June of last year, I referred to inflation as a “nonthreat”.

I know books are long and very tiring to read, but it would not have been too much to ask of Barro look at my most recent book, The Great Degeneration. I’ll spare him the trouble and offer the relevant passages:

Why did post-1918 Germany go down the road of hyperinflation? Why did post-1929 America go down the road of private default and bankruptcy? Why not the other way round? At the time of writing, it seems less and less likely that any major developed economy will be able to inflate away its liabilities as happened in many cases in the 1920s and 1950s. But why not? Milton Friedman’s famous dictum that inflation is ‘always and everywhere a monetary phenomenon’ leaves unanswered the questions of who creates the excess money and why they do it. In practice, inflation is primarily a political phenomenon.
Its likelihood is a function of factors like the content of elite education; competition (or the lack of it) in an economy; the character of the legal system; levels of violence; and the political decision- making process itself. Only by historical methods can we explain why, over the past thirty years, so many countries created forms of debt that, by design, cannot be inflated away; and why, as a result, the next generation will be saddled for life with liabilities incurred by their parents and grandparents …
If we do not … embark on a wholesale reform of government finance [,] then I am afraid … Western democracies are going to carry on in their current feckless fashion until, one after another, they follow Greece and other Mediterranean economies into the fiscal death spiral that begins with a loss of credibility, continues with a rise in borrowing costs, and ends as governments are forced to impose spending cuts and higher taxes at the worst possible moment. In this scenario, the endgame involves some combination of default and inflation. We all end up as Argentina. There is, it is true, [another] possibility, and that is what we now see in Japan and the United States, maybe also in the United Kingdom. The debt continues to mount up. But deflationary fears, central bank bond purchases and a ‘flight to safety’ from the rest of the world keep government borrowing costs down at unprecedented lows. The trouble with this scenario is that it also implies low to zero growth over decades: a new version of Adam Smith’s stationary state. Only now it is the West that is stationary. (pp. 6, 47)

This was not, however, the first time I had raised the possibility of such a scenario. If, as the Krugmanites insist, I was “derping” about inflation, why did I explicitly set out two scenarios for 2013 in the Harvard Business Review for July-August 2009?

If large deficits push down bond prices, raising long-term interest rates, the Federal Reserve will have no option but to increase purchases of Treasuries. In the process, it could overdo monetary expansion and thereby arouse fears of future inflation, increasing the upward pressure on interest rates…
[But[=3; Perhaps we should revisit 2013 against [a different] background. The outlook for the United States appears less apocalyptic than we first feared. In this asymmetric world, where everywhere else seems more dangerous and unpredictable than America, the consequences of the crisis are less terrible than those of the Great Depression. In this better-case 2013, the recession of 2007–2009 is a receding if still painful memory. We are over the Breakdown. Those who feared that Federal Reserve Chairman Ben Bernanke’s policy of quantitative easing would lead to inflation have been proved wrong: Prices have barely changed since 2009, despite the central bank’s best efforts. Thankfully, there hasn’t been severe deflation either.

I made the same point in another Newsweek article in November 2009:

In the wake of … debt explosions, one of two things can happen: either a default, usually when the debt is in a foreign currency, or a bout of high inflation that catches the creditors out. The history of all the great European empires is replete with such episodes. Indeed, serial default and high inflation have tended to be the surest symptoms of imperial decline.
As the U.S. is unlikely to default on its debt, since it’s all in dollars, the key question, therefore, is whether we are going to see the Fed “printing money”—buying newly minted Treasuries in exchange for even more newly minted greenbacks—followed by the familiar story of rising prices and declining real-debt burdens. It’s a scenario many investors around the world fear. That is why they are selling dollars. That is why they are buying gold.
Yet from where I am sitting, inflation is a pretty remote prospect. With U.S. unemployment above 10 percent, labor unions relatively weak, and huge quantities of unused capacity in global manufacturing, there are none of the pressures that made for stagflation (low growth plus high prices) in the 1970s. Public expectations of inflation are also very stable, as far as can be judged from poll data and the difference between the yields on regular and inflation-protected bonds. … And inflation might continue to surprise us on the downside. After all, consumer price inflation is in negative territory right now.

My expectation then – which I expressed repeatedly in interviews as well as articles – was that bond yields would remain above inflation, keeping real interest rates in positive territory. (Remember, this was before Quantitative Easing 2 and 3.) Sure enough, real interest rates – by Krugman’s own measure – remained positive until 2012. And this was one reason why U.S. growth disappointed in 2010, as I predicted.

“Deflation is a bigger threat than inflation,” I wrote in July 2010, in an article Paul Krugman certainly read because it was addressed to him and other Keynesians. The following April, in my regular Newsweek column, I made it clear that, with worldwide fiscal and monetary tightening, the only inflation worth worrying about was in commodity prices. My only mistake, against this background, was to give credence to Shadowstats in a subsequent column.

In short, the claim by Krugman and others that I repeatedly erred about the risk of inflation is easily exposed as fraudulent. By repeating it, Josh Barro and his fellow “plovers” reveal their own dishonesty. Or is it just laziness?


The Wizard Exposed

Paul Krugman has never shied away from criticizing me. He has relished it, and has not hesitated to spice his criticism with insults. And yet, when called to account for his own mistakes, not to mention his own boastful misrepresentation of his own record, he has collapsed. Manifestly unable to refute any of my charges against his work, he has added one final, infantile insult – proving my point about his chronic lack of civility – and passed the buck to his coterie of boosters. Yet not one of them even attempts to defend his record.

Perhaps it is worth asking, then, why anyone should continue waste time reading the stream of consciousness of an intellect long past its peak. He was a wizard, once upon a time ...

But now …

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