Tax the beasts

An interesting piece in the Economist this week (on "rebalancing") took note of Chinese retail sales growing faster than exports.  This is big news, folks.  If there is anything to my notion that the world as a whole is in a Keynesian configuration (demand-constrained, not supply-constrained) it will only show up if China and India can go on growing based on demand in their rapidly developing internal market, while the rest of the world goes through at least a slowdown or "growth recession."  A friend passed on reports from McKinsey types that China has vast excess capacity (but then, people have been reporting that since 98 or so, at least), but nearly every observer believes there is a vast unmet need for infrastructure, despite China pouring 50% of the world's concrete last year.  (The last time any country had 50% of the world's anything was 1948 when America had half the world's output.)

Now if we could just get them to try credit cards . . .  Hmm.  Maybe not the year to suggest it.

More interesting stats from the article:  the US would have been in a recession since last Fall if not for export growth.  US exports to China grew 20% year on year.  And China's trade surplus fell from 11% of its GDP to 9% last year.  Also BRIC demand (Brazil, Russia, India, China) is forecast to rise 9% next year.

Since I often dump on the Economist, I am happy to praise them now and then for getting the real facts together like no one else.  

Speaking of the credit crisis, fascinating to follow the debate over it.  I'm not optimistic for a real change in the regulatory regime until after the election, but if you look at what happened in the Microsoft case, you have to wonder if even the combination of Demo pres and Demo Congress could pass legislation that would hold up to capital market innovations.   Since what is really needed is discretion by bureaucrats to slap down any repackaged version of excessively risky behavior, you know the process would end up in the courts, and they have been taken over by Scalia types.  Lord, save us from another Republican administration.  We can't afford the bills.

Since I have argued that Demos need to look for actual solutions, and not settle for being mirror images of the Republican knee-jerk anti-governmentalists, let's try one.   Obviously the solution to the kind of slick exploitation that brought on the crisis doesn't have to be government saying "No."  Instead of an FDA-type supervisor that fines for bad behavior, we could just use extensive inspection and "truth in labelling" to give experience rating on the accuracy of mortgage originators, for example.   Now that has real difficulties: originators in Las Vegas would look a lot worse than originators in Chicago right now.  But the ratings can be corrected for regional performance, and those who lent to disproportionately many turkeys from a given area could be exposed for what they are to the markets.    My guess is that would shape people up a lot, without facing innovative packaging or court challenges.

But it has to go even deeper.  Basel II has put risk assessment in the hands of banks themselves. The flagship of sophistication was supposed to be Citibank, the best modelers outside of investment banking.  But like the ratings agencies, they proved to be systematically biased so that their spectacular failure in the light of hindsight turns out to represent an unspectacular but much more dangerous failure in pricing "expected outcomes."  Apparently counting next to nothing for liquidity risk was a big part of that - replicated throughout the financial system, that creates the potential for the systemic equivalent of a run on the bank that Bernanke has been doing such a good job of fending off.

I suggest, with all due humility, that the problem is externalities and the solution is a version of Polluter Pays.  Nobody worries about the fact that their excess leverage (lets call it what it is) imposes risk on the whole system.  So let's tax them.  Literally.  For overuse of Fannie Mae and Freddie Mac, for underuse of capital and reserves, and for failure to diversify their portfolio of assets. Make them pay for sampling to determine accuracy and completeness of the information they provide when they sell assets, and use SQL to charge them whenever they burden the system with asymmetries in their omissions: if, as one study found, the ones they sell do worse than the ones they keep, for any given Moody's rating, charge them (heavily) for it.  Charge them when too high a percentage of their assets are in the form of derivatives. Charge them when they have conflicts of interest, even if they haven't created any disasters yet. The flavor of the decade in the 90s was "Moral Hazard".  With all due respect, the problem wasn't the government standing ready to save the system when someone too big to fail looks like failing, it is the government's failure to charge for the risk those people impose on the system.  

Come to think of it, we need a "too big to fail" tax.

I like it so well, I think I will email it to Krugman.  If he uses it, you will hear from me.

But other than that, you probably won't hear from me.  School starts this week.  I doubt if I will find anything urgent enough to say before the election.

Oh, just one little note.  I heard about a great website: www.gapminders.org.  You can watch China and India catching up with the West before your eyes.