The Economic Costs of America’s Conflict with China

 via Project Syndicate: https://www.project-syndicate.org/commentary/economic-costs-of-china-america-conflict-by-stephen-s-roach-2023-04

The Economic Costs of America’s Conflict with China
Apr 24, 2023STEPHEN S. ROACH


In a wide-ranging speech on the US-China relationship, US Treasury Secretary Janet Yellen reversed the terms of engagement with China, prioritizing national-security concerns over economic considerations. The US case, however, rests not on hard evidence but on the presumption of China's nefarious intent.


NEW HAVEN – Five years into a once-unthinkable trade war with China, US Treasury Secretary Janet Yellen chose her words carefully on April 20. In a wide-ranging speech, she reversed the terms of US engagement with China, prioritizing national-security concerns over economic considerations. That formally ended a 40-year emphasis on economics and trade as the anchor to the world’s most important bilateral relationship. Yellen’s stance on security was almost confrontational: “We will not compromise on these concerns, even when they force trade-offs with our economic interests.”

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Yellen’s view is very much in line with the strident anti-China sentiment that has now gripped the United States. The “new Washington consensus,” as Financial Times columnist Edward Luce calls it, maintains that engagement was the original sin of the US-China relationship, because it gave China free rein to take advantage of America’s deal-focused naiveté. China’s accession to the World Trade Organization in 2001 gets top billing in this respect: the US opened its markets, but China purportedly broke its promise to become more like America. Engagement, according to this convoluted but widely accepted argument, opened the door to security risks and human-rights abuses. American officials are now determined to slam that door shut.

There is more to come. President Joe Biden is about to issue an executive order that will place restrictions on foreign direct investment (FDI) by US firms in certain “sensitive technologies” in China, such as artificial intelligence and quantum computing. The US rejects the Chinese allegation that these measures are aimed at stifling Chinese development. Like sanctions against the Chinese telecoms giant Huawei and those being considered against the social-media app TikTok, this one, too, is being justified under the amorphous guise of national security.

The US case rests not on hard evidence but on the presumption of nefarious intent tied to China’s dual-purpose military-civilian fusion. Yet the US struggles with its own security fusion – namely, the fuzzy distinction between America’s under-investment in innovation and the real and imagined threats of Chinese technology.

Significantly, Yellen’s speech put both superpowers on the same page. At the Communist Party’s 20th National Congress last October, Chinese President Xi Jinping’s opening message also stressed national security. With both countries equally fearful of the security threat that each poses to the other, the shift from engagement to confrontation is mutual.

Yellen is entirely correct in framing this shift as a tradeoff. But she only hinted at the economic consequences of conflict. Quantifying these consequences is not simple. But the American public deserves to know what is at stake when its leaders rethink a vitally important economic relationship. Some fascinating new research goes a long way toward addressing this issue.



A just-published study by the International Monetary Fund (summarized in the April 2023 World Economic Outlook) takes a first stab at identifying the costs. IMF economists view the problem through the lens of “slowbalization”: the reduction of cross-border flows of goods and capital, reflected in geostrategic strategies of “reshoring” (bringing offshore production back home) and what Yellen herself has called “friend-shoring” (shifting offshore production from adversaries to like-minded members of alliances).

Such actions result in “dual bloc” FDI fragmentation. The IMF estimates that the formation of a US bloc and a China bloc could reduce global output by as much as 2% over the longer term. As the world’s largest economy, America will account for a significant share of foregone output.

European Central Bank President Christine Lagarde recently stressed a different channel through which an escalating US-China conflict could adversely affect economic performance. Drawing on research by ECB staff, she focuses on the higher costs and inflation resulting from supply-chain disruptions implied by conflict-driven FDI fragmentation. The ECB study concludes that geostrategic conflict could boost inflation by as much as 5% in the short run and around 1% over the longer term. Collateral effects on monetary policy and financial stability would follow.

Collectively, these model-based calculations of the costs of conflict imply a stagflationary combination of lower output and higher inflation – hardly a trivial consideration in today’s fragile economic climate. And they dovetail with economic theory. Countries trade with others to reap the benefits of comparative advantage. Both inward and outward flows of foreign investment seek to achieve similar benefits, offering offshore efficiencies for multinational corporations that face higher costs in their home markets and attracting foreign capital to support domestic capacity expansion and job creation. Regardless of their different political systems and economic structures, this is true for both America and China. It follows that conflict will reduce these benefits.

Yet there is an important twist for the US: a chronic shortfall of domestic saving casts the economic consequences of conflict with China in a very different light. In 2022, net US saving – the depreciation-adjusted saving of households, businesses, and the government sector – fell to just 1.6% of national income, far below the longer-term 5.8% average from 1960 to 2020. Lacking in saving and wanting to invest and grow, the US takes full advantage of the dollar’s “exorbitant privilege” as the world’s dominant reserve currency and freely imports surplus saving from abroad, running a massive current-account and multilateral trade deficit to attract foreign capital.

As such, the economic interests of saving-short America are tightly aligned with its outsize imbalances of trade and capital flows. Barring a highly unlikely resurgence of domestic US saving, compromising those flows for any reason – say, security concerns over China – is not without meaningful economic and financial consequences. The research cited above suggests those consequences will take the form of slower economic growth, higher inflation, and possibly a weaker dollar.

This is hardly an ideal outcome for a US economy that is already at a precarious point in the business cycle. The tradeoff for national security should not be taken lightly. Nor should the US penchant to over-hype the security threat be accepted on blind faith.

Dean Baker: Get Over It -- China is bigger.

 

38 MINUTES AGO

China is Bigger, Get Over It

It is standard for politicians, reporters, and columnists to refer to the United States as the world’s largest economy and China as the second largest. I suppose this assertion is good for these people’s egos, but it happens not to be true. Measuring by purchasing power parity, China’s economy passedthe U.S. in 2014, and it is now roughly 25 percent larger.[1]The I.M.F. projects that China’s economy will be nearly 40 percent larger by 2028, the last year in its projections.

The measure that the America boosters use is an exchange rate measure, which takes each country’s GDP in its own currency and then converts the currency into dollars at the current exchange rate. By this measure, the U.S. economy is still more than one-third larger than China’s economy.

Economists usually prefer the purchasing power parity measure for most purposes. The exchange rate measure fluctuates hugely, as exchange rates can easily change 10 or 15 percent in a year. Exchange rates also can be somewhat arbitrary, as they are affected by countries’ decisions to try to control the value of their currency in international money markets.

By contrast, the purchasing power parity measure applies a common set of prices to all the items a country produces in a year. In effect, this means assuming that a car, a television set, a college education, etc. cost the same in every country. Applying common prices is a difficult task, goods and services vary substantially across countries, which is makes it hard to apply a single price. As a result, purchasing power parity measures clearly have a large degree of imprecision.

Nonetheless, it is clear that this is the measure that we are more interested for most purposes. If we want to know the quantity of goods and services a country produces in a year, we need to use the same set of prices. By this measure, there is no doubt that China’s economy is both considerably larger than the U.S. economy and growing far more rapidly.

Just to be clear, this doesn’t mean the Chinese people are on average richer than people in the United States. China has nearly four times the population, so on a per person basis, the U.S. is still more than three times as rich as China. But, it should not be a shock to us that a country with more than 1.4 billion people would have a larger economy than a country with 330 million.

For the folks who need more convincing, we can make comparisons of various items. We can start with auto production, a standard metric of manufacturing output. Last year, China producedmore than 27.0 million cars, the United States produced a bit less than 10.1 million. (China also leads the world by far in the production and use of electric cars.) The cars made in the United States undoubtedly were better on average, but they would have to be an awful lot better to make up this gap.

To take a more old-fashioned measure, China producedover 1,030 million metric tons of steel in 2021. The United States produced less than 90 million metric tons.

China generated8,540,000 gigawatt hours of electricity in 2021, nearly twice the 4,380,000 gigawatt hours generated in the United States. The gap is even larger if we look at solar and wind energy production. China has307,000 megawatt hours of installed solar capacity, compared to 97,000 in the United States. China has 366,000 megawatt hours of installed wind capacity versus 141,000 in the United States.

We can look to some more modern measures. China has 1,050 million Internet users. The United States has 311 million. China has 975 million smartphone users, the United States has 276 million. In 2016 China graduated4.7 million students with STEM degrees. In the U.S. the numberwas 330,000 for the same year. The definitions for STEM degrees are not the same, so the numbers are not strictly comparable, but it would be difficult to make the case that U.S. number is somehow larger. And the figure has almost certainly moved more in China’s favor over the last seven year.

In terms of impact on the world economy, China accountedfor 14.7 percent of goods exports in 2020. The United States accounted for 8.1 percent. In the first nine months of last year, China was responsible for $90 billion in foreign direct investment. This compares to $66 billion for the United States.

We can pile on more statistics, but in category after category, China outpaces the United States, and often by a very large margin. If people want to put on their MAGA hats and insist the U.S. is still the world’s largest economy, they are welcome to do so, but Donald Trump lost the 2020 election and China’s economy is bigger.

Size Matters

The issue here is not just a question of bragging rights. China is clearly an international competitor, economically, militarily, and diplomatically. Many people want to take a confrontational approach to China, with the idea that we can isolate the country and spend it into the ground militarily, as we arguably did with the Soviet Union.

At its peak, the Soviet economy was roughly 60 percent of the size of the U.S. economy, China’s economy is already 25 percent larger. And, this gap is expanding rapidly. China is also far more integrated with the world economy than the Soviet Union ever was. This makes the prospect of isolating China far more difficult.

As a practical matter, it doesn’t matter whether we like China or not. It is here and it is not about to go away. We will need to find ways to deal with China that do not lead to military conflict.

Ideally, we would find areas where we could cooperate, for example sharing technology to address climatechange and dealing with pandemics and other health threats. But, if anyone wants to push the New Cold War route, they should at least be aware of the numbers. This would not be your grandfather’s Cold War.

[1] I have included both Hong Kong and Macao in this calculation, since both are now effectively part of China.

Dean Baker: Can Jerome Powell Pivot on Interest Rates, Again?

 Can Jerome Powell Pivot on Interest Rates, Again?

When Jerome Powell took over as chair of the Federal Reserve Board in January of 2018, the Fed had already been on a path of gradually hiking interest rates. They had moved away from the Great Recession zero rate in December of 2015 and had been hiking in quarter point increments at every other meeting. The Federal Funds rate stood at 1.25 percent when Powell took over from his predecessor Janet Yellen.

Powell continued with this path of rate hikes until the fall of 2018, and then he did something remarkable: he lowered rates. He had lowered rates by 0.75 percentage points by the time the pandemic hit in 2020.

This reversal was remarkable because it went very much against the conventional wisdom at the Fed and the economics profession as a whole. The unemployment rate at the time was well under 4.0 percent, a level that most economists argued would lead to higher inflation.

However, Powell pointed out that there was no serious evidence of inflationary pressures in the economy at the time. He also noted the enormous benefits of low unemployment. As many of us had long argued, Powell pointed to the fact that the biggest beneficiaries from low unemployment were the people who were most disadvantaged in the labor.

A 1.0 percentage point drop in the unemployment rate generally meant a drop of 1.5 percentage points for Hispanic workers and 2.0 percent for Black workers. The decline was even larger for Black teens. Workers with less education saw the biggest increase in their job prospects. And, in a tight labor market, employers seek out workers with disabilities and even those with criminal records.

In short, there are huge benefits to pushing the unemployment rate as low as possible, and Powell happily pointed to these benefits as he lowered interest rates even in an environment where the economy was already operating at full employment by standard estimates. Powell was willing to put aside the Fed’s obsession with fighting inflation, even when it wasn’t there.

This was the reason that many progressives, including me, wanted President Biden to reappoint Powell. While Lael Brainard, who was then a Fed governor, would have also been an outstanding pick, as a Republican, Powell’s reappointment faced far fewer political obstacles. There was no risk that one of our “centrist” showboat senators (Manchin and Sinema) might seize on some real or imagined slight and block the nomination.

Powell was also likely to have more leeway as a second term chair in pursuing a dovish interest rate policy. Fed chair is a position where seniority matters a lot, as can be seen by the Greenspan worship that stemmed largely from his long service as Fed chair. Although Brainard was a highly respected economist, she might have a harder time staying the course if the business press pushed for higher rates.

Powell’s Pandemic Policy

Powell did pursue a dovish policy, acting aggressively to support the economy during the pandemic with both a zero federal funds rate, and also extensive quantitative easing that pushed the 10-year Treasury bond rate to under 1.0 percent in the summer of 2020. Low rates helped to spur construction and allowed tens of millions of people to refinance mortgages, saving thousands of dollars a year on interest rates.

As virtually everyone (including me) would now agree, he kept these expansionary policies in place for too long. While Fed policy was not the major factor in the pandemic inflation, it did play a role, especially in the housing market. While most of the rise in house prices and rents was driven by fundamentals in the market (unlike in the bubble years from 2002-2007), there was clearly a speculative element towards the end of 2021 and the start of 2022.

This became evident when the Fed first raised rates in March of 2022. Even though the initial hike was just 0.25 percentage points, the housing market changed almost immediately. Prior to the hike, almost every house immediately got multiple above listing offers. After the hike, many houses received no offers and it became standard for buyers to offer prices well below the asking price.

Given this outcome, it would have been good if the Fed had made this move several months sooner. Speculative runups in house prices are not good news for the economy in general, even if there may be a small number of lucky sellers who might hit the peak of the market.

Anyhow, after having waited too long to raise rates, Powell felt the need to re-establish his status as a determined inflation fighter. He embarked on a series of aggressive three-quarter point rate hikes and repeatedly appealed to the ghost of Paul Volcker.

Powell went farther and faster than many of us felt was warranted. It will take time to see the full effect of past rate hikes on the economy. The rapid rise in rates did create stresses in the banking system, although the failures of the Silicon Valley Bank (SVB) and Signature Bank seem to be largely due to incredibly inept management, coupled with major regulatory failures at the Fed.

While bank failures are always fun, the more important issue is what happens to the real economy. At this point it seems the economy faces greater risk on the downside, with unemployment rising, than with inflation reversing its current downward path.

There has been a clear hit to credit availability as a result of banks tightening standards following the SVB panic. Higher rates are also having their expected effect on loan availability. Housing starts have slowed sharply, although residential construction remains strong due to a large backlog of unfinished homes resulting from supply chain problems during the pandemic.

Higher rates have also put an end to the flood of housing refinancing that helped to support consumption growth through the pandemic. And, non-residential investment has also slowed sharply in recent months.

For these reasons, there are real grounds for expecting a growth slowdown and a resulting rise in the unemployment rate. The other side of the story is that it looks as the Fed has won its war on inflation.

I’ll admit to having been an inflation dove all along, but the facts speak for themselves. We know that housing inflation will slow sharply in the months ahead based on private indexes of marketed housing units. These indexes have been showing much lower inflation, and even deflation, since the late summer. They lead the CPI rental indexes by 6-12 months.

We got the first clear evidence of lower inflation in the CPI rental indexes with the March release, with both rent indexes rising just 0.5 percent, after rising at more than a 9.0 percent annual rate in the prior three months. The CPI rent indexes are virtually certain to show further declines over the course of the year, with rental inflation likely falling below its pre-pandemic pace.

Much has been made of the big bad news items in the March CPI, the 0.4 percent rise in new vehicle prices. This is certainly bad news for the immediate inflation picture as it seems that supply chain problems continue to limit the production of new cars and trucks.

But this is not a long-term inflation issue. We have not forgotten how to build cars and trucks. This is a story where the chip shortage, resulting from a fire at a major semi-conductor factory in Japan, has proved to be more enduring that many had expected. That hardly seems like a good reason to be raising interest rates and throwing people out of work.

The picture for many non-housing services was also positive. In particular, the medical services index fell 0.5 percent in March after dropping 0.7 percent in each of the prior two months. Some of this decline is due to the peculiarities of the way health insurance costs are measured in the CPI, but it is pretty hard to tell a story of excessive inflation in this key sector of the economy.

The March Producer Price Indexshowed even better news about inflationary pressures at earlier stages of production. The overall final demand index fell by 0.5 percent in March, while the index for final demand for services dropped by 0.3 percent. While there are areas where there seem to be price pressures, the overwhelming picture in this release is one of sharply lower inflation, or even deflation. Clearly higher inflation will not be driven by price pressures at the wholesale level.

Perhaps most importantly, the pace of wage growth has slowed sharply. The annualized rate of growth in the average hourly wage over the last three months is just 3.2 percent, down from a 6.0 percent pace at the start of 2022. This is lower than the pace of wage growth in 2018 and 2019, when inflation was below the Fed’s 2.0 percent target. It is very difficult to tell a story where wage growth is under 4.0 percent, and inflation is still much above the Fed’s target.

Can Powell Change Course Again?

This raises the question as to whether Powell will again follow the path he took in 2019 and reverse course when the data indicate it is appropriate? There is still much uncertainty about the course of the economy at this point. We don’t know the full effect of the fallout from the SVB failure and it’s not clear how much of the impact of past Fed rate hikes is yet to be felt.

That makes a strong argument for a pause at the Fed’s meeting next month, which will come before we get any data from April. However, if we continue to see evidence of economic weakness, as well as slowing inflation, the Fed needs to be prepared to start lowering rates.

Powell was quite vocal in recognizing the Fed’s twin mandate for full employment, as well as price stability, when he lowered rates in 2019. There is no virtue in going overboard in the effort to fight inflation. If the data show that the war on inflation has been won, and we see the prospect of a weakening economy with higher unemployment, it needs to shift course.

Powell went in the right direction four years ago when he bucked the conventional wisdom and lowered rates in 2019. He needs to be prepared to do that again this year.

Dean Baker: Have Workers Gotten Back Their Share of Income?

 

Dean Baker via Patreon

Have Workers Gotten Back Their Share of Income? I was surprised to see a Twitter thread last week from Jason Furman in which he said that the labor share of national income in 2022 was actually above its pre-pandemic level. I have been following this issue closely and the labor share of corporate income was still down by more than a percentage point from its 2019 level. If that sounds trivial, if the wage share rose back to its pre-pandemic level, and it was evenly shared, every worker would have a 1.7 percent increase in real pay. That won’t make anyone rich, but for a full-time full-year worker earning $25 an hour, the increase would be worth $850 a year. But Jason said there is no prospective dividend like this, because the labor share is already above its pre-pandemic level. Jason referred to the labor share of national income, and using this measure, he was right. I looked back to 2000 and saw that the labor share of national income had not fallen anywhere near as much as the labor share of corporate income, as shown above. The question is what is going on here. My reason for preferring the labor share of corporate income is that profits and labor compensation are well defined in the corporate sector. We have a corporation that earns profits and it pays out wages and benefits to workers. The corporate sector is also about 75 percent of the private business sector, so generally what is going on in the corporate sector tells us what is going on the business sector as a whole. But not this time. Apparently, there was a large increase in the labor share of income in the non-corporate sector. The Commerce Department has not published data for the non-corporate sector for 2022 yet, but in 2021 the labor share stood at 41.4 percent, up by 2.2 percentage points from its 39.2 percent share in 2019. A further increase in 2022 could certainly be enough to raise the economy-wide labor share above its 2019 level. So, what do we make of this large rise in the labor share in the non-corporate sector? That’s a difficult question to answer, but it’s certainly peculiar that the labor share in the non-corporate sector would be going in the opposite direction as the labor share in the corporate sector. There is at least one possible explanation that doesn’t involve ordinary workers in non-corporate sector gaining relative to their counterparts in the corporate sector. Most of the businesses (by revenue) in the non-corporate sector are organized as partnerships. This would include private equity and hedge funds. The earnings of the partners in these funds, which often are in the millions or tens of millions, are largely classified as wage income. If these partners were getting more wage income, or simply classifying a larger share of their fund’s earning as wages, it could lead to a larger labor share of income in the national accounts. That doesn’t especially help the worker in a fast food restaurant owned by a private equity company, but this could explain the rise in the labor share that Jason noted. This is obviously speculative and there could be a different story here, but in the corporate sector, where we do have solid data, we know the labor share has not recovered to its pre-pandemic level. And, if we want to go back to ancient history, the labor share is still down by 7.2 percentage points from its 2000 level. It would be a useful exercise to sort out what is going on with the labor share in the non-corporate sector, but it doesn’t seem unreasonable to think that the labor share in the corporate sector would at least return to its pre-pandemic level.

Dean Baker: The Social Security Scare Story Industry

 

The Social Security Scare Story Industry I’m on the road (literally, driving from southern Utah to western Oregon) but I thought I should quickly weigh in the on the scare stories we heard yesterday after the release of the 2023 Social Security and Medicare Trustees Reports. I’ll make four quick points: 1) The scare stories stem entirely from how we account for Social Security, as opposed to programs like education or the military; 2) We’ve already seen most of the increased burden associated with the retirement of the baby boomers; 3) It’s not true that our only choices are raising taxes or cutting benefits, as has been widely asserted; 4) We have seen great news on Medicare since the passage of the Affordable Care Act, which has been largely ignored. The Problem is Largely Accounting Starting with the accounting, Social Security is a program that we have decided to fund from dedicated taxes, primarily the 6.2 percent tax that employers and employees pay on the first $160,200 of income. (Part of the program’s problem is that the share of wage income going over the cap, and avoiding taxation, rose from 10.0 percent in 1982 to almost 20 percent today. This is because of the huge upward redistribution of wage income over the last forty years.) Most other items in the budget are not funded by a dedicated tax. If they were, we would have had many scary moments in the past and possibly in the future. For example, government spending on education increased from 1.3 percent in 1946 to a peak of 3.8 percent of GDP in 1970. This 2.5 percentage point increase in spending to accommodate the baby boomers needs when we were kids, is far larger than 1.8 percentage point projectedincrease in spending in Social Security from 2000 to 2040, the peak pressure of the baby boomers’ retirement. If we had funded education from a dedicated tax and were looking at accurate projections of future spending in 1946, it would have looked far more scary than the Social Security projections do now. In the same vein, many people want the U.S. to have a Cold War with China. China’s economy is already more than 20 percent larger than ours and is growing considerably more rapidly. (The Soviet economy peaked at around 60 percent of the size of the U.S. economy.) We are currently spending a bit more than 3.0 percent of GDP on the military. We spent 6.0 percent of GDP during the Reagan military buildup in the 1980s. If we went to this level of spending, or higher, to match the spending of a larger enemy, the projections would look much worse than anything we see with Social Security. We’ve Already Seen Most of the Cost Increase The Social Security trust fund built up a large surplus in the years when most of the baby boomers were in the labor force. This trust fund is helping to cover the current costs of the program. However, the cost themselves have been rising for the last fifteen years. We went from spending 4.19 percent of GDP on Social Security in 2000 to spending 5.22 percent of GDP this year, and increase of 1.03 percentage points. This cost is projected to increase further to 6.03 percentage points by 2040, a rise of 0.81 percentage points. This increased cost will impose some burden on the economy, but less than the increased burden we have seen to date. So, the idea that we are looking at some horror story down the road doesn’t make any sense, unless we think we are already living a horror story. It’s not True that Our Only Choices are Raising Taxes or Cutting Benefits Contrary to what NPR told us yesterday (“Patching the program will require higher taxes, lower benefits or some combination of the two”) there is an alternative. Historically, Social Security has been funded by its designated taxes, as noted earlier. But, if we are changing the law, we can also change this feature of Social Security. We could have it funded in part from general revenue, like the military or almost every other program. There are reasons we may not want to make this switch, but it is wrong for NPR and others to tell us that it is not a possible option. It is. Can we spend more from general revenue without raising some taxes? That is an open question. From an economic standpoint, it doesn’t matter whether spending comes from past surplus accumulated in the trust fund or whether it’s simply an appropriation from general revenue. As noted above, we have already seen most of the burden associated the retirement of the baby boomers, perhaps we could see the additional burden without any additional taxes. If the economy’s main problem is secular stagnation (a lack of demand) as economists like Larry Summers had arguedbefore the pandemic, there is little reason to believe that the additional deficits associated with higher Social Security spending will be a major problem. This would especially be the case if artificial intelligence leads to the huge productivity boom that many analysts are predicting. The Untold Great Story on Medicare The Trustees Report released yesterday showed a further improvement in Medicare’s finances. This is a huge deal that has gone largely unreported. In 2000, the Medicare Hospital Insurance Trust Fund was projected to face costs of 1.91 percent of GDP this year and 2.54 percent of GDP in 2040. In the most recent report we are projectedto spend 1.52 percent of GDP this year and 2.12 percent in 2040, a savings of 0.39 percentage points of GDP this year and 0.42 percentage points for 2040. These savings have hugely helped the program and meant that we have far more resources to spend elsewhere. People pushing scare stories probably don’t want to promote these facts, but that is the world. Anyhow, there are clearly issues with how we will deal with the retirement of the baby boomers, but the situation is not nearly as dire as many would like us to believe.

 The Silicon Valley Bank Bailout: The Purpose of Government Is to Make the Rich Richer #63,486

There is a standard tale of politics where conservatives want to leave things to the market, whereas the left want a big role for government. The right likes to tell this story because it advantages them politically, since most people tend to have a positive view of the market. The left likes to tell it because they are not very good at politics and have an aversion to serious thinking.

The Silicon Valley Bank (SVB) bailout is yet another great example of how the right is just fine with government intervention, as long as the purpose is making the rich richer. Left to the market, the outcome in this case was clear. The FDIC guaranteed accounts up to $250k. This meant that the government’s insurance program would ensure that everyone got the first $250,000 in their account returned in full.

The amounts above $250,000 were not insured. This is both a matter of law and a matter of paying for what you get. The FDIC chargesa fee on the first $250,000 in an account based on the size and strength of the bank. This fee ranges from 0.015 percent to 0.40 percent annually, depending on the size and riskiness of the bank. Most people would not see the insurance fee directly, because it is charged to bank, but we can be sure that the bank passes this cost on to its depositors.

However, these fees only apply to the first $250,000 in an account. This means that people who had more than $250,000 in an account were not paying for insurance. Nonetheless, when they needed insurance from the government, they got it, even though they didn’t pay for it.

As we are now hearing, in many cases this handout ran into the tens of millions, or even billions, of dollars, almost all of it going to the very richest people in the country. Compare these depositors’ sense of entitlement to a government handout, to the outrage over President Biden’s proposal to forgive $10,000 of student loan debt. (To be clear, depositors likely would have gotten 80 to 90 percent of their money back in any case.)

In the case of SVB, rich depositors could not bother themselves with taking steps to ensure that their money was parked in a safe place. This is in spite of the fact that almost all of them pay people to help them manage their money.

By contrast, in the case of student loan debt, many 18-year-olds may have misjudged their future labor market prospects. This sort of error would not be surprising given the economic turmoil we have seen since the collapse of the housing bubble and the Great Recession.

Making the Rich Richer with Drugs and Vaccines

The idea that the purpose of government is to make the rich richer pervades every aspect of economic policy. When we were confronted with a worldwide pandemic, the government spent billions of dollars to quickly develop effective vaccines and treatments. And then, after developing them, we gave private companies like Moderna intellectual property rights over the product.

Naturally, this sent Moderna’s stock soaring and made at least fiveModerna executives into billionaires. Only children and elite intellectuals could think the extreme inequality we see in this story has anything to do with the market, but we will get the same tale again and again. The right wants to accept market outcomes, while the left wants to use the government to address inequality.

It’s striking that even now the government is acting to make the Moderna crew still richer. Moderna and Pfizer have announced that they want to charge between $110 and $130 a shot for their new Covid booster.

Peter Hotez and Elena Bottazzi, two highly respected researchers at Baylor University and Texas Children’s Hospital, developeda simple to produce, 100 percent open-source Covid vaccine. It uses well-established technologies that are not complicated (unlike mRNA). Their vaccine has been widely used in India and Indonesia, with over 100 million people getting the vaccine to date.

If we want to see the vaccine used here it would need to be approved by the Food and Drug Administration (FDA). In principle, the FDA could rely on the clinical trials used to gain approval in India, but it indicated that they want a U.S. trial. (In fairness, India’s trials are probably lower quality.)

However, the government could fund a trial of Hotez-Bottazzi vaccine (Corbevax) with pots of money left over from Operation Warp Speed, or alternatively from the budgets of National Institutes of Health or other agencies like Biomedical ​Advanced Research and Development Authority (BARDA). With tens of billions of dollars of government money going to support biomedical research each year, the ten million or so needed for a clinical trial of Corbevax would be a drop in the bucket.

The arithmetic on this is incredible. Shots of Corbevax cost less than $2 a piece in India. If it costs two and a half times as much in the U.S., that still puts it at $5 a shot. That implies savings of more than $100 a shot.

That means that if we get 100,000 people to take the Corbevax booster, rather than the Modern-Pfizer ones (Pfizer is planning to also charge over $100 for its booster), we’ve covered the cost of the trials. If we get 1 million to take Corbevax, we’ve covered the cost ten times over, and if 10 million people get the Corbevax booster, we will have saved one hundred times the cost of the clinical trial.

But for now, we are not going this route. Remember, the purpose of government is to make the rich richer.

This is a huge story in the pharmaceutical industry more generally. We will spend close to $550 billion this year on prescription drugs. These drugs would almost certainly cost less than $100 billion a year if they were sold in a free market without government-granted patent monopolies or related protections.

The differences of $450 billion is roughly half the size of the military budget and more than four times what we will spend on the Food Stamp program. It comes to more than $3,000 per household each year, and yes, it mostly goes to people at the top end of the income distribution.

We would have to replace the roughly $100 billion a year that the industry spends on research, but we would almost certainly come out way ahead in that story, as with the Hotez-Bottazzi vaccine.

In addition, by making drugs cheap, we will end the crisis that many people face in trying to come up with the money to pay for life-saving drugs. We would also eliminate the enormous incentive that patent-protected drug prices give drug companies to lie about the safety and effectiveness of their drugs.

Structuring Finance to Serve the Market, not the Rich

We don’t need to have a financial system that has periodic bank collapses and makes millionaires and billionaires out of top bank executives. This is a policy choice by a government committed to making the rich richer.

The most obvious solution would be to have the Federal Reserve Board give every person and corporation in the country a digital bank account. The idea is that this would be a largely costless way for people to carry on their normal transactions. They could have their paychecks deposited there every two weeks or month. They could have their mortgage or rent, electric bill, credit card bill, and other bills paid directly from their accounts.

This sort of system could be operated at minimal cost, with the overwhelming majority of transactions handled electronically, requiring no human intervention. There could be modest charge for overdrafts, that would be structured to cover the cost of actually dealing with the problem, not gouging people to make big profits.

Former Fed economist (now at Dartmouth), Andy Levin, has been etching the outlines of this sort of system for a number of years. The idea would be to effectively separate out the banking system we use for carrying on transactions from the system we use for saving and financing investment.

We would have the Fed run system to carry out the vast majority of normal financial transactions, replacing the banks that we use now. However, we would continue to have investment banks, like Goldman Sachs and Morgan Stanley, that would borrow on financial markets and lend money to businesses, as well as underwriting stock and bond issues. While investment banks still require regulation to prevent abuses, we don’t have to worry about their failure shutting down the financial system.

Not only would the shift to Fed banking radically reduce the risk the financial sector poses to the economy, it would also make it hugely more efficient. We waste tens of billions of dollars every year maintaining the structure of a financial system that technology has made obsolete.

The current system also makes some people incredibly rich, even when they fail disastrously. Greg Becker, the President and Chief Executive Officer, earned$9,922,000 in SVB’s 2021 fiscal year (the most recent year for which I could find the data). That would be roughly 684 times what a minimum wage worker would earn for a full year’s work. (Top execs at the largest banks can earn three or four times this amount.)

If we think that a worker has a 45-year working lifetime, then Mr. Becker pulls down more in a year than what a minimum wage worker would get in 15 working lifetimes. The CEOs at Lehman and Bear Stearns, two of the huge failed banks in the financial crisis, walked away with hundreds of millions of dollars for their work.

So, the basic story is that the government has designed a financial system designed to redistribute massive amounts of money to the rich. We could have a hugely more efficient system, but since that would end the gravy train for those at the top, it is not on the political agenda.

The Big Lie: Conservatives Don’t Like Big Government

As this bailout should make clear is that, contrary to what the media tell us, conservatives love big government. They just think that the focus of big government should be making the rich as rich as possible, not helping ordinary people and securing the economy and society.

To be clear, I do think this bailout was necessary given the fragility of the economy at present (unlike the 2008-09 bailout, that was sold with the lie that we faced a Second Great Depression). However, we need to get our eye on the ball here.

The idea that conservatives like the market and not the government is unadulterated crap. It is a myth that they use to conceal the ways they have rigged the market to make income flow upward. Unfortunately, virtually the entire left has agreed to go along with this absurd myth. Moments like the bailout of the rich depositors at SVB make the truth about conservatives and the market apparent to all. (And yes, this is the point of Rigged [it’s free].)

Joseph Stiglitz: Another Predictable Bank Failure

 ar 13, 2023

JOSEPH E. STIGLITZhttps://www.project-syndicate.org/commentary/predictable-silicon-valley-bank-collapse-by-joseph-e-stiglitz-2023-03?utm_source=Project+Syndicate+Newsletter&utm_campaign=47be6695f6-sunday_newsletter_03_19_2023&utm_medium=email&utm_term=0_73bad5b7d8-47be6695f6-93461969&mc_cid=47be6695f6&mc_eid=6194caf520

The collapse of Silicon Valley Bank is emblematic of deep failures in the conduct of both regulatory and monetary policy. Will those who helped create this mess play a constructive role in minimizing the damage, and will all of us – bankers, investors, policymakers, and the public – finally learn the right lessons?


NEW YORK – The run on Silicon Valley Bank (SVB) – on which nearly half of all venture-backed tech start-ups in the United States depend – is in part a rerun of a familiar story, but it’s more than that. Once again, economic policy and financial regulation has proven inadequate.
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Lessons from the SVB Coll


The news about the second-biggest bank failure in US history came just days after Federal Reserve Chair Jerome Powell assured Congress that the financial condition of America’s banks was sound. But the timing should not be surprising. Given the large and rapid increases in interest rates Powell engineered – probably the most significant since former Fed Chair Paul Volcker’s interest-rate hikes of 40 years ago – it was predicted that dramatic movements in the prices of financial assets would cause trauma somewhere in the financial system.

But, again, Powell assured us not to worry – despite abundant historical experience indicating that we should be worried. Powell was part of former President Donald Trump’s regulatory team that worked to weaken the Dodd-Frank bank regulations enacted after the 2008 financial meltdown, in order to free “smaller” banks from the standards applied to the largest, systemically important, banks. By the standards of Citibank, SVB is small. But it’s not small in the lives of the millions who depend on it.

Powell said that there would be pain as the Fed relentlessly raised interest rates – not for him or many of his friends in private capital, who reportedly were planning to make a killing as they hoped to sweep in to buy uninsured deposits in SVB at 50-60 cents on the dollar, before the government made it clear that these depositors would be protected. The worst pain would be reserved for members of marginalized and vulnerable groups, like young nonwhite males. Their unemployment rate is typically four times the national average, so an increase from 3.6% to 5% translates into an increase from something like 15% to 20% for them. He blithely calls for such unemployment increases (falsely claiming that they are necessary to bring down the inflation rate) with nary an appeal for assistance, or even a mention of the long-term costs.1

Now, as a result of Powell’s callous – and totally unnecessary – advocacy of pain, we have a new set of victims, and America’s most dynamic sector and region will be put on hold. Silicon Valley’s start-up entrepreneurs, often young, thought the government was doing its job, so they focused on innovation, not on checking their bank’s balance sheet daily – which in any case they couldn’t have done. (Full disclosure: my daughter, the CEO of an education startup, is one of those dynamic entrepreneurs.)

While new technologies haven’t changed the fundamentals of banking, they have increased the risk of bank runs. It is much easier to withdraw funds than it once was, and social media turbocharges rumors that may spur a wave of simultaneous withdrawals (though SVB reportedly simply didn’t respond to orders to transfer money out, creating what may be a legal nightmare). Reportedly, SVB’s downfall wasn’t due to the kind of bad lending practices that led to the 2008 crisis and that represent a fundamental failure in banks performing their central role in credit allocation. Rather, it was more prosaic: all banks engage in “maturity transformation,” making short-term deposits available for long-term investment. SVB had bought long-term bonds, exposing the institution to risks when yield curves changed dramatically.


New technology also makes the old $250,000 limit on federal deposit insurance absurd: some firms engage in regulatory arbitrage by scattering funds over a large number of banks. It’s insane to reward them at the expense of those who trusted regulators to do their job. What does it say about a country when those who work hard and introduce new products that people want are brought down simply because the banking system fails them? A safe and sound banking system is a sine qua non of a modern economy, and yet America’s is not exactly inspiring confidence.

As Barry Ritholtz tweeted, “Just as there are no atheists in Fox Holes, there are also no Libertarians during a financial crisis.” A host of crusaders against government rules and regulations suddenly became champions of a government bailout of SVB, just as the financiers and policymakers who engineered the massive deregulation that led to the 2008 crisis called for bailing out those who caused it. (Lawrence Summers, who led the financial deregulation charge as US Treasury Secretary under President Bill Clinton, also called for a bailout of SVB – all the more remarkable after he took a strong stance against helping students with their debt burdens.)1

The answer now is the same as it was 15 years ago. The shareholders and bondholders, who benefited from the firm’s risky behavior, should bear the consequences. But SVB’s depositors – firms and households that trusted regulators to do their job, as they repeatedly reassured the public they were doing – should be made whole, whether above or below the $250,000 “insured” amount.

To do otherwise would cause long-term damage to one of America’s most vibrant economic sectors; whatever one thinks of Big Tech, innovation must continue, including in areas such as green tech and education. More broadly, doing nothing would send a dangerous message to the public: The only way to be sure your money is protected is to put it in the systemically important “too big to fail” banks. This would result in even greater market concentration – and less innovation – in the US financial system.

After an anguishing weekend for those potentially affected throughout the country, the government finally did the right thing – it guaranteed that all depositors would be made whole, preventing a bank run that could have disrupted the economy. At the same time, the events made clear that something was wrong with the system.

Some will say that bailing out SVB’s depositors will lead to “moral hazard.” That is nonsense. Banks’ bondholders and shareholders are still at risk if they don’t oversee managers properly. Ordinary depositors are not supposed to be managing bank risk; they should be able to rely on our regulatory system to ensure that if an institution calls itself a bank, it has the financial wherewithal to pay back what is put into it.

SVB represents more than the failure of a single bank. It is emblematic of deep failures in the conduct of both regulatory and monetary policy. Like the 2008 crisis, it was predictable and predicted. Let’s hope that those who helped create this mess can play a constructive role in minimizing the damage, and that this time, all of us – bankers, investors, policymakers, and the public – will finally learn the right lessons. We need stricter regulation, to ensure that all banks are safe. All bank deposits should be insured. And the costs should be borne by those who benefit the most: wealthy individuals and corporations, and those who rely most on the banking system, based on deposits, transactions, and other relevant metrics.

It has been more than 115 years since the panic of 1907, which led to the establishment of the Federal Reserve System. New technologies have made panics and bank runs easier. But the consequences can be even more severe. It’s time our framework of policymaking and regulation responds.