Cliff Diving in Europe

Worried about Europe? You should be! Via Stuart Staniford, here's the latest bad news from the eurozone: In September, as the chart below shows, industrial orders plunged 6.4% in the euro area (pink line) and 2.3% in the broader EU (black line). Here's Stuart:

There have been indicators suggesting mild contraction for a while — eg retail trade. But this is the first indicator I've seen that looks like the kind of sharp non-linear contraction characteristic of an out-and-out recession. I guess there's always the possibility that October will be better. However, given the financial news flow in the last six weeks, it's hard to imagine too many European executives getting all giddy and excited in approving new projects.

He's got more bad news at the link, if you have the stomach for it.

Electric cars are having a tough time finding buyers. Brad Plumer takes a crack at explaining what the problem is:

GM is struggling to meet this year’s sales target for the Chevy Volt, and Nissan has sold just 8,000 all-electric Leafs. Part of that might be due to the recession and the steep price tag: Like any new technology, the cars are pricey (the Volt goes for $40,000, though buyers can qualify for a $7,500 federal tax rebate). But a recent NPR report by Sonari Glinton highlighted another reason sales might be flagging — the fact that early models can’t go very far before needing a recharge, which gives would-be buyers “range anxiety.”

Electric-car advocates have occasionally dismissed range anxiety as irrational. After all, the vast majority of Americans commute less than 40 miles a day. So even a Nissan Leaf, which, realistically, gets about 65 miles on a single charge, should satisfy most of our daily needs. But what about slightly longer trips? Consumers really do worry about getting stranded on the road with a dead battery. Plus, as an executive at Better Place once told me, drivers don’t like feeling hemmed in. “Our research shows that people want to feel like they can get into their car and drive across the country at if they have to,” he said. “It might sound silly, but it’s real.”

At the moment, car companies are racking their brains for ways to allay these fears.

Wait a second. What am I missing here? Of course consumers are worried about getting stranded with a dead battery. That can't possibly be a revelation to the car industry, can it? It's the obvious #1 problem with electric cars: even if I normally drive 20 miles a day, occasionally I'm going to want to visit grandma in San Diego and I need a car that can do it. Who on earth thinks this sounds silly?

Besides, the Chevy Volt has a gasoline engine as well as a battery, so its range is the same as an ordinary car. Range anxiety can't be the problem there unless Chevy has been monumentally incompetent in its marketing campaign. (Always a possibility, of course.)

Surely the answer here is obvious. For pure electric cars like the Leaf, the issue is indeed range. Obviously. For the Volt, the issue is its fantastically high price tag. It's a Chevy Cruze (yours for $15K or so) that costs more than $30,000. That's my guess, anyway. Mickey Kaus has a different take:

I recently rented a Nissan Leaf all-electric car. No gas engine, just silent, battery propulsion. It worked fine. It did everything it was supposed to do. It was just incredibly boring.  Not just “doesn’t corner well” type of boring — though it doesn’t corner well — but boring in some corrosive, fundamental, existential way.

I don't think the Leaf is meant for car guys who want the thrill of a V-8 powering them through tight corners. It's meant for people who like boring cars. You know, Camry owners. So I'm skeptical that this is an issue either. But then again, I've never driven one.

The Washington Post reports that the terrorist group founded by Osama bin Laden is all but dead:

The leadership ranks of the main al-Qaeda terrorist network, once expansive enough to supervise the plot for Sept. 11, 2001, have been reduced to just two figures whose demise would mean the group’s defeat, U.S. counterterrorism and intelligence officials said.

Ayman al-Zawahiri and his second in command, Abu Yahya al-Libi, are the last remaining “high-value” targets of the CIA’s drone campaign against al-Qaeda in Pakistan, U.S. officials said....“We have rendered the organization that brought us 9/11 operationally ineffective,” a senior U.S. counterterrorism official said. Asked what exists of al-Qaeda’s leadership group beyond the top two positions, the official said: “Not very much. Not any of the world-class terrorists they once had.”

However, pretty much the entire rest of the piece is devoted to "U.S. officials" telling us that (a) none of this really matters, (a) al-Qaeda remains an enormous threat, and (c) we can't afford any kind of reduction in our overseas military presence. So don't let this get your hopes up.

I'm sorry, but I just don't have it in me to try and say something intelligent about tonight's debate. Generally speaking, it wasn't quite the train wreck that some of the others have been, but that's faint praise. And it's appalling that for the second time in a row, a foreign policy debate had no questions — not one — about Europe. The entire continent is on the verge of imploding, and possibly taking us down with them, and Wolf Blitzer doesn't care. And at the end, when the candidates got a freebie question to talk about any issue they felt wasn't getting enough attention, no mention of Europe again. It's just baffling.

Anyway, here's my Twitter stream for the night. That's the best I've got for you.

5:08pm Good to see Romney singing along. Looks authentic!

5:25pm I think Santorum just lost the Muslim vote.

5:28pm Newt Gingrich is....AWESOM-O!! ow.ly/7CnWd

5:32pm "Huntsman’s problem....is that he doesn’t seem to hate Democrats." ow.ly/7Co0n

5:34pm Hey, Perry mentioned India! Progress!

5:56pm And literally. RT @RichLowry: did newt just use candidly and frankly w/n abt 5 words?

6:04pm How much oil does Gingrich think we have in America?

6:04pm Oh, and Lean Six Sigma!

6:10pm Perry seems unaware that budget trigger was originally a Republican proposal.

6:13pm How long are we going to have to wait this time before Europe gets mentioned?

6:41pm This debate is only two hours, right?

6:42pm Why are candidates promoting drones on border instead of blimps? America needs a stronger blimp fleet.

6:43pm Jeez, such a whiner. RT @MaxBoot: No mention yet of Arab Spring, with demonstrations in Egypt, open revolt in Syria, etc.

6:45pm Already spent an hour talking about Iran, Iraq, Israel, Pakistan. But we're going to "widen" the conversation by going to the Middle East?

6:46pm Surprise final questioner will be George W. Bush! #secretsourcestoldme

6:50pm RT @RichLowry: a no fly zone is not a sanction its an act of war

7:05pm Virtues again from Perry. Is this some kind of dog whistle I don't understand?

I want to thank Ezra Klein for reminding me about this passage in Politico's postmortem on the failure of the supercommittee to reach an agreement. It's a description of the "wish lists" from each side:

House Republicans wanted to repeal Obama’s health care law, implement the controversial House GOP budget drafted by Rep. Paul Ryan (R-Wis.), save $700 billion by block granting Medicaid, cut $400 billion in mandatory spending, slash another $1.4 trillion in other health care mandatory spending, save $150 billion by slicing the federal workforce and put a $60 billion cap on tort reform.

Republicans were no more pleased to see what Democrats wanted: the president’s $447 billion jobs bill plus well over $1 trillion in new taxes.

Right. Toss in the extension of the Bush tax cuts, which Politico leaves out for some reason, and you've got $3.7 trillion in tax cuts in addition to repealing Obamacare, making massive cuts in domestic spending, and adopting Paul Ryan's scorched earth budget blueprint.

Democrats, by contrast, agreed up front to a $3 trillion deficit reduction package but wanted it divided into roughly two-thirds spending cuts and one-third tax increases. Plus a jobs bill since, you know, unemployment remains sky high.

Do these two lists sound roughly similar to you? Of course not. They aren't even from the same galaxy. The Republican list is a conservative wet dream. It's not even remotely a starting point for negotiation. By contrast, the Democratic list is a bog ordinary opening bid.

Ezra calls this an example of "asymmetrical polarization." That's a new term for me. I call it "negotiating with fanatics."

From the mailbag today:

I've been reading your prediction that Republicans will simply find a way to overturn any built-in cuts to defense spending. With Obama's veto threat, do you still see things the same way?

This is too hard to answer. The most obvious question, of course, is how resolute Obama will be. His past behavior certainly suggests a very strong preference for finding some kind of compromise position rather than digging in his heels, but then again, he doesn't usually make flat-out veto promises either. So maybe this time is different.

But I'm not sure it matters. Here's the only thing that's really important: the defense cuts don't kick in until 2013. In other words, not until after the 2012 election. And let's face it: all bets are off at that point. Maybe president Gingrich will be in charge then. Maybe Obama will win and cut a deal with the lame duck Congress, like he did last year. Maybe we'll be in the middle of a war with Ubeki-beki-beki-stan. Who knows? A year in politics is a long time to begin with, and a year plus a presidential election is like an eternity. Basically, after everyone has finished up wailing about the fecklessness of Congress and moved on to some other shiny new object — a process that should take no more than a week — the whole thing will be forgotten. When it's suddenly thrust back into the spotlight next December, we'll be living in a whole new world. Anything could happen.

Still, the smart money says that "anything" doesn't include very much in the way of cuts to the defense budget. There's just too much institutional and political pressure to keep money flowing to the Pentagon. No president in recent memory has stood up to it, and I doubt that Obama will be the first.

Via Matt Yglesias (writing from his new Moneybox home at Slate), I see that the Federal Reserve has, unsurprisingly, declined to adopt a policy of targeting nominal GDP growth:

A number of participants expressed concern that switching to a new policy framework could heighten uncertainty about future monetary policy, risk unmooring longer-term inflation expectations, or fail to address risks to financial stability. Several participants observed that the efficacy of nominal GDP targeting depended crucially on some strong assumptions, including the premise that the Committee could make a credible commitment to maintaining such a strategy over a long time horizon and that policymakers would continue adhering to that strategy even in the face of a significant increase in inflation.

Matt is unimpressed: "The claim that this would 'heighten uncertainty' seems to me to be just flat-out wrong." Of course it is. But that part of the statement is just window dressing anyway. The part that matters is in bold. Targeting higher NGDP levels would clearly involve tolerance for higher inflation, and there are lots of FOMC members who just aren't willing to go there, no matter how weak the economy is, how high unemployment is, or how big the risks from Europe are. Just as the Germans seem to be forever reliving the 20s, in the U.S. we are forever reliving the 70s. Inflation delenda est, baby.

Both Paul Krugman and Tyler Cowen recommend a new paper from Hyun Song Shin called "Global Banking Glut and Loan Risk Premium." If both of those guys say a paper is important, then it's probably pretty important. So I took a look. I'll confess up front that I had a hard time plowing through it, which means my summary might be off base a bit here and there, but here we go anyway. Roughly speaking, Shin says the following things:

  • Credit expands when banks lever up their balance sheets by piling up lots of debt.
  • Thanks to Basel II, European banks levered up even more than U.S. banks.
  • Some of this was intra-European debt, but lots of it was U.S. debt denominated in dollars. In total, European banks had about $5 trillion in claims on U.S. counterparties in the peak year of 2007, much of it via purchase of private label subprime securitizations.
  • In other words, the European segment of the shadow banking system was indirectly providing about $5 trillion in credit to U.S. borrowers. This was about as much as U.S. banks provided directly.
  • The mechanism for this indirect flow was simple. Starting in 1999, U.S. money began flowing in large quantities to the U.S. subsidiaries of European banks, then across the Atlantic to their home offices in Europe, and from there back to borrowers in the U.S.
  • Conclusion: the European banking sector provides about as much credit to the U.S. as the American banking sector does. So when the European banking sector deleverages, as it must, it will have a very substantial effect on credit conditions in the U.S. In Shin's bland phrasing, "The European crisis carries the hallmarks of a classic 'twin crisis' that combines a banking crisis with an asset market decline that amplifies banking distress....The global flow of funds perspective suggests that the European crisis of 2011 and the associated deleveraging of the European global banks will have far reaching implications not only for the eurozone, but also for credit supply conditions in the United States and capital flows to the emerging economies."

Translated, this means that as sovereign debt woes get worse, bank woes get worse too. And as bank woes get worse, sovereign debt woes get worse. The result is a vicious circle that produces a big credit contraction, and since European banks have become so important as funding sources to the U.S., it means a big credit contraction in the U.S as well.

Tyler's comment: "If true we are doomed." On a separate note, Shin also points out that after the euro was introduced in 2000, cross-border claims within Europe skyrocketed. Unfortunately, banks themselves mostly stayed pretty local:

The introduction of the euro meant that “money” (i.e. bank liabilities) was free-flowing across borders in the eurozone, but the asset side remained stubbornly local and immobile. It is this contrast between the free-flowing liabilities but localized assets of European banks’ balance sheets that has been a key contributing factor in the European crisis.

In other words, wholesale funding flowed easily to wherever it would get the best return, but banks mostly kept their loan books local. This produced big property bubbles in Ireland and Spain and big current account imbalances across the entire continent. There's no easy way for this to unwind, and unfortunately, even the moderately difficult ways appear to be out of bounds to the eurozone's policymakers. If we really are doomed, it's partly because of bad policymaking during the aughts, but it's also because of disastrous policymaking right now. I wish I thought that Shin was wrong about this, but I suspect he's not.

This is pretty funny. From ThinkProgress, it's Mitt Romney, in his own words, according to the Romney standard of accuracy. Enjoy.

Okay, this isn't actually raw data. In fact, it's very, very cooked and calculated data. But just so you know, Peter Diamond and Emmanuel Saez have tried to calculate the tax rate on the rich that would maximize revenue to the government. Paul Krugman summarizes:

In the first part of the paper, D&S analyze the optimal tax rate on top earners. And they argue that this should be the rate that maximizes the revenue collected from these top earners—full stop. Why? Because if you're trying to maximize any sort of aggregate welfare measure, it's clear that a marginal dollar of income makes very little difference to the welfare of the wealthy, as compared with the difference it makes to the welfare of the poor and middle class. So to a first approximation policy should soak the rich for the maximum amount—not out of envy or a desire to punish, but simply to raise as much money as possible for other purposes.

Now, this doesn't imply a 100% tax rate, because there are going to be behavioral responses—high earners will generate at least somewhat less taxable income in the face of a high tax rate, either by actually working less or by pushing their earnings underground. Using parameters based on the literature, D&S suggest that the optimal tax rate on the highest earners is in the vicinity of 70%.

Actually, Krugman is being conservative here. If you assume a broad base and no deductions, Diamond and Saez peg the revenue maximizing rate for top earners at 76 percent. That's for federal income tax only. (See page 173 here.)

You can decide for yourself if you think top marginal rates should be that high. After all, revenue maximization isn't our only social goal. Roughly speaking, though, this is a calculation of the peak of the famous Laffer Curve. (For top earners, anyway.) Above 76 percent, you really can generate higher revenues by lowering tax rates. Below that, higher rates generate higher revenue, just like you'd think.

Note that this is a result that both liberals and conservatives ought to take some satisfaction in. For liberals, it's confirmation that current tax rates are far, far below the Laffer maximum. We can raise marginal rates from 35 to 40 percent with only minor deadweight losses. For conservatives, it's justification for the 1981 Reagan tax cuts. When top rates were at 70 percent, reductions may not have literally paid for themselves, but they probably lowered revenue fairly modestly. We really were pretty close to the Laffer maximum in the '60s and '70s.