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A DAILY round-up of economic news:

Congress confirmed Timothy Geithner as Treasury secretary in a late vote (60-34) last night. Now, the board of the Federal Reserve Bank of New York is charged with the task of finding a replacement. William Dudley, an in-house candidate and former chief economist at Goldman Sachs, has been named as a likely choice. Mr Dudley could be appointed to the role as early as today.

The unemployment bloodbath is hardly over. Corning, a company that specialises in LCD glass production, intends to cut 3,500 jobs. Yesterday, seven major corporations issued lay-off announcements that amounted to over 70,000 jobs lost.

Fannie Mae and Freddie Mac may come back for seconds. With the housing market still in a rough state, the mortgage giants will likely appeal for $51 billion in additional federal assistance.

What a difference a year makes. The scene at the World Economic Forum in Davos, Switzerland retains little of its traditional optimism. Notably, officials from the Middle East's sovereign wealth funds say they are cutting back substantially, marking a shift from the exuberance of the previous meeting.

And authorities arrested a Madoff-in-training. Nicholas Cosmo, head of a New York financing firm, is being held under suspicion of orchestrating a $400 million Ponzi scheme. That this now seems like small potatoes is patently absurd.

(Photo credit: AFP/Getty Images)

Iceland's boiling point

CONSIDERING the devastating effects they experienced, the people of Iceland reacted to the economic crisis with relative calm in the weeks following the collapse of the krona and the failure of the country’s three major banks. Yes, there were rushes on grocery stores, and a black market for foreign currency sprang up through classified ads. Some even participated in protests on weekends. Still, there were no reports of unrestrained chaos.

Now, over three months after the banking failure, Iceland’s government has collapsed in reaction to mounting dissent. Geir Haarde, the Prime Minister, stepped down today after his party failed to meet the demands of the Social Democratic Alliance, its coalition partner.

Mr Haarde’s resignation comes amidst significant turbulence. Last week, Iceland experienced its first violent rally in decades, with police using tear gas for the first time since 1949.

Ólafur Ólafsson, a writer and photographer, was present at the rallies and explains the change in sentiment via e-mail:

The weekly peaceful protests with thousands participating didn't get any response from the government… the public wasn't informed what was being done… institutions were [not] being held accountable, nobody was fired despite evidence of horrendous negligence at best. The public just didn't want to be ignored any more… it takes some time for such a reality to sink in. We're an optimistic nation, we mostly expect the best, and we're prepared to work hard to make it happen too. This time the circumstances seem completely overwhelming and we're angry to have been put into such a situation by our leaders and countrymen.

Frankly, I am impressed—though not necessarily surprised—that it took as long as it did for Iceland’s political situation to catch up with its economic one. Once again, people are slow to react to the dramatic events of the downturn.

Link exchange

Martin Feldstein takes a seat on the eurosceptic bandwagon:

The very negative current economic conditions in Europe may cause substantial economic policy disagreements among the Eurozone countries… In these circumstances, it is possible that one or more countries might actually withdraw from the Eurozone. It is clear why some national political leaders – or would be leaders – might consider such an option. Doing so would allow their reinstated national central bank to choose an easier monetary policy. The national central bank could also create the currency needed to act as a lender of last resort to national commercial banks. The country’s fiscal authority would no longer be bound by the restrictions of the Stability and Growth Pact and could therefore pursue a large fiscal stimulus. The international value of the currency could adjust to make local products more competitive.

Sounds like the honeymoon period is approaching its end.

Downturns, deficits, debt, downgrades, and defaults—Carmen Reinhart thinks that the letter “D” is the most economically dire component of the alphabet.

Economists, what are they good for? Absolutely nothing, says Will Wilkinson.

A liquidity trap is a liquidity trap is a liquidity trap is a liquidity trap. Paul Krugman asks for the definition sticklers to back off and acknowledge that traditional monetary policy is simply not working.

The concept of fairness does more than simply separate humans from robots, says Bart Wilson. It also provides experimental economists with hours of entertainment!

And John Hempton is all for a literal helicopter drop.

Debating the stimulus

CERTAINLY Paul Krugman has said some intemperate things during the course of the stimulus debate, I imagine in exasperation. Mr Krugman pulls few punches when he thinks he's right on a question of the utmost importance—see his primary jibes at Barack Obama for an example. His tone, at times, has been unwarranted (see Tyler Cowen on Mr Krugman's dismissal of Robert Barro, for instance). But I think it's important to understand why Mr Krugman is frustrated.

For one thing, there has been considerable bad faith from the sceptics' side at times, not least with respect to the Romer paper mentioned by my colleague. It has been abused by a number of writers, many of which have implied hypocrisy or dishonesty on the part of Christina Romer, who is, of course, in the current administration, arguing in favour of fiscal spending.

For another, Mr Krugman is not just arguing with economists. He's also arguing with pundits and political leaders, many of which have not put forward coherent or factual critiques of fiscal spending. Amity Shlaes, for instance, has bounced from op-ed page to op-ed page making nonsense economic history arguments. The Republican opposition has also not acquitted itself particularly well. Mr Krugman is trying his best to convince influential people that John Boehner's arguments are essentially bunk, which, of course, they are.

And for every sceptical economist out there engaging supporters, there are others being entirely too careless with their argumentation. Greg Mankiw, unfortunately, has fallen into this category at times, linking to any old quote a blogger can dig up in opposition to spending, whether or not it's in context or accurate. If Mr Krugman doesn't always respond to valid arguments appropriately, it might be because he's so bombarded with invalid arguments,

But as my colleague notes, we are increasingly approaching a consensus—that the available empirical evidence on stimulus is indecisive. As such, and as Kevin Murphy and Dani Rodrik have noted, one's view of a spending stimulus largely reflects one's political priors. As Mr Rodrik says:

[T]he remaining disagreements are largely philosophical, political, and practical--revolving around the role of government, the extent of rent-seeking and public-choice concerns in government programs, and the right mixture of prudence and boldness that the situation requires.

Given this it's worth recalling Warren Buffett's argument in support of fiscal spending (deemed by Mr Cowen as perhaps the most compelling reason to favour stimulus):

All you know is you throw everything at it and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it. And people, they do not know exactly what the effects are. Economists like to talk about it, but in the end they’ve been very, very wrong and most of them in recent years on this. We don’t know the perfect answers on it. What we do know is to stand by and do nothing is a terrible mistake or to follow Hoover-like policies would be a mistake and we don’t know how effective in the short run we don’t know how effective this will be and how quickly things will right themselves. We do know over time the American machine works wonderfully and it will work wonderfully again.

The severity of the situation is pretty clear. Given a basic theoretical idea of how stimulus is supposed to work, it seems appropriate to go for it; concerns about rent-seeking just aren't as important. More worthy of consideration is the debt load position, but again, threat readings on the recession are currently scarier and more pressing.

At any rate, the matter is increasingly out of economists' hands. The voters chose their leaders, and their leaders favour stimulus. And so we'll see what happens.

Paul knows all

FOR such a smart man, Paul Krugman has an extraordinarily simple view of the world. It appears there are two types of economists—liberal and conservative. Liberal economists, through their divine access to Keynes, know exactly how to fix the financial crisis—goverment spending. Conservative economists, who have some secret agenda to undermine the economy, wish to derail the obvious and necessary policy prescription. The conservatives burden us with tedious talk of lag times, government waste, quibbling about multipliers and some nonsense about the sustainability of large, fiscal deficits.

The point is that nobody really believes that a dollar of tax cuts is always better than a dollar of public spending. Meanwhile, it’s clear that when it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts — and therefore costs less per job created (see the previous fraudulent argument) — because a large fraction of any tax cut will simply be saved.

According to Greg Mankiw, Christina (the next chair of the CEA) and David Romer found a dollar of tax cuts increases GDP by $3. Mr Mankiw compares this to a study that finds a multiplier of 1.4 on government spending. You could always quibble with any study that estimates the effectiveness of one policy versus another. You can also argue circumstances change and different policies become appropriate. But one thing is for certain, no one really knows for sure.

During my first year of graduate school I read countless empirical and theoretical papers that shattered, rebuilt, and shattered again the tidy Kenynsian models I learned as an undergraduate. My macro professor told me that economists only know two things for certain: bad/misguided monetary policy can bring on a recession and increases in productivity cause growth. This left me feeling confused when it came to fiscal policy, enough so I pursued public finance as one of my fields (full disclosure: I studied under someone whom Mr Krugman would call a “conservative economist”). After that I still did not know what to make of fiscal policy other than it is complicated, messy, hard to time properly, and no one really knows how effective it can be.

That is not enough reason to outright dismiss government spending as a waste of resources. But discussion, at least, is warranted. America sorely needs to revamp its infrastructure, so if (and not a trivial if) the government chooses projects wisely, the spending could be worthwhile. Also, consumers want to believe government can do something and goverment projects that employ people are easy to understand. Even if the projects have no effect until well into the recovery the mere anticipation of them might restore confidence.

Nonetheless, as a macro/public finance economist the only unambiguous feeling I have toward the fiscal stimulus plan is my personal excitement. The economics profession will probably learn from this experiment. Maybe economists will be able to sketch in some of the black box that is fiscal policy. Though it is an awfully expensive experiment to conduct.

The incredible shrinking world

THE sad truth is, we were never decoupled. In retrospect, it's not clear why anyone would have assumed that a decoupling process had taken place. Clearly, patterns of trade depended on a massive, and fairly stable pattern of financial flows, and global trade volumes had risen to unprecedented levels. Over the past decade, the world became as tightly linked, economically, as it had ever been. It makes perfect sense that a downturn anywhere would become a downturn everywhere.

And indeed it has. Alex Tabarrok links today to a Telegraph story listing the remarkable amounts by which trade activity has fallen. The story quotes an ING consultant who calls the situation, "a complete collapse in foreign demand". Meanwhile, the Council on Foreign Relation's Brad Setser writes that the developed world shouldn't count on emerging markets to save it. The commodity exporters are flailing. The commodity importers—China and India, for example, are stumbling. Developed Asia's export figures are dropping like rocks. Eastern Europe is rioting. Western Europe is increasingly uncomfortable.

As an economics writer, I am fairly in tune to the shape of the global crisis. I am struck, however, by the extent to which the domestic conversation in America has turned inward. This is a rather marked change from the shape of the discussion during the financial crisis last autumn. The state of global contagion was a prominent story at the time, and international cooperation was the order of the day; it was financial issues, recall, that led then-president Bush to convene a meeting of world leaders.

But that internationalism seems to have waned. This is troubling for several reasons. Obviously, no one wants to see an excessive focus on domestic issues mutate into a wave of beggar-thy-neighbour policies. But it strikes me as equally important to try and coordinate policy approaches to what is unquestionably a global downturn. The size and content of stimulus packages should vary by country. Countries might do well to consult together on regulatory changes. And it certainly seems as though international institutions could fruitfully be strengthened, to identify looming financial issues early on and to prevent Icelandic meltdowns.

Were we in the midst of a global political crisis, influential people the world over would be calling for dialogue. The same should apply to an economic crisis that is indisputably global in nature.

Betting on failure

FELIX SALMON continues his noble crusade to defend the honour of the embattled credit default swap (CDS). This time he takes Gretchen Morgenstern to task for suggesting that banks recklessly issued swaps when they were typically buyers. Equally troubling about Ms Morgenstern’s argument—her vilification of speculation in the market. She suggests that buying a CDS when you do not hold the underlying security is somehow immoral and even unpatriotic.

There is a viable and legitimate use for C.D.S.’s, especially when they allow bondholders and corporations to limit their risks. But in recent years, these contracts became a haven for speculators who were doing nothing more than betting on whether a debt issuer would survive.

My London colleague and I explained why buying a CDS can be “legitimate” when you do not hold the security it insures. The CDS may hedge another asset correlated to the underlying security. Further, even pure speculation provides invaluable information to markets. If many investors are betting on a firm going bankrupt, that sends an important signal to markets and the insured firm. Perhaps Ms Morgenstern is suggesting that it is immoral to bet against a company defaulting. How is that different from shorting a stock or buying a put?

Ms Morgenstern describes Sylvain R. Raynes’ solution:

Mr. Raynes’s resolution is more radical: unwinding all outstanding credit-default swaps through a process he calls inversion.

Under this plan, insurance premiums would be refunded to buyers of credit protection from the entity that wrote the initial contract. And the seller would no longer be under any obligation to pay if a default occurred.

The premium repayments would be made over the same period and at the same rate that they were paid out. If a contract was struck three years ago and charged quarterly premiums, the premiums would then be refunded quarterly over the next three years.

Mr. Raynes’s proposal would treat hedgers — buyers who bought C.D.S.’s to protect themselves because they actually hold the underlying debt — differently from speculators who bought C.D.S.’s simply to bet against a troubled company.

Those guys, the gamblers, would receive only the premiums they paid to an insurer. Hedgers would have their premiums refunded, in addition to the difference between the underlying debt’s face value and an independent assessment of its intrinsic value.

I realise these are extraordinary times, but it’s never advisable to arbitrarily label some positions as immoral and deny those investors returns. CDS are legal contracts that must be honoured. It is just as important to allow investors to profit on failure as success. Otherwise, we end up with even more volatile financial markets and investors reluctant to lend capital.

Speculative purchases of CDS are not the source of the problem. If anything, CDS made investors too complacent about risk; they may have demanded more CDOs because they believed they could hedge their positions. In that sense, CDS did create some moral hazard, but that can be said of all insurance products, or, for that matter, seatbelts. Ultimately, the existence of CDS meant that more companies could issue debt to undertake valuable investments. Sovereign CDS also empowers investors to buy the debt of developing countries.

The CDS market doesn't need to be shuttered, it needs to recover. And that is why Mr Salmon believes the Treasury needs to intervene to get the market back on its feet.