Sunday, August 31, 2008


Were the Early Christians Socialists?

Explanatory note: On this blog, I will focus on economic and financial matters, ranging from the household to a global scale. As the blog's subtitle suggests, my worldview is informed by my belief in Jesus and individual liberty, meaning I am a harsh critic of coercive government policies. I assume that most readers of this blog will identify with the latter mindset, though not necessarily the former. For that reason, I will restrict my explicitly "religious" posts to Sundays...


There is an undeniable tension between economics and religion (hence the title of my speech [video, audio] at the Mises Institute a few years ago), and more specifically between laissez-faire capitalism and Christianity. In the lecture linked above, I go through the reconciliation more methodically; in the present post I just want to focus on a particularly troubling Biblical passage for the libertarian Christian.

In Acts 4:32 - 5:11 we read:

32 Now the multitude of those who believed were of one heart and one soul; neither did anyone say that any of the things he possessed was his own, but they had all things in common. 33 And with great power the apostles gave witness to the resurrection of the Lord Jesus. And great grace was upon them all. 34 Nor was there anyone among them who lacked; for all who were possessors of lands or houses sold them, and brought the proceeds of the things that were sold, 35 and laid them at the apostles’ feet; and they distributed to each as anyone had need.
36 And Joses, who was also named Barnabas by the apostles (which is translated Son of Encouragement), a Levite of the country of Cyprus, 37 having land, sold it, and brought the money and laid it at the apostles’ feet.

Acts 5
Lying to the Holy Spirit

1 But a certain man named Ananias, with Sapphira his wife, sold a possession. 2 And he kept back part of the proceeds, his wife also being aware of it, and brought a certain part and laid it at the apostles’ feet. 3 But Peter said, “Ananias, why has Satan filled your heart to lie to the Holy Spirit and keep back part of the price of the land for yourself? 4 While it remained, was it not your own? And after it was sold, was it not in your own control? Why have you conceived this thing in your heart? You have not lied to men but to God.”
5 Then Ananias, hearing these words, fell down and breathed his last. So great fear came upon all those who heard these things. 6 And the young men arose and wrapped him up, carried him out, and buried him.
7 Now it was about three hours later when his wife came in, not knowing what had happened. 8 And Peter answered her, “Tell me whether you sold the land for so much?”
She said, “Yes, for so much.”
9 Then Peter said to her, “How is it that you have agreed together to test the Spirit of the Lord? Look, the feet of those who have buried your husband are at the door, and they will carry you out.” 10 Then immediately she fell down at his feet and breathed her last. And the young men came in and found her dead, and carrying her out, buried her by her husband. 11 So great fear came upon all the church and upon all who heard these things.

Now in light of a story like that, it's understandable how many Christians could think that their doctrine literally implies socialism, and in fact communism, by which I mean the violent imposition of collective ownership of all property. After all, upon a quick reading, it seems that the apostles (this is after Jesus left, btw) demanded that everyone throw their possessions into a common pot, and if anybody selfishly held back, he or she was executed. Not exactly Adam Smith material, eh?

However, I think that's an oversimplification. There are two crucial facts about the above story, which demonstrate that a modern-day communist revolution cannot be justified by reference to the early Christian communities:

(1) The apostles did not compel membership. Now I'm not claiming that Ananias and Sapphira signed a document saying, "We agree to turn over all of our property to the apostles for distribution, and we agree to be put to death if we are caught violating this pledge." But clearly the early Christians were not a roving band of thieves, seizing random people's property under threat of execution. So that right there jettisons any modern attempt to violently overthrow private property in a misguided attempt to recreate the early Christian lifestyle.

(2) Strictly speaking, Peter did not kill Ananias and Sapphira. Rather, God did (perhaps acting through the guilt of Ananias and Sapphira). I grant you that the distinction is tricky, especially in the case of Sapphira; e.g. is it correct to say that Peter healed the lame? Yes and no.

However, my point is that clearly Peter did not use physical force against them. And so if a modern-day Christian socialist wants to be true to this story, he shouldn't authorize men with guns to override bourgeois prerogatives. Rather, he should say, "Bill Gates, give all of your money to Henry Paulson, or else God will strike you dead." And then we could wait and see if God agreed with this.


Why Government Regulations Keep Us Less Safe

I am a very "extreme" (I prefer the term "consistent") advocate of free markets. Not only do I think the private sector should provide 100% of the schooling services in a country, but I also think the government shouldn't be in the business of guaranteeing product safety. For a quick exposition of my views relating to air travel safety and the TSA, see this article. And for a deeper treatment, buy the Best Economics Book Ever.

Basically, my point is that there's nothing magical about government inspectors; any experts whom the government could hire, so too could the private sector. The crucial difference is that a private rating agency would go out of business if (like the FDA) it erroneously told people to stop eating tomatoes, etc., time after time. In contrast, government agencies get more funding after they screw up. If a plane crashes and records reveal shoddy maintenance logs, this is chalked up to "the free market," even though that plane was operating under the protective oversight of the FAA.

Now, one of the best objections to my way of thinking is that, on the surface, it seems nothing is preventing these private sector analogs of the FAA, FDA, etc. from arising. According to this line of thinking, the addition of a layer of government regulators can't possibly hurt (except for false alarms and the waste of tax dollars if the government regulators are truly redundant). But their presence can't make us less safe, my critics claim.

Well it turns out government agencies do make us more insecure. When the government decides to "guarantee" safety in a particular area, it doesn't want some other competing group showing it up. In the weekend (Aug. 30-31) Wall Street Journal, page A2, there is a story, "Private Mad-Cow Tests Can Be Banned, Court Says." It's short so I'll just type in the whole thing, bold is mine:

A federal appeals court said the government can prohibit meat packers from testing their animals for mad-cow disease.

Because the Agriculture Department tests only a small percentage of cows for the rare but deadly disease, Kansas meatpacker Creekstone Farms Premium Beef of Arkansas City, Kan., wants to test all of its cows. The government says it can't.

Larger meat companies worry that if Creekstone is allowed to perform the test and advertise its meat as safe, they could be forced to do the expensive test, too.

The U.S. Court of Appeals for the District of Columbia Circuit on Friday overturned a lower-court ruling that would have cleared the way for the testing. The appeals court said restricting the test is within the scope of the government's authority.

Ah, this is just a great illustration of how things really work in the world. Far from the government chafing huge corporations with its noble efforts to save the public, on the contrary the government is in league with big business. The free market doesn't lead to rampant sickness and accidents, it takes the government to suppress the natural free market reactions to such inefficient outcomes.

I can understand a teenager who thinks politicians are really trying to help. But how can grown men and women actually believe that politicians will side with them, and not the huge corporations that fund their campaigns?

Saturday, August 30, 2008


Is Home Equity a Form of Saving?

In a recent NYT article Tyler Cowen wrote:

The fundamental problem in the American economy is that, for years, people treated rising asset prices as a substitute for personal savings. The thinking went something like this: As long as your home’s value rose every year, you didn’t have to set aside so much from your paycheck.

This is true, insofar as it goes. And indeed in the sharp debate on Kudlow's show between Arthur Laffer and Peter Schiff, the same point came up; Schiff criticized the "saving" of rising home values as illusory while Laffer thought the economy was in fine shape.

Incidentally, this insight helps explain the shockingly low (even negative) "savings rate" of American households in recent years. These Keynesian-type aggregate statistics don't count rising asset values as part of income, and so make people appear as spendthrifts. For example, suppose your salary is $75,000, your house appreciates $25,000 in market value, and you consume $75,000 worth of goods and services (fancy dinners, vacations, etc.). According to the standard macro accounting, your savings rate is 0%, but according to a broader measure that includes assets, your savings rate is 25%, because your total income (broadly defined) was $100,000 and you only consumed $75,000 of it.

Now it's true that because of the recent episode, it appears that treating home equity as "saving" is crazy. But I think that's the wrong conclusion. Really the mistake was "investing" in an asset that would soon drop sharply in price. If you really try to come up with a principled way to criticize the person for treating home equity as savings, you're going to tie yourself in knots.

Let's return to our example above. The guy normally makes $75,000 a year. But this year is special, and he gets a bonus of $25,000. His wife wants him to spend it on diamonds and a two-week blowout trip to Paris, but he thinks that would be irresponsible. "No no honey," he says, "let's instead build that extra guest room like we've been talking about. I've talked with real estate agents, and they tell me it would pay for itself; the market value of our house would go up by the $25,000 it would cost us. Instead of blowing the money now, let's invest it in our house so it will be there when we sell the place and move to Florida for our retirement."

I'm saying if his wife agrees to this plan, then their saving rate for the year is 25%. His income was, hands down, $100,000, and they only consumed $75,000 (at most). Now is this economically different from the first scenario, where the guy's paycheck was always $75,000, but the market value of his unaltered house went up by $25,000? I don't see how.

There is no such thing as a truly safe investment. Even the US federal government might default on its bonds, especially with the clowns we have in there right now. So you certainly can't say, "Putting your money into bonds is saving, but putting it into real estate isn't."

The people who "legitimately" saved, and put some of their paychecks into Fannie Mae and Bear Stearns stock, also got hammered.

I anticipate one possible objection that says, "C'mon, you can't withdraw the equity on your house very easily, so that's why it's not really saving." But by the same token, you can't withdraw contributions to your 401(k) very easily, either. It's still saving though, right?

On an individual level, there is nothing wrong about treating a capital gain as part of one's income--indeed a standard definition for income is, "How much one can consume in a period without impairing the capital stock."

Now it's true, something seems illusory in an entire nation importing foreign goodies (like cars and computers) while they sell off ownership claims to their assets. That seems like cheating, versus the nation devoting some of its resources to producing tools and machinery. But I think this reflects an unsupportable prejudice, comparable to someone saying, "You can't have a strong economy without a strong manufacturing sector. A nation of programmers and musicians isn't really productive." (For more on this last point, see my article here where I show that a libertarian community would probably run perpetual trade deficits.)


Does Tyler Cowen Really Not Endorse ABCT, Or Is He Just Yanking My Thread?

In a previous post, I explained that Tyler Cowen unwittingly proved the predictive power of Austrian business cycle theory (ABCT) several years ago, in a post titled (a la OJ Simpson) "If I believed in Austrian business cycle theory..."

But oops Tyler did it again in his recent New York Times article. Seriously, there are some very ABCT-ish passages in this article, such as:

Behind every financial crisis there is usually a crisis in the real economy, based in some underlying structural deficiency...

The third problem is that lower consumer spending will require the American economy to make some shifts. That may mean fewer Starbucks and fewer new homes but more tractor production for export to foreign markets. In the long run, shifting some consumption to investment is probably beneficial to the economy; in the short run it means job losses and costly readjustments.

In addition, there are still excess homes on the market, and housing prices need to fall further. Of course, such price declines can make banks less solvent and thus worsen the credit crisis. And politicians would like to moderate this fall in prices, again prolonging the adjustment process...

What should policy makers do? One path that is likely to prove counterproductive is further fiscal stimulus in the form of tax rebates. Such stimulus can raise consumer spending and bolster the economy in the short run, but it works — if it works at all — only by pushing consumers to spend rather than to save. It merely postpones needed adjustments by providing a grab bag of goodies at exactly the wrong time.

Now I grant you, Tyler's* article isn't a canonical exposition of the ABCT; for that, I naturally direct you to something I wrote.

But what's really touching/frustrating, is that Tyler is begging for a business cycle theory to organize all of his (good) intuitions. In the MR post where he promotes his NYT article, Tyler explains:

I've become increasingly interested in how an economy can be "tangled up," a notion I first learned from Axel Leijonhufvud. The literature on self-organizing critical systems considers this idea, but I don't think it has been expressed in simple, intuitive form and in a manner that can be integrated with other macroeconomic ideas.

Seriously, folks, ABCT is just what the doctor (not an MD, mind you) ordered. The Austrian theory explains how artificially low interest rates (caused by Fed injections of phony credit) lead to unsustainable investments. The economy's capital structure is a complex web of interrelated processes, and most schools of thought don't model it at a rich enough level to capture this. So that's why only the Austrians have a chance of explaining what happened in the recent housing boom-and-bust. There's more to the story than simple "greed," because speculators and real estate agents were greedy in the 1990s too.

If you really want to see the Austrian story of how the Fed sets in motion an unsustainable expansion--how things get "tangled up" if you like--I encourage you to watch Roger Garrison's phenomenal PowerPoint shows. Really first rate stuff.

* After you criticize someone in 25 separate blog posts, you earn the right to call him by his first name, correct?

Friday, August 29, 2008


McCain Picks a Woman VP!!

Wow, this presidential season is just showing how awful I would be as a campaign manager. Back in January I thought it was a foregone conclusion that Hillary Clinton would not only be the Democratic nominee, but the next president. And three months ago I was sure Obama was going to clean McCain's clock,* but now I think it's going to be a nail-biter. You have to hand it to the McCain camp (and I read that he switched managers fairly late into it, but I forget the new guy's name), with the drilling issue and now picking Alaska governor Sarah Palin (instead of white male Romney), they are putting up a fight.

* If you say that three times fast you will probably make a naughty.


If Obama Wins, Can You Ask for a Raise?

Von Pepe (not his real title) emailed me and declared:

"But, I am thinking that [redistributive] tax policy has CAUSED more income inequality. The highly productive have such high taxes that they demand much higher wages (which later gets redistributed). So, as taxes go higher the wealthy's wages go much higher."

He then went on to say that he is letting his boss know that if Obama wins, Von Pepe expects a big raise to cushion the blow to his take-home paycheck.

Being a trained economist, my first reaction was to scoff. After all, if your boss can afford to give you a big raise, why do you need to wait for an Obama win to ask for it?

However, even as I was typing this, I felt as if my standard analysis was leaving out some important things. First, contrary to popular belief (and which you will even see spelled out in the Greatest Economics Book Ever), in a free market workers do not get paid their marginal product. There is a tendency for this to happen, but there are all sorts of things that prevent it from literally occurring. There are obvious "frictions" from lack of perfect information and transactions costs, but even besides that, there is the fact that specialized workers are very heterogeneous, and so their marginal product at one firm (especially if they've been there for years) might be higher than it would be at any other firm. So for these workers, there is a surplus available that must be split according to bargaining strength.

For example, suppose there is a partner at law firm who adds $1 million in net revenue to the firm every year. That is to say, if he died, the firm's revenues from clients would be $1 million lower. However, suppose that the next-best option he has is to work for a rival firm, whose clients he doesn't know etc. If he worked for them, even after he found his groove, he would only add $800,000 per year.

So there is a $200k gap that he and the first firm must haggle over. Competition in the labor market will not ensure that the lawyer earns $1 million in the long-run. He will definitely earn at least $800,000 (assuming no information deficiencies or high transaction costs), but there's no reason he needs to get all of the $200k pie.

If Von Pepe is in a situation like this, then his boss could indeed afford to give him a raise, and maybe the guilt trip of "Obama is making me pay my fair share!!" gives Von Pepe a bargaining edge that he lacked before.

There is a second issue involved in all this, however. Even if we make all the textbook assumptions, it is still the case that Von Pepe might ask for, and get, a raise if Obama wins and jacks up tax rates. This is really no different from saying that the market price of oil will rise, if Obama imposes a windfall profits tax on oil producers.

The subtlety is that Von Pepe's marginal productivity itself might rise (indirectly), because of Obama's tax hike. With lower after-tax returns, rich people work less. The supply of skilled labor shifts left, and so its market price rises. So those remaining in the industry get paid more in pre-tax dollars.

In conclusion, I endorse Von Pepe's plan to ask for a raise in the event of an Obama victory. It just took us a few email exchanges for me to get past the stumbling block of my PhD in economics to see why he was right.


Is Offshore Drilling a Realistic Solution?

Like playing with a canker sore, I can't help checking out the Env-Econ blog. In a recent post, John "I'm funny enough to compensate for my tree-hugging views" Whitehead was urging his readers to go vote against offshore drilling in a poll hosted here. Now if you click that link and check out the context, you will see some amazing objections to offshore drilling:

* It will be 10 years before oil will start to be pumped into refinery pipelines, from the point the exploring begins.

* Oil will start being pumped out in 10 years, but maximum capacity isn’t expected to be reached until 2030.

This is irrelevant, as I explain in this post. If producers with current excess capacity (such as Saudi Arabia) anticipate greater competition down the road, they will pump more now. This seems to be what happened just recently, when oil prices started dropping the DAY that President Bush lifted the executive moratorium on offshore drilling.

* As the oil is pumped from these new leases, it will just be auctioned off into the global market, and the highest bidder will buy the oil. It will not be set aside solely for Americans, unless we are planning to change the way we participate in free global markets.

Oh my gosh, somebody help me back into my chair... Did they really just say that? Global demand curves slope downwards. If you throw more oil on the global market, the global price of oil goes down, meaning Americans pay less for their imported oil. The really ridiculous thing is, suppose they did pass a law requiring any new production to be sold to Americans. That would simply lower Americans' demand for imported oil, which would lower the world price, which would redirect some of the previously imported oil to the highest bidders elsewhere in the world. Good grief, if you don't know the first thing about economics, why are you setting up a website making economic "points"?!

* Even though the [Gang of Ten] plan projects to raise $84 billion for alternative energy projects, drilling in these off-limit areas will risk serious environmental damage to our coastlines.

This is great, and this is just what the Gang of Ten was supposed to accomplish. Now we're arguing not over "offshore drilling" but rather the piddly little concessions offered in the Gang of Ten plan. The plan doesn't call for revoking the federal ban, instead it calls for renewing the ban, and then allowing four coastal states the right to opt out of it (if their state legislatures so vote), BUT no matter what, even these four coastal states still can't drill anywhere within a 50-mile buffer zone off their shores.

And anyway, what are we afraid of? I thought the evil oil companies were sitting on 68 million acres of leased land where they weren't drilling. So why would they start drilling offshore if they were given the green light?

Thursday, August 28, 2008


Why Keynesian Macroeconomics Screws Up Financial Reporting

Sorry for the delay, folks; my power lunch ran longer than expected, and so this post is coming a few hours later than I had intended. I hope it will be worth the wait. One final caveat: This post will be a bit longer and more academic than most, but I really want to get to the heart of this issue.

In this post I want to pinpoint exactly what is wrong with the typical financial reporting--and it's not really the reporters' fault, they're just quoting the mainstream economists!--when it comes to the strength of the economy. We always hear the mantra that consumer spending represents some huge component (70 percent at the end of 2006) of GDP, and therefore is the key determinant of economic growth. Lately, we've heard things like, "The one silver lining has been the fall of the dollar, which has boosted exports and kept the economy out of recession."

This is all palpable nonsense.

What has happened here is a classic confusion of correlation with causation. Ex post, if you want to measure the "total gross output" of an economy, it sort of makes sense to count up how much money people spent on stuff produced within the United States. (Even here there are serious methodological issues, but those aren't relevant for the present post.) You can't simply count up all the physical things being produced, because that would just give you an immense vector of different items: x amount of iPods, y amount of golden delicious apples, etc. There would be no way to just look at the gross physical output from one year to the next, and be able to say, "The economy grew 3.4% in real terms over the year."

So the way economists get around this issue of aggregation is to use the money prices of the goods as a way to compare their relative importance. So if one more unit of something is produced that a buyer is willing to spend $100 on, that counts as twice as much "output" as one more unit of something that a buyer is willing to spend $50 on. Again, there are methodological problems here, but let's ignore them to concentrate on an even more blatant mistake in the conventional approach.

Every transaction involves an expenditure and an equal receipt of income. That is, when you buy a TV for $100, that's $100 more in "consumer spending" but it is also $100 more in "business revenue." For various reasons--including accessibility of the data--macroeconomists focus on the expenditure side of the coin, and sum up all the expenditures in the economy in order to measure gross output for the period.

In an ex post fashion, there is nothing intrinsically wrong with this choice; any philosophical problems you had with it, would (I believe) also apply to measuring income.

However, the fundamental mistake comes in when people stop using the expenditure approach as a backward-looking bookkeeping trick, and instead use it as a forward-looking, causal theory of GDP growth. That is to say, the act of people spending money on consumer goods does not constitute economic growth.

This is so obvious that I feel funny spelling it out, but somebody needs to do this once in a while to remind everyone how ridiculous the standard commentary on GDP and recession is. If you want to boost economic growth, go work more, produce more stuff. Don't go to the mall and buy things; that's consuming, it's not producing.

Although what I just said is a truism, the reason it's a bit subtle is that (as I explained above) you really do need a link to consumer spending, in order to quantify how much your "production" is worth. If you go out and bust your butt for 8 hours "producing," you really might not be very productive in an economic sense, if nobody wants to buy whatever it is that you made. So in a sense, it's true that if nobody spent a penny on anything made within the US, then we could say "nothing" was produced that year (unless we bring in a timing issue, where people produce stuff that they plan on selling in the future). This subtlety notwithstanding, it should still be clear that consumer spending per se does not constitute production, or contribute to economic growth. It is rather a reflection of economic output.

When I tried to get this point across to my macro students, the best example I could think of was the component of depreciation. Here is the standard formula for GDP:

(1) Y = C + I + G + (X-M),

where X is exports and M is imports. However, we can rewrite this equation as

(2) Y = C + (N+D) + G + (X-M),

where N is net investment and D is depreciation. Back in equation (1), "I" stood for gross investment, and net investment is gross minus depreciation, so that's why I = (N+D).

OK now just stare for a minute at equation (1). In the typical press discussions of the economy, they would say things like, "Consumers are getting increasingly worried about winter heating costs and gasoline prices, and so C is falling. That's bad for total output, Y, so we might enter a recession. On the other hand, the weak dollar is boosting exports X, and reducing imports M, so that is tending to keep Y up, keeping us out of recession." (Of course they don't use the letters, but I'm trying to tie the verbal discussion into equation (1) above.)

As anyone with a background in old-school economics knows, this type of talk can't be right; how in the heck is it "good for the economy" if people go spend like sailors, or if the dollar falls? That doesn't make any sense. But what specifically is the mistake?

Here's where equation (2) comes in. I'm going to employ the same reasoning, but with a new variable. I'm hoping that in this new context--where it hasn't been hammered over your head by "expert" PhDs for your whole life--the absurdity will jump right out at you.

Looking at equation (2) above, suppose someone said, "Well Maria, the economy is experiencing tough times. Consumer spending is down, government spending is down, and net investment is down. However, the one silver lining in all this, is that because of a new type of road salt recently adopted, all of the nation's tractor trailers are wearing out much more quickly than anticipated. Trucks that were thought to have 100,000 more miles in their useful life, are now expected only to eke out another 25,000 miles. Because of this sharp increase in depreciation, the economy might just barely skirt recession. Treasury Secretary Paulson is in fact calling on local governments even in southern states, where there is no snow, to begin salting their roads to promote this growth spurt from depreciation."

OK, does everyone see how I used the exact same logic as the talking heads on CNBC, to "prove" that raising depreciation boosts economic output? Something is clearly crazy here.

I'll end the suspense. Specifically, the problem is that people look at that accounting tautology--Y = C + (N+D) + G + (X-M)--and then mistakenly assume that if they increase a variable on the right-hand side, then the way the equation remains true is that the variable Y on the left-hand side goes up accordingly.

But duh, that's not the only way to balance the equation. In the salt example, what happens is that if D goes up, then N goes down, so that the equation is still true. Gross output isn't affected, but the capital stock grows less than otherwise, because more of the gross investment I (from eq. 1) is being sucked up by the wearing away of the tractor trailers.

It's similar with the nonsense over the rebate checks. If people are good little citizens and do what Paulson wants, then yes C goes up. But that doesn't mean Y has to go up, instead it can just push down I (in eq 1) or N (in eq 2). Duh! If you pay down your debts with your stimulus check, then that gives more loanable funds to the financial sector so some businessperson can borrow it and expand his operations.

Finally, what about the falling dollar? Again, just looking at the equation: If X goes up and M goes down, this isn't necessarily balanced by a rise in Y. On the contrary, it could be offset by a fall in C and/or a fall in I. This should be obvious; a falling dollar makes foreign imports more expensive, and so of course Americans can't consume as much (because part of what they consume is imported goods!). A falling dollar also makes inputs more expensive for US businesses, like, oh I don't know, those who rely on petroleum products. (Duh!)

In conclusion, the GDP accounting tautology is true, if we ignore serious methodological problems. But because of Keynesian theory (not a tautology!), the causal relationships between the variables in the tautology are assumed to work in a particular direction. That is, it is Keynesian theory that says if you increase C (or G), the result will be an increase in Y. This is consistent with the tautology, but is not required by it.

Classical (and modern Austrian) economic theory would say that in general, when people save more, this lowers interest rates and leads to higher investment, and so doesn't affect Y in the near-term. With freely floating wage rates, it doesn't matter how much of their income people "spend" versus how much they save. If consumers start saving 25% of their income, the relative prices and wage rates adjust so that teenagers who used to flip burgers and tear movie ticket stubs, are now working in factories cranking out tractors and drill presses. Total gross output (which includes both consumer and capital goods) doesn't need to fall, and in fact will grow at a faster rate year after year, the higher the savings rate and hence the higher net investment is every period.

Alas, when it comes to the financial press--and even free market economists who ought to know better--"we are all Keynesians now."


Recession Episode III: The Revenge of Keynes

I have to run to a power lunch* but when I return, I promise to explain why these financial press discussions of recession are absurd. Reading these conventional analyses, you would think that if the dollar just kept falling, and consumers ran up their credit cards to buy DVDs and steak dinners, then we would have strong economic growth.

*Note on nomenclature: A "power lunch" is one in which I scrounge for money from possible clients. In preparation, I have been studying beagles and how they droop their eyelids.


Six More Join the Gang

Oh great, the Gang of Ten is now the Gang of Sixteen. These terms are thrown around as if they're funny, when the serious truth is that the entire Congress is a Gang of 535. (Fine fine, Ron Paul fanatics, the Gang of 534.)

If you want to see a point-by-point critique of the original Gang of Ten plan, go here (pdf). In this post, I just want to elaborate on the political context.

Back in June, there was both a congressional and an executive ban on (new) offshore oil drilling in large portions of federally controlled areas. On July 14, President Bush rescinded the executive ban. (Incidentally, that's the exact day when oil prices began dropping like a stone.)

The congressional moratorium expires on September 30 with the federal fiscal year. That means the Congress will have to take positive steps to renew the ban, and the White House will have to sign it into law.

So you can see the pickle that the anti-drilling forces (mostly Democrats) are in. A substantial majority of Americans tell pollsters they want more domestic energy production. So the Democrats can't come out and renew the ban; the Republicans would have a field day in November with that.

Enter the Gang of Ten. By adopting a Paris Hilton compromise, it seems they are being very sensible and above politics--hey, that's so touching that they have five Republicans and five Democrats! Aww, I'm tearing up.

But this "compromise" is nothing of the kind. The plan has $84 billion in subsidies and tax credits for lefty pet projects (fuel efficient cars, biofuels, etc.), and it will pay for $30 billion of this by removing the manufacturing tax credit on oil and natural gas companies. (They didn't specify where the other $54 billion will come from, but I imagine it's not the Tooth Fairy.)

Oh, but at least it allows for more offshore drilling, right? Well, barely. It allows four coastal states to opt out of the current ban, if their state legislatures approve. BUT, even so there will still be a 50-mile buffer zone, meaning that even these four states still won't be allowed to drill anywhere near their coasts, even though some of the most promising known deposits are within 50 miles of the shore.

This is why commentators at the Wall Street Journal and the Excellence in Broadcasting Network are so mad at the Republicans who joined the Gang of Ten (Sixteen). The Republicans had a straightforward, winning issue by championing drilling. But now the Democrats can point to the bipartisan compromise plan, putting the onus back on Republicans to oppose it--and thereby risk a government shutdown blamed on them, if they can't agree on a new bill to fund the government by October 1--or to accept it, even though this will yield a piddling amount of new domestic energy production.

I think this is why purists couldn't believe I was wasting my time working for a think tank, trying to educate politicians about sensible policies. Even if it looks like the strategy is working--the voters are for it, the economics is right, and the "free market" politicians will be popular by supporting it--something will always happen to ensure that inefficiency wins the day.


"Presumptive": One Down, One to Go

At this point, the press can stop referring to Obama as the "presumptive nominee," right? It would be interesting to do a graph of how often the word "presumptive" was used in news stories during 2008. I'm guessing there was a bit of a spike in the last few months...

Wednesday, August 27, 2008


Is Tax-and-Spend Worse than Borrow-and-Spend?

Larry Kudlow interviewed Rudy Giuliani (transcript here), and they naturally started bashing Obama. Here's Kudlow's question:

Kudlow: [O]ne of the big topics of this program tonight for investors is, are we going to return to a real tax-and-spend approach to economic policy, which was used in the 1970s? As you well know, it caused -- it caused sluggish economic growth, it spurred inflation. Stock markets did very badly.

Hmm let's see: High government spending, sluggish economic growth, high inflation, and poor stock market performance. Does that sound like an exclusively Democratic description?

As the chart below indicates, the S&P 500 is lower in nominal terms today than it was when George Bush assumed office.

In that same period, prices in general have risen (even according to the bogus official measures) by about 25 percent. Check out the chart below and compare the inflation record of the two Bushes against the Clinton years. (Of course the worst is Carter.)

Finally, let's check out government spending. It's a good thing W. won and kept out those big-spending Democrats!

In conclusion, YES I realize there are extenuating circumstances. Clinton would have spent more were it not for the Republican Congress, and George W. Bush would have spent less were it not for 9/11. And as far as the stock market, it's not Bush's fault that the dot-com bubble burst right when he took over.

Even so, there's much to be said for the cranky old man's wisdom who claims there's not a dime's worth of difference between the two parties. Going the other way, I also can't get worked up when Democrats try to scare me with references to the police state under McCain. The Democrats in 2006 had a clear mandate to oppose Bush on these matters, and they just rolled over on wiretapping, war funding, etc.


Will Dollar Fall Another 40 Percent?

"Jurg Kiener, CEO of Swiss Asia Capital, expects the dollar to lose another 30% - 40% on the dollar index over the next 3 - 4 years." See the full story.

I'm not sure about the specific magnitude of his prediction, but I definitely agree that the dollar still has to slide significantly, in order to reduce the huge US trade deficit.

In general, a large current account deficit doesn't mean that a currency is doomed, because a current account deficit is the accounting flipside to a capital account surplus. So for example, if the next US president were to sharply cut marginal tax rates, eschew any massive carbon legislation, open up domestic energy production, etc., then investors would flock to US assets (raising the current account deficit) even as the dollar soared.

But that's not what's been happening during the last few years (and it's not what will happen with the next president!). The massive piling up of indebtedness to foreigners is not analogous to a new bio-tech company going public and raising capital. Rather, it's more like a lawyer who just got laid off, and continues with his previous lifestyle by racking up credit card debt.

For more details, see my article here.


Are You Rich If You Make $250,000?

Barack Obama has suggested that people making $250,000 are rich, and so can afford to pay higher taxes.

Now there are all sorts of quibbles we could raise. For example, if you are a young, single professional, then $250,000 per year allows you to live it up. On the other hand, if you are in your forties and have a spouse and three college-age children to support, you're probably not taking weekend trips to Vegas very often.

There is also the issue of where you live. As this article points out, someone making $250k in Paducah, Kentucky would need $586k in New York City to live comparably. Now these comparisons are always flawed, because you can't ask, "How much does a Broadway show cost in Paducah?" Still, the point remains that picking a single number for "rich" is silly.

I'm not the first to suggest this, but it's a great point and so I'll plagiarize: I would love it if Rick Warren or some other moderator would ask Barack Obama, "What percentage of total income tax revenues should the upper 1% pay, in order to be paying their fair share?"

Can you possibly imagine Obama saying on the spot, "Eh, I think the top 1% should pay about 40% of all income taxes"?! Of course not, that would sound crazy. But then he would have some serious backpedaling to do, as this chart shows. Probably Obama would know better than to answer the question directly. Instead he'd say something like, "You know, this is a complex issue with many facets. Our dynamic economy relies on innovative entrepreneurs to create jobs and new products that benefit us all. All my plan asks is that they give back some to the community which has provided them with such opportunities."


We Need Privacy From the Government

At LRC today I have an article explaining why the free market provides the efficient amount of privacy, while government is the true threat. An excerpt:

Even in a completely free society where everyone respected private property rights, it would still be the case that your doctor would know what medications you were taking, your ob-gyn (if you are a woman) would know whether you had had an abortion, your bank teller would have a pretty good idea of how much money you made (especially if you ran your own business and deposited written checks from your customers), and the teenager at Blockbuster would know if you rented naughty movies.

The reason consumers would tolerate these "invasions" of privacy is that the goods and services provided, would be much cheaper if the providers didn’t have to adopt costly screening measures. For example, it would certainly be possible for Blockbuster to set up its stores and checkout procedures, so that the kids working the cash register didn’t actually see which movies each customer rented. For example, the physical DVDs or cassettes could be bar-coded with no other identification on them. The customers would use a key to go find their desired title. So unless Rain Man were on duty, nobody would know if you rented Sister Act 2 every week. (Please tell me you don’t.)
Ultimately, in a free market competition would ensure that customers’ privacy was protected as much as possible, consistent with other desirable product features. In this sense we can say the market provides the "optimal" or "efficient" amount of privacy. If a bank had poor safeguards and its clients’ personal information repeatedly were stolen by hackers, it would eventually go out of business. Third-party agencies could provide consumers with ratings on privacy issues for various businesses.

In contrast, nobody gets to fire the FBI if they think its warrantless searches and wiretaps – not to mention all the tax dollars it receives – are too high a price to pay for the "services" it provides in, say, finding anthrax killer(s).


Tyler Cowen Accidentally Confirms Austrian Business Cycle Theory

This is almost too delicious to be true. Back in January 2005, Tyler Cowen (an econ prof at George Mason who runs the very popular blog MarginalRevolution) had a post titled, "If I believed in Austrian business cycle theory." It's hilarious because Cowen did (and does) not believe in ABCT, yet his "predictions" were uncanny--I encourage you to click the link and see for yourself, and remember what things felt like back in early 2005.

Anyway, Austrian enthusiasts have been calling him out on it lately, and Tyler is a good sport about it here. (I should mention that there is also a discussion of breast implants, if that encourages you to click the link.)

I really can't understand the reticence of some free market economists (not just Tyler Cowen, either) to blame the housing boom and bust on the Federal Reserve. This was an almost textbook illustration of ABCT. As I explain in this article:

The case against the Fed is straightforward: In an attempt to jumpstart the economy out of recession, Greenspan slashed the federal funds target from 6.5% in January 2001 down to a ridiculous 1% by June 2003. After holding rates at 1% for a year, the Fed then steadily ratcheted them back up to 5.25% by June 2006. The connection between these moves by the central bank, versus the pumping up and popping of the housing bubble, seemed to be more than just a coincidence. On the contrary, it looked like a classic example of the Misesian theory of the business cycle, in which artificially low interest rates lead to malinvestments, which then require a recession to correct.

Tuesday, August 26, 2008


Offshore and ANWR Drilling Would Lower Prices Immediately

Notwithstanding certain politicians' claims to the contrary, if the federal government gave the green light to development of ANWR and offshore oil deposits, prices would fall immediately. This is because producers with excess capacity in the present (basically, Saudi Arabia) would see the drop in future prices (because of the new barrels hitting the market in ten years), and that would make it more profitable for them to pump more in the present. I explain the mechanics of this more fully here.

President Bush lifted the executive side of the offshore drilling ban on Monday, July 14. Although it's not airtight proof of the immediate effects of policy changes, even so it's amazing that that day was virtually the all-time peak in oil prices; since then they have collapsed.

Imagine what would happen if Congress let its ban expire with the federal fiscal year (September 30)?!


Are We in a Recession?

Unable to fool the public into thinking things are rosy, here is now the "consensus" view from official economists: "The U.S. economy may have avoided a recession but will grow below trend for some time..."

Isn't it surprising that during the worst financial crisis in decades, with record oil and food prices, and with the housing sector in shambles, we're not even in a recession?

The answer is that the CPI and unemployment figures aren't calculated as they used to be. So for example, when people look at today's figures and compare them to earlier periods, it seems like America is a bunch of whiners.

But that's because those numbers are comparing apples to oranges. Besides the trend to reporting "core inflation"--as if food and energy aren't really important items to most households!--there is the fact that even the regular CPI has all sorts of seasonal and "hedonic" adjustments made to it. For example, in this article I went through and tried to understand how in the heck the BLS said gas prices fell by 4.6 percent from March to April this year. (!) Guess what? No matter how hard I tried, I couldn't reproduce that result. I guess we just have to trust that the government statisticians wouldn't fudge things.

I haven't independently verified his methods, but John Williams over at ShadowStats claims that, using the old methods of calculation, CPI and unemployment would be much higher than what officials are telling us. (As for unemployment, part of the trick is that now they don't count people who are "discouraged" and stop trying to find a job.)

Now folks, some of you may be new to all this, and you think I am a paranoid nut. So let me ask you: Do you do the grocery shopping for your household? Do you think prices have only gone up 5 percent or so over the last year? You know your energy costs have gone up far more than that. Hasn't milk and chicken gotten a lot more expensive too? C'mon, you know the official CPI figure is bogus.

Nominal GDP has been growing much more slowly than consumer prices. We have been in a recession for some time now.


One last comment from the CNBC article linked above... Check this out:

Economists in the quarterly National Association for Business Economics survey were less pessimistic about the economy's outlook in the June 19 through July 10 survey than they were in April, but price pressures will weigh on growth.

"More firms reported higher sales, but also higher material costs and lower profits, in the second quarter than in the first quarter,'' said Ken Simonson, chief economist at the Associated General Contractors of America.

My economic worldview might be wrong, but at least it is coherent. In contrast, these mainstream prognosticators think that (a) economic growth causes inflation (not!), and (b) inflation hinders economic growth. How the heck do economies ever grow, in their books?


How Secure Is Your Bank's Website?

Some commonsense tips that are worth skimming. For example, I knew about "https" but I didn't realize the shading of the URL bar meant anything. Thanks to Robert Wenzel for the link.


House Prices: It's Always Darkest Before Dawn?

Housing prices have just set another record year-over-year decline: They fell 15.9 percent from June 2007 to June 2008.

Ah, but never fear! The monthly fall (from May to June) was only 0.5 percent, which is the lowest monthly drop since July 2007.

Because of this last fact, the headlines read, "House Prices Show Signs of Stabilizing," "Housing: Is the Worst Over?" etc.

Is it just me, or has the financial press been telling us "We've finally hit bottom!" for about 8 months now?

In terms of policy recommendations, it's simple: The government should stop leading people on with hopes of ever more generous taxpayer assistance to the housing sector. People can't just cut their losses, slash prices and move on with their lives, if they think the government might announce yet another unprecedented bailout next month.


Fisher Says 50-50 Chance of High Inflation

Perhaps the most sensible voting member, Dallas Fed President Fisher thinks there is a 50-50 chance our recent inflation spike is a "one-off" event:

"The real concern I have as a central banker is whether or not [inflation] begins to affect the mentality of spending patterns by consumers [and] pricing patterns by producers," Fisher told Dow Jones.

"I don't know the answer to that question - it's sort of 50-50" whether the inflation gains will prove a "one-off event," or something more persistent, Fisher said.

I realize Fisher is in a tough spot politically, and the above is probably the most controversial statement he can make without ruffling too many feathers.

As I will explain in forthcoming posts, I think there is a very real danger--I won't insult you by assigning it a meaningless numerical likelihood--that the official CPI will grow by more than 10% during calendar 2009, at least if they calculate it the way they are now. (I.e., I'm saying that if the figures were supposed to be that high, the BLS might tweak the hedonic measures to bring the numbers down into more reasonable territory.)


David Friedman on House Prices

My previous post on oil and stock prices naturally leads to the in-between case of houses, which provide immediate services and are a durable asset. Thus, when house prices go down, it's not as obvious whether this is a good or a bad thing (as opposed to the cases of oil and shares of stock). On the one hand, falling house prices means that housing is more affordable; some people can buy houses who previously couldn't, and others can afford bigger houses than they previously could. (In the extreme case, intelligent termites who bought houses for food would be ecstatic that the Case-Shiller index keeps falling.)

Of course, the downside to falling prices is that existing owners were counting on their houses as part of their financial wealth. Even if you are planning on living in your current house until the day you die, even so it probably makes you worse off if its market value plummets. This is because you always had the option of selling your house and moving into more humble quarters, if (say) your kid needed an operation, or you get accused of a homicide and need to hire some high-priced attorneys.

For years I have been poking fun at an argument David Friedman (son of Milton) advanced in his books, wherein he claimed that when a person buys a house, then whether prices go way up or way down after the purchase, the new owner benefits either way. Friedman's case is based on a static model, where the consumer makes one decision--on how to allocate his given income between housing and "everything else"--after seeing the new house price, and then that's it. In this setup, yes, the consumer can only be helped by a change in house prices. After all, the consumer can always retain his existing house, and so (according to Friedman's assumptions) changes in price can't possibly hurt. And indeed, they will in fact help: If house prices go up, then the owner can sell his new home for a gain, move into a slightly smaller house, and then buy more of "everything else" with the leftover money. And if house prices go down, then the consumer can buy fewer units of "everything else," and use the freed up money to buy a bigger house. Win-win.

There is something fishy with this analysis; I spell out the fallacies in this piece. But for the present post, I want to report an email with David Friedman. With all the mess in the housing market, I wondered if he still clung to his argument. (I.e., why aren't we all rejoicing that we can now afford more square footage than we could in 2006?) Specifically, I asked him if he had any comments about his argument from years earlier, in light of the current housing debacle. Here is his response, quoted with permission:

Not really. The argument is specifically about people who have bought the house that, if nothing changes, they will want to live in more or less forever. That doesn't describe all that many people. For that case, the argument is correct--although you need the additional assumption of zero transaction costs to get from "are no worse off" (because they can do what they would have done if prices hadn't changed--stay in the same house) to "are better off" (because they can now adjust their housing consumption up if prices are lower, down if higher).

But I do find it amusing that when house prices are high, people complain about how high they are, and when they come down, people complain about falling house prices.

One final point: PLEASE PLEASE believe me, that I understand Friedman's argument. I am not saying that he's wrong, inside his model. My point is that his model assumes away the very reasons that, in the real world, owners hate it when house prices fall. So it's not a very useful "counterintuitive" result, since it is only true in an alternate universe. And if you go and read his exposition (in the link above), you'll see that he made it sound as if real people in the real world were wrong when they complained about falling house prices.


Why Do We Want Low Oil But High Stock Prices?

The short answer is that (usually) oil is quickly consumed while corporate stocks are pure assets. When the price of oil drops, it allows people to consume more oil and get more benefits from it--they can drive more, produce more oil-based products, etc. In contrast, if the price of Fannie Mae drops 10%, nobody says, "Great! Now I can use the stock certificates to wallpaper the baby's room! The wife told me last month that it was a ridiculously expensive notion, but she can't say that now!"

Of course, for people who do own large stocks of oil, then rising oil prices are a good thing. And countries that are net oil exporters do well when world oil prices skyrocket. But since the US is a net oil importer, the country as a whole is worse off with high oil prices.

What's really amusing about all the hand-wringing over speculators is that they allegedly can do whatever they want with prices. We are told that the evil hedge funds aggressively buy oil futures, which itself pushes up oil prices and earns them huge profits. At the same time, we are told that the evil speculators short-sell (sometimes without even wearing undies) financial stocks, again in a self-fulfilling prophecy that guarantees them money. Meanwhile, Joe Sixpack has to pay $4 per gallon, and his bank collapses.

Do you see how truly despicable these speculators must be? Why can't they have the decency to make their guaranteed profits by pushing down oil prices and boosting up financial stocks? What jerks!

(To avoid confusion: I am being sarcastic. The answer of course is that the speculators can't drive prices against fundamentals, in the long run. Oil is up because demand has outgrown supply, and financial stocks are getting hammered because of the bad loans made during the housing bubble.)


Nobel Laureates Endorse Marxism

My title is a bit of an exaggeration. (Isn't it?) Monday's WSJ has an article, "Nobel Laureates Say Globalization's Winners Should Aid Poor" (sub req'd). The more I read of this article, the more grateful I became that I was never awarded the (pseudo-)Nobel Prize in economics.

The entire premise of the article is that "[g]lobalization and technology have increased income inequality around the world," and that governments need to sop up some of the admitted gains from globalization in order to compensate the losers.

Yet I challenge step one in this argument. It is certainly possible that globalization has increased income inequality in the richest, most capital intensive nations (such as the US). But my strong hunch is that global inequality has gone down because of globalization. Yes, a measly few million capitalists in the West have gotten much richer because they could move factories to China, employ call center operators in India, and so forth. But the bigger story is that billions of the world's poorest people are now earning higher wages than they were before foreign investors came to town. I would be interested to see a calculation (however rough) where someone plugged in the various incomes from around the world to see what the global Gini coefficient was in, say, 1988 versus 2008. (A quick search shows me [pdf] that the world Gini apparently went up from 1988 to 1993, but since then China and India have grown much faster than their richer peers. My guess is that the Gini went down from 1988 to 2008.)

As Ludwig von Mises would often observe, Western workers are all about redistribution, until you point out that by global standards, blue collar workers in the US are among the richest of the population. So if they are serious about taking from the filthy rich and giving to the neediest, they should send 75% of their paychecks to African orphans every month.

One final quote from the WSJ article to reassure the reader that I am not being unfair to these Nobel clowns. Here we pick up where the reporter quotes Finn Kydland:

"Globalization ought to be good for all countries," though it isn't unless government policies are up to the challenge, he said. Look at Brazil and Argentina over the past two decades, he added. In Brazil, global growth has boosted low-wage workers' income levels more than the levels of higher earners. Argentina, by contrast, saw its per capita GDP slide by some 20% in the 1980s as a series of government administrations piled on a debt load that eventually became crippling. Since then, real wages have fallen and the gap between rich and poor has widened.

What made the difference? "Bad economic policy," said Mr. Kydland. "If there's not a mechanism for redistribution, it probably won't happen."

Wow. I initially read this passage at the gym--my superior physique is not natural, my friends--and thought it was dumb. But now I see that it is D-U-M dumb. Yes Mr. Laureate, if a government piles on a crippling debt load that caused per capita GDP to slide by 20%, then that can seriously harm an economy--and one of those harms is that the poor typically will get hit harder during such a calamity. But what the heck does this have to do with lower tariffs and costs of transportation, foreigners investing capital in your country, etc.?

It is true that in some South American countries, brutal thugs seized control and implemented--at gunpoint--Chicago-style economic reforms. But Naomi Klein notwithstanding, that doesn't prove that market forces are a bad thing, anymore than the Spanish Inquisition* proves the case for atheism.

In conclusion, let me concede that it is theoretically possible for an entire country to become poorer due to globalization. (All you have to do is take the group of people who are losers from globalization, and put them into one country. Voila!) However, for the world as a whole, globalization raises per capita living standards, because it increases productive efficiency--humans as a race churn out more stuff per period, when production is concentrated in those areas with the highest return. And empirically, even though some capitalists do very very well in the new system, much of the benefits of the higher output is showered on the masses. I explain more fully in this article.

* I bet you weren't expecting a reference to the Spanish Inquisition...

Monday, August 25, 2008


I Have a T-Bone to Pick...

Over at Crash Landing (the "2nd best blog in the world," according to one noted economist) I criticized the Pickens Plan for its awful economic analysis. (Note that I am heeding the conservationists' pleas and have thus recycled my incredibly cheesy post title.) Pickens says:

As imports grow and world prices rise, the amount of money we send to foreign nations every year is soaring. At current oil prices, we will send $700 billion dollars out of the country this year alone — that's four times the annual cost of the Iraq war. Projected over the next 10 years the cost will be $10 trillion — it will be the greatest transfer of wealth in the history of mankind.

In that previous post, I responded by saying: Importing oil doesn't represent a wealth transfer. In exchange for our $10 trillion in cash, the rest of the world is giving us oil. And how much oil, you ask? Why, $10 trillion worth. Ain't that grand!

Today I can now add to this critique. While driving to the office just now (and right before skirting death from a school bus), I heard the familiar drawl on AM radio, talking about the need to end our "dependence on foreign ahhl."

When listing the advantages of his plan, Pickens said something like, "And switching to natural gas for our vehicles will provide us the one thing money can't buy: time."

Huh? If you have money, you can stockpile barrels of oil, which buys you time to adapt if foreign imports get cut off for some reason. As of early August, the government had about 73 days' worth of net crude imports stockpiled in the Strategic Petroleum Reserve.

I confess I haven't done even a back-of-the-envelope comparison, but I bet it would be far, far cheaper to bridge the interval from now until electric cars (or whatever) are cost-effective, by stockpiling crude rather than converting the entire US fleet to run on natural gas. Keep in mind, the relevant cost isn't the upfront price of a barrel of oil. Rather, the relevant issue is the storage cost per unit of time, which includes only interest on the upfront price of the barrel.

(On a side note, I have wondered why the private sector hasn't been accumulating larger crude inventories, especially as tensions heat up with major oil exporters [Venezuela, Iran, and now Russia]. But it's really no surprise, because the government would either slap a huge windfall tax on domestic "evil profiteers" who were selling their inventories at $200 per barrel during an OPEC embargo, if they didn't just confiscate their oil outright. With that kind of risk, it would be ludicrous to make purely speculative investments in physical crude stocks, at least for investors in US jurisdiction.)

Pickens is plain wrong when he says that money can't buy "time," meaning time to deal with a disruption in oil imports. Not only can money buy extra time through stockpiling crude, but it would probably be much cheaper than Pickens' proposal.

For more criticisms of the plan--especially to see the pitfalls in wind power--see this IER analysis.


A Classical Mechanics Question to Break Up the Monotony

A quick puzzle before plunging back into the dreary financial news...

So I'm sitting in the left turn lane, the first car in line waiting on the turn signal. A school bus is turning left, coming from my right; i.e. it is making its turn in front of me. At first the driver is cutting it too hard, so that the bus (for a few moments) is literally heading right for me.

Question: If I really thought the driver wasn't going to correct, should I have put my foot on the brake as hard as I could? (If so, should I also have applied the emergency brake?) I'm thinking yes, because then some of the bus's kinetic energy would get transferred to my brake pads (as heat), meaning my car has to accelerate less, meaning the seat belt has to press against my chest with less force to get my overweight body moving at the same velocity as the drunk bus driver.

Does your answer depend on whether there is a vehicle behind me in the turn lane?


Anonymous Surveys Worse than Free Advice

"The U.S. economy may have avoided a recession but will grow below trend for some time as firms face higher prices for a range of goods that will cut into profits, according to a panel of economists surveyed," we learn in a CNBC article this morning. As Nassim Taleb demonstrates in his book The Black Swan, the record of "professional forecasters" in these matters indicates a dismal science indeed.

What really bugs me about these forecasts--which never really give you new information, they're always adjusting the forecasts in light of news that everyone in the market already knows about--is that we have no quality control on the survey respondents. For example, this particular news story is referring to "101 NABE members." Well how accurate have these 101 people been in the past? Just because they have a PhD--do we even know if they all have PhDs to be called "economists"?--doesn't mean they are good at predicting economic growth six months from now. I would much rather hear the forecasts from, say, "10 economists who predicted the financial sector was in real trouble by late 2006."


Plug for Schiff's Book Crash Proof

As part of my atonement for mocking Schiff back in early 2007, I always plug his book whenever appropriate.

I don't recommend it as a place to learn international trade theory, but if you accept his conclusions about the direction of the dollar and US assets in general, then you should read his recommendations for how to protect your wealth. For example, he doesn't recommend shorting the US stock market, because you are still tied to US dollars. Instead, he makes the initially surprising recommendation to take out home equity loans and use the proceeds to buy foreign assets. My full book review is here.

Sunday, August 24, 2008


Schiff versus the Establishment

Peter Schiff is a very interesting guy. He has been basically spot-on for the last few years with his warnings about the US economy. Are you surprised to learn that many big gun finance gurus mocked him along the way? Below are three good examples:

(1) Schiff versus Arthur Laffer (8/28/06)

(2) Schiff versus Steve Forbes (June 2008, I believe)

(3) Schiff versus Bob Murphy (!?!)

Yes, I didn't care for Schiff's explanations on why trade deficits are bad. (I still think his analogies are a bit misleading.) However, in the grand scheme he was obviously right, and I should have realized it much sooner. I don't claim to be omniscient folks, but when I make a mistake I admit it quickly and try not to repeat it.


Is the Fed Inflating or Deflating?

At first you would think this should be an easy question for economists to answer--much like asking a doctor, "Is the patient's fever getting worse?" However, there is actually healthy disagreement on the point even within the narrow group of very-free-market economists. Hard money guys like Peter Schiff have been warning that the US dollar is dead as a doornail, while Gary North (pdf) has actually been warning of deflation for over a year. (Note on nomenclature: For North, "deflation" means a falling money supply, which should tend to lead to lower prices. But the price movements are not the definition of inflation/deflation for him.)

Part of the problem is that some things are zigging instead of zagging, and we economists don't like change. As I explain in this piece, normally when the Fed cuts its target rate, this goes hand in hand with an increase in the money supply (however you want to define it). But since the credit crunch, the Fed has slashed interest rates even while the rate of growth in aggregates such as the base and M1 is very tame, by historical standards. Hence, some economists are aghast at the "easy money" Fed policy, while others are screaming that Bernanke is insane for putting on the brakes while the credit markets are frozen.

Below is a chart (reproduced from my article linked above) showing that the textbook relationship hasn't held during the credit crunch. Note that by Feb 2008, total bank reserves had fallen more than $1 billion since the previous summer, even though the Fed had cut the target rate 225 bp by that time. That's not how things used to work on the blackboard when I taught at Hillsdale College, I can tell you that!

As always, the explanation for all this is that in economics, its laws are only true when you hold "everything else equal." In September 2007 and beyond, certain key interest rates (apparently) were falling on their own because of the new conditions. In that context, it's hard to say whether the Fed was "contracting" or "expanding." Part of the problem is that the very presence of the Fed distorts market behavior; it is impossible for the Fed to truly "follow the market" and "not intervene," as some economists recommend. That's like telling the Soviet planners to mimic what the market would have done.

We will return to these issues often in future posts. The lesson is that we need to be careful before applying rules of thumb that are inapplicable because conditions are different from previous downturns.


Time Says Oil Prices Rigged

In a piece that starts out harmlessly enough and then descends into absurdity, Time argues that oil producers themselves are probably buying futures contracts in order to fatten their earnings. You might think manipulating the world oil market would be risky and expensive, but you (apparently) would be wrong, according to these writers:

The point is, it would only take about $9 billion to control the entire long position in oil. That sounds like an enormous amount of money, but some of the major individual players in oil are bigger than the market itself: Sultan Hassanal Bolkiah Muizzaddin, of Brunei Shell Petroleum, is worth about $23 billion; Saudi Prince Alwaleed Bin Talal Alsaud is worth about $21 billion; Russian Vagit Alekperov of LUKoil is worth about $13 billion...

All an oil supplier would have to do to raise prices is buy up futures contracts.

It's not even that risky. Either the suppliers/investors risk an insignificant fraction of their gargantuan fortune, or they entice other investors to share the risk. With virtually unlimited resources and an actual tie to the underlying commodity, oil suppliers are in a far better position to accomplish this manipulation than, say, the Hunt brothers were during their attempt to corner the silver market in the 1970s.

There are lots of holes in the overall piece, and I will dissect them in an upcoming issue of The Freeman. For now, those readers who are dying to know why speculation in the futures markets isn't causing record oil prices, should refer to my report for IER, or the geekier discussion at EconLib.


"Is My Bank Safe?"

Robert Wenzel over at EconomicPolicyJournal gives us his thoughts on protecting yourself from bank runs.* On a related note, in years past my wife and I had used Emigrant Direct as a way to take money out of our checking account (where we might spend it) and get it earning interest but in a very accessible place. It paid much better rates than what our bank's saving accounts offered, and it was all online.

Well, I'm not sure we want to continue using Emigrant Direct for our alternative savings account anymore, because its business is basically home loans, which (so I hear) isn't the best bet at the moment. Anyone have any thoughts on ED (not to be confused with a disappointing condition)? ED's accounts are FDIC insured, but still, if the point is to have a place to store your months' worth of savings in case you get laid off, you don't want the hassle of a bank closure.

* Did you know that bank runs are not a fact of life, but rather the result of government-sanctioned fractional reserve banking? Read Murray Rothbard's The Case Against the Fed (free pdf) for the juicy details.


Recession Does Not Mean Low Inflation!

There is a myth that during an economic downturn, the one silver lining is that pressure is taken off prices and so inflation rates come down. This mentality oozes from the financial press, and even Ben Bernanke endorsed it Friday during the Group Think session in Jackson Hole, Wyoming. Even though the PPI just hit a 27-year high, the Chairman isn't worried. From the above NYT article:

Mr. Bernanke, while acknowledging “an increase in inflationary pressure,” reasserted his view that in the near future, the upswing in inflation from the oil and food shocks was likely to moderate.

"The recent decline in commodity prices as well as the increased stability of the dollar has been encouraging," he said. "If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year."

Now folks, I realize this is going to sound crazy at first, but Bernanke's view is exactly backwards. Other things equal, if you tell me that economic growth is going to slow, then that tends to make prices go up, not down. What is the lay explanation for inflation? "Too much money chasing too few goods." So during a recession, there are fewer physical units of products and services getting cranked out, while the number of dollar bills (and checking account balances, etc.) hasn't dropped.

For a fuller analysis, see my previous LRC article on why central banks--the Fed in the US--are to blame for rising prices, not "robust economic growth." (Incidentally, Ron Paul backed Bernanke into a corner one time, and got Big Ben to basically admit that an increase in real output actually tends to lower prices--because the same stock of money is chasing more goods. Unfortunately, I can't remember enough about their exchange to find it for you.)

If I've got you wavering with my verbal arguments, click on the graph below, constructed with the Fed's own data. It shows quite clearly that inflation often spikes during recessions.

Saturday, August 23, 2008


Basic Steps to Prepare for a Possible Crisis

I am pessimistic about the U.S. economy's prospects for the next five years. So let's go over some very basic and obvious steps every household should take, as quickly as possible. Note that the goals don't have to be achieved overnight, but setting those goals should be done ASAP.

(By the way, I admit that what I am talking about in this post is nothing brilliant. But it's like going to church every week to hear a sermon on what you ought to be doing. You know what you're going to hear, but you need someone else to say it once in a while.)

OK so here are some basic steps every American household should take:

(1) Set up a monthly budget that has a long-range view. Make it very convenient for yourself, to be able to just change a few entries and then see how, say, saving an extra $100 per month, impacts your net worth in five years.

(2) Don't pay off dollar-denominated debts, even credit cards. Rather, defer those as best you can, and use the freed up dollars to tackle steps (3) and (4).

(3) Figure out how many months you would need, in order to find a job that could pay the bills, assuming you lost your present source(s) of income. People throw around rules of thumb, but I think that's ridiculous; individual circumstances are very different. For example, in my case I have bounced around quite a bit, and do most of my work on a laptop. So I figure I really only need about two months' worth of regular income in terms of very liquid reserves. That's because if something happened and I lost my major source of income right now (I'm a consultant so I don't have "a job" to lose), we could go into austerity mode and make two months' of normal income stretch out for three, and I am certain that I could at least partially restore my income flow within three months. Even if I were in a car accident, I could still work unless I died (in which case my life insurance would cover things).

Yet for somebody else, maybe someone who works at a factory but doesn't have obvious alternatives if that factory should shut down, maybe that household ought to have six months' of income in the bank. Also remember that if you lose your job because of a crisis, then a lot of other people will be looking for work too. So the question isn't, "If I quit tomorrow, how long to find another comparable-paying job?" No, the question is, "If I get laid off tomorrow, how long...?"

(4) If you currently do not have the liquid funds that you figured out in step (3), then start working towards that amount. When doing so, consider acquiring actual gold coins as at least a portion of your liquid savings. Again, some might quote you formulas for what percentage of your reserves should be dollar-denominated, and what percentage should be in gold coins, but it will depend on the individual's tastes. Some people might feel like Indiana Jones if they kept $15,000 in gold hidden around their house, and economics can't say that preference is irrational. People spend lots of money on fancy sports cars too; there's nothing wrong with spending your money in a way that pleases you. So by the same token, if it excites you to own gold--maybe you are a libertarian and think you are giving a nod to a time when the dollar was tied to gold--then go ahead and make a larger fraction of your liquid fund consist of gold coins. On the other hand, if gold seems really scary and volatile to you, then invest in government bonds to supplement your checking account. (In future posts at Free Advice, we will develop more formal analyses as to "smart" investments, but a lot will still ultimately depend on subjective tastes.)

One final thought on gold: Unless you have to deal with tax consequences (because you have an IRA etc.), I would recommend getting the actual physical gold, rather than gaining exposure to a gold ETF in your portfolio. In the type of scenario where you might really need to access those emergency, liquid funds, the government could quite easily declare a financial crisis and suspend withdrawals from commodity ETFs. So in such a calamity (after a terrorist attack, or if Israel starts bombing Iran suddenly), you would be in a much more secure position if you held the actual coins in your possession.


The Unintended Consequences of Bailouts

"Despite" the federal government's recent assurances, Freddie Mac and Fannie Mae continue to struggle. From today's Washington Post:

A major credit rating agency cut the preferred share rating on Fannie Mae (FNM.N) and Freddie Mac (FRE.N) amid mounting concern about the ability of the two largest U.S. home funding providers to access capital, in the latest blow before a widely expected government bailout.

Gee, why is this happening? Oh, maybe this guy can help us:

Early in the day, influential stock market investor Warren Buffett told CNBC there is a "reasonable chance" that Fannie Mae and Freddie Mac stock will get wiped out in a government rescue, reflecting market sentiment that has slammed the companies' shares toward 20-year lows this week.

This is why government interventions in the economy never work as they "should." At first it sounds odd that stock could get wiped out by a "rescue." What's happened is that the government was very austere in its handling of the Bear Stearns meltdown, so as not to set up a "moral hazard"--where investors become reckless because they think heads-I-win, tails-the-feds-bail-us-out.

Yet ironically, they now have the opposite problem. Now if there is a financial firm that's on the ropes, the very presence of the government, waiting in the wings to "help" with a rescue that is very bad for regular shareholders, distorts the situation. People are less likely to pump in new capital, and so the fear of an austere bailout becomes a self-fulfilling prophecy.

Here's a thought: Instead of trying to micromanage the financial markets, maybe the people in DC should have some humility. They don't exactly have a good track record when it comes to financial discipline.

If the regulators would just stop interfering in the market, the morons on Wall Street would get weeded out and everybody could get back to work.

(For a related article, here I discuss the absurdity of restrictions on naked short selling.)


The Importance of Tithing

Folks, this is going to sound corny, as if I'm doing my gosh darnedest to sound like Gary North or Charley Reese. So be it: My wife and I are Christian and so we tithe, meaning we set aside 10% of our monthly income and give it to the Church. (This book gives an in-depth explanation of tithing's Biblical origin, whether tithing on only after-tax income means you're going to Hell, etc.)

I have noticed that without fail our monthly budgets are overflowing with money when we are tithing, and we are living paycheck to paycheck when we are not tithing. Really, I am quite confident that this statement accurately describes my household, and I bet it does yours, too.

The principle can work for secular people as well, but it doesn't have the supernatural implications. Here, the idea is one important reason to form a budget and make long-term savings goals, is that it gives you discipline to get your finances under control. After all, you have to know how much you make each month, and how much you spend, in order to make long range forecasts. Finally, if you keep a meticulous budget like this, it will be painfully obvious to you what you are sacrificing by eating out every day, rather than brown-bagging it. Your budget shows you quite clearly that this is preventing you from taking a Vegas trip in x months. Really? Is Arby's that much better than a deli sandwich you can make in your kitchen? Do you really need to hit Starbucks every morning?

Incidentally, this is a great illustration of my view that everything "supernatural" that God does in someone's life, is also perfectly consistent with the laws of physics. So when you start tithing--and think, "Oh no, if things were tight before, how can I give up an additional 10% of my money off the top??"--all of a sudden your nets are overflowing with fish. And people think, "A miracle! The Lord kept His promise."

But the atheist accountant could point out all the pragmatic and psychological reasons that the very decision to begin tithing, had on monthly inflow and outflow. Nothing magic here!

Right, and that's how God controls everything. It's not just miracles but also everyday life that He controls. It's far more elegant that we can discover simple laws governing subatomic particles, and that this all yields the tremendous complex beauty of the macro world.

So if you are a believer and have been feeling guilty, start tithing. If I told you that a certain prayer would give you an extra 5% income per month, you'd say the prayer. Well I'm telling you that if you start tithing as you know you ought to, then you will get paid for it, literally.

Finally, if you are a skeptic: You understand that the above appeal didn't really depend on belief in an omniscient Deity. So if you want to multiply your paycheck, adopt a long-term budget in Excel (or something comparable), so that you can really see how much your current behavior influences the trend of your standard of living. Now here's the kicker: Go ahead and every month donate 10% to your favorite charity(ies). (Steve Landsburg argues it's "rational" to concentrate your entire donation into one lump sum for the most important organization, but I disagree.)

I think that if you designate a truly altruistic use for 10% of your income, that somehow keeps you objective and you can more dispassionately assess your financial situation. It probably also makes it harder for you to just skip "doing the budget" for a few months because things are crazy at work, you caught the flu, your girlfriend dumped you, etc. But hey, if you're just saving for your future retirement, then you're not hurting anybody by spending recklessly in the present...

So if I'm right about that last observation, then that gives a good, secular explanation for why it's not a burden but actually a blessing if people really think they have a duty to give 10% of their income to something much more important than their consumption.


Don't Pay Down Your Credit Card Balances

In a recent LRC article, I made the case for not paying down your credit card debt. Rather, if you expect the dollar to fall (and prices to rise) fairly rapidly over the next few years, then you should let your card balances roll over, and use the freed up dollars to buy assets such as physical gold or bonds denominated in other currencies.

I recently got a 12-month, 0% APR balance transfer offer, with a 3% transfer fee. So I transferred my (regrettably sizable) credit card balances on to this new card, and will use any savings in the coming months to (a) make payments on my tab with the IRS, (b) build up my reserves of very liquid funds, and (c) buy actual gold coins that I can bury in my backyard.*

*Figuratively speaking. Please don't Google me and come to my house with a shovel.

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