Friday, October 31, 2008


Lew Rockwell Interview With Naomi Wolf

I am not exaggerating, this is quite possibly the best interview I have ever heard in my life. (Just click on the link and then play it from within your browser.) During the show itself, Naomi Wolf comes to see why libertarians are so opposed to the IRS and the Department of Education. She (at least twice) says, "Oh my God, you are so right." Hint: it's not because we hate poor people.


Paulson's Plan Making Things Worse

So I argue in a Sacramento Union piece. A sample:

When the House of Representatives failed to pass the original request for $700 billion from Treasury Secretary Henry Paulson on Sept. 29, the Standard & Poors 500 (S&P) fell about 8.8 percent. This supposedly proved how vital the rescue plan was for the health and stability of the economy. And yet on Oct. 15—-after the porked up $850-billion bill was passed—-the S&P fell more than nine percent, its biggest drop since the 1987 crash. It’s not just single-day plunges that have gotten worse.

In the year prior to the collapse of Lehman Brothers in mid-September, the average daily move (up or down) in the S&P was 0.8 percent. And yet since then, the average daily move has increased to 3.1 percent. If the government’s measures were supposed to restore calm to the markets, they have been a huge failure thus far. Many free-market economists have been warning that this would happen.


Nouriel Roubini Pics: Dr. Doom or Dr. Dionysus?

I will do a more serious post later, but first thing's first: Let's bump up the Free Advice traffic with some silly pictures!

Here is Nouriel Roubini when he is discussing "stag-deflation":

And here's Roubini when he is just kickin it at his Manhattan pad with some NYU grad students:

BTW I learned of the NYU photos from EPJ, but I can't locate the original post.

Thursday, October 30, 2008


Should We Fear Inflation?

In addition to arguing over the existence of a "credit crunch," we libertarian economists can't even decide on the sign of price changes over the next six months. (Really, I feel I should go apply at the IPCC.) For example, I'm currently throwing down with Mike Rozeff on the Mises blog about gold prices.

Robert Wenzel has a new post explaining why he is dipping his toes into the alarmist camp. C'mon in, the water's fine! I am quite confident our gurus will do what it takes to prevent price deflation, just like Greenspan did back in 2003. (Folks, they were actually worried about falling prices and paying off the entire federal debt back then! Sort of the central banker's analog to the missile gap. BTW I can't find a link to him warning about the loss of the Treasury debt market, but here is Greenspan in 2001 forecasting that the government would pay off the federal debt.)

Let's review the money supply figures. First, the truly scary monetary base (which includes bank reserves and actual currency). And note that these are bi-weekly, and the units are the % change from the prior data point:

OK that's pretty crazy. In fact, if you do it monthly, you have to go back to a single month in the 1930s with a higher month/month percentage growth than the most recent data point.

"But that's misleading!" say some people. "Sure, Bernanke's pumping in base, but it's just offsetting declines in other components of the total money supply."

OK let's go up one level to M1. It too shows rather healthy growth. (Here the frequency is weekly, and again the units are the % change from the prior data point.)

Now because of the frequency, the above graph is pretty choppy. (If I weren't so lazy I would download the data myself, and then plot it in Excel doing a month/month change, but FRED won't let me do that with the latest weekly data points.) Still, I think you can see that recent growth in M1 is quite high, going back 10 years.

Still, you could say that doesn't imply prices will rise, since people are just sitting on cash. Fair enough. We finally can try M2. (The Fed stopped releasing M3 numbers.) And, just to eliminate one possible objection, we will remove the non-M1 components of M2, and just show the remainder. So the chart below doesn't include anything that M1 counts, namely actual cash and checkable deposits. So I think more than any other item that FRED stores for us, the following chart should give an idea of the "non panic hoarding" money supply as of late:

In the above, note that I smoothed it out by switching to yr/yr growth rates. This actually downplays the most recent data points, because M2 growth was admittedly very low earlier in the year.

Still, yr/yr growth in "Non-M1 Components of M2" has been higher the past few weeks, than during the entire time from about 2004-2007.

Maybe I'm missing something, but when people say, "Aww, you can't just look at those huge spikes in the base, because there's a credit crunch man!" I don't see it. I see healthy growth in M2, and I see un-freakin' believable growth in the base.

P.S. It's late, but tomorrow I will go over this again and clarify the components of the various aggregates.


IER Commercial

Ah, it brings a tear to my eye every time I watch it. (BTW, they don't feature me because we don't want Greenpeace knowing what I look like.)

It's actually Silas' birthday today! This one's for you.

Joking aside, here is the "Help Us Fight Back" page where I got this, and here is IER's main page. (I work for them in case it's not obvious.)


Is Gold Going Up or Down?

Michael Rozeff goes into the pit of lions to argue that gold is overvalued. (Really, look at how defensively written his article is. I bet he gets at least 25 LRC readers emailing him in outrage.)

Rozeff is a sharp guy, and (like him) I was surprised that the CPI figures apparently aren't too bad for a long stretch of time. But even if gold right now is undervalued looking backwards--i.e. if gold has risen more than prices in general since a previous benchmark date--that doesn't really mean too much. I think prices are going to go through the ceiling in the next few years, and take gold with them.

I know, I know, there are plenty of smart people pointing to M1, the Great Depression, blah blah. I have three things in response:

(1) Ben Bernanke believes that the Great Depression was caused by price deflation. So he will do whatever he can to inflate, thinking that he is saving us by doing so.

(2) You're saying banks will just sit on the new money? Fine, the feds will borrow and spend it. And again, they will think they are doing a courageous, noble thing; here's Barney Frank saying the government has to start spending, and concerns about the deficit need to take a back seat right now. Here's Paul Krugman saying the same. So that's the Fed chairman, the chairman of the House Financial Services Committee, and the most recent economics Nobel Laureate all proclaiming that more injections of money and debt are the way out of our current mess.

(3) My closing argument is the chart below. Yeah yeah, go ahead and talk about sterilization all you want. I am going to drop the PhD and naively say, "Duh, big money means big prices!"


The Best Comment So Far at Free Advice

Coming from Joe, a former student:

I always thought you were a really good teacher and I'm still kicking myself for not taking your Game Theory class. I still remember you coming into the Austrian class with absolutely no notes or outline and still delivering a structured, organized lecture without forgetting anything.

What Joe doesn't realize is that I would forget stuff all the time, but since there was no formal outline nobody caught me.


Why "APR" on Small, Short Loans Can Be Misleading

On a recent MR thread, Tyler Cowen was pointing to ridiculously high APRs on certain consumer loans, and speculating on the reason for their existence. My good friend Silas (aka Person) was the first to provide the solution, namely that people were paying 35 pounds for convenience; they weren't taking out a loan with 222% interest.

I seconded Silas' explanation, relating how I would agonize over different credit card offers etc. until I realized I was wasting a half hour stressing on something that would mean a difference of $65 either way. And regardless of where that number was coming from, I was getting way too worked up over $65.

But a third commenter really sealed the deal with this scenario from his blog:

In his breathless expose of the payday loan industry [Dec. 3, 2005], the Citizen asks, "would you pay 61 trillion percent interest on a loan?" Well, in some cases, yes, I would, and you probably would too.

I'm in line at the coffee shop at work, and realize I forgot to bring my wallet. I turn to my co-worker. If he can lend me $20, I tell him, I'll buy him a $2 coffee. He agrees. The next morning, after I've been to the bank machine, I pay him back his $20.

Clearly, my friend is an exploitative loan shark. With compounding, the twenty-four-hour loan cost me an annual interest rate of about 128 quadrillion percent -- 128,330,558,031,335,269,* to be more exact. That's 2,000 times higher than even the payday loan operators.

And it's a good thing I didn't stop by the bank machine until the next day. There's a bank machine between the coffee shop and my desk. If I had paid back the loan in five minutes, rather than 24 hours, the effective interest rate would be much higher. Much, much higher -- it would have 4,354 digits!

* In the comments he caught a mistake; he had calculated the rate based on a loan of $20, but actually it was a net loan of $18 because of the coffee.


A Synergy Between Austrian Business Cycle Theory and Best Business Practices?

(Yes I am purposely using buzzwords...)

Barry Linetsky sent me a note saying he liked my sushi article, and that it dovetailed with his own management philosophy of "Achieving More By Doing Less." If you scroll through, you'll see some charts that look vaguely like Hayekian triangles!


Don't Vote! A "Parody" That Just Proves the Point

So Bryan Caplan was on a 20/20 spot on why too many ignorant people are voting. For whatever reason, the piece came off as a hit job on young people. (First clip below.) In response, some pro-voting group made a parody, that showed why older people shouldn't vote (second clip below). But far from refuting Stossel, it just proved the point! There are plenty of ignorant young people and old people, none of whom should be voting. To repeat the old joke: I'm opposed to women getting the vote...but I think they should take it away from men too.

Incidentally, check out the "responses" that the pro-voting guys use in the original interview. Hard to argue with that!

Wednesday, October 29, 2008


Econ Bloggers Gain Clout

I saw this article linked from MR, and then Robert Wenzel just emailed it to me. Naturally it features plenty of quotes from my favorite blogger. It also says that MR gets 25,000 viewers a day. Hmm, we're not quite there yet, kids. But just be patient.


Another I Told You So Re: Greenspan the Traitor

Robert Wenzel tipped me off to another cartoon taking advantage of Greenspan's idiotic "confession":

In case you're wondering, this isn't turning into a kid's book about economics site. It just so happens that a lot of artwork is relevant, lately. Plus it helps to break up the monotony of my long-winded treatises.


Feds May "Invest" $600 Billion in Home Mortgages

All I can say is, if you are predicting price deflation over the next five years, then I think you are nuts.

The federal government is now considering backing up to $600 billion in home mortgages. Now I'm sure a lot of proponents will rush to explain that not all of that will go down the toilet, since not everyone will default. But of course, it is targeted to "troubled" loans; that's the whole point. (You don't need to rescue healthy people, unless you are one of the 9 largest banks in the country I mean.)

So it's true, the government's move will not actually increase budget deficits by $600 billion over the next few years. Let's say $25 billion and call it a day.

This is one of the many problems of the original Paulson bailout. Once the government approved $700 billion for rich bankers, the floodgates were open. Now, if someone recommends any plan involving less than $50 billion, it doesn't even sound serious. "Where you been, Jack?" The public has been desensitized to the astronomical* numbers, and so now we must prepare for trillion-dollar-plus deficits very soon. Maybe not in FY 2009, but I bet FY 2010. I am willing to make a public wager on that, if someone wants to take the other side.

* I am reminded of a funny Feynman quip where he says something like, "People say 'astronomical' to mean really large, but things in astronomy only go up to the billions. Yet the national debt is in the trillions. So I propose the term 'economical' for really big numbers."


The Fed Really Wants to Test Whether Low Interest Rates Mess Up the Economy

Ironically, just after I posted (below) that Brad DeLong has finally come around to questioning whether Greenspan made the right move in cutting interest rates so much, I see the headlines that the Fed has once again lowered rates down to 1%.

Let me say it once again, for the record: Suppose that Ludwig von Mises and Friedrich Hayek were right, and that really low interest rates (caused by the central bank flooding the market with artificial credit) screw up the market's coordination over time. Then that means we are now sowing the seeds for an even bigger crisis four or five years from now.

It's true, many people would say, "That's irrelevant. Right now the pain is so bad, we need to stop the bleeding and deal with future problems down the road."

However, that's exactly what people were saying in light of the "unacceptable" pain that would have occurred due to the dot-com crash and 9/11 attacks. It never occurred to people back then, how bad the housing boom would end up being.

Oh, another little twist: Keep in mind we will probably have very liberal Democrats running all branches of government when the chickens come home to roost. So on top of the Fed distortions, let's throw in some tax hikes, and maybe some explicit price controls too. And maybe some more concessions to unions--why not?


Two Interesting Posts from Arnold Kling

In this one, he quotes his former classmate, Bob McDonald, who says in an Oct. 9 post:

[Bob McDonald:] At this time, the government is the only agent in a position to intervene, but the government is also part of the problem. No private solution will emerge with the government hovering in the background, making decisions on the fly (will a particular institution be rescued or abandoned?) and essentially commandeering markets.

This is in synch with my much more zealous LRC piece in late September:

[Murphy:] And yet, there is no rhyme or reason to the government’s decisions. Lehman Brothers was allowed to fail. In essence, you’ve got a massive beast stalking the financial markets. This creature has many trillions of dollars ultimately at its disposal, and oh yes, I should add: It is not afraid to send armed men to your house if you should ever really cross it. In this environment, is it any wonder that the credit markets are "frozen"? When the SWAT team bursts into your kitchen window, you freeze up, right? Why should things be so different on Wall Street?

(BTW I'm not accusing McDonald of plagiarism, I'm just saying you heard it here first.)

Then in another post, Kling has some very revealing quotes that show just how bankrupt mainstream macroeconomics is. Here's Bernanke in an interview he gave to a guy writing a book (not sure of the date of this):

[Ben Bernanke:]A price target that avoided deflation would have de facto forced abandonment of the gold standard and would have eliminated a major channel of depression...So I do agree that stabilizing prices is the ultimate lesson of the Great Depression and also of the 1970s. There really is nothing more a central bank can do for domestic economic stability than make sure that inflation remains low and stable over long periods.

So do you see why, in retrospect, that's pretty damning? There was price stability (in consumer goods) during the 1920s--that's why monetarists think the Fed did a great job during the Roaring decade. And there was very low consumer price inflation during the housing boom--again, that's why monetarists thought the Fed rates reflected changes in the "real economy," and weren't generating the boom in housing. Oops.

Now Kling also quotes Brad DeLong who (courageously) admits that he didn't second-guess Greenspan's decision with interest rates at the time--or even six months ago. It is only now that he is having second thoughts:

[Brad DeLong:] The current financial crisis has its roots in Greenspan's decision to keep interest rates very low in 2002 and 2003 to head off the danger of a deflation-induced double-dip recession, and his subsequent decision that the costs of cleaning up after a housing bubble were likely to be less than the costs of the high unemployment that would be generated by a preemptive attempt to pop a housing-speculation bubble. Two years ago, I would have said that Greenspan's judgment here was correct. Six months ago, I would have said that his judgment was probably correct. Today -- in the middle of the largest nationalizations in history -- I can no longer state that Greenspan made the right calls with respect to the level of interest rates and the housing bubble in the 2000s.

Seriously folks, why oh why can't these economists just admit that central planning is a bad idea when it comes to the capital markets? Why is that so hard? Is it because the Austrians have annoying personalities (and yes many of us do!) and our gloating would be really really obnoxious?


More Confusion on That #$# Bond Chart

OK here it is once again folks:

Let me review the standard interpretation, and then repeat my criticism of that standard view. But then I will bring up Matt Machaj's devastating critique of my explanation. (Yes, that's right--by the end of this post, you will see that I have no clue what is going on. But it serves a purpose to show why no one else does either, right?)

Standard Story: "The market expects (price) deflation. If the CPI actually goes down, then the Treasury reduces your principal on the TIPS you are holding. So that's why investors insist on a higher TIPS yield than nominal yields on regular Treasurys; with a negative purchasing power premium, the usual gap between nominal and TIPS has reversed itself."

Murphy's Objection: Look up at that chart. In January 2008, the TIPS yield was about zero, while the nominal was 2-and-change. So presumably, at that point investors were freaked out and just wanted to maintain their purchasing power (i.e. insisted on a real yield of roughly 0%), and they were forecasting (as they had been since 2003) moderate CPI increases of a little more than 2%.

Now, suppose the conventional story is right, and that since January, people have gotten much more pessimistic about the economy, and their expectations of CPI increases have gotten steadily lower, as the weeks rolled by. I submit that we would have seen the TIPS stay smack dab at roughly zero--i.e. investors would not insist on higher real yields as the economy fell apart--and the yield on nominal Treasurys would have come down to zero as well, since investors would stop building in a purchasing power premium.

And yet, that is obviously not what happened, as the chart above illustrates so well. Starting around June, the two series moved in opposite directions--the first that had happened in the history of the 5-year TIPS. (I.e. these particular contracts were only offered by the Treasury starting in 2003.) And now that the TIPS yield is higher, note that it is the highest it has ever been. If people are expecting price deflation, and this is the worst economy since the Great Depression, then why the heck are investors still insisting on nominal yields of more than 2.5%? Surely investors haven't gotten greedier since January, and surely (according to the Standard Story) investors weren't predicting deflation back then as much as they are now. So why are nominal yields higher now than back in January?

My (partial) explanation thus far to explain all this has been that investors are worried that the Treasury will fudge on the TIPS contracts. Rather than outright defaulting on conventional Treasurys, the government will first cut corners by not adjusting the principal on TIPS, or by pressuring the BLS to underreport the "true" increase in CPI (i.e. making that announcement even more bogus than it already is). So for example, if investors expect actual CPI to rise 7%, but the BLS reports it as 4%, then investors would insist on 3% points more in their TIPS yield to compensate.


Matt Machaj threw a wrench into my explanation above. My theory explains why TIPS could shoot up, but by itself it doesn't explain why the TIPS should now be higher than the nominal yield. A quick example: Suppose investors predict actual CPI increase of 7%, but fear the BLS will report it as 4%. And suppose the investors want a real yield of 0%. So the TIPS yield would shoot up to 3%, just like it has. So far, so good.

But Matt points out that the nominal should still be higher; it should be 7%. (Investors expect CPI increase of 7%, and they want a 0% real return.) So my observation about BLS hanky-panky works here, if people are saying, "The market expects inflation of 4%." I can say, "No, they expect 7% but fear fudging of 300 bps." Yet Matt is still right, that I haven't explained why the nominal should ever be below the TIPS.


What's the resolution? I regret to say that I don't know. That chart above is defying explanation. We econ PhDs are like Scotland Yard trying to investigate a crime scene, and Sherlock Holmes has not showed up yet to explain what must have happened. All I know is, I feel uncomfortable with all of the "explanations"--mine included--offered thus far. Each of them explains one feature of the chart above, but none explains all of its features.

One last twist: Something that might be going on here, is that nominal yields can't fall below zero. This is because investors can always hold actual currency. So if people expected price deflation of 3%, then they would need a TIPS yield of 3% just to break even (because the Treasury will lower your principal on a TIPS contract if the CPI falls).

However, that still doesn't explain why the nominal yields are so high. If investors are happy with a 0% real return, and they drove TIPS yields up to 3% because they fear price deflation, then why haven't nominal yields (on 5-year contracts) fallen to zero? I.e., why are investors insisting on a higher expected real return on (much safer) nominal Treasurys, than they are on the TIPS contracts?

I suppose you could invoke a rising fear of outright default, so that's why nominal Treasury yields are staying up there. But I feel very uncomfortable that I have to invoke at least three changes in unseen forces (fear of default, BLS hanky-panky, and price expectations) that change juuuuust right in order to reconcile my explanation with the prima facie refutation provided by the data. Now I know what it feels like to work for the IPCC.*

* A little climate change "denier" joke for you.


It's a Good Thing I Don't Believe in "Intellectual Property"

What do you think, kids? At MR on October 27, Tyler pointed to the higher TIPS yield than nominal, as evidence that the market was predicting deflation. In the comments (time-stamped at 1:23 PM), I referred to a FRED graph that showed the history of the two series, in order to argue that Tyler's explanation was bogus.

Then, on the evening of October 27, I posted that same (incredible) chart here on Free Advice, with an elaborated explanation.

Now today, Matt Machaj linked me to this post (note it was made on October 28) and asked what I thought. You can imagine my first thought, and it had nothing to do with the bond market.

Now it's not a smoking gun, I grant you. After all, we are both linking to a FRED-generated graph. But still...

Tuesday, October 28, 2008


The Return of Silas X

What does this mean to you?


Today, Non Sequitur; Tomorrow, Ziggy

This blog is growing by leaps and bounds. It obviously inspired this cartoon:

(HT2 Steve Horwitz)


Two New Websites

Ilana Mercer and Matthew Mueller have both recently launched new websites, which may prove interesting to Austro-libertarians.


I Told You Greenspan's "Admission" Was Fatal

Reader Bob Roddis alerted me to this annoying cartoon. All I can say is, I told you so.


Cap & Trade: If I Can Change Just One Mind...

...I'm not sure it's worth it, but hey it's encouraging. AEI's Ken Green and I butted heads (politely) at last year's Heartland "denier" conference in NYC. Green acknowledged the caveats but, at that time, still thought the government should try to implement a revenue-neutral cap & trade program. He has now apparently retracted his earlier support (HT2 Rob Bradley):

I previously felt that a revenue-neutral carbon tax was a good idea, because it would be both effective and could even be economically beneficial. But three developments have caused me to retract my support. First, rising energy costs have already imposed a huge carbon tax with little GHG reduction. This suggests that the elasticity of energy use could be lower than prior estimates, meaning it would be a useless gesture. Second, as implementations of carbon taxes in Europe and Canada have demonstrated, governments simply cannot implement such tax systems without sucking up some of the revenue, and using the rest to benefit crony-capitalists and steer money to favored constituencies. And finally, because using biofuels such as ethanol would let people save on carbon taxes, demand for such fuels will grow, only compounding the environmental and nutritional mischief they cause.

What is interesting about Ken is that he is quite clearly still concerned about manmade climate change (just skim his article above). So he is living proof that someone can endorse the IPCC's science, but not its policy recommendations.

And by the way, Ken is not recommending a "do-nothing" approach:

Policymakers who really want to implement rational climate policy should be focused, here and elsewhere, on building resilience to climate variability by removing the kind of risk subsidies that lead people to put themselves in climatically sensitive areas, to build on flood plains, in storm tracks and so on. They should be focused on ending the kind of subsidized infrastructure programs that lead people to build giant cities in deserts dependent on far-away sources of seasonal snow. And they should put economic repairs first: only the surplus wealth of productive economies allows us to protect our environment, set aside natural resources, and tread more lightly on the Earth.


Two Random Notes

Andrew Sullivan linked to my Crash Landing post challenging Obama supporters to list things that he could do (assuming he wins) that would make them regret their current support for him. Traffic jumped 732% from the previous day. Too bad there are no Google ads over there!

On a completely unrelated note, my friend Sam is a graphic artist and mentioned that he redid the cover of a Mark Twain publication with which you may be unfamiliar. It's odd that this book is so obscure, because I guarantee school boys would read this volume more than Heart of Darkness or other "classics."

Monday, October 27, 2008


Is the Market Forecasting Deflation?

As I have explained in a previous post, a typical measure of the market's inflation forecast has been falling, and just recently actually went negative. Specifically, if you take the yield on 5-year Treasurys and subtract the yield on 5-year TIPS, that should give you an approximate reading on what investors think annual increases in the CPI will be over the next five years. (I explain this a bit more in the post linked above.)

Tyler Cowen happily cites this fact, since it buttresses his argument that the credit markets are collapsing. (I.e. if there is no credit, prices fall.)

But if we look at the actual constituents of this "market forecast"--i.e. if we break it down into the nominal and TIPS yields--then we see something very strange. Since 2003 (when the Treasury began offering 5-year TIPS), the spread between nominal and TIPS Treasurys has been 2-points-and-change, presumably reflecting the market's expectations of moderate price inflation.

But then since about June of this year, the gap between the nominal and TIPS has completely disappeared. To repeat, this is why those calling for a deflationary depression feel vindicated. But if their explanation is correct, we would expect that the TIPS yield fell during the last 5 months (as investors' forecasts about future growth got more and more pessimistic), while the nominal yields fell even more (as investors grew pessimistic about the economy and started to factor in lower and lower price increases).

But the opposite happened, as the chart below beautifully illustrates. Nominal yields have fallen a little, but the main reason the gap between nominal and TIPS disappeared is that the TIPS yield shot way up. In fact, the 5-year TIPS yield is currently the highest it has ever been, going back to 2003.

This chart is totally incompatible with Tyler Cowen's explanation. It can't possibly be the case that investors are currently forecasting the strongest 5-year growth since 2003. Something else must be going on here.

I submit that one explanation is that investors are growing less confident in the government honoring TIPS contracts. Remember, the way these work is that the government pays a contractually fixed rate, but the principal is adjusted based on changes in the CPI. Thus, it is a "Treasury Inflation Protected Security" (TIPS).

But what if the Treasury is running an $800 billion deficit next year? Isn't it just possible that, before it actually defaults on nominal Treasurys, it first starts cutting corners with the principal adjustment on TIPS? It wouldn't even have to be an official adjustment in the rules; it could simply lean on the BLS to underreport the increase in CPI.

I am not saying this aspect is the whole story, but I think it is definitely a part of it. The market price for insuring even regular Treasurys against default has risen sharply since January. So I think it is very reasonable to suppose that investors are insisting on higher TIPS yields, because they fear hanky panky in the principal adjustment over the next five years.


Laffer Excoriates the Bailout

My ex-boss has an uncharacteristically harsh op ed in today's WSJ. When I worked at Laffer Associates a couple of years ago, he would sometimes have to tell his critics, "I'm not always an optimist, I just happen to be right now." Well, I don't think he'll need to worry about that particular caricature for the next few years... Some excerpts:

No one likes to see people lose their homes when housing prices fall and they can't afford to pay their mortgages; nor does any one of us enjoy watching banks go belly-up for making subprime loans without enough equity. But the taxpayers had nothing to do with either side of the mortgage transaction. If the house's value had appreciated, believe you me the overleveraged homeowner and the overly aggressive bank would never have shared their gain with taxpayers. Housing price declines and their consequences are signals to the market to stop building so many houses, pure and simple.
If you don't believe me, just watch how Congress and Barney Frank run the banks. If you thought they did a bad job running the post office, Amtrak, Fannie Mae, Freddie Mac and the military, just wait till you see what they'll do with Wall Street.

I am glad that a solid group of free market economists are yelling and screaming that this bailout is nuts. At least we will be on record when the excrement hits the rotating blades.

Sunday, October 26, 2008


I Have a Hard Time With the Story of Noah's Ark

I think a lot of people are shocked to discover that I believe that, say, Jesus really healed the lame, and that He really did walk on water. Well I do, and if you think that I must not understand modern science, then I think you must have way too much confidence in your understanding of what is "possible." Keep in mind, for example, that the apostles who saw Jesus "walking on water" wouldn't have examined the situation with the eyes of Richard Feynman. I haven't done research on the topic, but just to give you an idea of what I mean, it's possible Jesus was standing on the back of an aquatic creature. You see people "coasting on water" every time you go to Sea World.

Or how about bringing people back from the dead? Does "modern medicine" teach us that is impossible? Of course not. If you were watching Nova and they interviewed a guy in a white coat with an MD after his name, and he said how a person was clinically dead but they fished her out of the frozen lake and revived her, you would totally believe that tale; you wouldn't even bother googling for corroboration. And yet you wouldn't hesitate to confidently tell me the Gospels are myths because it is "impossible" that Jesus raised Lazarus from the dead.

(Incidentally, some Christians get annoyed when I "cheat" like this; it seems like I'm taking away from God's miracles. But c'mon, I already believe that God created the universe and all of its laws. Obviously God can do whatever He wants. I just think it is more elegant if matter behaves according to some simple rules, and even so yields "miraculous" outcomes that were completely unanticipated by dull humans. This seems more impressive than parlor tricks where He suspends the laws of physics that operate 99.999% of the time.)

OK, now that you know where I am coming from, let me confess that I am having a very hard time taking the story of Noah and the flood seriously. (See Genesis 6-8.) Put aside the logistical problems of getting all the different animals on board, how to feed them, get rid of their waste, etc. etc. There are still some really serious problems with this story.

For one thing, it's not clear to me how the waters can "recede" after it stops raining. If a local area is flooded by rain, then yeah the water levels recede after it stops, but that's because the water goes somewhere and ends up raising the water level in a lake or the ocean.

But if the whole earth was underwater, even the mountains, then how could the water levels have receded? I suppose there could have been cracks in the ocean floor that allowed the water above to drain into underground cavities, but it sure seems like this was a tall tale written by someone who was extrapolating from his experience with regional flooding after a lot of rain.

(It occurs to me that maybe a bunch of the water evaporated. Does anyone know how much water the atmosphere holds? I have no idea, but I'm guessing it doesn't hold so much that a shell of water bigger than the globe would shrink much. But maybe I'm wrong.)

Now a second huge problem: The wording is ambiguous, but it seems that 47 days after dry land first appears, Noah releases a dove from the ark and it flies back with a freshly plucked olive leaf. So how did that happen? Even if you say that somehow the seed of an olive tree survived the flood, even so, 47 days is not enough time for it to grow and generate a leaf, right?

Again, this smacks of someone who is writing a story and didn't think through all of the implications.

So when people ask if I believe the literal word of the Bible, I'm not sure how to answer. I don't, since I'm prepared to say that the story of the flood did not play out exactly as the Bible describes it. But on the other hand, I don't just think the Bible is a collection of myths "with a good lesson." I really think there was a guy named Jesus who healed the sick and rose from the dead. In future posts, I will eventually explain why I think my belief in Him is more "rational" than those who dismiss it as a fairy tale.


Stephen King on the Financial Panic

The byline says it's Stephen King, "managing director of economics at HSBC," but it's got to be the famous novelist. This piece (HT2 Jeff Tucker) is weirder and scarier than Firestarter. There's no point in me even excerpting it; let's just say, the author implies that Alan Greenspan ignored the warnings--given by both Keynes and Mises & Hayek--that unregulated markets can't adequately cope with the problems of time.

Someone please make the voices stop. I can't take much more of this.

Saturday, October 25, 2008


Megan McArdle & ABCT: The Silly Woman Theory of Error

Reader Bashkim Rrahmoni notified me of a Megan McArdle attack on Austrian business cycle theory. I was going to cut her some slack, but the more I thought about it, the more ridiculous her post struck me. In "The evil man theory of failure," she tries to play it above the fray, transcending the foolishness of left and right:

Both right wing Austrians and many liberals have a common theory of how all this happened: Alan Greenspan dunnit. The mechanisms by which he accomplished his foul task are different in the two cases, of course. Austrians, and many other free-market types, believe that by lowering short-term interest rates after 9/11, Alan Greenspan made the housing bubble, and its eventual bust, inevitable. The liberals think that by failing to regulate . . . er, something (usually either mortgage originations or CDS's) more closely, he made the crisis inevitable....

Here's the problem: if markets are so great, how come the entire system can be brought low by a smallish injection of short-term capital? The alternative question for the liberals: if regulation is so great, how come one guy, or one fairly minor bill, can apparently single-handedly destroy the most heavily regulated industry in America that doesn't actively involve radioactive material? If your preferred system is really that fragile, then maybe we should be looking into alternatives.

OK, we all get her point, and maybe it's a good one with regard to the leftists. (Will Wilkinson takes this tack too, and I think he and McArdle are on to something. But that's probably my bias talking; maybe a leftist could blow them up the way I'm about to do to McArdle.)

OK, first we'll show the specific details of how silly McArdle's post is (vis-a-vis the Austrians), and then we'll pull back and do a "McArdle is a Moron" from 50,000 feet.

This "smallish injection of short-term capital" corresponded to the lowest that the Fed had set inflation-adjusted rates since 1979. I explain the matter in this piece, but here's the relevant graph:

And note too in the above chart, it's not like Greenspan had cheap credit for three weeks or something. He held the (nominal) fed funds rate at a ridiculous 1% for an entire year. And the year in question was June 2003 to June 2004. Did that coincide at all with the housing boom? Surely a coincidence.

OK sure, Greenspan made credit really cheap. But maybe that was partly a result of the infusion of foreign investment, the bogeyman that Tyler Cowen and Alan Greenspan are blaming. ("And my scheme would've worked, too, if it hadn't been for those meddling savers in China!") So let's just look at something that Greenspan directly controlled, namely the monetary base. The below chart shows the absolute change in the monetary base from the prior year; so be careful, this is in dollars, not percentages:

As you can see, Greenspan let the base grow far more than at any time in prior US history. (The big spike up and down is because of the Y2K scare; they flooded the system with liquidity so people wouldn't pull out their money. Also, in % terms Greenspan's actions were not unprecedented, but still significant.) From January 2001 to June 2004, the monetary base grew by $154 billion--and remember, this is the base of the money-and-credit pyramid. I know Ms. McArdle gets a lot more readers than I do, but still, if she considers $154 billion in base money just a "smallish injection"--te salute, Ms. McArdle!

Finally, the big picture: Suppose I blamed the economic disaster in interwar Germany on the guy(s) running the printing press. Would McArdle ridicule that as an evil Kraut theory?


Greenspan Surrenders in the Battle Over Narrative

I hope this post doesn't disillusion some of our younger readers, but we don't hold back here at Free Advice: Ever since the financial crisis became obvious to all, many other free marketeers and I have been consciously trying to make sure government gets the blame for this, not "laissez-faire capitalism." Obviously we are doing this because we think it is true, but I do want to acknowledge the strategic aspect of it. In particular, I have been trying to drive home the Austrian business cycle theory now that there is a brief window in which many academics, as well as a bunch of nerdy investors, would be far more receptive than ever before.

But alas, with Greenspan's recent testimony, we lost. He conceded defeat. It doesn't matter how many impassioned pleas or delectable analogies I write. The single person on earth who bears the most responsibility for the housing bubble is taking responsibility--by saying it was his faulty faith in deregulated markets. Here's the smoking gun:

Waxman: Dr. Greenspan, I'm going to interrupt you. The question I have for you is... You had an ideology ... You had the authority to prevent the lending practices that led to the subprime mortgage crisis, you were advised to do so by many others, and now our whole economy is paying the price. Do you feel that your ideology pushed you to make decisions that you wished you had not made.

Greenspan: Well, remember what an ideology is. It's a conceptual framwork for the way people deal with reality. Everyone has one. To exist, you need an ideology. The question is whether it is accurate or not. And what I'm saying to you is that I found a flaw - I don't know how significant or permanent it is - but I've been very distressed by that fact. But if I may, can I just answer the previous question?

Waxman: You found a flaw in the reality...

Greenspan: I found a flaw in the model that I perceived is the critical functioning structure that defines how the world works.

Waxman: In other words you found that your view of the world, your ideology, was not right. It was not working.

Greenspan: That's precisely the reason I was shocked because I was going for forty years or more with very considerable evidence that it was working exceptionally well.

Checkmate. Weisberg 1, Liberty 0.

Sure, we will keep writing, just for posterity. People 50 years from now can read our reports to understand precise details that would otherwise be forgotten. But let's not kid ourselves that we can still spin the narrative to exonerate markets.

Nope, this is about as damning a concession as if Don Rumsfeld testified, "Yeah, I am quite frankly shocked at how badly things turned out in Iraq. I mean, the use of overwhelming firepower worked so well in World War II and the first Gulf War. I have to rethink my views on diplomacy."

Can you imagine Bill Kristol trying to spin that? So now you feel my pain.*

Oh, at this point it probably goes without saying that Tyler Cowen disagrees with me; he doesn't think Greenspan conceded much at all.

* Don't get mixed up, folks. I was against the Iraq invasion. And so I'm saying, it would be hilarious to me to watch an intellectual try to justify militarism in light of the chief architect admitting it didn't work. So by the same token, how can I possibly be taken seriously by leftists who distrust the market, after its leading "proponent" and architect of the housing bubble admitted that the Invisible Hand doesn't work after all?


"If You're So Scared, Why Don't You Stockpile Water?"

So asks Pete Leeson in a provocative blog post (see the opening thread, and then in this one a bunch of us [ex] Hillsdale profs tag team the poor pirate pedant*).

In response, I pointed out that we don't need to do that yet, because so far (except for gasoline) the government hasn't imposed price controls. And on the gas situation, I'm referring to the "anti-gouging" measures in some states that kept stations from raising their prices after the hurricanes. In Nashville, we really did have maybe 40 - 50% of the gas stations closed for a few days, and then long lines--spilling out onto the roads--at the remaining, open stations.

Anyway, it would not surprise me in the least if, a few years from now, there is a black market in bottled water. Check this out (HT2 Dan Simmons):

BTW, it occurs to me that because Google is inexplicably flashing pro-Obama ads all over my blog, I should clarify for newcomers that I do NOT endorse the views in this trailer. My point is, there is a growing campaign to demonize bottled water. Even a relatively free market guy like David Zetland has blog posts calling bottled water "evil." (In fairness to David, I should mention that he opposes government restrictions on bottled water.) So my fairly alarmist views on the Paulson heist etc. don't imply a rush to stockpile canned goods (contrary to Leeson's caricature), but some of this other garbage might, a few years down the road. Specifically, what could happen is that the recent shenanigans will lead to massive price hikes, and then a solidly liberal Democrat federal government will "protect the poor" with various measures. Then you might want to stockpile on water and tuna while they're still on the shelves.

* "Pedant" is a word with negative connotations, which I didn't really intend. I couldn't think of a better word that started with "p" though.

Friday, October 24, 2008


Hollywood Behind the Drug War?

When I was much younger, I was shocked to read that mobsters might favor gambling and drug prohibition, since they were involved in those areas. I.e. I still clung to the naive view that actual businesspeople longed to be left alone by the government.

In that spirit, it occurred to me the other day--after watching No Country for Old Men--that Hollywood might be behind the Drug War. After all, think of how many cool movies would be totally boring if drugs were legalized! You've got obvious ones like Traffic and Serpico, but also The Godfather and, most recently, No Country for Old Men. And as cool as Russell Crowe and Denzel Washington are, American Gangster would have been rather lame if drugs were legal. "Frank Lucas is the most intimidating importer in the country! He's pulling in, like, ten grand a month! Let's make sure he's not violating OSHA rules!"


Arnold Kling Is Not Impressed With Mainstream Macroeconomics

This guy might be crankier than me! He quotes from a widely circulated Blanchard paper that summarized the state of macro and concluded it was "good." Kling merely paraphrases Blanchard's observations (fairly, too--i.e. Kling isn't putting words into Blanchard's mouth), and then points out that one might easily have concluded that mainstream macro is in the toilet. Here's Kling:

So, the state of macro is this:

1. We have a workhorse model, with no capital or financial markets.
2. We have some work on asymmetric information and financial markets that is not really integrated into the workhorse model, but which suggests that when "shocks" occur, their effects may be amplified relative to the workhorse model.
3. Real-world data have interesting patterns that either are unexplained by or contradict the most widely-used models.
4. Papers follow a "haiku-like" ritual in order to be published.

And this is "good." I agree with all four propositions, but I disagree with the conclusion.

Then in another angry post, Kling says:

I am shocked at the behavior of my fellow economists during this crisis. They are claiming to know much more than they do about causes and solutions. Rather than trying to understand and explain what is going on, they are engaged in a fierce battle over narrative.

Later on he has this quotable quote:

I have always thought that the issue of the relationship between financial markets and the "real economy" was really deep. I thought that it was a critical part of macroeconomic theory that was poorly developed. But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men's urge for mathematical masturbation.

I didn't know Kling was so feisty! He's bald so I bet he worries about everything like I do, too! As Little Big Man's grandfather said (in reference to General Custer): "I'd like to meet this man, and smoke with him."


Fed Credit Charts as Fine Art

For those who have long suspected that economics is not a science, I am ashamed to report that several of us PhDs can't even agree on whether there was a "credit crunch" during the first half of the year.

Exhibit A is the Mark Thoma/Alex Tabarrok feud. They look at the exact same charts and conclude opposite things. (Here is Alex responding to the Thoma link, so you can see what I mean.)

For my part, I side with Alex. Below I reproduce just two of the charts Thoma shows, but the others all show a similar pattern. During the dark days of the credit crunch, when we were warned the entire financial system would collapse if we didn't cough up $700 billion, the supply of "industrial and commercial loans at all commercial banks" was at an all-time high, and in fact its year/year rate of growth at its lowest point was "only" 12% or so. If you exclude the last few years--which everyone agrees was an insane period with perhaps criminally lax lending standards--then the year/year rate of growth in these loans was higher than at any point going back to the early 1980s. Really, this is amazing, given all the fear-mongering we've been hearing. Just study the picture below for a few moments and let it sink it. (Remember, this is is year/year growth; look at the units on the left axis.)

But here's my favorite. Even if we look at "real estate loans at all commercial banks," we see that the year/year growth rate was always positive, and in fact stayed above 4% the entire time (I'm just eyeballing the chart, it's probably close to 5%).

That's right folks, during the "credit crunch" fueled by the subprime crash etc., the volume of real estate loans made by commercial banks only experienced a significant slowdown in its rate of growth. Sounds like something worthy of bank nationalization to me.

Good job on all this, Alex. Fight the power.

One closing caveat: If you dabble with these series at the Fed site (and it's very convenient to do so--you might as well get something for the depreciating dollar), you will see that in some cases, there was a drop in the level starting in 2008. But still, the charts above show that there was still year/year growth. I.e. even though some credit items fell from, say, December 2007 to March 2008, those items were still higher than they had been in March 2007. If one wants to argue that the economy was slipping off of a cliff, and Paulson needed to save us, OK that's consistent with the charts. But it is NOT true that we were already in a crisis (vis-a-vis the entire scope of the various credit markets) when Paulson and Bernanke had no choice but to go for the Fidel Castro option.

Thursday, October 23, 2008


The Problem With Minarchist Analogies

This post will be critical of John Stossel, so I just want to make clear that he is awesome and is doing a lot to spread free market ideas. Now then...

In a recent WSJ op ed, Stossel compares society to an ice skating rink, and explains that he filmed an attempt to "centrally plan" 100 skaters using a bullhorn. (This was Daniel Klein's idea.) Then they even got Brian Boitano to try it as well, and even here the outcome was obviously inferior to a "deregulated" skating environment.

Well, in today's WSJ, there were a bunch of cynics pointing out that if you slightly changed the analogy to make it closer to the financial bailout, then Stossel would obviously want a "referee." (E.g. if there were so many skaters that if they piled onto one area of the rink, the whole building would collapse and kill the spectators.) And then someone else sarcastically agreed with Stossel, and said he also thought we should get rid of stoplights. Somebody else said you need referees in professional ice hockey.

Now, I'm sure Stossel's TV show was worth doing; it sounds like they did it pretty cleverly, and bringing the "expert planner" Boitano in was a great twist. (I must confess that I can't hear that guy's name without thinking of South Park.)

This exchange of views illustrates the difficulties of minarchism. A Rothbardian anarchist can quite consistently say, "Yes, it's not whether there are 'rules' or not, it's that owners should set the rules on their property. So darn tootin you get rid of government streetlights and stop signs, and you sell the roads to the private sector. Let them decide how to provide the best service to their customers."

If you are a consistent champion of the free market, then all these nagging problems fall away. You're not in the awkward position of having to say that the financial bailout is wicked and stupid, but the Pentagon and Supreme Court are virtuous and brilliant.


Wanda Sykes on the Bailout

A surprisingly libertarian analysis. (She's actually pretty good on other issues too since her Bush-bashing matches up with most of my views. I'm sure I will hate her comedy routines during an Obama administration, though.) HT2 Mitche.

Wednesday, October 22, 2008


Scott Horton Interviews Murphy on Credit Default Swaps, etc.

This interview is another long one--you people are probably wondering how I get anything done. What's good about these ones is that Scott and I are close enough that if he sets up a premise, I'm not afraid to disagree with him.

Incidentally, in our original interview Scott asked me whether things would have been different had the Fed tried to do a "soft landing" after the Greenspan stimulus. (I'm not sure if this portion was retained in the edited version linked above. And my computer is messed up and I can't just listen to that portion of the interview to check.) I explained that that is exactly what they tried to do. As the graph below indicates, they raised the rates back up very gradually, and they made sure the markets knew exactly what was coming.

This episode really underscores the importance of capital theory. If macroeconomics were really just about aggregate spending and "the price level" and so on, then the Fed did a great job handling the dot-com crash and then 9/11. In fact, that's why they hailed Greenspan, and why so many supply-siders were so bullish for so long. (After all, Bush cut taxes, and the markets were fairly deregulated.)

But subscribers to Austrian business cycle theory knew that the housing boom had sown the seeds for a recession. The entire world's capital structure was altered into an unsustainable condition by the injections of central bank funny money. If the Fed had kept rates at 5.25 percent back in September 2007, the US would have entered a sharp recession. (On the bright side, we would probably be through the worst of it by now.) But instead the Fed started cutting rates and--more important--giving lifelines of artificial credit to all of the needy bankers. The economy has been limping along in a state of denial ever since.

Tuesday, October 21, 2008


A Call to Popperians: How Can We Pit Cowen vs. ABCT?

In this post, Tyler Cowen acknowledges my capital-consumption story, and contrasts it with his own explanation. In a nutshell: Tyler is saying that the housing boom was fueled by the real savings of foreigners, and this explains how it is physically possible that Americans consumed more (TVs, iPods, etc.) at the same time that they were expanding the housing sector.

In contrast, Tyler says, the Austrian story would need to link the booming housing sector with falling consumption. After all, if the boom is artificial and based on Fed funny money, then there is a tradeoff between houses and iPods; Americans couldn't have had more of both from 2001 - 2006.

Especially as Tyler clarifies in the comments of the above thread, his point is that yes, capital consumption (a la my sushi story) is theoretically possible, in order to reconcile the facts with the Austrian story. But, he says, the evidence seems to point to his theory.

Well let's do a test! And to make it extra scientific, let's lay out our criteria right now, and THEN go look at the data. (Obviously I know how some of the below will turn out, but not all of it.) So in the comments please give me additional areas in which Tyler's theory and mine give opposite post-dictions (i.e. predictions after the fact).

(1) If I'm right, housing prices should have gone up when Fed was cutting rates, and they should have peaked/started falling when Fed starting raising them.

(2) If Tyler is right, housing prices should have gone up with increased savings in foreign countries that invest in US assets. We could probably refine this some; help here. E.g. maybe we want to look at growth in Treasury holdings by the Bank of China. And then housing prices should peak / fall when the foreign banks slow down their purchases.

(3) If Tyler is right, rising home prices should be accompanied by a rising (or at least stable) dollar. After all, if it's foreign savings coming in that are pumping up the housing sector, that has to put upward pressure on the US dollar. (I grant this this is self-serving, since we know what happened to the dollar. But the direction is right, don't you agree? I.e. if Tyler's story were true, wouldn't it have propped up the dollar?)

(4) I admit I haven't fully worked out all the nuts and bolts of it, but surely the theory that there was massive capital consumption occurring is consistent with a falling dollar. As I say, it's a bit tricky because the Austrian story is that people were consuming capital without being aware of it.

Any other ideas? The obvious problem with the above is that I know how at least 3 of them are going to turn out, so there's a danger that I say, "Yeah, my story predicts a falling dollar" when maybe I wouldn't have said that in 2000.

So can people come up with ways to separate Tyler's theory from mine, that rely on rather obscure things that aren't currently common knowledge? Or maybe that rely on things that switch, to mark the difference between the expansion and the contraction? I'm thinking of things that would happen in the different sectors of the Chinese and US economies, in terms of a Hayekian triangle.

I guess another obvious one is:

(5) Tyler's theory shouldn't require a major recession, whereas mine does.

And the beauty of (5) is that it's still not decided! So I will say this, if unemployment has peaked, then I am wrong. We have not yet begun to recess, if the ABCT explains what happened with housing.


Jeff Tucker Interviews Murphy on Austrian Business Cycle Theory, and the Sinister Bailout

This is a fairly long one [mp3], but I know some of you are students and some are retired.


I Can Die Now

Tyler Cowen links to my article "The Importance of Capital Theory"--via a foreign website, strangely enough. You can read his post and my response, which is about 30 comments from the top.

What I don't get is that Tyler keeps thinking the coincidence of high consumption and high investment is a problem for Austrian business cycle theory. No it isn't. It is a cornerstone of Garrison's Power Point expositions, and it's in Mises and Hayek too. So it's not merely that I'm scrambling to defend ABCT from this unexpected thrust; on the contrary, this feature is why the Austrians say the boom period is unsustainable.

In other words, what Tyler is calling an inconvenient truth for the Austrian explanation, is actually one of its necessary ingredients. If consumption fell in order to free up resources to "fund" the expansion in investment, then there wouldn't be a bust period. To switch to Krugman's "hangover theory" label: It's as if Cowen is saying, "Obviously the theory that the hangover is due to a drinking binge is silly. Why, drinking large amounts of alcohol can mess with your system."

(If the above two sentences don't make any sense, good. Just like Tyler's "critique" of ABCT doesn't even make sense, let alone is it correct.)


Tom Woods, Manipulator of Crowds

I don't understand how this happened. I knew Tom Woods was going to be giving a rousing speech at the Ron Paul rally (down the street from the McCain convention), and I kept asking him when it was going to be on YouTube. And then somehow, I didn't end up watching it until a few days ago.

Anyway, it is pasted below. I have watched it twice now, and I'm still trying to figure out how Tom got them to go nuts over the dorkiest parts of his speech. That takes real talent.

Monday, October 20, 2008


The Importance of Capital Theory: A Reply to Krugman (and Cowen)

OK folks, I know I borrow the Rush Limbaugh cocky narcissism angle a lot in my posts (though he has parlayed it into more $$ than I have, thus far). But honestly, I think today's article over at on "The Importance of Capital Theory" really spells out the nuts and bolts of a boom-bust cycle. It's more difficult reading than the average article, and for maximum effect you should probably print it out and read it on your lunch break or something, rather than in your cubicle with the guy next to you yelling at his cable provider on the phone.

Strictly speaking, I am writing a response to Tyler Cowen, who resurrected an old Slate column by Paul Krugman after he won the Nobel. Krugman ripped the "Austrian" theory of the business cycle back in 1998, and Cowen was citing this piece as one of his favorites by Krugman. (All links are provided in my article, linked above.)

However, if you're not an econ geek, you can skip all of the petty infighting. Just scroll down to the section "A Sushi Model of Capital Consumption" in my article and start reading there. If you really give it 10 - 15 minutes, I think you will have a much better understanding of what happens during an artificial boom period, and then why the recession (and unemployment) are necessary afterward.


Anthony Gregory Puts the Smack-Down on Weisberg's "The End of Libertarianism"

In libertarian circles, Jacob Weisberg's recent Slate column, which blames the financial mess on free markets, has been ruffling feathers. Really, you need to read it if you haven't already. (And even if you have read it, it might wake you up this Monday morning to read it again.)

I had toyed with writing a response, but it seemed too difficult. Weisberg doesn't really have an argument, besides the analogy of Marxists who deny that the fall of the USSR has anything to do with their worldview. In particular, Weisberg doesn't point to this particular deregulation or that, and explain why these changes caused the housing bubble to occur when it did. No, he just asserts that a sufficiently regulated market wouldn't have gotten into such a pickle.

As so often happens in these matters, Anthony Gregory has ended my anxiety, by writing a column as good as I would have. (Possibly better, but let's not explore that possibility.) My favorite part--and what really bothers me so much about this "it's the fault of the free market" BS:

Anyone under fifty who went to public school probably remembers this lesson: We used to have laissez-faire, and it caused great inequality, poor working conditions and bank panics, so we had the Progressive Era and the creation of the Federal Reserve. But we still had too much economic liberty and it (not the Federal Reserve) brought on a Stock Market bubble that burst in 1929, so we had the New Deal, the FDIC, national economic planning and the like. While that didn’t quite end the Depression then (perhaps World War II did?), it did guarantee that we would never have one again. Thanks to government interventions from Teddy and Franklin Roosevelt to Lyndon Johnson, our modern economy will never have the troubles it did in the 1930s. Central banking and millions of pages of federal regulation keep this economy afloat and comfortably growing.

Now all of a sudden the statists claim we are having the same kinds of troubles, and once again it’s all the free market’s fault – the same free market they said no longer exists, due to decades of intervention. It’s the freedom to buy and sell, to contract with one another, to exchange within a framework of free association, free pricing and property rights that has, once again, brought on economic calamity. Not the century of interventions that they said have guaranteed no such catastrophe would ever again happen. No, the remaining pockets of liberty are at fault.

Anthony really nailed it there. In 2003, if you had proposed abolishing the SEC, Jacob Weisberg would have soiled himself. "Are you nuts?! We can't have a completely unregulated market!! Imagine how leveraged everybody would be! Don't you remember, that's what caused the Great Depression!"

You see the point? We don't get to have liberty, because it would supposedly usher in a depression. And yet then when the heavily regulated system spits out another depression (we are warned, in any event), this is taken as confirmation that liberty causes depressions.

Incidentally, the above musings haven't proven that free markets are good. If I were advising the Moscow government back in 1983, and they said, "Let's abolish money," I would have said--after putting down my Star Wars toys--"No guys, remember what happened when Lenin tried that? Don't destroy the last vestiges of freedom or your people will starve!"

And then when the USSR collapsed, a die hard Marxist could have said, "Jeez you capitalist pig, you warned us that pure socialism would lead to collapse, so we compromised. And look what happened!!"

Fortunately, Anthony deals with this matter too, i.e. he explains the primacy of theory when it comes to evaluating social systems.


Robert Wenzel: The Man, The Myth, The Legend

Free Advice readers may wonder who the heck this Robert Wenzel guy is, perhaps the only person mentioned more than 5 times on this blog whom I am not mocking. Well, over at the second best blog in the world, RW and I went head-to-head over some trivial issue. (In retrospect, I think we both lost that argument. And to avoid confusion, he had a slightly altered name, just like David Banner would do in the TV series.)

Eventually RW linked to his own blog, and I took a look. To be honest, I was underwhelmed. In the 8 seconds I devoted to the initial survey, I thought he was just pasting in news about financial markets from other sources. What was worse, he often wouldn't provide links! Sort of like the guy who hooks his friends up with small doses of heroin but doesn't ever say who his supplier is.

Well, I am now happy / ashamed to report that I completely underestimated Robert Wenzel in my initial survey. (Sometimes the opposite happens.) Assuming you believe that the following is true--and I'm about 98% there myself--I think you will agree that Wenzel's site is one to check often, typos notwithstanding.

Last July Wenzel explained that it was ridiculous to expect the Fed to police financial markets going forward, because the smarty-pants Fed economists didn't even recognize the housing bubble as such before it popped. To prove this, Wenzel points to a 2004 paper [pdf] by Jonathan McCarthy and Richard W. Peach, titled "Is There A Bubble in The Housing Market Now?"

You can guess what their answer was. Their reasoning was that the fundamentals justified the rising price of houses--in particular, interest rates were really low. (!!)

Now what's really great is that Wenzel wrote a rebuttal at the time, which included this great paragraph:

But does this mean real estate prices will not drop? Our answer is decidedly no. Indeed, McCarthy-Peach report that “since 1995, real home prices have increased about 36 percent, roughly double the increase of previous home price booms in the late 1970's and late 1980'’s.” We view this increase as largely the result of the Federal Reserve's lowering of interest rates and the pumping of liquidity into the banking system, thus producing the byproduct of higher housing prices. But by incorporating falling nominal interest rates as a “fundamental factor” that can not be a cause of a bubble, McCarthy-Peach have literally defined the cause of the current bubble from being taken into consideration.

Hang on, the story gets better. Peach read Wenzel's article and incorporated the money quote into his Power Point, with the slide titled, "A dissenting view":

The faulty analysis by Federal Reserve economists McCarthy and Peach may go down in financial history as the greatest forecasting error since Irving Fisher declared in 1929, just prior to the stock market crash, that stocks prices looked to be at a permanently high plateau.

As Wenzel says, they probably aren't using that Power Point slide anymore. (Incidentally, here is their whole presentation, if you're curious.)

One last thing: If you follow the links above, you'll see that it's not "Robert Wenzel" but rather "Raymond Sabat" who penned the prescient critique. Wenzel explains that this is because of his sensitive work commitments at the time.

I can totally empathize. By the same token, during 2006 I became very concerned about the prospects for the dollar, and wrote a book (which came out in early 2007) urging Americans to protect themselves. But at the time I was working in the financial sector, so I couldn't use my real name.


The Recession Hits the NY Fed

I'm glad to see our quasi-governmental agencies lead the way in belt-tightening. Matt Machaj alerts us to this press release from the NY Fed:

October 16, 2008

The Federal Reserve Bank of New York will cease publication of its weekly Statement of Condition with the October 30, 2008 release. The information will continue to be available on the Board of Governors’ Statistical Release H.4.1 Factors Affecting Reserve Balances, Table 5 Statement of Condition of Each Federal Reserve Bank.

The H.4.1 is released each Thursday, generally at 4:30 p.m. ET.

Public Affairs
(212) 720-6130
(646) 720-6130

Some readers may remember a similar episode back in March 2006 when the Fed stopped releasing the M3 monetary aggregate, explaining that:

M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.

In tough times like these, I'm glad to see at least some officials keep a sharp eye on costs. You know, it occurs to me that the whole election process burns a lot of money too. What with the bailout, maybe we should skip it this cycle, and reevaluate in 2012?


Should the Fed Burst Bubbles?

The prevailing wisdom among Fed academics used to be "no," but now that is changing. (If we're throwing out private property, we might as well look at some other principles to jettison too.) I summarized my views on the issue in response to Tyler Cowen's remarks on the WSJ article linked:

Cowen: Should the Fed burst bubbles? Maybe in its role as regulator, if not monetary policy.

Murphy: If one thinks that the Fed created the housing bubble, then the above two sentences are truly scary. It would be akin to Richard Nixon saying, "What's the story with these rising prices?! We'll combat them through legislation, if not monetary policy."

Tyler, I realize you think Greenspan's negative real interest rates were, at most, necessary but insufficient conditions for the housing boom. Fair enough. But even if you think it really was "market failure" that caused the present mess, I am continually surprised at how easily you throw out the suggestion that maybe regulation X or regulation Y, or a few hundred billion here or a few hundred billion over there, will make things better, going forward.

Do you actually trust the real human beings who are in DC right now, or who will be in there after the election, to implement a Pareto improvement? Did you hear Obama and McCain talk about their, shall we say, nuanced endorsement of free trade in the last debate? (Hint: It doesn't include cocaine imports for McCain, and it doesn't include car imports for Obama.) And one of these two clowns is going to correct the flaws in second-best outcomes due to asymmetric information in the financial markets?

Incidentally, if you read the WSJ story, you'll find this asinine paragraph:

The Fed's view on bubbles helped fuel what became known as "the Greenspan put" -- the conviction among investors that the Fed would let them take excessive risks and step in as custodian if the bets they made went awry. By giving market participants an incentive to assume greater risk than they would have otherwise, the Fed's laissez-faire position on bubbles may have contributed to the surge in credit that helped push housing prices skyward in the first half of this decade.

Got that, everyone? Now "laissez-faire" includes: A situation in which the central bank will expand the money supply in order to prevent Wall Street investors from being burned by risky bets.

And this is the Wall Street Journal. It would almost be a challenge if this were all a grand conspiracy to undermine the free market, but I think 95% of it is sheer laziness / sloppiness.* Eh, what's the big deal? Who cares what words "really" mean? Everyone else is talking like that, we all know what we mean. Our article was double-plus-good.

* And yes, technically they said "laissez-faire position on bubbles." But again, if the bubble is caused by the Fed itself, then this is still a rather odd way to phrase it. To borrow an analogy from Rothbard, it would be like allowing the Post Office to jack up rates on First Class stamps to $1, and then calling that "laissez-faire." Now that I mention it, I don't see why Paulson doesn't hop on board. He's against price controls, for heaven's sake!

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