Thursday, April 30, 2009


Man versus Beast

I am a pacifist when it comes to interpersonal relations, but not when there is a showdown between humans and the lower creatures. We have these ginormous carpenter bees that find our wooden house delectable. So last Sunday I took a tennis racket and slew 15 of them (as well as a wasp that chose its flight path poorly).

Today I was packing the car for my short trip to Memphis (for the ALEC Spring Task Force). A carpenter bee moseyed on up to me. Alas, my trusty weapon was 15 feet away, and behind a door to boot. (Otherwise I just would have used the force to retrieve it.)

So what did I do? Did I run into the house squealing like a little girl?

No sir, I cupped my right hand and served that bee right into the concrete. BAM! That's what I'm talking about. A light tap from my sandal put the reckless insect out of its misery. Let that be a lesson to other carpenter bees.


OK I had an epiphany. I recently watched the clip of Winston in Room 101 (it had to do with the Bush torture memos and how they basically were trying to do Room 101 for their prisoners--i.e. come up with "the worst thing in the world" after a psychological profile).

So I was trying to think if it were possible that Winston could have extricated himself from that predicament without giving in. And I know it's a long shot--it actually would probably work for one rat, not sure about two--but hear me out:

When they lift the partition and the rats come at your face, you offer them your tongue. I think that would be a nice fleshy thing for them to sink their teeth in. Then once they're latched on, you retract your tongue back into your mouth and CRUNCH you bite their heads as hard as you can at the neck, decapitating them if you can but at the very least killing them.

If you did that, I think even Big Brother might be tempted to let you go. Or at the very least, he'd have the decency to shoot you.


Will Wilkinson Inhaled

WW comes out of the closet at Cato. I know I know, this raises an obvious question for me as another prominent blogger who can sway public opinion: For the record, I have never smoked pot with Will Wilkinson.

Wednesday, April 29, 2009



* During the debate over cap and trade, there was a lot of gnashing of teeth--including a "worst person in the world" designation from our national moralist--about the Republicans' use of an MIT study to say the average American household would pay $3100 per year, once the program really kicked in. The MIT professor said that was crazy, and you can guess what ensued. I was the lead author in this American Energy Alliance piece explaining the controversy. (And yes, some other members of the team jazzed it up for Beltwayese.)

* I meant to blog this a few days ago when it ran... The WSJ had a great editorial showing just how underhanded Paulson and Bernanke were with Bank of America.

* If you are interested in the torture debate, here's Glenn Greenwald teeing off on David Broder. Sometimes GG is a bit shrill for my taste, but when he's in the zone he really hits it out of the park. (Or if you prefer, "he's on fire.") I think GG missed two of the most outrageous elements of Broder's piece however, which I put in bold in the excerpt below:

Obama is being blamed by some for unleashing the furies with his decision to override the objections of past and current national intelligence officials and release four highly sensitive memos detailing the methods used on some "high-value" detainees.

Again, he was right to do so, because these policies were carried out in the name of the American people, and it is only just that we the people confront what we did. Squeamishness is not justified in this case.

But having vowed to end the practices, Obama should use all the influence of his office to stop the retroactive search for scapegoats.

This is not another Sept. 11 situation, when nearly 3,000 Americans were killed. We had to investigate the flawed performances and gaps in the system and make the necessary repairs to reduce the chances of a deadly repetition.

First of all, since when does something become "what we did" just because the people doing it claimed to be acting "in the name of the American people"? If you want to say, "The American people re-elected George Bush, knowing full well what his policies entailed, and so it's a bit self-serving to now indignantly claim to be shocked! shocked! by it all," then OK that would be a decent argument. But that's not what Broder is arguing above. He smoothly flows from "done in our name" to "what we did." Huh?

Second of all, look at the sheer monstrosity of the second part in bold. Broder doesn't spell it out, but what he's saying is, "After 9/11, we needed a commission because those were some serious mistakes--American people died, for heaven's sake. But this stuff with the torture, well, it was just a bunch of Arabs getting tortured, so no big deal. If it happens again, well, we'll all have to feel bad again for a few months."

That sounds eerily similar to the infamous dialog that got Huckleberry Finn banned from some schools.


Another Aspect to the Mankiw Money Madness

Taylor Conant emailed me his post bringing up a quote from Rothbard regarding "hoarding." It raises a good point that I had originally meant to discuss regarding Mankiw's negative interest rate column, but I ran out of room in my Mises Daily.

Anyway, the point is that people are increasing their demand for cash balances (or "velocity is falling") for a reason. People are uncertain about the future, and so they are (trying to) stock up on their liquid purchasing power. Money provides a service when it is "idle" in your wallet or under your mattress.

So both the grad student's suggestion (to deactivate 1/10 of the cash every year*) and Mankiw's preferred technique of debasing the money with future inflation, are designed to reduce the ability of cash to serve this purpose. Mankiw doesn't care why people are stocking up on cash, he just throws out ideas to get them "spending" again. For an analogy, it would be as if Americans kept buying cars from Japan. In order to get Americans spending money back on Detroit autos, Mankiw's student suggests putting a venomous snake in every tenth import from Japan. Mankiw, the wizened veteran, thinks that idea shows promise but is a bit impractical. Instead, he suggests a 10% tariff. (Sure, the free market is nice in theory, but in the real world Detroit car prices wouldn't fall quickly enough to clear the market, hence the need for government action.)

* Paul Nelson emailed me this, and I must confess I'm stumped. As a good Austro-libertarian economist, I favor the removal of all legal tender laws. So why am I mad at the grad student's suggestion, which strictly speaking wasn't to destroy 1/10 of the cash at the end of the year, but rather to remove its legal tender status? In other words, I (and the student and Mankiw) were assuming that taking away legal tender status for particular dollar bills was the same thing as literally seizing and destroying them. But is it?


On a completely unrelated matter, Taylor also asks me if there is any way to order signed copies of the new book. Sure, if you email me we can arrange it. I guess I would need to charge $25 per book to cover my shipping etc. (Obviously I'm giving the answer here in case anyone else wanted to know.)


GDP Down 6.1% in 1st Quarter

Here's a depressing article...Some excerpts:
The U.S. economy contracted at a surprisingly sharp 6.1 percent rate in the first quarter as exports and business inventories plummeted.

The drop in gross domestic product...was much steeper than the 4.9 percent annual rate expected by economists and followed a 6.3 percent decline in the fourth quarter.

GDP...has now dropped for three straight quarters for the first time since 1974-1975.

...The Fed, which has cut interest rates to almost zero and pumped about a trillion dollars into the economy to try and break its downward spiral, is expected to leave policy unchanged at the meeting.
The advance report from the Commerce Department showed business inventories plunged by a record $103.7 billion in the first quarter, as firms worked to reduce stocks of unsold goods in their warehouses.

Exports collapsed 30 percent, the biggest decline since 1969, after dropping 23.6 percent in the fourth quarter. The decline in exports knocked off a record 4.06 percentage points from GDP.

Investment by businesses tumbled a record 37.9 percent in the first quarter, while residential investment dived 38 percent, the biggest decline since the second quarter of 1980.

...The Commerce Department said the government's $787 billion rescue package of spending and tax cuts...had little impact on first-quarter GDP.

A separate report showed U.S. home loan applications fell last week to the lowest level since mid-March, even as mortgage rates clung to record lows.

I'm sure that medieval physicians had conversations like this too.

"How's the patient doing?"

"Not well. He's even weaker than when his wife brought him in. In fact, I've never seen someone this sick."

"Hmmm. You've tried bleeding him, right?"

"Of course, that was the first thing we did. In fact, I've taken more blood out of this guy than any of my previous patients, but this is the toughest disease I've ever seen. He's not responding to unprecedented treatment."

Tuesday, April 28, 2009


Answering Scott Sumner's Questions About Austrians

Scott Sumner asks some great questions about the Austrian view of the financial crisis. I'll do my best to balance brevity against comprehensiveness in my answers.

1. Why did NGDP collapse late last year?

I'm not saying this is the whole story, and someone might plausibly say I'm confusing cause with effect, but I think the following were all involved:

(a) People panicked because they were told by "the authorities" that the entire world financial system was on the brink of collapse. So the demand for cash shot way up.

(b) The real economy was due for a serious correction after the housing boom. In this article written in September 2007 (which itself was based on an analysis I made in July 2007), I was calling for the worst recession since the early 1980s. That clearly hadn't "hit" as of last summer, so I was not surprised that things finally started falling apart. I don't know why it happened late last year, except to say that the Fed and Treasury had been doing unprecedented things (TAF etc.) to keep the plates spinning. Once people realized that Paulson and Bernanke were bluffing, and that they had no clue what they were doing, panic set in and people understood that there would be no magic undoing of the malinvestments of the boom years by "injecting liquidity" or other such crankish schemes.

2. Could a suitably expansionary monetary policy have stopped NGDP [nominal Gross Domestic Product] from collapsing?

Of course. What was the growth rate in Zimbabwe's nominal GDP? (I actually don't know but I'm assuming >> 0%.)

3. Wouldn’t Hayek have favored enough monetary expansion to keep NGDP from collapsing?

You mean Friedrich, right? If so, I'm not sure. I believe the mature Hayek thought the Fed should have prevented M1 from falling during the Great Depression, but that's not the same thing as propping up NGDP. The best single paper on Hayek (and Robbins') changing views of "liquidationism" in the 1930s I've seen is this one [pdf].

4. Hayek originally thought that the Depression was a needed corrective for the excesses and misallocations of the late 1920s. He later changed his mind and argued that the Fed should not have allowed NGDP to collapse. Was he right to change his mind?

No. Read the book.

5. If monetary policy could not have prevented an NGDP collapse, what is your story? Is it the Keynesian liquidity trap? (I assume the answer is no.)

I do not fear NGDP collapses. I eat units of food, not dollar bills.

6. If a suitably expansionary monetary policy could have prevented an NGDP collapse, should the Fed have tried to do this?

No. Please don't ask me again.

7. If the answer is no, why not? Wouldn’t that have prevented the collapse in manufacturing in Asia late last year? What is the structural imbalance corrected by having 10s of millions of Chinese loose jobs making stuff like shoes? (Presumably there was no shoe bubble.) Are Austrians worried about the U.S. trade deficit?

Are you comparing shoemakers to prostitutes?

The world economy was in an unsustainable configuration during the boom years of 2002-2005. The flow of consumption goods (including durable goods like housing) coming out of the capital structure pipeline increased, but at the expense of necessary maintenance. See this article for a very simple, yet numerical, model of what I'm talking about.

I think he sometimes overshoots into too much "commonsense" simplicity, but I think Peter Schiff is dead right when he ridicules the notion that Asia needs US consumers to fuel their economic growth. The idea seems to be, if Asia didn't have fat lazy Americans grabbing iPhones and plasma screens, then the Asians would be thrown out of work. That's the crudest of...well something, I don't know what. I wanted to say Keynesianism but I think it's older and more primitive than that.

During the boom years, the Chinese and other net exporters were willing to ship Americans consumption goods, in exchange for a growing stockpile of claims on future income. This was clearly unsustainable. So yes, the expansion of Chinese export sectors--to the extent that they were catering to purchases made by Americans who were falsely believing themselves to be rich because of rising house and stock values--was indeed a "bubble." If American real estate had grown at a "proper" rate, then those Chinese exporters wouldn't have seen their demand grow so quickly.

People often ask me, "OK so what sectors were starved for capital, if you think housing, Wall Street quant departments, etc. expanded too much?" I don't know, but if we believe in scarcity and moderately full employment of resources during 2002-2005, then there must have been such sectors. I'm a lover, not an applied economist.

I get why we needed housing to decline for eight straight quarters from mid-2006 to mid-2008, but I don’t get why we then needed to violate Hayek’s maxim to keep NGDP from falling, and let NGDP fall sharply—causing massive output declines in sectors completely unrelated to the housing bubble. Recall that those non-housing sectors held up well during the first two years of unwinding the housing bubble–so we are not just talking about manufactured goods like rugs and furniture.

I'm not sure if this answers your question, but here goes: If in August 2007 the Fed hadn't starting cutting rates (the discount rate at the time, following next month by fed funds target rate cut), and if the government had said, "Well we live in a profit and loss economy, boys, I guess you'll all be filing Chapter 11," then there would have been a horrendous quarter or two. But all of the remaining assets owned by the insolvent banks and other financial institutions would have been sold off to the highest bidder, we would have had functioning asset markets, and there would have been no "credit crunch" because everybody would know exactly what the derivatives were worth, and who was holding what.

But that's not what happened. The government made bolder and bolder moves every month, leading the insolvent firms to believe that if they could just string their investors and creditors along, eventually they would be bailed out. And they were right.

So the Austrian business cycle theory explains why there needs to be a depression following an unsustainable boom. But if the government minds its own business (or better yet, cuts spending and taxes) then the economy can recover fairly quickly.

For example, during the 1920-1921 depression, the government cut the budget outrageously (at least 30% in one year, and I believe even more from 1919 to 1920 I believe) and the NY Fed jacked its discount rate up to a record high for the 1913-1931 period. (I think the record would extend beyond 1931 but I know the above is true for sure.) You had prices fall more than 15% in one year.

So if the Keynesian or monetarist explanation of the Great Depression is right, the 1920s should have been a decade of stagnation.

And yet they weren't; they were the Roaring Twenties. That's because Harding didn't do squat, and so unemployment peaked at 11.7% in 1921 and then was down to 2.4% in 1923. (See this article for more.)

I think Friedman and Schwartz were totally wrong in blaming the "inaction" of the Fed for the 1930s. Was the Fed more inactive then, compared to when it didn't exist pre-1913? How could it possibly be that the worst depression in US history was the fault of a timid Fed, when there were several bad (but not "Great") depressions that occurred before the Fed was created?

Oh, and one other question: As you know I am completely contemptuous of those (mostly Keynesians) who use interest rates as an indicator of monetary policy. Interest rates were very low in American in 1931; and very high in Germany in 1923. I believe that interest rates tell us precisely nothing about whether money is too easy or too tight, especially short term rates. The key variable is NGDP growth (which I believe Hayek also favored targeting.) Do you agree with my view that the 1% (short term) interest rates of 2003 were a totally meaningless indicator of the stance of monetary policy?

I agree that interest rates need not indicate the tightness or looseness of monetary policy. But since prices were falling more quickly in the 1920-1921 depression than in any single year from 1929-1933, I think the NY Fed's discount rate of 7 percent in the first period, versus 1.5 percent in the second period, shows that the Fed was halting money growth in the first period while at least being more liberal in the second. (I didn't have access to a consistent series on monetary aggregates for the whole period.)

So yes, the mere fact that Bernanke Greenspan brought the target down to 1% (in June 2003) by itself doesn't prove anything, but I have argued that he allowed the base to grow at rates that were almost as high as any point in the 1970s. So if we think that the Fed was too loose in the 1970s, then I think we can agree the Fed was too loose in the early 2000s.

Also, if we adjust for actual price inflation, then the real fed funds rate went negative in the early 2000s, something that hadn't happened since the 1970s. (See here.) Since I don't think the technical productivity of roundabout processes went negative (on the margin), this is a clear indication to me that Greenspan was pushing rates down, rather than passively responding to real changes in the supply and demand of loanable funds.


Think Twice News, on the Tea Parties

My old college / grad school buddy Jason Osborne is producing a series on the Tea Parties. Here is the first episode. Note: I'm not embedding it here, because if you go to YouTube and click the HD in the bottom right corner, you get a much nicer picture. I had recorded some audio comments on the event, and they worked a few into the episode.


"Charles Krauthammer Day"

I have to admit, the leftists are more clever than their right-wing opponents. It's too bad they don't know how market economies work.

This guy celebrates "Charles Krauthammer Day" (HT2 Brad DeLong) because back on April 22, 2003, Krauthammer said:
DR. KRAUTHAMMER: Hans Blix had five months to find weapons. He found nothing. We've had five weeks. Come back to me in five months. If we haven't found any, we will have a credibility problem. I don't have any doubt that we will locate them. I think it takes time. They've obviously been deeply hidden, and it will require that we get the information from people who know where they are.

If you're looking for anthrax and VX gas, which can be hidden in a basement or a closet, in a country the size of Germany, you can understand how in five weeks we might not have stumbled across them.

I understand that from the Austrian point of view, Americans appear rather naive. I can assure you that from the American point of view, Austrians appear rather cynical.


I do not want to get sucked into a foreign policy debate; feel free to call me an idiot or a French-loving commie in the comments. I just want to remind everyone that we were clearly told that Saddam HAD WMD IN HIS POSSESSION, and that that's why we had to invade Iraq pronto. After the weapons didn't turn up, there was a lot of optimistic revisionist history going on, a la "Bush never said Saddam had WMD, he said he was developing the capacity for them. So I guess you think we should have sat back and let Saddam butcher those people?"

So to repeat, maybe it was a good idea to invade, maybe not. (Personally, I think not.) But what is NOT up for debate is whether the official reason was the clear and present danger of existing stockpiles of WMD. If you doubt that, then please explain why Krauthammer said the above.


Fed Misled By Libertarian Dogma

So argues Henry Kaufman in FT:
The Federal Reserve has been hobbled by at least two major shortcomings that were primarily responsible for the current and several previous credit crises. Its failure to spot the importance of changing financial markets and its commitment to laisser faire economics were big mistakes and justify a fundamental overhaul of the Fed.

Kaufman actually comes close to my own view near the end of his piece:
Ironically, the problem was made worse by the fact that the Fed was inconsistently libertarian. The central bank stuck to its hands-off approach during monetary expansion but abandoned it when constraint was necessary. And that, in turn, projected an unpredictable and inconsistent set of rules of the game.

We should, therefore, fundamentally re-examine the role of the Fed and the supervision of our financial institutions. Are the current arrangements within the Fed structure adequate – from its regional representation to its compensation for chairman and governors to its terms of office for governors? How can the Fed’s decision-making process be improved? If we were to create a new central bank from the ground up, how would it differ? At a minimum, the Fed’s sensitivity to financial excesses must be improved.

That's right Mr. Kaufman, the Fed was entrusted to do all the things you discuss in your article, and the Fed screwed up horribly. But rather than tinkering with it and getting it j-u-u-u-u-st right, let's be consistently libertarian. No central bank with a monopoly on money production, no legal tender laws, no special regulations on banking. And if a bank gets overleveraged and blows up, Go Straight to Bankruptcy Court. Do not pass Paulson, do not collect $700 billion.


Mankiw Doesn't Realize When He Has Been Beaten...

...and portrays me as an unrealistic ideologue. (In fairness, I implied Mankiw was crazy in my original critique to which he was responding, so he handled it with class.) Mankiw first quotes me, saying that future inflation is not necessary to clear the market, because another solution would be for current prices to fall. (Thus, even if it's true that the "equilibrium real interest rate" is very negative, butting up against the nominal zero rate barrier, then you still get market clearing because the large drop in present prices gives you room for a steep price inflation back up to "normal" levels in the future.) To this Mankiw replies:
I think this analysis is correct, under the maintained assumption that prices (including wages) are completely and instantaneously flexible. But if prices are sticky, then the immediate deflation and concurrent increase in expected inflation won't occur painlessly. Instead, it would take a while for the price level to fall, and as we wait, the economy would suffer through a period of depressed economic activity.

According to conventional new Keynesian analysis, sticky prices are the ultimate market imperfection that makes aggregate demand matter. If you deny that prices are sticky and assume they can instantaneously jump downward to new equilibrium levels, many macroeconomic problems become much easier to solve. Indeed, you don't need to solve them at all, as the market would do it.

I wish we lived in the world that Mr Murphy describes, but my reading of the evidence is that we don't.
[Bold in original]

OK hang on a second. I didn't say prices would "instantaneously" drop down to new equilibrium levels (where "equilibrium" isn't even really a good term because Mankiw means something different from what Hayek or Garrison would in this context). Rather, I said that the market isn't so impotent because of the zero-nominal-interest-rate barrier as Mankiw and others seem to think. The market is trying to adjust to the shocking realizations that have set in after the housing collapse--and this includes the huge increase in the demand to hold cash--but Bernanke won't let it. So as usual, we have Mankiw et al. blaming the market for something that their own prior interventions are causing.

You don't need to take my word for it. I will quote someone whom Mankiw presumably respects to make my case:

In this post the economist gives a "Deflation Alert." So presumably deflation is possible. Oh darnit, on second thought that's not really such a decisive point in my favor, because people who worry about deflation might mean long-term deflation. In contrast, I was arguing that prices could fall fairly rapidly in order for the market to clear, without the need for Mankiw's own suggestion of promised massive future inflation.

Ah, but that's why this blog post from last November is relevant. The author reports with worry that, "The CPI drops 1 percent. Even the core CPI is falling." Now this is quite interesting. From September to October 2008, general consumer prices fell one percent--and that's the actual fall, mind you, not an annualized figure (which would have been in excess of 12 percent deflation per year). What's even more extraordinary is that this price drop of 1 percent occurred while the stock of money held by the public (M1) rose by more than 2 percent (and again, that's the monthly figure).

Hang in there folks, we're almost there: Now if prices fell by (more than) 1 percent in one month, at the same time that the quantity of money rose by (more than) 2 percent, we're looking at a 3 percent monthly drop had Bernanke merely held the money stock constant. If the CNBC pundits are right, and what the economy "needs" right now is a negative 5 percent real rate of interest, and if nominal interest rates are zero, then that means it would take the market economy all of 50 days to achieve the necessary price deflation to clear. (Again, this calculation assumes that Mankiw's diagnosis of the problem, and his prescription of negative real interest rates, is correct.) The economy has officially been in recession since December 2007, meaning that the interventionist approach has not fixed things in at least 16 months. Note that 50 days << 16 months.

To sum up, in case my cutesy-ness has lost some readers: Mankiw admits that my proposal of allowing prices to fall would work, if only prices in a market economy could quickly fall. But alas, in the real world, market prices don't fall quickly enough, and so that's why Mankiw thinks Bernanke needs to promise to dump massive amounts of inflation on us in the future.

Yet I am claiming that the only reason prices haven't been falling very rapidly is that Bernanke has been pumping in money like there's no tomorrow. We all know he's increased the monetary base at an absurd pace, but even the M1 money stock rose 17% during 2008. So if the overall CPI was roughly flat for the year, while the money stock rose by 17%, imagine what would have happened had Bernanke merely pumped in enough base just to maintain M1, let alone had Bernanke truly done nothing and let things play out.

I will leave you with this final quote from Mankiw. Again, does the following sound like a guy who thinks that the market can't give us price deflation in a timely enough fashion?
The credibility of the promise is paramount. To get long-term real interest rates down, the Fed needs to convince markets that it will vigorously combat deflation, and that if deflation happens in the short run, the Fed will reverse it by subsequently producing extra inflation. A credible promise of subsequent price reversal after any deflation ensures that long-term expected inflation stays close to the inflation rate implied by the Fed's target price path.

So there you have it, folks. The Fed needs to credibly promise to inflate in the short run, in order to prevent prices from falling. And then the Fed needs to credibly promise to inflate in the long run, because in the imperfect market economy, prices don't fall in the short run.

UPDATE: I realized I had left one gaping hole in my response. Mankiw might say, "Sure, gasoline and stock prices can fall very rapidly, but the one really sticky price is the wage rate. So you might get housing markets and commodity markets clearing, but you'd still have incredibly high unemployment if we followed your crazy advice and let the CPI drop, say, 17% in 2008."

It's true that wages are stickier than many other prices, but that's largely due to other interventions in the market (unions etc.). But fine, let's take all those as given. It still doesn't follow that the market is as fragile as Mankiw believes. It's not that people in particular jobs would have to take a 20% pay cut, but rather that laid off workers would need to settle for much lower pay in order to get hired someplace else. So if a former quant at a hedge fund that blew up used to make $200,000 a year, and now is driving a cab for $50,000 (I don't know what cabbies make), that's a 75% wage cut right there. Were it not for Paulson and Bernanke's bailouts, there would be plenty of huge cuts like that to be thrown into the national averages.

Monday, April 27, 2009


Another Northern Female Political Leader

Though this one is indisputably cool, as all partisans must agree. If you're really important and work at a law firm or something, it's probably not worth watching the whole thing, but be sure to listen to her discussion of the city's financial situation. (Thanks to my wife Rachael for the link.)


CNBC's Description of John D. Rockefeller

OK so I was taking a break in between tasks and flipped through CNBC's Best American CEOs of All Time slideshow. #6 was Rockefeller, and here's what they had to say:
It’s hard to top Rockefeller as a monopolist or philanthropist. While doling out dimes and nickels to the poor, John D. built a sprawling empire by squashing, undercutting, and buying up the competition. Over a two-month period in 1872, Standard Oil absorbed 22 of the 26 petroleum firms in Cleveland, where the company was first headquartered. By 1879, it had about 90 percent of the market for refining petroleum and all but complete control of the U.S. oil industry.

THE STAT: Rockefeller’s fortune peaked in 1912 at $900 million ($19 billion in today’s dollars), but by the time he died, in 1937, he’d given most of his money away to heirs and charities.
Let's put aside the scurrilous "monopolist" charge, since Rockefeller was able to "squash" his competitors by slashing the price of kerosene and other refined oil products. (I discuss Rockefeller and other "robber barons" in my PIG to Capitalism.)

Where in the HECK do they get off saying he gave out "dimes and nickels" to the poor?!* Even if you buy into the standard (crazy) notion that Rockefeller was bad for making so much money, but good for donating most of it back, you can't say that he nickel and dimed the objects of his philanthropy. Just look at some of the things his money financed.

* In the comments a reader informs me that Rockefeller handed out nickels and dimes to the poor. Hence, that is probably where the writer got the idea for putting that in the description.


Taking the Good with the Bad: N. Gregory Mankiw

I have two negative things to say about the analysis of Greg Mankiw, so let me start off with two positive things. First, check out this hilarious post where he busts the hypocrisy of Ben Bernanke.

Second, reader Stan Kwiatkowski sends me this blast from the past where Mankiw praises Barney Frank for citing Mises and Hayek. (!)

OK but now the bad news. Here I strongly criticize Mankiw's notorious NYT op ed where he called on the Fed to promise large future inflation as a way to rescue the economy.

Finally, in this post Mankiw epitomizes a trend that really irks me among academic economists. What happens is that they set up a model of the economy that is unrealistic, but they forget that. And then when someone thinks about the economy in an unrealistic but different way, the academic economist pounces as if he has a monopoly on truth--even though the layman's model's result might actually be closer to reality!

I've criticized David Friedman and Steve Landsburg for this type of thing in the past. For our present example, Mankiw is pooh-poohing a website that offers a simulation of a rollercoaster ride the mimics the Dow Jones Industrial Average from 2007 to 2009. Mankiw comments:
But that can't be right. Stock prices are approximately brownian motion, which means they are everywhere continuous but nowhere differentiable. In plainer English, "continuous" means that stock prices an instant from now, or an instant ago, are close to where they are now. But "not differentiable" means that the direction they move over the next instant is not necessarily close to the the direction they were heading over the last instant. A roller coaster with that property would be quite a ride.

Hang on a second. First of all, stock prices do not obey Brownian motion. As Mankiw says, Brownian motion is continuous, meaning that if a stock price goes from (say) $100 at 9:30 am to $110 at 9:31 am, then technically the stock price must have hit every intermediate price--$100.01, $100.02, all the way up to $109.99--for some definite time interval in between 9:30am and 9:31am. Obviously that's not true, and it's why Hu McCulloch actually favors Mandelbrot's "stable Paretian" (a non-Gaussian) model of stock price movements, which allows discontinuous jumps (after a bad report on the company, or a war breaks out, for example). (Thomas Bundt and I have an article in the Review of Austrian Economics on this, but I don't think the issue is online yet? I can't find it online and it came out pretty recently.)

So sure, Mankiw is right that the rollercoaster simulation is just taking averages of the truly erratic movements in the stock price, but so what? That's what the Brownian motion approximations used in cutting edge finance models do as well. (And we all know how accurate those models have turned out to be...)

Finally, if I may be a true geek: Is it really the case that a track involving continuous but non-differentiable pieces would be "quite a ride"? I admit that it's not everywhere non-differentiable, but unless Mankiw lives in a ranch, I bet everyday he traverses a track that is continuous and (at several points) non-differentiable. Yet he probably negotiates it without too much trouble.


How Tyler Cowen and David Friedman Can Get Rich(er)

One of the things that contributes most to my feelings of guilt is that I have to blow off so many people who email with possibly fantastic new ideas that would revolutionize a particular academic field or even the "real world." More and more, I've had to say, "You may very well be right, but I simply don't have the time to read your paper. I encourage you to try to clean it up and submit to journals X, Y, Z..."

The problem, of course, is that a lot of these people are...weird...and on top of that they don't have any official credentials. Furthermore, they are often (rightly or wrongly) bitter that here they are, sitting on Fantastic Idea X, and even the Austrians / libertarians / whomever don't appreciate how awesome it is!!

So I thought of a possible way to process these ideas, to reduce the chance that we're letting something beautiful slip away just because the guy who thought of it has a tendency to send emails with a lot of CAPITALIZED WORDS. This approach wouldn't work with me (yet), because I'm not a big enough gun for most academics or venture capitalists to care about. But it might work for, say, Tyler Cowen or David Friedman, who not only are big names and considered really really smart, but also have a reputation for being multidisciplinary. In other words, I think a lot of people would take it seriously if Cowen or Friedman thought they came across a really good idea. So here's the process:

(1) At the start of the calendar year, the Big Gun establishes a submission price. Let's say it's $1000. The entrant submits a Great Idea with the $1000 fee, and then the Big Gun will spend 5 quality hours really considering its merits. For this effort, the Big Gun pays himself $500, and puts the other $500 in a pot.

(2) At the end of the calendar year, the Big Gun ranks the submissions in terms of which should receive more attention from the experts in the relevant field(s). I.e. the top pick is "the single most promising idea submitted to me all year."

(3) Besides the seal of approval from the Big Gun, the top entrant(s) get dibs on the other half of the submission fees. E.g. maybe the first place gets 50% of the pot, while second place gets 35% and third place gets 15%. The cash award helps the submitters develop their idea more.

Now if this were to really take off, it would spawn a new industry of talent scouts. E.g. after Tyler Cowen had announced his rankings three years in a row, third parties would have a pretty good idea of what types of entries end up winning. (E.g. anything involving secession would be out, and anything involving ethnic food would be a strong candidate.) So these scouts would setup websites where Joe Schmoe could email in his idea for free. Then if the scout thought Joe Schmoe's idea good enough, the scout would (according to a prearranged contract on the website) pay Joe Schmoe a flat fee (say $100) and then put up the $1000 submission for Tyler's own procedure. If Joe Schmoe's idea won that year, then the talent scout would retain the cash award (and maybe give Joe Schmoe a cut, again based on the arrangement beforehand) but of course the world would know it was Joe Schmoe who actually came up with the idea.

I think a process like this would avoid some of the flaws in our current arrangement. I really am not being facetious when I say that I've had some potentially brilliant ideas emailed to me, but I'm also being dead serious when I say I just can't afford to properly investigate them. And it's also not "right" that I should only consider ideas where someone pays me to consider them (e.g. here). That would leave too many potentially great ideas unconsidered.

Over time, those Big Guns who proved themselves capable of really identifying promising ideas would be able to command bigger and bigger fees. Competition would presumably also whittle down the percentage of the submission fees that the Big Gun keeps for him or herself. Those thinkers who have a comparative advantage in spotting a promising idea--which may not necessarily be the same thinkers who can dream up their own ideas, or who can take a promising idea and bring it to completion--would end up spending more and more of their time evaluating entries. With the promise of someone taking them seriously, thousands of amateurs all over the world would dust off that one really great idea they had, and spend a few weekends developing it enough to send to the talent scout websites.

And Hayek would smile on the whole enterprise.


Do Parents Matter?

Bryan Caplan has been pounding on his theme over at EconLog that "parents don't matter." (See here and here.) I must confess that I am incredibly biased because one of my core beliefs is that parents have an incredibly profound influence on their kids. But having confessed my bias, I must report that I find this whole line of thought to be silly, because the proponents are quite obviously exaggerating their findings.

For example, in the first hyperlink above, Caplan asks, "Do Parents Affect How Long You Live?" Do we really need to debate that? Does Caplan deny that if a parent locks a toddler in the closet, he'll die? Of course not. OK let's make it fairer: Does Caplan deny that a kid raised by parents in certain African regions will have a shorter lifespan than a kid raised in 90210? Of course not.

Well then what does he mean? Turns out he's referring to nagging, as in, if you tell your kid not to eat potato chips, will he end up living longer. Bryan says the literature on twin adoption studies shows once again that "parents don't matter." I confess I haven't looked at the studies, but I will go out on a limb and say they are flawed (if they conclude what Bryan says they do).

As I pointed out in my critical review of Freakonomics, these "parents don't matter" arguments seem to really just rule out a particular mechanism through which parents might matter. In Freako, Levitt said that telling your kid to read doesn't affect how much he reads. Aww dangit, I can't influence my kid. Shoot.

Oh wait a minute, you know what Levitt says does get your kid to read more? If you have a lot of books around the house and your kid sees that you yourself are a reader and value reading.

And I feel the same way about other studies that purport to show, "Hey it's not parents, it's a kid's peers that affect his personality." Well duh, you don't think parents influence that? Just deciding where to live and what school to send the kid to, has a huge influence in that respect. It's not just threatening Johnny to stop hanging out with those hoods down the street.

Last point: I asked Bryan for the single best article to show me that parents don't affect outcomes, and I promised I would read it carefully. But he sent me an article that DID say parents affected outcomes, and Bryan was merely quibbling about how big the effect was.

So for all you parents out there, sorry, you should still feel responsible for how your kid turns out. I know I know, you haven't gotten a good night's sleep since they were born, and on top of that now I'm saddling you with a bunch of guilt too. But at least they're outrageously cute. (Bryan agrees with us on that score.)

Sunday, April 26, 2009


Robert Wenzel: I Love the Way This Guy Thinks

Check out his post speculating that the mysterious flu outbreak was a botched effort to force the commander in chief to assume room temperature. (Note that I am trying to avoid being flagged by the government computers that undoubtedly scour the internet looking for key phrases. Because of the post I've linked to above, I'm sure Wenzel is now on some list. Of course, he probably got on that list 7 years ago.)


Which One Doesn't Belong?

At least one legal scholar in the photo below is not enthusiastic about Rothbardian private legal systems. Can you guess who? (HT2 Dick Clark for the photo.)


Ben Stein's Expelled

A few years ago, when I was a college professor at Hillsdale (where a large fraction of the student body was very interested in Intelligent Design), I spent a lot of time reading in this area. My conclusion was that (a) the vast vast majority of people who subscribed to ID were Christians who had already rejected the orthodox Darwinian account on other grounds, and (b) the prominent evolutionary biologists who said things like "evolution is a fact as well established as gravity" were bluffing. But as with most heated disputes that get people yelling at each other, a lot of the problem was in their framing of the dispute; each side was misunderstanding the claims of the other.

Anyway I recently watched Ben Stein's documentary Expelled: No Intelligence Allowed, which you can watch instantly at Netflix. My first thought is, "I can't believe he interviewed all those big guns in the various fields, and managed to produce an entire documentary in which the new viewer would walk away with not a single major argument over which the ID debate rages." The beginning of the movie focuses on people who were allegedly blacklisted by their professional peers because they had the audacity to discuss ID in a sympathetic light. (Tim Swanson points me to this site claiming that this sob stories are deceptive.) Judging just from the interviews in the movie, I got the sense that a few of the people seemed as if they had been railroaded, but a few other ones seemed to have a martyr complex, so I was suspicious.

The most hilarious thing in the movie--and which perfectly epitomizes the huge waste of time in this debate--is that in the final encounter, Richard Dawkins literally gives up the whole game to Stein, and then Stein manages to come back and (almost) surrender to the other side. Naturally, neither man seemed aware of how poorly he had played in their match. Argh.

In order to explain my observation, I'll give a very quick background: Contrary to what you may have heard, the proponents of ID do not necessarily even dispute the theory of common descent. For example, I am pretty sure that Michael Behe (who coined the term "irreducible complexity" and loves talking about the "outboard motor" of a bacterial flagellum) is perfectly happy to concede that all living cells today are descendants from a single cell that was the only living thing billions of years ago. But what Behe (and other IDers) dispute is the standard neo-Darwinian claim that it was random mutations and natural selection alone that could have transformed that first cell into all of the things we see today in biology.

In particular, the IDers reject the standard claim that "nobody directs evolution" or that "there is no designer when it comes to life." They think that this is a completely unwarranted leap beyond what the brute facts of biology tell us. The ID people think that the hard, scientific facts leave open the possibility--and in fact render it the most likely explanation--that something intelligent must have been involved to produce the current mix of life forms. Obviously, most IDers think that intelligence was in the mind of God, but strictly speaking ID theory itself does not get into the identity of the intelligence.

In opposition to ID, the standard Darwinian response has been to (a) dispute the particular "impossible" leaps that the IDers say foil the random mutation / natural selection story, (b) go even further and claim that the very notion of discussing an intelligent designer is unscientific and out of bounds, and (c) speculate that ID is really just a smokescreen for Bible-thumping Christians to smuggle Genesis back into the classroom and label it "science" instead of religion.

OK I'm not going to get into the pros and cons of this position. Like I said, a few years ago I got sucked into the debate and it was a huge time suck. (Not to mention, it convinced many people that I was crazy and/or an idiot.)

But I don't have to discuss the pros and cons of the case, because Dawkins and Stein each validated the strongest charges of each other (and without realizing it). In the final scene, in a moment of graciousness Dawkins concedes that OK there could be an intelligent designer of terrestrial life, but only if life evolved on other planets (through the undesigned Darwinian process) and then those life forms designed and seeded life here on earth.

At that point, Stein had won. Had he really understood the ID position and the philosophical issues flying around in the debate, he should have said, "I am sorry to inform you, Dr. Dawkins, but you just declared Michael Behe and William Dembski the undisputed winners, and Eugenie Scott the clear loser. For Scott and the other "consensus" scientists have been saying that the very notion of looking for "motives" and "design" in biology is not just wrong, but unscientific. You have just shown that this is silly. If indeed aliens designed the first terrestrial cell and planted it here billions of years ago, then it would naturally take human scientists to uncover this fact and study it. We wouldn't rely on philosophers and theologians to flesh out the theory of alien seeding."

But alas, that's not what Stein said. Rather, he muttered something like, "So you're not against design, just a particular kind of designer." Now actually, that was a decent point--i.e. Stein was highlighting that the Darwinians were bluffing when they categorically stated that design per se was unscientific--but he nonetheless confirmed all of the atheist biologists' suspicions that the IDers really were after confirmation in God designing everything.

Final point: I could not BELIEVE Stein spent a large chunk of the movie exploring Nazi death chambers. I don't know what the point of that was. Anybody who was convinced of the merits of ID didn't need to see "where evolutionary theory takes us," and opponents of course would just go ballistic at such a blatantly emotional ploy. It would be like a pro-Darwin documentary spending time on the Inquisition to show the "logical conclusion" of Intelligent Design theory.


God and Government

A colleague in Nashville (who is also an Austrian and a Christian) and I have been discussing the well-known passage in Judges (17:6) that says, "In those days there was no king in Israel; everyone did what was right in his own eyes."

I think most American Christians believe that this passage condemns anarchy, i.e. a lack of what we all mean today by the term "government."

But my colleague and I have been wondering if that's a misreading. For sure, God certainly doesn't seem to think that the absence of an earthly king is a problem. He famously warns the Israelites when they ask Him to choose a king over them (I Samuel 8):
10 Samuel told all the words of the LORD to the people who were asking him for a king. 11 He said, "This is what the king who will reign over you will do: He will take your sons and make them serve with his chariots and horses, and they will run in front of his chariots. 12 Some he will assign to be commanders of thousands and commanders of fifties, and others to plow his ground and reap his harvest, and still others to make weapons of war and equipment for his chariots. 13 He will take your daughters to be perfumers and cooks and bakers. 14 He will take the best of your fields and vineyards and olive groves and give them to his attendants. 15 He will take a tenth of your grain and of your vintage and give it to his officials and attendants. 16 Your menservants and maidservants and the best of your cattle [b] and donkeys he will take for his own use. 17 He will take a tenth of your flocks, and you yourselves will become his slaves. 18 When that day comes, you will cry out for relief from the king you have chosen, and the LORD will not answer you in that day."

19 But the people refused to listen to Samuel. "No!" they said. "We want a king over us. 20 Then we will be like all the other nations, with a king to lead us and to go out before us and fight our battles."

21 When Samuel heard all that the people said, he repeated it before the LORD. 22 The LORD answered, "Listen to them and give them a king."

So it's clear that God may have thought it was important for the Israelites to have human judges but not a (human) king. I find this fascinating since I have mused on how a completely free market in law might function.

Incidentally, there is a more succinct way to handle the issue, found in Deuteronomy. The typical Republican Christian is right when he thinks, "You can't have people just doing whatever is right in their own eyes!" And indeed, Moses tells the Israelites (Dt 12) that when they cross into the Promised Land:
8 “You shall not at all do as we are doing here today—every man doing whatever is right in his own eyes—9 for as yet you have not come to the rest and the inheritance which the LORD your God is giving you."

OK, but then how should they behave? He explains in Dt 13:
17 So none of the accursed things shall remain in your hand, that the LORD may turn from the fierceness of His anger and show you mercy, have compassion on you and multiply you, just as He swore to your fathers, 18 because you have listened to the voice of the LORD your God, to keep all His commandments which I command you today, to do what is right in the eyes of the LORD your God.

So it's certainly true that you can't have "anarchy," meaning people doing whatever the heck they feel like. But from that it does not at all follow that those who believe in the God of Moses should establish and obey human political rulers, certainly not as they exist in our modern nation-State, which in practice has truly been institutionalized evil since its invention.

Saturday, April 25, 2009


The League of Monetary Cranks...

...has been established by Scott Sumner, my favorite new blogger. In his latest post, he points out that the author of the leading monetary textbook, Mishkin, is in fact a "monetary crank" because "[t]he sine qua non of a monetary crank is the bizarre belief that even depressions featuring zero interest rates can be magically cured by printing money."

Exactly. Mishkin--and all other orthodox theorists operating within the aggregate demand paradigm, and that includes most Chicago school guys as well as MIT'ers--are indeed monetary cranks. The WSJ op ed pages, as well as blogs that promise to make the world better through small steps, are chock full of the idea that printing green pieces of paper can help the economy re-coordinate itself after a massive disruption in the physical capital structure. What cranks!

The funny part, of course, is that Sumner is merely trying to show that his own theory--that the Fed caused the crisis by being far too restrictive up until last September--is actually very close to orthodox opinion. So Sumner is really saying, "You're calling me nuts? Look, if I'm nuts, then everybody in the profession is nuts!"

That's right, Dr. Sumner, welcome to the Austrian's world.


Murphy Interviewed on New Book

I've been doing tons of these, but this one is fairly long so it gave me time to give complete answers to the questions. In the beginning my words are a little distorted, but I think it gets better a little way into it. (I was hearing feedback on my phone in the beginning, not sure why.)

Friday, April 24, 2009


Toward a Review of Tom Woods' Meltdown

I always thought it was funny when people would use that phrase; e.g. I have a book called Toward a History of Game Theory. I think it means, "If I weren't so lazy I would write..." For sure, that's what it means in this blog post.

Flat out, Tom's book Meltdown is freakin' sweet. I had trouble getting through the first chapter or two, not because of anything Tom did, but just because I am so sick of talking about Paulson, MBS, Greenspan's rate cuts, etc.

But after getting through that necessary drudgery, the book was (is) awesome. I am in amazement at how much great economics and obscure history Tom was able to weave into this thing. E.g. he very quickly but elegantly dispatches with typical objections such as, "Well if it was all the Fed's fault, what about the panics before 1913?" and "Doesn't the depression of 1937/38 vindicate Krugman?"

But beyond all that, Tom is just a wonderful writer. I periodically put the book down and just imagine hundreds of thousands of people reading the paragraph I just read, and I think, "Wow, that is so great that Tom just shot that into so many minds. Awesome."

Not that this is even the best passage I've come across, but it's where I am in the book and it illustrates what I mean:
If we want a repeat of [the Depression] years, or if we'd like to share the fate of Japan for the past 18 years, we should listen to Paul Krugman and implement exactly the same policies that gave the world these two disasters. On the other hand, we might for once permit ourselves a heretical deviation from the Official Version of History (TM), cease waving incense before the Great Presidents we are taught to admire, and consider the possibility that the government's efforts to fight depressions may in fact have lengthened them. Let's spare ourselves the ordeal of a ten-year depression--and the added indignity of being told ten years from now that it was the government's brilliant plan that eventually rescued us.

In short, if you have been on the fence about ordering Tom's book--maybe you think that his buddies at LRC are exaggerating its quality--let me go on the record and say believe the hype. If you have a leftist friend who thinks deregulation caused our woes, and your friend is willing to read one book on the matter just to humor you, go ahead and give him Meltdown. (Just make sure it's Tom's Meltdown, since there is some liberal collection of essays with the same title!)



* Robert Wenzel tells us "the next big thing" in the financial world. (I think he means, the next big thing after Bernanke's balance sheet.)

* The principles of Walt Disney's success [pdf].

* The 1870s depression wasn't so bad after all (HT2 Tom Woods).

* This guy says what everyone needs to be saying: It is immoral and illegal to torture people, even if you work for the government and even if you have lawyers telling you it's OK. (Note that I'm not saying Obama or the AG should prosecute anybody for these actions--and if you consider yourself an extreme skeptic of government actions to "make the world a better place," I invite you to really put your views to the test when it comes to the federal government punishing itself for violating rights.) Before 9/11, it would have made a good Onion headline to say, "Torture: How much is too much?" But that's basically where we are now, here in the shining city on a hill, land of the free, home of the brave. Anyway, let me get off my soapbox and give an excerpt from the linked article:
Today the Washington Post features yet another screed...arguing that the torturing (once again using the Orwellian term "enhanced interrogation techniques") of prisoners has been so effective that we cannot possibly give up this weapon in our arsenal. Thiessen asserts self-justifying, unverifiable McCarthyite claims regarding the efficacy of torture. Now I am highly skeptical about this -- nothing written by professionals in the field suggests to me that this is true....

But in the end, I think this is not an avenue worthy of argument. I actually don't give a sh*t if it's effective. It's wrong, barbaric, dehumanizing, and altogether unworthy of how a great people and great nation would act. We don't eschew torture for utilitarian reasons -- we do it based on our deeply held belief in our principles, in the rule of law, the dignity of man, and our shared common humanity. We don't resist the use of torture because it is the easy thing to do or because we are not under threat or not afraid. We resist it because we believe at a core level that some principles are sacrosanct even if we may face risk or even death at the hands of fanatics -- we stand by the essential tenet that we mustn't become monsters in order to defeat a monster.


TARP, a Criminal Enterprise

So says Larry Kudlow (HT2EPJ). Some strong words indeed for a CNBC article:
Is the whole TARP plan a criminal enterprise? Sounds farfetched, I suppose. But after reading about Special Inspector General Neil Barofsky’s report, it may well be that TARP is just one big criminal problem.
I know, let's play a game! I'm going to give you two quotations from economic analysts from last year, before the TARP had been approved. One of them is Kudlow, and the other is some other guy. Can you guess (a) which is Kudlow and (b) who the other guy is?

Economist #1 on TARP, from September 30, 2008:
The Paulson bailout failed in the House. If it isn't a death blow to the plan, it should be. This is not an economic plan: it is a heist....The economics behind it are nonsense, but we are naïve if we spend much time even considering the "arguments" for it. This is a money and power grab, pure and simple....Because of all the mumbo jumbo thrown around to show why the plan is necessary, some very sharp academic economists are in a tizzy trying to treat this as an extra-credit question, rather than a crime scene.

Economist #2 on TARP, from September 27, 2008:
The single-biggest mistake in the Paulson bank-rescue-plan marketing effort has been the failure to explain clearly how taxpayers are going to recoup $700 billion used to buy toxic assets at auction in order to unfreeze the banking system. In other words, folks don’t understand how taxpayers will be paid back, and may actually make profits, which will enable the new government debt to be erased after the Treasury bank-rescue is completed.

Here’s the key point: Any loan package bought by the Treasury will be 100 percent taxpayer owned. Period.


Local Communities Start Printing Own Currency

A few people have mentioned this to me; here's a USA Today article (so it must be true):
A small but growing number of cash-strapped communities are printing their own money.

Borrowing from a Depression-era idea, they are aiming to help consumers make ends meet and support struggling local businesses.

The systems generally work like this: Businesses and individuals form a network to print currency. Shoppers buy it at a discount — say, 95 cents for $1 value — and spend the full value at stores that accept the currency.

I'm not really sure how to process this. I think it is just an elaborate form of coupon clipping, but it surprises me that it has taken off.

Thursday, April 23, 2009


Barney Frank on Ron Paul (and not on Steady Cam)

I'm sorry folks, but ever since I testified before his committee (though he was never in the room when I was speaking!), I have liked Barney Frank. There's all kinds of funny stuff in this clip (HT2LRC)--especially watch for him talking about the Democrats treating Ron Paul better than the Republicans did--but note that he says something and then catches himself, "I take that back..." Just little acts of human courtesy and humility like that are what I like about him. Not saying it overshadows his role in the housing boom, but c'mon it's a low bar he has to get over to be one of my favorite Congressmen.


Does the 1937-38 "Depression Within the Depression" Vindicate the Keynesians?

In the thread of my infomercial for my new book, a reader asks an excellent question:
Just yesterday I received your book and after skimming it, I must say that it looks like it is going to be excellent! Hopefully I can start reading it this weekend. One point though. In part of your first chapter you bring up the "depression within the Depression" of 1937/'38. In that chapter you describe what happened in that episode. However, when I searched the latter part of the book for your explanation of why that "depression within a depression" occured, I could not find it. I think that explaning why the '37/'38 depression occured is important because I recall Krugman using it to defend Keynesian theory. If I recall correctly, he said that FDR decided to try to reduce the deficit at that time by raising taxes and cutting spending and for this reason the tenuous recovery was aborted. This, Krugman claims, is evidence that Keynesian theory is accurate. So, my question to you is, do you explain the cause of the depression of '37/'38 in your book, and if so on what pages? If you don't discuss it in your book, how would you answer Krugman?

My response:
Thanks for the note. You're right, any Keynesian who reads the book is going to accuse me of deception for "glossing over" the 1937/38 episode.

There were a few things going on, which I didn't go into because my editor was already pruning way back on the technical tangents.

So yes, FDR tried to close the budget deficit somewhat, and that's what Krugman et al. think did it.

But there was also a doubling (I believe) of the reserve ratio for the banks, and that's what monetarists point to, to prove their theory that it was insufficient money pumping.

Yet a third thing was that the Supreme Court upheld the NLRB, and union membership shot way up in one year, pushing up certain wages. Not surprisingly, this is the factor that I like. :)

So basically you had all kinds of stuff changing, and whatever the economist's favored theory is, will be there for him to see.

I think I did a pretty good job exploding the alleged medicinal role of huge deficits by comparing Hoover's experience with Harding's. I.e. if it were really true (as Krugman claims) that cutting the deficit caused the problem in 37/38, then what Wilson/Harding did in 1920-21 should have yielded by far the worst economy in US history. But no, it paved the way for the best economy in US history (Roaring Twenties).


Did Abandoning the Gold Standard Get Us Out of the Depression?

Greg Mankiw has come out of his shell lately on his blog. Whenever I visited in the past, I would quickly move on because he would offer links with at most a sentence of commentary. Unfortunately, now he is devoting his writing skills to pushing the benefits of massive inflation.

Last week Mankiw wrote an op ed for the NYT saying the Fed should promise large inflation in the future, in order to push the "real" (inflation-adjusted) interest rate into negative territory. Apparently many readers were upset--imagine that!--and Mankiw has been defending his flank ever since. In his most recent defense he writes:
As to the Fed announcing a commitment to a moderate amount of inflation, let me point out that according to many macroeconomic historians, the abandonment of the gold standard was the most useful thing that the federal government did to get the country out of the Great Depression. A commitment to producing a moderate amount of inflation would be the modern equivalent of that act.

As I argue in my new book, The Politically Incorrect Guide to the Great Depression and the New Deal, this hostility to the gold standard is misplaced. Before we delve into the economic theory, just consider the brute historical facts: In prior US depressions (or "panics"), when the US dollar was tied to gold, the country began to recover typically within about two years. In contrast, it wasn't until the governments of the world all abandoned gold, that the entire world was mired in the worst downturn in history, and for a decade to boot!

Let me dispatch with an obvious response. Mankiw could say, "Well sure, the gold standard tied the hands of central bankers, but it had an irrational aura of inviolability, and so it's not surprising that it took the worst downturn ever to finally get the Fed to drop the barbarous relic. The US economy turned around on a dime the moment FDR severed the tie to gold."

But no, that doesn't quite work either. If it were really true that it was the gold standard holding the US in Depression, then surely, say, five years after FDR severed the link, the economy should have been humming, right? But the official unemployment statistics (and note these BLS figures don't count people receiving WPA checks as having a real job) record that in 1938--five years into the New Deal--the unemployment rate averaged 19%. So when people tout how great things were for the US economy once we ditched gold, keep that in mind. Yes, 19% is lower than 25% (the rate in 1933), but to repeat, in all prior US history, a depression would have been long gone five years after the trough.

But now let's use economic theory to make sense of these undeniable historical facts. I argue in the book that the one thing that set the Great Depression apart from its earlier peers was that Herbert Hoover subscribed to an underconsumptionist theory of the business cycle. After the stock market crash in 1929, Hoover called all the big business leaders to Washington and told them not to cut wage rates, because (he thought) to do so would simply reduce incomes and hence would exacerbate the downturn in spending on business.

So what happened is that workers' paychecks fell much more slowly than prices in general, during the 1929-1933 period. In fact, workers' "real" wages (i.e. actual dollar amount adjusted for falling prices) rose more quickly during this period than they had during the Roaring Twenties! So it's no wonder that unemployment rates skyrocketed, because the relative price of labor kept rising even amidst horrible business losses.

In this context, running the printing press could provide at least short term relief, and I believe that is the explanation for Brad DeLong's favorite chart. If the government (in concert with unions) is enforcing very severe nominal wage rigidity, then the normal price deflation during a depression will be catastrophic. By freeing central banks of their obligations to redeem currency for gold, they were given the ability to run the printing press and push prices back up, easing the massive surplus in the labor market.

But it would be very queer to describe the high unemployment of the early 1930s as the fault of the gold standard. No, the blame rests squarely on government policies (and support for unions) that kept wage rates above their free market levels. In the 1920-1921 depression, for example, prices in the US fell much more quickly than they did during any single year of the 1930s, but unemployment spiked at 11.7% and then was down to 2.4% by 1923.

The reason? Wages fell even more quickly than prices; they dropped 20% in a single year. At the time Herbert Hoover (Harding's Commerce Secretary) was horrified, but it was a much better outcome than what his "compassionate" policies would unleash on workers a decade later.

Wednesday, April 22, 2009


Scott Sumner Restores My Faith in Economists

Wow. I am totally blown away by Scott Sumner's blog, The Money Illusion. He is a Chicago PhD who specializes in the gold standard and the Great Depression. I don't even necessarily agree with his overall views, but WOW his posts are really really good. It's what I would have expected from nerdy academic economists before I actually saw the real world buffet available for sampling. People have been linking to him a lot, but for some reason I never clicked on it until DeLong linked to him recently.

In particular, check out this post on Friedman and Schwartz's success with their Monetary History. It is a very long post and you need to just sit down and read it (if it interests you), but here is an excerpt to show why I am so impressed with this guy:
The difference between my view and Krugman’s view cannot be resolved through econometrics, it is a complex question of interpretation, including how one thinks about the relevant counterfactuals. For instance, for me the relevant counterfactual is what would have happened if the Fed had abandoned the gold standard as soon as it began to constrain their policy. We know that after they did so in 1933, NGDP rose very rapidly. So what Krugman views as evidence of monetary policy ineffectiveness (say the failed 1932 open market purchase program), I view as merely reflecting the constraints of the international gold standard. On the other hand Krugman could point to recent liquidity traps in Japan and the U.S., which occurred under fiat money regimes. And you already know my views on those episodes.

One of the things that has most puzzled me about recent events is that many of the very same economists who were persuaded by F&S’s evidence, most notably Ben Bernanke, now seem strangely passive in their evaluation of current Fed policy options. And almost none blame the Fed for the rapid decline in NGDP that began last September. So does that mean Krugman wins the argument? More likely it means both Krugman and I will lose in the short run.


Will New Fed "Tools" Avert Hyperinflation?

My sources say no. An excerpt:
For a different idea, economists Woodward and Hall think the Fed just needs the ability to charge banks for holding reserves....How does this avert the threat of hyperinflation? Simple, according to Woodward and Hall. If banks ever start loaning out too much of their (now massive) excess reserves, and thereby start causing large price inflation, then the Fed can simply raise the interest rate it pays on reserves. Banks would then find it more profitable to lend to the Fed, as it were, rather than lending reserves out to homebuyers and other borrowers in the private sector. Voila! Problem solved.

Obviously these tricks can’t avoid the consequences of Bernanke’s mad money printing spree. At best, they would merely push back the day of reckoning, while ensuring that it grows exponentially (quite literally).

A quick numerical example: Let’s say the Fed wants to drain $100 billion in reserves out of the banking system, in order to cool off rising prices. But it doesn’t want to sell off some of its assets on its balance sheet (like “toxic” mortgage-backed securities), so instead the Fed sells $100 billion worth of the brand new “Fed bonds,” as Yellen hopes.

In the beginning, this will indeed solve the problem. When people in the private sector buy the Fed-issued bonds, they write checks on their banks and ultimately those banks see their reserves go down at the Fed. There is less money held by the public, and so prices don’t rise as quickly.

But what happens when the Fed bonds mature? For example, if the Fed sold a 12-month bond paying 1% interest, then after the year has passed our private sector buyers will hand over the securities and now their checking accounts will be credited with $101 billion. At that point, the economy would be in the same position as before, only worse: there would be an extra billion in newly created reserves (because of interest on the Fed debt).

Incidentally, the Daily Reckoning doesn't do hyperlinks, so here are some of the things I relied on for the article:

* The CBO analysis of Obama's 10-year budget plan,

* The CBO's forecast in 2001 of $5.6 trillion in surpluses over the next decade,

* Janet Yellen discussing Fed debt as as "exit strategy,"

* Woodward and Hall discussing positive and negative interest on reserves as a way to avoid hyperinflation.


Private Law and the Somalis

Dick Clark the Younger has an interesting article that he adapted from an actual law school assignment. An excerpt:
Because I recognize that government courts serve primarily to advance the interests of government power, my goals as an aspiring attorney are to use what I can from my legal education to work against the State—to oppose government action where private, voluntary action would better serve the interests of justice. It is the subsequent question—“How can private actors be entrusted with the provision of public goods like defense and justice?”—that makes a book like The Law of the Somalis important.

Van Notten, a Dutch lawyer, lived with the Somali people and applied his legal expertise to learning and understanding the Xeer, the traditional Somali legal system that has developed over thousands of years. The Xeer is remarkable because it is not dependent on a central government authority, but instead relies on familial, economic, and cultural pressures to insure that justice is done. While the details of the system leave some things to be desired—equal rights for women and greater alienability of property outside of the clan, for starters—it is based on core principles which are admirable and reasonable...


The Real Lessons of the Great Depression

Since late 2007, more and more commentators have drawn parallels between our current financial crisis and the Great Depression. Nobel laureates and presidential advisors [pdf] confidently proclaim that it was Herbert Hoover’s laissez-faire penny pinching that exacerbated the Depression, and that the American economy was saved only when FDR boldly ran up enormous deficits to fight the Nazis. But as I document in my new book, The Politically Incorrect Guide to the Great Depression and the New Deal, this official history is utterly false.

Let’s first set the record straight on Herbert Hoover’s fiscal policies. Contrary to what you have heard and read over the last year, Hoover behaved as a textbook Keynesian after the stock market crash. He immediately cut income tax rates by one percentage point (applicable to the 1929 tax year) and began ratcheting up federal spending, increasing it 42 percent from fiscal year (FY) 1930 to FY 1932.

But to truly appreciate Hoover’s Keynesian bona fides, we must realize that this enormous jump in spending occurred amidst a collapse in tax receipts, due both to the decline in economic activity as well as the price deflation of the early 1930s. This combination led to unprecedented peacetime deficits under the Hoover Administration—something FDR railed against during the 1932 campaign!

How big were Hoover’s deficits? Well, his predecessor Calvin Coolidge had run a budget surplus every single year of his own presidency, and he held the federal budget roughly constant despite the roaring prosperity (and surging tax receipts) of the 1920s. In contrast to Coolidge—who was a true small-government president—Herbert Hoover managed to turn his initial $700 million surplus into a $2.6 billion deficit by 1932.

It’s true, that doesn’t sound like a big number today; Henry Paulson handed out more to bankers by breakfast. But keep in mind that Hoover’s $2.6 billion deficit occurred because he spent $4.6 billion while only taking in $2 billion in tax receipts. Thus, as a percentage of the overall budget, the 1932 deficit was astounding—it would translate into a $3.3 trillion deficit in 2007 (instead of the actual deficit of $162 billion that year). For another angle, I note that Hoover’s 1932 deficit was 4 percent of GDP, hardly the record of a Neanderthal budget cutter.

The real reason unemployment soared throughout Hoover’s term was not his aversion to deficits, or his infatuation with the gold standard. No, the one thing that set Hoover apart from all previous U.S. presidents was his insistence to big business that they not cut wage rates in response to the economic collapse. Hoover held a faulty notion that workers’ purchasing power was the source of an economy’s strength, and so it seemed to him that it would set in motion a vicious cycle if businesses began laying off workers and slashing paychecks because of slackening demand.

The results speak for themselves. During the heartless “liquidationist” era before Hoover, depressions (or “panics”) were typically over within two years. Yes, it was surely no fun for workers to see their paychecks shrink quite rapidly, but it ensured a quick recovery and in any event the blow was cushioned because prices in general would fall too.

So what was the fate of the worker during the allegedly compassionate Hoover era, when “enlightened” business leaders maintained wage rates amidst falling prices and profits? Well, Econ 101 tells us that higher prices lead to a smaller amount purchased. Because workers’ “real wages” (i.e. nominal pay adjusted for price deflation) rose more quickly in the early 1930s than they had even during the Roaring Twenties, businesses couldn’t afford to hire as many workers. That’s why unemployment rates shot up to an inconceivable 28 percent by March 1933.

“This is all very interesting,” the skeptical reader might say, “but it’s undeniable that the huge spending of World War II pulled America out of the Depression. So it’s clear Herbert Hoover didn’t spend enough money.”

Ah, here we come to one of the greatest myths in economic history, the alleged “fact” that U.S. military spending fixed the economy. In my book I relied very heavily on the pioneering revisionist work of Bob Higgs, who has shown in several articles and books that the U.S. economy was mired in depression until 1946, when the federal government finally relaxed its grip on the country’s resources and workers.

For a fuller exposition, you’ll (naturally) have to buy my book. But here’s the quick summary: Sure, unemployment rates dropped sharply after the U.S. began drafting men into the armed forces. Is that so surprising? By the same token, if Obama wanted to reduce unemployment today, he could take two million laid-off workers, equip them with arm floaties, and send them to fight pirates. Voila! The unemployment rate would fall.

The official government measures of rising GDP during the war years is also misleading. GDP figures include government spending, and so the massive military outlays were lumped into the numbers, even though $1 million spent on tanks is hardly the same indication of true economic output as $1 million spent by households on cars.

On top of that distortion, Higgs reminds us that the government instituted price controls during the war. Normally, if the Fed prints up a bunch of money to allow the government to buy massive quantities of goods (such as munitions and bombers, in this case), the CPI would go through the roof. Then when the economic statisticians tabulated the nominal GDP figures, they would adjust them downward because of the hike in the cost of living, so that “inflation adjusted” (real) GDP would not look as impressive. But this adjustment couldn’t occur, because the government made it illegal for the CPI to go through the roof. So those official measures showing “real GDP” rising during World War II are as phony as the Soviet Union’s announcements of industrial achievements.

I have only scratched the surface in this article of all the myths surrounding the Great Depression and the New Deal era. For example, we are also constantly told—this time by Chicago economists, not Keynesians—that “we learned in the Depression” that the Fed needs to rapidly expand the monetary base to avert disaster. Oops, turns out that’s bogus too. But you’ll have to buy my book to learn why.

This article first ran on

Tuesday, April 21, 2009


Why Did Texas Skirt the Housing Crash?

Von Pepe sends me this interesting analysis of the relatively moderate boom/bust in Texas house prices.

The analyst thinks the answer is that Texas law prohibits prepayment penalties. In other words, homeowners in Texas were allowed to pay down their mortgages ahead of schedule, without being penalized by the lender. He concludes:
I also want to get away from the duality of thinking of the subprime crisis as evil banks looting homeowners or evil lenders tricking banks. With the genius of prepayment penalties, banks didn’t have to make money by lending loans to credible homeowners - they could form a de facto company with unqualified borrowers to bet on house prices rising. The prepayment penalty was the bank’s equity in this endeavor. Or another way to say it is that the banks found a way to hire a person to sit in a house they wanted to gamble on; this was a subprime loan with a prepayment penalty. More to follow.

An interesting theory; I would like to see some more evidence though before signing off on it. (And the guy promises to do more research in future posts.) For example, if he could show that all or most states that banned prepayment penalties experienced low default rates, and in particular if he showed that the worst states all allowed the penalties, then that would be something.

In any event, I wrote an article defending prepayment penalties back when primary presidential candidate Hillary Clinton proposed abolishing them. An excerpt:
[I]t actually hurts borrowers (and lenders) when possible, voluntary contracts are declared inadmissible. Despite the presidential candidates’ desires to mother all of us, most people aren’t nearly as incompetent as the politicians would have us believe, especially when it comes to huge decisions such as financing a home purchase. The reason some borrowers are willing to sign contracts that include prepayment penalties is that the interest rate is correspondingly lower. If you think a prepayment penalty is absurd, you don’t need Hillary Clinton to rescue you. You can simply choose to take out a mortgage without a prepayment penalty (and pay a slightly higher interest rate because of your decision). Pretty simple, eh?

What most people don’t realize is that helping the borrower by giving him the option of prepaying the mortgage necessarily hurts the lender. When the bank lends you $200,000 to buy a house, it needs to compare the pros and cons of that loan with other possible investments. For example, it could have bought $200,000 worth of government bonds instead. Now from the bank’s point of view, one of the benefits of the mortgage loan is that it pays a higher rate of return than the government bond. But one of the drawbacks is that, if interest rates drop, the homeowner can refinance, whereas Uncle Sam can’t call in his bonds...

In other words, when the bank is planning its cash flows into the future, it is far more confident in fixed opposed to payment streams that might suddenly stop (such as a homeowner who refinances). In the financial community this is called prepayment risk. And guess what? If bankers are going to take on riskier investments, they require correspondingly higher expected returns. That’s part of the reason that mortgage rates are higher than U.S. bond rates...Including prepayment penalties in mortgage contracts mitigates this risk, and so allows the lender to charge a lower interest rate than he would accept without such a built-in compensation.


Worst Job in the World: White House Press Secretary

This is hilarious. I heard this on the radio and had to share it. I only could stand the first 80 seconds or so, but make sure you listen for the male reporter who jumps in. Seriously, I understand why politicians lie--it's good to be the king. But what's in it for the press secretary? Wouldn't you break out in boils or something from this job?


Government Report: "Oops We Aren't Good With Taxpayer Money"

According to CNBC:
In a 250-page quarterly report to Congress, TARP's special inspector general concludes that a private-public partnership designed to rid financial institutions of their "toxic assets" is tilted in favor of private investors and creates "potential unfairness to the taxpayer."

In related news, the National Academy of Sciences released a report saying that water runs downhill.


Tentative Winner in Austrian vs. Chicago Reader Contest

Last week I pointed out that I had started saying "more than a year" ago what Chicago economist Casey Mulligan just recently realized, namely that the hope of government bailouts caused or at least exacerbated the frozen market in "toxic" assets.

Because I was far too lazy to document my bold claim, I promised a signed copy of my new book to the reader who could find the earliest online example of me saying this.

The deadline for submissions was last Saturday, and by my reckoning Dave F. is the winner. He found me saying the below in the June 2008 Freeman (and note that the first sentence is one element in a list of bad policy moves that I am describing):
Accepting mortgage-backed securities as collateral for short-term loans. On March 11, the Federal Reserve announced the Term Securities Lending Facility, authorized to lend up to $200 billion of the Fed’s holdings of Treasury securities to primary dealers in 28-day loans. The Fed agreed to accept MBS as collateral for these loans. The move promoted “liquidity” because it is much easier to raise cash in the market with bonds issued by the federal government (Treasurys), rather than securities tied to mortgages at risk of massive defaults.

There are several problems with this arrangement and others like it. First, it obviously puts taxpayers on the line if the primary dealers default and the Fed is stuck with (grossly overvalued) MBS. Second, it intensifies the moral hazard discussed above; it benefits those who hold a large amount of MBS—precisely the investors with poor foresight. Finally, it perversely encourages holders of MBS to keep them off the market, since the Fed will accept them at an unrealistic book value.

To repeat, the problem in the credit markets isn’t simply the massive losses from bad loans. It’s also the uncertainty caused by the large holdings of derivative assets tied to mortgages. Only when institutions bite the bullet and begin selling these assets, presumably at large losses, can realistic market prices be established. Only then will banks be able to assess each other’s creditworthiness, and only then will they begin lending freely to one another. Government efforts to prop up the MBS market perversely stall this shakeout.

So I will let this sit for a day in case there are any challengers. (I had to get up at 5:15 this morning so my blog analysis skills are not in optimal condition.) But barring any challenge, Dave F. is the winner!

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