Thursday, December 31, 2009


Memorable Free Advice Posts from 2009

I was going to do a Top Ten but that would take too long. Browsing the archives, here are some that jumped out at me (asterisks mean I think it's a double plus good post):

Marianne Sierk Standup

Obama Nominates a Socialist

Coining a New Term for the Coming Economic Disaster

Of Flat Taxes and Idols

Tyler Cowen, a Sensible Central Planner

Did Deflation Cause the Great Depression?

Casey Mulligan: "Wow, I Was Only Wrong by 72% to 575%"

The Merciful God of the "Old Testament"

Not So Silent Cal

The Stock Market in 1929 Was Undervalued?!

Obama Will Be Re-elected

** Why Does God Let Bad Things Happen? Part 28 **

Ben Stein Suspicious of Those Untrained in the Ways of High Finance

Comrade Obama to Make Bank Nationalization Official

Scott Sumner Restores My Faith in Economists [SIC!!!]

TARP, a Criminal Enterprise

Toward a Review of Tom Woods' Meltdown

Robert Wenzel: I Love the Way This Guy Thinks

The Peace That Passeth All Understanding

Star Trek: Get Me to Sickbay, I'm Gonna Puke

How Am I Like Jenny McCarthy?

Awkward Thoughts on Memorial Day

Krugman vs. Murphy on Inflation: Two Men Enter, One Man Leaves

Do Non-Believers Burn in Hell?

** JFK: Courage Under Fire? **

An Unexpected Invitation from the LORD

Wenzel vs. Murphy: the Grand Finale

Invasion of the Purchasing Power Snatchers

** The Big Picture **

Believing is Seeing, Economic History Edition

Hillary Clinton, Pod Person?

Ezra Klein Apparently Doesn't Think Immigrants Are Part of the Universe

** My Solution to the Mind-Body Problem, and the Reconciliation of God's Sovereignty With Free Will **

** The Coming Marijuana Legalization **

** A Review of Jon Sciescka's Smash! Crash! **

The "Efficient Markets Hypothesis" Is a Mental Crutch for Economists

Has Andrew Sullivan Disavowed Barack Obama, Like He Promised?

The Innumerate Billy Ocean

Kroger Receipt from August 27, 2009

More Free Market Evangelism From Larry Kudlow

That Settles It, Glenn Beck Cannot Be Trusted

** My Response to John Cochrane **

God the Father

** How to Predict the Coming Bank Pay Regulation **

** "My God, It's Full of Stars!" **

Arnold Kling's Bizarre Monetary Theory

Crimes vs. Sins: Letterman's Blackmailer

** Why Military Spending Didn't Get Us Out of the Great Depression **

Scott Sumner's Mind Is a Terrible Thing to Waste

A Little Stimulus Arithmetic

** Thoughts on Libertarians and Immigration **

Did Krugman Get the Inflation Go-Code at the G30 Meetings?

I Told You Guys That Krugman Was Misleading the Children


Two Funnies From the 5-Year-Old

I was reading my son his bedtime story and he had a long hair in his mouth. So we commented on its yuckiness and so forth, and then he started rubbing his head. He said, "I have lots of hairs." Then he rubbed my head and said, "You have 2 hairs."

Later on I was getting ready to leave the room and he said he needed his lamb (i.e. a stuffed animal). I asked where it was. He pointed and said, "Right there." So I'm looking all over the place and don't see it. "It's right there?" I demand, gesturing at the wall. He says yes.

After some exasperation, he finally gets up to get it himself. He walks out of the bedroom and into his play room. I start cracking up and say, "So you were pointing through the wall?!" and he answers "yes" as if that's totally normal.

In retrospect, who ever said you can't point through a wall? We adults impose all sorts of constraints on our minds.


The Jackpot Question In Advance

I know many of you simply assume that an internationally known Austrian economist (that's me) would be ringing in the new year hanging with my boyz in da club, and then we'd take the show back to the hotel to party some mo. Alas, my wife is out of town so I am spending New Year's Eve entertaining my 5-year-old.

We did the usual circuit: First we hit Barnes & Noble for some Thomas the Train action, followed by the joys of coin op Bob the Builder and the generic fire engine. But since today was special, I capitulated when my son headed into Dave & Buster's. (I actually hadn't heard of it until coming to Nashville, so maybe you haven't either: It's a restaurant/arcade combo and even has bowling alleys.)

Here are some random observations:

* My son is mercifully still at the age (and we let him play arcade games so rarely) that we spent a half hour in there with him just enjoying the demos of various games.

* Although I didn't have my son's patience with games that were waiting for quarters, I was perfectly content to watch a 15-year-old kill dozens, perhaps hundreds, of storm troopers and other miscreants in the employ of the Emperor. It would have been in the thousands, except the TIE fighters blew him up defending the original Death Star and he stopped pumping in more money. I don't think I've ever seen anyone actually fight Vader, even though that scene is featured when no one's playing the game.

* I didn't conduct an extensive survey, but it seemed that the gap between the 1st and 2nd place high scores was much much bigger than the gaps between the other rankings. On one game that had cardinal scoring, the 1st place score was almost 5 times higher than the 2nd place score, whereas after that the scores would drop by 10% or so with each step. On the racing games, where the scores were in terms of lowest times, the "Course Record" was so low that I wasn't sure I was reading the information correctly. The 3rd place would be, say, 3:02, the 2nd place 2:40, the 1st place would be 2:31, and then the "Course Record" would say 0:48 or something. So like I said, I'm not sure what that meant, but it could have been consistent with the cardinal top scores. The point being, there isn't a bell curve when it comes to killing Aliens. The best guy is WAY the heck better than the others.

* There were security cameras distributed around the place, and there were also TV monitors that would cycle through the cameras. So the point was, they were letting you know they were watching. My son was on a motorcycle and for some reason reached out and put his hand over the lens of the camera and moved it so it pointed somewhere else. Atta boy. Fight the power, my son.

* Without any prodding from his pacifist father, my son grew quickly bored with the shoot-your-way-out-of-a-zombie-house game and spent most of his time racing. (Or more accurately, he spent most of his time watching commercials for racing games.)

* I think if someone from the 1950s--who had warned that Elvis' devil music would corrupt America--were magically transported to a modern arcade, he would feel completely vindicated. There weren't too many games that honed your hand-eye coordination by seeing how many kittens you could rescue from a towering inferno, or how many heart transplants you could perform in 60 seconds.

* I'm sure everyone thinks the games of his childhood were the best ever, but I still say nothing beats Super Mario Bros. on the original Nintendo.


The Wonders of the Internet

I've enjoyed Rick Rolls, and I enjoyed seeing the young Bill O'Reilly explosion when it first surfaced. Can the two be married? Apparently so (HT2 Brad DeLong), and watch out for the F-bomb if you are viewing in a sensitive location (or have morals):

Wednesday, December 30, 2009


If You Go to a Birthday Party at a Restaurant and Somebody Skips Out, Who Pays Her Bill?

Akal Singh Krau is an extremely interesting guy who is a law student at the University of Tennessee (Knoxville). A few months ago he invited me to give my standard doom-and-gloom talk to bum out his peers, and we realized that he literally grew up down the street from where I currently live. Anyway, since he was back home for the holidays we had dinner. Afterward my other buddy and I went to the karaoke bar (of course), while Akal went to a "hip" Nashville restaurant, PM, where one of his friends was having a birthday party celebration. Here's Akal's post-game show:
The scene at the restaurant was...highly contentious by the time I left! One of the birthday girl's friends accidentally walked out without paying her check. Other than the birthday girl, no one else present knew the friend who walked out, so none of us felt any responsibility.

The waiter and restaurant manager kept pushing the concept of "the table" as a single entity by which all persons present are accountable for every item brought to it. I tried to explain basic contract liability (which I presented as methodologically individualistic) but completely gave up when the manager looked at me and said, "Life is gray; nothing is black and white." It wasn't pleasant.
In a follow-up (after I asked for permission to blog this) Akal added:
Yeah, it was kind of interesting. I felt some sympathy with the restaurant's table-as-entity argument since even customers don't always know how the check will be paid. Sometimes I might cover your meal, or you might cover mine; and social grace does not permit us to explicitly work this out in advance. As it would be indelicate for a waiter to require an explicit account for each item ordered and brought to the table, the assumption that someone will cover it seems proper.

On the other side of things, the happenstance placement of one's derrière does not sufficiently communicate an intention to incur gaurantor liability. And how do you define the concept of "the table?" By physical proximity of physical tables? By degree of interaction or familiarity between persons?



* I know we rarely say nice things about Matt Yglesias around here, so I should point out this really good post arguing that the comparison of legislation to sausage making is unfair to the sausage makers.

* EPJ links to a very interesting story about how Business Insider got hacked. Really, you should check out what the Nigerian email scammers did once they gained control of the email account; they were fast and clever.

* One of the justifications for formalism is that it allows arguments to be settled quickly. Rather than people going 'round and 'round, equivocating and playing word games in their arguments, you just make your claims in formal language and BAM everybody can quickly determine who's right. Or not (see comments).

* This is a short video [.wmv] showing the end of Kodak Park. (If I didn't know better, I'd swear the Kodak buildings were taken down by passenger jets flown by radical Muslims.) I grew up literally down the street from a Kodak plant; in fact I suspect its smokestack is the source of my super powers. (Either that or the red Krypton sun.) Unfortunately that building is still standing, according to my dad, so I can't give this blog post too much personal flavor. I am pretty sure though that my dad spent much of his career in some of the buildings that are now demolished. Outsourcing takes no prisoners.


Bill and I Don't See Eye to Eye on Estate Taxes

Check out this comment from "Bill" when Alex Tabarrok discussed estate taxes:
Having been the surprising beneficiary of an uncle's demise, I can assure you that estate taxes, or rather the absence of them, are quite a surprising windfall.

You see, my uncle never paid taxes. He did all he could ever do to defer taxes, buying equipment when he didn't need to, just tons of stuff. I mean tons of stuff, all for the purpose of avoiding taxes.

So, when he died, and I along with some cousins inherited his estate, I thought, well, at least my uncle's estate finally paid taxes.

Nope. No estate taxes. No capital gains. Nada. When the tax lawyer told me I couldn't believe it.

My uncle is probably laughing from the grave, but I'm wondering: how did we ever let people escape paying taxes? We probably got some chumps to repeat the slogan death taxes long enough so they were mesmerized into submission. Thank you for your generousity. Now, let's talk about the deficit.


Regrets, I've Had a Few...

I made a joke comment at MarginalRevolution, and then another commenter wanted me to elaborate, so I did:
What I meant was, when I was reading Black's collection of essays, and hit the one on interest rates as an option, I made an intuitive connection between the major project I was grappling with at the time. Namely, I was trying to enter the finance world as an economist with a dissertation in capital theory, and so I was trying to come up with a paper where I linked up standard finance papers explaining interest rates as random walks or whatever, with standard GE econ models explaining interest rates as the marginal product of capital. I thought I could provide more constraints on how interest rates evolved over time, by bringing in "knowledge" from macro econ models.

So anyway Black's approach to interest rates clicked with me and made me think I was on the right track, but then I got a job offer and it's 4 years later and I can't really remember what my brilliant insight was. :(


A Quick Note on Recapitalization

In November of 2008 I had a long phone conversation with the impregnable von Pepe, which clarified the typical discussions of the financial crisis in light of my hazy knowledge of accounting. In fact I was so energized after the call that I set out to do a whole series of blog posts sharing my newfound understanding.

Well that never happened. But I had another talk with von Pepe tonight and something really clicked, so I thought I would share it verbally (i.e. without coming up with a hypothetical balance sheet to illustrate the idea) while it's still fresh.

One last point before we dive in: I am going out of my way to "not get it" in the analysis below. Before my talk with von Pepe, it's not that I doubted the conventional wisdom on these matters, but I just had my doubts and wasn't sure how to dispel them.


Here's the context: After the crisis, you heard many commentators say things like, "The banks took huge hits on their holdings of mortgage-backed securities and standard loans. After writing down their assets, they have very little equity remaining. They need to issue more stock to recapitalize themselves."

Now here were two vague concerns I had with this type of statement:

(1) Why did the firms need to attract new capital through the issuance of stock? If they needed to raise money, couldn't they just issue more bonds? But then that wouldn't be a recapitalization, it would be borrowing.

(2) If these firms were on the ropes because of their huge losses, how does that get magically fixed by pumping in more capital? Or to put it another way, why would investors want to buy shares in a company on the verge of bankruptcy? To put it a third way, if the company is solid and outside investors are willing to pump in more money, then who cares if they currently only have a razor-thin margin of shareholders' equity? What's a billion here or there in extra losses on MBS holdings if the underlying firm is solid?

The answer to all of the above turns out to be really elementary, but for some reason it didn't click with me until my phone call tonight. So here it is: When a corporation issues more debt, it is taking on fixed liabilities (to make periodic interest payments and eventually return the principal). If the corporation does really well and has high earnings, then it pays off the bondholders the contractual amount and keeps the rest. On the other hand, if the firm loses money, it still owes the bondholders.

In contrast, if the corporation issues new shares of stock, it isn't committing itself to future payments. If times are bad, nothing happens. If times are good, however, then the pool of available earnings to be distributed as dividend payments must be spread over a larger number of shares.

So if we're looking at a financial institution that took huge writedowns on its loan portfolio and holdings of MBS, such that there is only $1 billion in shareholders' equity compared to (say) $100 billion in outstanding debt, then that firm is incredibly leveraged. If things go smoothly and no further writedowns occur, then it will slowly climb out of its hole and the shareholders will make a killing.

However, if they lose just 1% in the value of their assets, that could wipe them out and they would have to declare bankruptcy. I.e. their liabilities would exceed their remaining assets.

So rather than remain in such a precarious position, the corporation can issue new stock and spread the potential gains and losses among a broader base of capital. If the corporation does well, it dilutes the return to the original shareholders. On the other hand, if things go poorly, the original shareholders aren't wiped out. In essence they've brought in others to reduce both the expected return and its variance.


Is the Fed Monetizing the Debt?

Some of us have been surprised at how low the yields on Treasury debt continue to remain, despite the government's explicit and implicit promises of future deficits. Given all the shenanigans, I have suspected that somehow the Federal Reserve has been buying much more of the Treasury's bonds than we are being told.

In this context I read with great interest a recent analysis from Zerohedge [.pdf] that claims the government's own figures show that huge amounts of new Treasury debt has fallen into an accounting black hole:
So who really picked up the tab? To our surprise, the only group to actually substantially increase their purchases in 2009 is defined in the Federal Reserve Flow of Funds Report as the "Household Sector". This category of buyers bought $15 billion worth of treasuries in 2008, but by Q3 2009 had purchased a whopping $528.7 billion worth. At the end of Q3 this Household Sector category now owns more treasuries than the Federal Reserve itself.

So to summarize, the majority buyers of Treasury securities in 2009 were:
1. Foreign and International buyers who purchased $697.5 billion.
2. The Federal Reserve who bought $286 billion.
3. The Household Sector who bought $528 billion to Q3 – which puts them on track [to] purchase $704 billion for fiscal 2009.

These three buying groups represent the lion’s share of the $1.885 trillion of debt that was issued by the US in fiscal 2009.

We must admit that we were surprised to discover that "Households" had bought so many Treasuries in 2009. They bought 35 times more government debt than they did in 2008. Given the financial condition of the average household in 2009, this makes little sense to us. With unemployment and foreclosures skyrocketing, who could afford to increase treasury investments to such a large degree? For our more discerning readers, this enormous "Household" investment was made outside of Money Market Funds, Mutual Funds, ETF’s, Life Insurance Companies, Pension and Retirement funds and Closed-End Funds, which are all separate reporting categories.

So that's rather odd, right? But then you read this and start to get queasy:

This leaves a very important question - who makes up this Household Sector? Amazingly, we discovered that the Household Sector is actually just a catch-all category. It represents the buyers left over who can’t be slotted into the other group headings. For most categories of financial assets and liabilities, the values for the Household Sector are calculated as residuals. That is, amounts held or owed by the other sectors are subtracted from known totals, and the remainders are assumed to be the amounts held or owed by the Household Sector. To quote directly from the Flow of Funds Guide, "For example, the amounts of Treasury securities held by all other sectors, obtained from asset data reported by the companies or institutions themselves, are subtracted from total Treasury securities outstanding, obtained from the Monthly Treasury Statement of Receipts and Outlays of the United States Government and the balance is assigned to the household sector."...So to answer the question - who is the Household Sector? They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the Federal Reserve’s Flow of Funds report.
Now it's true--as Robert Wenzel says in his pooh-poohing of this report--that the terminology is inaccurate. For one thing, it's not really clear that this would be a Ponzi scheme, and for another, the Household sector obviously exists. Also, I had trouble following their argument, because they kept switching between fiscal and calendar years, and I wasn't sure that they themselves were keeping the distinction straight.

Even so, I think Wenzel is quibbling over the authors' use of headline grabbing vocabulary, when their underlying analysis (assuming it is accurate) is quite startling. It's true that we might expect households to load up on Treasurys because of the crisis, but wouldn't you expect them to do so through MMFs, Mutual Funds, ETFs, etc.?

Wenzel also says this: "In short, the Fed has been conducting business as usual, printing money, aka counterfeiting. It is highly unlikely they have attempted to cook the books when they have willingly reported the trillions in reserves they have otherwise pumped into the system. It makes no sense."

Of course Wenzel is right in the grand scheme of things, but I think he is being a bit too glib here. Even the average investor, who doesn't even know how a gold standard works and thinks money is supposed to be pieces of paper, understands the danger in the Fed "monetizing the debt." Up till now, the Fed officially says that its purchases of Treasury debt are only to achieve its goals of monetary policy.

But if the average investor starts to think that the Fed is buying more Treasury debt because Obama needs to run a bigger deficit, then the fat lady needs to warm up her voice. At that point, even the dullest of financial analysts will realize, "Wait a minute, they're just printing up new dollars to pay their bills! Prices will surely rise."

Last point: The Zerohedge report says that in 2Q 2009, the Fed (through its "quantitative easing") purchased 48% of the new Treasury debt issued! I hadn't realized it was so high.

Eh, maybe Wenzel is right: If worldwide investors can see what's right in front of their faces and not bat an eye, maybe the Fed has no reason to hide anything. Bernanke could say, "My parametric estimation leads me to conclude that a sustained yet modest recapitalization of my personal checking account by $1.8 million per week will be vital to achieving the Federal Reserve's dual mandate of vibrant economic growth and low price inflation."

Tuesday, December 29, 2009


Thomas Schelling: Nuclear Weapons Are Like the Log-Plume Ride...

...the anticipation is scarier than the realization (HT2MR):
In summary, a "world without nuclear weapons" would be a world in which the United States, Russia, Israel, China, and half a dozen or a dozen other countries would have hair-trigger mobilization plans to rebuild nuclear weapons and mobilize or commandeer delivery systems, and would have prepared targets to preempt other nations' nuclear facilities, all in a high-alert status, with practice drills and secure emergency communications. Every crisis would be a nuclear crisis, any war could become a nuclear war. The urge to preempt would dominate; whoever gets the first few weapons will coerce or preempt. It would be a nervous world.
Now before you lecture me on unstable equilibria in the comments, please realize I am objecting not to Schelling's overall conclusion--that the desire to ban nuclear weapons overlooks many strategic considerations--but rather I am pointing out that the particular argument above is silly.


Bernanke Will Be Revered By Future Fed Chairs

Afraid to ask Congress* last year for the authority to issue the Fed's own debt to the public, Bernanke decides it's better to seek forgiveness than ask permission:
The U.S. Federal Reserve on Monday pressed ahead toward the creation of a new mechanism it says could be used to withdraw money from the banking system once policymakers decide to tighten monetary policy.

The program, called the term deposit facility, would allow financial institutions to earn interest on loans of longer maturities to the central bank. The Fed already pays interest on banks' overnight reserves.

"Term deposits would be one of several tools that the Federal Reserve could employ to drain reserves to support the effective implementation of monetary policy," the Fed said in a statement that was the Fed's first detailed proposal for the new facility.

Rates on term loans, whose maturity would likely range between one and six months and would not exceed a year, could be determined via competitive bidding at auction, the Fed said. They would be available only to financial institutions eligible for federal deposit insurance, not the general public. Once lent to the central bank, the money cannot be withdrawn.

Excess Problem

In its effort to battle the worst financial crisis since the Great Depression, the Fed has deployed an extraordinary array of emergency measures, leading to a surge in outstanding credit to the banking system to more than $2.2 trillion.

The amount of money sloshing around has fueled concern about the possibility of high inflation. Withdrawing the reserves at just the right time is seen as crucial to keep consumer prices under wraps.

"They have a big problem with excess reserves and this is one of the ways to deal with it," said Raymond Remy, head of fixed-income at Daiwa Securities.
At the height of last year's financial meltdown, the Fed had been discussing going to Congress to request the authority to issue its own bills. The term deposit facility achieves a similar purpose, but can be undertaken within the Fed's existing authority and does not require congressional approval.

"This is more of a politically acceptable way of getting the same thing done," said Tom Simons, money market economist at Jefferies.
Those readers who have read my opinion on the "tool" of paying interest on overnight reserves can probably guess what I think of this: At best it simply pushes back the problem, and only for six months to a year. Really, this isn't too hard, and I am astounded that nobody says this except in non-mainstream articles or in comments on official news stories. How in the world is it a "tool to drain liquidity," to implement a strategy that results in more reserves in a few months' time? I mean, that would be as crazy and Orwellian as the president of the United States calling for fiscal responsibility while he runs up the biggest budget deficit in histor--oh wait.

More serious, Bernanke is doing what all good political leaders do, in that he is exploiting a crisis to expand the powers of his organization. At the very least, this gives the Fed more options, similar to an individual getting a huge new line of credit. But someone (maybe one of the GMU bloggers?) said something like, "If I have a printing press, why do I want the ability to borrow money?" and I confess I am perplexed by this move as well. For all I know, this really is just a pointless accounting gimmick that Bernanke wants the bloggers to focus on this week, while he somehow takes assets away from Freddie and Fannie behind the scenes.

* At least, that was my recollection--that the Fed discussed the plan to issue its own debt, but never actually approached Congress and formally asked for this power. Please correct me someone if I'm wrong.

Monday, December 28, 2009


John Cassidy Fails in His Critique of Markets

I explain at Mises today:
While driving my son to school one morning, I heard a National Public Radio interview with John Cassidy, author of the new book How Markets Fail. Fortunately, we got to the front of the line before Cassidy let out the zingers. A few minutes earlier, and my son would have seen Daddy lose his temper.

Cassidy first caricatures the case for free markets, then tries to demonstrate the hypocrisy of a "free-market" financial bailout. Yet his arguments obviously don't bear on whether markets fail or need government supervision. Indeed, Cassidy himself acknowledges that what happened at the end of the Bush administration was anything but the free market.


How the Fed's Massive MBS Purchases Harm Banks

Editor's Note: I asked "Mike in Alaska" to expand some of his intriguing blog comments into a full-length article. Note that I have added the underlining below, not the author. --RPM

How the Fed’s Massive Purchase of Mortgage-Backed Securities
Plays a Role in Harming Banks and the Overall Financial System:
A small town community bank perspective.
By Michael J. Dunton

Creation of Excess Reserves Earning 0.25%

Let me explain to the average reader what excess reserves mean in a context of a small community bank. Each day a young lady from my staff would come into my office and show me where we were at, in cash (paper and electronic), from the day’s course of business. I always had to know what time it was in the morning so as to be ready for her visit between 11:30 and Noon—I sometimes could be in a meeting in the building, or could be somewhere about town. If we needed cash, I would call up the Federal Home Loan Bank that we belonged to and borrow overnight funds—or I could borrow for 30, 60, 90, 12, 180, or 360 days if the rate was too good to pass up. We could even borrow on a term facility for up to 30 years, but going out that long on the yield curve, whether borrow or lending, is a bit dramatic for me. The same goes if we had excess cash: I could lend it out overnight, or buy a CD of varying maturities and rates.

That was then.

Fast forward to now and we get the situation where we haven’t had to borrow for daily liquidity for so long that I have forgotten the Federal Home Loan Bank’s phone number and our bank’s account number (don’t worry, I have it written down). We are swimming in excess cash. We see this as a result of several events: first, mortgage-backed securities we hold have been paying off at a faster speed due to the Federal Reserve’s purchase of MBS in the market; second, our loan demand is down—our loan balances are about 5% lower than normal; third, other bonds' yields are being dragged down and issuers are calling the higher yielding securities and reissuing new bonds at lower yields; lastly, our customers are holding higher cash balances. I now needn’t worry if I have to borrow for my daily liquidity on any given day for the foreseeable future—I just need to worry how to stay in business with $15 million stuck earning 0.25% and flat to decreasing loan demand for the next year.

Let’s explore why the Fed has been affecting excess reserves by way of buying up mortgage-backed securities. The Fed is trying to stimulate the economy, help homeowners, and buoy the banks by re-inflating the housing asset bubble. Most mortgages are rolled up into securities (MBS) and sold to investors. We’ve written, through November, $126 million in mortgages versus $58 million last year. We’ve only kept on our books about $28 million in mortgages. Most of our mortgages are sold to Fannie, who then rolls them into large pools of MBS. Regular banks (the big boys), in the past, have done the same thing as Fannie and Freddie and rolled their mortgages into private-label MBS. As I will discuss later, Fannie and Freddie pretty much control the mortgage landscape right now and other players are living off the crumbs.

Depressed Yields and More Risk for Banks

Most MBS are good, but enough of the bad ones went south to affect the entire economy and paralyze the banking system. The Federal Reserve stepped in and bought up enough MBS so as to push mortgage rates down to bring buyers back into the market and prop up housing values. No one outside the Fed is certain what specific MBS were bought and from whom, but it was enough to pretty much control the pricing of all new mortgages. New mortgages were written up as refis and for new purchases. Now when those old loans were paid off at the new closing, the MBS that were connected to those old loans were quickly paid down, if not paid off entirely. That means those older, higher-yielding MBS that banks and other investors were holding gradually disappeared during this time—those MBS were paying a lot higher yield than the new MBS that took their place. Banks investments in MBS now earn less and if we want to replace the yield, on a one to one basis, we have to go out longer on the yield curve and accept more risk.

Let me now try to further explain why the Fed buying up these mortgage-backed securities is harmful to the economy and to banks in particular. When the Fed buys a bunch of MBS, it is overpaying for them—its like a rich guy early in an auction putting a ridiculously high bid on an valuable item that pretty much ends the bidding. This makes the yield on the MBS go down—it forces the mortgage market to offer 30 year mortgages between 4.5 to 5%. Now, no one in the mortgage market likes depressed prices like that for a 30 year income stream, but Fannie and Freddie were there to catch all that action. Don’t get me wrong, we made money doing the dirty work for Fannie and Freddie by originating and servicing the loan, but the risk is all on Fannie and Freddie right now. For the most part, they are the market for the foreseeable future. There are other institutions out there doing the same thing, but the real action is all Fannie and Freddie. Now Fannie and Freddie can push off any screwball regulation and fees on us with impunity. Each new rule and regulation costs a bank to implement through training and changes in systems. So now we’re getting increasingly pinched on the origination side of our business by Fannie and Freddie, which was made possible by the Fed’s involvement in buying up MBS.

Distorted Prices

Finally, the Fed’s foray into the mortgage market, by buying up MBS, has distorted true market prices for mortgage products, both in terms of revenue and costs. As it stands right now, the mortgage market is entirely dependent upon the federal government (the Fed, Fannie/Freddie, and the rest of the DC klunks). We essentially have people running the market, those pulling the strings from above, who derive the livelihood not from their financial performance, but from their position in government. Because banks, especially community banks, derive a large source of their income through mortgage activities, they will be forced to take what the government determines is right. There’s simply no viable alternative to the federal government’s heavy handed tactics in the mortgage market. The average homeowner may think he is getting an absolute steal by getting a sub 5% 30-year mortgage, but as a taxpayer he will receive a bargain he had not planned for. With virtually no private capital alternative to challenge Fannie and Freddie, the distortion will continue and true market prices will be an afterthought.


The Fed’s actions to help the economy by helping homeowners and banks through purchases of mortgage-backed securities is riddled with hidden costs and unintended consequences. Although mortgages have become cheap and commoditized, banks are earning less from their investments in MBS and direct holding of mortgages. Excessive purchases of MBS, by the Fed, have increased banks' excess reserves while decreasing mortgage loan pricing. These extra reserves now sit at the Fed earning a paltry 0.25%. Furthermore, the mortgage market is almost entirely dependent on the federal government and this has created distortions in price and its correspondent risks. Finally, if the Fed and the rest of the Washington apparatchik decided to get out of the mortgage business, or play a diminished role, then it would do so with the risk of the housing bubble deflating, due to greatly increased mortgage costs to consumers and further weakening banks by collateral values plummeting.

Michael J. Dunton is a SVP at a community bank in Alaska.

Sunday, December 27, 2009


Was Jesus a Pacifist?

This is a lightly edited article that originally ran on a few years ago, but in response to an email from John Goes I dug it up. I thought some new readers might be interested. --RPM

Was Jesus a Pacifist?
By Robert P. Murphy

In a 2002 article, World Net Daily editor Joseph Farah challenges the view that Jesus was a pacifist. Inasmuch as I have asserted otherwise, I’d like to defend my opinion a bit more thoroughly. I’ll first explain the general reasons I believe Jesus was/is a pacifist, and then I’ll address Farah’s specific arguments.

Regardless of His possible divinity, Jesus was clearly a revolutionary thinker who challenged the seemingly natural idea of retribution. Rather than vengeance, Jesus commanded forgiveness (Mt. 18:22). Instead of the pagan ideals of strength and power, Jesus offered the Christian ideals of humility and meekness (Mt. 5:5). Jesus went so far as to demand that His disciples love their enemies (Mt. 5:44).

The above is not in dispute. Even most atheists would agree that Jesus’ teachings were wise precepts concerning the uselessness of hatred and revenge. But did Jesus literally require pacifism?

A straightforward reading would suggest that He did. He literally (given the translation) commanded “whosoever shall smite thee on thy right cheek, turn to him the other also” (Mt. 5:39). But perhaps this was just a specific rule? Well, immediately before this famous injunction, Jesus also gave the general rule, forbidding resistance to evil. It is this passage that inspired Christian pacifists such as William Lloyd Garrison and Leo Tolstoy, and I find their interpretation entirely plausible.

Of course, Jesus often spoke in metaphors; one should be very careful in deriving categorical conclusions from a few Gospel passages. When studying not merely His words, but His actions, does it seem that Jesus was a pacifist?

I for one think this is the only sensible conclusion. He rebuked Peter for drawing his sword during His arrest. And of course, the entire purpose of Jesus’ coming to Earth was to suffer unjustly at the hands of evil men, despite the fact that He obviously had the power to prevent this. Such an argument alone doesn’t prove the case for Christian pacifism, but it does show that the doctrine is consistent with Christianity.

Horrible things happen to good people all the time. The use of violence won’t ever “solve” this. Most people would agree that it is impermissible to murder someone, even if so doing would save (through a heart transplant, say) a child from death. Yet most people believe that it is permissible to kill someone in order to prevent him from killing a child. The apparent inconsistency is evaded by classifying the latter case as justifiable defense, and by classifying the dead man as a criminal, worthy of less respect and rights than “civilized” people.

Yet it is precisely this mentality, I claim, that Jesus sought to overthrow. The kingdom of God on Earth can only be realized when everyone voluntarily renounces violence against his neighbors. And isn’t it just possible that the best and surest way to reach that goal is for each of us personally to renounce violence, for whatever reason, right now? To say, “I will lay down my arms just as soon as all the evil people do first” is to guarantee that you will never see the kingdom of God in your lifetime.

* * *

We now move on to Farah’s arguments. He really has only two. First, he reminds us that Jesus came, not to overturn the Mosaic Law, but to fulfill it. He also reminds us that Jesus and God the Father are the same. Therefore, since the God of the Old Testament was clearly not a pacifist, Jesus can’t be either:

Moving to the Gospel of John, we learn that Jesus is eternal. He always was and He always will be. He made the world and the universe. He is one with the Father. So, all of the commandments of God, as we know them, in what Christians call “the Old Testament,” are likewise the commandments of Jesus. He didn't come to overturn them. He came to fulfill them.

Read the Book of Judges and you will find that God told the Jews to utterly destroy entire unrighteous nations so that they could occupy the Promised Land. When the Jews failed to do this, they paid a heavy price. In Genesis, God Himself destroys Sodom and Gomorrah because of immorality. Throughout the Old Testament, we witness God destroying unrighteous men and ordering unrighteous men destroyed. Keep in mind, also, we are told in Hebrews 13:8 that Jesus is the same yesterday and today and forever.

If Jesus is the same yesterday, today and forever, that means Jesus destroyed unrighteous men and ordered unrighteous men destroyed.

Now this is, to me, a rather strange argument. Granted, to the extent that we use the Trinity to make Jesus the same as the Old Testament God, then Jesus isn’t a pacifist. (And we can also prove that Jesus is His own grandfather. That’s part of the danger of reasoning with a doctrine that is beyond human reason.) But that’s not what Christian pacifists mean; I don’t think anybody would argue that the God of Moses was a pacifist. In any event, when I say that I think Jesus was a pacifist, I mean the living and acting man of the New Testament renounced the use of violence, and commanded His followers to do the same.

More serious, I simply cannot understand Farah’s argument concerning the Mosaic Law. In the very sermon in which Jesus states that He has come to fulfill it, Jesus goes on to “update” all sorts of Old Testament commands. It is true, for most of them Jesus merely increases the requirements, in the sense that a Christian must not only obey the letter of the Law but do so with the right heart.

Nonetheless, Jesus clearly overturns many literal rules of the Old Testament. The most relevant for the current article is the “eye for an eye” revision; this was not some pagan barbarism, but commanded by God (Ex. 21:24). God also told the Jews not to gather food on the Sabbath (Ex. 16:28-29). Indeed, when Jesus’ disciples did this (with His approval), the Pharisees accused Him of breaking the Mosaic Law (Mk. 2:23-24). Finally, Jesus did not endorse the Mosaic penalty of stoning for an adulteress, but rather forgave the woman and told her to sin no more (Jn. 8:3-11).

Farah’s only other argument is Jesus’ command to purchase swords (Lk. 22:36). Now this is one instance where I think Jesus is speaking metaphorically; in the context it seems to me that He is trying to prepare His disciples for the fact that their leader will soon be taken from them. (In any event, He says that two swords are “enough.” I have heard one interpretation that Jesus was exasperated that His disciples had once again misunderstood His message, and so said, in effect, “Enough of this.” But even if one takes that literally—so that two swords among all his disciples are “enough”—then this hardly seems reconcilable with Farah’s belief that Jesus believed in smiting evildoers.)

Shortly after the admittedly troublesome (from a pacifist viewpoint) verse in which Jesus tells his followers to buy swords, He is arrested. He rebukes Peter for cutting off the ear of the high priest’s servant, saying, “Put up again thy sword into his place: for all they that take the sword shall perish with the sword” (Mt. 26:52).

* * *

In conclusion, I think there is ample Biblical support for the belief that Jesus was a pacifist, and that Christianity is a pacifist creed. I realize the case is not beyond doubt; I am certainly open to counterarguments. However, I don’t think the particular claims of Farah are very convincing, as I have tried to show above.

Finally, let me end by saying that I am not claiming that someone who, say, shoots a home invader is therefore a “bad Christian.” Such a judgment on my part would itself be contrary to my interpretation of Christianity. My only purpose in writing the present article was to explain why I personally think Jesus was a pacifist, and why I try to live up to that difficult requirement in my own life.

Robert P. Murphy holds a Ph.D. in economics from New York University. He is the author of The Politically Incorrect Guide to the Great Depression and the New Deal (Regnery, 2009), and is the editor of the blog Free Advice.

Saturday, December 26, 2009


Potpourri: Be Afraid, Be Very Afraid Edition

The translucent von Pepe sent me some scary articles today. I am not in the warp and woof of the markets enough to say whether the below excerpts are 100% right, but they definitely express the foreboding that von Pepe and I share.

* This FT article talks about hedge funds betting on rising bond yields by buying deeply out of the money options. I loved this part (though see the following paragraphs on what happened to such investors in Japan):
Hedge fund managers, however, have been hesitant to engage in short sales of Treasury bonds to profit from the rising yields – and falling prices – because of the Federal Reserve’s heavy involvement in the market. This has led some to buy options – dubbed “high strike receivers” – that would enable them to profit from sharply higher Treasury yields, hedge fund managers say. These trades, which are relatively cheap to execute because they are so out of the money, are based on the thesis that yields could hit 7 or 8 per cent.

“If they are right, and the world ends, they will make a fortune,” said one fund manager who is sceptical of the idea. “If they are wrong, they haven’t lost much.”

* In this apocalyptic post, "Tyler Durden" argues that in 2010, demand for US fixed income assets has to rise elevenfold over the 2009 level or else we're all eating Ramen noodles.

* Another ZeroHedge post, breaking down the changing holdings of Primary Dealers. I'm not sure what the moral is, but I don't like it. (It's sorta like if you told me Tim Geithner was using a fake name to massively short Quaker Oats. What does it mean?! I don't know, but I don't like it.)

* I don't even know how to describe this one. Just skim it and then pick your jaw back up. Notice that when politicians run a region (Michigan) into the ground economically, they just double down. Stick a fork in the US economy. If and when the crisis erupts as I (and Tyler Durden) have been predicting, Obama & Friends aren't going to cut taxes and privatize federal assets. No, they're going to pass anti-gouging laws, void commodity ETF contracts, and start another war.

* To cheer you up, EPJ passes along season's greetings.


Pretty Neat for a 20-Year-Old

My dad's friend is into mass emailing, but fortunately half his stuff is pretty good. Case in point is this video apparently made by a 20-year-old for an AARP contest:

Here's a hint: Something neat happens halfway through the video. See if you can see it coming.


Krugman DID Identify the Housing Bubble in 2005

OK after browsing through his archives circa 2005, I must retract my earlier criticism of Paul Krugman. For sure, Krugman did identify the housing bubble before many other analysts (including me), and so he's not bluffing when he says nowadays that he called it. Also, people who comment at his site should be a little more nuanced instead of saying things like, "None of you Keynesian wizards saw this coming, so why should we listen to you now? Only Peter Schiff and the Austrians predicted the crash."

Last apology: I also was suspicious in the previous post that Krugman didn't point to any of his own articles (for proof that he had called the bubble), but instead linked to a 2005 article which in turn referred to Krugman's 2001 articles--when those articles came 95% close to recommending that Greenspan create a housing bubble!! In retrospect, I think Krugman probably did that to show, "Hey, I know I was calling this back in 2005, and here are people attacking me for saying so--therefore I clearly was making loud noises about the bubble!" (Also, it's possible there is a typo in that article critical of Krugman; I could never find his article that they were talking about.)

OK now that the apologies are out of the way, let's go through and see the difference between Krugman's identification of the bubble, versus a Peter Schiff or a Mark Thornton (from 2004). Here's Krugman from May 2005:
Remember the stock market bubble? With everything that's happened since 2000, it feels like ancient history. But a few pessimists, notably Stephen Roach of Morgan Stanley, argue that we have not yet paid the price for our past excesses.

I've never fully accepted that view. But looking at the housing market, I'm starting to reconsider.

In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund, predicted that the Federal Reserve would simply replace one bubble with another. "There is room," he wrote, "for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand that Mr. Greenspan deny any such thing."

As Mr. McCulley predicted, interest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt. All of this created jobs to make up for those lost when the stock bubble burst.

Now the question is what can replace the housing bubble.

Nobody thought the economy could rely forever on home buying and refinancing. But the hope was that by the time the housing boom petered out, it would no longer be needed.

But although the housing boom has lasted longer than anyone could have imagined, the economy would still be in big trouble if it came to an end. That is, if the hectic pace of home construction were to cool, and consumers were to stop borrowing against their houses, the economy would slow down sharply. If housing prices actually started falling, we'd be looking at a very nasty scene, in which both construction and consumer spending would plunge, pushing the economy right back into recession.

That's why it's so ominous to see signs that America's housing market, like the stock market at the end of the last decade, is approaching the final, feverish stages of a speculative bubble.
Even Alan Greenspan now admits that we have "characteristics of bubbles" in the housing market, but only "in certain areas." And it's true that the craziest scenes are concentrated in a few regions, like coastal Florida and California.
The important point to remember is that the bursting of the stock market bubble hurt lots of people - not just those who bought stocks near their peak. By the summer of 2003, private-sector employment was three million below its 2001 peak. And the job losses would have been much worse if the stock bubble hadn't been quickly replaced with a housing bubble.

So what happens if the housing bubble bursts? It will be the same thing all over again, unless the Fed can find something to take its place. And it's hard to imagine what that might be. After all, the Fed's ability to manage the economy mainly comes from its ability to create booms and busts in the housing market. If housing enters a post-bubble slump, what's left?

Mr. Roach believes that the Fed's apparent success after 2001 was an illusion, that it simply piled up trouble for the future. I hope he's wrong. But the Fed does seem to be running out of bubbles.
Not to beat a dead horse, but let's go back to August 2002 closer to when the guy from Pimco first made the comment about Greenspan replacing the Nasdaq bubble with a housing bubble. Here's what Krugman said at the time:
The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Judging by Mr. Greenspan's remarkably cheerful recent testimony, he still thinks he can pull that off. But the Fed chairman's crystal ball has been cloudy lately; remember how he urged Congress to cut taxes to head off the risk of excessive budget surpluses? And a sober look at recent data is not encouraging.
So yes, Krugman did identify that there was a housing bubble in progress in 2005, but it was akin to a doctor thinking a cancer patient was reacting very severely to aggressive chemotherapy. The Fed-induced housing bubble wasn't poison, as far as Krugman was concerned, just medicine that was having unfortunate negative consequences. His recommendation wasn't for the government to stop tinkering and fueling new booms, but rather to search for something else to inflate.


Sometimes You Have to Salute Krugman's Audacity (or Maybe Just Sloppiness)

This guy is really something else. In this post, Krugman matter of factly said that he had predicted the housing bubble, in contrast to Bernanke. Apparently some people demanded that Krugman give examples of where exactly he warned that housing prices were too high, because in a subsequent post Krugman wrote:
3. Some commenters ask for proof that I warned early about the housing bubble. As it happens, I ran across this interesting piece from 2005, denouncing the lying liberal media — mainly me — for asserting that there was a bubble in housing.
Now right away my Spidey sense was tingling; Krugman didn't actually link to his article, but to someone else talking about his articles. Why not cut out the middle man, if there were a smoking gun article?

If we go to the "piece from 2005," we see that yes indeed, it is from a right-winger who thinks wacko liberals are complaining unfairly about home prices. Yet here's what they say about Krugman:
Journalists have been talking about a housing bubble since 2001. On September 3 of that year, Forbes magazine warned its readers about the consequences of home equity values starting “to wobble,” while stating, “There are ominous signs that this is about to happen.” On the same day, a BusinessWeek editorial cautioned about a “double bubble” and told its readers, “A housing bubble may be developing – right behind the Nasdaq bubble.” Both indicated that such an event would be devastating to the economy.

What those reports failed to explain was that an investment bubble occurs when an asset appreciates by extraordinary percentages for a short period of time, culminating in a rapid decline that wipes away most of the gains. A perfect example is the NASDAQ stock index, which went from roughly 1,400 in October 1998 to more than 5,000 in March 2000 (a 250-percent gain in less than 18 months), only to fall back to about 1,400 by October 2001 (a 70-percent decline in about 18 months). The housing market is less liquid and prices don’t usually change quickly like stocks do.

Four of 16 media reports in 2001 that referenced a housing bubble were either written by or cited New York Times economic columnist Paul Krugman. Of particular note was a September 30 Times article by Krugman entitled “Fear Itself” where he wrote: “Housing was doing better, thanks to low interest rates, but some analysts were warning about a housing bubble – and even if they were wrong, how solid a recovery could we have from housing alone?”
Unfortunately I can't find the particular article they are talking about; maybe someone can help me out. (I've check the NYT archives both by title and by searching for "Fear Itself," and I don't see anything close to what these people are talking about.)

However let's look at a Krugman NYT piece from August 14, 2001 where he said:
The driving force behind the current slowdown is a plunge in business investment. It now seems clear that over the last few years businesses spent too much on equipment and software, and that they will be cautious about further spending until their excess capacity has been worked off. And the Fed cannot do much to change their minds, since equipment spending is not particularly sensitive to interest rates.

Still, as former Treasury Secretary Larry Summers says, you don't have to refill a flat tire through the puncture. To reflate the economy, the Fed doesn't have to restore business investment; any kind of increase in demand will do.

How might demand increase? Consumers, who already have low savings and high debt, probably can't contribute much. But housing, which is highly sensitive to interest rates, could help lead a recovery. Even more important would be a turnaround in the U.S. trade balance. America's deficit has lately been running at 4.5 percent of G.D.P., three percentage points higher than it was as recently as 1997. Reversing that trend -- which would mean both exporting more and buying domestic instead of imported goods -- could deliver a big boost to the economy.
Sooner or later, of course, investors will realize that 2001 isn't 1998. When they do, mortgage rates and the dollar will come way down, and the conditions for a recovery led by housing and exports will be in place. But for the time being delusions of an instant return to prosperity stand in the way of a real economic turnaround.

Hmm that doesn't sound exactly like he's warning everyone of the dangers of artificially high home prices. And let's not forget his now-notorious 2002 NYT column which even the NYT archive summarizes this way:
Paul Krugman Op-Ed column on role of American consumers who have rushed into fray, fending off recession's worst effects time and again; suggests that recession of 2001 was not typical postwar slump but prewar-style recession, 'morning after' brought on by irrational exuberance; says Fed needs to fight back with soaring household spending to offset moribund business investment, for which Alan Greenspan needs to create housing bubble to replace Nasdaq bubble.
OK let's pause in our victory lap, I'm pretty sure there are some 2005 columns where Krugman is talking about there being an ominous housing bubble. It's late and I have to crash; I just saw these titles now as I was looking for the notorious 2002 one. If any readers find a smoking gun where Krugman clearly calls it, let me know and I'll do a new post.


The New Republic: If Something Is Taken for Granted, It Must Be a Good Thing

Arnold Kling links to this TNR article showing allegedly absurd warnings from the past, which are supposed to make current Obama-haters rethink their rhetoric. Funny thing is, a bunch of those warnings strike me as confirmed, or at the very least still open for debate. The TNR writers don't actually give a "The Claim...The Reality" type analysis, but instead list these quotes as self-evidently dumb. Here is what the TNR writers say about it in the intro:
Conservatives have lined up in near-unanimous opposition to any progressive legislation introduced during President Obama’s first year in office. Whether they’ve been railing against health care reform, a climate bill, or financial regulation, their ire has stemmed less from legislative specifics than from a generalized prophecy of doom: Obama’s proposals will move the country toward socialism, bankrupt entire industries and small businesses, and deny Americans their basic freedoms. These arguments, however, aren’t new. Conservatives—not just Republicans, but various politicians and groups who’ve resisted major social changes—recycled them throughout the twentieth century. They used them to oppose numerous progressive measures that Americans now take for granted, from women’s suffrage to child-labor laws to Medicare.
Really, with that intro, you're expecting to see all manner of crazy, bigoted things. Don't get me wrong, some of the quotes ARE just that, but several of them are not only understandable, I think they are confirmed.


I Have Been Following The Rock's Career With Great Interest

I'm not sure if I blogged about this before, but it's been very interesting to watch "The Rock's" transition from wrestling to film stardom. Today I took my son to see Alvin and the Chipmunks (the only non-scary kid movie available, though it featured wedgies) and here was one of the trailers (just move the pointer to the 2:10 mark if you want):

Now when this particular guy first started in films, he was billed in the Previews as "The Rock." Then in subsequent films he was referred to as "Dwayne 'the Rock' Johnson," and there might have also been a period where they used both names separately.

Now, in this film (and I believe his previous one) they don't even use "The Rock" at all. He is trying to put that behind him so he can become a real movie star, a la Marky Mark and the Fresh Prince.

Mr. Johnson's transition will not be complete until he can star in a movie without taking his shirt off.

Last point, I actually like him a lot. I love the self-deprecating comedic roles he takes, in particular in Be Cool (sequel to Get Shorty). This is one of his best parts, where he's auditioning by re-enacting a scene from Bring It On. (Sorry I couldn't find a better video.)

Friday, December 25, 2009


I Told You Guys That Krugman Was Misleading the Children

Jeff Tucker passed along a very critical comment from reddit on my recent article accusing Krugman of making a basic mistake on trade theory. Here's the opening salvo:
Has this author ever even taken macroeconomics in college? This crap was on my freakin midterm; Krugman is 100% right. Increasing or decreasing the amount of trade we do via protectionism or trade liberalization only changes the volume of trade, but not the balance of trade, ergo it doesn't affect short run GDP. That's what Krugman is saying, and it's extremely obvious to anyone who knows that NX = Savings - Investment. Maybe if the author actually went over NX = S - I, he'd realize why what he's saying is wrong.

OK, criticizing Krugman on general economics is one thing, but you'd have to be a damned fool to criticize him on trade theory. That's all Krugman does, academically speaking. The author of this piece is WAY out of his own league. To say that "Krugman is wrong even within the Keynesian framework" is completely laughable; take it from someone who just studied most of this junk.
If you are interested in using Keynesian macro variables to express sound economics, I think you will enjoy clicking the link and watching this guy (?) and me debate. For example here is part of his follow-up:
You're 100% right; trade barriers adversely affect C and I. But it's more of a long run effect than a short run effect.

Trade in itself does not contribute to output, it just turns your output into something else that you want. If I'm making 40 bushels of corn and trading them with China for 40 teddy bears (backwards, I know), and all of a sudden a barrier is put up so I can't trade for teddy bears anymore, if I'm still producing 40 bushels then my output hasn't changed; it is and always has been 40 bushels. So GDP remains the same.
This is--I believe--totally totally wrong, but it's a very interesting mistake that I've never encountered before. So if you want to see me pick it apart, follow the link.

Last point: I'm almost glad that this guy (?) made this confident comment about my article. Kevin Donoghue and some others had me doubting myself, and thinking that Krugman wasn't misleading his readers. Well, he certainly fooled this person.



* It's the clash of the titans over at Crash Landing, concerning a popular and allegedly circular argument against the State.

* TokyoTom takes a break from discussing my income stream to pointing out the ominous WSJ series on financial "reform." (I think it's like health care "reform.")

* A naive economist allows his anti-Fed arguments to be used by above-mentioned WSJ.

* M4liberty passes along this interesting board game trivia. I'm glad to see I'm doing my share to save the planet.

* Mankiw sees the wisdom in economists adopting the medical analogy for the failures of Keynesianism.

* Gary North writes favorably of Oral Roberts (no surprise) and Frank Zappa (huge surprise). (HT2 Lew Rockwell)

* Tyler Cowen linked (with bemusement I think) to this Italian song about what Americans sound like to foreigners, but I thought the song was awesome. USA! USA! In any event, I'm not sure when this was released, but if it came after Austin Powers, then this guy's got nothing on Mike Meyers. Seriously, isn't this video just the opening of Austin Powers II?


When Life Gives You Taxes, Make the Savior of the World

Merry Christmas! And as part of our ongoing series, "Why does God let bad things happen?" here we explain that if King Herod and Caesar had become Rothbardians, the Scriptures wouldn't have been fulfilled.

The Jews in Jesus' day were waiting for their Messiah, but the prophecies said he would come from Bethlehem. So you can understand Nathanael's confusion when Philip tells him the good news:
Jesus Calls Philip and Nathanael

43The next day Jesus decided to leave for Galilee. Finding Philip, he said to him, "Follow me."

44Philip, like Andrew and Peter, was from the town of Bethsaida. 45Philip found Nathanael and told him, "We have found the one Moses wrote about in the Law, and about whom the prophets also wrote—Jesus of Nazareth, the son of Joseph."

46"Nazareth! Can anything good come from there?" Nathanael asked.
"Come and see," said Philip.
So the confusion here is that this guy Jesus is the son of a carpenter who grew up in Nazareth. Hence, he couldn't possibly be the promised Messiah, since all educated Jews knew the Messiah was supposed to come from Bethlehem (from the line of King David).

Of course, the wrinkle is that Jesus really was born in a manger in Bethlehem--his earthly parents Mary and Joseph had to make the trek there for a census being conducted for tax purposes:
The Birth of Jesus

1In those days Caesar Augustus issued a decree that a census should be taken of the entire Roman world. 2(This was the first census that took place while Quirinius was governor of Syria.) 3And everyone went to his own town to register.

4So Joseph also went up from the town of Nazareth in Galilee to Judea, to Bethlehem the town of David, because he belonged to the house and line of David. 5He went there to register with Mary, who was pledged to be married to him and was expecting a child. 6While they were there, the time came for the baby to be born, 7and she gave birth to her firstborn, a son. She wrapped him in cloths and placed him in a manger, because there was no room for them in the inn.
So when earthly rulers seek to rip off poor people, they unwittingly fulfill the Scriptures and allow the rise of the true King whose majesty renders them paupers. And later on, when earthly rulers have Him killed, they unwittingly fulfill the Scriptures yet again and allow Him to save the world.

You and I are dirty sinners, but the reason we should feel down is that we're not doing what God wants. We don't need to worry that we're going to screw up His plans. He knew you were going to do that before you were even born. He's disappointed, but don't worry--He was ready for it. Good will still triumph, sometimes in spite of us.

Tuesday, December 22, 2009


It's All About Me Potpourri

* I am on vacation and am not getting out my Rosetta Stone, but I frankly don't know what Mish is even talking about in this response. It seems he is using a variation of the legal defense, "My client wasn't at the murder scene, and if he were he doesn't own a gun, and if he did he is legally blind and so couldn't possibly have been the shooter." Naturally Mish doesn't explain why we will have about 2.9% CPI inflation in 2009 if his analysis is the correct one.

* I walk through Krugman's (apparent) goof on international trade and the Keynesian accounting identity.

* I quintuple-down on my inflation bet, this time with David Henderson. If Arnold Kling wants a piece of it, I will have to buy a credit default swap on EconLog.

* I have been waiting since the summer for this: The YouTube of my appearance on a TV show in the Bahamas. Like Obi-Won, I easily fend off anticapitalist attacks from two assailants.

If you want to see the rest go here and scroll down in the "Related Videos" to see Parts 2 etc. of "Dr. Robert Murphy on Platform TV." Note that I am at my parents' house and I can't figure out how to turn on the volume on their computer, so I hope it sounds OK.

Sunday, December 20, 2009


When You're Right With the Lord, You Make Good Decisions

I am at my parents' house so blogging will be sparse for a while. In the meantime check out this passage (2 Chronicles 26: 1-15) which illustrates the way I think God works in history:
1 Then all the people of Judah took Uzziah, [a] who was sixteen years old, and made him king in place of his father Amaziah. 2 He was the one who rebuilt Elath and restored it to Judah after Amaziah rested with his fathers.
3 Uzziah was sixteen years old when he became king, and he reigned in Jerusalem fifty-two years. His mother's name was Jecoliah; she was from Jerusalem. 4 He did what was right in the eyes of the LORD, just as his father Amaziah had done. 5 He sought God during the days of Zechariah, who instructed him in the fear [b] of God. As long as he sought the LORD, God gave him success.

6 He went to war against the Philistines and broke down the walls of Gath, Jabneh and Ashdod. He then rebuilt towns near Ashdod and elsewhere among the Philistines. 7 God helped him against the Philistines and against the Arabs who lived in Gur Baal and against the Meunites. 8 The Ammonites brought tribute to Uzziah, and his fame spread as far as the border of Egypt, because he had become very powerful.

9 Uzziah built towers in Jerusalem at the Corner Gate, at the Valley Gate and at the angle of the wall, and he fortified them. 10 He also built towers in the desert and dug many cisterns, because he had much livestock in the foothills and in the plain. He had people working his fields and vineyards in the hills and in the fertile lands, for he loved the soil.

11 Uzziah had a well-trained army, ready to go out by divisions according to their numbers as mustered by Jeiel the secretary and Maaseiah the officer under the direction of Hananiah, one of the royal officials. 12 The total number of family leaders over the fighting men was 2,600. 13 Under their command was an army of 307,500 men trained for war, a powerful force to support the king against his enemies. 14 Uzziah provided shields, spears, helmets, coats of armor, bows and slingstones for the entire army. 15 In Jerusalem he made machines designed by skillful men for use on the towers and on the corner defenses to shoot arrows and hurl large stones. His fame spread far and wide, for he was greatly helped until he became powerful.
So of course the writer attributes Uzziah's (initial) success to his obedience to the Lord's ways, but an atheist could say, "No that had nothing to do with it. Look the guy was a smart military commander and even spent money on R&D for advanced weaponry."

Friday, December 18, 2009


Wenzel Flips?

A few readers want to know what I think of this provocative post by Robert Wenzel, in which he says Bernanke conned a bunch of us (bold mine):
This is big. It is going to knock for a big loop all those concerned about the inflationary consequences of the soaring monetary base. The Federal Reserve Bank of New York today released a report, "Why Are Banks Holding So Many Excess Reserves?".

Fed economists Todd Keister and James McAndrews state that while the high level of reserves in the U.S. banking system during the financial crisis reflects the large scale of the Federal Reserve’s policy initiatives, it conveys no information about the effect of these initiatives on bank lending or on the level of economic activity. This is another way of saying what I have been saying right along, watch the money supply, not the monetary base.

Keister and McAndrews explain that the buildup of reserves in the banking system is a by-product of the liquidity facilities and other credit programs introduced by the Federal Reserve in response to the crisis. They also discuss the importance of paying interest on reserves when the level of excess reserves is unusually high. But the key point they make remains that the majority of the newly created reserves end up being held as excess reserves and, therefore, the data on excess reserves provide no useful insight into the lending decisions and other activities of banks. Got that? The trillion dollars sitting as excess reserves has had no impact on the economy, and as the Fed stops it's emergency facilities, it is going to be drained. The trillion never went into the economy and never will.

If Keister and McAndrews are correct, and I believe they are, then the Fed will have little problem in ending its emergency lending facility activities. The banks by maintaining those funds as excess reserves (for whatever reason, even if it is simply to earn interest) have in reality kept those funds out of the economic system. As the Fed ends its liquidity emergency facilities they will have to pay back the borrowed funds.

The alarmists, who have thus pointed to the surge in the monetary base as a sign of soaring Fed monetary "easing" and who have been shouting about the inflationary consequences, are going to go into cardiac arrest once they see the monetary base crash when the Fed winds down its emergency facilities and the banks use the excess reserves to pay back the facility funds.
The super-decline in the monetary base, as was the super-increase in the monetary base, will of course mean nothing relative to the actual money supply, which is where one should have been keeping one's eyes all along.

In a way Bernanke played a huge shell game on the global financial world. All the so called easing never happened. Let me repeat, what was touted by almost every economist in the world as the extremely loose monetary policy, didn't happen. The money never entered the system. It was a bluff. Bernanke has set us up for Crash II and few see it coming. I wouldn't want to play poker against him.
So here are my quick reactions:

(1) I think those Fed economists are wrong. I think we are going to get big-time price inflation, and when we do, people will look back at those who were blowing off a tripling of the monetary base in a little more than a year and think, "Wow, that's as inconceivable in hindsight as the people who said we weren't in a housing bubble." And incidentally, two of the people who said we weren't in a housing bubble were Fed economists at the height of the boom. How do I know? Because Robert Wenzel told his readers about it.

(2) It's true that Wenzel was the first guy I saw who was warning that Bernanke had put the brakes on M1 and M2 growth back in March or so. But it was also Wenzel who taught me that the Fed won't be able to simply reverse its injections of reserves, because the assets it purchased on the way up won't fetch the same price on the way down. I.e. the Fed can't simply reverse its actions and "suck the liquidity out of the system," because it may have seriously overpaid for a bunch of the MBS, Freddie and Fannie debt it added to its balance sheet.

So I don't view the Wenzel quotation above as a shot against me; if it is, it's only because of views that I literally learned directly from Wenzel himself.

(3) One final thing: I am going to be really peeved if everything I have been saying turns out true--namely that those excess reserves start finding their way out into the hands of the public (through various mechanisms we have been discussing on this blog), and then when price inflation breaks 10% Wenzel says, "See? M2 is up 28% year-to-date. A lot of economists were flipping out last year because of the huge monetary base, but only EPJ readers knew that the monetary base wasn't the story, M2 was. You need to read my blog to know what's up."


Jim Manzi Talks About the IPCC Consensus and Tom Friedman

I loved this Jim Manzi guest post at MasterResource, particularly because I recruited him for the task. The irony is that the latest IPCC report does not support aggressive emission cuts. You'll notice that the people who do propose such actions will say things like, "Things have gotten worse since the IPCC AR4 report came out, as this paper in Science suggests..." Here's Manzi:
It is amusing to watch advocates of rapid, aggressive carbon dioxide emissions reduction, when confronted with the plain facts of the consensus scientific projections for climate change and its associated damages, move from “science says we must do this or die” to “well, actually, the science is pretty uncertain, so it’s possible that we might die,” and then proceed to some restatement of Pascal’s Wager.

Tom Friedman’s recent New York Times column is a perfect illustration of this logic. I’ll quote him at length, before demonstrating that his emission-cuts-as-insurance analogy breaks down once you plug in actual numbers...

Wednesday, December 16, 2009


Talk to Me Like I'm a 4-Year-Old: Why Aren't Banks Putting Those Reserves to Work?

Carlos Lara and I just spent 5 hours in the car driving to an undisclosed location in Indiana to meet with some life insurance people for our forthcoming book. Not surprisingly, we talked about the $1.1 trillion in excess reserves, and what it would take for them to start trickling (gushing?) out.

I explained that I have always found this typical explanation incomplete: "The banks can't lend right now because they fear another wave of defaults and so they have to be ready for their balance sheets to take another huge hit."

I don't think that can be the whole story. I don't doubt that this is basically correct, but I'm an economist so I need it to be right in theory before I can accept it even if I'm sure it's right in practice.

Specifically, here's my problem: Suppose the banks didn't fear any future defaults. Then they'd start making new loans and earning a lot more than Bernanke's piddling interest payments. So their balance sheets would get better more quickly than if they kept their reserves parked at the Fed.

OK, so if the way to increase your shareholders' equity (i.e. gap between assets and liabilities) in normal times is to lend out excess reserves, that fact isn't changed per se by the possibility that a bunch of your assets are bad. In fact it should make you even more eager to seek the most profitable use of your reserves.

Like I said, I know there is something wrong with my argument; I believe the people who are saying the banks aren't making new loans because they're worried that a bunch of their current loans will stop performing. But I just want to hear the explanation spelled out a little more.

For example, is it really like this: The banks are like households, and they have standard operating expenses. Right now they have cash coming in the door every month from people paying down their credit cards, mortgages, car loans, etc. But if those people get laid off and stop making payments, now the banks can't pay their leases, utility bills, employees, etc. So if they have a stockpile of reserves, they can start drawing them down. But, if they had foolishly invested all of their excess reserves even in super great projects yielding 80% over 5 years, they would have to shut down if those projects were illiquid and they couldn't meet their basic expenses.

Is the above paragraph in the right spirit?

Last point: If indeed it's true that the banks are keeping their reserves on hand, in case they need to draw them down to cover their operating expenses, then...

Doesn't that mean prolonged unemployment will lead to those reserves getting back into the hands of the public??


CNBC Doesn't Anger Me on Inflation Report

They didn't say, "Inflation is back! Ru-u-u-un!" but they at least didn't say anything aggravating like, "Inflation pressures remain modest." Here's CNBC terse discussion:
U.S. Consumer Prices Rose 0.4% in Nov., Deficit Widens

U.S. consumer prices rose in line with expectations in November on a surge in energy costs, but prices were flat, excluding food and energy, a government report showed Wednesday.

The Labor Department said its Consumer Price Index leaped 0.4 percent on a seasonally adjusted basis after an unrevised 0.3 percent gain in October. A 4.1 percent burst in the energy index led the rise, as gasoline, electricity, fuel oil, and natural gas prices rose.

Prices rose 1.8 percent over the last 12 months, as expected, the first year-over-year gain since February. Core prices rose 1.7 percent over the 12-month period.

Separately, the U.S. current account deficit widened as expected in the third quarter to $108 billion, largely driven by a big trade shortfall, a Commerce Department report showed on Wednesday...
For the record, non-seasonally adjusted CPI is up 1.8% over the last 12 months (from Nov. 2008 - Nov. 2009), and from Dec. 08 - Nov. 09 it's up 2.9%, which works out to an annualized rate of about 3.2% if I've done my math correctly. (I just woke up.)

So don't let anybody tell you we're stuck in a liquidity trap with its related "paradox of thrift" and now the "paradox of toil" (in which output drops when the government cuts labor taxes).

Tuesday, December 15, 2009


What Kind of Nutjobs Raised Andy Williams?

Did any of you grow up with a family tradition of telling scary ghost stories around Christmas?


Matt Yglesias, Inflation Denier

Despite the theoretical connection between printing money and rising prices, and the empirical evidence staring him in the face, Matt Yglesias continues to raise doubts in the minds of the public over the threat of purchasing-power change. Here's Yglesias telling us up is down:
Inflation continues to be very low. But here’s how Daniel Costello reported it from Planet Money:
The core PPI – which excludes food and energy prices – rose 0.5% in November, more than expected. Leading the advance: truck and cigarette prices. Core prices are up 1.2% over the past year.

The news is unlikely to change the Fed’s decision on whether or not to keep interest rates at a record low Tuesday. But it does add to concerns the central bank’s loose monetary policy could lead to greater inflation and new asset bubbles down the road.

In 2008, the CPI increased 0.1 percent, way below the Fed’s 2 percent implicit target. In 2009 thus far, the CPI is set to increase by a number that’s higher than that, but still below the implicit target of 2 percent. So why, logically, would an increase from “way below target” to “somewhat below target” spark a concern about inflation? It would take a year or two of inclation above the target rate for the price level to return to its long-run trajectory. I doubt that if we had a year of 3.9 percent inflation followed by a year of 2.6 percent inflation that you’d hear people saying the Fed was worried about deflation. They’d say the Fed was glad things were getting closer to the target.
OK so Yglesias is making two separate claims here:

(1) Inflation continues to be very low.
(2) Using core inflation as an index, we are below the long-run target of 2% per year.

Both claims are wrong, unless we very carefully choose our time frame. In terms of reaction to the PPI report, inflation is very HIGH--after all, the actual PPI went up 1.8 percent in one month (seasonally adjusted), which works out to annual inflation of about 24%; hardly tame. The core PPI went up 0.5% in one month--an annualized rate of 6.2%, triple the target.

Now of course, you can't judge a trend just by looking at a single month's reading, but again this drives me nuts when the news hook for a blog post is a very high reading, which is then reported as "evidence" for the low inflation. (!)

Anyway, let's look at Yglesias' second point, that we are still digging our way out of the actual price deflation of late 2008. Or rather, his point is even subtler--it has to be, because we already are above last year's price levels. What Yglesias is now arguing is that the current level of prices is below where it would have been, had we experienced "target" core inflation last year.

OK but what's so special about a two-year window? If we start in October 1971, when we were off the gold standard, and look at the 38-year change in core CPI through October 2009, then there is an annualized increase of core CPI of about 4.4%, assuming I did my Excel formula correctly. I think 4.4% is way way above the Fed's target of 2%, and since it's done that on average for 38 years straight, I think we are in line for some serious under-inflating.

Maybe Yglesias thinks I'm cherry picking by selecting 1971. OK if we go back to the start of FRED's core CPI series, in the 52-year span from October 1957 through October 2009, annualized core inflation has been just shy of 4.0% (again, subject to my quick Excel calculation in which I have 70% confidence). So the long-run trend is DOUBLE the official target, and it's been that way for 52 years. I'm too tired right now to think carefully through the compound growth issues, but I think that means we should have stable prices for 26 years straight in order to get back to where Yglesias wants us to be.

But I don't think Yglesias will agree with my assessment. He has done the equivalent of pointing out that since 1998, we have had no appreciable warming. Except, in Yglesias' case he is doing something more like saying, "Purchasing-power change halted in October 2008! Whence this 'consensus' on money and inflation?"

DISCLAIMER: I actually like Yglesias' posts, because he strikes me as sincere. I just think he is horribly wrong on this issue, being misled by people like Krugman whose sincerity I am not sure about.

This page is powered by Blogger. Isn't yours?

Subscribe to Posts [Atom]