Tuesday, December 23, 2008

Follow-up on Mike's jobs post.

The emphasis on jobs is, as you say, disheartening, particularly since the Big 2 bailout was often pushed in almost exclusively employment-related terms.

I think Arnold Kling has pointed this out several times, but it's disingenuous completely predictable that politicians talk about jobs like unequivocal benefits.   If I had a task that needed done and I thought to myself, "This is going to need such and such materials and two helpers," then those helpers are costs, same as the materials.  Bragging about how many jobs your program is going to create is simultaneously to flaunt how much it's going to cost.  Assuming the job isn't all that necessary, it's a bizarrely masochistic form of welfare, where money is given to individuals for doing stuff that no one wants done.  What people don't seem to appreciate about the dig-a-hole-and-fill-it example is that it's not only wasteful, but it's actually kind of evil from a utilitarian perspective--it makes everyone worse off because, presumably, the guy digging would rather be doing something else.

Which has always made me think this green jobs strategy (which pales in comparison to the newer, incredible mayors-of-the-world-unite in the largest-cash-grab-the-world-has-ever-seen strategy, coming early 2009) is closer to Bastiat's broken window fallacy.

In related news, Greg Mankiw has an excellent post in which he merely copies and pastes a letter he received from a reader familiar with government bureaucracy. Excellent excerpt:
To make a long story short, you cannot juice up a government agency's budget by tens of billions (or in the case of the stimulus package, hundreds of billions) and expect them to be able to process the paperwork to contract it out, much less oversee the projects or even choose them with any kind of hope for success. It's like trying to feed a Pomeranian a 25 lb turkey. It's madness.
What gets lost in the nearly-incomprehensible size of these "stimulus" packages is the likelihood that they will be badly, badly mismanaged. America needs James Q. Wilson now more than ever (though if my POL113 students are any indication, they wouldn't read him anyway) for the simple but irrevocable fact that bureaucracies operate according to perverse and often inscrutable incentives. This was my primary empirical-theoretical (not normative) beef with Mike's support for what would become TARP--that despite the enormity of the problem, the solution was not a feasible one based purely on the sorts of institutional incentives that original $700 billion had to make its way through. The news appearing daily about bureaucratic mismanagement and companies quickly and surely finding their way around compensation limits is not in the least surprising--this was always the way this had to go. If Washington was filled with sharks (lobbyists, rent-seekers, money-starved executive bureaucracies) before, we've quite wittingly dumped unprecedented amounts of blood into the water. Expected and realized results: more sharks (hello GM, Chrysler, Ah-nuld, state of New York, America's governors and mayors, etc.).

Actually, the sharks point is different. Regardless of lobbying influences, the point here is that these bureaucracies are operating, presumably, at something near their funds-allocating capacity. Allocating money, believe it or not, requires time and manpower in terms of deciding where money is going to go and how it's going to be spent. What gatekeeping and oversight that these agencies previously managed is going to go directly out the window when their budgets and handout-seekers quintuple. Look for corruption on a scale we haven't previously imagined.

Monday, December 22, 2008

From the Office of Monitoring the President Elect....


Above is a link to the transcript of Mr. Obama's Friday press conference. I wanted to highlight a few fundamentally flawed positions taken in the speech.

Whenever I've been asked how I measure the strength of the American economy, my answer is simple: jobs and wages. I know we will be headed in the right direction again when we are creating jobs instead of losing them, and when Americans are gaining ground in terms of their incomes instead of treading water or falling behind.

This is a clear misunderstanding of measuring economic strength. Jobs are supplied by owners of capital who see a way to use the labor of others (human capital) to create wealth for themselves. Economic Strength is measured by productivity growth, which is wealth creation for human capital. It is easy to attain full employment; consider that when every citizen lives on the farm and scratches the ground for a living, unemployment is zero (remember that unemployment measures only those looking for work who can't find it.) We can argue about whether or not growth in wealth is the best way to measure economic strength, or personal well-being, but job growth in a vacuum is meaningless. Ditto wage growth, unless we are talking about real wage growth, which is, again, related to productivity growth.

with the goal of creating two-and- a-half million new jobs and strengthening our economy for the future

See above for the jobs part. Strengthening the economy is indeed a good policy, if we are talking about policy which encourages productivity growth.

Whether it's creating green jobs

Lots of problems here. Green jobs seem to me to be a meaningless distinction. If people demand alternative enery, technology will be created to supply it, with concomitant jobs, assuming it can be done profitably. As I've discussed earlier, if environmental externalities need to be internalized, raise the final price with taxes, a la the Pigou Club as Greg Mankiw has discussed at length (as long as tax proceeds are actually spent on remediation). Capital creates jobs, not the other way around, and new speculative capital needs a high return to be invested.

that pay well and can't be outsourced,

Don Boudreaux has an excellent podcast about globalization and free trade over at econtalk.org, and reminds us that an outsourced job is an unambiguous positive (at least longer term). Cheaper production of the same goods creates wealth for consumers and producers, and signals to suppliers of labor that they can and should try their hand at something more productive

or raising the minimum wage in California

Why won't minimum wage mythology die? It is a clear negative for unskilled workers and restricts the demand for labor at a price where it may very well be willingly supplied.

protecting workers' rights, from organizing to collective bargaining, from keeping our workplaces safe to making our unions strong. Standing up for our workers means putting them back to work and fueling economic growth.

Capital puts workers back to work, capital which sees ways in which labor can be employed to create profits. Not governments. Also, unemployment is low both relative to history and the rest of the world. I have no problem with collective bargaining, as long as it doesn't become government-supported collective strong arming, which it does.

Doing so will not only help meet our energy challenges by building more efficient cars, buses and subways or making Americans safer by rebuilding our crumbling roads and bridges, it will create millions of new jobs in the process.

Again with the jobs. If we need new infrastructure, give capital the appropriate incentives and property rights to provide it, and it will be supplied.

When contemplating this world view, remember Say's Law, which, although somewhat flawed, has enormous truth and insight. I will be discussing this in detail in my next deflation post, but Say's Law says that supply creates its own demand, i.e. productivity is wealth, and money is simply a way of distributing productivity. This is why policies such as paying people to dig holes and fill them in again have negative real value, not zero value. Zero product is created, but the money supply is enlarged, which ultimately causes inflation.

Thursday, December 18, 2008

Money Delusions Part I - Some Groundwork

Brandon asks where deflation will hit him the hardest. It is a great question, as the negative effects of a general deflation are not immediately apparent. Let me first restate the issue. What we are worried about is not "a modest deflationary trend in the real cost of goods". What we are worried about is a modest or immodest deflationary trend in the nominal cost of goods. Real general deflation can only be caused by increases in productivity due to technology or a permanent increase in the velocity of money that increases capacity utilization. This kind of deflation happens all the time, and it is almost unconditionally good. It increases real wealth. In addition, he correctly points out that real deflation (price declines in excess of the general price decline) in many specific goods, especially claims on productive assets, is wonderful for those of us who don't own as many of them as we would like to own eventually in order to maximize our future wealth (assuming these prices are mean-reverting). The rest of this post will deal with the problems that stem from general deflation in the nominal cost of goods.

The place to start is the macroeconomic equation of exchange. This is a tautology which states: M*V=P*Q. In words, the money supply times the velocity of money is equal to the general price level times the quantity of goods and services produced. For a given time period, each side of this equation represents the gross domestic product for the economy being analyzed. If you state this as a difference equation, you get dM*dV=dP*dQ, or the change in the money supply times the change in the velocity of money is equal to the change in the price level times the change in production (i.e. the change in GDP.) The great macroeconomic debates tend to range around whether and how these four variables change over time, and to what degree government can and/or should try to influence specific components.

Let's define and analyze these various components a little further. The first is M, or money supply. In order to think about money supply we need to define money first. Money is a technological innovation that allows for the conversion of an individual's productivity into a highly transportable and fungible form. It is an abstraction that allows the division of labor to become much more specialized and efficient than that which a barter system would ever produce. It is generally agreed that good money satisfies three conditions: it functions as a medium of exchange (it is accepted as payment for goods, services, and debts), it serves as a unit of account, and it is a store of value. As an aside, I think that the store of value attribute of "moneyness" becomes less and less important as information and transaction costs converge to zero. This is why I find concepts such as a "gold standard" of money to be unnecessarily restrictive. What is key is the free convertibility of fiat money into any commodity such that, if you like, you can put yourself on a gold standard or an oil standard or even a "stock standard" or a "house standard" or whatever you think will protect your purchasing power better than the full faith and credit of Uncle Sam. The price of any one good, even gold, is far too vulnerable to exogenous changes in demand and supply to base a currency system on its immutable price in said currency.

Now that we've defined money, we can talk about money supply. In the U.S., the supply of money denominated in dollars is controlled by the Federal Reserve using two basic tools. The first is the creation of physical currency, and the second is the establishment of a required reserve rate for lenders. I've inserted a few money supply pictures below. The first is the monetary base, commonly referred to as M0, which is physical currency and bank reserves. This is commonly referred to as "high powered money" because it has not yet been leveraged through our fractional-reserve banking system.

Note the fairly steady rise in reserves over time (I'm sure this would be pretty linear on a logarithmic scale) and the huge spike in just the past few months. The second picture is that of various other monetary aggregates that are officially measured. You should note that the bulk of the money supply is created by the banking system through loans. The amount of lending capacity is theoretically limited by the required reserve ratio of Federal Reserve member banks, currently set at 10%. This means that every dollar of currency and reserves created by the Federal Reserve has the theoretical potential to become 10 dollars of money supply. The broadest measure of the money supply currently compiled by the Federal Reserve is known as M2, which is currency+reserves+checking accounts+travelers checks+savings accounts+CDs under $100,000. The Federal Reseve stopped compiling M3 data a few years ago because it was very expensive to do so, and they felt that it conveyed little information beyond M2. You can see that M2 tends to be roughly 7-8 times the size of the currency base, and M3 tended to be roughly 10 times the currency base, indicating that the system generally creates about as much money as is statutorily allowed.

The next component of the equation of exchange is the velocity of money. This is simply a measure of the number of times that the money supply turns over for a given period. It is computed by dividing GDP by the monetary base. In the picture below, the monetary base is M2 from the above picture, and it shows that the velocity of money has had a mean of 1.67 over the past 100 years, and has ranged from a low of 1.15 to a high of 2.12.

The third component of the equation of exchange is the price level. It isn't really useful to think of the price of the "average good produced" by an economy since goods have such wide variation in value, so in practice we try to measure the change in the price level of a representative basket of goods over time. This is complicated because consumer preferences, technology, and quality of goods produced are all constantly changing, but economists have developed some fairly sophisticated methods to correct for these things. It is extremely important for whomever is responsible for managing the money supply to have a good handle on how the general price level is changing over time.

The final component of the equation of exchange is Q, or the quantity of production. Once again, it makes very little sense to think of the units of "product" produced because goods are so variable, so we tend to think of product in terms of dollars (which brings price level into the equation by definition). GDP is typically broken down into the following: GDP = Consumption + Investment + Government Spending + Net Exports. Note that we are only trying to measure the value of final goods produced, not every intermediate step in the chain of production. When we are trying to measure how real GDP (total productivity) has changed over time, we scale our nominal GDP number by our best estimate of the change in the price level over the given time period. Below is a graph of real and nominal GDP over time.

In the next post we'll be looking at the evolution of various schools of macro-economic thought through the lens of the equation of exchange. The elasticities of the four inputs to the equation will be key to the deflation discussion, along with increasing financial intermediation in directing productive activity, inter-temporal effects, the role of expectations in decision making, the danger of aggregating individual choices into something we call "demand" and a particular focus on the role of money as a unit of account.

Sunday, December 14, 2008

Barney Frank makes me hate Massachusetts even more than I already do, which is saying something.

Unwittingly caught the 60 Minutes piece on Barney Frank tonight.  If you caught it, you may have noticed how flabbergastingly often your jaw dropped onto the carpet.  From the transcript on the 60 Minutes website:

Barney Frank has been called the "smartest guy in Congress," which is lucky for us since he works on some of the thorniest issues around.

I have literally never heard Barney Frank described this way, and at no point did 60 Minutes attempt to explain why we should consider this boorish turd any smarter than the rest of Congress.  Also, is the "smartest guy in Congress" just Lesley Stahl's super-coy attempt at an insult?

"But I wonder why? Because when these companies finally get into bankruptcy they can do the tough things that they can't otherwise do," correspondent Lesley Stahl asks.

"There's only one thing you can do in bankruptcy: break your word, break your deals. It allows you to say to the small businesses, who have been catering lunches for you, 'Sorry, we're not paying you.' It allows you to go to the workers and say, 'Sorry, we're not paying you,'" Rep. Frank says.

Hear that auto companies?? Don't try taking the easy way out--we're on to you!

Again though, this is par for this piece--a perspective I've literally never heard before.  Chapter 11 just gets you out of every legal obligation you have? That's literally the "only one thing" that happens in Chapter 11? Does Barney Frank realize that there are, like, econ and finance professors who access and opine on the "internet," and that regular old people can "google" things like "chapter 11" and figure out whether or not they're essentially get-out-of-jail-free cards? And if this is what bankruptcy is like, then why aren't the Big 3, currently hemorrhaging debt like some third-world government, why aren't they filing like right freaking now?

"What about the idea that in capitalism, if a company doesn't cut it, they die?" Stahl asks.

"That's what Herbert Hoover said. And Franklin Roosevelt said no," Frank says.

"It's what Darwin said," Stahl points out.

"Yes, it's true," Frank acknowledges. "And Darwin was a very good biologist. I don't think he was much of an economist."

In Frank's defense, Stahl is, and has proven relentlessly to be, a complete simpleton who probably shouldn't be on TV as much as she is.  But, yes, according to this exchange, FDR alone stood against the united if unlikely axis of Herbert Hoover and Charles Darwin.  Hoover, I've heard, signed Smoot-Hawley only after considering a few of the early passages in Origin of the Species.

"What we're now faced is with all the taxpayers having to prop up companies that made terrible decisions consistently," Stahl remarks.

"No, we're not propping up companies," Frank insists. "That's your mistake. We're propping up individuals. The world doesn't consist of companies. The world are people. The country is people."

I've been sitting here for a few minutes trying to come up with something witty to say about this.  Nothing's coming to mind.  I'm sure this is philosophically invidious in some way, and that it somehow demonstrates a dangerous and misleading way of thinking.  But I can't get past how indelibly retarded it is.

"You know, there's a theory out there that you, the congressman, had this public spanking of these [car-company CEOs] in order to cover yourselves,” Stahl asks but then Frank interrupts:

"That's the kind of argument that people who do not have any idea what they're talking about like to make.”

"Are you telling me I don't know what I'm talking about?" Stahl asks.

"By making that argument, yes," the congressman says.

This is the closest we're ever going to see to Lesley Stahl speaking truth to power.  And that's about the reaction you'd expect power to have.  Frank's arrogance is as pathetic as it is utterly incommensurable with his actual fluency in subjects like economics.

By the way, you'll have to watch the clip to see it, but Stahl literally makes a pouty-face after her second line there. 

"Television is apparently the enemy of nuance. But nuance is essential for a thoughtful discussion," Frank told her.

Like discussions about Calvin Coolidge and the principles of evolutionary biology.

The relationship between Frank and Paulson has soured lately, since Paulson hasn’t spent any of the rescue money to help struggling homeowners. "Secretary Paulson is refusing to use that money that Congress voted to reduce foreclosures. The bill says he’s supposed to. He won’t do that," Frank says.

"You wrote the bill," Stahl points out. "You’re, quote, 'the smartest man in Congress.' How did it happen that you wrote a bill that the secretary of treasury has the power not to fulfill in the way you wanted it fulfilled?"

"Because there’s a metaphor that works here: you cannot push on a string. There’s no Constitutional way to force them to do things," Frank says.

"But didn’t you write the bill in a way that allows him to do this? And you could have written it differently," Stahl remarks.

"No. There’s no way you can force people to do things," Frank says.

This is my favorite exchange, I think.  Stahl brings another sharp comment, but I suppose she's probably just trying to lead him along.  It's my favorite exchange, of course, because what Frank says is demonstrably false.  Why "demonstrably"? Because it says so in the first two articles of the Constitution, the very document Frank references here.  One of the reasons behind the great expansion of the executive bureaucracy (a bureaucracy Hank Paulon works in) is that the legislature has, over the past 100 years or so, delegated far more discretion to the executive branch in terms of how laws and programs are enacted.  So, while one might argue that TARP doesn't have the teeth to give the legislature direct oversight over Paulson, to say that it couldn't be written that way is a blatant lie.  Then again, maybe Congress's smartest man doesn't know the rules.  Either is reprehensible.

Then again, Frank's pretending to care for the rules is even more disingenuous.  Fifty bonus points if you can find in TARP anything about giving cash to auto companies, which is exactly what Frank is exhorting Paulson to do. 

But to recap, TARP is a)unenforceable and b)not broad enough to combat the whole problem.  Frank designed TARP.  Frank is Congress's smartest man.  My eye is bulging from my skull.

But there are those who argue that reducing foreclosures would reward and encourage delinquencies. "You have the guy who’s working three jobs so he can pay off his mortgage; you have a guy who’s delinquent. He gets help, this other guy doesn’t get help. So isn’t there an unfairness…," Stahl points out.

"Yes, there is," Frank acknowledges.

"That you're setting up? And why shouldn't the guy over here who's been paying off his mortgage," Stahl asks. "Why doesn't he deliberately stop paying it."

"Let me give you another unfairness. I wanna see what you think about this. What about someone who's been working hard, 40 hours a week, maybe with some overtime, and goin' to work every day. And then his neighbor loses his job. The neighbor starts getting unemployment insurance. The neighbor who lost his job is getting money for nothing, from the government. There's some unfairness there," Frank argues.


Frank, who composes letters by Dictaphone - not e-mail, and doesn't even use a computer, delved into the intricacies of modern banking, becoming the authority on all things Wall Street.

Who constructed these sentences?!? Are they being ironic? Who in the right mind would call Frank "an" authority on Wall Street, let alone "the" authority? And how is all this accomplished without a computer? Would you trust your accountant if he didn't use a computer? Of course not.  And here's Barney Frank throwing around billions and billions and billions of other people's money and he doesn't use an effing computer.

"The problem in politics is this: you don't get any credit for disaster averted. Going to the voters and saying, 'Boy, things really suck. But you know what? If it wasn't for me, they would suck worse.' That is not a platform on which anybody has ever gotten elected in the history of the world."

Yes, Barney, the problem is that politicians don't get nearly enough credit.  You spend other people's money for a living, taking photos over shaking hands every time you come up with a new and incompetent way of pissing away money you never earned.  What a reprehensible turd you are.

Note: didn't Bush win in 2004 on this platform?


Friday, December 12, 2008

Still coming soon..

TARP money will be used to float automakers until new administration / Congress is ready to revisit. I expect headlines imminently to that effect. Read Don Boudreaux's editorial in yesterday's WSJ as to why this is a bad idea.

Wednesday, December 10, 2008

Coming Soon...

This has been making the rounds, but I want to make sure it finds its way here at some point. I'd give a hat tip or credit, but I'm not sure where it should go. I first saw it, I suppose, on Will Wilkinson's facebook page.

Non-sequitur of the day.

The Turner household has had a longstanding moratorium on Burger King (somewhat tyrannically imposed by one member who, she claims, "doesn't really care for their fries"), but this Turner has always thought of them as sensationalist marketing gone very right.  Their bits with a masked and footballing Burger King were the most forgivable of the endlessly-recycled commercials during the 2005-7 football seasons, and their recent "Whopper Virgins" campaign is pretty cute, I suppose.

Cute, did I say? I meant offensive.  People are creating a fuss over this apparently imperialistic/cruel/wasteful exercise, but the WTF-prize goes to Sharon Akabas, who, unsurprisingly, hails from Columbia University.

"It's outrageous," said Sharon Akabas of the Institute of Human Nutrition at Columbia University. "What's next? Are we going to start taking guns out to some of these remote places and ask them which one they like better?"

Ignore for a moment the typically offensive implication that these places are filled with noble savages, childlike innocents whose fall from grace can only begin with the introduction of guns by Westerners (a la Steinbeck's The Pearl), and just focus on that remarkable leap of association.  Yes, Akabas, Whoppers and guns are, despite some cosmetic differences, basically the same thing. 

See the rest of the articles for some equally (and, by even these standards, remarkably flimsy) arguments against the King's capitalistic plague, most of which amount to: how dare Burger King spend its money instead of...giving it to me?!?


I highly recommend checking out Russ Roberts's EconTalk podcast over at
http://www.econtalk.org/. He is a faculty member of George Mason University and the podcast is brought to you by the Library of Economics and Liberty. He also blogs here with Don Boudreaux, who is the Economics Department Chair at George Mason University. Don has put together a great department of Libertarian Economists, and many of the blogs I follow are written by faculty of said University (Brandon T put me on to many of these).

Still working on my deflation post. The scope keeps widening on me and I seem to need to research every sentance to make sure I get the logical steps right.

Friday, November 21, 2008

A counting game...

This is hot off the Associated Press. Please remember that the Associated Press is an organization of journalists, who are so-named because they practice something called "journalism."

Stocks jump on report of Geithner nomination - Yahoo! News

NEW YORK – Wall Street is ending a volatile week with an unexpected jolt of confidence following reports that President-elect Barack Obama plans to name New York Federal Reserve President Timothy Geithner as Treasury secretary. The major indexes have jumped more than 5 percent, with the Dow Jones industrials surging nearly 500 points.

Stocks have erased about half of the losses that came in steep selling Wednesday and Thursday.

Wall Street appears buoyed by reports that Obama plans to name his economic team on Monday — offering investors some hope of a smooth transition in an uncertain market.

The Dow is ending up 494, or 6.5 percent, at the 8,047 level.

Now, go back and count a) the number of facts, and b) the number of entirely unsubstantiated conjectures. Which is greater? Which of the two, facts or conjectures, are likely to be seen as the "point" or "theme" of the story?

Thursday, November 20, 2008

George Friedman On G-20 and GM

George Friedman of Stratfor is a relentless geopolitcal realist. He gives too much weight to State power, but he's very smart and extremely plugged in. Whenever I want to know what's really going on in the world, who the players are, and what the calculus is, I see what he has to say.

Where were you in 1997?

The S&P 500 last traded at today's prices in April, 1997...and that's NOT adjusted for inflation.

Mikey G. on Deflation

Mike: what's the deal here? Not to sound like a punk, but I feel like a modest deflationary trend in the real cost of goods is a pretty good thing for people like, well, Becky and I, who carry almost no debt, have highly marketable skills, a relatively robust amount of liquidity, and a very broad time horizon in terms of investment.

Tell me where deflation is going to hit me hardest. 

Also, I'm working up a post in response to your comments yesterday. 

And you should get ScribeFire, if you haven't already. I just hit F8, type up some stuff, and, as Madden would say, BOOM.

A followup...

...to yesterday's bit about having it both ways on oil prices. Look at this hyperbolic release from the AFP:
LONDON (AFP) – Oil prices sank under 50 dollars a barrel in London on Thursday, reaching the lowest levels for three and a half years, as the market was plagued by weak energy demand.
Oh those halcyon days of $150/barrel oil! Oh, how we dreamed that it might reach $200! But then, even as we were tempted by the gods, this plague of cheap-as-hell energy befell us!

Wednesday, November 19, 2008

Some really good stuff in the roundup this morning.

Jacob Sullum on the unbelievable case of forgetsies the press seems to suffer from. The daily headlines that manage to combine falling oil prices with economic ruin ("Oil falls to 22-month low as fears of recession sharpen") would be merely puzzling if the press hadn't hooted and hollered mere months ago over the prospects of $200 barrels of oil. It begs the question, which can only be asked with incredulity by anyone with the ability to recall events and facts that occurred more than 30 days prior in time: "Where the hell have you been?"

I see gas under $2.00 in Winston and think to myself, "Wow--this is great. The amount I'll save from all our Christmas driving alone will pretty much pay for gifts this year." That doesn't even begin to address the benefits our battered and imperiled middle class will be reaping when they get this year's energy bill. The question remains: if increasing oil prices are unequivocally bad, which the press has claimed ad nauseum for the better part of a year, then the decline in oil prices has to be good simply by the law of non-contradiction. The less child-like observer--even those with little experience in the field of economics--knows that the press simply doesn't understand things like supply and demand--and therefore doesn't understand that rising oil prices are not simply a natural disaster, like earthquakes.  Rising oil prices are exactly what they are--an increase in the price of a good--and they will be offset by future developments or decreases in demand.

But this childishness is not the exclusive domain of the press, as Louis CK points out here on Conan.

Count your blessings, says Mankiw.

In other news, anyone interested in the future of libertarianism, particularly in the age of corporatism, owes it to themselves to follow the debate at Cato Unbound, initiated by Roderick Long. His piece and the several replies to it are all required reading. I've got my own response to this brewing, but it'll have to wait for some quiet time.

Finally, George Will on the auto bailout. Will seems to be suffering from a bit of Rip Van Winkle syndrome; he writes as if he just woke up from a 20-year slumber and doesn't quite recognize the people around him. Yes, George, this is your party--I'd get moving if I were you.

Tuesday, November 18, 2008

Shark problem? Add blood!

No other metaphor captures the pure insanity of the bailout like the shark one.  Here's another reason why:

Nov. 16 (Bloomberg) -- Genworth Financial Inc., the insurer spun off by General Electric Co., said it’s in negotiations to acquire InterBank Fsb and with it eligibility for the U.S. Treasury’s $750 billion bailout program.

Genworth is seeking to buy the Maple Grove, Minnesota-based thrift in order to gain recognition as a savings-and-loan holding company. Talks are in progress and terms are being negotiated, Genworth spokesman Al Orendorff said today.

Genworth Financial would join the more than 50 regional banks offering stakes to the U.S. Troubled Asset Relief Program. The bank is seeking to tap bailout funds after a surge in claims at its mortgage insurance unit and investment losses.

An attempted response.

Mike poses an important question, and one I've been struggling with lately.  The most depressing feature of the bailout--besides, of course, its existence--was the incredible disconnect between its facts and its normative import.  When we say something is "too big to fail," what do we mean? We mean that the sheer size and force of a company make it indispensable and thereby places it above the normal schema we employ when thinking about questions like this.  Undoubtedly, most said, there should be no handouts; undoubtedly, it is bad policy in terms of moral hazard and really bad policy in terms of blatant disregard for property rights--undoubtedly, we would never do this under normal circumstances.  Unfortunately, these aren't normal circumstances--this company and that company are too big to fail.  I remember the night the bailout passed, there was a Frontlines special on oil companies on PBS, and I remember them talking about this offshore oil platform Exxon had built that cost something like forty billion dollars.  Forty billion! Here's a private company with a single tool that costs forty billion dollars! And I thought, "this company is too big to fail."  I also wondered whether freedom was even possible in a world of companies as big as Exxon.

I teach political theory for a living.  I teach classical liberal theory for a living: Locke, Smith, Hume, Montesquieu, Madison, Tocqueville, Mill--you name it.  I teach this stuff because I think passing these thinkers and their ideas on is vital to the preservation of a free society.  Yet, some days I wonder why we don't just dump this stuff in the trash can and quit pretending it matters.  Locke's theory of property, Tocqueville's ideas about civic freedom, even Madison's ideas about checks and balances and limited government--these seem like a joke today.  Few people read them, fewer people believe them, and even fewer are willing to do anything more than nod to them when things are going well.  We're a nation of Locke-lovers and Founder-worshippers when things are going well, but, oh buddy, when things go wrong! Don't talk to me about the Second Treatise when my 401k is tanking; don't talk to me about limited government when my entitlements are about to be cut. 

Which is why I've always taken a certain pride in being affiliated with groups like Reason and IHS, why I've always taken a real pride in seeing Cato's latest press release--because these guys mean it, and they mean it as much as I do.  In the face of ruin, these organizations stuck to their principles--a set of ideas about property and the extent of government that, despite its unpopularity and despite its hard lessons in liberty, remains the single best framework for organizing society.  I was proud to be a classical liberal, even as I despaired at living in such a world.

This has become rather long-winded. 

If there is one thing for which I fault libertarians more than anything, it is their abandonment of the public sphere.  What is most galling about the abandonment of all things public is that many libertarians wear it as a badge of honor: "I certainly don't engage in politics, because that would be coercive; I don't engage in politics, because they just want my money; I don't engage in politics, because that's where the corruption/sin/evils of the world lie."  The sanctimony in the libertarian rejection of the public sphere is equaled only by its irrationality and unjustified disregard for every single member of the classical liberal canon.

I blame this on two shifts in the liberal tradition: the rise of Ayn Rand in the normative sphere, and the rise of the Austrian school in the economic sphere.  I've read the Rand oeuvre, and it was Rand that brought me to libertarianism in the first place; her work is of tremendous value and that is not in question.  But Rand was a wildly inconsistent philosopher for the simple reason that she mistook her own art for reality (and this, even though her own aesthetic theory should have made it clear to her that she dealt in works like Atlas Shrugged with a world that was nothing more than an idealized version of our own).  The problem with Rand is that freedom looks really, really easy; the good guys win because reality dictates that they must.  This is absurd.  To put this another way: Rand can so unequivocally endorse freedom in her own work because, in the world of Atlas Shrugged and the Fountainhead, fate itself is a libertarian! My beef with the Austrian school is less epistemological: it is, simply, that the Austrian school conflates growth with freedom, a conflation that normally goes unnoticed but which produces a real tension between principled liberals and Austrian utilitarians when the chips are down.  Tyler Cowen, for whom I have immense respect, was consistently for the buyout, and almost always for some bedrock value akin to "happiness," a word utilitarian liberals like to trot out even as they acknowledge its hopeless ambiguity and ultimate meaningless.  Tyler might not even be an Austrian, so maybe I should retract that.

What am I driving at? I'm driving at the fact that, to a man, the classical liberals conceived of liberty as something that could be realized only with some difficulty.  Liberty means responsibility.  It means sticking to your principles--namely, the principles of liberty--even when they are not convenient.  It means this further: that we are willing to embrace liberty in our lifetimes even if we knew, as a matter of fact, that something less than liberty would yield greater economic or utilitarian returns.  Why? From what position can we say that liberty is worth sacrificing well-being, that liberty is actually, really the greatest good and not just an instrumental good?

From the perspective that associates liberty with, to use an unpopular term, manliness.  Perhaps it is better to say that I equate liberty with adulthood.  The classical liberals, to a one, supported this liberty: a manly liberty that stressed above all else independence, individual responsibility, personal restraint, and an unwavering willingness to take care of one's affairs.  This is why liberals can tell overextended "homeowners" that, sorry, no handouts here: because to do otherwise would be to treat them like children.  The sad part is, of course, that they want so, so badly to be treated like children.

Where this all comes back to the question is on the matter of the public sphere.  Managing one's private affairs is a sign of adulthood--that much is clear.  What is just as clear, but has been apparently forgotten by libertarians for some time now--is that taking care of one's public affairs is just as important.  The public sphere is not some necessary evil--it is not some concoction of the simple-minded evil-doers who want a way of coercing the good, industrious, freedom-lovers who just want to be left alone.  This is a myth, and the faster we destroy it, the better.  Nowhere, and I mean nowhere, is the "right to be left alone" invoked, endorsed, or otherwise sanctioned by any classical liberal before the Randian/Austrian revolution in the 20th century.  Perhaps I overstate.  No classical liberal suggests, pace Rousseau, that attention to the public sphere should be required, that's true.  But none of them, not one, produces the fantasy of a perfectly self-regulating public sphere, a fantasy libertarians cling to with reckless disregard.  As soon as you acknowledge that there is such a thing as "public business"--and it is impossible and irresponsible to deny the existence of common problems (at least, such a denial has only emerged in the last seventy years)--then the notion of manly liberty compels everyone, including libertarians, to tend to this public business. 

Thus, my suggestion to libertarians everywhere: run for office.  Write an op-ed.  Tend to the public sphere.  It is your manly duty. 

Saturday, November 15, 2008

Open question.

We would like to advance libertarian principles in American policy. How do we allocate our time and treasure most effectively? Do we focus on the biggest long term threats to freedom? Things like entitlement reform, health care reform, free trade, global hearts +minds, etc. Do we push hardest on areas where we might have public opinion in our corner already? Issues like school choice, fair tax policies, protecting speech and privacy and reducing government waste seem like good candidates.

Do we push for huge changes or collaborate for incremental positive steps?

Friday, November 14, 2008

This Amorphous Bailout

At his Wednesday press conference, Hank Paulson came clean that, no, he didn't intend to use TARP funds in the way he previously agreed promised was apparently bound by law said he might use them--namely, to buy up bad securities. We'll now be using it to recapitalize banks directly (so they can resume lending, remember? remember guys? resume lending, right?) and to free up consumer credit. Bailouts for the auto industry and credit card companies appear imminent.

Tyler Cowen reflects on his own bailout position. That one of the more intelligent bailout-backers finds the need to reassess is troubling.

Here's another bailout-backer backpedaling a bit.

Here's Arnold Kling, who I've agreed with the most consistently since this whole thing went down. Kling posts often, and many of them reach beyond my understanding of macroeconomics, but this is him at him most lucid and organized--a compendium, of sorts, of Kling-on-Bailout. A nice read.

The question, of course, is why I prefer Kling to Cowen, two macro guys whose disagreements, no matter how fundamental, exist at a level of economic comprehension that far exceeds my own. That is, in response to the question of whether I have a rational, reasonably-well-reasoned preference of Kling over Cowen--the answer is no.

Why the Kling preference, then? His zombie-banks approach is intuitively appealing, for one, and his dexterity in BS-sifting is considerably greater than most. More than anything, however, is the congruence in terms of conceptualizing the market. Kling is a Hayekian on these questions; so am I. Everything about Paulson and TARP is a bad idea because it runs counter to everything Hayek has to say about markets, information, and the relationship between these as a function of centralization. What is growing abundantly clear is that Hank Paulson has an incredible amount of power and no idea how to use it. This is no knock on Paulson, because no human being could possibly know how to coordinate markets in the way Paulson is being asked to coordinate them.

Then again, this last sentence should not read: "Paulson is being asked to coordinate them." This is a gross error on my part. Paulson has asked to coordinate markets in this way; Paulson has repeatedly threatened economic ruin upon those who would oppose his coordination of markets. I'll repeat: Henry Paulson is a tyrant. Unfortunately for us, he is not one of the cleverer tyrants.

Thursday, November 13, 2008

Global financial crisis explained

Bad debt, mortgages, etc = pie. Insert preferred villain as LardA##

Sad but true? Well, sad for sure.

From "Overheard" in the WSJ this morning:

Circulating in Asia, a view of how the Chinese stimulus package fits in history:

1949 (Chinese revolution): Only socialism can save China.

1979 (Deng Xiaoping reforms): Only capitalism can save China.

1989 (Fall of Berlin wall): Only China can save socialism.

2008 (Global crisis): Only China can save capitalism.

A recent discussion on TARP

“There are no atheists in foxholes, and no libertarians in financial crises.”
-- Paul Krugman- Economist and New York Times contributor

"In a credit crisis, a central bank should lend freely against good collateral at a high rate of interest"-- Walter Bagehot, Editor of "The Economist" in the 1860's

I've been thinking that I could and should write something about the extraordinary events of the past weeks and months, and the extraordinary request by Hank Paulson for a $700 billion dollar fund to use at the Treasury's discretion. Most of you who read this note will probably be surprised that I support the Paulson/Bernanke/Bush part of this plan. Clearly I and my industry are in "the foxhole" currently. I will not blame anyone who dismisses this note as an abandonment of principle under fire.

It is easy to point out many policy prescriptions that, had they been followed, may have prevented this mess. The mistakes at the government level were myriad 1) Massive government incentivization of home ownership 2) Massive government funding to assist homeownership 3) Legislative extortion of lenders to lend to those who should not have borrowed. 4) Persistent positive inflation causing money illusion and over-borrowing 5) Accounting Rules which were pro-cyclical and did not promote transparency or honesty. The list goes on.

However, none of this is relevant to the world that we live in. Here is the case as I see it, and how this action can be supported. Keep in mind that masochism is not policy and schadenfreude is a particularly pointless emotion. Also keep in mind that I totally disagree with Paul Krugman, and Libertarians can support action in the real world without sacrificing their beliefs. The fact is that in present form our "financial markets" are not free. For better or worse, in the wake of the Great Depression we decided that the act of providing long term credit to those who needed/demanded it was in many ways a social function that needed to be highly regulated. What we have is an intricate web of public and private actors, goals, interests, and incentives that form our financial market.

It is tough to think of a good jumping off point to explain the current financial situation, but here goes nothing. Let’s start with the fact that, our currency, the dollar, is a fiat currency. This means that our currency is NOT freely convertible into any recognized store of value (e.g. gold) AT A RATE SET BY LAW (it is of course freely convertible into almost anything at rates set by the market--a hugely important point). In other words, all that it is backed by is the full faith and credit of the U.S. government and, by extension, your tax dollars and your productivity (assuming we don't have a revolution). The Department of the Treasury is responsible for the management of the supply of this fiat currency in concert with the Federal Reserve. What does this mean?

Here is the normal, semi-Faustian bargain that the people have with the managers of a fiat currency:

1). Rational economic agents recognize that the monetary authority will permit and even desire mildly positive inflation over time because the central government will tend to run deficits and issue debt and, as the nominal value of debt is fixed, inflation will erode the real cost over time.

2). These same rational economic agents quickly learn to treat the currency as a unit of account, but not as a store of value. Immediate consumption occurs in terms of the currency, but stored productivity (savings) occurs in real or financial assets that offer positive or perhaps neutral real returns (stocks, bonds, houses, gold, coins, art, etc.)

3). As time marches on, rational economic agents additionally recognize that their wealth can be increased by borrowing in nominal terms of the unit of account, and investing the borrowed money in real assets (taking a mortgage). Lenders, in a stable positive inflationary environment, can price fixed nominal debt in such a way that they earn a positive spread over time. Everyone is happy.

Occasionally, in periods such as the years leading up to 2007, markets enter manias where flawed assumptions and flawed math lead everyone to believe that the nominal prices of certain real assets will never again go down. When everyone reaches this conclusion, there follows a massive expansion of credit as people attempt to capitalize on this opportunity to build real wealth. For the purposes of this piece, I will just assert that this happens without trying to explain its genesis. It can be seen over and over in the historical record. We have just had one of these in residential and commercial property.

What is the aftermath of such a "mania"? It is important to know the answer, because we are currently there. There comes a time when people start to realize that imprudently high prices have been paid, and perhaps the stored value of their productivity is not safe after all in their recently acquired assets. They try to sell them. If they all try at once, we have a real problem. Why? Remember that the nominal value of the debt that they incurred in the unit of account (the dollar) is fixed. However, the price of the real asset is floating (or sinking in this case). When you have a massive increase in the supply of an asset priced in dollars, the price of that asset in dollars goes down. At the same time that this is happening, lenders start to realize that some horribly imprudent loans have been made, and that they are going to have problems. They begin to call for more collateral to support the loans they have made, and to stop making new loans to protect their own balance sheets. Collateral calls force asset owners to do more selling, further depressing prices. At some point, equity in these assets (value of asset less value of debt supporting asset) disappears. When that happens, the asset owner loses all incentive to continue to pay for and manage the asset. He or she gives it back to the bank in order to satisfy the debt. This is a disaster for banks. They operate on preciously thin capital cushions. For most, an 8-10% loss of asset value would make them totally bankrupt. They do not want to own and manage real assets. They want to own paper claims on future cash flows. Banks tend to sell assets acquired this way almost immediately, perpetuating a downward price spiral. Eventually the reduced value of all the assets on the books of these banks falls below the value of their liabilities in terms of customer deposits and other borrowings. This is called insolvency, and leads to bank failures.

If the only result of these events would be that bad borrowers and bad lenders lost wealth and capital, the proper response would be to simply allow it to play out. However, the particularly vicious reality of a debt-driven asset deflation cycle such as the one I’ve laid out is that the severity of the cycle will harm otherwise prudent borrowers and lenders that potentially need not have been harmed. The Great Depression is the ultimate example of this situation. During the Great Depression, real GDP decreased by a third, and nominal GDP decreased by half. Suffice it to say, owners of assets do not retain much wealth in situations such as these, no matter how prudent they are. Outcomes such as these are truly disastrous for everyone, no matter what “street” they live on. The American people have far more debt today (and far more wealth) than they did going into the Great Depression.

Ben Bernanke is a student of the Great Depression. He knows (or believes) that the transmission mechanism which turned a business downturn and then recession 1929-1930 into the Great Depression was a debt-driven asset deflation cycle which caused a collapse in the banking system, a collapse in lending, and ultimately a collapse in the money supply. This is a view supported and promulgated by Milton Friedman and Anna Schwartz in their seminal work on money and inflation. No matter how likely you think this scenario is (for the record I think it is highly unlikely), it is to be avoided at all costs. I promise you that he has no vested interest in saving “Wall Street” other than his certainty that the potential (however slight) exists for enormous pain to be felt on Main Street.

Now let’s consider Hank Paulson’s view from the Treasury. He knows America as a nation is immensely wealthy. This is because we have the most productive labor force in the world that has flourished in a mostly-free-market regulatory environment that encourages wealth creation and risk-taking. It is also partly because of, and related to, the fact that people all over the world have recognized this and lent us their money to use to create wealth. They have done this lending in exchange for debt denominated in U.S. dollars. Most of this lending (or equity financing) has been to the private sector, but a lot of it (2.5 trillion) has been foreign lending to the U.S. Government. Since the start of this financial crisis last September, the U.S. dollar has actually performed remarkably well versus the rest of the world’s currencies. The dollar is roughly unchanged over this time period. The implication of this is that while foreigners may have been selling riskier dollar-denominated assets, they have then held the cash in U.S. dollars, or used the cash to purchase U.S. Treasury bonds, which are still perceived to be the safest asset in the world in terms of retaining principal value. The nightmare scenario is that you have a debt-driven deflationary cycle which engulfs the entire financial system, causing foreigners to totally lose their faith in its integrity as a whole. The flight of capital out of dollars and out of our country would add immeasurably to the pain of any downturn. It would dramatically increase the cost of capital for every project imaginable and harm our future wealth in a way that would take a very long time to repair. No matter how you feel about “foreign capital”, the reality on the ground is that our current standard of living requires billions of dollars of it to flow into our country every single day.

Let’s fast forward to today and then talk solutions. I have chosen to take at face value the fact that Paulson and Bernanke believe that there is a non-zero and growing chance that we will have a total collapse in our banking system. The ongoing stress in the credit and interbank lending markets corroborate this reality. The price tag of such a collapse is unknowable, but suffice it to say, it would be trillions and trillions of dollars. It will make $700 billion seem like a tag sale. The Treasury hopes that by buying assets from banks that can afford to sell to them, the collapse will be averted and the system will have time to absorb its losses in a rational manner. The optimal outcome is for good banks that are currently caught in the vortex to survive, and for bad banks and managements to go out of business. In some sense the Treasury’s plan can ensure this outcome by paying a price for assets that will bankrupt imprudent banks and recapitalize and buttress prudent ones. I do not know whether or not it will work or whether or not Paulson and Bernanke are even correct about the potential for a melt down. Let’s look at four possible outcomes though:

1) Approve plan, P/B wrong about meltdown. Markets don’t collapse, perhaps the money never even gets invested, tax payers make out like bandits on what they do buy.

2) Approve plan, P/B right about meltdown. Money gets invested. Perhaps the potential meltdown is averted. If so, taxpayers make out again. If not…we have a deep and prolonged recession with awful (but perhaps lessened) consequences.

3) Vote down plan, P/B wrong about meltdown. Markets don’t collapse, we experience some further stress, we have a mild recession, and growth continues

4) Vote down plan, P/B right about meltdown. Financial disaster ensues. Trillions of dollars worth of wealth that was honestly acquired and prudently protected is destroyed. America loses its preeminent position in the world financial system. A 10-20 year depression follows.

I believe alternative four is to be avoided at all costs, and further that delay is likely to cause wealth losses in this country that far exceed the $700 billion dollar price tag of this plan, even in scenario 3, no bill, no disaster. Exhibit A is the loss of 1.6 trillion in stock market wealth on Monday, along with huge losses in bond market wealth as well.

At this point it feels almost like a coda, but I believe a purely Libertarian argument can be made for this action on the grounds that the proper sphere of government is in preventing and redressing the harms that one man may inflict on all others as a direct result of his/her actions. I promise you that many many many extremely innocent players could be deeply harmed by continued forced liquidation of real assets at fire sale prices. If this causes a halt in lending, (as it already has in many cases) folks that have no debt may find themselves out of jobs they would have otherwise retained due to business failures during this downturn. The Paulson Plan could almost be seen as forced vaccination against a communicable and fatal disease (financial panic) like polio.

A pragmato-libertarian argument is that if this scenario could be prevented at a small cost to the tax payer or perhaps even at a tremendous gain, it could stave off the avalanche of increased and restrictive legislation that is certain to rain down on us in the aftermath and that could cause decades of unnecessary below-trend growth.

A purely pragmatic argument is that if Paulson is wrong, the cost is almost certain to be negligible to the tax payer, whereas if he’s right, the costs will ultimately be much much higher than $700 billion. In either case, he should have the ability and freedom to try.

You should be angry with our government and your representative for a pattern of action lasting over 70 years that was a major contributor to this problem. You should be angry that the mechanism for getting this passed seems to be stuffing it full of unnecessary goodies. There is plenty of blame to be leveled at both Wall Street and Main Street for the massive expansion of lending/borrowing which led us to this point. However, you should not let any of this stand in the way of the fact that almost no matter how small the probability of a total collapse in our banking system is, the weighted present value of such a collapse is likely to far exceed whatever losses we may all incur in an attempt to invest $700 billion dollars to unclog our banking system and allow for an expedient resumption of the necessary credit which is the engine of our financial system and economic growth.


Michael W. Griswold