Sunday, December 27, 2009

A Theory of Depressions

In an economy in equilibrium, demand and supply are in balance. It may be growing with population and productivity, stable or even declining if they decline. The economy may grow out of balance gradually due to mistaken expectations of profits, or momentum investing fashions, or the accumulation of debt that cannot be repaid, and turn on an endogenous shock when these expectations are dashed, or it may be happen suddenly when struck by an exogenous shock. The shock leads to reductions in investment and employment in the affected areas, reducing demand. Prices initially are more elastic than wages which can lead to real wage rates rising even as total real wages fall. This creates an incentive to delay spending for lower prices and even higher real wages creating deflation. While prices are initially more elastic though, and sellers may be willing or forced to sell inventory at or below marginal cost, they are not likely to produce below cost, so eventually price declines reach a limit of wage declines. The duration of the production cycle would throttle the rate of decline since prices must eventually cover earlier incurred wage costs. At this point, there is little more incentive to delay. Prices fall until price elasticity matches wage elasticity. If prices fall, wages also fall, and attempts to save more fail as they do so. In this case, it is not rising real wages that terminate deflation, but that they cease to rise. At this stage deferred spending picks up and along with it production, employment, and total wages. It does not necessarily pick up where it was before soon though. Even if bad debt and bad investments have been written off, there may not be anything else to soon take its place, and while real wages may no longer be increasing, they are likely still too high for full employment. Inflation helps by allowing real wages to fall and employment grow.

Monday, November 23, 2009

Detestable Economics

Economists should examine why their arguments are so often the crux of dispute rather than enlightening and so frequently polemical rather than scientific. One of the largest problems is the implicit assumption what is good for themselves is good for everyone else or to select who is favored. Another is the willingness to overlook shortcomings in favor of support for favored policies, often focusing on the insignificant rather than the important. In the attempt to be useful towards setting policy, they often argue legalistically from the results desired backwards rather than
forward from facts. They will often defend something while ignoring how that which they are defending is not that at all.

Some examples will help clarify this. The natural constituency of economics are consumers, so whenever an economist argues the position of a producer something is up. An example is arguing farm subsidies disadvantage foreign producers while ignoring how it benefits foreign consumers. Another is arguing energy excise taxes will discourage production while ignoring they will fall almost entirely on producers rather than consumers and would be remarkably efficient as a result. Another is to declaim for free trade and rail against protectionism while ignoring exchange rate pegging that prevents it from being free and induces protectionism, asserting the free lunch of bargains while ignoring the harm done by such policies. Selective bias towards preconceived conceptions is abundant in economics writing.

Wednesday, October 28, 2009

Energy Economics and EROI

A lower EROI means higher real energy costs, ceteris paribus. If it fell to 1 or below, production could only be sustained with inputs being cheaper than outputs. In so far as energy is conservable or substitutable, it will be as costs rise. In so far as it is not, its price will be fixed by its marginal productivity. The economy will survive, but it could be a very different economy from the one we have, one where long distant trade and travel declines, one where energy use becomes an active consideration rather than an afterthought. Technology will help ward off this future, more so in conservation than in production, but it would take a new industrial revolution to substantially reverse it. Possible, but not one you can predict, and a high risk strategy to rely on, as the industrial revolution may not have even occurred without lower real energy costs.

Monday, September 7, 2009

Macro Economic Instablity

Is the macroeconomy inherently unstable? Is it only through monetary and fiscal policies that it is stabilized? This is the intriguing question of a post of Nick Rowe. As much as I believe there should be, I cannot think of any reason to be so. My first thought was assets, debt, and equity, through cash flow, give mass to the body of income, and this could at least limit swings in income, on the negative side by assets providing positive cash flow and on the positive side by assets appreciating faster than increases in cash flow. Asset values swing, debt defaults rise and fall, equity shifts, and cash flow with them though. While they may swing differently from other income sources, it does not seem it would provide much if any stabilization.

There seems to be a finite amount of useful work at any given time, and this amount may fall sharply should a significant amount of it be found unuseful. Useful is in the sense of covering costs and profits. Cutting wages doesn't make more useful work any more than cutting prices does if costs and profits cannot be covered. One could redistribute the remaining work among more workers, but this would not increase overall income without other changes. What is needed is the creation of new useful work generating new income, but this is a slow difficult process. The economy may range from a deluge of innovation with an abundance of new useful work to be done to a dearth of innovation with a lack of new useful work, or from innovation that creates new useful work to innovation that destroys existing useful work. There is no assurance of a balance of work and workers in the short or even long term because there is no assurance of a balance in the occurence of innovation.

Thursday, August 27, 2009

Peak Oil

Does the long term real price of oil look like it is falling? Sure it may have fallen after the peak in the 70s and again recently, but overall it is up. Oil at $20 is likely gone forever. Oil at $30 is largely gone and unlikely to be seen other than briefly. Oil at $40 or $50 we should see until the next shortage drives another spike in oil prices. We have been able to extract more, but not more cheaply. We will use less, because it is more expensive. We will develop alternatives, because oil will eventually be more expensive than those alternatives. The only way it will fall in price over the long run is if it is displaced and no longer wanted.

Tuesday, August 25, 2009

Dividing the Division of Labor

The division of labor can produce higher quality output and do so more efficiently but only by a limited amount. Labor has specialized since the beginning of civilization but produced only infinitesimal growth. Only the application of scientific knowledge and the advent of powered machinery produced modern levels of growth. This has led to greater specialization but there is little reason to attribute growth to this beyond its embodiment in knowledge and technology. The real usefulness of the division of labor is not in labor at all but in gaining specialized knowledge and replacing labor with technology, automating production.

Thursday, August 20, 2009

Two Centuries of Growth

The Growth of Real Income (real gdp per capita) in the US demonstrates the transition from an agrarian to industrial to post industrial power. Growth was slow initially but rose over the 19th century in fits and starts. It would rise sharply during booms only to stagnate or fall slightly through busts lasting a decade or more. A dramatic fall occurred over 1929 to 1933 followed by as dramatic a rise climaxing during World War II before settling back to extended consistent growth at the best rates ever. Variability has diminished somewhat over time. Most deviations are small from this upward drift over history. Growth appears to have reached an asymptote of about a factor of 10 per century or about 2.3% a year. So much for past golden ages.

Thursday, July 23, 2009

Deflation is Depressing

Is deflation always bad? Some industries exhibit falling prices which are beneficial to consumers, so if deflation leads to most falling that should be good as well, right? No. Deflation leads to a riskless real return on money. This is bad for the economy as any investment that returns less than that, or even more than that but carries some risk is not made, and growth slows to reduce that return to zero. Falling prices lead to delayed sales and raises real debt burdens slowing the economy further and leading to more deflation. The economy has difficulty adjusting to deflation due to the lack of expectations and sticky prices, creating a vicious cycle. In a perfect world with known expectations and all planning, contracts, and prices adjusted seamlessly, deflation would not present a problem, but in such a world neither would it be necessary, and as prices must respond to supply and demand rather than uniformly, resistance and stickiness would remain. In the end, deflation is depressing.

Thursday, July 16, 2009


A really nice paper on the unsustainability of the bubble is this 2006 paper by Robert Parenteau, US Household Deficit Spending. We were well into Minsky's ponzi finance regime where debt is acquired to pay off previous debt leading to a debt trap. Even if income increased with productivity, it could not sustain debt rising with asset values. Finance wasn't growing with the economy, it was the growth of the economy, it was growing at the expense of the economy. This is why it is so unbelievable so many failed to see it coming. They had to close their eyes really tightly.

Monday, June 29, 2009

Investment, Speculation, and Bubbles

Investors invest on a value basis for the long term. They try to determine what an investment is worth and value investments according to the income they expect. Speculators invest on a momentum basis for the short term. They try to determine what others think an investment will be worth and value investments according to the gain they expect. These are caricatures somewhat as many will consider themselves investors only to turn into or be turned into speculators after the market moves against them.

During a bubble there is a transition from assessing value to assessing other peoples assessment of value recursively providing convergence in expectations and a positive feedback loop for the explosion of prices. Eventually it runs short of new money or participants. Price increases start falling short of expectations. Speculators are forced out or start selling out. Prices start to fall. Expectations change. Feedback turns negative resulting in an implosion of prices.

In no place was the difference clearer than the housing bubble. Incomes never grew through it. The Fed has largely come to define income growth as inflationary and stemmed any real increase in it so no one should expect rapidly rising incomes. There was no investment case for housing in general. Lower interest rates meant property prices would increase, but also meant if they rose, prices would decrease. They could only always be worth more if one expected interest rates to keep falling. That is quite hard to swallow. The reason prices rose was because speculators were investing on a momentum basis and the reason they fell is because they were disinvesting whether due to being unable to carry them or on the same basis.

Under efficient markets, price is value, bubbles don't exist, and none of this makes sense, but to make sense of efficient markets one has to theorize investors had expectations prices would continue to rise, but how could prices rise without incomes to support them? Did they really believe the Fed would inflate to keep prices heading up after 20 years of disinflation? Could they really believe interest rates had only one way to go, even after the Fed began raising rates? Efficient markets strain credulity the same way lending standards strained credulity during the bubble. The only way to make sense of it is to assume limited rationality that makes momentum speculation reasonable. The only problem with that is it undermines and makes a mockery of efficient markets.

Thursday, June 25, 2009

The Housing Mirage

In a notable piece of research reported in the WSJ, mortgage equity withdrawal, 25% to 30% of equity increases, may have contributed as much as 2.3% to gdp over 2002 to 2006. This is consistent with the reports of CalculatedRisk. If one also adds to this the amounts due to increases in the construction and finance and real estate industries over this period, perhaps 1.0% to 1.5% of gdp, there likely was no real growth over this period, none at all. Economic growth was a complete mirage due to the housing bubble. The question now will be whether there will be any going forward. I have my doubts, but at least we are no longer under any illusions.

Monday, June 22, 2009

Credit Crisis Continued

If only the Fed had ensured proper lending standards, it wouldn’t have been a housing bubble, but a sustainable rise in prices.

The presumption is often that rates were too low. In fact, they were too high, kept there by our ponzi financial system. Remember when Greenspan started raising rates, long rates fell. Bad lending was promising ridiculously high future returns which markets took at face value or ignored due to bad ratings and bad insurance. Bad lending increased leverage, reduced and eliminated qualification, promoted fraud and escalated asset prices. What started as a small problem was allowed to grow into a large problem (I would call $3T large) which was then compounded into an immense crisis when the Fed balked at covering those losses.

If only good lending had been allowed, rates would have had to have fallen much further to the point where it wouldn’t have been worth investing here and lenders would have had to choose between losing money, lending elsewhere (probably also losing money), investing elsewhere (risking losing money), or consuming more (spending money). Would this have just created a recession anyway? It could have as trade adjusted to the new reality, but it wouldn’t have led to a crisis of bad debt. Bad debt is bad enough, but when uncertainty exists as to how much, where, what, and who holds it, and how much punishment the Fed has in store, fear takes over. And it is not just about past losses, but also future losses due to breaking of the housing industry, breaking the consumption of asset price appreciation, and breaking of the financial sector’s means of revenue generation.

There were certainly failures all around. Much of the fraud was implicit and indirect. Don’t ask, don’t tell. Bad lending, bad ratings, and bad insuring were market failures due to agency problems and bad incentives. It was investors allowing bad ratings and bad insurance on bad lending to substitute for judgment. It was everyone trusting (wink, wink, nod, nod) everyone else to do their job. It was the market depending on the Fed to save them from their folly. And finally, since to coin money and regulate the value thereof is a governmental function allowing unchecked fraud and then allowing the economy to collapse from it are regulatory and monetary failures.

Tight money is the current, largest, and principal problem, though I lean in the direction it is tight because of lost faith in the ability to repay it, by both borrower and lender, but that is the reason it is all the more important for the Fed to change those expectations. Increasing credit is probably not possible currently due to this loss of faith. Reducing debt loads through refinancing with lower rates is also limited, collateral values being so reduced. Increasing money through asset purchases is possible but assets require management.

I have to say I have no better word than fraud for making loans that cannot be repaid other than through escalating asset prices. One can call it speculation, but there is no reason for the pretense of lending on speculation other than to mislead the ultimate lender into thinking the loan is safe and will be repaid. The entire prospect was oriented to disguise and hide risk and the fact that this was speculation from them. How much will you lend me to bet on black? I will offer a great interest rate but if it is red, sorry, you will be out of it. Even if prices escalate, even if there are some reasons to expect them to escalate, no one has any right to expect them to escalate forever and ever. Housing speculation was driving prices only I would not say it was only or even primarily borrowers speculating. It was as much lenders (intermediaries) speculating against each other. Home prices tripled or quadrupled in the most bubblicious areas. It was apparent there was not and would never be enough income to repay these loans. Even increased immigration increasing incomes comes up short when there are only so many families you can crowd into a home and no evidence of increasing incomes otherwise.

Don’t confuse the agents, the employees of these firms, with the firms themselves. No doubt they lost their jobs and some deferred compensation, but that was nothing compared to the money they took out of the system doing so. A half a billion dollar bonus goes a long way to alleviate any qualms. Finance operates under extreme discount rates, and are even higher for the individuals involved. So were the high salaries in finance due to their laughable brilliance or their employers incompetence? What market failure led to that? Yes, I am sure they all really, really, believed black would come up and keep coming up. It was just a case of bad luck. Heck, they didn’t even know red existed. Aw, shucks. Now that would be one for a movie script but no one would find it credible.

Saturday, May 23, 2009

Debt Deflation Depressions

As Irving Fisher noted, depressions are always associated with high indebtedness. Attempts to liquidate this debt then induce deflation which actually increase real indebtedness. The only ways out of this are repudiation of the debt through default, reduction of the debt through inflation, or repayment of the debt over time. Is it possible or even desirable to prevent the rise of indebtedness?

The source of indebtedness changes between depressions. The Panic of 1837 centered on real estate, the Long Depression of 1873 on railways, the Great Depression of 1929 on stocks. Not that these areas alone were affected. Debt spreads to whatever can absorb it, it is just that there are not that many areas of sufficient capital value at a given time to absorb large amounts of debt. Real estate is a common one, as are large scale infrastructure such as canals and railroads, utilities such as electricity and telecommunications, to stocks. Only the largest, most capital intensive, most geographically extensive, most economically productive, most impressive new industries qualify, but as these are at the center of the economy, all others are encompassed by them.

The amount of lending reaches a climax, optimism reducing risk perceptions. Conservative lending can prevent credit bubbles by focusing on retrospective rather than prospective views, and based on income as much as asset values, but whether conservative lending can be maintained amidst the temptation of quick easy gains is difficult. Easy lending then chases out hard lending as easy lending increases all asset prices, even those hard lending lends on. Once the price of an asset becomes detached from the value of the income to pay for it, once the price comes from the gain expected rather than the dividend generated, a bubble becomes inevitable.

Some approaches to preventing this have been to limiting the amount of debt raised through debt covenants, limiting the debt leverage involved which was done in the case of stocks, and limiting the types of loans allowable such as requiring income documentation and requiring qualification at market interest rates, and these can work, but only if maintained and required. It will probably take another generation for people to forget and for the temptation of easy lending to arise and it will likely occur in some different area as yet untouched by it. A vigilant market and a vigilant regulator may keep it at bay longer, but when our guard is down and we least expect it, it may come again.

Friday, May 22, 2009

Double, double, toil, and trouble

Can bubbles be predicted? Can they be avoided? One of the key functions of the financial system is not to avoid bubbles but to blow them. The greatest profits are to be made in skimming money from fools and bubbles offer the ideal prospect. It is the why behind ponzi schemes. It is just most of the time the ability of finance to persuade others to bite is limited, the burden of defectors can be heavy, and all too easily you can end up the fool, the fool being the last one in and last one out.

There are two methods of profiting from bubbles, for investors it is timing them, and for dealers it is trading them. Timing is always difficult, but trading is always profitable. It is just necessary to avoid investing the profits into the bubble.

The book Contrarian Investment Strategies: The Next Generation by David Dreman, begins with a tale of casino with two rooms. The red room is crowded and exciting with large sums being won and lost but the house always gets their cut. The green room is sparse and quiet and actually rewards investors for playing but it is boring. Most people prefer the excitement of the red room to the dull rewards of the green room.

A successful theory of bubbles could be preventative. Yet it is always tempting to believe what you want to believe. Anyone looking at incomes and housing prices or equivalently debt from 2004 on knew we had a bubble. It was apparent they simply could not be afforded. Even knowing this doesn’t tell you how big the bubble will get, when it will burst, where the wreckage will end up, or how bad it will be afterwards. Some will avoid them, some will hope to get out before they burst, some will play them for what they are worth, some will misjudge them, and some will be suckered into them. Bubbles exist, but they are difficult to predict and difficult to profit from them.

I doubt most bubbles could be predicted but that is unnecessarily stringent. A theory might still be useful even if it only made predictions after one burst. One might not be able to avoid them but might still be able to address them after the fact. I don’t even see bubbles as something to be avoided at all costs. They may well play an important part in creative destruction.

Credit bubbles are an altogether different matter. They are tend to be easy to see and prevent by requiring lending be limited to retrospective rather than prospective views and based on income as much as asset values. All losses aren’t preventable but systemic losses usually are. Such a bubble could continue to grow, but only through equity rather than debt. Even this isn't foolproof, though, as debt can be floated rather than formally lent. Debt makes bubbles far worse because its systemic nature results in far larger bubbles, its rigidity makes it difficult to deal with, and its liquidation can lead to deflation.

I view bubbles as a transition from assessing value to assessing other peoples assessment of value, recursively providing convergence in expectations and a positive feedback loop.

Thursday, May 21, 2009

Tell me Sammy, what do you know about the world of business

Did you know, beginning in the late 19th century, corporations were granted all the rights of the individual, but none of the annoying responsibilities. They lack, almost by design, any kind of moral compass, conscience, or compassion. Basically corporations are way to enact sociopathic behavior on a grand scale. In short, they're what makes this country so damn great!

-- The Devil, Reaper Season 2 Episode 12

It wouldn't be so hilarious if there weren't a bit of truth in it, at least from the Devil's point of view.

This illustration of the corporate hierarchy/social pyramid is that of GapingVoid

Monday, May 18, 2009

Ebbing economic tides

Rising tides usually lift all boats, while ebbing tides lower most if not all of them. When the economy grows, people don't mind when some prosper inordinately as long as they themselves are as well or better off than they were before. They like to believe they will also prosper. When the economy shrinks though, the easiest gains are often at the expense of others. For that reason, there is a strong counter tendency towards egalitarianism in times of economic stress to prevent this. We must find a commonality of purpose to pull together to overcome our hardship. We must share in the punishment and reward alike and strengthen our resolve to stand united or divided we fall.

Saturday, May 9, 2009

Market Fundamentalism

Market fundamentalists believe markets can handle anything the world sends at them, except government. They are fooled by government, naively misled by it, unable to anticipate it, or induced to take advantage of it, forced to misbehave by it, or cynically exploit it. Whenever markets fail it is the fault of government, they were only doing what was expected. The devil made them do it. How lame. Well since everything is the government's fault, it must be their responsibility to fix.

Thursday, May 7, 2009

Debt and Deflation

The banes of credit crises are debt and deflation. Debt is the destruction a credit crisis leaves in its wake. Attempting to liquidate it can result in deflation and the ridigity of debt then results in a vicious cycle. Since deflation increases the real interest rate, it makes it more difficult to repay debt while making it more imperative to do so, leading to more liquidation through default or reduction, and more deflation. Deflation must be prevented and debt defused over time. Reasonable inflation can help defuse it, allowing debt to be liquidated and easing the drag on the economy from it.

Austrians and Economics

Markets good, government bad. Markets never fail. When they fail, it is always the fault of government. Austrians suffer from an extreme anti-government bias that taints all their reasoning. Since government always exists and is always to blame, it is impossible for markets not to fail. Austrians should give up before they start since they can’t use history to establish anything. All we have is assertions that something else will be better, even though that something suspiciously resembles what we had in the past and were not happy with. At best it is assertions and wishful thinking. Wishful daydreams of ancient golden age market utopias. A kingdom for ‘the right monetary policy’. Austrians offer little in the way of explaining, preventing, or responding to business cycles than interest rates and ideology. That summarizes Austrian economics in all its tediousness and answers any question that arises.

There is some truth in credit induced booms and busts. Austrians explain a business cycle, but not the business cycle. There are more reasons than low interest rates for booms and more causes than high ones for busts. In this one it was far more relaxed lending standards than low interest rates. While lower interest rates can, although not necessarily do, relax lending standards, that is not the only way. Higher monetary velocity can as well and the central bank has even less control over that than interest rates or money. It seems evident from experimental work that bubbles are inherent to market processes.

Central banks make mistakes. So do markets, and no, they are not all due to government however fervently Austrians want to believe. The ability to make mistakes also implies the ability to correct them. We live in a more complex world than Austrians admit. While money is predominately created by the central bank, they are not alone in creating credit. While interest rates are powerful, other things such as lending standards and monetary velocity are as well. While one answer for everything may be satisfying to the zealot, it leaves a lot to be desired for the rest of us.

It is possible the central bank can’t really prevent cycles, that the most they can do is redistribute their occurrence, frequency, and magnitude, but if it is possible to make them worse it should also be possible to make them better. While accidents may happen, our actions in response need not be accidental.

Now both markets and government are subject to human foibles and both can error. Even Adam Smith thought interest rate caps prudent to prevent bad lending. Certainly the Fed should have watched the burgeoning of credit and taken steps to limit bad lending which was what made this boom unsustainable, and it should probably be doing more rather than less now to prevent further damage, but those are errors of omission rather than commission.

Tuesday, May 5, 2009

Credit Crisis Severity

Why do some asset booms end so much worse than other asset booms? Why did the housing boom end so much worse than the tech boom for example? The answer is amount, debt, and expectations.

The amount most have invested in equities is much less than they have invested in real estate, partially due to less leverage, partially due to the necessity of shelter, and substantially due to real estate coming in such large units.

Consider an asset that rises from price p to price 2p before falling back to p. Anyone that held it for the duration would be no better or worse off. Someone that sold at the peak would have a gain of p, and the buyer would have a loss of p when the price fell. In total, there is no gain or loss, only a transfer from the buyer to seller. It is zero sum to first order. Any losses leave no debt behind. Wealth was not created or destroyed overall, only redistributed.

Now consider the same situation where the asset is acquired with borrowed money. Since these asset prices are afforded by incomes which change little over a boom, they will often vary roughly inversely with interest rates, with rates falling by half before rebounding. Anyone that held it for the duration and did not refinance would be no better or worse off. Anyone that refinanced the same amount to a lower fixed rate at the peak would be better off, while anyone that refinanced to the full amount at the peak may or may not be worse off depending on the terms of the loan, but may be much worse off than they expected if they did not anticipate the decline. Someone that sold at the peak would have a gain of p, and the buyer would have a loss of p when the price fell. The lender will also have problem if the owner cannot make the payments, must sell the asset, or even is no longer willing to pay, as the asset no longer provides sufficient collateral for the loan. This is not something the lender expected. Though this is also zero sum to first order, expectations make the result worse. Some will have consumed temporary gains leaving themselves more indebted. Some will have lost any equity they may have had. Some won't be able to afford it. Some won't be able to repay the loan if they have to sell. Some won't want to pay for something that has lost so much. The lender will suffer unexpected losses. Losses often leave debt behind, debt being the residual of crushed expectations. Wealth was not created but it very often is destroyed by being consumed during the boom leaving only the debt afterwards.

So what makes equity markets so much different from real estate markets? Equities amount to much less then real estate in most instances. Equities are much more liquid in most cases. Equity markets offer much lower leverage to retail investors, a factor of 2 (50%) compared to 10 (90%) or more for real estate. Equity markets are callable and marked to market daily, limiting losses, while real estate is at the option of the owner and marked to market only on sale. Equities are volatile, fast, and changes are expected, while real estate has low volatility and changes slowly with considerable inertia and momentum.

Thursday, April 30, 2009

Happy and Not-So-Happy Markets

The problem with the Efficient Market Hypothesis, EMH, is eventually proponents have to assume it and whatever happens becomes its confirmation. This makes it unprovable and useless, but better that than wrong.

How compatible are efficient markets and psychology? Can psychology just be treated as an exogenous variable to efficient markets? I would call this the happy markets theory, or the markets are efficient except when they are not theory.  Was the market failure the failure to anticipate such a change, to anticipate the effects of such a change, or in the reaction to such a change? Were prices too high before, too low now, both, or neither?  What are markets failing to anticipate next? What are they overreacting to now?  Will they fall by half or double tomorrow?  Are prices anything other than the whims of participants?  There is nothing wrong with treating psychology as exogenous other than making a mockery of EMH. It is notable how the same reasons are used at times like these, psychology, technology, .. and there may well be some truth in them, but such truth would be far more significant than the meaninglessness of EMH.

Wednesday, April 8, 2009

A Hyper-Ricardian Hypothesis

Conservative economists simply assume recessions don't exist, that they can't exist, that there are no idle resources, no involuntary unemployment. Since everything is already optimal and in equilibrium, the economy is a zero sum game and any attempt at change can only make things worse. Because of this no stimulus is even possible as it can only redirect resources from their current use to the use of government. There is even a bit of truth in this during normal times when the economy actually is operating at capacity. There is no cure for recessions because they are figments of our imagination. It certainly saves a lot of work trying to predict, explain, and remedy them. In this bizarro world, there is no output gap, empty homes and idle factories are just speculations for higher future prices and the unemployed are just enjoying leisure. Putting more people to work is just denying them their leisure and recessions are just long awaited and much desired vacations. If you believe this, not only is fiscal stimulus impossible, even monetary policy is unnecessary so one has to ask them why it should be pursued. One can only imagine what other innovations they might suggest, an end to unemployment and welfare, balanced budgets, and the rest of liquidationist policies.

Now over the long haul stimulus would not be stimulative because the economy would be operating near capacity and it would just redirect otherwise occupied resources within the economy, possibly to less desirable ends. But the same is not true in the short term if there are idle resources. In fact, if Ricardian equivalence holds there is little reason to expect people have not already taken these government stimulus actions into account in their planning from the start and have planned for the government to do just this for them in a situation like this. Call this the Hyper-Ricardian Hypothesis. In that case to not do it would be disappointing expectations that had been previously established.  Far from people countering fiscal action to make it ineffective, they will have planned for it and be relying on it to smooth their consumption.  Lack of stimulus could mean they may not be able to.  

Sunday, March 22, 2009

Ricardian Equivalence

I think of it as rational expectations and efficient markets theory taken to its farcical limit, the market always efficient, the economy always operating optimally, unemployment and recessions figments of our imagination. It shows how ludicrous a theory it can be and if you take it seriously, you have just missed the joke.

The Low Interest Rate Myth

Probably the most common explanation for the financial crisis is that interest rates were too low for too long.  I would dispute this.  The whole point of our financial ponzi scheme was to promise and keep interest rates higher than what they would otherwise have been.  Had only good lending been permitted, vast sums would have had no investment opportunity driving interest rates far lower than they had been.  Interest rates were not too low but too high given the available investment opportunities.  So when people ask, how can more of the same which got us into this trouble solve our problems they are incorrect.  This is not more of the same but something very different, the truly low interest rates the investment possibilities offer us.  It is the spur in our sides to take more risk to build a better future because our current one is not very promising.  

Wednesday, March 18, 2009

Incentives and Investments

The incentives were wrong, but the incentives are always wrong. It is in the interest of those that profit from the incentives to insure they are wrong so they can benefit from them. That is why it requires an honest regulator, but despite the incentives rather then because of them, as their incentives are wrong as well.

If only good lending was allowed, then interest rates would have had to have dropped further and lenders would have to decide whether to continue to lend or to speculate or consume. If they continued to lend, the bubble would have been sustained, speculate and it would have been diverted into equities, consume and it would have expanded the economy. Any of these would have been a better solution than what we had. The big problem is when there is a paucity of good investments for the amount of saving people want, the only thing left to invest in is ponzi schemes.

Thursday, March 12, 2009

On the Causes of the Current Crisis

While the low interest rates and abundance of savings amplified the result, it was bad lending that really created it. Bad lending is not only bad in itself but turns even good lending bad by increasing asset prices beyond their true value. Part of the job of regulating the value of money is regulating credit. Failing to do the latter is failing to do the former.

Whenever one hears of the profits of financial innovation the presumption should be someone is getting robbed and if you don't know who, it is probably you. There were no profits, only hidden future losses for the taxpayer to pick up. The innovation consists of fooling others and looting the treasury.

Monday, March 9, 2009

Animal Spirits, Knowledge and Psychology

Why do we make mistakes in economic calculations? What do we mean by animal spirits? Are these a cause or a result? In psychology as a cause theory, it is not that people don't learn from the past, but rather, learn too well from the recent past, and not well enough from the distant past, that outside of their experience, and end up repeating the mistakes of their forebearers. There does seem to be a disconnect between what we think we learn and reality though, that what we may learn may be false or incomplete such that we always have new lessons to learn as well as some we need to unlearn. In that, it is less of psychology as irrational emotionality than as bounded rationality limited by the truthfulness of our conceptions. Thus it seems both knowledge and psychology play a part in our mistakes.

Sunday, February 22, 2009

Feelings of Depression

Can talk cause depressions? No, I don't believe talk causes anything but is the result of experience, and while emotion is important, it can be fleeting. Psychology can be longer lived though. I think there is a short term rational response that leads to an irrational longer term response, that is, irrational in the very long term. I think people are captive to their experiences and memories and their reactions to them can lead to exactly this, while in the much longer term, these can be exaggerated. For all those past depressions, life went on, they all ended, and times improved as will happen this time, but when we are in the midst of one, we can't see how or when. In part, people want a depression, they want to be punished for prior excesses, they want frugality and righteousness to be rewarded, and morality restored. Once they believe they have been punished enough, that as bad as things are, worse really won't be that much worse, and that tomorrow will come and be a bit brighter, times will improve. Can this process be hurried along? It is really difficult as we are captive to our past, but it must be tried with every fiber of our being, to do otherwise is to yield to fate. As Chauncey Gardener said, spring will come again. Looking for it better than lamenting winter.

Saturday, February 7, 2009

Investment, The Fallen

Why has investment fallen?  There is a great fall in investment because those investments were bad, finance and housing number one among them. There is also a great fall in investments that while seemingly good in themselves were predicated on spending from the bad debt they created and from the false profits generated by them, cars and most consumer goods being among these. A false market was created and there was too much investment in these and now these must be written off. There is no lack of goods that more investment would solve but rather a surplus that cannot be afforded. Now there is some investment that can make sense, but this investment is innovative and risky. It is small and scattered. It takes time to develop and grow, and it is not in a position to help us much now. So now we have a long tough slog to write off bad debt, bad inventory, and bad investment. The best way to ease and hurry the process and reduce the overhang is more inflation to combat deflation. Debit cards are interchangeable with cash so that doesn't require more spending but more cash, a lot more cash, say $8000 per citizen, in people's hands is just what is needed.  Debit cards may be a useful method of distribution though.  They could be loaded quarterly until positive inflation and growth is sustained.  

Thursday, January 29, 2009

On Macroeconomic Disagreements

Why do economists differ so greatly as to solutions to the current economic crisis?  Why haven't they explored situations like these and arrived at a consensus?  There are several possibilities.  

Ignorance.  They do not know what they do not know, and they do not want to know it.  

Arrogance.  They already presume to know so no investigation or proof is necessary.  They have accepted their position as an article of faith, therefore nothing can contradict it.  Anything that does is in error.  Ideology is more important than reality.  

Antipathy.  The result may be contrary to their personal consideration and it is better to deny than admit it.  They seek power rather than truth.  

More deeply, I think the situation that would call for fiscal stimulus has been consciously avoided because the implications and solutions are highly unpleasant to economists. Instead the belief that monetary policy would always be sufficient and superior held sway. Economists want to believe markets are always and everywhere superior to government, that they are always more efficient, that their distribution is optimal, and that the worst market failures are less than the least government imperfection. There have been circumstances where they have had to confront externalities and failures, but have done so only at the greatest reluctance. Something as deeply problematic as catastrophic economic failure is confronted with shock, denial, and all of grief.

At least that is the charitable view. Others see in this the denial and propaganda of the true believer or the greedy self-interest of the powerful to preserve and protect their ideology or interests at the expense of the others and the public. I do not doubt many know what they are paid to offer and that they were selected for that. They know what their customers want to hear and they want to give it them. It is far from uncommon to seek narrow short-term advantage at the expense of broad long-term gain.  That is, after all, what got us to where we are now, but that is not a comfortable place.  Deluded or deluding?  Obsequious or opportunistic?

Sunday, January 18, 2009

The Disconnect of Economic Measures

So often, economists focus on the wrong measures and end up with the wrong arguments and then wonder why people are unconvinced and feel differently.  Economists focus on measures like gdp, employment, and inflation, when what is important to people is gdp per capita, employment over workforce growth, and real wages.  Their economic measures are important and have their place for a country, but are not nearly as important as these more relevant measures to people.  A country may grow even while life becomes increasingly tough for people.  Economists too often feign cluelessness about this, and consider it whining.  They are just using the wrong measures and should know better.  

Often these errors, innocent or not, are made promoting an agenda or view favorable to theirs.  Economics suffers from political bias more than most fields because arguments can be put together so easily that appear meaningful while ignoring more relevant conflicting information, stretching facts to fit desired conclusions.  It takes advantage of the fact that most people seek to confirm their biases rather than analyze arguments.  

Tuesday, January 13, 2009

Inflation and Living Standards

Inflation is difficult to measure and living standards difficult to compare over long periods of time. Most of what we spend money on does not change that much. The basics are quite basic and the areas that change the most are often those that not much is spent on in the first place. Cell phones and the internet are great advances and allow us to do things we never could before, but they are not that expensive.

Over long periods, I like to look at real gdp per capita and consider the period to double the standard of living. Over the last 30 to 50 years it doubled in around 36 years. If you believe inflation has been overstated by 1% though, it doubled in around 24 years. The latter seems preposterous to me. I hardly even notice the difference other than on inconsequentials. Even 36 years seems short. How much has life really changed over that period? Records have gone and computers and ipods are here but day to day living has only moderately changed. A doubling should be noticeable. I am more willing to believe it has doubled in 50 years or so, but this is probably more due to less personal experience to compare with over that time.  Then again, it may be because my spending has been relatively constant over much of that time.  

Thursday, January 8, 2009

Is income taxation progressive?

Superficially it is.  Those with higher incomes pay at higher marginal rates.  How could it not be?  The fallacy here is in accepting how is income defined.  

One cannot define income without accounting for the expenses of generating that income and offsetting these against it.  To do otherwise is to measure revenue or sales, not income.  If those at the bottom truly identified all those costs and could deduct them, if they did not have to pay more for less, if they had healthcare and pensions, they would have no true income and would not be paying any tax. The rich get very nervous at the thought of this, that a large number of people that pay no taxes would have no objection to raising them. To circumvent this, they tax them on income they don't actually have, only to subsidize them and complain about having to do it, to persuade them to oppose taxes on themselves while telling them they are on their side and support them through those subsidies. This is called having everyone pay their fair share, or pay something.  It is all a shell game played through the tax code and other spending.  

Now if everyone could deduct anything soon no one would have any income.  The main difference is the rich have more power to accommodate the law and accommodate to the law.