Coin Of The Realm

Labor Fallacies

2011-05-11T19:27:00.000-07:00

In micro, if supply increases and demand remains unchanged, then it leads to lower equilibrium price and higher quantity. Applied to labor it would say increased labor supply lowers wages, or would if it did not also increase demand. The question then is how much does it increase demand. In the infinitesimal limit supply and demand are simply additive and should have no effect on wages. This fails to be a good approximation at large scales however.

Increased labor supply lowers returns for productivity enhancing capital investment and human capital investment, and raises returns for resource producing or saving capital investment, or more simply, lowers the return to labor and raises the return to capital. In doing so, it will lower the growth of the labor supply and increase the growth of capital but this takes time. Increased labor supply increases output but diminishes the growth in output per capita as specialization is overrun by diminishing returns. Now larger markets afford greater specialization and specialization increases growth in output per capita, but specialization is more about technology than population even if population is the source of that technology. The path to growth of output per capita is better sought through technology than population.

Depressions causes

2011-03-03T16:11:00.000-08:00

Sticky prices and wages? Money? Necessary but not sufficient. Prices and wages are sticky and this causes adjustment problems during depressions, so lowering them will help, right? Yes and no. It helps to lower their real costs, not their nominal costs. Lowering their nominal costs can even make things worse as it boosts deflationary expectations and increase debt deflation. Nor would the result be equilibrium if they were perfectly flexible, but wild swings between self fulfilling deepest despair and exuberant euphoria. Sticky prices dampen reactions to fluctuations. A monetary depression can't occur without money but not many would wish to ban it to prevent them.

Depressions are examples of flee goods, seek money. The increase in money demand comes at the expense of the economy. Instead of being spent on consumption or investment, it is hoarded as fear grips the economy. Fear of risk and loss. Enlarged perceptions of risk and diminished expectations of gain. Not until they are assuaged or countered, not until those demands are satisfied can growth resume. In part the hoarding is thwarted by unemployment, forcibly turning savers into spenders. In part people doing what they must to survive. In part austerity fatigue. In main by the monetary authority persuading it has the power and the will to reverse it by providing the money needed.

Living with Standards

2011-02-06T10:20:00.000-08:00

Consider if you went to the store to buy bread and five varieties were offered all at the same cost. The next time you went fifty varieties were offered but still at the same cost. The cost of living remains unchanged. Since you are unlikely to eat any more, the economy hasn't grown either. Yet you have many more choices. Most would say they are better off even though the change would not show up in the data but how much better off. What if it came with the effect that oven hot fresh bread was no longer available? Would you consider yourself better off then? How much does the fiftieth variety add to your well being? How much would it add if it became the most popular and in fact extinguished five lesser varieties? Would you be better or worse off? Most would be unaffected by most changes but a few will be so in aggregate little of significance is changed, yet the aggregate of many such changes still can be. We have no method of measuring these for the individual much less between individuals or in aggregate. Living standards can improve or diminish without appearing in the measurements.

Seasons of the Economy

2011-01-29T15:46:00.000-08:00

Thinking in terms of Patterns of Sustainable Specialization and Trade, one could say that the economy develops such patterns over time but these patterns are subject to instability and collapse which then have to be rebuilt, usually in a new and different manner. One can consider it seasons of growth and decay. In spring, growth and production is low but improving, over summer strengthens and becomes vigorous, bearing the bounty and fruit of fall, in winter decaying and collapsing to a low level from which new growth develops. In summer, production and profits are high with high levels of specialization and trade, but winter comes, production and profits fall, and specialization and trade collapses. The economy itself is less productive until new patterns can be found to support growth. Meanwhile, people are left with time on their hands and find it cheaper to learn to do it themselves or do without than hire. One can argue this occurs continually so what is it that causes this to overwhelm the entire system and result in a recession? Just a matter of size and scope of the change required or errors and mistakes in trying to compensate for them, or in suddenness and rapidity with which it strikes?

This brings to mind the various kinds of specialization available to those of differing productivity and wealth, such as creator or owner that capitalizes on his creations or assets to extract rents if they can obtain and sustain them, performer that relies on his unique knowledge and talents to produce for the few or the many, and servant that relies on his general knowledge and specific spatial and temporal presence to produce. Creators and owners earn incomes without effort or with past effort and are not dependent on their efforts for their current incomes. Performers rely on their efforts and can work in conjunction with other performers to produce for many. Servants have little specialization to trade other than their general knowledge, effort, and specific presence. Servants lack the specialization to make it worthwhile to trade with each other. The best they can hope for is to work for one of the former or become one. If it becomes more difficult for creators and owners to sustain their rents and performers find it more difficult to sustain their advantage due to offshoring, greater numbers of servants will have difficulty as well. Sustaining incomes monetarily would still help through lowered exchange rates or inflation in countries with pegged currencies.

Growth vs. Population

2010-12-23T14:37:00.000-08:00

Economists believe increasing population increases growth. It does increase gdp, but it does not generally increase gdp per capita. It can create larger markets and more specialization over time, but before it does so it also increases the supply of labor, lowers its income share, and diminishes the incentive for most technological advancement, labor saving rather than material saving. Population growth did not contribute to gdp per capita growth during the Malthusian Era. Only technology did that and population is better considered the result of growth than the cause of it.

The UK has had a stable population for over 30 years and has grown gdp per capita at rates greater than the US over that period. When population lags, investment in human capital becomes more attractive and takes up some of the slack. An aging population does slow demand growth, but still increases demand relative to supply of labor. They still need product even if they no longer need jobs. Growth slows but steadies. Transfers will rise, but government less transfers should steady or even fall with productivity as expansion is no longer necessary but sustainment still is. It does tend to be deflationary, but labor will do better than capital in such an environment. Nothing to fear, but something to expect. Need I say, deflation is (almost) always and everywhere a monetary phenomena?

In a world of more or less free trade, the question of whether population growth here is good is an anachronism. The real question lurking beneath the surface is if it were, why wouldn't population be growing on its own as a result? I am sure economists can come up with some excuses, but they fall flat in the face of evidence.

Welcome to the Antipodes

2010-12-08T11:59:00.000-08:00

There is an argument that follows from the standard New Keynesian monetary model in cutting the payroll tax one should favor the employer over the employee. The reason being that current real wages are too high, so by lowering them to the employer, the employer will be encouraged to expand hiring, while increasing real after tax incomes of employees will just make them more high. Normally this would be correct, but not during a depression. The key element of a depression is the demand for money and its preference to the demand for goods. Cutting employer costs will increase their profits but their demand for money will override their demand for goods, investment or otherwise. They will not invest it unless they see demand increase which this won't do. Cutting employee costs will increase their take home cash and their demand for money would override their demand for goods, but they are frequently credit constrained. As they are more likely to be credit constrained, increasing their cash flow will lead to more demand for goods to which employers will respond. This is a demand, not supply problem, the demand for money. Giving money to those that need it most is most stimulative of demand. Given the regressiveness of the payroll tax, and the greater credit constraints of the employees, giving money to the employees is most effective. This would not be the case if demand were growing sufficiently, but will be until the demand for money is satisfied.

Employment for a Day

2010-12-03T14:15:00.000-08:00

The problem as I see it, is unemployment. There are two approaches, blame the unemployed for their unemployment, saying what they produce is no longer desired and they must accept whatever they can find or go without resulting in deflation, or blame the employed, saying their wages are now too high and allow inflation to lower them and raise employment. The former attempts to preserve the value of debt but erodes the amount through default while the latter erodes the value of debt but preserves its amount. What do the employed owe the unemployed? What is the moral position and what will produce the best outcomes? Will real growth increase before inflation as well?

Deflation can work to a point, generally to the extent of productivity growth so nominal wages don't have to be reduced. Beyond that it doesn't. Deflation increases real debt faster than default can eliminate it. It is not effective in the face of high unemployment. Inflation can work to a point. That point is where most resources, or at least critical resources, are in use and it is anticipated. It is effective in the face of abundant unused resources. More inflation is warranted here and now.

Ideally, there is a middle ground that lets the most heavily indebted default, the burdened have their loads lightened, and promotes sufficient growth to ease unemployment. The same level of unemployment may not be reachable if the real output potential of the economy has fallen, but the only way high unemployment can be sustained is through both market failure and monetary failure.

Why is America Great?

2010-11-10T13:56:00.000-08:00

While there are many measures of greatness, let us take one of the simplest, income. America does have one of the highest median household incomes in the world. It may not look as good if you consider income distribution, hours worked, benefits provided, or other security or quality of life issues, but it would still be very high. So why do Americans have such high incomes?

Culture and institutions undoubtedly have an effect. Immigration was proposed as an answer, but immigration is really an effect rather than a cause. People want to move to where they can earn higher incomes. One of the reasons they have higher incomes here is because there are fewer people for the available productive resources, natural and otherwise, relative to those elsewhere in the world. Immigration can be beneficial in bringing in resources, but only if it brings in more than it consumes or competes with others already here. Immigration is beneficial to immigrants or they would not chose to come, but is only beneficial to existing inhabitants if the immigrants are above the average inhabitant, whether in achievement, skills, or resources. Unlimited immigration would be a negative as population would rise to equalize endowments and incomes would fall towards average, until no one more would want to immigrate here. For some, all that matters is whether the immigrant is better off, but most will consider whether they are better off as well, both individually and collectively. Some, especially those above average, may be better off as there will be more below them, but they may not be if social cohesion disintegrates, neighborhoods deteriorate, and the country declines to third world status. What even will the immigrant have gained if they no longer have anywhere they would want to immigrate to or would not want to do so again? Immigration can be good, but there can be too much a good thing. The downside can be in the stagnation and lack of progress of country left behind.

Economics and Growth

2010-08-31T19:12:00.000-07:00

Economists favor trade and wider markets to promote economies of scale and higher degrees of specialization. Yet trade increased widely from the feudal period to the modern period without producing sufficient growth to lift the world out of its Mathusian state, only technology did that. They prefer to side with consumers over producers, at least when they don't have ulterior motives, and often favor lower wages to lower costs and raise productivity. Yet wages were lower in the east, but the industrial revolution occurred in the west. Lower wages reduce the incentive to develop technology. Economic policies do not give enough attention to technology and do not always promote growth.

Manufacturing has been very productive and generally still is. While some services are productive, it is generally more the exception than the rule. Services, for the most part, have not been amenable to automation that produces increasing returns to scale, nor are they scalable for the most part. That is why they are still services and not goods. The differences are significant. Only technology accomplished lifting us out of the Mathusian state and know how itself was never enough but its embedding into tools that could be used without it. Services are costs. This is not to say they aren't desirable or valuable, but by themselves they are consumption rather than production. It is only when they and the knowledge they represent become embedded in the devices and processes of the world that they really become productive. As long as we have agriculture to feed us and industry to enrich us we should prosper. We are moving to a service economy, but that is something to regret, not celebrate. It does, however, offer us the potential of many more creations and discoveries, and many more new products as fewer are necessary to produce them. Due to this, workers are increasingly a cost that only serve to reduce the wages of others, unless they can partake of that creative process.

On Uncertainty

2010-07-13T19:06:00.000-07:00

When a downturn occurs, the anticipated fails to materialize, our expectations are dashed, and uncertainty increases. The old verities have become less true. We become less sure of our beliefs and of what to believe. Our plans are drawn in, focusing less on the future and more on the present. The good times have gone and we struggle, not knowing how bad times will get, how long they will last, or how fast good times will return. What is uncertain is the future.

With stability and time, our anxieties recede and we become more confident of what tomorrow will bring. It is difficult to believe in the end of the world forever. As our worst fears fail to be realized, we become more sure of our position and its possibilities.

Stability and time can be hard to come by though. Since we were taken by surprise by the downturn, and uncertain about the cause, condition, cure, and what will happen next, we steel ourselves for more surprises, and if they materialize our uncertainty is redoubled. People will seek out uncertainty and take note of it at times like these as justification of their uncertainty and to avoid taking actions, but the real uncertainty is always the future. The search for new truths, for reassurance of familiar patterns, will continue until a new stability and a new time is made.

On Deflation

2010-07-12T17:31:00.000-07:00

Deflation is rare but has occurred occasionally through history. As experience with it is very limited and much of common experience fails to apply, many of its features are counterintuitive. Existing theory is heavily flawed as a result. These are critiques of it.

As inflation is a signal to flee money and seek (fixed) debt, deflation is a signal to seek money and flee debt. Commonly, decreasing the price increases demand, but under deflation demand for money is stronger and falling prices allow the conservation of money, so lowering the price reduces demand.

Sticky prices lead to unemployment, but they also lead to, that is, preserve, employment. The problem is flexible prices would not lead to equilibrium in general, but to instability and swings due to everyone trying to anticipate and exceed everyone else's expectations. The problem is not that they are sticky but that they are not uniformly sticky for if everything changed in the same proportion it would be as if they did not change at all. It is really that this is not true initially that creates deflation and the reestablishment of this feature that ends deflation.

As prices fall, real balances rise, but the expectation they will continue to fall induces delay to purchase, not advancement. If you were becoming wealthier at an increasing rate, you would be more inclined to delay, but while sellers may be willing or forced to sell inventory below cost, they are not likely to produce below cost, so eventually price declines reach a limit of wage declines and real balances cease to increase. The duration of the production cycle would throttle the rate of decline. At this point, there is no more incentive to delay. If prices fall, wages also fall, and attempts to save more fail as they do so. It is not rising real balances that turns deflation around but that they cease to rise, or equivalently, it is not that real wages rise but that they eventually cease to rise.

Falling prices do not lead to increased output. Flexible prices would not lead to equilibrium. Rising real balances are the result of deflation, not its end.

On Barter and Money

2010-07-10T15:56:00.000-07:00

Under barter, economic actions are linked, production with consumption, savings with investment, wages with prices. One can trade for mutual benefit or accumulate assets and inventories but that is the only way to separate these functions, speculate, or store wealth. There may be excess or shortages of specific goods but never all goods at the same time. The hazards are vicissitudes of life, nature, and the market.

With money all these actions may be separated and wealth accumulated more conveniently. For these benefits, there is a price to be paid, and that is an shortage or excess of money. A shortage results in deflation while an excess in inflation. Both impair the function of money as a medium of exchange, deflation by elevating its function as a medium of storage at the expense of trade and the economy, inflation by lowering its function as medium of storage diverting it into assets and inventory. Money largely works through interest rates and credit, making investment more or less risky. This has real effects when investments fail or succeed, though they may fail due to the underestimation of risk as well as its increase and succeed due to the overestimation of risk as well as its decrease. Deflation can destroy money by credit contraction, bankruptcy, and making otherwise profitable investments unprofitable. Inflation can create money by credit expansion and making otherwise unprofitable investments profitable, some of which may only be profitable with inflation though these will be realized over time. These can amplify themeselves over time, but if not allowed to do so, economies can adjust and neutralize them over time. Otherwise it can lead to a return to subsistence and barter.

On Intergenerational Transfers

2010-06-19T13:48:00.000-07:00

Finance is simple at sight, whether the question is what a dollar will be worth sometime in the future, what a dollar sometime in the future is worth now, or what the net present value is of an income stream extending far into the future. There are assumptions and unknowns, of course, most of which we can estimate from past experience, if only roughly, and if only assuming some similarity between past and future, but these are the kind of assumptions we must make whenever we approach the future. The predictions we make can be informed and weighed and even reasonably accurate where we are concerned. Without some semblance of predictability, no actions can be planned and no expectations can be formed.

It is easy to believe that adding up everyone's expectations is sufficient to extend this to society and assume the same, but it would be wrong. The assumptions and unknowns that individuals face within a society are of an entirely different order than the assumptions and unknowns a society must face. Each of us is a small enough part of the whole that our actions and expectations do not much effect that of the whole, but the whole of us is broadly affected by the whole of our actions and expectations. As individuals we can estimate savings rates, inflation rates, interest rates, discount rates, return rates, and tax rates, but a society cannot because their actions and expectations are not independent of one another.

Finance is much more complex at heart, and a dollar in time is as illusory as our ability to predict the distant future. A society cannot assume a rate of return, they must produce it. A dollar in time will be worth whatever society will make it worth. Assets require considerable reinvestment over time to maintain their usefulness. Few have lives even approaching that of individuals, and changes in circumstance and technology can make them obsolete even before then. We inherit the natural environment, our knowledge and technology, our institutions and society, and the state of world as it exists, but remarkably little else over a lifetime. We have done well if we leave it improved.

We can acquire assets in other societies, but this is dependent on someone having the means and desire to acquire them in the future and not every society can have a positive net balance with every other society so these may be a poor store of value, but everything may be a poor store of value.

Money and time are considerations for work, debt, savings, transfers, and retirement. For an individual, societal rank is often more important than absolute level as it will determine their call on societal resources, and this is what their savings provides. For societies, absolute level is usually more important since others are more distant and this will determine their call on world resources and their standard of living. Most of what we consume must be produced shortly before, from perishable food, worn clothing, household maintenance, depreciating autos and equipment, and deteriorating shelter. Shelter and furnishings are among our longest lived personal assets and both require regular maintenance and upkeep. Little can be stockpiled and stored in any sizable amount for any considerable time. Our main choice, if it is a choice, is whether or when we transition from work to retirement. Even that is transfer in part since remaining in the workforce will lower the real wages of other workers. Dependents always live on the efforts of the independent. How well they live is largely dependent on the productivity and numbers of those providing for them. Debt, savings, and transfers are largely how we divide this output and all are burdens on producers, but production limits what can be divided. The lower the transfers the higher debt and savings and asset prices, and the higher the transfers the lower the debt and savings and asset prices. People retire on the economy they create and live off its product. Society may prosper or suffer and this is the greatest threat to work and retirement, not some numerical return that results.

On Demand Curves

2010-06-13T09:13:00.000-07:00

Normal demand curves are downward sloping. Lower prices will increase the quantity demanded and higher prices will decrease them. How do monetary conditions affect this? Deflation tells us prices will be lower in the future and falling prices tell us to seek liquidity and delay our purchases, inducing them to fall further. Inflation tells us prices will be higher in the future and rising prices tell us to flee liquidity advance our purchases, inducing them to rise further. Significant monetary conditions can invert normal demand curves and negate normal elasticities. Falling prices can lead to falling demand and output. Rising prices can lead to rising demand and output. They just can't do so predictably indefinitely because our expectations will adapt, but they can do so on the cusp of reversing.

Monetary conditions can be altered and are a necessary condition to a reversal, but are not sufficient in themselves. Expectations must also be changed. It is not enough to change the present if most do not believe you have the power or will to change the future. It is not enough to change the present if expectations are it will all be abandoned and reversed in the future. Demonstrations of power and will, of dedication and persistence, are not purchased cheaply. That can be difficult if you have built your reputation on fighting the opposite problem and don't want to lose it. You can't forget to seek stability, but you have to remember that involves fighting instability of both ends and persisting in this as the job is never done.

A Balancing Act

2010-06-01T17:21:00.000-07:00

Economic growth has been very slow and risks returning to retrograde. The appropriate solution depends on the diagnosis of the problem.

If one views the recession as one of demand, a financial one, the problem is nominal and the solution is to provide more money. This could be the monetary authority purchasing other assets increasing their prices and introducing more money to the system, the fiscal authority running larger deficits whether spending more or purchasing other assets similarly. If the fiscal authority fears larger deficits or the monetary authority's willingness to absorb them, there is no reason they can't subsume some of the monetary authority's powers, suspend borrowing and merely credit their accounts with any amounts they deem necessary. We have no reason to fear deflation other than our own unwillingness to do what is necessary.

If one views the recession as one of supply, a resource one, specifically oil, the problem is real and the solution much more difficult. Oil is fairly unique in this regard. No other resource is as abundant in use and as difficult to substitute with substitutes generally being much more expensive. Its price seeps throughout the economy into everything. While inflation is low and unemployment is high, oil is still high at 2005 levels. Inflation could increase growth but even moderate growth could cause us to hit the supply wall and cause oil prices to increase faster than the economy can grow. They doubled over 2006-2008 and will do so again. The economy can adjust to moderate price increases, but prices can always increase by more than this. They must, since that is the only way for the market to balance demand and supply since supply is lagging. So unemployment may be the cost of keeping demand in check. Now inflation is low and somewhat higher inflation could be tolerated, but it could also shorten the time until we next hit that supply wall. The solution in this case is to accelerate development of alternatives though it is difficult to accelerate what is already urgent.

Let me say that I do not believe oil caused this recession. I do believe it could cause one though. I believe it lowered the growth rate to near zero and that we are growing now because it has fallen and if we grow much faster it will double again causing growth to collapse again and that we won't be able to grow solidly again without oil collapsing or competitive alternatives.

So does one increase inflation and growth now at the risk of a recession sooner or try to buy time for alternatives and supply to increase before one hits at the risk of incurring one now? It a balancing act.

On Experiential Goods

2010-05-08T10:48:00.000-07:00

Experiences are isolated episodes in our past. They have beginnings and endings and are intangible, existing only in our memories. This can make them more enduring than the tangible goods, more inclusive and encompassing of our lives in general, and more pleasurable as perception filters out the discomforting, the inconvenient, and the imperfect. We don't focus on what preceded or followed it, or even what annoyed or bothered us during it, only savoring the selective pleasures of it. Often you don't realize how much you enjoy something until it's gone, yet its absence makes the heart grow fonder. It is what makes it an experience in the first place and we focus more on gain than the loss of it. Then the fondness grows through reminiscence while familiarity breeds contempt or at least the discount of neglect of our present surroundings.

Products fulfill ongoing needs extending over time and are usually replaced by newer, better products that displace those of older ones. Products form a part of the substance of our experiences, but experience encompasses much more whose cost is often only the time to appreciate it such as nature or people. Aren't the best things in life free? Is there anything better than free? Experience endures through memory as products are consumed and deteriorate. Yet, I can still recall the satisfaction and memories of an old jacket lovingly worn out after twenty five years, or the comfort of a well worn pair of shoes that endured for years. How difficult it is to anticipate these though. Sometimes newer isn't better, and products end up as losses over time, reminding us of the transitoriness of existence.

On Investment Singularities

2010-05-01T12:54:00.000-07:00

The Gordon Dividend Discount Model establishes the price, P, of a stock based on dividends, D, at a required rate of return, r, that grow at rate g in perpetuity as P = D/(r-g). This has a singularity at r = g. While this may occur asymptotically or temporarily, it can never do so forever and always in a finite universe. There is always a finite number of people to bid for it, amount of money to buy it, or borrow against it. At most it would be potentially infinite with a trade off between those so wealthy they have no other outlet for their money and those for whom it is so much that the alternatives are as pleasant or even more so in case of boredom, and the impermanence of life and division between heirs or absence of them.

Consider too if our estimate of r-g were off by 1% or if when we wished to liquidate our investment it were off by 1% or if it drifted away by 1% over time. P would drop all the way from infinite to 100 D, so even if we thought we were getting a bargain, it could easily end up not being one. Our best estimate may be that of the next best alternative. Who would ever want to sell such an investment? Wouldn't the income flow ever be enough? If we were immortal, if our tastes never changed, if our investment never changed, perhaps not, but those are not that likely.

On Downturns

2010-04-24T16:00:00.000-07:00

This is a continuation of the analysis of downturns and managers in Productivity Sense and Nonsense, and More Productivity Sense. In essence, a sizable portion of the economy that was generating, thought to be generating, or thought it would generate substantial profits is discovered no longer, not to, wasn't, or won't, be generating them. Assets may have to be marked down and past investments written off, present ones reduced, and future ones abandoned. May be because these may be dependent on interest rates which may restore or increase profitability as they fall. The economy has had a hole blown in it that cannot be filled in short order.

As we left it, prices and wages are unchanged but quantity and profit has been reduced. In addition, due to fixed costs, profitability has been reduced. In the worst case, this can lead to high rates, loan calls, default, bankruptcy, asset liquidation, mergers, and sale of firms, when values are already distressed, but set this aside for now. Fallen assets and wealth, lowered profits and profitability, and excess capacity and reduced future expectations delay recovery. Prices and wages are sticky, and this can result in unemployment for some time, but this does not cause output to fall or prevent it from falling initially.

Managers would like to sell more to increase their profits and profitability, but as most everything is overcapacity, they can do so only at the expense of others. They may be tempted to lower prices to increase quantity, but this is by no means certain. If their customers come to expect lower prices in the future they may delay rather than accelerate purchases setting up deflationary expectations. Cuts in prices and wages may further intensify this into a downward spiral.

If real wages rose at an increasing rate, buyers would be more inclined to delay, but while sellers may be willing or forced to sell inventory below cost, they are not likely to produce below cost, so eventually price declines reach a limit of wage declines. Prices, initially more elastic than wages, would fall to the point their elasticity matched that of wages. The duration of the production cycle would throttle the rate of decline since sellers will want to make sure their costs are covered. Only when prices and wages have stabilized will the downturn end. At this point, there is little more incentive to delay. If prices fall, wages also fall, and attempts to save more fail as they do so. In this case, rising real wages do not terminate deflation but are triggered by it, and that they eventually cease to rise that end it. So while sticky wages result in unemployment, and less sticky prices can result in deflation, sticky prices and wages eventually prevent total implosion.

Finally employment income and output stabilizes at its new lower level. The workforce continues to increase and productivity rises, leading to increasing output and rising unemployment until output grows fast enough to add more workers than by which the workforce is growing.

On Minimum Wages

2010-04-19T21:06:00.000-07:00

Most of the poor do not earn the minimum wage and most of those that do are not poor, so raising the minimum wage may not be the most efficient means of helping the poor.
If you want to help the poor give them money. The easiest way of doing that is giving everyone a minimum amount of money and taxing back that above the minimum. The reason this is done through wages rather than directly is to encourage productive work. The down side is it misses those unable to do so. No solution is without its problems. Providing money without a minimum wage would discourage work. A negative income tax would be more efficient in distribution but less efficient in collection. Encouraging lower productivity work would encourage employment but discourage innovation.

We could use more information on the poor that don't earn the minimum wage, and whether they are retired, disabled, unemployed/unemployable, employed at higher wages but seasonally or limited hours, students, single parents, large families, or experienced a capital loss. Just as low wage may be a poor measure, poor may be as well.

I can see three scenarios, 1) there are no gains only losses, those with lower productivity lose their jobs, 2) employers are labor short and forced to pay them more than their productivity, there are gains for workers but costs to employers whether passed on to customers or not, or 3) employers are labor short and invest to raise their productivity, gains all around.

I place little emphasis on scenario 2. I don't believe the employer will accept lower profits other than temporarily and if the employer can raise prices, they have raised their productivity. The argument against a higher minimum wage is not that it doesn't much help the poor but that it will mean more unemployment among the unskilled, fortunately that falls mostly on the non-poor. It will help the skilled somewhat, and innovation can help everyone more. Still, there is little evidence lower real wages (due to inflation) increase unskilled employment. Mostly, it just causes people to leave or not enter the workforce, but this is likely due to the minimum being below the market wage in substantial portions of the country.

One should equate wages to the marginal productivity of the work, not that of the worker. This is why raising the minimum wage can increase productivity; it can induce the investment necessary to do so. This is not without cost, and there are limits to what it can achieve, but this may be a better reason to support it than helping the poor.

A minimum wage can be useful if it leads to productivity boosting investment, or as a demarcation between welfare and work, but those are fairly limiting roles for it.

On Rising Debt

2010-04-19T20:34:00.000-07:00

Debt service may be a better measure than debt unless one assumes some more or less constant reversion to a mean discount/interest rate. It is at least useful to consider the two, debt service and discount rates, separately. There are, of course, good debts and bad debts though the portion is adjustable through discount rates.

A borrower will look at it in terms of debt service. If it isn't rising neither they or their lender will be too concerned about repayment. If it is rising, they are either optimistic, speculative, or desperate, and the means to turn debt into equity, and the lender better know which, whether reasonable, and what the collateral is valued at.

A lender will look at it in terms of interest rate. Lower rates may mean increased wealth or reduced investment opportunities or increased risk aversion. If it is falling, borrowers are not borrowing enough and it is contractionary for the economy, but will lower debt service and allow the pursuit of lower return or riskier activities. In general I would say it is a case of dismal expectations or people would be investing in equity rather than debt, but perhaps not as dismal as feared, leading to better equity returns in the future.

Since no one is forced to borrow or lend, borrowing, in terms of debt service, must be seen as, a possibly unwarranted, but fundamentally optimistic act, and retreat from it as either the payback of a successful result or a failed one, but one must be wary of exuberance and despair, conscious of the investment being undertaken, and aware it can't grow without limit. A falling rate should be seen as concurrently negative but hopefully prospectively positive event.

Overall, the change is more significant, but the rate can change faster than the debt. Demographics, fiscal and monetary policy, risk aversion, or available investment opportunities may all alter preferred levels so the result can be difficult to interpret.

Is debt good though? Certainly the rate will determine whether it can be repaid or not, but ideally should the amount of debt change? I think not. Ideally, demographics are stable, the economy grows at a steady rate and offers a steady stream of investment opportunities and a steady return, and booms and busts don't occur. In such a world, there would be no reason for debt to change, but it isn't an ideal world. It might be rather boring if it were. What needs to be asked is whether optimism or pessimism is warranted or not. If not, debt should be headed in the opposite direction. Sudden changes may be necessary, but they are suspicious.

More Productivity Sense

2010-04-19T18:07:00.000-07:00

A manager, when faced with a reduction in demand, responds with a reduction in supply. He takes his input prices as market driven and by setting the productivity of some to zero, allows the productivity of the rest to stay at or return to their previous level. This frees resources for else where while maintaining competitiveness. This is normally the correct response. The manager knows his demand is falling; he cannot be expected to know most everyone's demand is falling. To expect different behavior under different conditions which are unclear may be to much to ask. Moreover, maximizing employment and work is not the main goal of society; maximizing living standards is. While reducing wages, work sharing, or tax redistribution can increase equality, it is just redistribution and doesn't increase living standards.

In a downturn, the economy itself has become less productive. The engine of the economy has failed and the train is coasting and slowing down. Most of it was only boxcars being pulled along by it and redirecting fuel to the boxcars won't accomplish anything. Only another engine will power the economy. The problem was not that the engine ran into trouble; all engines run into trouble. The problem was there were no other engines to reduce the load on that engine and prevent it from failing and take up the slack from it. About the best that can be done is support and sustain those laid off until the economy can reabsorb them and allow low rates and inflation to promote economic adjustment and growth of small but profitable businesses.

Changes in the Standard of Living

2010-04-17T17:22:00.000-07:00

Comparing standards of living across time is essentially an impossible task due to changes in circumstances, conditions, lifestyles, and technology, but is still fascinating to think about. A clever way of considering this is to ask, if your income and wealth were doubled, but you would have to live in the past, how far back would you be willing to live. By this meaning your rank in society would be equivalent of the current rank of someone with double your current income and wealth. One should assume no future knowledge after being transported back to then. Inevitably there is some preference due to what we know occurred back then, such as growth during the 1950s, but one should try to set this aside as if you did not know. One problem is it may actually be more growth rather than level that attracts someone, but in this case how far in the past would not be a meaningful measure. Assume all consumption would be in the products available then with lifestyles changed to accord with what was available. For example, twenty years ago there would be no internet, or at least world wide web, so all the time spent on it would have to spent on other things like going to the library or on television. For someone that grew up with it, it is probably difficult to imagine what life must have been like without it, so age may limit how far back one is willing to go. Nor should one consider this a vacation, but a permanent one way trip since every time could be interesting if we could always go home. So this is primarily about what value you place on changes in lifestyle and technology over that time and how much you are willing to give up as well as get in exchange. For it is not just a matter of giving things up but appreciating other things like less population and density, more local social activities, and a slower pace of life. While technology changes, there is always some earlier technology to substitute with a reduction in utility like paper for the internet, or landlines for cellphones. So how far in the past would you be willing to go?

I don't see much of a problem going back 30 years for double the income and wealth despite the vast changes the lack of the internet and primitiveness of pcs would impose. I could do without gps and cellphones. On the other hand 50 years with its lack of air conditioning and microwaves would be pushing it although I could live in some pretty nice areas and eat out to compensate. Going through the energy crisis again wouldn't be much fun though, not only the crisis itself but the poor growth of the period as well. From this, I subjectively judge the real growth rate of the standard of living to be more than 1/50, 2%, but less than 1/30, 3.3%, which is quite close to measured real gdp per capita changes. Thus I see little mismeasurement in the official statistics as a result. Your feelings may differ.

Productivity Sense and Nonsense

2010-04-17T15:19:00.000-07:00

One often hears "workers are paid according to their productivity" and "the least productive workers are laid off first". These are mutually incompatible statements as commonly used. Either workers are paid according to their productivity, meaning no productivity basis exists for determining which are laid off, or they are paid on bases other than their productivity and laid off on that basis. Productivity is just output over input. If workers are paid for their productivity, the input, their wages, has been adjusted to equalize productivity among workers, so how can some be less productive than others? Individual productivity may be difficult or even impossible to measure, but that would just mean it is irrelevant to pay and both statements are false. It may be difficult to anticipate when hiring, but new hires that don't work out are often terminated, and if not, wages can be adjusted by raises or their absence over time. There is only one sense in which these statements can be understood together.

In a downturn, what changes is the relative desirability or values of outputs, not inputs. The price usually doesn't even change much, but the quantity demanded. It is the work that becomes less productive, not the worker. Prices are sticky and wages are even more sticky. The worker that is laid off is no less productive than the co-worker that stays behind, rather, the workers that suffer layoffs are less productive in the sense of being less desired than workers that don't suffer layoffs. Productivity is an industry concept, only wages are an individual one. It is not productivity the manager uses in selecting which workers to lay off, rather, it is desirability the market uses in selecting which industries to reduce. Managers could reduce prices and wages to maintain quantity and employment, but some costs are fixed, some work has to be done, and some are other inputs over which they have no control, so it is easiest to treat both prices and wages as fixed and allow quantity and employment to fall. So what criteria do managers use in layoffs when all their workers have become less productive in the sense of desired? They may choose to layoff those with the highest wages to minimize number of layoffs and keep those more able to improve or less likely to demand their productivity or cause trouble, or they may select on connections or influence, pliability or sociability, seniority, or even age, race, and sex, but it is not productivity, per se, in the common sense of the meaning. Layoffs are fundamentally about discrimination. This is probably why most managers dislike doing it, or at least the good ones.

Formative Books

2010-03-18T19:54:00.000-07:00

I have read so much that few books rise above the rest. While I have read my share of fiction which often has deeper and truer ideas than nonfiction, mostly I read nonfiction and more recent works often leave a more vivid memory.

1. The Foundation Trilogy, Isaac Asimov. Like Paul Krugman, I did find the conception of psychohistorians captivating.
2. Louis XIV, John Wolf. A tale of power, wealth, and the fragility of life. Puts life into context when the most powerful man on earth is succeeded by his great great grandson, faith restoring for me.
3. The American Class Structure in an Age of Growing Inequality, Dennis Gilbert. The distribution of income and wealth as a parade of midgets.
4. The Wealth of Nations, Adam Smith. Perceptive in observation, reasoned in analysis, careful in conclusions, pragmatic in application, a true philosopher at work.
5. General Theory of Employment, Interest, and Money, John Maynard Keynes. The sum can be more than its parts, economic relativity.
6. The Worldly Philosophers, the Lives, Times, and Ideas of the Great Economic Thinkers, Robert Heilbroner. A history of economic ideas and placement of them in context, revealing in scale and scope, there is progress.
7. Adam's Fallacy: A Guide to Economic Theology, Duncan Foley. Some of the problems of his followers.
8. Economics and Evolution, Geoffrey Hodgson. When action in self interest is in common interest.
9. Guns, Germs, and Steel, Jared Diamond. Human civilization.
10. Farewell to Alms, Gregory Clark. Economic archeology overturning theory with fact.

Some formative video series, I usually read the book afterwards.
1. Cosmos, Carl Sagan. The universe.
2. Life on Earth, David Attenborough. The evolution of life.
3. A Glorious Accident, Understanding Our Place in the Cosmic Puzzle, Wim Kayser. Human consciousness and thought.
4. The Power of Myth, Joseph Campbell. Human culture and eternal verities.
5. Guns, Germs, and Steel, Jared Diamond. Human civilization.

Ricardian Equivalence Holding

2010-03-16T20:12:00.000-07:00

For Ricardian Equivalence to hold, fiscal policy must be exogeneous and that can only occur if it is unexpected; if it is expected then such policy actions will have already been anticipated and incorporated into actions. Ricardian Equivalence cannot hold for an event it is already holding for. The problem here is the government action is not exogeneous because it is anticipated, but rather than an argument against stimulus, it is an argument that the government has no choice but to stimulate because that is what is expected of it. If government starts raising taxes during a recession or cuts spending during a surplus, pays down debt during a recession, or increases borrowing during a boom, it may hold, otherwise there is nothing unexpected about such actions and they do not constitute an exogeneous event. After more than a half century of Keynesian stimulus, the idea fiscal stimulus can be unexpected is incredulous. Rather, lack of stimulus would be unexpected forcing people to modify their behavior accordingly if they are capable of doing so, which they may not be able to if they are credit constrained. The real surprise may be that combining state and federal spending, there has been no stimulus.

Leverage and Risk

2010-02-26T12:49:00.000-08:00

Leverage alone doesn't cause recessions, so there is no problem with leverage, right? No. Leverage increases the risk of recession due to an unexpected shock, and adds rigidity to the economy making it more difficult to deal with the result. Leverage is often the symptom of other serious problems such current account imbalances due to mercantilism, or an unwillingness to face the real risk of investing for the future, or subterfuge in submerging real risk beneath the surface. Investors may prefer a lower exchange rate, or saving to investing, or the illusion of risk avoidance, but these are not necessarily in the interest of the country or the economy as a whole. Investor preferences are often the result of government policies themselves, so we need to make sure what we encourage is what we want.

Leverage is a tool and not good or bad in itself. One should expect leverage to grow with more productive opportunities and the income to support it and diminish with fewer of them and reduced prospects. One must be extremely cautious of leverage for other purposes, such as for currency manipulation, or to increase consumption or speculation. Increasing leverage is expansionary while decreasing leverage is contractionary. There can be real dangers to our economic financial well-being due to leverage and risk.

harply increasing leverage demands negative real interest rates to combat it, more inflation, but increasing asset prices can cause bubbles and keep real interest rates too high until they burst. Trying to avoid risk by shoving it onto government isn't avoidance at all. Unless we really want the socialist paradise where government is the only equity owner and everyone else can be debtors and lenders, it is in public policy to discourage it.

Risk

2010-02-11T19:38:00.000-08:00

Risk depends on concern and time. If you are unconcerned about the future, or concerned about a loss of future value, you may prefer to consume rather than save, or save rather than invest, or prefer short term to long. If you are unconcerned with the present, or concerned about a loss of future income, you may prefer to invest rather than save, or save rather than consume, or prefer long term to short. These preferences are not fixed but will change with your position, your income and wealth, your attitude, concerns, and expectations for the future, including the expectations of others. Risk varies across assets as well as time and people can differ in their reaction to these different kinds of risk. Often it is not your perception of risk but your perception relative to that of the market that matters. Since income risks, sources, and sinks, range and vary over time, a diversified portfolio generally provides the best match.

A Theory of Bubbles

2010-02-09T08:09:00.000-08:00

Everyone has a personal discount rate that informs them and determines how much of their income they save and how much they spend, how much they invest and how much risk they will take. This will vary with income and expenses that they have become accustomed to, their wealth, changes in these, and with theirs and others perception of risk. The weighted sum of all these individual rates produce a market discount rate. Those with discount rates greater than the market I will call traders and those with ones less than the market, investors. Individuals may experience individual changes that move them between traders and investors, or changes in the market rate may move them from one to the other. While some movements are conscious and deliberate, others are often accidental and disconcerting and they will adjust their portfolios to return to their relative position.

Investors trade little and are mostly fully invested, but their flows into and out of the market are fairly steady forming slowly changing trends that are part of long term investment fundamentals. Traders trade often setting market prices at any given moment and their shorter term focus leads them towards short term value or momentum investing. An investment that starts out fairly valued according to long term fundamentals may experience a some unexpected good news. Traders will become encouraged and bid up the investment. Others will see the increase and bid it up more. The more that can be persuaded these represent long term fundamentals, the more investors will see it as less risky and join in, raising the price more. Eventually the number of new investors that can be persuaded diminishes, possibly due to exhaustion of supply or some less positive information. Value traders will have begun seeing it as overvalued and began selling. Prices after holding steady for a while will begin to fall. Momentum traders sensing weakness will shift from long to neutral and eventually short causing them to fall further. Some investors realize those weren't long term fundamentals, come to see it as riskier than they thought, or realize their risk tolerance is lower than they thought and sell more. Eventually the number of investors that were actually traders falls through attrition and declines slow. Value traders come to see it as undervalued and begin buying. Momentum traders sensing strength will shift from short to neutral and eventually long. Prices will once again rise to their long term fundamental value. This appears as short term embellishments on long term trends.

The price changes caused by traders are large compared to variations in long term fundamentals but usually small compared to what is called a bubble. Yet these microbubbles seethe almost continuously keeping the market perking. For one to get large by market standards some conditions usually must be present. A long period stability can encourage the dismissal of risk. Lower interest rates can provide a notable initial bump. Innovation and a story can obscure fundamentals and cause investors to believe in a new era and this time is different. A large number of increasingly wealthy but inexperienced traders believing themselves investors that entrain themselves into the bubble without much fear of loss. Once one bursts, it can be difficult to reinflate since they have lost a sizable amount and become highly skeptical of any new one, at least in the same asset class, while those who profited have to resort to trading in a new asset class they are less familiar with in the hope of finding more. Eventually traders are faced with the more difficult prospect of profiting at each others expense, trading success and interest diminish, and after a long while, after it proves itself again, long term investing comes back into favor.

Efficient at what?

2010-02-05T13:18:00.000-08:00

The primary problem is people misinterpreting and overinterpreting EMH, often as not its proponents as its opponents. It actually says very little. Like Yglesias, if it were called the unpredictable market hypothesis, it would likely both be more widely accepted and less controversial. The problem is efficiency is equated to rationality but if markets were rational prices would not be subject to tectonic changes, nor would they vary widely from fundamentals. Markets may be efficient at reflecting our beliefs but our beliefs are not necessarily rational. Often people interpret it as markets may not be efficient but they tend towards efficiency (rationality). Yes, markets can stay and increase their irrationality longer than you can stay solvent, and when everyone is being irrational, there is efficiency in being irrational.

If one interprets information in an objective sense, then efficiency would imply rationality, but if one interprets it as future expectations, and especially as expectations of others expectations, then there can be no objectivity nor rationality because we are not considering the past but the future, all information concerns the past, and we are free to imagine any possible future. As future becomes past these expectations can swing wildly and imaginations can trample the hardiest of fundamentals. Imaginations are free to soar and plummet even as fundamentals keep us tethered to the realities of the past. Markets are efficient at reflecting our hopes and skepticism, greed and fear, dreams and nightmares.

Progress in Economics

2010-02-05T10:57:00.000-08:00

What does it mean to make progress in economics? I was thinking of how Austrians are the logical descendants of the Free Banking School, Monetarists and Keynesians of the Currency School, and Real Business Cyclists of the Banking School, and how little the arguments have changed or disagreements have been settled. There may be more acceptance of a variety of causes of recessions from low interest rates and credit expansions, to high interest rates and credit contractions, to exogeneous shocks, or perhaps not. There may be a broader diffusion of responsibility from government regulation and central banks, to banking and market misjudgments or non judgments, to changes in circumstance and new information, or perhaps not. There may be more ambiguity as to problems and solutions and their effectiveness and efficiency, or perhaps not.

It also brings to mind what is meant by cause. If there is a cause than removal of the cause should prevent the effect, while if many causes it may only shift the source. If the cause may not be removed it may not be possible to prevent the effect, but if the cause may be addressed the effect may be remedied ex poste if not ex ante. If a cause under our control is powerful enough to create an effect, it must also be powerful enough prevent or remedy one, or if not, there is nothing to be done. If one has the power, one also has the responsibility, and while it may be disclaimed, it can never be disavowed. If we are capable of doing bad, we must also be capable of doing good. Causes are often selected more for the remedies they offer rather than their actual effects. This is bad science but can be in one's self interest and difficult to resist.

Science progresses through incorporation of the useful and elimination of the unuseful, and we shouldn't expect valuable insights to disappear, but neither should we expect fringe views to disappear on their own. If there weren't some truth to them they would have never been adopted and if there weren't some utility to the promulgators they would have never been kept. Progress is possible but often painstaking.

Efficient or not?

2010-01-16T09:51:00.000-08:00

If prices are unpredictable, then rational behavior is an impossibility. If rational behavior is possible, they must be at least somewhat predictable. They may be more predictable in the long term than the short, but without predictability no coherent action is possible.

Equating price to value eschews any independent assessment of value. Without any fundamental value, prediction can only be extrapolation, and extrapolation leads more or less directly to bubbles. Extrapolation can take several forms, historical, momentum, or statistical, but they all rely on predicting future price from past price and change in price. Price is not always value. Often it becomes an assessment of the value of others, an assessment subject to wild speculation in the absence of any fundamentals. Stocks have earnings and real property has rents and while these are subject to change, they aren’t totally unpredictable, but once people focus on price and price change, they are no longer investing but speculating. Speculation may be self correcting eventually, but it is not necessarily in the short term. Speculation can feed on itself until the ponzi scheme runs low on new entrants or encounters a sufficient number of defectors. Prices then collapse to or below fundamentals.

It is precisely when people give up making their own prediction and rely instead on the predictions of others that trouble arises. They are no longer interested in the prediction, but what others believe and predict, what others perception of value is. They can then extrapolate that to absurdity.

For debt to be supported, income must exist to repay it. Where was income all these years? Flat to falling. That does not support growing debt. We were well into the ponzi finance stage. The big money is jumping on the bubble while it is inflating and only jumping off and shorting when it is about to decline. That is what makes bubbles unpredictable, not that they don’t exist, but that they require market timing. And there are winners, but fewer than losers or a bubble wouldn’t have inflated in the first place, and the interest of the most knowledgeable is not to counter the bubble but to feed it. Bubbles start in uncertainty, grow to absurdity, and burst unpredictably.

The flaw of efficient markets is to equate price to value, making price the fundamental value, forestalling the real search for value, and defining markets as efficient rather than ask the tough questions of how efficient it is and whether that efficiency is increasing or decreasing. Until we go beyond it, we will get nowhere.

Economics and Ethics of Walking Away

2010-01-13T13:23:00.000-08:00

Business has perfected limited liability and asset stripping that turns business into one sided options. A non-recourse mortgage is really nothing more than a limited liability company. Now if someone wants to argue in favor of absolute liability and doing away with the corporate structure and business as we know it that is one thing, but to argue business should have privileges and perks unavailable to individuals is grossly inequitable.

After a crisis short of people operating economically rationally, I don’t think encouraging people to continue acting irrationally is reasonable. Let people weigh all the benefits and costs of their actions and decide what is best. We are all better off from such actions, not just some lender that acted irresponsibly in the first place. Some will err and suffer for it as they should, but don't insist people have an ethical duty to act contrary to their interests. Economic thought and behavior needs to be encouraged, not negated, for that is the truly ethical path.

I have no objection to changing the rules, but anyone following them is behaving ethically. If you don't consider something ethical or socially desirable, you should focus on changing the rules, not superimposing an ethics contrary to them and then blaming people for not following them. I do not blame finance for unethical bonuses, but I would for their part in setting the rules that allow them. Economics and ethics in conflict indicate inappropriate rules. Under the rules we have adopted, this is not an ethical decision but an economic one and should be treated as such. It is, and should be, just business.

A Theory of Depressions

2009-12-27T10:45:00.000-08:00

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.

Detestable Economics

2009-11-23T09:52:00.000-08:00

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.

Energy Economics and EROI

2009-10-28T13:17:00.000-07:00

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.

Macro Economic Instablity

2009-09-07T19:09:00.000-07:00

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.

Peak Oil

2009-08-27T12:13:00.000-07:00

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.

Dividing the Division of Labor

2009-08-25T20:16:00.000-07:00

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.

Two Centuries of Growth

2009-08-20T20:17:00.000-07:00

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.

Deflation is Depressing

2009-07-23T16:42:00.000-07:00

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.

Unbelievable

2009-07-16T20:21:00.000-07:00

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.

Investment, Speculation, and Bubbles

2009-06-29T20:26:00.000-07:00

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.

The Housing Mirage

2009-06-25T21:20:00.000-07:00

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.

Credit Crisis Continued

2009-06-22T15:35:00.000-07:00

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.

Debt Deflation Depressions

2009-05-23T13:16:00.000-07:00

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.

Double, double, toil, and trouble

2009-05-22T16:45:00.000-07:00

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.

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

2009-05-21T21:41:00.000-07:00

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

Ebbing economic tides

2009-05-18T21:12:00.000-07:00

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.

Market Fundamentalism

2009-05-09T19:43:00.000-07:00

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.

Debt and Deflation

2009-05-07T19:19:00.000-07:00

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

2009-05-07T17:12:00.000-07:00

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.

Credit Crisis Severity

2009-05-05T17:15:00.000-07:00

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.

Happy and Not-So-Happy Markets

2009-04-30T14:09:00.000-07:00

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.

A Hyper-Ricardian Hypothesis

2009-04-08T20:25:00.000-07:00

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.

Ricardian Equivalence

2009-03-22T10:26:00.000-07:00

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

2009-03-22T08:19:00.000-07:00

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.

Incentives and Investments

2009-03-18T14:44:00.000-07:00

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.

On the Causes of the Current Crisis

2009-03-12T13:40:00.000-07:00

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.

Animal Spirits, Knowledge and Psychology

2009-03-09T13:25:00.000-07:00

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.

Feelings of Depression

2009-02-22T12:23:00.000-08:00

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.

Investment, The Fallen

2009-02-07T21:00:00.000-08:00

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.

On Macroeconomic Disagreements

2009-01-29T13:54:00.000-08:00

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?

The Disconnect of Economic Measures

2009-01-18T11:00:00.000-08:00

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.

Inflation and Living Standards

2009-01-13T16:04:00.000-08:00

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.

Is income taxation progressive?

2009-01-08T19:46:00.000-08:00

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.

On Finance

2008-09-19T20:55:00.000-07:00

Will the finance industry repeat the same mistake in the future? No, they won't make the exact same mistake again, but they are creative and will find new ways to make it. That is the foundation of the finance industry; it isn't very profitable without them in the short term, or very profitable with them in the long term. It is called separating fools from their money. The public good of finance is the allocation of capital to where it is best used. The private good is that it does better out of the hands of fools. Unfortunately, taxpayers are often left as the greatest fool.

On Housing

2008-09-16T15:44:00.000-07:00

What caused the speculative bubble in housing? People point to loans to the uncreditworthy, to low income households, low or no down payments, interest only loans, adjustable mortgages, low interest rates, loan fraud, appraisal fraud, and a myriad of other causes. While most of these were involved, the core problem was lending to people who could not afford to repay the loans. This was due to the failure to verify incomes and qualify the loans on fully adjusted market rates. Without the income to back up the loans there was no security for the loans other than the property and no constraint on prices other than the eventual shortage of speculators and funding for them. What caused the speculative bubble in housing was what caused the speculative bubble in stocks, the decoupling of prices from income. Without this decoupling, no bubble can form, with it, one is inevitable.

This was a lending problem. One must expect borrowers to deceive, to gamble, to look only at initial payments, and to do whatever it takes to acquire a speculative asset. Lenders possess the money and must be held to a higher standard. Lenders are normally much tighter in their lending, anticipating this, but the resale, repackaging, and securitization of loans separated the borrowers from the lenders and not only allowed deception and fraud but encouraged it. Adjustable rates with low teaser rates, interest only or interest optional features were designed to enable borrowers to obtain loans they could not afford. If borrowers had to qualify at full market rates there would be little need or want of them. A few might prefer them, but if they received them they would still be able to afford them, come what may. Lenders greedy for higher returns accepted, even preferred, higher risk loans to provide them, as long as they could hide it and pass it along to others.

Other factors, good or bad credit, rich or poor, high or low downs, affect the likelihood of default and that risk may be over or under priced, but these cannot affect overall prices greatly. If one is capable of affording the property but not willing, another can and will.

Why did this happen? Anytime incomes and prices can be decoupled, immediate and substantial short term profits can be made and are irresistable. Rationales are invented to justify these desires. Even though unsustainable and even though recognized as such, it may be rational to play the game and hope to leave ahead of the crowd. Instead of how much it costs, the question becomes how much gain is possible. Instead of asking whether one can afford to buy, the question becomes whether one afford not to buy.

On Debt

2008-09-15T13:51:00.000-07:00

What good is debt? How does debt benefit me? How does someone else's debt benefit me? Should interest not be tax deductible? Should mortgage interest not be tax deductible?

Debt allows one to convert income into assets and assets into income. This makes it a very useful financial tool in many ways. It allows the acquisition of assets without having to pay for them up front. It unlocks wealth that is otherwise trapped in assets. It allows consumption smoothing over time. It can transfer inflation risk from borrowers to lenders. It enables the debt market which provides another investment vehicle. It enables expansion of capital intensive business. Many small businesses are actually funded by loans on the proprietor's residence. It permits leverage to increase risk and return. It can be abused, but it can increase flexibility and power when well managed.

Without a deduction, borrowing to invest would make much less sense. Much lending would be driven to internal sources and much less money would be made available on the market without it. It would tilt investing from debt towards equities. Making some borrowing deductible and others not present another tax avoidance incentive since borrowing on deductible assets would then be diverted towards nondeductible assets. Treating individuals and businesses differently create another tax avoidance scheme. Real property is a productive asset despite assertions to the contrary.

Liberal Views

2008-08-25T19:02:00.000-07:00

On Social Security

Despite the harsh words, the real difference here is values. Libertarians value personal liberty and money and not much else. Liberals value those, but also social values. Libertarians see themselves as islands separate from society. Though they believe in markets, they see money as a zero sum game, taxation as impoverishment, and want the freedom to spend their money as they see fit. If it leads to large numbers of starving elderly, well they will just deny that it will, blame it on their foolishness, or if that is not enough, that that is what charity is for. Liberals see themselves in the middle of society and see money as a social artifact. They see their neighbor's wealth as enriching their own and their neighbor's poverty as impoverishing their own. For them freedom is good, but not an absolute good. Freedom to starve as no freedom worth defending. The conflict is irreconcilable logically, but only through a change of heart. It may be resolved in time though as society becomes wealthier and can provide the basics to everyone at minimal cost and we start to focus on our potentials rather than whether our neighbor's meal is food off our table.

Healthcare Reform

2008-08-25T18:41:00.000-07:00

From DeLong on Waldmann's Healthcare Reform a most informative comment:

Wow. Where to begin.
1.) The assertion that high tech/high cost intervention is responsible for improvement in coronary disease mortality is at least questionable and probably wrong. The US actually trails most other developed nations in the effectiveness of care for coronary disease, and almost all of them use much more conservative care based on medicines and rehab and much less coronary bypass (the US performs 75% of the bypasses done in the world) and angioplasty. The big changes in coronary disease mortality are better ascribed to the development of new classes of drugs (especially beta blockers) than to interventional techniques. A recent US study showed that angioplasty actually resulted in worse outcomes than medical treatment in most patients.
2.) The regional differences in health care costs people like to talk about are based on two things: lower utilization of high tech/high cost techniques and the government policy of paying providers much less for care in some parts of the country than others. The index study on this compared Minneapolis and Miami. Miami happens to be the highest reimbursement area in the country. Minneapolis is in the low range for reimbursement among large metro areas. The government (HCFA) justifies these differences – often as much as 80% -- in reimbursement based on cost of living, but in reality political considerations are very important (if you are a congressman from South Florida and wish to continue your employment, you had better be very interested in Medicare reimbursement issues regardless of what party you belong to, whereas a congressman from Minnesota may be much more interested in farm policy.)
3.) The notion that health care costs are lower for people with good health habits is true only in the short term. Investigation by the Dutch national health system showed that non-smokers, people of more ideal weight, and people with healthy exercise patterns actually cost the system more in the long run. The reason is that they live longer. All people absorb large amounts of health care expense when they go through the process of health collapse and dying, and all people – especially old people – absorb health care expense in both a regular (normal year to year care) and irregular (more acute care) basis over time. People with less healthy habits enter the crisis stage of health care at a younger age. The baby boomer population of the US is now in an age range (45-65) where there is sharply increased morbidity and mortality among people with poor health habits. The more healthy boomers will experience the same sort of spike when they reach their 70’s, 80’s, and 90’s, and in the meantime will receive cataract surgeries, hip replacements, hysterectomies, prostate surgeries, treatment for low grade skin cancers, etc. etc. In the words of Bruce Springsteen, “everyone dies, and that’s a fact.” The only health care systems that benefit financially in the long term from insuring more healthy patients are systems, like our private insurance programs and HMO’s, which can dump the cost of caring for older people on other systems – Medicare. So while better health habits benefit the patients themselves and are to be strongly encouraged, they will actually increase costs to the entire national medical system in the long run. The notion that better health habits will reduce overall health costs is not correct.
4.) Prospective payment systems – paying providers a lump sum based on numbers and possibly types of enrolled patients – do not save money and do not improve health outcomes. America’s thirty year flirtation with HMO’s has shown that beyond a reasonable doubt. Most systems throughout the world have found that fee for service payments work best. While fee for service does contain some perverse incentive to provide extra unnecessary service in order to increase profits, that tendency can be controlled by use of practice standards enforced by central payers in single payer and social insurance systems. The perverse incentives in prospective payment systems are to deny necessary service in order to increase profits and to select patients less likely to require services while rejecting patients who need them. This has proven much more difficult to control since it involves much more subtle forms of behavior. It is much easier to tell a provider that they will not be paid for lumber spine MRI in a patient who does not meet certain criteria than it is to figure out that providers are not offering MRI to people who actually need it or are avoiding covering people with history of back pain.
5.) THE MOST IMPORTANT POINT: I am always amazed at the discussions by American economists, political scientists, health care providers, health care theorists, and politicians about health care and the question of what will work. This discussion is similar to someone debating how to manage infectious diseases but pretending that they have never heard of antibiotics or that antibiotics are a strange and questionable development. The answers to how to make health care work are on the shelf. They have been discovered by everyone else in the developed world. They have been shown to work well in general and specifically to work much better than our system both economically and medically. We are at the bottom or near the bottom in terms of health care performance in the developed world and at the top in terms of health care costs by a wide margin. To deliberately pretend that there is a question as to what would work better than our system is to literally bury our heads in the sand. Conservative politicians of all stripes, and the insurance companies, pharmaceutical companies, HMO’s, medical equipment providers and others who realize huge profits from our current mess of a system (at the expense of both patients and the economy) are only too glad to encourage this behavior, but it is disappointing when people who should know better play along.

Posted by: Patrick Schoenfelder | July 27, 2008 at 07:39 AM

Reasons for Progressive Taxation

2008-08-25T18:28:00.000-07:00

A nice synopsis from Independent via Early-Retirement.org:

It seems to me that the same pros and cons show up every time someone says “progressive taxes”. Here’s my list of “pros”, with numbers for easy reference.
Note that the items are not necessarily independent or consistent, and the list probably isn't complete – these are just arguments that I’ve heard that seem plausible.
I’ll let someone else take the “cons”.

Practical arguments
1) Can’t get blood from a turnip
2) Got to go where the money is
3) Some gov’t spending explicitly supports the poor. It’s silly to tax the poor or lower middle for this spending

Incentive arguments
4) High earners make more per hour, consequently higher tax rates on them leave more level incentive to work
5) It’s better to tax dumb luck than hard work (this may be identical to (4), or may be a “fairness” argument)

Utility arguments
6) High income/high wealth have more to protect, hence should/would pay more for protective services
7) Same as (6), but expanded to entire social structure
8.) Low income get more utility from marginal income, hence we increase total utility by shifting taxes to higher income

Social structure arguments
9 ) Prefer more uniform distribution of income/wealth – don’t like societies with extremes of rich and poor
10) Concentration of wealth gives excessive power to a few (this also supports wealth taxes)

Fairness argument
11) Our system generates large (unfair) differences in opportunity, progressive taxes somewhat offset this

Principles of Taxation

2008-08-25T17:28:00.000-07:00

Someone must have a set of principles of taxation that would clear up much of the nonsense one hears when talking about taxation. Since I am not familiar with any though, I thought I would compose some.

First. Be clear on what you are taxing. Taxing revenues is a sales tax. Taxing revenues less expenses is an income tax. Taxing assets is a property or wealth tax. Defining revenues, expenses, assets and determining values is the hard part. Don't assume tax law gets it right. It rarely does.

Second. If you tax something you will have less of it, unless everything else is taxed more. Tax something less and you will have more of it. Differences in taxation are there to be exploited. Money flows to its least taxed form and taxes are avoided where ever possible. Don't tax business and most income will be become business income. Allow business but not personal deductions and personal deductions will migrate to business. Gaming the system is standard behavior.

Third. One can tax transactions but one can't prevent them from disappearing. People sometimes argue debt should not be deductible, but one can't prevent debt from disappearing through internal lending. Taxing sales can shift to leases and rentals. One must always consider unintended consequences.

Fourth. Taxation should be indifferent to the entity involved, but never are. Changing from an individual to a business often changes many things. This offers another means to game the system. 'Businesses don't pay taxes, people do' doesn't make much sense when people should just be considered businesses with their own revenue and expenses.

Fifth. Simplicity and fairness often conflict. Ease of collection and ease of evasion must always be considered. The narrower the base the higher the tax and more desirable avoidance and evasion.

Sixth. Nothing changes like taxation. Time offers another dimension for avoidance. The benefits of improvements must be weighed against the costs of doing so and how the system will adapt to them.

Consider each individual a business with revenues and expenses. They need food, clothing, shelter. They need utilities, communications, and transportation to work. They need education, and health care. The standard deduction is $5-10k. Does anyone think this comes close to covering basic expenses? I don't know anyone that could even rent for that. The real figure must be several times that. Yet, the income tax considers that income. Is the income tax really progressive, or do we labor under a false assumption?

Gambling, Speculation, and Investment

2008-08-25T16:25:00.000-07:00

Mike Moffatt asked How do Investments, Gambles, Speculation, and Insurance Differ?

The only potential difference I can think of between gambling and speculation is that gambling often doesn’t change the odds but speculation always does, if only infinitesimally, by providing information to the market. One could restrict gambling to fixed odds but that would not be common, so I would say this transaction alone, a far out of the money option, is gambling and speculation. If combined with an offsetting position, say a real trade, it can then be insurance and a hedge, the difference is which a hedge can be profitable while insurance can only offset a loss. The differentiating factor between speculation and investing is investing provides an income flow while holding it. This may be restricted to interest and dividends or relaxed to earnings but in their absence is only a speculation. A liquidation value is more or less speculative. Depending on services provided or cash flow, real estate may be an investment or speculation.